> that have mountains of their own money to burn (rather than investors')
I totally agree with everything you're saying. But I'm going to quibble with your phrasing. Apple's cash reserves belong to the shareholders just as much as Uber's funding rounds.
Too many CEOs operate under the mistaken belief that retained earnings is "play money" in the way that paid-in-capital is not. For investors, retained earnings are subject to the same opportunity cost of capital as funds raised by equity or debt.
Its management's responsibility to deliver returns exceeding the firm's weighted-average cost of capital. If they can't do that, then they should return capital to the shareholders, who can then use it an alternative higher-returning venture.
Good point. I didn't have that perspective in mind so the wording was off.
My sentiment was that if a company is losing money consistently and egregiously, they are on borrowed time and a borrowed dime in very real terms as the trajectory is towards 0 - but the context is largely psychological. To your point, waste is waste. I agree wasting cash generated from profits is equivalent to wasting it from earnings.
I'd insist there is some practically relevant difference in there though.
Wasting money during a trajectory to bankruptcy creates a narrative of negligence that accelerates failure, while wasting it during a consistently profitable trajectory seems like sub-optimal management. The kind of thing that is theoretically identical, but in the real world of behavioral economics, the former seems more certain due to how easily the trajectory to failure can be estimated. The latter creates a weak narrative because of hidden information - nobody will ever know what "could have been" and so can never quantify how sub-optimal the management was.
E.g. nobody is dragging GE executives out of retirement/the grave to answer for long-term effects of sub-optimal management, and further nobody could prove at the time it was sub-optimal, only hypothesize. On the other hand, everything Elon Musk does at Tesla is torn apart and front page news, because they have a trajectory towards failure a high school student could easily calculate.
So "management's responsibility" to optimally allocate capital is sound in theory, but in the real world of imperfect and outright unknowable information, nobody ever really knows what optimal is. Sub-optimal comes to be expected as normal, but accelerating a trend towards failure is a powerful defining narrative. Somehow this matters.
Why would someone whose been tasked with a job that is involved with gathering as much money as possible, be willing and able to just turn that part of their personality off and start giving money to someone else? Why would they do this just because its investor's money rather than customer's money?
I get that this is the normal ideological description of firms post-70s neoliberal whatever, but if that’s true, like why not just say firms suck, we need communism? Like your description makes Pikkety look like an optimist. “The purpose of a firm is to help rich people get money faster than other rich people” logically implies that eventually a small group of rich people will have all the wealth. That’s feudalism. If that’s the goal, let’s start a revolution instead.
I agree, but the theory "firms exist to maximize shareholder value" ensures that they will be.
Put it this way: gravity turns space dust into supernovas. Dust is just ever so slightly attracted to other dust, so it accumulates and accumulates, and eventually it becomes so massive that it forms a star.
The theory that firms should beat the market makes money gravitational. A shareholder who beats the market will get more money than other shareholders. Now they have more money that they can use to invest in other market beating schemes, etc. If whether a firm beats the market is random, then some investors will win and some will lose but it all balances out. But if beating the market is not random (and how could it be totally random?) then those with the most money can invest in the best firms faster and more easily than smaller investors and crowd them out. Remember that companies only have a finite number of shares, so not everyone can invest in a winner. If there's even a slight bias towards having more money making it easier to beat the market, then eventually you will get a supernova.
We all understand this on some level. Why is insider trading illegal? Because it makes it trivial to beat the market!
Put it this way, if the standard theory of why capitalism beat Soviet communism is that competition created better products etc. none of that requires that the goal of firms is to create better than market average returns to shareholders rather than the goal of firms being a) earn sufficient profit to continue to exist b) benefit consumers c) benefit employees d) benefit shareholders. Yes shareholder would prefer to invest in companies that prioritize them over all else, but why should we the public not say “that’s not an acceptable charter. We don’t want feudalism to happen again, so we are not allowing firms to prioritize shareholders over consumers.”
If the only defense of capitalism is competition, why not market socialism? As in, markets, competition, and entrepreneurship still exist, but all firms must be worker-owned.
Because then you would be forcing everyone to be an equity partner, even if they would rather take a higher salary than share in the risk. Doesn't sound like freedom to me.
Quibble: I don't really see worker-owned firms as a form of socialism, which I understand as the government ownership of the means of production. Worker-owned firms I associate more with distributism.
Worker-owned firms are a great idea, but if that's the only ownership model then you lose some ability to diversify your investments. Everyone's 401k goes poof.
Thinking through this, what are the alternatives? Simple cash reserves are out (because most societies can't seem to shake the tendency towards inflation). Bank savings accounts are a good idea, although impractical in our current society because interest rates are so low.
Alternatively, management could be inclined to not give piles of wealth to people who had zero hand in its creation (shareholders, modulo some employees who also own shares [rounding error]) and use it to pay engineers to do interesting things.
You need 4 things to run a company, in small companies some roles may overlap. In no particular order Workers, customers, management and shareholders/capital. When one gets too much power the company goes rotten. Usually but not always, it’s management.
Shareholders pick the board, board picks CEO. If CEO wants to spend money that his choice until the board gets rid of him.
It's not some sacred pile of cash that 'belongs to investors/shareholders'
I totally agree with everything you're saying. But I'm going to quibble with your phrasing. Apple's cash reserves belong to the shareholders just as much as Uber's funding rounds.
Too many CEOs operate under the mistaken belief that retained earnings is "play money" in the way that paid-in-capital is not. For investors, retained earnings are subject to the same opportunity cost of capital as funds raised by equity or debt.
Its management's responsibility to deliver returns exceeding the firm's weighted-average cost of capital. If they can't do that, then they should return capital to the shareholders, who can then use it an alternative higher-returning venture.