Thursday, September 21, 2006

Sarbanes-Oxley (again)

It has been fascinating, awful and surprisingly delightful to watch how the mechanics of the pursuit of earnings growth has slowly eviscerated Dell Computer company.

Once expected earnings growth is factored into his company's stock price, the CEO faces a dreadful choice as his company settles into a mature field and business pattern. On the one hand, a great company, with a great business model can make a great deal of money and pay great salaries to a great many employees, but the stock will plummet when earnings stabilize, even if the company has settled into a regular and profitable groove, as it will be valued more as an predictable annuity than a growth equity. As the company makes the transition into a mature institution, the ceo is vilified, the stock painfully adjusts to a more realistic level, until ultimately becoming so despised and undervalued that the former growth stock becomes a candidate for the "value" basket a few years later. And this is the best case scenario.

On the other hand, many publicly held companies are destroyed because CEOs lack the courage and incentives to manage the transition. Modern CEOs rarely think in terms of the employees, customers & the institutional future of the company, particularly because CEO compensation is often linked to stock price. The modern CEO continues to relentlessly squeeze employees, customers and suppliers, to manufacture earnings growth for Wall Street by monetizing the company's good will. If they can hand the business to a new CEO before the inevitable reckoning, they can even socially mingle with their jet-setting friends in Jackson Hole, who will say things like: "Gosh, I wish you were still running your company. That new guy is doing a _terrible_ job."

Before Sarbanes-Oxley, the "discipline of the market" led many CEOs to condone accounting fraud, while their underlying companies continued to be sound businesses. Sarbanes-Oxley was designed to protect investors, but it has ended up hurting employees, customers, and society in general. With Sarbanes-Oxley, since CEO's can no longer just make stuff up, their pursuit of earnings growth is destroying the companies themselves. The collapse of Dell is a beautiful example. A company once known for quality control and customer care has been slowly cheapening its brand for the last ten years, until the customers who buy exploding laptops find themselves unable to parse the thick accents of the customer care representatives.

I should be clear that this is not a slam on South Asians: there are many people in Kerala with impeccable, beautiful, and easily understood accents. Dell, of course, does not just go to India for cheap labor, but their need for earnings growth has led them to buy ever-cheaper labor in India. Further, just as intelligent Americans are avoiding Dell as a brand, intelligent Indians are avoiding Dell as an employer. And that means that the customer service representatives with mellifluous Bollywood tones and charming names like Sita are working for other companies, and people who call Dell are routed to somewhat abrasive and slightly overwhelmed people with names like Abdul.

So it's not just that the stock market itself is volatile, it's "discpline" increases the volatility of the businesses that are listed on it. If Dell had simply been privately held, they would probably have resisted the temptation to cheapen their brand until there was nothing left. In other words, if they could find a way to be meeker, private equity funds are poised to inherit the earth.


Blogger M.D. Fatwa said...

"Before Sarbanes-Oxley, the "discipline of the market" led many CEOs to condone accounting fraud, while their underlying companies continued to be sound businesses. "

By this, I take it you mean Enron, Worldcom, Adelphia, and Parmalat? Or did you mean just those companies whose stock prices dropped dramatically after it became clear someone was cooking the books, but who otherwise didn't go bankrupt (Tyco, Shell, Xerox, Global Crossing, Hollinger, etc. etc.)?

When a company "restates" its financials and the stock drops, you either have to assume investors are selling because they thought the company was worth more than it apparently is (in which case it isn't "otherwise sound"--at least not to the tune of whatever the stock price was), or investors are just stupid. And if investors are just stupid, you have to ask why we let them buy stock to begin with. Private equity would clearly be more efficient. Maybe it is. But this has nothing to do with Sarbanes-Oxley.

Otherwise, you are just saying that investors and companies would all do better if we just let the CEOs tell us some lies about how the company is doing every once in a while. Would you trust politicians to tell such "noble lies" about the condition of your government? And if you don't trust them, why would you trust a corporate manager?

9:38 AM  
Blogger georgeborrow said...

I was hearkening back to my youth, when theorists were eager to assert the rights of "stakeholders" in corporations alongside the rights the owners and creditors. I was thinking of the glorious fictive accounting of, for example, a visionary manic-depressive like Ellison, who would be serving a dozen jail terms for his Oracle hijinx if he had done them post Sarbanes-Oxley. Ellison made the markets a more interesting place, and was nonetheless a fine CEO, who paid his employees well throughout the 4x valuations and devaluations of his stock. The market's ultimate verdict was, of course, that ORCL was "sound", despite Ellison's curious need to periodically cook his books. My point was that Sarbanes-Oxley, by narrowing the gap between the representation and the reality of companies, is partially responsible for Dell's demise, because the only way to manipulate earnings is to manipulate the company itself rather than putting on song-and-dances for Wall Street.

In Mr. Fatwa's response, I would call readers' attention to an odd rhetorical device that creates juxtapositions and assumes that they encompass the entire range of acceptable thought. Nonetheless, I am happy to engage in dialog, and my answers his questions are "no, no, no, and 'if the corporate manager's social role were defined in terms of his responsibilities towards the stakeholders in his organization, I might be wryly amused if his commitment to his other stakeholders led him to treat his investors with manipulative contempt."

5:21 PM  
Blogger oli said...

Los Angeles private equity funds that invest in other private equity funds in order to provide investors with a lower risk product through exposure to a large number of vehicles often of different type and regional focus. Fund of funds accounted for 14% of global commitments made to private equity funds

4:18 AM  

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