Corporate executives, short-term management, the asset-lite movement, and the supply of equities
Supply of Equities and Short Term Corporate Executives
The Asset-Lite Movement
Efficiency in Shuffling Assets
Sometimes companies hold assets that are truly irrelevant to their economic ends and that constitute an unnecessary burden to shareholders.
Berkshire-Hathaway efficiently discarded unproductive property for the benefit of its shareholders.
Most of the equipment that blacksmiths used to make horseshoes in the nineteenth century has rusted, been recycled, or landed in museums and antique shops.
Berkshire-Hathaway, the old textile mill that Warren Buffett used to hold his long-term investments, is an example of the efficient discarding of unproductive property.
Gradually, over the years, the assets of this textile business were liquidated, the proceeds being applied to more productive lines.
Eventually, Berkshire-Hathaway, still one of the most successful enterprises in American history, was no longer in the textile business.
Unions, Tort Lawyers, and OSHA
Berkshire-Hathaway’s most modern looms and yarn spinners could not overcome the crushing expense and comparative inefficiency imposed by union workers, the Department of Labor, OSHA regulations, tort lawyers, pension reform, taxation, and general government meddling that drove the textile business out of New England and most of the United States.
In a global context, the asset-lite philosophy is nonsense.
The assets required to produce textiles did not disappear, for people continued to wear clothes.
The factories, land, and equipment were simply reestablished in other countries.
In the global context, the asset-lite philosophy is nonsense.
If all companies in the world were to get rid of their productive assets, there would be no more production and the world economy would end.
Trading Is Nice: But So Is Production
Enron might have found a way to make money by trading in electric power, oil, and gas, but it would have had nothing in which to transact if someone else had not been willing to accept the 'incumbency of assets' and produce the things in which Enron was dealing.
Enron was trading in values created by someone else.
The consultants at McKinsey, groaning under a heavy burden of doctoral degrees, might have believed that Enron was 'a leading value creator' in the electric, oil, and gas industries, but it should have been obvious to humbler minds, that the real value – the actual electricity, oil, and gas – was being created by someone else.
From the examples of the nineteenth-century blacksmith, Berkshire-Hathaway, and Enron, we see that there is no automatic universal efficiency in adhering to asset-lite concepts.
Business should discard property used to produce goods that people no longer want.
Lacking government protection, companies must also allow production to go elsewhere, when the economic environment no longer favors continued activity at a particular location.
From Manufacturer to Merchant-Trader
However, there is no inherent advantage in switching one’s line of business from that of a manufacturer to that of a merchant-trader.
Enron was no more 'attacking and atomizing traditional industry structures' than were the thousands of stores and stock-brokers that were earning a living as intermediaries.
Production and intermediation are different lines of business, with dissimilar criteria for success, and deserving different measures of performance and efficiency.
The last manufacturer in a world of traders may become extremely wealthy.
Competition and market environments determine the balance between merchant-traders and producers.
If all producers but one were to reduce their manufacturing capabilities to become merchants and traders, the remaining producer, with no competitors, would glory in the 'incumbency of assets' and become extremely wealthy.
On the other hand, if all merchants but one were to set up manufacturing operations, the remaining trader could play them off against each other and reap the benefit of controlling the channels of distribution.
Uncritical acceptance of the asset-lite idea, devoid of context, can only lead to half-baked economic policy.
Asset-Lite Thinking and Equity Supply
Anything that reduces the need for issuers to place new shares on the market or that encourages the repurchase of existing shares, leads to a reduction in the supply of equity securities.
If this occurs over a long period, when demand for stocks is rising, the result is a shortage of equities and over-valued stocks.
Emphasis on short-term improvement in ROE led to a shortage of equities.
The emphasis given to short-term improvement in ROE by hired corporate executives led to a diminished supply of equities over twenty years, during a time when investor demand, fed by increased need for retirement savings, the incentives of tax-deferred 401(k) plans, and the uncritical acceptance of equities at any price, as per the Common Stock Legend, created the shortage of equities that was behind the Great Bubble of the 1990s.
There are essentially three ways in which asset-lite thinking reduces the supply of publicly traded equities:
- Outsourcing Capital Needs: Franchising, contract manufacturing, off-shore facilities, and outsourcing of factory services, transfers the need for capital from the out-sourcer to some other firm.
- Often, the outsource supplier is a small domestic or foreign company, without stock traded in the American capital market.
- The result is a decline in the supply of negotiable equities.
- More Efficient Financial Structures: Cutting inventories (through just-in-time manufacturing), reducing accounts receivable (through the use of asset-backed securities), and avoiding fixed asset investment (through the use of leasing) all contribute to a reduction in corporate need for equity financing.
- Short-term Performance Goals: Asset-lite management, with the implicit focus on quarter-to-quarter improvements in ROE, profits, and sales, tends to discourage long-term projects that require years to show profits.
- Investment in research and development is discouraged.
- A reluctance to 'over-capitalize' in order to have surplus funds available for such long-term projects, contributes to a reduction in the supply of equities.
With universities churning out MBAs indoctrinated in the Fallacies of the Nobel Gods faster than engineers, and with mutual fund managers that control the majority of traded stocks demanding short-term results, the stage is set for a long-term shortage of equities.
Before proceeding, check your progress:
Self-Test
Enron was typical of the asset-lite movement because:
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The supply of the stock of American companies is likely to be reduced when:
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Short-term performance goals tend to reduce the supply of equities because:
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Investment Theory of Capital Flow Analysis : continued >
