A CEO’s Dilemma
Updated on September 23, 2014
CEO Frank: You two have given me a tough decision to make. Will we spend $100 million of our surplus on a growth program being proposed by Ted, or spend it on stock buy backs recommended by Jim?
COO Ted: Boss, we need that $100 million to expand our product line. We’re profitable but growing slowly. This new product will take five years, but then will raise our growth rate by a couple of points, and hire close to a hundred new workers, including rehiring the fifty downsized last year. Every new program has a risk but I would bet on this. You told me years ago that your view of capitalism is a superior system that not only maximizes wealth but also provides jobs. “Life, liberty, and the pursuit of happiness” is an empty promise if people can’t get a job. The downsizing changed that culture pretty badly. The politicians are bragging about getting unemployment down towards 7%, but that’s a phony number. It doesn’t include those who have stopped looking for a job--the ones we should be most concerned about.
CEO Frank: You’re quite right, Ted. The real number is a record 24 million Americans of working age without a job. We want to grow the company, of course, but we were under attack by the short-sellers because of our slow growth. The big surplus we built partly by cutting back growth programs also attracted the short-sellers. My first responsibility is to our company itself! We have to protect this fine company--with all of our jobs--from the take-over artists. We brought Jim in to help us.
COO Ted: But isn’t stronger economic growth key to the condition of our whole society? When we create jobs, doesn’t that also turn workers into consumers who buy things and keep job growth expanding? I read something about a multiplier effect. Isn’t that what we’re talking about?
CEO Frank: Finance is not your thing, Ted, but you do know that the promise of a five- year program is not of interest to most Wall Street people. Long-term for them is a week from Tuesday. They are consumed by quarterly earnings—next quarter! But let’s let Jim make his proposal and then we will decide.
CFO Jim: Thanks boss! We have a great opportunity for the shareholders including the people in this room. It will not take five years, it can be done in an afternoon. I’ve been doing the financial engineering and can show you how to buy your yacht and go fishing. Our e.p.s is $1 a share and based on a price/earnings ratio of 13, slightly below average, our stock price is $13. Wall Street thinks we are solid but dull. If we take that $100 million and buy back stock, we can increase the e.p.s to $1.25 simply by dividing the profits by a lower number of shares. Another good part is that Wall Street will see that we are more aggressive in our financial engineering and probably bring our price/earnings ratio up to 17, slightly over average, for a stock price of $21. An afternoon of work and you are a wealthy man.
CEO Frank: What did the consultants you brought in propose? Was this their plan?
CFO Jim: No they concentrated more on a big new stock-option plan. Their idea is a “pay for performance” plan that avoids criticism for excessive CEO pay.
CEO Frank: How does it work?
CFO Jim: You’re rewarded only if the stock price goes up.
COO Ted: I can’t believe it! Your plan would provide a big win if the stock price goes up even if the growth rate goes down.
CEO Frank: These are pretty wild numbers, Ted. How long do you think it would take to get the stock up to $21 based on your program?
COO Ted: The new products are great and can improve annual earnings a very strong 15%, but I think you know, Frank, that it would still take over five years to get us to $21 a share. But that’s OK: What’s capitalism for--the stock price tomorrow or jobs for the future?
CFO Jim: Don’t forget, Ted, according to your interest in the multiplier effect, the money would be returned to the stockholders, including to the worker-capitalists with their trillions of dollars of pension savings and profit sharing in the stock market.
CEO Frank: Not so fast, Jim. Most of the money would go back to the money managers and be recycled on Wall Street. This bothers me because I read about Jack Bogle, the founder of Vanguard, who points out that the money managers charge ten times index funds without any improvement in performance.
COO Ted: I didn’t know--and I don’t think the workers know--how badly Wall Street is ripping off their pension savings. I know from talking to the workers that most are long-term in their thinking. They are excited about the opportunity to build the company and don’t spend much time asking questions about the handling of their pension money. Maybe they should, but they don’t.
CFO Jim: All these wonderful feelings for the company and the workers are fine, but we have a simple decision to make--$21 a share now or over five years in the future?
COO Ted: It seems like the deck is stacked. Why don’t the tax laws support growth programs or dividends returned to the economy?
CFO Jim: That’s a good question, Ted, but you must realize that from the beginning, the Founders were not able to diffuse economic power along with political power. The record concentration of wealth now in the country is the result of finance capitalism’s domination of the economy. Wall Street writes the tax rules that favor short-term stock prices. Stock buy backs will total a near record $500 billion this year. IBM will spend twice as much on stock buy backs as they do on research and development!
CEO Frank: Thanks guys—We’re getting into urgent questions that need study and resolution. Tell Congress to pass tax laws that penalize wasting surplus on stock buy backs but reward putting it back into the economy. Let me know what they say. Meanwhile-talk about short-term!—I’ve got a decision to make. If you will excuse me, I’ll go off into the corner and earn my money.