Excellent workshop at Sloan last Friday (March 11th). There were two case studies – “Managing Opportunities and Risks in Global Markets” (a case study focused on Nike) discussed by Richard Locke, and “Business Decisions and Accounting Choices” by Joseph Weber.
The first one raised some interesting questions about the meaning of “good corporate citizen”, in the context of globalization and considering that different states and different countries may have different laws and regulations. That certainly means that it is a significant challenge just to be ethically neutral, let alone have a common definition of “goodness”. As a contrived, but hopefully plausible example, consider the following scenario in which US laws stipulate that “No imported components used in the manufacture of fireworks should be manufactured by foreign facilities employing minors” and a foreign sovereign state uses similar language, except defines minors as children under 16 years of age, instead of 18 in the case of US. How should the global entity address this seemingly intractable trade situation?
The second talk “Business Decisions and Accounting Choices” by Joe Weber was perhaps even more interesting, as it involved accounting, and more numbers. The HBS Case Study by Robert Kaplan and David Kiron (which served as a pivot for the talk) focuses on two dubious accounting tactics used by WorldCom. The first tactic was the accrual releases in 1999 and 2000 period, and the second tactic was the capitalization of line costs in 2001 and 2002. Accrual releases tactic essentially tried to understate (ostensibly “correct”) the projected future expenses. While “fraud” at WorldCom is not subject to interpretation at this point, still, I must confess that I find the study’s proclamation of “fraud” in this particular tactic less than crystal clear. Allow me to explain. The study claims that over 1999 and 2000, “WorldCom released $3.3 billion worth of accruals…. future cash payments were well below the actual amounts they would have to pay when bills arrived..” Now, now, $3.3 billion is not pocket change, but we also do not know the relevant numbers in which this appears. The report does not say what that delta was however, except saying that it was “well below”. How much below is well below? Considering that the WorldCom CFO released $3.3 bn at least six months before the bills came in, and that this article was written two years after the scandal had been in limelight, it doesn’t do well enough to establish guilt. For example, if it turned out that future cash payments were a $1 billion below the actual amounts, then that would imply that the WorldCom financial team was actually right in more than 70% of the cases! Similarly, if it turned out that the future cash payments were a whopping $10 billion below the actual amounts, then that would imply that the problems weren’t even with the releases at all. And even if somehow the delta matched up to be close to $3.3 billion, we would still be left to solve and justify the “correlation does not imply causality” theme.
The second tactic – the capitalization of line costs – is dubious, sure, but in an abstract way is essentially a cost allocation issue – is the cost a cap ex, or is it op ex. Sure, interesting question, and we can argue it for hours, but I want to move on to something bigger, better and tastier.
So fine, let me accept what the rest of the world is already at peace with, or at least, let me accept it for a minute: “WorldCom played it bad. Moved op ex to cap ex. Told lies about the bills that were coming.” Ok, fine. Then what? It certainly didn’t print its own dollar bills. So how did it manage the cash flow? For example, see this LA Times article from 2000. While the rest of this “fraud” was still being perpetrated, the news that it was “financial engineering” was already doing the rounds. So, if a firm is not showing cash to its shareholders (also known as dividend – you can google it. oh wait, google doesn’t have dividend, never mind, I am just getting carried away by what is coming next), then what is the stock price being kept on? Doesn’t it represent a certain lack of basics on us, the society as a whole? That, mind you, is not greed. In fact, that is quite the opposite of greed. In fact, that is the ability (both emotionally, and mathematically) to believe that stock price of $18 is worth the paper that we are holding, even though it is not returning 60 or so cents that this paper should be returning to me TODAY.
It is easy to make fun of a company that existed many years ago, but how is that so different from a certain large company (like Google) today? Google doesn’t have dividends, rather we are happy to hold the stock for $600, because it continues to “reinvest” the earnings into the business! Jolly, that is great, but I am thinking, couldn’t Google at least start paying one dollar back to the share holders from the $22 EPS? How old does a company have to be, to become a card carrying, dividend paying corporate citizen?
Obviously, all of these differences in opinion are business and in part due to me playing along in this Socratic game. You certainly can’t take away that I had an awesome time at the workshop in beautiful weather Boston, meeting new people and talking to many brilliant people. For example, Min Chen perhaps has a simple yet insightful definition of the stock market:
Stock market is the gambling den for the intellectuals.
I do agree with Min’s articulation, even though I don’t expect to be similarly eloquent or funny myself. Larry Kahn (a much admired board member at NTELX, and a Sloan alumnus, while we are at the topic) often says, “Who the heck knows?”, whenever the issue of stock market comes up. And I certainly don’t get the sense that Larry is trying to be funny.
While these two presentations and discussions were great, the workshop really saved the best for the last. Andrew Lo gave a scintillating presentation on how the financial engineering can cure cancer, solve the energy crisis and stop global warming. Andrew Lo is a speaker that other speakers love to listen to, and speaks with a certain passion that keeps you glued to your seat while swimming through outer space.
All I can say at this stage is that if my 401k ever offered an option to invest $2000 into Andrew Lo’s fund (an idea that he hopes some greedy capitalist pig will steal), I will gladly do it, and that is purely from a financial perspective.