More on "Beyond The Corporation"

From the lengthy thread following my earlier post on the book Beyond The Corporation:

I said: "The way I understand it, his argument is that the economy works far better if those 'super profits' are shared firstly between the providers of the actual money invested (as interest) and the remainder between all the employees."

Bayard countered: "What about the the providers of the actual money invested as share capital (as dividends)? People seem to be forgetting that, before every one's money was tied up in ridiculously expensive housing, business start-ups were financed through share capital, not loans from banks."

To focus thinking about all this, I find it helpful to distinguish between 'capital' (the value of the assets of the business, which could be financed by share capital, reinvested profits or new borrowing) and 'market capitalisation' (i.e. the total value of the company's shares in existence).

Let's take Tesco's 2010 financial statements as a nice simple example and round the figures a bit:

* 'Super profits' £2,336 m (we can safely assume that they buy and sell stuff at market value and pay market wages, so this is the surplus that arises from 'economies of scale' or 'synergies' or 'dominant market position' etc).

* Employees 472,000

* Net assets £15,000 m (broadly speaking, this is land and buildings £24,000 m minus net current/non-current liabilities of £9,000 m)

* The share capital side is £15,000 m (£5,000 m share capital and £10,000 m retained profits).

* We can contrast this figure with Tesco's market capitalisation of £31,000 m.

Questions

1. So what do we mean by 'capital'? Do we mean the value of the assets employed in the business of £15,000 m? Or do we mean the total value of Tesco's shares, which is slightly more than twice that £31,000 m?

2. Which capital is 'at risk' here - the £15,000 m or the £31,000 m?

Cluebat: If - like most accountants and solicitors, the very people who go round telling everybody else to incorporate and go for a trade sale or flotation* - the business were run as an LLP, the capital employed would clearly be £15,000 m. If all the employees were members of the LLP (and vice versa), they'd have an average partners' capital of £32,000 each and the average profit share (on top of market salary) for 2010 would have been £5,000 each.

3. Assume that Tesco were run as an LLP. Maybe next year will be a bad year, profits will halve to £1,200 m and each employee-member gets a bonus of 'only' £2,500. Would they consider their wealth to have been halved, or have they still become wealthier? How would this be different if this remains a quoted plc?

Cluebat: The market capitalisation of quoted plc's is broadly speaking a multiple of earnings, that multiple being decided by 'the markets' and being largely a function of factors outside the control of the business, i.e. interest rates. At present that p/e ratio happens to be 13.2. If profits were to halve, then all things being equal, the market capitalisation falls from £31,000 m to £16,000 m. So shareholders have suffered a 'capital' loss of £15,000 m, even though actually they made a current profit of £1,200 m.

4. Or maybe next year it will make a small loss of £500 m (or £1,000 per employee-member). How much has each of them lost - £1,000 or 'nearly everything'?

Cluebat: Let's assume that we expect those losses to continue for the foreseeable. If this were run as an LLP, the members would either radically re-shape the business or pull the plug, trying to salvage as much of their original £32,000 average stake as possible and they'd get two-thirds of it back (capital minus fire-sale losses, but no redundancy costs). However, Tesco is a quoted plc, so in this case, we'd expect the market capitalisation to fall to a break up value of (say) £10,000 million (i.e. £15,000 m minus a £500 m loss, minus redundancy costs, fire-sale losses and liquidator's costs), so outside shareholders only get a third of their money back.

* This phenomenon will be the subject of a separate post.