August, 2002

Fruits of Thought

Taking Stock

The Dole Food Company put itself on the side of the angels with its recent announcement that it would start expensing stock options. Although there are technical questions about how this should be done, Dole put itself in league with America’s leading corporations such as Coca-Cola and General Electric in helping to restore public confidence in our markets by putting on the books a compensation expense that obviously belongs there.

If you are interested in the produce industry, you need to pay attention to proposals for reforming corporate governance and procedures at publicly held companies. Although consolidation gets all the attention, it is in many ways a sideshow. The fact that companies are bigger will probably not influence corporate behavior half as much as the fact that these bigger companies are likely to be publicly held.

This change is most pronounced in the retail end of the business, where it was once an industry dominated by regional chains, each controlled by a single family. Now it is an industry of publicly held behemoths, such as Wal-Mart, Safeway, Kroger and Ahold. Since our industry is increasingly going to be influenced by the behavior of publicly held companies, we have an interest in them being properly run and their accounting being clear. A few areas are crucial:

  1. The Initial Public Offering also is the initiation point for a lot of corruption. The problem is that though these are defined as “public” stock offerings, the company and its underwriters are free to manipulate who gets the shares. Because offerings can sometimes zoom on the first day, this is a way to bribe politicians, to get corporate officers to throw business to investment bankers and, generally, serves as a currency to win friends and influence people. The solution is simple: Take the discretion away from companies and investment bankers. Public stock offerings should have to be made available on a proportionate basis to all comers.
  2. Options should be expensed when granted. Companies can pay their employees in cash, in peanuts or in stock options. All have a cost, and that cost is a compensation expense which should be reflected on the Profit and Loss (P&L) Statement. Simply put, a company should not be able to overstate its profits by shifting compensation to options.
  3. Pension Fund accounting must be made more conservative. As it stands now, companies make projections on what their pension plans will earn and the earnings shown reflect these projections. In most cases these projections are far higher than any third party would guarantee. Limitations on projections have to be imposed, perhaps tying them to long-term Treasury Bond returns and then making adjustments for actual returns above or below that level.
  4. Especially after 9/11, insurance is an important area that can cloud earnings reports. If companies go naked, or simply increase deductibles and other limitations, what look like predictable earnings will become far less predictable. Far better disclosure on what is at risk needs to be exposed.
  5. Corporate governance issues – independent directors, independent compensation committees, etc. – must be addressed. We have created a vicious cycle in which corporate executives hire compensation experts who want to be hired again. Not surprisingly they recommend more for the same executives that hire them. It’s a racket and has to be stopped.
  6. Options in particular need to be reduced as a percentage of top executive compensation. The idea was to tie executive interests to shareholder interests, but real shareholders care not only about the stock going up, but also about it not going down. Far better to lend executives money to buy real shares than to give options. With actual stock the executives have both upside opportunity and downside risk – just like everyone else.
  7. Stock buybacks are a terribly corrupting influence in the market. It is sort of like an auction where the seller is permitted to secretly bid. If a corporation wants to buy back stock, it should be able to do so either through a fixed price tender offer 20.00 for X shares or via a Dutch auction whereby the company buys back X amount of shares at the best price it is offered. And the company should be out of the market for five months out of every six. This will make stock prices more reflective of market conditions and give buyers more confidence they are paying a fair price.
  8. Top executives should have good portions of their stock restricted from sale for extended periods. It is imperative to avoid incentives to “pump and dump”.
  9. Auditors can’t be too desperate to keep clients. Term limits to five years would help, as would restrictions on selling other products and services.
  10. Perhaps most important of all, it has to be made clear that the job of a CEO is not to try to get the highest possible stock price. The responsibility is to run the business well. In terms of public markets, the CEO should be certain to get out all the information stock pickers might need to make an informed decision to buy, sell or hold. But a CEO should be as concerned if the market is overvaluing his company’s stock as if the market is undervaluing it.

If we manage to have good corporate procedures for publicly held companies, it will make it easier for the produce industry to focus on adding value. If this is the focus driven by the growth of publicly held companies affecting the trade, the result will be a positive one for the business.  pb