Between a stock and a hard place

The collapse of Enron is just the latest example of problems that can arise with struggling firms facing Wall Street's demands on share values

January 20, 2002|By Michael Hill | Michael Hill,SUN STAFF

One essential element of the collapse of Enron is a theme of such downfalls in recent years - the pressure to maintain a high and increasing stock price.

The allegations at Enron are that large amounts of debt were essentially kept off the books, allowing the company to appear to be as profitable as Wall Street analysts wanted, ensuring that its stock continued to rise. After word of their accounting irregularities leaked, panicked Enron executives asked the White House to intervene, trying unsuccessfully to convince administration officials that the collapse of their inflated stock would take down a large chunk of the country's economy.

When Washington-based MicroStrategy's stock tanked two years ago, putting a large hole in what was then the huge dot-com bubble, the charge was that the company took money from one quarter and put it in the previous quarter, again to beat those Wall Street earnings projections and keep the stock soaring.

FOR THE RECORD - An article in last Sunday's Perspective section gave the wrong affiliation for Walter Schubert. He is chairman of the finance department at La Salle University in Philadelphia.
The Sun regrets the error.

Albert Dunlap and other former executives of the Sunbeam Corp. agreed last week to pay $15 million to settle a shareholders' class action lawsuit that accused them of misleading investors to keep the stock selling.

"There's a lot of pressure on CEOs to keep the stock price up and have it increase," says Peter Cramton, a professor of economics at the University of Maryland, College Park. "This especially becomes a problem in periods of irrational exuberance when stock prices are unjustifiably high.

"It puts CEOs in a position that in order to justify that extremely high stock price, they have to have phenomenal growth, and maintaining that growth is really virtually impossible," he says.

Though the dot-com bubble collapsed, its hangover remains. For many, the way to make money in business is not to profitably produce a product people will buy, it's by hitting it big on the stock market.

That is exactly the way many executives make their money. As "maximizing shareholder value" became the accepted mantra of American business, more executives found their compensation tied to their company's stock price.

When William Clay Ford Jr. announced tens of thousands of layoffs at Ford Motor Company a few days ago, he said he would take no salary, only stock options.

"There has always been some kind of obsession with stock prices," says Nagpurnanand Prabhala, assistant professor of finance at UMCP's Smith School of Business. "It went up vastly more in the '90s. It is hard to say if the relationship is causality or correlation, but you can't ignore the fact that this happened at the same time more and more executives were getting option guarantees."

Many argue that executives' salaries should be tied to stock performance.

"There is no more important and appropriate job for a CEO than supporting the stock price," says Joel N. Morse, director of the division of economics, finance and management at the University of Baltimore.

Morse says that a high stock price means a company has access to capital to pursue its goals, short-term and long-term. When the system works correctly, he says, investors weigh the long-term prospects of a company as they decide on the value of its stock today.

But he agrees that the pressure in today's market to keep the stock price rising can lead to distortions.

"If you are an executive of a corporation and you know you'll lose your job and your fortune if your stock goes from $100 to $50, but you know you need to be cautious in a few areas of your business and you want investors to know that, it's hard to do," he says. "It's harder to call a spade a spade and the whole American market is based on calling a spade a spade."

Some tie the stock price obsession with the rise of financial analysis industry.

"The growth of this tremendous investment community and all the specialists who work in it and all the media that report on it, it seems to me, puts substantially more short-term pressure on management to keep the pipeline going, keep the growth rate going," says Louis Galambos, an economics historian at the Johns Hopkins University. "The external pressure has changed."

Galambos says company CEOs have few more important tasks than their presentations for Wall Street financial analysts whose projections have a tremendous impact on stock prices.

"The amount of preparation for these reports is awesome," he says. "That's because of the pressure they feel from the financial analysts and from the media. Sometimes this kind of pressure can distort things. It can distort prices."

J. Edward Ketz, an associate professor at Penn State's Smeal College of Business, says this exercise has gotten out of hand.

"What started out as a useful service to society by analysts when they collect and study the financial statements and other news about a corporation's welfare to predict its future earnings has become an insane escapade," he says.

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