I say Yes. Clayton M. Christensen, the Harvard professor who popularized the term “disruptive” in a 1995 superficial Harvard Business Review article in 1995 that he parlayed into tenure at Harvard and a consulting business, says No. Here’s the story.
Tag Archives: business
am I reviving my Odds and Ends page?
I once thought that Odds and Ends would be a regular feature of my blog–a place to record information that might be useful but which had no immediate stock market urgency. It hasn’t turned out that way. I’m not sure why.
Fir the first time in a long while, however, I”m writing about two items that really belong there: Activision and King Digital, and Urban Outfitters’ acquisition of a small upscale pizza business. Here they are.
the agency problem
principal – agent
The principal – agent relationship arises when one person, the principal, hires someone else, the agent, to act on his behalf in some matter.
agency problem
The agency problem is that the agent may have a different set of economic interests from the principal and may act on them rather than do the best thing for the client.
examples
Studies seem to show that real estate agents behave differently when they sell their own houses than when they sell for a client. Working for themselves, they take more time and achieve higher prices. This is also the issue in the current discussion about whether brokerage financial advisors should be fiduciaries, that is, whether they should have a legal obligation to recommend the best investments for their clients. At present, they aren’t …and don’t.
for us as investors
If we hold shares of the common stock of individual companies, we are in some sense owners of the company. (Note: we can also hold shares of stock in individual companies indirectly by buying shares of ETFs or mutual funds. We can hold the shares in, say, a 401k account sponsored by our employer, too. These create further layers of principal – agent relations. In this post, I’m going to ignore them.)
The chief power we have as shareholder-owners of a company is that we vote to elect a board of directors to act as our agents. The board, in turn, selects a management team (another set of agents) to run the operations of the company in our behalf.
an aside: stakeholders
Management hires employees, makes ties with suppliers and customers and may borrow money from a bank. The group comprised of this wider net of interested parties plus us as principals and the two sets of our agents is usually referred to as stakeholders.
potential stockholder – agent conflicts of interest
the board
Where do board members come from? The slate we vote for is typically put together by the management of the company. The list will consist of some members of top management, plus “outside” directors. This latter group may include retired managers from other companies in the industry, or executives from suppliers or customers. But it may also contain prominent political, military or academic figures, who have little knowledge of business generally–and still less of the particulars of the company on whose board they sit.
As agents, the board has its own set of interests and priorities. More important, though, it can easily have a much closer attachment to the management that nominated them than the anonymous group of shareholders who voted for them and are technically their bosses. And, of course, management may seek rubber stamps instead of gadflies.
If individual shareholders had a problem with the composition of the board, how would they take effective action?
management
Let’s say a CEO has spent 25 years rising to the top spot in a corporation, where he has, say, five years to collect high salaries and bonuses and cash in on stock option awards.
Suppose our CEO sees a severe structural problem with the business, which can be papered over for a while but which will begin to erode market share and profit margins within, say, six years. The problem can be fixed, but only by a restructuring that will crush profits (and maybe the stock price) for at least the next two years but which will pay huge dividends toward the end of the decade.
What does he do? …restructure and risk turning his $60 million five-year day in the sun into $25 million, or simply paper over and collect the higher sum?
Tomorrow: the latest twist.
Employment Situation, October 2015
The Bureau of Labor Statistics, part of the Labor Department, issued its monthly Employment Situation report for October this morning at 8:30 est.
After two below-trend reported jobs gains in August and September, the October figures were very much above trend, at a gain of +271,000 net new jobs. Revisions to the prior two months were mildly positive, at a total of +12,000, but didn’t change the general picture of shifting into a lower economic gear painted by those ES reports.
The main significance of the October report, I think, is to reaffirm the health of the economy and to remove any hesitation the Fed might have had about raising interest rates slightly next month.
In futures trading, Wall Street is so far taking a ho-hum attitude to this news. S&P futures have declined by about a quarter of a precent from where they were before the announcement.
falling sales, rising profits…
…are usually a recipe for disaster on Wall Street. Yet, in the current earnings reporting season, a raft of companies are reporting this presumably deadly combination …and being celebrated for it, not having their stocks go down in flames.
What’s happening?
the usual situation
First, why falling sales and rising profits don’t usually generate a positive investor response.
To start, let’s assume that a company reporting this way is maintaining a stable mix of businesses, that it’s not like Amazon. There, investor interest is focused almost solely on its Web Services business, which is small but fast growing, and with very high margins. AWS is so valuable that what happens in the rest of the company almost doesn’t matter.
Instead, let’s assume that what we see is what we get, that falling sales, rising profits are signs of a mature company slowly running out of economic steam.
So, where does the earnings growth come from?
Case 1–a one-time event. Maybe the firm sold its corporate art collection and that added $.50 a share to earnings. Maybe it sold property, or got an insurance settlement or won a tax case with the IRS.
All of these are one-and-done things. How much should an investor pay for the “extra” $.50 in earnings? At most, $.50. There’s no reason to make any upward adjustment in the price-earnings multiple, because the earnings boost isn’t going to recur.
Similarly,
Case 2–a multi-year cost-cutting campaign. AIG, for example, has just announced that it is laying off 20% of its senior staff. Let’s say this happens over three years, and that the eliminations will have no negative effect on sales, but will raise profits by $1 a year for the next three years.
How much should we pay for these “extra” $3 in earnings? Again, the answer is that the earnings boost is transitory and should have no positive effect on the PE multiple. So the move is worth, at most, $3 on the stock price.
Actually, my experience is that in either of these cases, the PE can easily contract on the earnings announcement. Investors focus in on the falling sales. They figure that falling earnings are just around the corner, and that on, say, a stock selling for $60 a share, the non-recurring $.50 or $1 in earnings is the equivalent of a random fluctuation in the daily stock price. So they dismiss the gain completely.
why is today different?
I don’t know. Although early in my career I believed that earnings are earnings and the source doesn’t matter, I’m now deeply in the only-pay-for-recurring-gains camp.
I can think of two possibilities, though:
–Suppose Wall Street is coming to believe (rightly or wrongly) that we’re mired in a slow growth environment that will last for a long time. If so, maybe we can’t be as dismissive as we were in the past of the “wrong kind” of earnings growth. Maybe company managements that are able to deliver earnings gains of any sort are more valuable than in past days. Maybe they’re on the cutting edge of where growth is going to be coming from in the future–and therefore deserve a high multiple.
–I’m a firm believer that most mature companies formed in the years immediately following WWII are wildly overstaffed. I also think that even if a CEO were willing to modernize in a thoroughgoing way–and I think most would prefer not to try–it’s immensely difficult to change the status quo. Employees will simply refuse to do what the CEO wants. As a result, this makes companies showing falling sales prime targets for Warren Buffett’s money and G-3 Capital’s cost-cutting expertise. In other words, such companies become takeover targets, and that’s why their stock prices are firm.