Monday, January 9, 2012

Dark Secret of our Latest Financial Crisis

At the risk of being politically incorrect, I would like to address the US economy from a rarely discussed perspective. The stock market had more responsibility for the economic crisis than you may think. 

While the latest mortgage fiasco was very damaging to the US economy, it is only part of the story told by the media. An equally dangerous practice was taking its toll on businesses: publicly traded companies buying back shares of their own stock in excess to drive stock appreciation.

In some cases, buy-backs can be beneficial. For instance, if the market significantly undervalues a corporation’s stock and management knows they have winning products and services in the pipeline, it could make sense for them to buy back shares of their stock. It is a way for a company to invest in itself and reward shareholders.

On the other hand, the practice can serve to over inflate a company’s earnings. Buying back stock drives up the price and gives the appearance of greater performance. Consequently, more investors will be willing to purchase the stock. It ends up working much like a pyramid scheme. For example, the average investor sees a company buying back shares at $50 in 2007, gets excited for that company’s prospects, and eventually the stock rises to $70 on little more than false confidence. The company then looks like its performing well and investing in itself.

What happens, however, is that the corporation then has a lot of its money tied up in stocks. So when the market tanks and that stock that was worth $50 a share is now down to $10, the company has lost a huge part of its investment until they can drive the price back to $50. The organization will then have to make up for that loss by cutting back in R&D, laying off employees, and finding ways of cutting expenses.

As a community of customers, investors, vendors and government, we have to start questioning management’s decisions of buying back shares instead of investing in innovative products and services that benefit society. If a business’ intention is only to do financial reengineering, we have to wonder if it is still relevant to society. Apple Computer has done an extraordinary job of benefiting stakeholders by reinvesting their money in R&D.

My biggest fear is that we have management teams who have so much cash that they do not know what to do with it. This is a sign of incompetence. Leadership’s job is to build a perpetual company that provides value to stakeholders. While shareholders are important, if there are no customers, the business will soon cease to exist.

It is time we the people take a stand and demand value from enterprises. It is time we stand for leadership to make choices that benefit the whole and demand organizations uncover alternatives to laying off employees. Without people, there is no company. If we refuse to take this stand, we will go through continuous cycles of severe crashes. It is easy to assume we are witnessing greed. It has more to do with what society accepts. Our tolerance and integrity is built into the training of all leaders. Take a stand and demand more from yourself and leadership will follow.    

I welcome your thoughts below.  

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