Financialization Is The Problem. Equity Paybacks Are The Solution.
Paul Barnett shares with us today his thoughts on an article appearing in today's Financial Times, entitled
Have America's industrial giants forgotten what they are for?
Paul's take-away from this article is
To conclude, America’s industrial giants, industrial giants the world over, have not lost their way. It is simply that those who direct and manage them are operating according to the long-outdated management theories and practices they have been educated in.
I agree.
Which creates a space for inquiry in search of insight and new learning about why these "management theories and practices [that those who direct and manage][industrial giants the world over] have been educated in" have become outdated.
The pivotal insight in this inquiry can be found in these words, attributed to Elliott Investment Management L.P., identified as an activist investor, quoted by author Andrew Hill in the referenced Financial Times article, as criticizing a corporation financed through the capital markets for:
"an underperforming share price"
These words show us the true purpose of the corporation that has been financed by selling shares into the capital markets: to grow their share price.
The corporation is a 19th Century social innovation in enterprise ownership and control for investment that creates the profession of the management of a business enterprise for the benefit of non-participatory owners who own shares of ownership in that corporation.
The securitization of the corporation for the sale of shares into the share price trading markets, is a 19th innovation in enterprise finance that turns the corporation into a financing agreement between Management and the Markets. The primary term of this agreement is an obligation by Management to grow the selling price of the corporations ownership shares in the Markets.
This term is absolutely critical, because the Markets must deliver to market participants the liquidity that market participants require as a condition to their participation in the markets: buyers who become sellers must be able to sell; which means there must always be buyers willing to buy; buyers won't buy unless they are confident that they will be able to see, at a profit, to new buyers, when they become sellers, in their turn.
The much ballyhooed and maligned Friedman Doctrine tells us, "The social responsibility of business is to increase its profits".
There is absolutely no legal or experiential basis to support that Doctrine, expressed in that way.
If we look at enterprise as the social configuration of physical Knowledge + Networks + Routines for converting cost-for-value into value-for-price by putting technology as practical knowledge of how the world about us works in some specific way, and how the world can be made to work more a way we choose to make it, in that specific way, into action constructing a surplus of artifacts as expressions of that knowledge that can be offered to others for their use in making our own personal and private worlds that we construct for ourselves in which to live our own best lives, as best we can, under the circumstances then prevailing, personally and privately, in exchange for a price paid in money, or other value that can function as money, then we can see that the purpose of every business is to pay its costs in order to earn its price, recovering its costs from its price, and realizing a profit as the excess of price over costs.
Realizing a profit, and increasing profits are not the same thing, and there is nothing inherent in the social construct of a business enterprise that requires that business to increase its profits.
To the contrary, every enterprise that establishes for itself a place in the economy enters into a social contract with popular choice that flourishes for a time, and then fades in the fulness of time, as times change and humanity evolves prosperous adaptations to life's constant changes, through inquiry for insight and new learning that informs innovation, making new choices more popular as better fit to changing times, while letting previously popular choices fade into history, as a good fit at an earlier time.
There are moments in the enterprise journey, from Innovation to History, when popularity, and profits, are increasing, but there is also always a time when growth in poularity levels off, as the enterprise becomes the standard choice that people choose.
That is the point when the teachings of Growth Economics and Economies of Scale become outdated, and need to be replaced with a new Economics of Purpose, and Sufficiency for Longevity.
But we do not currently have such an Economics of Purpose and Sufficiency.
We have only an Economics of Neo-Elitist, Neoliberal Financialization that is a corruption of the authentic Economics of Growth through Economies of Scale.
This corruption finds its expression in a corrected statement of the Friedman Doctrine, that
the social responsibility of the corporation financed by the capital markets is to grow its share price
This corrected restatement of the Friedman Doctrine shows us that financialization enters the economy through the corporation that gets financialized by the capital markets, but how do the capital markets become financialized?
We can see through the framing of enterprise as a social configuration of physical Knowledge + Networks + Routines for converting cost-for-value into value-for-price, that every enterprise needs money to pay its costs before it can realize its price (with the exception of made-to-order businesses that can collect a portion of its price sufficient to cover its costs before doing its work and collecting the balance of the price, which is its profit, on delivery, but that is a business model that does not scale).
When Enterprise needs money, Finance provides it.
Finance is a social institution of agency, authority and accountability that aggregrates money set aside by others, for a purpose, for a time, as savings available for investment in financing for enterprise, and allocates those aggregations as money made to flow into enterprise, for its use in doing its work of paying costs to earn its price, for a time, at a cost and on terms that allow the financiers to mediate the tensions that exist between our need, as individuals, for liquidity in increments in our investments and the need of enterprise of longevity at scale in its financings.
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The capital markets are a financial institution that mediates those tensions by securitizing ownership of enterprise into large numbers of small, legally equal, commodity shares that can be bought and sold at market clearing prices, in different increments, at different times, by different market participants, without the participation, consent or even knowledge of the enterprise (except after the fact, for record-keeping purposes only).
When the primary participants in the capital markets are individuals buying and selling with our own savings, for our own account, decisions to buy or sell are driven primarily by life events outside the markets themselves - people buy when they have money to invest, and sell when they need that money back, to spend on something that we want - constrained by our own personal moral values and guided by our own individual moral compasses.
These markets move to the stately rhythm of buy-and-hold, and impose the moral value of market participants on the corporations whose shares are being bought and sold in those markets.
These are the markets that thinkers like Milton Friedman are thinking about when they say things like "the social responsibility of business is to increase its profits".
Increasing profits increases share prices, and increasing share prices deliver liquidity to market participants, whose personal moral values act as a constraint on how business goes about increasing its profits, to ensure that profits are increased in socially responsible ways.
But this is not how the capital markets operate today.
Beginning in the 1970s, the demographics of the markets began to change, as first university endowments, then endowments for foundations and finally social trusts for workforce pensions began flowing the vast sums of money these social constructs control as forever trusts for programmatic purposes into the share price trading markets.
These forever machines do not have life events. They are constituted by the laws of their creation to do the same thing every day, day after day, which is to invest the money entrusted to their control for income as well as safety to assure income security in a dignified future, for retirement, in the case of Pensions, for mission, in the case of Endowments, prudently exercising the capacity they derive from their character of vast size, programmatic purpose and forever time, in undivided loyalty to their legally constituted aims, which are to keep themselves ongoing, making the contractually calculated payments to contractually qualified recipients at contractually specified intervals, "every month, forever".
Their institutional moral compass is The Hypothetical Prudent Steward of a Social Trust, as the legal avatar for the common sense of prudent people familiar with such matters, under the circumstances then prevailing.
And there is no tension between these trusts and enterprise relative to the size and scale of investment in financing: both social trusts and business enterprises need longevity at scale.
So the mechanism of securitization used by the capital markets for mediating tensions in scale and longevity is both unnecessary and inappropriate.
When this forever money enters the capital markets, the purpose of these social trusts, to invest money for sufficiency to their own longevity, gets replaced by the purpose of the capital markets, to extract profits from growth as gain on sale.
Growth is not what the individuals who contribute to Pensions & Endowments are bargaining for: they want sufficiency to their own longevity, in retirement, in the case of Pensions, or for mission, in the case of Endowments. But the Capital Markets are not built to deliver sufficiency to longevity to investors. They are built to deliver liquidity in increments, through Growth. So, when Pensions & Endowments invest in the Capital Markets, their institutional exercises of their institutional authority/power becomes corrupted. They stop acting, authentically and with integrity, as financiers allocating aggregations to enterprise, and start acting, inauthentically and without integrity, as Investors in the Capital Markets, that then act as the financiers who are allocating money aggregated from social trusts (who aggregated the money from individuals) to enterprise.
In the process, the moral compass of these social trusts gets bent, away from its true purpose of income and safety to assure security and dignity and towards the sale, and the selling price.
As more and more of the fiduciary money aggregated into these social trusts gets used to purchases shares in securitized financing agreements in the capital markets, these shares get rebranded as financial assets and the fiduciary money aggregated into these social trust gets rebranded as Assets. Fiduciaries of these trusts become Asset Owners, whose fiduciary duty, they are told, is to allocate their assets across asset classes, and within classes, to select Asset Managers who are peer benchmarked by Consultants for outperformance in maximizing the highest possible profit extraction from the capital markets, solely in the financial best interests of capital markets professionals in increasing the fees and profits that they extract from the capital markets, in reliance on the axiomatic assertion that more quantities of money for capital market participants will also always mean a better quality of life for the rest of us.
This is Financialization: the replacement of careful consideration of the actual, physical connection between quantities of money and quality of life with the axiomatic assertion that more money (for them) always means a better quality of life for all.
There is an alternative.
Social trusts for Pensions & Endowments derive from their legally constituted character of vast size, programmatic purpose and forever time the actual, practical capacity to use the personal computing technologies of spreadsheet math, desktop publishing and digital communication to financially engineer equity paybacks to an actuarial/fiduciary cost of money sufficient to their longevity, in undivided loyalty to their legally constituted purpose, plus opportunistic upside, from enterprise cash flows prioritized by contract for suitability of the technology to the times, longevity of the enterprise, and its social contract with popular choice, over time, and fairness in how the business does business all the time.
These Equity Paybacks do not require Growth. They require longevity, perfectly matching the need of social trusts, for longevity in their investments, with the need of enterprise, for longevity in their financings.
They do not bend the purpose of enterprise, away from sufficiency to their social contract with popular choice.
They do not bend the loyalty of social trusts, away from their legally constituted aims, to invest money for income as well as safety to assure income security in a dignified future, for some, directly, as a private benefit, and for us all, consequently, as a public good.
They do not accept the axiomatic assertion that more = better.
Instead, they engage in constant conversation about the actual, physical connections between quantities of money and quality of life, in business, and in social trusts.
They are the foundation for new learning about "management theories and practices" that can and should replace the outmoded theories and practices of Growth as enterprise exits the capital markets and enters into prudent stewardship of purpose.