TCS Daily

Poisoning Shareholders

By Tim Worstall - August 1, 2006 12:00 AM

"Don't mess with markets" is sound advice for anyone, most especially politicians trying (on those rare occasions) to make the world a better place. "Don't listen to them" is also useful, especially for politicians being told how to make the world a better place. For, as is inevitable, those doing the telling will be pushing actions that will make the world a better place for themselves -- usually by messing with markets.

Armed with our newly created homespun wisdom we can now set out to explain the recent rises in executive compensation in the US. As The Economist tells us:

"In 2004 the ratio of chief executives' compensation to the pay of the average production worker jumped to 431 to one from 301 to one in 2003, according to 'Executive Excess', a recent study of 367 big American firms by the left-leaning Institute for Policy Studies. That is not quite a record: in 2000 the ratio reached 525 to one [...]. In 1990 the ratio was 107 to one and in 1982 a mere 42 to one. This year's numbers seem certain to show the gap widening still further."

Now I am not one to worry much about the distribution of wealth or income in society, apologies, but egalitarianism just isn't one of my motivating drives. There are, as you know from reading other writers in other places, plenty who do indeed worry about such things and this trend is, of course, driving them absolutely nuts. What would be interesting then would be to try and explain why there has been this huge rise in executive pay relative to Joe Six-Pack. A number of ideas come to mind.

It could be that executive pay in the 1980s was depressed in some manner and that we are now returning to a more historical norm. I have to admit though that unless we're about to start talking about the income differences between a Renaissance Prince or Pope and a medieval villein working the fields, I really don't think that idea is much of a starter.

Another idea could be that there has been a mass outbreak of greed, that somehow the moral climate has changed, or perhaps some horrible virus has infected the executive suite which causes them to act in such an inhuman manner. Which would be rather an odd thought for there have been written condemnations of coveting thy neighbor's house or ass for at least 4,000 years showing that greed is not exactly a new phenomenon in humans. Indeed, it's pretty much one of the basic thoughts of the entire classically liberal canon that humans are greedy (and lazy) which is why they respond to incentives.

A third, and I think correct, explanation is offered in Deepak Lal's new book Reviving the Invisible Hand. As a result of the takeover boom of the early 1980s the managements of some of the larger corporations started to look for permission, from both courts and politicians, to protect themselves with poison pill defenses in order to thwart takeover bids. These take a number of forms but the essential outcome is much the same: it makes the hostile takeover of a company by a corporate raider more expensive.

This strikes to the heart of the agency problem. In a modern corporation the shareholders have to hire experts (managers) to do the actual work for them. But how are they to ensure that what is good for the shareholders is exactly the same as what is good for the managers? In fact, as is fairly obvious, whether or not a company gets taken over is exactly when those interests diverge. If there is a hostile takeover, the shareholders get the bidding premium, take their money and go and do something else with it. The managers lose their jobs. A pretty clear divergence of interests there I hope you'll agree?

The managers clearly benefit from the poison pill defenses and the shareholders equally clearly do not. As Lal quotes from a paper by Manne from 2002:

"Every statute, adjudication, or regulation that in any way inhibited the free functioning of the market for corporate control simply raised the cost of ousting inappropriate managers. Dollar for dollar, every increase in these costs could be claimed by incumbent managers, either in greater rewards for themselves or in inefficient management policies. Until the real cost of wastefulness equals the cost of a successful takeover fight, they remain secure behind a legal barrier to their ouster, at least until the whole house of cards collapses."

Another way of putting this is that back in the 1950s and 60s, when there was a fairly unregulated market for corporate control, managers could not pay themselves huge sums in this manner because someone could and would come along and buy the company and throw the bums out. Now that those poison pills form the corporate defenses they can't, or at least only at vastly greater cost. If we accept, as I do, that people will broadly do whatever they can get away with in their own self-interest then there is absolutely no surprise in the finding that executive pay has risen.

All of this now brings us to the question of what we should do about it, if anything. Various trial balloons have been floated, for example that executive pay deals should be approved in a vote by the shareholders, even some are insisting that there should be legal limits on top pay. Which all seems a bit odd, really. The problem has arisen because we've allowed the politicians and the courts to mess around with a market, that for corporate control. Rather than adding another set of regulations, which will undoubtedly have knock on effects in other areas, why not just undo the original interference?

Of course, I look forward to those complaining about what they perceive to be excessive executive compensation beginning a campaign in favor of hostile takeovers. Only by restoring a competitive market for corporate control can such behavior be limited, if that is something that we actually want to limit.

The larger point should also be clear. Changes and alterations to the incentives faced by actors in a marketplace almost always have unexpected and possibly unwanted effects elsewhere. The lesson to both courts and politicians is therefore, obviously, "Don't mess with markets".

Now, can we let Michael Milken work his magic once again?

Tim Worstall is a writer living in Europe.



Managerial sleight of hand
Tim, there's really no great mystery in all of this. It has to do with the weakening of labor as a force affecting the management of large corps. When the shareholders are the sole arbiters of how a company does business, it tends to reward only those tactics that make them more money. And short term gains are always preferred over long term viability.

A smart CEO in the new era would, for instance, always seek to automate the operation. Let's say by doing so he sacrifices 1,000 jobs, each worth 50K annually. That's a first-year savings of fifty million. All the costs of conversion, the automated equipment, etc can be pro rated over their lifetime. Thus the true cost of the switchover disappears into the accounting. Some arbitrary figure is established to reflect the new cost of production-- say ten million each year.

All the shareholder sees is that his choice is whether to reward the fellow who just saved the company forty million by giving him twenty million, or to fire the guy and try to find someone who will hire the thousand people back. Unsurprisingly, they always vote to reward him with the twenty million.

Will you please?
Try to write somnething that makes sense?

That post is so unintelligible that its impossible to determine what point, if any you are trying to make.

It has to do with the weakening of labor as a force affecting the management of large corps. What?

All the costs of conversion, the automated equipment, etc can be pro rated over their lifetime. Thus the true cost of the switchover disappears into the accounting. Huh?

Some arbitrary figure is established to reflect the new cost of production-- say ten million each year. What?

The only thing you wrote that is understandable, is wrong.

Let's say by doing so he sacrifices 1,000 jobs, each worth 50K annually. That's a first-year savings of fifty million.

Add: Cost of pensions, healthcare, vacations etc. (add 60%)

other factors
Don't forget the tax structure which still discourages the payment of dividends. Since the corporation pays dividends with after tax money, it is easy to make the decision that stock buy-backs and, huge stock option packages as supposed rewards for enhancing the value of the shares, is the way to return value to the shareholders. This is great cover for the management and does not benefit long term shareholders as much as an increase in dividends.

The other explanation seen regularly is that the corporation needs to pay competitive salaries. Of course, with presidents of major corporations serving on other boards and voting on salaries of other CEO's, they help create the upward pressure of the "competitive" salary.

roy's delusions
The workers have never had a say in the management of large corporations. The shareholders have always been the sole arbriters of how a company does business.

It's a myth to claim that shareholders have no interest in the long term health of the companies that they own. Examination of stock prices shows that the they are determined not just by what next quarters dividends are, but the expected dividend stream out to infinity. (Of course time value of money shows that the further out you go, the less value that future money has.) Next quarters dividends do have more impact than any one future quarter, but since there are an infinite number of future quarters, the net weight of the long tail outweighs next quarter.

Roy wants to turn over everything to politicians, politicians who don't care about anything past the next election.

As to roy's last example.
Roy apparently thinks that the 50 million that was saved disappears into the ether.
Some of it is given to shareholders. Shareholders who then go out and buy things. The things they buy have to be replaced on store shelves. In order to replace those things, other factories have to hire more workers.
Some of the savings goes to customers in the form of lower prices. Which gives the customers more money to buy other things. Etc.

The 10,000 employees in roy's example will get rehired. They will get rehired making other things, and the entire economy improves.

If roy had his weigh, we would all still be riding horses, so that whip makers would not have to worry about losing their jobs.

When one or a few people own a company, management...
...runs the company for the owners when there are no large share holders management runs the company for thier own benefit. Now to certain degree management and stock holders interests are similar but as far as management's compensation goes the interests clash.

But let the market find a solution to this problem.

PS stock holders are not poor...
...peaple and can generally take care of themselves. They do not Politicians comming to thier rescue.

Open Books
Once the shareholders know how they're top executives are being compensated, I'm fairly confident the appropriate steps will be taken (if any).

Let me help you
I can see you're having trouble with my comment, so I'll lead you by the hand.

You are correct in principle that there are additional costs for an employee beyond his salary. But they do not amount to an additional 60%. The employer has to pay his portion of the FICA plus workmen's comp and unemployment benefits. But typically now there is neither profit sharing nor a defined-benefit pension. And there is no cost to a paid vacation beyond salary. So the additional factor is more like 30%.

I should have said the 1,000 terminated employees each had a total compensation of $50K per year.

As for the accounting attendant on converting to an automated operation... are you telling me that if the cost of the conversion is one billion, that billion is expensed the first year? And nothing is expensed the second? No, depending on the nature of the equipment it can be expensed over 20, 30 or even 40 years. This disguises the amount of time the investment pays for itself.

Recently our power company let go 500 meter readers. Anyone doing the math would find that the cost of the automated meters that replaced those readers would only be regained after many years. It was not a sound business decision, but it was presented in such a way that the executives responsible got themselves voted extremely generous comps for the deed. And the customers got stuck with the bill, because as it developed they had to raise the rates to pay for the conversion and the executive comp together.

This is a very typical story nowadays.

Quarterly Reports
Because companies must make quarterly reports, do you think this has any effect upon corporate myopia?

And when coporations will subjected to two or three sets of tax changes every year, do you think this might lead to short term thinking?

And since there are no guarantees, a CEO would be a fool to take over a company without significant compensation.

Look at the pay of college basketball coaches who get fired frequently.

there is no cost to the employer for vacation?
roy does live a fantasy world, doesn't he.

How about the cost of paying someone, despite the fact that no work is being produced? This decrease in output, without a corresponding decrease in cost, is most definitely a cost to the employer.

Roy also forgets the cost of health insurance.

As to his example of the meter readers, roy doesn't give any numbers, so it's hard to tell just how delusional he is in this instance. However, I love the way roy declares himself to be an expert in finance. He knows so much more about finance than people who actually study it, that he is able to see that the power company was making a mistake, where nobody else was.

No Subject
We were speaking of market mechanisms and the momentous increase in executive comp over the past 25 years. One factor we find very prominent in many such instances is that the CEO hollows out the company in order to force a handful of huge quarterly gains. He then points to these gains as evidence of his personal wizardry and reaps the benefits from a grateful body of stickholders.

In a few years when the true costs of these strategies come home to roost, he has already providently provided himself with a golden parachute.

But I know the deal, Mark. It's not that you have any substantive critism of the comments I've made. It's only that at all costs you have to find some way to show me up. It's a sad, sorry game you play.

As for labor having input into management decisions I do note that throughout the years when labor was a powerful force they got to a position of poweful influence over the ground rules of employment: wages, benefits, working conditions, retirement plans, etc etc. You're saying the period from the 1940's through the 1970's never happened?

Finally your argument, that the thousand jobs lost are an insignificant issue because the money being saved on their cancelled wages can be used by others, can be used to justify communism. Because if everyone's means of income can be cancelled at will, we can just confiscate the fortunes of the rich. They can be put to much more productive use being spent by poor people. Right?

Short term gains, long term deficits
As this thread relates to the article, we were talking about mechanisms that lead to short term strategies. And I think you must agree that we've seen a lot of pursuit by avaricious CEO's of short term strategies that are designed ONLY to show a handful of impressive wuarterly gains, so the fellow can go to the bank and be awarded humongous sums of money from the moolah he has allegedly made for the stockholders.

Then by the time the strategies backfire, and the hollowed out company keels over like a prize dahlia given too much plant food, he avails himself of his golden parachute and conveniently bails in advance of those same stockholders with their pitchforks.

There has been no year when any company has been subjected to two or three tax changes. Does Congress commonly pass two and three tax bills each year?

The cost of a vacation
"How about the cost of paying someone, despite the fact that no work is being produced? This decrease in output, without a corresponding decrease in cost, is most definitely a cost to the employer."

In France,where long vacations and short work weeks are the norm, workers are significantly more productive than ours when measured on an hourly basis.

American workers are only more productive on a yearly basis because they have to work such ridiculously long hours. So building some vacation time into a company's comp package can definitely be a wise move.

This claim runs counter to everything I have ever seen
American workers are amongst the most productive in the world on an hourly basis.

roy lets his Little Red book do his thinking for him. (is that a step up from his gut?) and he tell
When you can get past left wing slogans and start actually making sense, then maybe we can start an actual debate.

I'd love to have roy for once, back up his claims that CEO's are destroying companies.

And finally, quit lying roy, I did not say that the loss of thousands of jobs was insignificant. I said that the loss would be made up elsewhere.

Why don't you learn to respond to what people write, instead of building pathetic little strawmen.

Federal, State, County, City,
all have tax authority and can change those policies on a whim.

But you know that, you are/were in business?

Power has passed from the sovereign...
In the 60 years since the end of the Second World War and the beginning of the Cold War sovereign nations have mostly competed on the basis of "Gross Domestic Product as a tax base." The Arms Race with the Soviet Union devolved into a war of attrition as the Communist economy was not able to support the required diversion of its industrial capacity into their military buildup and simultaneously create a consumer market. Without banking, rapidly growing small private companies and Wall Street leveraged public companies the Soviet could not compete. Advanced Capitalism is more productive than Communism.

Financial Economics creates more wealth than Military Capitalism. And as long as military imperialism (annexing your neighbor) is not allowed the State depends on its own economy to provide the revenues to sustain its foreign policy. As modern corporations go global they often "shop" for business-friendly national venues to operate in and low tax markets wherein to "capture a margin".

The corporate entities are now in charge. They know it and their managers take full advantage of it. Governments resist them at their own peril and workers never had a chance. Shareholders are fools. Private citizens should use their money as working capital to create their own wealth rather than to invest it into someone else's venture.

Shareholders are given the greatest encouragement to speculate in a stock and the least actual return possible to sustain it. As a business practice it is prudent to invest in opportunities that will grow the entity. Unreinvested earnings, profits, taxes and dividends equal perfectly good projects that fall below the budget line. This is all bad for the business but good for senior management (compensated with stock) and good for the government.

There are too many ways for our accountants to make a company that is marginal or even losing money look profitable enough to pay taxes and declare a dividend. If a stock is valued at the "net present value of the discounted future flow of dividends" then taxable earnings are necessary to support the stock price. Same story for calculated "multiple of earnings" valuations.

Shareholders are only "virtual" owners at the mercy of management and the Board of Directors (who are dominated by management). Shareholders put their money onto other people's balance sheets. They can then do nothing to "make" such investments work out. They bear 100% of the risk and almost none of the upside. And it is not in the interest of the government to do anything at all about it.

French productivity: number one
"This claim runs counter to everything I have ever seen"

That's not saying much.

Frpm the WSJ: "However, productivity levels per hour in France, Germany and the U.K. are nearly equal to those in the U.S. In comparing 2002 GDP-per-hour levels in the four countries with the U.S. fixed at a base of 100, France tops the list at 103, Germany comes in at 101 and the U.K. bottoms out at 79.

"Some economists say because French workers put in overall less time, they perform better than workers in other countries. The problem thus is not lack of productivity, but the amount of hours worked."

Forbes offers this, from their article "France: Bastion of Productivity":

"Still, French workers remain among the most productive in the world, ahead of Britain, Germany, the United States and Japan, according to the European statistics agency Eurostat, the AP reports."

Even your favorite economist, Paul Krugman, admits it:

They can just get another job
The classic example was Enron, but Northern Telecom and many others went the same route during the Meltdown. They all pursued the same kinds of strategies, and got similar results.

In saying that the people who lost jobs could find other work you treated the loss as insignificant. In fact job loss is far from insignificant, and has psychological aspects almost as significant as the death of a spouse. In terms of financial crisis, it is responsible for many thousands of bankruptcies, particularly in our credit-driven age, where savings rates are marginal or nonexistent. Yes, losing a job is significant.

Thats help?
As for the accounting attendant on converting to an automated operation... are you telling me that if the cost of the conversion is one billion, that billion is expensed the first year? And nothing is expensed the second? No, depending on the nature of the equipment it can be expensed over 20, 30 or even 40 years. This disguises the amount of time the investment pays for itself.

Depreciation doesn't "disguise" anything. Best as I can guess (since attendent isn't an accounting term), you think depreciation is sleight of hand. I can't begin to tell you how wrong you are-every time you write, its obvious that your rants are fueled by ignorance and disorder. Roy, sit down, shut up and stop rambling about things you don't have a freaking clue about.

Thats help?
As for the accounting attendant on converting to an automated operation... are you telling me that if the cost of the conversion is one billion, that billion is expensed the first year? And nothing is expensed the second? No, depending on the nature of the equipment it can be expensed over 20, 30 or even 40 years. This disguises the amount of time the investment pays for itself.

Depreciation doesn't "disguise" anything. Best as I can guess (since attendent isn't an accounting term), you think depreciation is sleight of hand. I can't begin to tell you how wrong you are-every time you write, its obvious that your rants are fueled by ignorance and disorder. Roy, sit down, shut up and stop rambling about things you don't have a freaking clue about.

Depreciation: fact or fiction?
You keep answering my specifics with your own generalities. If I may further describe my point, the period for allowable depreciation is set by the IRS for specific types of expenditures. Therefore arbitrarily they will decide how long certain equipment is to be depreciated. This has little to do with actual costs.

Therefore the investor, trying to figure out how much a conversion actually is costing him, may never know that in the first year the company has actually paid out (for example) a quarter of the billion dollar total, because the books conveniently convey the notion that (according to a thirty year schedule, for instance) the first year cost was only $33.3 million. The total has been amortised over an artificially determined life span.

That to me is sleight of hand. It's figures conveying a false impression.

roy thinks everything he doesn't understand is slight of hand
Add in the fact that corporations are evil, and you get his assumption that everything corporations do is designed to steal from honest people.

While they are set by politicians, it isn't as arbitrary as you want to believe
the depreciation schedules are based loosely on how long a piece of equipment is expected to last.

If equipment last 10 years, it theoretically looses 1/10th of its value each year. Thus you remove 1/10th of it's value from the balance sheet.

You could theoretically calculate a depreciation period for each individual piece of equipment, but the extra accuracy is not worth the huge extra cost.

life is change
get used to it.

if Krugman admits it, it must be wrong
Krugman hasn't been right about anything in 20 years.

Whoop de freaking do. A whole 3% advantage. That's well within the margin of error. I'd have to see how this "survey" was done before I put any weight behind it.

Especially since this one survey comes up with results that run counter to every other survey and study done.

Breathtaking Display of Ignorance.
What specifics? What point?

You are ranting on and on about a benign topic which any first year undergrad business school understands as a necessary attempt to match the economic usage of a fixed asset with the period in which the usage occurs. Despite the limitations of depreciation, its better than immediate expensing. Moreover, any annual report will contain notes to explain depreciation policies and for those that are interested in cash a Statement of Cash Flows is required by FASB 95 as a part of a full set of financial
statements. You obviously have never read an annual report.

But you continue compounding your lack of general understanding with error. The IRS does not set depreciation periods except for purposes of maximum deductibilty from tax. Incidentially, they are designed to ensure that a company does not immediately expense the cost of fixed assets, which is what you think is proper.

You can continue to believe your some sort of autodidact, but anybody reading you realizes your rants are composed of ignorance of the subject matter and negligent disregard for your own lack of knowledge. The fact that you don't have the ability to understand what professionals in a field are doing, doesn't make it incorrect or malfeasant.

Please Roy, continue to purport the evils of depreciation and continue to argue accounting with a CPA.

French productivity.
Roy is correct here, on a per hour basis French workers are more productive. As Brad Delong has pointed out, of course they are. Increasethe vacations, lower the work week at no loss in pay and each worker is now more expensive to the employer. So said employer will reduce thelabour force and increase the use of labour substituting capital. So those fewer workers who get to keep their jobs will bemore productive.

Whichis fine.

All that leaves is the 10% who can’t find any job, the 20% youth unemployment, the 50% youth unepmployment of the immigrant families.

All of whom areof course producing nothing at all. Which is the reason why the US is 30% richer than France even thought the smaller number of French who do actually have jobs are slighty more productive on a per hour of work basis.

Depreciation (continued)
My experience with depreciation comes from the housing market, where improvements are considered to become completely valueless after 27.5 years.

This is an arbitrary figure. But when used in an annual report it gives rise to a deceptive concept of cash flow. Some properties are maintained well, and are worth far more after a century than their original cost of construction. Others are ticky tacky, and are worthless after 15-20 years.

It's a little like saying the average life span of an American is 73 years. Therefore it follows that all 76 year olds are dead. It's bad accounting.

More accurate would be to disclose the actual costs of retrofitting, and give the caveat that the new uquipment is expected to last x years before significant upgrades are needed. But try finding that on your annual report.

Knee jerk opinion
So show us another recent survey that compares American and French productivity on a per-hour basis. Don't just knock a survey on principle that appears to be accepted both by the WSJ and by Forbes. What do they know that you don't?

Perhaps they've actually read the report.

What happens to French productivity when you include the 10 to 20% unemployment?

Why do you consider it a completely arbitrary figure?
Have you discussed this with accountants and economists?

Or are you just listening to what your gut tells you again?

roy is utterly convinced that the world is involved in a conspiracy to deny him his rights.
he just has to figure out the details.

Uh Roy, Er I mean Michael...
But when used in an annual report it gives rise to a deceptive concept of cash flow.

You are about as persistent as you are ignorant of the matter.

Depreciation is a non cash expense, the result of accrual accounting, which has proven to be more useful than cash basis, because INCOME ISN'T CASH!

If you want to see cash flow, consult statement of cash flows. Didn't I just tell you this?

Are you for real? Or do you just project a persona of a complete dolt to see how long people will try to lead you on the path of righteousness? Seriously, you can't be this dense.

Productivity tradeoffs
Well said, Tim. The increased hourly productivity of the French is indeed offset by higher production costs for the employer. I'm not so sure French workers are paid the same as Americans, though, on an annual basis. And I'm not sure there is any direct link between higher production costs and Europe's chronic underemployment.

I would look to see what has changed since the days when Europe's unemployment rate was routinely half that of the US.

One tradeoff is that American workers now have no clout in the employment marketplace, so must work longer hours and harder hours in order to earn their wages. So if you're managing a national economy for the benefit of the shareholders, America is better. If it's for the benefit of the workers, Europe is better.

Corporations & Government
Its also somewhat amusing that his assumption that corporations exert tremendous power through bureacracy could be applied to government. Of course government has the tools of taxation and imprisonment, unavailable to corporations but he sees nothing but benevolence and light from the feds.

All bureacracies tend to pursue their own ends, but corporations can be erased by competitors.

Immediate expensing
In your own personal bookkeeping, do you make any attempt to monitor actual cash flow on a real time basis? That is, do you "attempt to match the economic usage of a fixed asset with the period in which the usage occurs"?

When you pay cash for an item that may give you twenty years of use, you don't actually pro rate the expense at so much per year. You pay all the cash up front. And if it puts you in debt and you have to pay in installements you add the cost of the loan (origination and interest) to the cost of the purchase. These are things one's wife, one's bookkeeper or if one is a corporation, one's stockholders, have an interest in knowing.

Actual cash flow is always a good thing to keep an eye on. Otherwise you can indulge in subterfuges like transferring assets to dummy corporations that then pay handsome installment payments back to you-- with your own money. Or, depending on what you want to convey, transfer assets to cutouts who then lease them back to you. In that instance you pay handsome leasing fees back to yourself, and take the deduction.

With tricks like these, it's well known that a corp can convey any impression it wants to-- telling the investors, for instance, how much money it's making while at the same time, telling Uncle Sam how much money it's losing.

But what I really want to know when I analyze any property is, in a given time period, how many dollars does it actually put out, and how much does it actually take in?

Why is depreciation arbitrary?
I've worked with questions of depreciation for thirty years. It's an absolutely arbitrary concept, of use only in filing one's tax returns. It deals with an imaginary disposition of dollars.

Still at it huh?
Hire a CPA to explain it to you.

Stop banging your head against the wall. It will feel better when you stop.

Outdoing Yourself Everytime
Read the cash flow statement.For the third time, cash isn't income.

Also, your confusion aside, I don't issue financial statements on myself and intentional failure to disclose related party transactions isn't anything like depreciation.

Here's the final thought. For a licensed CPA to issue an unqualified opinion on financial statements that were supposed to be prepared with generally accepted accounting principles, but which expensed capital assets immediately would result in loss of license, fine or imprisonment.

Finally, on second thought don't hire a CPA see a psychiatrist.

Cash flow defined
Cash flow statements that allow for the use of depreciation in the place of actual cash flow distort the picture to the degree that it is unusable as a guide. Depreciation is a false figure, arbitrarily derived. A property with a twenty year depreciated life span may at the end of twenty years be worth five times the original cost, or it may be worth nothing at all. It depends on maintenance.

Cash flow in my world is the difference between actual cash in and actual cash out. When more goes out than comes in you have to borrow to make up the difference.

Cash flow, for the layman
Okay, I see the problem. You must be an accountant. I'm not (as though I needed to tell you).

I am vaguely familiar with Generally Accepted Accounting Practises, and note that they never seem to want to tell me what I most want to know. As a small investor I find them instead to make financial statements needlessly opaque. I want something that I can use to readily look at what I (incorrectly, I'm sure) refer to as a company's cash flow. Which is, how many dollars they write out as checks each year, as opposed to how many dollars they take in as revenue.

I don't find that on the prospectuses. Periodically someone does move to simplify the accounting as it is presented on these mazes of obfuscation so an untrained eye can figure out how the company is doing. The motion never does quite come to pass. For me, the reasons are obvious. If they were ever to simplify the format, just anyone could see whether the company in question is doing well, or not so well.

To arbitrarily say an investment in new plant should be expensed over a twenty year period (for instance) just obscures the central question: how much they are actually spending on new plant and how much of this is borrowed funds. As it stands, the amount of interest involved in one area is lumped together with interest in other areas, and the whole thing takes on the character of an optical illusion. The numbers dance around on the page, revealing nothing.

When I ask myself how to evaluate residential rental property, which is something I do know something about, I ask an entirely different set of questions. And I get answers I can use.

I hope this addresses the bug that's chafing your britches.

The only part of depreciation that is arbitrary is the fact that every known product is clumped into only a handfull of categories. This is done because coming up with depreciation schedules for the gazillions of known products, plus bazillions of new ones being created every year, would cost more money than the effort is worth.

Depreciating something as it is used up, rather than all at once, in the year it was bought, makes sense.

How many people do double entry book keeping.
If you don't then you don't need to worry about depreciation.

Do you even know what double entry book keeping is roy?

No deception there
"Guess what, honey. We just bought ourselves a brand new Toyota!"

"What did you pay for it?"

"That's the best part! It only cost us $2,000."

(Goes out into driveway.)

"You liar. That car cost $20,000 easy."

"Well, yeah. But it'll last us for ten years."

Looks like I was right
roy hasn't the foggiest clue as to how double entry book keeping works, or why businesses use it.

He just falls back on his, if I can't figure it out, it must be evil schtick.

If your paying for it over 10 years, then the cost would be $10K/yr.

oops, that would be $2k/yr. My second mistake, how can I live with the shame.

Brilliant Analysis!
According to your logic people are plunking down 20,000 one day and having an absolutely valueless piece of metal in their driveway tomorrow.

Must be some new Marxist economic theory, certainly would come as a surise to those of us who've HAD TO BUY a used car. Dammit, stupid me and all the other fools looking for wheels on used car lots.

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