The Shareholder Value Cult

The current profit squeeze besetting corporate America is structural - not cyclical. Misguided financial restructuring and investment spending are backfiring on profit performance. In our view, the obsession with shareholder value in America is the greatest folly in economic thinking and theory in history.



CANNES, France - During the boom, time horizons for profit growth under the new"shareholder value cult" were getting shorter and shorter. Corporations stampeded into debt. And they retired equity across the board through mergers, acquisitions and stock buybacks, while downsizing their capital spending on new plants and equipment.

Why invest in capital stock when it is much easier to get earnings-per-share growth from stock buybacks? In the pursuit of quick riches, Corporate America embarked on a relentless ravage of its balance sheets.

What happened on the asset side of corporate balance sheets as counterpart to this borrowing binge? In general, by paying for the purchased stocks of other companies vastly in excess of the book value of underlying real assets, the huge difference could not be expensed. It had to be capitalized as goodwill. Soaring shares of goodwill in corporate balance sheets became one of the most striking hallmarks of the new shareholder value cult.

Unfortunately, the incurred liabilities involved steeply rising interest expenses, whereas the fictive asset of goodwill yields nothing.

Stupidly, share prices were boosted at the expense of future profits.

In the same vein, this drastic financial restructuring went together with a drastic shift in the composition of business capital investment. As mentioned earlier, investment spending shifted massively towards very short-lived, new high-tech assets, chiefly computers and software, from which wonders of productivity and profit gains were expected. The essential further negative effect on profits in the longer run was the soaring depreciation charges that are now squeezing corporate earnings, while the productivity and profit miracles expected from the massive high-tech investments failed to materialize. Total net investments, adding to the capital stock, have remained rather small.

What is happening is pretty clear. After all, the short-term positives inherent to the corporate strategies implemented to lever shareholder value are being overtaken by inherent longer-term effects on business profits, capital spending and economic growth. What we are witnessing is not only the bursting of a bubble but the undoing of the shareholder value cult.

All in all, this says that the current profit squeeze bsetting corporate America is structural - not cyclical. Misguided financial restructuring and investment spending are backfiring on profit performance.

It is our long-held view that, from a macroeconomic perspective, the obsession with shareholder value in America is the greatest folly in economic thinking and theory in history.

This devastating judgment arises mainly from two recognitions: first, that simply too many possibilities exist to manipulate reported profits and stock prices with a plethora of accounting tricks and other devices; and second, that these strategies widely implemented to lever shareholder value have effects that impair economic growth in the longer run.



Respected International Banker, Economist and Author

Dr. Kurt Richebächer's articles appear regularly in The Wall Street Journal, Barron's, The Fleet Street Letter and other respected financial publications. France's Le Figaro magazine did a feature story on him as 'the man who predicted the Asian crisis.' Dr. Richebächer is currently warning readers to be cautious in the face of The Crisis Almost No One Sees Coming.


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