How quarterly treadmill keeps mills of America muddling
Boston — Bucking skeptics and powering its way into a sixth year, the elderly bull market seems to symbolize an American economy that must be doing some things right. Naysayers may point to overvalued stocks, trade deficits, budget deficits, and even the ugly idea of inflation's making a return - but corporate earnings are up, investors can't buy enough equities, and the market continues to signal that the nation's businesses are thriving.
Now what's wrong with this picture?
Before the stock market began its explosive rise, and long after a correction deflates the hopes of Wall Street, the nation will have a problem to solve: the short-term, quarterly-profit mentality its business leaders have been locked into.
``It's been a wrenching experience for managements,'' says William Dunk, head of William Dunk Partners, a management consulting firm based in New York. ``The pressures in the financial marketplace are such now that your incentive as a top manager for operating long term is taken away. If a guy is investing too much in long-term activity, he's going to get taken by a raider.''
For the past five years, ``merger mania'' and a reshuffling of America's corporate assets have been the rule, putting corporate raiders, arbitrageurs, institutional investors, and investment bankers into the limelight and giving them power.
But whether looking to ``maximize shareholder value'' or just make a quick buck, there seems little doubt that Wall Street's raids, takeovers, and asset plays have encouraged an increasingly dangerous short-term mentality on the part of business executives. Most have learned to do the financial acrobatics needed to churn out quarterly profits - and keep their jobs.
Still, ``we've seen a rash of CEOs [chief executive officers] get the boot in the last year or so,'' says Allan R. Cohen, a professor of management at Babson College, in Wellesley, Mass. ``The job of the CEO is to look long term. It's a bad sign when there's a climate where CEOs get bounced.''
Sometimes, of course, even sacrificing long-term growth for short-term profits won't do the trick.
``As a number of companies find out, just doing all right isn't enough,'' Professor Cohen says. ``We've seen many that were reasonably well run get attacked.''
Managers at Boeing, the giant Seattle-based aircraftmaker, considered a very well run company, recently felt a flicker of fear as raider T.Boone Pickens bought up a sizable chunk of its stock. The concern? Despite tremendous sales, and order backlogs a mile long, the company was considered vulnerable because its earnings were cyclically low due to heavy research-and-development expenses and retooling costs.
In a market characterized as ``earnings driven,'' costs like R&D that produce profits in the long run have become less important than profits today. There is danger for any company chieftain trying to diversify into an area that does not yield immediate earnings.
Surging stock prices do not necessarily reflect strength or competitiveness. Investment has gravitated to companies whose earnings have risen sharply because of cuts in research, capital spending, layoffs, and shedding of operations intended to take them into the future.
R&D spending is one measure of how far ahead management is looking. This year, US companies will spend a paltry 1.9 percent more on research than last year, compared with much higher growth by several of America's rivals. (See chart.)
Capital spending, although affected by tax reform and other factors, is also a measure of investing in the future. It too has lagged. The problem with this is that both capital spending and research funding are indicators of America's intention and ability to compete in the world market in the future.
``The downtrend in R&D spending is not a good sign,'' says Peter Jordan, an analyst with Data Resources Inc., a Lexington, Mass., research firm. ``Technology is the future. If you're not spending money to develop those areas, then that can be a real problem. In many sectors people are just trying to prop up their share prices by taking on new debt and doing a lot of financial paper shuffling. It's not a good sign for long-term competitiveness.''
There is concern that MBAs with their sharp financial knives and restructuring skills not only have made flabby companies ``lean and mean,'' they may also have mortgaged these companies' - and the nation's - future growth.
While most stock analysts gauge a company according to its profits, a few, like Margaret Brill, editor of the PSR Prophet newsletter, are ignoring profit reports and looking at raw sales instead when sizing up a company's future growth. Hard sales numbers are especially helpful in the current market, she says, because it is just too easy for a sharp financial manager to make profit numbers look good.
Sales are really what makes a company competitive or not, Mrs. Brill says.
``Whether it's the person on the streetcorner shining shoes, or a major producer of aluminum or rubber, if you don't increase your sales on an annual basis you're not doing very well.''
America's relatively poor performance in selling to the world market is echoed in its trade deficit. Sales at home have been chewed into by imports. So a booming stock market and good corporate earnings are being accompanied by a slump in American competitiveness.
``The bull market should not be taken as evidence of superior US economic competitiveness or superior performance,'' says David J. Teece, a business professor at the University of California at Berkeley.
``Obviously corporate America is delighted by the fact stock prices are higher and profits are up,'' Professor Teece says. ``But it doesn't indicate performance in the trenches is better. There are international factors which are fueling it.''
Stock market analysts say much of the surge on the Dow Jones industrial average is because foreign investors find US stocks cheap to buy because of exchange-rate differences - and in comparison with costly stocks at home.
Japan's Nikkei index is sky high. The Dow does not look very high to Japanese, who must invest the billions they have earned (much of it by outcompeting US companies) somewhere.
``You hear about all these US corporate raiders,'' Brill says, ``but a lot of them come from overseas, and are taking advantage of the comparatively cheap market.''
One overseas raider who rode a bull-market wave to this country was Sir James Goldsmith. His encounter with Akron-based Goodyear Tire & Rubber Company and its chairman and chief executive officer, Robert E. Mercer, won't soon be forgotten.
Sir James made a takeover run at the company last year, proposing to sell off some unprofitable parts, trim its work force, and return it to the tire business, from which it had been diversifying.
``If you have the ability to come in and destroy a company, what's the difference if you destroy it with bombs or if you do it inside with a financial threat?'' asked Mr. Mercer after the takeover attempt failed last year. ``The company gets destroyed one way or another.''
Sir James backed off. Ironically, Goodyear has had to take many of the steps Sir James outlined in order to pay off the nearly $2 billion in debt it assumed to buy back stock from him. It sold its oil and gas operations, aerospace division, and other assets for $1.7 billion. It cut 5,000 employees and closed three plants. Earnings are up (because costs have been pared), and Wall Street has bumped up the share price accordingly.
But Goodyear is back at Square 1. It is stuck in the tire business, a mature, highly cyclical industry with slow or no growth expected. It had hoped its oil and gas properties and aerospace division would become 50 percent of sales a few years from now. Now its business is nearly 100 percent oriented to tires and rubber.
``What we were originally trying to do, and what Mr. Goldsmith didn't like, was our program of diversification,'' says Hank S. Ruppel, a Goodyear spokesman. ``Now we have temporarily deemphasized the long-range type of R&D and concentrated on things that have a more immediate payout.''
Mr. Ruppel says Goodyear has also cut back capital spending from about $1.3 billion last year to $500 million this year. The ironic thing, he says, is that ``our prior investments in automation are now reaching the payout stage.''
The bull market may well lead to a false sense of security and accomplishment on the part of businessmen and the American people, says Teece of UC-Berkeley.
``People are going to say the bull market is up, inflation's down, interest rates are reasonable, unemployment's not bad - what's the problem?
``The problem is that if you look at our society, we're not competing as well as others. We're not doing as well as we could do. We're not doing as well as we need to do.''