by Deb Cupples | It still amazes me when so-called "free market" proponents rail against attempts at forcing a bit of accountability on Corporate America, even when evidence suggests that lack of accountability has wreaked havoc on America's economy and on millions of Americans' financial stability -- even when we taxpayers have been forced to cough up $350 - $700 billion to bail out companies whose executives pocketed millions while driving their companies into a ditch.
The latest example is an op-ed in the Wall Street Journal by Michael S. Malone, whose regular job is as a columnist for ABCNews.com. The first glaring problem is Mr. Malone's title: Washington is Killing Silicon Valley.
Didn't Silcon Valley start marching toward the graveyard back in 2000, when the tech-stock bubble burst? You remember: after that period in the '90s, during which numerous companies (with questionable assets) were allowed to go public, allowed to rake in millions from ordinary investors via IPOs, and then failed. How, exactly, was government regulation responsible for that?
The op-ed only gets worse after the title. Check out Mr. Malone's first few paragraphs:
"Even as economic losses and unemployment levels mount, America's most effective engine for wealth and job creation is being dangerously -- perhaps fatally -- compromised.
"For more than 30 years the entrepreneurship-venture capital-IPO cycle centered in Silicon Valley has generated new wealth, commercialized innovation, and created new companies and industries. It's also spun off millions of new jobs. The great companies created by this process -- Intel, Apple, Google, eBay, Microsoft, Cisco, to name just a few -- have propelled most of the growth in the U.S. economy in the last two decades. And what began as a process almost exclusively available to scientists and engineering Ph.D.s became open to just about anyone with a good business plan and a healthy dose of entrepreneurial drive.
"At its best, the cycle is self-perpetuating. Entrepreneurs come up with a new idea, form a team, write a business plan, and then pitch their idea to venture capitalists. If they're persuaded, the VCs invest, typically through several rounds during which the start-up company must meet performance benchmarks. Should the company succeed, it then makes an initial public offering of stock [IPO].
"The IPO can reward the founders and venture-capital investors, and enables the general public to participate in the company's success. Thousands of secretaries, clerks and technicians at these companies also have come away from the IPO richer than they ever dreamed. Meanwhile, some of those gains are invested in new venture funds, and the cycle begins again.
"It has been a system of amazing efficiency, its biggest past weakness being that it sometimes (as in the dot-com "bubble") creates too many companies of dubious viability. Now, this very efficiency may be proving to be its downfall. (WSJ Online)
Apparently, the "entrepreneurship-venture capital-IPO cycle" is directly tied to the American Dream of quick wealth coming out of nowhere -- making barons out of secretaries simply because they had stock in a start-up company that went public.
Bake me an apple pie and sing me a chorus of God Bless America.
Notice that Mr. Malone mentions the huge successes that came out of said "entrepreneurship- venture capital-IPO cycle" (e.g., Intel, Apple, Google, eBay, Microsoft, and Cisco -- companies that provide real goods or services).
What about all the failures and snake-oil peddlers?
Mr. Malone gives them honorable mention (albeit, very vaguely) in the fifth quoted paragraph, where he states that the system's biggest weakness is that it "creates too many companies of dubious viability."
That's a major understatement. Conspicuously absent from Mr. Malone's Rockwell-esque picture is who pays the price when companies of "dubious viability" are allowed to go public: the ordinary folks who buy stocks in the dubiously viable companies with money from their 401(k)s or their children's college funds.
A 2004 Washington Post article gives a few concrete examples of companies that went public and failed:
"LifeMinders Inc. sent users e-mail messages to help them keep track of their busy lives. [Like a calendar wouldn't have done the trick?] In classic dot-com style, the company did not charge for its services, relying instead on advertising for revenue. With 3 million users and no profit in sight, the Herndon company went public in November 1999. Its stock debuted at $14 a share and rose 60 percent on the first day of trading. The company raised $58.9 million through its IPO.
"The company bought a pricey Super Bowl ad, held a secondary offering that raised $86 million in February 2000 and announced plans to acquire a wireless messaging company for $24 million -- just a month after posting a $13.7 million loss for the second quarter of 2000....
"By January 2001, the company had ousted its founder and chief executive, begun layoffs among its staff of 200 and told investors it was dropping its efforts to enter the wireless sector. Its loss ballooned to $70.5 million in the last quarter of 2000.
How does a small company turn $140 million in new shareholders' money into a $70.5 million loss in less than a year? If nothing else, couldn't company executives have invested those funds in providing new goods or services that had a chance of becoming profitable? Precisely what did LifeMinders' executives and managers spend the company's money on?
Here's another example from WaPo:
"MusicMaker.com Inc. raised $67 million in its initial public offering. Its business plan: Customers could pick songs from a Web site, then employees would copy them onto compact discs to be mailed to the buyer. During its first year on the market, the company's stock hit a split-adjusted high of $239.
"While MusicMaker.com paid record companies to use their songs, Napster and other file-swapping programs popped up, ignoring the rules and providing free instant access to music.
"In January 2001, MusicMaker's shareholders voted to liquidate the firm. After selling much of the company's equipment at auction, MusicMaker announced that it would distribute $3 a share.
Imagine how you'd have felt if you'd been one of the investors who enthusiastically bought MusicMaker stocks at $200+ a share (likely based on company hype) or even $50 a share -- only to get back $3 a share when company execs chose to liquidate. I'd like to know how insiders at MusicMaker fared.
A third example from WaPo:
"Value America Inc., a Charlottesville online retailer that raised $126.5 million in an April 1999 IPO, suffered a similar fate. The company's goal was to become the Wal-Mart of the Internet, a one-stop shop where people could buy anything and everything.
"Shares of its stock started trading at $23 and were driven up to $55.18 on the first day of trading before slipping into the teens within two months. Sales did not keep pace with investments in marketing and staff. The firm lost $143.5 million in 1999.
"In August 2000 Value America filed for Chapter 11 bankruptcy protection. Its assets were sold in November 2000 for $2.4 million.
Here we go again. Value America's executives managed to take $126 million in new shareholders' money and turn it into $143 million in losses in less than a year. Too bad for the shareholders that collectively handed the $126 million to said executives but failed to dump their stocks early enough.
These are not isolated examples. During the '90s, numerous companies went public and failed -- and numerous ordinary investors were left holding empty bags.
Is this the sort of entrepreneurial activity that Mr. Malone thinks our representatives in Washington should allow to grow unfettered?
Frankly, I think that's precisely what Mr. Malone has in mind -- given his immense aversion to corporate accountability and regulations. Here's his take on that:
"Faced with crushing reporting costs if they go public, new companies are instead selling themselves to big, existing corporations. For the last four years it has seemed that every new business plan in Silicon Valley has ended with the statement "And then we sell to Google." The venture capital industry is now underwater, paying out less than it is taking in. Small potential shareholders are denied access to future gains. Power is being ever more centralized in big, established companies."
I must interject here: Mr. Malone writes of ordinary investors being "denied access to future gains." That's completely inaccurate.
When ordinary investors lose an opportunity to throw their money at some untested, newly public company, said investors are denied access only to potential future gains. They are simultaneously spared potential losses.
Given that Mr. Malone writes for a living, he should have been able to easily state that obvious fact. Back to Mr. Malone's take on our nation's corporate regulatory system:
"For all of this, we can first thank Sarbanes-Oxley. Cooked up in the wake of accounting scandals earlier this decade, it has essentially killed the creation of new public companies in America, hamstrung the NYSE and Nasdaq (while making the London Stock Exchange rich), and cost U.S. industry more than $200 billion by some estimates.
"Meanwhile, FASB has fiddled with the accounting rules so much that, as one of America's most dynamic business executives, T.J. Rodgers of Cypress Semiconductor, recently blogged: 'My financial statements are a mystery, even to me.' FASB's 'mark-to-market' accounting rules helped drive AIG and Bear Stearns into bankruptcy, even though they were cash-positive.
"But FASB's biggest crime against the economy and the American people came when it decided to measure the impossible: options expensing. Given that most stock options in new start-up companies are never worth anything, this would seem a fool's errand. But FASB went ahead -- thereby drying up options as an incentive for people to take the risk of joining a young company and guaranteeing that the legendary millionaire secretaries would never be seen again.
I have read elsewhere that Sarbanes-Oxley made reporting more costly for public companies. It's late, and I just don't have the energy to do a crash course on Sarbanes-Oxley, but if you're interested, the SEC has a page full of links on the topic.
I'm not sure if Mr. Malone's statements are accurate regarding the London Stock Exchange or the $200 billion in industry losses. If Mr. Malone had bothered to explain his claims, we readers might have a better understanding.
I seriously doubt his contention that mark-to-market accounting rules caused Bear Stearns and AIG to go into bankruptcy.
First, as of this writing, AIG has not filed for bankruptcy protection. It seems unlikely that the government will allow that, given that it has already committed $150+ billion to bailing out AIG alone.
Second, it seems more likely that reckless investment decisions and inadequate risk-management were what actually caused turmoil for AIG, Bear Stearns, and a slew of other firms: mark-to-market rules simply forced a realistic (and embarrassingly public) reckoning.
Basically, mark-to-market rules required firms to value their assets (like mortgage-backed securities) at real market value -- instead of at wildly inflated values.
In other words, mark-to-market rules prevented firms' executives from fooling potential investors into thinking that the companies' assets are worth way more than they really were.
What's wrong with that? Seriously.
This nation has known about the housing bubble since at least 2005. The sophisticated folks who get handsomely paid to run firms like AIG and Bear Stearns (specifically because of their sophistication and "talent") reasonably should have known that any assets tied to housing prices would deflate when the housing bubble started deflating.
If executives at AIG and Bear Stearns (and the firms that are now getting taxpayer-funded bailouts) had engaged in wise investment strategies and insisted on sound risk-management practices (i.e., if they'd resisted the temptation to make highly risky investments whose values were obviously inflated), those firms likely would have fared better when it came time to book their assets at real market value.
About FASB's call for stock-options expensing: what's wrong with it? Every dollar's worth of stock options that an executive gets is one less dollar in the company's coffers. Period.
Why should a company be able to not count stock options as an expense? By not treating stock options as an expense, a company would appear to be worth more money than it really is -- which would give potential investors a false sense of the company's value.
That's why super-investor Warren Buffet has, for years, publicly called for the expensing of stock options. In 2004, for example, Buffet said that failure to accurately expense stock options "enables chief executives to lie about what they are truly being paid and overstate the earnings of the companies they run."
Precisely. In other words, it enables executives to more easily dupe shareholders, potential investors, and others. Why should our government (or FASB) put us ordinary investors in a position to be so duped?
Charles Munger, Buffet's right hand at Berkshire Hathaway, said that the people who oppose expensing stock options "are worse than stupid. They know it's wrong and want to do it anyway." Buffet added:
Presumably, Mr. Malone (being a savvy business columnist) knows of Buffet's and Munger's very public arguments. Presumably, Mr. Malone understands the scandals that taint Corporate America's history.
Yet, Mr. Malone thinks FASB is the enemy for requiring public companies to expense stock options?
One thing seems obvious: Mr. Malone is not the least bit interested in promoting a corporate climate that actually enriches ordinary shareholders and investors.
If you fall into either category (as I do), you might be better off taking his op-ed with a grain of salt -- or using it to line the litter box.
Memeorandum has commentary.
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