Tag: things i think about

Accounting and finance: the rationale

I’ll do my best to describe my understanding of finance, based on my accounting and finance classes this term, my discussion with the lecturer last week, and some thoughts I’ve put together since then. This post will be long and specific but some people have asked for it.

I will break up the topic into two posts. A 2000 word essay on accounting might be a bit much to take for readers of what Blogshares calls a humorous blog. This post looks at:

  • What is my function as a shareholder?
  • What does it mean, to own a ‘share’ in a company?
  • It seems like only the initial investors provide the needed capital. Why should subsequent investors get dividends and control of the company too?
  • So why does a company’s share price go up and down so much? Surely its assets don’t fluctuate from day to day?

The next post will be released in a few days and will consider:

  • Why does a company exist to profit shareholders?
  • What happens when a company fails? Who suffers the most?
  • Should companies be blamed for bad behaviour?
  • Is capitalism the answer? Is there are better way, waiting to be imagined?

I have been thinking about whether or not it is fair or desirable for people to live off a passive income from their share holdings. Companies operate to maximise profits to shareholders and in doing so, they may do things that I intuitively think is unfair, like downsize (‘rightsize’) their workforce, pollute the environment, avoid tax (legally), and lobby to keep perverse subsidies. What do shareholders do to justify such unswerving loyalty from the company? Well, I don’t do an awful lot, yet I’m getting money from dividends. And so, I’ve been worried that it is unethical for me to invest on the sharemarket.

What is my function as a shareholder?

Another way to ask this question is ‘How do shareholders contribute to the productivity of society?’ The traditionally held notion is that productivity requires three things: land, labour and capital.

In the past, aristocrats had a monopoly on land, which is the limiting factor in an agrarian society. Land is no longer so important, especially with the rise of knowledge-based services and the mass production of crops.

With the abolishment of slavery, nobody owns labour except their own (and maybe some powerful employee unions). Labour is not an asset; it does not show up on financial statements because a company cannot own its employees. Because you can only control your own labour, you will not get rich by working for a living.

Finally, society’s productive endeavours require capital, some means of obtaining the goods (shovels, computers, buildings) to do something. The function of shareholders is to provide capital. They also take on the residual risk, which I will talk about in the next post.

What does it mean, to own a ‘share’ in a company?

A ‘share’ is a claim on the assets of a company. The assets may be tangible, like property or equipment. They may be intangible, like money owed to the company and patents.

However, when an investor buys shares in a company, they’re not really interested in what the company owns at this moment. Its current assets are insignificant compared to the income that the company will generate over its life in the coming years. People choose to invest based on if they believe that future income will justify their initial outlay of cash and if they think they will do better here than putting their money in the bank, property or other stocks.

It seems like only the initial investors provide the needed capital. Why should subsequent investors get dividends and control of the company too?

When a company wants to raise money, it tries to convince potential investors that they will do better buying its stocks than anyone else’s: ‘Give me capital now and in return, you have a claim on my future income.’ The investor weighs up the risks and chooses to invest.

At some point, though, they decide they don’t want this risk anymore. In their opinion, the company’s fortunes are going down or they find an investment that they believe will give them better returns. So the initial investor says to the market, ‘Who would like to buy off me the risk of owning this company?’ and someone says, ‘Based on my analysis of the company’s prospects, I will buy the risk for this amount.’ If the price is acceptable, the exchange takes place.

So why does a company’s share price go up and down so much? Surely its assets don’t fluctuate from day to day?

Shares are a measure of a company’s value. Some of the value is based on its assets and liabilities (debts and obligations) but the most important things to a company’s prospects cannot be represented on a balance sheet. Things like research investment, many patents, staff experience and skills, brand, relationships with existing clients, company leadership, company strategy, all these aspects cannot be valued financially and/or controlled by the company, so do not show up on the balance sheet.

Their effects, however, do show up on the income statement, which shows how much money the company made over the year. Investors trying to decide what a good price for a company is will look at the income statement and extrapolate it into the future. In doing so, they have to make assumptions about the company’s growth rate, tax obligations, industry and political factors, the time horizon, and so on. All those things depend on the hard-to-value factors like brand and staff.

So, the reason why share prices go up and down so readily is that it relies on people’s different judgements of the company’s prospects and their own value of risk. This is why a stock price might plunge if a company is taken to court or spike if there is a new CEO. These factors are generally more important than how many buildings or bulldozers it owns.

An encounter with graciousness

I had four accounting and finance classes with the head of the MBA program here at Cambridge. I found it truly interesting. Accounting is such a limited yet powerful tool. After the classes had finished, I sent an email to the lecturer, pouring forth all the questions I had wanted to ask in class.

Why does a company exist to increase value for shareholders? What is the function of a high share price? (To ‘do better’ than the cost of capital, to prevent takeovers…) Does it matter to a company’s day-to-day operation if the share price falls? (I suppose the share price should reflect operation rather than the other way around.) What would happen if a company’s first allegience was to its employees? When wages are an operating cost, is there shareholder pressure to reduce them? Is there some way to modify the accounting system to reflect social costs? (But these are difficult to price and are not levelled against the company.) Perhaps it would be more workable/sustainable for the government to internalise such costs so that they show up in the balance sheet as part of a company’s normal operations. To what extent is a company’s behaviour shaped by its balance sheet and accounting practices?

I felt like I just had to get the questions out but at the end of the email, I backed away and said the equivalent of, ‘You don’t need to answer these questions. This is just me thinking.’

Against all reasonable expectations, the lecturer replied. ‘Joan. These are all very good questions. I would be happy to discuss at some point if you would like.’

Do you know how excited I was? I was very excited — in an absolute flap, really. Why? I would have access to someone who knew the world’s financial systems, someone who I believed didn’t have a left or right wing agenda, someone who would listen to me and answer my questions. I’ve been looking for an opportunity like this since reading The Divine Right of Capital.

I met the lecturer yesterday and we chatted for half an hour or so. He answered all the questions I had in my email, and more. I’m still processing some of what we talked about.

He must be a very busy person. He didn’t have to speak to me: I’m not in his course, the discussion was essentially recreational, I gave him an easy way out in my email. Yet, he did and in no way made me feel like he was doing me a favour. I’ve met people less important than him and far less generous with their time.

Such graciousness is something to aim for.

Mr or Ms Not-quite-right

This is interesting: All Men Are Liars describes ‘the 80 per cent relationship‘.

I think you just need to be careful about the criteria you put on your scorecard. There are important criteria. For me, it’s intelligence, sense of humour, generosity… For others, it might be religion, interests, independence, attractiveness…

I do believe that people are often too picky. Their scorecards are loaded with things that don’t matter or are unrealistic. Perhaps no one should settle for 80 per cent, but if someone is consistently finding 60 and 80 percenters, then maybe he or she needs to look at his or her scorecard.

CheatNeutral — a funny but limited analogy

My friend, Dan M, sent me a very funny link. CheatNeutral pokes fun at the carbon offset industry by comparing it to people paying to offset their cheating.

I wrote back to Dan. This below is a slightly edited version of what I sent.

This is very funny. I’ve sent it onwards to five of my classmates. We’re working with an architecture firm on the legal/technical/social/economic/environmental management of carbon offset projects for renewables in building projects around the world.

The analogy between carbon offset and cheat offset is a tad questionable, though. Cheat offsetting is clearly a ridiculous concept and it’s meant to highlight the problems with carbon offsetting, namely that relying on offsetting does not provide incentives for reducing the source of the problem. However, some of the ‘outrage’ from cheat offsetting is that cheating is a moral issue. More and more, pollution has become a moral issue (‘It’s evil or irresponsible to pollute at any level’) but the morality of pollution is by no means universally accepted.

There are still large sectors of society that believes that there may be an optimal level of pollution and appropriate compensation for pollution. This is completely different to, say, if a Chief of Police comes out and says that their crime fighting budget has been allocated based on a risk assessment that has determined the optimal number of child molestations. That’s because child molestations (and cheating) are moral issues.

It’s kind of like the difference between the Australian government views drug use (‘Just say no’) and the Netherlands treatment of drug use as a health and social problem. Or the way medical researchers say that the costs of some animal suffering are justified by the benefits from testing on animals, while to animal rights activists, there is no ‘optimal’ amount of animal suffering.

So the key difference between carbon offsetting and cheat offsetting is that carbon offsetting can work. It does suck carbon out of the air. It could help mitigate global warming.

(Note that in Europe and other places, carbon offset projects include replacing fossil fuels with renewables or more efficient appliances. It doesn’t just cover sequestration by growing trees or pumping CO2 into the ground).

Of course, we can’t rely on carbon offsetting because the fundamental problem is that we live in a world that encourages (even mandates) increasing consumption and growth. Even if we were to eliminate CO2 emissions, current CO2 generating activities have other environmental impacts that cause problems, like resource depletion, toxic pollution, habitat destruction and so on. Offsetting can’t address these problems. Even eco-efficiency can’t address these problems (see Jevons Paradox). I have come to believe that cold nuclear fusion (clean limitless energy) will just allow us to destroy the earth even faster.

To me, it would have been more correct to have compared carbon offsetting with, say, a reliance on chemotherapy. Chemotherapy doesn’t generally have a moral dimension. It’s effective in many situations but there are plenty of negative side effects — and surely it is ‘better’ to address cancer triggers.

Of course, that wouldn’t have made as funny a website as CheatNeutral.

Campaign for real beauty

You’d think that someone with a supportive family, a good brain and happy outlook on life would be in the best position to ignore media pressure to be conventionally beautiful. I’m afraid not. Despite all reason and logic, I have, at my core, tied no small measure of my sense of self-worth to how my skin is behaving, what my hair looks like, if the clothes I used to wear still fit, and if I can wear the clothes that people think I should wear.

I found this interesting — Dove’s Evolution Film. Women are told all the time, “It’s all make-up and Photoshop.” It’s one thing to be told. It’s another to see it.

Thanks to sharnofshade for the link.

Chinese dolphins

I watched a debate at the Cambridge Union. Halfway through her speech, I realised that one of the speakers was an Australian. This is how I recognise fellow Aussies: I don’t notice an accent. Only when I notice that I feel completely comfortable listening to someone speak, do I think, ‘He /she must be Australian!’ This is a much slower process than pinpointing people’s English, German, American, Chinese accents.

My mum says that I speak Chinese with an Australian accent.

When I saw Indian people selling clothes and food in a Taipei station, it occurred to me that there must be people who speak Chinese with an Indian accent.

On that same trip to Taiwan, I went to Hualien Ocean Park, where I watched dolphins performing. As the dolphin trainers called out to the dolphins, I started laughing: ‘Those dolphins speak Chinese!’

Going nowhere

Whenever I go to the gym, I think about the waste of energy. For most of history, there were no such things as gyms because people expended energy by walking, farming, doing household chores, climbing stairs. Now, it’s kind of funny thinking about all the people at the gym cycling on the spot, going nowhere. Or running a treadmill, going nowhere. Or climbing on the StairMaster, going nowhere. Or lifting weights, up and down, up and down, then putting them back exactly where they were before.

Sometimes, I think that all those machines should be hooked up to generators so that the dissipating energy could be put back into the electricity grid. Wouldn’t it be great if the roomful of people could power a laundromat? We could arrive at the gym, load up the washing machine and ride our way to clean clothes.

A Study Into the Effects of Make-Up on Observers

I had to learn how to put on make-up because I performed in theatrical dance competitions and concerts. Before starting work, the only time I would wear any sort of make-up was for:

  • dance performances;
  • balls and dinner dances; and
  • job interviews.

I now wear a little bit of make-up when I go to work. A style coach at university convinced me to wear make-up to work (we also had an etiquette coach, remember?).

One day, when I was going to do fieldwork all day, I decided to skip putting on that bit of eyeliner, eyeshadow and lipstick.

“Hi Joan,” Nuno said when I arrived at work. “Gee, you look tired.”

Whoops. I guess I set the standard for my appearance on my first day in the office.

The next Monday, I decided to do the full make-up thing: foundation, dark eyeliner, eyeshadow, shiny red lipstick.

I ran into Genevieve at the train station.

“Good morning, Joan. You look nice today.”

*Bing!*

Here are my conclusions, then.

  • Wearing make-up helps you look prettier.
  • But once you start, you can’t stop.
  • If you decide not to wear make-up, you forgo the opportunity to look your best.
  • However, you don’t run the risk of having an uglier-than-usual day.

I explained all this to Damjan. I’ve been thinking about whether or not I want to step onto the make-up treadmill when I go to Cambridge. New people = opportunity to decide such things.

Damo was not satisfied with the rigour of my study and therefore could not place any confidence in my conclusions. Being the statistician that he was, he proposed I do a blind test.

“Right, Joan. Wear make-up one day and don’t tell me. Ask me if you look pretty today and then write down my response. Then, on another day, don’t wear make-up and do the same thing. We can then compare the results because they’ll be meaningful!”

I wondered whether or not the integrity of the test would be compromised by the general practice amongst boyfriends of never saying to girlfriends that they looked anything less than optimal. Then again, I’ve known Damo to err on the side of honesty over diplomacy on some occasions.

Damo became even more animated: he had found a way to enhance his research proposal. “We can make it a double-blind test!” he said.

“What, both of us can close our eyes? And you can guess if I’m wearing make-up?”

“Perfect!” he crowed.

Figure 1: Scenario A, where woman who normally wears make-up stops doing so briefly

Figure 2: Scenario B, where woman who does not normally wear make-up does so briefly

Moving to Blogger Beta

This blog may look as it always has but things have changed. Last night, after cringing and chuckling my way through Bridget Jones’s Diary (the movie), I shifted my blog over to Blogger Beta. It took me hours to reconstruct the look of this blog.

The only reason for me to shift is to make use of the ‘Labels’ functionality. I love putting things in categories. Last night, instead of sleeping or doing my homework, I labelled 100 of my most recent posts. Talk about a waste of time.

However, with the shift to Beta, I’ve now lost my ‘Recent comments’ list. The hack I was using no longer works. This updated template has a recent comments feed. Unfortunately, it only displays 25 of the oldests comments on this blog, comments that date back to mid-2004.

When they fix this bug, I’ll be able to display the RSS feed in my sidebar, hurrah.

I was thinking about how I would be if I were 30, single, and 10 kg overweight. Would I be as downtrodden and desperate as Bridget Jones? I think that at times I would be. If you’re over 30 and haven’t had a serious relationship for some years, then you can’t help but wonder if this is going to be the trajectory for the rest of your life.

I also believe I have a greater sense of self-worth than Bridget and would never index my value to the amount of attention I get from inconsiderate men. But who knows what I’ll be like after being starved of affirmation and recognition for a few years.

Updated 11:01 PM
I decided I liked the ‘recent comments’ functionality more than the labels so I’ve reverted back to my old template. I’ll jump on the Beta Bandwagon when they’ve sorted out the issues with the comments feed.

No one trips over themselves to help

“For someone who dances, you sure keep falling a lot,” Vera said to me once.

That’s right, folks. I fell again. This time, it was on the steps leading up from the subway corridor to Platform 2 at Flinders Street Station. It wasn’t spectacular or painful. It was loud and awkward, though. I had been carting my luggage from Shepparton — a wheeled luggage bag, a backpack and a handbag. I fell forward on to the steps as I was trying to drag everything up to the platform. I might have shouted an expletive.

People saw me fall. No one asked if I was all right. No one offered to help. This happened last time I tripped at Melbourne Central as well.

As someone who falls a lot, I’m starting to get annoyed that people don’t seem to care. Did they ever?