McValue

McBankers justify their $200m. bonuses as rewards for “adding value”. That phrase has gone feral among private equity merchants.

But what kind of value? To answer “the share price” makes a $90bn takeover sound cheap, at least, aesthetically. Yet it seems that some public affairs consultant has succeeded in re-branding “price” as “value”, and vice versa. 

That prestidigitation is replete with paradox. Three instances can be tracked across economic theory to accountancy and then stock-broking.

From the 1870s, jettisoning “value” as metaphysical was the launching point for the Neo-Classical economists, the progenitors of today’s orthodoxy. What mattered to them was not some intrinsic value in a commodity, but its price as determined by supply and demand. To reach this position, they turned their backs on Adam Smith.

Then, in 1926, Piero Sraffa showed that the Neo-Classicals had been calculating capital and profit in terms of each other. For the next fifty years, the brightest and the best of them tried to rescue their premises. Failure led them to pretend that the circularity in their algebra was merely “technical”.

(The above will surprise most economics graduates since the history of their discipline is eschewed as subversive in many Australian universities.)

Meanwhile, accountants had no “technical” bolt hole. Their scholarly literature was blotted with worries about which number to inscribe against capital goods. Should they be entered at their historic cost? Or at the cost of replacement? The oldest swindle for adding value was to switch between these two criteria for pricing stock and plant.

Because McBankers claim to “add” value, their accountants need some measure to quantify the performance bonuses. In the old days, one basis would have been an increase in the price of a share in some toll road; the alternative might have been the growth in the capitalised value of that business.

But the value-adders at McBank are no longer bound to either the past or the present. Values at McBank are neither “historic” nor “replacement”, but “futurist”. Executives who can not put a number on their current debt know with certainty what the earnings from that leverage will be several years hence.

In promising bonuses for all, the McBankers have learnt from the mistakes of the dot.com boomers whose share prices went stratospheric without ever turning a cent of profit. Today’s value-adders operate a new law of value: dividends first, profits later.

20 July 2007