Welcome to European Tribune. It's gone a bit quiet around here these days, but it's still going.
Display:
There was a time when stockholders would be happy to get consistent dividends. Nowadays, "stockholder value" means starting a financial bubble around a company's stock and getting out before the bubble bursts. Some might call it pyramid-scheme business administration.

From the business' point of view, I don't understand why anyone would want to attract that kind of predatory stockholder. It's suicidal for the company and damaging to employees and customers alike. Can someone explain to my why it is so critical for companies to maximize their market capitalization?

A society committed to the notion that government is always bad will have bad government. And it doesn't have to be that way. — Paul Krugman

by Migeru (migeru at eurotrib dot com) on Mon Oct 17th, 2005 at 10:50:50 AM EST
[ Parent ]
I've suggested creating a new investment instrument: a performance-based bond.

The would pay a fixed interest rate like all bonds and have a fixed maturity (and perhaps call) date. In addition the bond would pay an optional bonus amount which would depend upon the earnings of the company. This way the bondholders would be able to participate in the growth or prosperity of the company.

The bonus would be paid on an annual basis, perhaps six months after the close of the measuring period. This would discourage trading to time getting the bonus. The price of the bond would vary depending upon interest rates and the expected (or announced) bonus.

The virtue of this is that the company could finance operations without having to issue common stock. There would be no incentive to manipulate pricing to game the issuance of options to management. Speculators would be less interested in the stock and the company could spend its time running its business instead of playing up to Wall Street investors.

For hundreds of years companies financed their operations with bonds or closely held stocks. With the creation of the stock market and the involvement of the greater public the focus has shifted from the fundamentals to speculation.

It all goes back to the "South Sea Bubble".


Policies not Politics
---- Daily Landscape

by rdf (robert.feinman@gmail.com) on Mon Oct 17th, 2005 at 11:39:25 AM EST
[ Parent ]
I've come to think of it as economic strip-mining.  That's also basically what Wal-mart is doing to whole towns in a way.

Maybe we can eventually make language a complete impediment to understanding. -Hobbes
by Izzy (izzy at eurotrib dot com) on Mon Oct 17th, 2005 at 03:28:57 PM EST
[ Parent ]
I will try to keep this answer to your question brief.  first, because there are many financial textbooks that address your question (but they are admittedly incredibly boring), but second I'm answering the question so many days after you posted it, I'm not sure my answer will be seen.

first, understand that market capitalization means the current market estimate of the value of the company.  It is a value that is set in a very real time market place by current owners of the company (shareholders) and those that are considering buying the company (in a stock market like the New York Stock Exchange, or footsie or others).  So if you draw an analogy to selling your house, you would like to get the current market price--so shareholders would like to do the same.

Second, and here is where the value of a company on the stockmarket differs from your home, the value of the company is estimated by the market as the value of "future cash flows discounted back to the present".  So in straightforward terms, it means estimating how much money your company is going to generate in the next, let's say, 20 years, discount that back to the present, and that's the value of the company.  You may already understand the concept of "net present value", and therefore discounting cash flows, but if not, i'd suggest a google search or a text book.  I can't give a much better explanation than the fact that 1 Euro in 10 years promised to you, is worth less than 1 Euro in your hand today, because the one in your hand can be put in a bank account (or some other investment vehicle) and be worth a lot more than the promise in 10 years.  And of course the promise in 10 years is a little riskier than the Euro in your hand, because whoever gave you that promise, may be dead in 10 years and can't pay in 10 years.

So the reality is that companies are valued (ie market captialization) based on the esimate of their future earnings potential, and of course the risk of that earnings actually happening.  (If you know your Euro is in credit suisse, and will earn 3% per year, that's pretty solid.  If you're talking to a guy like me, who has a dream about his company that is wildly exciting, but risky--well, you and the market need to estimate the value of an investment in my company.  You'll probably believe I'm honest in that I'm sharing my dreams, but,,,dreams are often shattered.  so your euro in credit swisse is almost certainly worth 1.5 euros, while your euro in my start up company is worth nothing (probably) to the moon.

so this whole "market capitalization" thing comes down to an estimate of the future.  so a company that is very stable, with zero growth, may choose to pay out their earnings to the owners of the company every year in the form of dividends.  they are not growing, so they don't need the money to finance growth.  Growth companies may choose to pay no dividends to shareholders, because they see their growth opportunities as huge and want to reinvest those funds in the business.

I'll leave this for now, because I'm not sure anyone will see it.  It's like a chapter 1 (incredibly brief).  but chapter 2 would be about explaining why the growth companies need to explain their story, share their vision of the future, because they need to either raise more money, or explain to their current owners (shareholders) why they are not paying dividends, and instead reinvesting the money into their dreams.

by wchurchill on Sun Oct 23rd, 2005 at 03:41:02 AM EST
[ Parent ]
Thanks.

I understand present value and asset valuation. What I don't understand is why every single company needs to go to the stock market, and why they need to make the value of their stock grow as the #1 priority.

I thought that going public was a way to raise money as an alternative to getting a load from a financial institution. The problem is that, as soon as the company goes public, management starts talking about "maximizing shareholder value" and doing things that drive the company to the ground while getting ready to bail out just as the bubble pops.

And, when a company's stock valuation gets into a boom/bust cycle, the market valuation has effectively decoupled itself from the present value of the company's future performance.

So you haven't really answered my question, or I am just slow this morning. Maybe I need to get my brain washed at a business school.

A society committed to the notion that government is always bad will have bad government. And it doesn't have to be that way. — Paul Krugman

by Migeru (migeru at eurotrib dot com) on Sun Oct 23rd, 2005 at 05:03:02 AM EST
[ Parent ]
Thanks for your response, and I hope I didn't seem patronizing, I didn't mean to be.  i really didn't know how they system worked, in the sense that I was responding so long after your question.

There are so many reasons for going public, that it's a little difficult to address your question.  My own experience is in this California high tech/health care start up environment.  I would say in 80% of the cases, the reason for going public is that the original investors, who have made an investment that is very risky from their personal perspective, want to "cash out".  Remember that all their investments are not winners, they lose their full investments on the losers, so it's only fair, IMO, that they get a chance to cash out on the winners.

And for this size company, which would normally have sales revenues of $30 million or so (obviously company's like Google are an unbelievable exception to the average startup), even if their investors didn't need to cash out, borrowing from a bank is incredibly expensive as opposed to going public, and having shareholders share the risk of future expansion.  So getting money to fund expansion from equity investors, as opposed to banks, just makes logical sense.

In my experience, maximizing shareholder value is not consistent with driving a company into the ground.  Building shareholder value means building a real company, that meets customer needs, and introduces incredible products, better than the existing products,,,, and then replacing those with better products.  I know the companies that hit the headlines are driven by ,,,,pejorative term,,, people that I would like to see jailed, but it's just not the normal person in business.

You are correct that a company's stock price is influenced not only by their results, but by the overall market valuation, influenced by interst rates, and other factors.  But in terms of leading a company, you are a fool if you get taken away by that.

I'm very discouraged that so many people's opinion is driven by the Enron's, etc.  in general, people that run business, IMO, are just as good in a values sence, as anyone else--in my experience, which has been in healthcare, it's been higher.  My own experience is filled with people, at all levels in a company, that work their tails off, to come out with wonderful products, consistently at the highest quality, that meet the needs of physicians who treat patients with these products.  it's always very depressing to read the press, who highlight the errors that are made, the people that have bad motives, etc.  it seems to me like picking an ethnic group, and based on the highly publicized activites of a few, discriminating against that group.  It's just not fair.

And responding to your close, my experience is more real world than business school--take that for what it's worth.

by wchurchill on Sun Oct 23rd, 2005 at 05:52:22 AM EST
[ Parent ]
If going public with dividend-paying stock is what it takes to discourage the predatory stockholders, I have nothing against it.

You are sort-of confirming my suspicion that, once again, what one gleans from the press (even the business press) about what business management is like is not sensible.

I did not find you patronizing, nor did I intend the comment about brainwashing to refer to your position. It refers to the opinions of those in a position to influence the public discourse.

A society committed to the notion that government is always bad will have bad government. And it doesn't have to be that way. — Paul Krugman

by Migeru (migeru at eurotrib dot com) on Sun Oct 23rd, 2005 at 06:17:44 AM EST
[ Parent ]
Sorry, I'm not following you entirely.  and maybe I wasn't clear with my comments, or perhaps I misunderstand your comments.

When a start-up company goes public, it gives the original shareolders a chance to sell their shaes to the public market.  the original shareholders don't have to wait for dividends, they can just cash out.  With young companies going public, it would be incredibly rare (I can't think of an example) for the company to pay a dividend.  Normally they need the money to reinvest into the company to grow, and in fact may need more than they can generate themselves, and thus need to put a secondary offering out to the public to get more money.

anyway, my apologies if we are miscommunicating on these issues.

by wchurchill on Sun Oct 23rd, 2005 at 06:30:18 AM EST
[ Parent ]
Not really miscommunicating, but I really know very little about business finance and this is not the best medium to hash such things out.

A society committed to the notion that government is always bad will have bad government. And it doesn't have to be that way. — Paul Krugman
by Migeru (migeru at eurotrib dot com) on Sun Oct 23rd, 2005 at 06:50:51 AM EST
[ Parent ]
I would say in 80% of the cases, the reason for going public is that the original investors, who have made an investment that is very risky from their personal perspective, want to "cash out".

By "original investors", do you mean venture capitalists?

"maximizing shareholder value" seems to be a bogus propaganda argument for "maximizing the value of my own stock options".


A society committed to the notion that government is always bad will have bad government. And it doesn't have to be that way. — Paul Krugman

by Migeru (migeru at eurotrib dot com) on Sun Oct 23rd, 2005 at 06:31:04 AM EST
[ Parent ]
original investors would include a broad group of people: venture capitalists would be one.  Private investors another.  the time and money of the entrepreneur would be another.  in most cases I'm involved with, the entrepreneur has his family and friends involved.  then if the company looks good, and meets milestones, other investors will get in the following investment rounds, and might include other financial investors, like banks and funds focused on "mezanine" type financing.  the previousl list is not exclusive, there might be others--pension funds, for example.
by wchurchill on Sun Oct 23rd, 2005 at 06:37:46 AM EST
[ Parent ]

Display:

Occasional Series