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Companies and Their Role in a Society in Crisis
[Analysis] A look at ethical financial practices
Alfredo Ascanio (askain)     Print Article 
Published 2009-03-09 11:51 (KST)   
At this time of crisis it is worthwhile to summarize the reflections of US Vice-President of AT & T Corporation (1967) John J. Scanlon.

What level of earnings is required if US business is to grow and prosper to meet national objectives? What is the best test of corporate earnings adequacy?

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There is much uncertainty and confusion regarding these questions. But we develop the point of view that the best guide to an answer is not earnings-per-share trends or the cost of capital; it is the concept of opportunity costs, as was noted in the sixties by academics from Harvard University.

At the outset of this discussion, therefore, let us examine the close relationships among plant and equipment expenditures, profits, and growth in gross national product (GNP). By way of conclusion, we shall raise some questions relative to the significance of the corporate earnings and investment picture for public policy.

How Profits Nurture GNP

At all times, unless in times of great crisis or recession, the United States has emerged as the most productive and economically most powerful nation on earth.

The upward thrust in the US economy's expansion has resulted in a level of national living that is at once the envy and aspiration of every other nation. Indeed, "blue collar" workers in the United States always enjoyed a standard of living equal to or surpassing that realized by most of the so-called privileged classes in many advanced Western nations.

But this does not mean that the need for economic growth in the United States is diminishing. Just the opposite is true. The increasing importance of growth is underscored by the projected increase in the labor force, today brutally diminished by the deep crisis of this century. But jobs must grow at a 50 percent greater rate than in the past decade, addition to the unemployed of today (8 percent).

Both political parties have accepted the doctrine of full employment and it has been the focus of attention for the past years in each of the Economic Reports of the President.

Will the US's productive capabilities be able to keep pace with its economic and social commitments in the years ahead? More specifically, will the output of the private sector be adequate to meet the truly enormous demands of a sharply rising labor force, a rapidly growing body of elderly citizens, and an ever-rising population of school and college age?

To throw some light on these fundamental questions, we must consider more fully the framework within which the corporate sector of the US economy has operated in recent years and consider the goals of future years.

For many years, US corporations have expended billions and billions on new plants and equipment, and this has had a major impact on the growth of GNP. Plants and equipment expenditures are considerably more volatile than GNP, but there been a significant increase in the ratio of capital investment to jobs.

Investment and Profits

Under the profit-and loss incentives inherent in this free enterprise system, plant and equipment expenditures can proceed only when reasonably adequate profit opportunities are contemplated. The overriding importance of profits in spurring investment was recognized by President Kennedy and was pointed up by President Johnson.

While profits are not the only source of funds for capital investment, they play the key role. The importance of internal sources, primarily reinvested earnings and depreciation charges shows the persistent tendency of internal funds to satisfy about three fourths of corporate needs. Reinvested earnings, of course, are generated directly from profits being the balance remaining after the payment of cash dividends to shareowners. The most compelling reason is a solid earnings record and prospect of improved earnings in the future.

The first criterion focuses on short-term increases in earnings per share as the sole guideline, but today's increase in earnings per share may be tomorrow's decrease if investor expectations and investment potentials are not taken properly into account.

If management imposes undue financial risk on the common shareowners by "leveraging" its capital unwisely, i.e., adding too high a proportion of debt obligations, it will be only a question if time before the company's shares is reevaluated in the market.

But the true cost of equity capital for a company is the earnings the shareowner's capital could attain in alternative opportunities (12 percent or 15 percent?). By focusing on opportunity costs, we are unshackled from the vagaries of stock market prices and the host of related problems. Using the opportunity cost concept, corporate management can determine the earnings rates required by making a comparison with a broadly representative cross section of alternative investment opportunities.

The Task Ahead

This nation faces human and economic problems of truly staggering proportions. Prominent among these are the task of providing employment for the millions of people who are currently unemployed and millions more who will soon increase the labor force substantially. Many young people will be attaining marriageable age during the next 15 years, and a tremendous increase in household formation may be contemplated. All this adds up to an overwhelming need for continued high levels of investment in companies, schools, housing, public utilities, hospitals, and the like.

Businessmen must strive to serve the national interests fully in attaining the country's economic goals, with ethical financial practice. This means that as decision makers in the corporate process, all the people must be alert to remind the nation's political leaders of the fact that any reduction in corporate profitability at this time carries the threat of increasing more unemployment and economic stagnation. This is a price the citizenry can ill afford to pay.

Alfredo Ascanio is a professor of economics at Simon Bolivar University in Caracas, Venezuela.
©2009 OhmyNews
Other articles by reporter Alfredo Ascanio

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