You're going to hear us talking an awful lot about helping small business owners. We've long said that small businesses are the bedrock of the United States economy, but we acknowledge this might sound cliché. While there's nothing inherently bad about large companies, we'd like to welcome you to Downstream Wealth by introducing our perspective on why small businesses are so important.
Misaligned Incentives
Many college textbooks claim that the objective of a corporation is to maximize value for shareholders. For instance, a quick Google search shows that Penn's Wharton School (frequently ranked the top business school in the U.S.) required students to read Principles of Corporate Finance by Richard Brealey, Stewart Myers, and Franklin Allen. A preview of the book on Amazon emphasizes maximizing current shareholder value as the top priority (our bold emphasis added).
A smart and effective manager makes decisions that increase the current value of the company's shares and wealth of its stockholders. This increased wealth can then be put to whatever purposes the shareholders want. They can give their money to charity or spend it in glitzy nightclubs; they can save it or spend it now. Whatever their personal tastes or objectives, they can all do more when their shares are worth more.
And then...
Major corporations may have hundreds of thousands of shareholders. There is no way that these shareholders can be actively involved in management... Authority has to be delegated to professional managers. But how can the company's managers make decisions that satisfy all shareholders?... Delegating the operation of the firm to professional managers can work only if these shareholders have a common objective. Fortunately, there is a natural financial objective on which almost all shareholders agree: Maximizing the current market value of the shareholders' investment in the firm.
This is consistent with what I learned in college, and on the surface, maximizing value for owners seems like a great idea. Shareholder "value" should be a reflection of profits, and therefore value added to customers. However, there are several issues with this theory, beginning with the authors' continued use of the phrase "current value."
Short-Termism
Wall Street is obsessed with short-term figures. If you're unaware, Wall Street banks and brokers have analysts assigned to thousands of publicly traded companies. Their primary responsibility is to analyze company performance, talk with management, and arrange meetings with the "buy-side" (investment firms). These analysts have 12-month price targets, which is their estimate of where a stock will trade over the next year. These targets are used by investors to help inform their investment decisions.
Additionally, publicly traded companies host quarterly earnings calls, and Wall Street analysts inundate themselves with Excel spreadsheet models to forecast the next quarter's revenue and earnings down to the nearest penny per share. When you hear in the news that a company has "beat" or "missed" earnings, that's based on the company's quarterly performance relative to aggregate analyst estimates.
Analysts then join the call and drill management if short-term figures or stock prices aren't meeting their estimates. Again, Wall Street is concerned with the CURRENT market value for shareholders. This naturally creates a conflict of interest, and for those familiar with Infinite Banking, this breaks Nelson Nash's number one rule: think long range.
Conflicting Values
Another issue is that when companies get large enough, wealth isn't a great barometer for value added to customers, and therefore, a capitalist society. To better understand these conflicts of interest, let's take a look at Intel Corporation. Intel started as a small business prioritizing innovation and customer satisfaction with the goal of developing standardized microprocessors that would be widely accessible. Clearly, Intel has played a huge part in technology as we know it today, but what made Intel large and what kept Intel large are two different things.
Over the past 35 years, Intel has bought back more than $152 BILLION in stock. Stock buybacks are a form of stock manipulation (creating demand for shares), and therefore, rather than taking a portion of that $152 billion and spending it towards increased R&D, building new manufacturing facilities in the U.S., or hiring more workers, Intel has decided to increase the percentage of ownership for its top executives, which aligns with textbooks' aim to maximize CURRENT shareholder value.
It's understandable to buy back a portion of your company if you believe in long-term growth, but a significant portion of profits are being used to buy back stock across corporate America. Therefore, what's left to help businesses grow? It doesn't stop there either. Companies are issuing more and more debt, especially in ultra-low interest rate environments, to buy back more stock.
Let's think about this. We're now living in a time where semiconductor manufacturing is deemed a national security risk. China's pressure on Taiwan has politicians scrambling and planning to intervene. That begs the question: how did we get in this position where our largest, most successful, and highly innovative companies like Intel are prioritizing buying back shares over bringing manufacturing back to the U.S., which would have reduced reliance on foreign manufacturing and increased American jobs?
This is even more confusing when we remember that Intel was given an $8.5 billion grant on top of another $11 billion in favorable loans as part of the CHIPS Act. The White House initially calculated that as a part of the favorable grant and loans, Intel would create 20,000 temporary construction jobs, along with 10,000 more permanent jobs. Therefore, what's incredibly frustrating is Intel's earnings report from this past quarter. The company's earnings release shows that revenue was down $12.8 billion from last year, and the company lost $0.38 per share. The company has since decided to cut headcount by 15% and reduce costs by $10 billion! Why are we giving money to a company who can afford $152 billion in stock buybacks, but apparently can't afford to keep workers employed?
Intel has been leveraging favorable borrowing benefits and political favors to maximize current shareholder value for years. This worked for a while, especially for the top executives who were given stock options and could cash out at market highs. But as a result, the company has sacrificed long-term growth, and the stock is now trading at 15-year lows. This trend is very common on Wall Street and stems from flawed thinking about the purpose of a corporation.
Production vs. Consumption
One other major issue is the U.S.'s adherence to Keynesian economics, which posits that consumption is the real driver of economic growth. This is why government officials measure "growth" from quarterly GDP, which is about 70% consumption. This gives policymakers an incentive drive more consumption, which either comes from printing money to distribute to the people or an expansion of credit (money) from low interest rate environments through our fractional reserve banking system.
While this drives some arbitrary number higher, many people would probably agree that the only true "growth" we've seen in the past four years has been prices. Keynesian economics fails because it ignores supply constraints. We believe in Say's Law, named after Jean Baptiste Say, who acknowledged production precedes consumption and demand is constrained by supply. The Keynesians also fail in their "paradox of thrift" theory, which asserts that individuals deciding to save more is bad for growth. According to Say's Law, savings are never wasted, but instead represent an accumulation of capital that can be opportunistically spent on productive factors like capital goods, which can increase future consumption.
If we back up to Intel, and we see that companies were essentially being punished to save through negative real interest rates (because the government wanted to drive consumption), then it makes sense why companies would buy back stock rather than invest in long-term productivity. After all, the new increase in "money" was printed out of thin air, and if inflation increases enough, the Fed may pull the plug, resulting in a contraction of credit. Therefore, because consumers didn't save the increase in "money" to begin with, their future consumption is reliant on more and more money printing, which isn't guaranteed.
The bad news is that the American economy is plagued by flawed thinking. Academics believe that a company exists to serve shareholders. Politicians believe that debt-based spending drives economic growth. Economists attempt to micromanage the economy by encouraging price controls on money.
The Good News
The good news is that this flawed thinking presents a huge opportunity for small business owners who are willing to think differently about the world. When it's all said and done, a business owner's goal is to monetize the value of their business. However, shareholders don't determine "value." Value is a reflection of the company's ability to profitably serve customers today and in the future. Once the company has differentiated itself by delivering more products/services, higher quality products/services, or creating new products/services, shareholders will benefit as a byproduct of profit growth. However, customer satisfaction must come first.
One cannot create value without having resources to invest in the company. Accumulating capital is difficult because of our government's insistence on maintaining negative real interest rates that punish savers. However, the answer isn't to abandon saving altogether since we know savings drives growth. This is where Infinite Banking comes in, serving as a sound money alternative that allows business owners to safely grow and leverage capital, thereby increasing the efficiency of their cash flow.
Most Americans would tell you that prices are still way too high, and by increasing local production, small business owners can pick up the slack of our policymakers and largest corporations. By thinking long-term, saving capital to reinvest in the company, and prioritizing customer satisfaction over short-term shareholder value, business owners can accelerate value creation in their businesses while also helping the American people.
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