In the financial world.
We praise our economy, and then faced with a severe disturbance for what, 4 weeks now, many of our largest companies are ready to file for bankruptcy. I have been blessed with making decent money so have saved much and have easily 2-3 years cash on hand to weather this severe downturn. Why don't we demand the same for our companies?
I understand that someone who works a MCD's or other low-level service job can't save enough to be in the position I am in, and will truly struggle with rent, etc. But why do we allow our major companies/industries, who pay their Exec staff 100s of millions, to be run as if they are low-level service jobs? Why should they be rewarded for that?
I mean, there have been many, many posters here that say keeping more than a couple of months worth of expenses in cash is an inefficient use of those funds and comes with significant opportunity costs. Some even advocate for essentially no cash emergency funds (choosing to use credit cards as the E fund while they liquidate other assets to generate income to pay the card off). Many of these people are intelligent, wealthy, successful people that view cash on hand as a drag rather than an important safety net. Cash on hand is money that's not earning anything for you. It's not being invested. It's not being used to increase your skills. It's just sitting there making you feel more secure until the odd day that you do need it.
If we're going to treat companies like people, and expect them to have cash on hand for emergencies, then that's money that can't be spent on R&D. It's money that can't be returned to shareholders. Basically, if we want our companies to keep a ton of cash on hand to cover times of need, then we need to be willing to accept lower investment returns all the time from those companies.
+1
Companies have evolved to become very efficient just-in-time operations to deliver the best profit and return, but at the trade-off of resilience, and we collectively praise them for doing so when we feel great when the S&P is hitting new highs.
A business analyst would look at the human body and conclude that having 2 lungs and 2 kidneys was financially inefficient, and probably engage in the organ trade business.
The world could do with an approach that leaves a little more fat on the bones for most companies to survive a bad downturn, even at the cost of a few percentage points of efficiency and profitability.
Exactly. A company holding, say, a billion dollars in cash in a highly liquid savings account or treasuries would be killing it's own ROI and ROE. They would be borrowing at, say, 5% and sitting on the cash, paying $137k in interest every day, on the rationale that something bad could happen someday. Investors (i.e. us) would flee from such a company. Activist investors would take over the board and evict the management who made such a decision. Competitors would steal market share by offering lower prices and reinvesting their higher profits. Bottom line, the concept of a company that could self-insure itself is an impossibility.
The closest we get to that would be the commodities companies who use futures contracts to hedge and buy themselves a year or two of survival at commodity-crash prices like we're seeing now. But at least futures contracts have an expected value of near zero (the losses and the gains offset over very long periods). There is no break even rationale for a company paying the cost of capital to hold cash earning nothing.
I was taught in my MBA finance class that companies can boost their ROE by increasing leverage - at least to the point that their cash flows are reliable enough to make the payments. Also, one gets a job in upper management by offering shareholders a plan to boost ROE. So the incentive is there to take on debt and buy back shares to increase ROE. Thus, most companies will be leveraged to the full extent allowed by their lenders.
Fast is fragile. If you drove an F1 race car around your neighborhood, you might do a million dollars damage to the carbon fiber bodywork or suspension while slowly rolling over the first bump. The space shuttles Challenger and Columbia blew up due to small cracks on the tiles. Meanwhile a family sedan can continue to function at its speed after having its entire bumper knocked off, and a locomotive can continue to function at its speed after crashing into a family sedan. Ships frequently collide and continue to function afterward. Investors prefer the F1 race car or the space craft, because these are expected to outrun their competitors in the foreseeable future. Investors set their own AA's and cash cushions instead of expecting their companies to do it for them, and own funds containing thousands of companies. They are only even aware of bankruptcies if it is one of the larger more newsworthy companies.
Given these facts and circumstances, it is inevitable the economy will be full of highly leveraged companies holding almost no cash.
Does a government backstop encourage this behavior? Maybe, but it's debatable. I think the easy availability of huge amounts of venture capital and loans during the good times negates the benefits of saving up for bad times. A company with a conservative balance sheet might be the only one in its industry to survive a black swan event. However, a short time after the crisis they would face startup competitors with no prior debts and huge amounts of venture capital and bond funding. Then they get beaten in the good times by competitors who can afford all the best equipment, tech, talent, and supply deals! So why invest in companies with conservative balance sheets? Heads (no crisis) you lose and tails (crisis) you lose, just a little bit more slowly.
