by

Companies prepare share buyback bonanza as profits surge | Financial Times

Companies are preparing to launch a record wave of share buybacks as executives get comfortable with spending excess cash following a blockbuster earnings season and greater clarity on the trajectory of the world economy.

US companies announced $484bn in share buybacks in the first four months of this year, the highest such total in at least two decades, according to Goldman Sachs.

Source: Companies prepare share buyback bonanza as profits surge | Financial Times

 

Northern Comment – Are share buybacks not management saying we have more cash than we know what to do with. Our entrepreneurial flare has run out and we need to give cash back to investors so they can allocate it more efficiently? If this is the case why would they do it when share prices are increasing or does the price have no impact in the sense that the scale of the cash released is the issue for better investment decisions.

I wonder what impact all this might have on senior management earnings and whether all the companies engaged in this have fully funded pension schemes.

Is the principle / agent problem now one where the interests of both are aligned but aligned against the interests of the company?

by

The Principle, the Agent and the Company

Over recent years executive pay has become an increasingly thorny issue. From the 1980’s onwards a growing body of thinking saw executive pay as being the vital spur to entrepreneurial growth but that levels of pay current at the time were not adequate to this. It was important to increase the level of incentive to senior managers and particularly CEO’s so they were appropriately incentivised.

In parallel with this there was a concern about how such incentives could be structured so as to align the interests of executive agents with those of the principal owners. How to align the owners long term interest in the growth of the company with the short term interests of the managers to inflate profits today.

The way around this principal/agent dilemma was to provide stock options. These were options to buy shares in the company at a point in the future at a discount to the current price. If the Executives increased the value of the company its share price would increase thus increasing the value of their share options when exercised.

The development of this theory is explored in Tom Bergin’s excellent new book Free Lunch Thinking. He charts the rise of the theory to the status of common sense and then explores problems raised by reviews of how executives actually perform when their pay is thus inflated.

His point is that the evidence about executive performance does not seem to confirm that it improves with greater pay. His first point is a generic one about the relationship between corporate performance generally and senior pay. He points out that between 1945 and 1970 corporate earnings in the US grew at the highest rate they have in the country’s history. This was a period when CEO’s were paid “like bureaucrats”, eg. in 1965 CEO’s were paid c20 times what the average worker was. By 2018 this ratio had increased to 278 times average earnings, however corporate earnings had declined.

Another problem was the link between successful management and share price. Theory would have it that the share price is the product of a multiple of the earnings of a company. However, the work of economist Robert Shiller who analysed share prices and earnings over a century discovered that the share price was far more volatile than the earnings multiple model would suggest.

For a number of other reasons Bergin finds the link between pay and performance to be tenuous at best. Generally his point is that the agent/principal problem is not sorted by increased pay channeled through share options because the link between performance and reward is not nearly so clear. If principal owners want their executive agents interests to be aligned with the success of their company ever higher pay levels and share options might not be the best way.

This picture seems to cohere with everyday experience that some people are highly motivated and some are not. The correlation of that to pay is not always obvious and any causal link is even more difficult to confirm both in terms of direction and strength.

A major assumption in this model is that the interest of principals and the companies they own are synonymous. The principal wants their company to be a success. This may have been the case in the 19th Century in private companies where all the shares were owned by an individual or family. But in an era of rapid trading the principal may have a fractionally small period of ownership and very little interest in the future success of the company.

An interesting example of this is provided by Shell’s annual accounts for the year 2019. Shell is a fossil Fuel company. In recent years the need to move away from fossil fuel use has become increasingly apparent and increasingly urgent. Given this you might think the company, with an eye to the future, would be devoting substantial resources to a move away from fossil fuels and towards alternative energy sources.

The accounts reveal however that in the year to 2019 the company invested $962m on Research and Development which might include work on renewable energy, but more than twice that amount, $2,354 billion was spent on Exploration which one might assume relates to the search for fossil fuels as we know where the sun and the wind are.

Despite the fact that it faces what many would see as an existential challenge the company feels it has got too much cash. In 2018 it launched a $25 billion share buyback programme and in the 2019 report its CEO was pleased to announce that $14.75 billion of that programme had been achieved by February 2020.

Given the longevity of Shell, which started out in the 19 century importing antiques and sea shells from the Far East, and its scale, its revenues were just under $345 billon in 2019, there are doubtless many long term investors in the company like pension funds. Will they, however, have the same level of commitment to the future of the company as its founder Marcus Samuel, or will they simply shift their investments elsewhere? And for the more frequent traders will there be any interest at all in the long term future of the business over its short term cash flow and share concentration?

Aligning the interests of the agent with the principal has been a long term concern of companies with professional management. What might have been missed is the problem of aligning the interests of both the principal and the agent with the long term interests of the company.

by

The Triumph of Values over Value

The proposal to create a super league of European football teams has been decisively rejected. The existing, rather ramshackle governing bodies, players past and present, bandwagon politicians, but most of all “legacy fans” have demonstrated that not everything is up for sale.

Their opposition to the move struck a much deeper chord than just within the football community. It revealed in sharp focus a view of the world which says that value, and more specifically exchange value is the measure of all things. The fans begged to differ and they were supported, I suspect, by the vast majority of the country who are sick of having the value of everything reduced to its exchange value.

The essence of sport is competition and fair competition means you cannot know what the outcome will be. It means you might win but also that you might lose. It is a gamble. The billionaires who have pumped up the amount of money in the sport to excessive levels are now wanting to take away this essential risk. They want to turn the investment in equity with risk, the value of which depends on the performance of their club/business, into a bond with a guaranteed return. However, they want to have their cake and eat it by securing the level of return appropriate to equity.

Their attempt to assert the rule of exchange value has been overwhelmed by the assertion of moral, ethical, social and community values. Values, concerned with fairness, responsibility, dignity, reason and passion. It is the clash of two very distinct cultures. One which had been in the ascendency for many decades and results in the value free zone of financial capital trying to impose its debit and credit culture on all. The other, that for whom the worth of the beautiful game is intrinsic and a part of their culture and life.

Let us hope that this is a sign of a wider changing cultural landscape. A signal that exchange value and commercial efficiency are not the final measure of all things.

by

Lying with Statistics, is Just Lying

In these times of alternative facts Tim Harford’s quietly spoken commitment to the notion of truth is enormously welcome. His programme, More or Less, on BBC’s radio four is an enlightening analysis of statistical claims made on the news, often by politicians. Attempting and succeeding to distinguish the soundly based from the mildly misleading, the recklessly inaccurate and the straightforward propaganda lies.

For fans of the programme his book “How to Make the World Add Up” is a must read and for a much wider audience it is a should read. The first thing to say is that it is a book about statistics that those who did not even do O Level Maths can read with pleasure. There are no complex formula. On the contrary it is a limpid paean to the importance of statistics and its power to deepen and clarify our understanding of so many aspects of the world we live in.

Throughout there is a reassuring tone of common sense and inspiring presentation of how maths and statistics can be used to penetrate complex issues and abused to mislead and confuse. It is like being back in secondary school with that teacher who never raised his/her voice but never lost control of the class. Who maintained everyones interest through their enthusiastic mastery of their subject and ability to communicate in a manner accessible to all.

The book sets out eleven rules about how you should approach statistical claims. They all attempt to help you avoid confirmation bias which in the age of social media echo chambers leveraged by bots trolls is a vital skill. Asking you to think how you feel when you see a statistical claim. Does it give you a positive emotional boost as you find evidence to support your core beliefs/prejudices or does it make your hackles rise by contradicting them?

His advice is to treat those two imposters the same way and apply an objective set of challenges to both to try to discern the gold from the dross. This involves a deal of common sense and attempting to secure some kind of contextual framework. One which combines a birds eye view with a worms eye view. And one which understands what question any set of numbers is supposed to be answering. What are the definitions of the things that are counted. If it is gun deaths in the US is that about, mass killings, accidents, suicide or all the above?

it is important to avoid being enticed by the unusual nature of the findings in a report. Science progresses by findings exceptions to what is known. Scientific publications are would be tedious if all they ever published were results confirming what is already known. This means they look for the unusual. When combined with the academic imperative to publish or perish this can lead to the publication of findings which are unusual.

These may be a genuine step forward in scientific knowledge or they may be a result which is either unreplicable or designed in such a way as to provide eye catching if not knowledge enhancing results. Things like red wine prevents (yeay) or causes (boo) cancer. Along the way Hartford provides pointers to helpful tools which present a comprehensive picture of the state of peer reviewed research on medical matters, eg. the Cochraine Library.

Another target is the extravagant claims made for big data. The claim that google’s search engine was better at predicting flu epidemics than more traditional surveys, or that loyalty cards can predict your future shopping needs and that because such enormous data sets are being used the need for sample design was avoided, the facts would speak for themselves. At this point Harford quotes Professor Sir David Spiegalhalter of Cambridges University who said all this was “complete bollocks”.

This assessment may be of limited import when related to predictions about your need to buy nappies on the back of your previous purchase of follic acid. However, when such techniques are integrated into algorithms to guide recruitment or predict criminal behaviour or which teachers are failing to perform and need to be sacked, then they become of real concern. What they seem to end up doing is replicating and legitimating unfounded biased decisions.

The problem does not so much reside in the data sets or the use of algorithms in principle. Rather, it is the secrecy clothed in commercial confidentiality which means it is difficult to challenge results which seem to be producing bizarre outcomes. If big data is going to become a useful tool for analysing consumer preferences, criminal propensity, or professional competence it needs to be done in an open and transparent manner so that the logical steps in the chain of reasoning can be understood rather than hidden under a mountain of data.

If the misuses of statistics are of concern in civil society their manipulation by the state are a much greater concern. The book makes the point there are times when the bedrock statistics from national governments cannot be relied upon. This can never be right but is often ominous. Clear, reliable statistics about crime, health, the state of the national economy are fundamental elements of open government. They allow opposition parties, the media, academics and concerned citizens to question the government about the impact their policies are having. The book rightly draws attention to the geeks who try to protect the

Harford clearly articulates how critical reliable data is in modern democracies. Without a solid base to build knowledge all claims are equal. This is the realm of alternative facts. It is the logic of ex President Trump that if you don’t count the number of infections they go away.

The easy readability of this book belies the urgency, importance and contemporary relevance of it messages. One of which is the importance of sound maths and sound statistical techniques. But the other rather more profound one is the importance of bringing a critical mind to what the numbers purport to tell you. The need to understand what it is the numbers actually relate to and how accurate they can possibly be. What the standing of the authors is and the transparency of their sources, data and techniques.

Most important however is the need to examine your own motivations and biases. Carefully consider the extent to which your understanding of the numbers is guided more by your deep seated beliefs and prejudices than by what they actually say. In a world where some see evidence as a weapon to be tailored to promote a preconceived theory, or where dispassionate review of facts is dismissed as the tyranny of experts this book speaks to a key issue of our age, how we secure sound knowledge. Should be on the reading list of every first year University course in the country.

How to Make the World Add Up: Ten Rules for Thinking Differently About Numbers. The Bridge Street Press 2020. Tim Harford.