Category: Commentary

The foundation of global financialization of capitalism in government created fiat currencies and bank credit may face disruption. Facebook seeks to use computers and the internet to provide private money.

The analogy comes to mind of “gold,” which was once the atlas supporting paper money and national credit. The modern administrative state has moved beyond gold to fiat currencies and central banking.

Facebook proposes to issue a digital currency called Libra. Facebook has 27 partners in this innovation in finance. Facebook will provide a government-free currency and a payment system through which to use it in the settlement of buy/sell transactions.

But the significant question is: how many Libras will be created?

The prudence associated with gold as support for money was that there was not so much of the ore available and more gold could not be made and disbursed on command by those prone to excessive consumption in the short run. If the amount of Libra in circulation can be gamed for short-term advantage, the currency will encourage boom/bust cycles and periodic collapses of financial markets as in the tulip mania, the South Sea Company, the Mississippi Company, 19th century bank crises in the U.S., one after another, the stock market crash of 1929, the dot-com bubble and the subprime mortgage crisis of 2008.

Government regulators, to date, are not opposed to the Libra. They just want it regulated in the public interest.

I have mixed feelings about the innovation. Competition with government fiat currencies may provide new opportunities for ordinary people to access goods and services or receive as wages. But the history of money and credit is one of many false hopes and manipulation of amounts in circulation contrary to the common good.

In the last day or so, several people have asked to see just where the new and very significant Business Roundtable “Statement on the Purpose of the Corporation” does indeed track the Caux Round Table for Moral Capitalism’s (CRT) Principles for Business of 1994. So, I made this document (PDF) putting provisions of the CRT Principles below the associated provision of the Business Roundtable Statement.

Frankly, I am impressed with how well and how extensively the CRT Principles anticipated the Business Roundtable’s statement.

I’m sharing this in large part to honor the forethought of those CRT leaders from Japan, Europe and the U.S. who articulated this new theory of the firm 25 years ago.

I have received a particularly thoughtful email from former Dutch Prime Minister Jan Peter Balkenende, now Chairman of the Dutch Sustainable Growth Coalition. I have his permission to share his observations with you.

He wrote:

Dear Steve,

The statement of the Business Roundtable attracts a lot of attention. It is important to hear about your observations. In your email to Herman, you have explained that the declaration is a kind of tactical maneuver. A statement to avoid tougher policy steps. But … at the same moment, the statement is there and people, also from politics, the business sector, NGOs, universities and media, will start asking questions about the real meaning and significance of the statement and practical consequences.

I think three elements are key regarding this statement.

1. The discussion about capitalism. In the Dutch newspaper Financial Daily, a reference was made to the Rhinelandic model which is more focused on long-term thinking and solidarity than the Anglo Saxon, neo-classical economic model. I would like to know how the subscribers of the statement really think about the future of capitalism. You cannot deliver such a statement and leaving capitalism for what it is now. The Dutch newspaper I mentioned published an article today saying that at this moment, in practice, the shareholder still clearly is number one. Buying own shares is only one example. You recently wrote about this issue.

Regarding capitalism, there are in fact three routes. The first is the liberal, neo-classical capitalism. More and more, you can feel this capitalism is under attack. The second variant is the government-oriented type of capitalism. Joseph Stiglitz’s recently released book Progressive Capitalism is an example of this approach. The third version is moral capitalism, of which you are one of the clearest advocates. There are also connections with conscious capitalism, inclusive capitalism, etc. In my opinion, it is essential to choose for the last variant: moral capitalism.

2. A new view on business models. Traditional capitalist views are connected with the views of Milton Friedman: The business of business is business. In fact, the supremacy of the shareholder. Today and tomorrow, it should be about creating shared value, about the full integration of sustainability into business models, about making the Sustainable Development Goals of the United Nations a reality, also in the business sector. I would like to know what the subscribers of the statement will do in this regard. It is possible to change business models. You know about my role as Chairman of the Dutch Sustainable Growth Coalition, a coalition of eight Dutch multinationals.

3. The essence of metrics and valuation. When the discussion about new, sustainable business models started, frontrunners were convinced that this should not be a story of good intentions but a matter of clarity and honesty. Therefore, companies have to redefine their KPIs, have to choose for life cycle analysis and must have the willingness to be transparent about the real results: integrated reporting. You are playing a fantastic role in the debate about valuation. It is necessary to invest in these measurement tools. If the subscribers of the statement take their intentions seriously, they also have to choose for new valuation techniques. I hope we will get clarity about this issue.

I am happy with the statement. It’s an important document that offers inspiration and a new view on the role of the corporation. But the success of the declaration only depends on its implementation: practicing moral capitalism, sustainable business models and valuation.

Wishing you all the best.

Warm regards,
Jan Peter

Twenty five years ago, the leaders of the Caux Round Table for Moral Capitalism (CRT) from Japan, Europe and the U.S. published our Principles for Responsible Business to affirm that modern capitalism should seek the wellbeing of stakeholders. Yesterday, the Business Roundtable, composed of 200 CEOs, issued a statement affirming that core belief and recommendation of the CRT:

Statement on the Purpose of a Corporation

Americans deserve an economy that allows each person to succeed through hard work and creativity and to lead a life of meaning and dignity. We believe the free-market system is the best means of generating good jobs, a strong and sustainable economy, innovation, a healthy environment and economic opportunity for all.

Businesses play a vital role in the economy by creating jobs, fostering innovation and providing essential goods and services. Businesses make and sell consumer products; manufacture equipment and vehicles; support the national defense; grow and produce food; provide health care; generate and deliver energy; and offer financial, communications and other services that underpin economic growth.

While each of our individual companies serves its own corporate purpose, we share a fundamental commitment to all of our stakeholders. We commit to:

Delivering value to our customers. We will further the tradition of American companies leading the way in meeting or exceeding customer expectations.

Investing in our employees. This starts with compensating them fairly and providing important benefits. It also includes supporting them through training and education that help develop new skills for a rapidly changing world. We foster diversity and inclusion, dignity and respect.

Dealing fairly and ethically with our suppliers. We are dedicated to serving as good partners to the other companies, large and small, that help us meet our missions.

Supporting the communities in which we work. We respect the people in our communities and protect the environment by embracing sustainable practices across our businesses.

Generating long-term value for shareholders, who provide the capital that allows companies to invest, grow and innovate. We are committed to transparency and effective engagement with shareholders.

Each of our stakeholders is essential. We commit to deliver value to all of them, for the future success of our companies, our communities and our country.

On behalf of the CRT board of directors, I welcome this statement as an inflection point in the evolution of modern capitalism towards achieving the common good. This validation of CRT efforts over many years now is reassuring. It is also an opportunity to continue forward with determination, good sense and high purpose in line with our principles to make them useful to all companies, large and small.

Last Wednesday, I spoke with our Chairman Emeritus, Lord Daniel Brennan. He brought me up to date on the current and heated public discussion in London over a report by Muddy Waters Research on Burford Capital Ltd. as it pertains to the importance of company valuations.

Burford has a market capitalization of 2.45 billion English pounds. Its business is to invest in litigations and share in any proceeds recovered from defendants. The assets of the firm are mostly contract claims for a share of future winnings. These are very intangible assets. The underlying factors which determine the probability of winning the selected lawsuits are human skills in judgment as to the merits of the plaintiff’s case, research, data analysis, legal argument and persuasion of judge and jury. Rather like betting on who will win a prize fight or a football or soccer game. The bet is only a contract claim to be paid a sum of money depending on an outcome. How, then, should the chances of winning be valued in either case?

The Muddy Waters Research report concluded:

We are short BUR. For years, it was the ultimate “trust me” stock. Thanks to a light disclosure regime, the esoteric nature of its business, and unethical behavior by its largest shareholder, Invesco, it turned Enron-esque mark-to-model accounting into the biggest stock promotion on the AIM. This has all recently changed though. Just this year, BUR began publishing more detailed investment data. This data proves that BUR has been egregiously misrepresenting its ROIC and IRRs, as well as the state of its overall business. We have identified seven methods by which BUR manipulates Concluded Investment ROIC and IRR.

BUR’s top management, through their shareholdings (and sales), is in effect primarily compensated for aggressively marking cases in order to generate non-cash fair value gains. Until now, BUR has gotten away with aggressive and unwarranted marks by touting ROIC and IRR metrics. We show that BUR heavily manipulates these metrics. BUR then actively misleads investors about how its accounting for realized gains works. As a result of this deception, we believe investors give credence to BUR’s fair value gains. In actuality, BUR’s net realized returns have relied on a very small number of cases. Just four cases have produced approximately two-thirds of BUR’s net realized gains since 2012. (One of the four outsized contributors was actually a loss at trial, and was bailed out by BUR’s largest shareholder, Invesco, at the direction of Neil Woodford protégé Mark Barnett. Absent the bailout, the case almost certainly would have been a total loss.)

BUR is a perfect storm for an accounting fiasco. BUR’s governance strictures are laughter-inducing. The CFO is the wife of the founder/CEO. Under the best of circumstances, this should alarm investors; however, with a company that consistently books non-cash accounting profits, it is unforgivable. BUR has cycled through four prior CFOs or senior finance managers (none of whom stayed for long). These facts beg the question “Is (current CFO) Elizabeth O’Connell the only CFO who can be relied upon to approve the accounts?” (see here)

The full Muddy Waters Research report can be found here.

The issues around Burford’s accounting and valuation estimates raise very difficult questions about the valuation of intangibles. One set is how to do this responsibly. Another set is how to prevent misrepresentation and fraud in the use of assumptions about the probability of future events. And a third set is what rules and standards should be adopted to constrain forecasts which will easily and quickly slip-slide away into fairytales and artfully constructed ratios and financial categories which will mislead even sensible investors.

Since it is more and more accepted that in today’s global economy, intangible assets are growing in importance as drivers of profits, getting them measured properly and their valuations disclosed properly is also more and more necessary.

I noticed recently what might be another big ethics issue with corporate use of profits in the U.S. – stock buybacks. According to Federal Reserve data compiled by Goldman Sachs, over the past nine years, American corporations have used profits to buy some $3.8 trillion of their shares from owners.

I noted that in the 2nd quarter, Apple spent $17 billion on stock buybacks.

This use of funds, rather than for dividend payments, gets a share of corporate profits back to investors at capital gain, not income tax rates. By reducing the shares outstanding, it raises the price of shares remaining in the public market, thus adding booster fuel to rising equity market prices and enticing the diversion of money to such markets from other alternatives, such as investment in startups.

But the practice is not evenhanded in its distribution of benefits. Money spent on share buy-backs is not there for wage increases, R&D or factory expansion.

Corporate executives have been found to have sold five times as much stock in the eight days after the announcement of a buyback as they did on an average day.

Of course, one reason for executive preference for stock buybacks is that much of their total compensation comes not from salary, but from grants of options to buy company stock. The net value of the option is directly related to a rising market price for the shares. If share prices go up and up, executives cash out very nicely.

The preference for using stock options for compensation responds to a populist law passed under President Clinton which limits the amount of salary a corporation can deduct as a business expense on its taxes. Options are not considered an expense of the company.

The law could be repealed and executives could be paid cash only, as is done with wage earners.

Many investors also like buybacks. They have no intention of being long-term owners of the company. Any market move which gives them a quick profit on their investment has its attractions – a bird in hand is worth two in the bush. The world of owners of public companies these days is one of short-term “hookups,” trading and speculation, not marriages ‘til death do us part.’

A recent story in the Wall Street Journal brought to mind – once again – the two-edged sword which is debt: it can cut for you and it can cut against you. It all depends.

An inability to borrow to bring future income into the present and use it wisely is a curse of being poor. Lack of credit keeps people from accessing capital with which to take risks and create wealth.

Hernando de Soto wrote about the “mystery” of capital as a magical force which could propel the poor into prosperity – if only they had assets against which they could borrow. We have seen the growth in income made possible by microcredit loans.

At the same time, too much debt brings too much risk and often leads to financial failure. Poor people who borrow against paltry income just entrench themselves in poverty, losing their few assets to the money lenders and falling into wage slavery.

As has been said many times, asset bubbles get bigger and bigger through debt. Irrational exuberance is never so enticing as when you are speculating with other people’s money, borrowing and betting that market prices will just keep on rising.

Debt is necessary for wealth creation and growth, but excess of debt leads to loss of wealth and recession. Too much of a good thing turns good into bad. One drink of wine may be tasty and even healthy, but too many drinks make for an alcoholic.

As the Greeks and the Buddha advised, keep to the middle path of moderation.

The Wall Street Journal also reported that for the American middle class, the majority of American voters, incomes have largely been stagnant for two decades while cars, college education, houses and medical care have steadily become more costly. Debt has made up the difference between income and consumption expenditure.

U.S. consumer debt is now $4 trillion, the highest ever.

But thanks to low interest rates, courtesy of government provision of credit, households spend only 9.9% of income on debt service.

Two recent news stories brought me back to basics:

In New York City, the renown men’s store Barneys is filing for bankruptcy. It’s not making enough money. Rent on its flagship store went up to $27.9 million. Buyers use the internet more and more. In short, the company is not meeting consumer demand in a way that produces a profit.

Secondly, America’s two largest chains of print newspapers are merging. Ad revenue is no longer enough to sustain them as separately profitable businesses. The rise of the internet with “free” news and entertainment articles for many customers has cut readership for newspapers. If the old print newspapers can’t make money, they too will go out of business, like Barneys.

More than 2,100 newspapers have closed since 2004 and now Google and Facebook are expected to take in 51% of all digital advertising revenue in the U.S.

So, no matter how much we should be concerned with ethics, responsible stakeholder relationships and the social and environmental footprints of companies, if they can’t make a profit, they have no claim on our charity for keeping them going with subsidies.

That is a hard but necessary reality of capitalism – every tub on its own bottom.

I wanted to share with you an interview with Rev. Robert Sirico, President of the Acton Institute, which appeared a few days ago in the Wall Street Journal titled “When the Market Meets Morality.”

Rev. Sirico’s institute has many insightful articles and thoughtful books on issues related to our work.

I would be most interested in your thoughts and reactions to the interview.

Giant, high tech firms with vast earnings and even greater stock market valuations are the cutting edge of evolving capitalism. I have suggested in previous commentaries that market power can lead a company to be placed under obligations to seek the common good. In the U.S., long after anti-trust officials in the E.U. looked askance on the market power of Google and Facebook, the U.S. Department of Justice has opened a broad review of whether dominant technology firms are unlawfully stifling competition.

The review will examine on-line platforms as gateways to commerce in internet searches, social media and retail services.

One point of worry for me is the ability of internet firms to suck in advertising revenues and so drive older forms of media – print media – into economic failure and closure, directing our politics towards demagoguery, delusions and dumbing down our people.

I have noted before that the opinion of the U.S. Supreme Court in the 1876 case of Munn v. Illinois, a case of cartel monopoly power over grain storage elevators in Chicago, provides an ethically based reason for restraining companies which stand at the gateway of commerce and take a toll to permit passage of goods. The Court asserted that a willing assumption of monopoly power brought upon a company acquiescence to the right of society to assert a license over the company to take care that the good of the public was not harmed.

The Court held by imputation that if a company did not want to operate under such a restricting license from public authority, then it need only not seek monopoly power. Instead, the company was free to choose to do business facing the hazard of competition.

The policy of the Court was to ensure that lawful commercial arrangements would not be misused and lead to inequitable outcomes in practice; that financial and economic power would be diffused widely and decentralized. This policy was the natural corollary to the principle of constitutional democracy that government power must be disbursed across institutions where one would check another from aggrandizement and tyranny.

I am reminded of the admonition of James Madison in commenting on the provisions of our U.S. Constitution: “If men were angels, no government would be necessary.”

Where there are no ethics, law must safeguard our wellbeing. Or to put it slightly differently: where there is no virtue, power assumes control and must be disciplined by law – even in capitalism.