“Business Ain’t Usual” from Visible Hands

The following blog post is reposted from Visible Hands, a weekly newsletter founded by two GSB 2021 students, Libby Coleman and Jessica Chao. Their newsletter covers how business works, the implications of business on society, and how individuals can keep them accountable. You can subscribe to their newsletter here.

We had the pleasure to speak with Anat Admati, economist, finance professor at Stanford Graduate School of Business, and Time’s 100 Most Influential People. For more of Anat’s thoughts, you can find more in this piece about shareholder maximization and The Bankers’ New Clothes: What’s Wrong with Banking and What to Do About It. We spoke about the role of the Fed, debt overhangs, and the link between capitalism and democracy. We’ve condensed and edited the interview for concision and clarity.

Business as Usual? 

VH: Is the crisis that companies found themselves in around the time of COVID because of COVID? Or were the signs already lurking?

 AA: Bankruptcy, which sometimes leads to liquidation or restructuring, deals with debt and whether a business is viable. Sometimes a company is not successful or another technology comes along. Going into the Covid-19 crisis, debt was building up over the decade because of post-2008 low-interest rates. All this “propping-up” puts off bankruptcy and leaves us with a lot of zombie (insolvent) companies that are inefficient and dysfunctional. When left to their own devices, such companies can behave recklessly to “gamble for resurrection.”

The economy is a bunch of linked IOUs. The bond market, corporate and business debt, mortgages, student loans, credit card debt, and even rent payments to a landlord. The policy question is: which commitments are more important? The government provided some limited support to small businesses and froze evictions for a while. Individuals who have debt are struggling. Corporate bond investors benefit from government and Fed support.

 VH: We have noticed that realities of the pandemic-induced economic crisis and the stock market seem disjointed. As a finance professor, how do you make sense of this?

AA: The stock market represents public companies, which tend to be the larger ones, and it is dominated now by big tech companies, which are actually thriving in the pandemic.

What’s causing some of the market highs is also government support, and especially actions by the Federal Reserve. The Fed did extraordinary things a decade ago, but it’s doing even more now, including buying corporate bonds of dubious credit quality and thus encouraging ever more borrowing and risk-taking.

Extremely low-interest rates tend to lead investors to overlook risk as they chase better returns. When corporations make payouts to shareholders such as dividends, and continue to borrow, they become ever more fragile, as does the entire system. Remember that the investor class is not representative of the population. Nearly half of the population owns no stocks at all. The richest 1% of the population now owns half of the stock markets, while the bottom 90% own only 12%. Propping up the stock market thus helps the rich disproportionately.

VH: Debt seems to get preferential treatment in our tax code (i.e., interest expenses create a tax shield). Why do we subsidize corporate debt? And can you share some learnings from your research on debt addiction?

AA: Subsidizing corporate debt and mortgage debt is a distortion. There’s no good rationale. Policymakers find it inconvenient to fix this problem even though there is a broad understanding that this debt tax bias encourages fragility and inefficiencies.

Once debt is in place, how do you maximize “shareholder value” as measured by the value of a share? It turns out the incentives get distorted in favor of more risk-taking and more borrowing, as long as previous creditors would allow it. The distortions come from intense borrower-creditor conflict. In addition to the possibility of taking excessive risk and “gambling for resurrection” with risky investment, borrowing creates incentives to continue borrowing, make payouts to shareholders, and generally take actions that increase indebtedness.

 VH: What worries you the most about the state of play right now?

AA: I worry about the dual crisis of trust in both capitalism and democracy. They are intertwined. I also feel that our economic and political systems are unjust in many ways.  

When companies lobby against the public interest in the name of maximizing shareholder value, they can distort competition, rules, and democracy itself. I wonder how democracy can survive and keep corporate power in check when many people are angry, without understanding what specifically needs to be done or being able to get policymakers to act on their behalf.  

What Now?

Thanks to Anat for many of these suggestions!

 As a consumer:

• Check out Erin Brokovich’s newest book, Superman’s Not Coming, which focuses on the U.S. water crisis and Michael Lewis The Fifth Risk. The big lessons? Appreciate the importance of a competent government, don’t assume that someone else is making sure the government works on your behalf, and make your voice heard in every sphere! 
• Look into Transparency International and Global Witness to better understand corruption globally.
• Get involved in advocating for consumer protection. One example is the non-profit Kids in Danger (founded by Anat’s close friends after their toddler died from a recalled portable crib in 1998) that fights for children’s product safety.

 As an investor:

• Better Markets is working toward fairer, more transparent financial markets.
• Pressure corporations to avoid lobbying against the public interest or trying to act in ways that deprive the government of resources, incentives, and expertise to act in the public interest.   

 As an employee:

• You can monitor your company’s balance sheet to see whether debt is becoming a large portion of its funding.
• Find ways to speak up and collaborate if you feel your employer is acting illegally or unethically.

As a citizen:

• Look at the Center for Political Accountability for more transparency and disclosures on political activities.
• Some legislation passed post-2008 financial crash, like parts of the Dodd-Frank Act, are not enforced to their full ability. And there are parts of the tax code & bankruptcy code that fully remained intact that ought to be changed in order to have a more fair economic system. Keep your elected officials accountable to make sure such laws are properly implemented.