Colorado House Rejects Benefit Corporation Law

On Tuesday, May 15, 2012, the Colorado House allowed legislation to die in committee that would have given firms the opportunity to incorporate in Colorado as "benefit corporations."  Similar legislation passed overwhelmingly in the Colorado Senate earlier this month.  If the law had passed, Colorado would have been the ninth state to adopt benefit corporations. 

The Colorado Bar Association lobbied against the legislation, claiming that the social benefit purposes were defined too narrowly, and that the requirement for third-party certification (such as B-Corp) was too restrictive.

The eight benefit corporation states (in order of passage) are: Maryland, Vermont, New Jersey, Virginia, Hawaii, California, New York and Washington.  Several other states are considering this sort of legislation.  A complete list of the status of benefit corporation legislation in each state is on my website.  It is updated regularly.

Benefit Corporations are FOR-PROFIT firms that have an explicit social or environmental purpose stated in its founding documents. The idea is that its officers will be free to pursue these social purposes without fear of retribution or revolt from shareholders. Benefit corporations will still try to earn a profit for their shareholders, but will not be required to pursue profits exclusively. A comprehensive list of companies that are organized as benefit corporations is provided on my website, and is updated regularly. As of the writing of this article, there are a total of 94 firms that have elected to incorporate as benefit corporations. The two most well-known firms are Patagonia and King Arthur Flour.


Craig R. Everett, PhD
Graziadio School of Business and Management
Pepperdine University

Washington State Adopts Benefit Corporation Law

On March 30, 2012, Washington become the eighth state to adopt benefit corporation legislation.  As of June 7, 2012, firms will be able to incorporate as "Special Purpose Corporations," or existing firms can convert to this new status with at least a two-thirds shareholder vote.

Special Purpose Corporations in Washington are similar to other for-profit firms, except that there will be a social purpose included in the articles of incorporation.  A social purpose is defined as some goal related to social responsibility, such as environment, human rights or any other charitable purpose.  The idea is that officers and directors of these firms are no longer required to exclusively pursue shareholder financial profits.

The new legislation in Washington State differs slightly from benefit corporation statutes in other states so far.  The first main difference is that using a third-party assessment is optional.  More specifically, the organizers may optionally include a third-party assessment requirement in the articles of incorporation, but it is not required that they do so.  Second, it is optional whether or not to require the officers and directors to consider the social purpose impact of every decision.  These modifications to the standard benefit corporation "boilerplate legislation" were intended to give firms more flexibility about how to accomplish their social purpose.

A full list of states with benefit corporation statutes is available on my website, along with a listing of companies that have adopted this new corporate entity type.

Craig R. Everett, PhD
Graziadio School of Business and Management
Pepperdine University

More States Adopt Benefit Corporation Legislation

On April 13, 2010, Maryland become the first state to allow businesses to incorporate as "benefit corporations."  Vermont followed a month later.  As of this publication, there are now seven states that allow this for-profit entity type, including (in order of adoption) Maryland, Vermont, New Jersey, Virginia, Hawaii, California and New York.

So, what exactly is a benefit corporation?  It is a for-profit firm that has an explicit social or environmental purpose stated in its founding documents.  The idea is that its officers will be free to pursue these social purposes without fear of retribution or revolt from shareholders.  Benefit corporations will still try to earn a profit for their shareholders, but will not be required to pursue profits exclusively.  A comprehensive list of companies that are organized as benefit corporations is provided on my website, and is updated regularly.  The two most well-known firms are Patagonia and King Arthur Flour.

In addition to the states listed above, ten additional states have legislation pending: Alabama, Colorado, Connecticut, Florida, Illinois, Louisiana, Michigan, Minnesota, North Carolina and South Carolina.  In two states, Wisconsin and Pennsylvania, legislation has either failed or has been tabled (respectively).  Specific status of legislation is available here.

So what does all of this have to do with finance?  Well, benefit corporations are financially fascinating for several reasons. I'll address a couple of them.  First, most of financial theory assumes that the purpose of a corporation is to maximize shareholder wealth.  Once this assumption is weakened - as it is with benefit corporations - governance becomes more complicated.  Another interesting complication is in calculating the firm's cost of capital.  Since part of a benefit corporation's shareholder's gain is social rather than financial, how does this actually impact the shareholder's required return?  I have a forthcoming paper on this exact topic.

All and all, benefit corporations will undoubtedly prove to be a fertile field for business research.  Their adoption appears to be accelerating and although there are now only approximately 70 firms that are benefit corporations, this number is likely to grow quickly, as more entrepreneurs realize that incorporating in this manner allows them a unique path to "doing good while doing well."

Craig R. Everett, PhD
Graziadio School of Business and Management
Pepperdine University

Why Businesses Aren’t Hiring

The continued high levels of unemployment have sparked a growing amount of criticism of corporate America. The argument goes something like this: “In these days of record high corporate profits and stock market performance, it is irresponsible for companies to sit on the sidelines of the economy and not employ more people.”

It is certainly reasonable to ask the question of why companies seem to be choosing to refrain from hiring. My intuition is that there are many reasons, which probably vary from company to company. As such, it is not likely that there is a simple explanation that applies to all firms. Nevertheless, there is a relatively straightforward explanation of this phenomenon that is grounded in one of the most basic principles of finance, Capital Budgeting.

Capital budgeting is the process by which firms analyze potential investments (like starting a new product line or opening a new factory) and then decide which ones should be pursued. In a nutshell, most decisions that would result in hiring more workers are either an expansion of existing operations or the start of a new venture. Either way, it’s a capital budgeting decision.

So how are capital budgeting decisions made? There are many analytical techniques that managers use to evaluation the financial worthiness of new projects, including Net Present Value (NPV), Internal Rate of Return (IRR), Profitability Index (PI), Payback Period, etc. etc. I will not attempt to explain the workings of any of these techniques here, since those details are available in any finance textbook (or by doing a search on the web). They all share a common attribute, however. They all require a reasonably accurate estimate of the future cash flows of the proposed project.

If, for example, the proposed project is the building of a new widget factory that has a life-span of ten years, the start of any capital budgeting analysis is the estimation of the up-front investment costs and then the yearly cash flow from the new factory. Cash flow in a future period, simply stated, is the revenue from the project minus the costs in that period. Ongoing costs include things like materials, labor, equipment maintenance, utilities, taxes, regulatory compliance, etc.

And there’s the rub. Right now there is a great deal of uncertainty regarding some of these costs. Healthcare costs are a growing piece of overall labor costs, but since many of the details of the Patient Protection and Affordable Care Act (commonly known as Obamacare) remain to be decided by regulators, it is not possible to accurately estimate future labor costs. There is similar uncertainty concerning environmental regulations, financial regulations, and tax policy.

The cumulative effect of all this uncertainty is the inability of financial analysts to be able to comfortably estimate future costs, and thus it is extremely difficult to engage in meaningful capital budgeting activities. The unfortunate result is that since managers cannot make an informed “go” or “no-go” decision on new projects under consideration, they will default to “no-go” until better information is available.

This is not a commentary about the relative merits of any particular regulation or policy. The fatal error of the current administration is that by leaving so many legislative “loose-ends,” they have created an unacceptable level of uncertainty about future costs, thus making capital budgeting decisions nearly impossible. The tragic result is that the growth engine of the United States economy, private-sector business investment, has been stopped in its tracks.

The good news is that once some degree of certainty has been restored, regardless of the details, the growth engine will start to resuscitate. Of course, certainty in the direction of lower costs will result in more new project approvals than certainty in the direction of higher costs, but ANY certainty is better than none at all.

Adjustable Rate Loans (ARM) Becoming Unpopular

According to the most recent report from Freddie Mac, 95% of refinanced mortgage loans are fixed-rate products. Adjustable rate mortgages appear to have become wildly unpopular.

Frank Nothaft, chief economist for Freddie Mac attributes the shift to two factors: ultra-low fixed interest rates and a desire for predictability of monthly payments (peace of mind). As of the end of last week, the average rate for a 30-year fixed-rate mortgage was a mere 4.97 percent.

Although two-thirds of loan applications are currently refinance loans, not new loans, the National Association of Realtors claims that the low fixed rates are primarily responsible for the recent improvement in sales of existing homes.

Ford Posts A Profit for First Time Since 2005

In comparison to the other American car companies, Ford has been doing well this past year. While GM and Chrysler have experienced declining revenue, Ford has enjoyed increased sales.

The cherry on the top of this automotive parfait is Ford's announcement today that they have posted their first annual profit since 2005. This profit represents a whopping earnings per share of 43 cents, handily exceeding analyst estimates of 26 cents. And all this without taking bailout money...

Clearly, Ford is doing something right.

Junior Achievement Celebrates 90 Years of Financial Literacy Education

In 1919, Theodore Vail (President of AT&T) and Horace Moses (President of Strathmore Paper) raised $250,000 to start an organization for boys and girls activities that would become what we know today as Junior Achievement. In the words of Horace Moses:

"The future of our country depends upon making every individual fully realize the obligations and responsibilities belonging to citizenship. Habits are formed in youth…what we need in this country now … is to teach the growing generations to realize that thrift and economy, coupled with industry, are necessary now as they were in past generations."

Today, Junior Achievement is the largest organization in the world that is dedicated to children's financial literacy and entrepreneurship education. It has programs in 123 countries around the world and reaches 9.3 million students with nearly 300,000 volunteers.

In today's economic environment, many have recognized the need for kids to become financially literate in order to succeed in life. Thus, dozens of new organizations have popped up in recent years with the stated purpose of improving financial literacy. Junior Achievement, however, has been doing exactly this kind of work for ninety years now with impressive success. JA is unique among financial literacy organizations because it has the existing infrastructure to effectively provide free-of-charge educational programs to millions of students worldwide.

In recent years, school demand for JA's free programs has increased significantly. JA's ability to meet these increased demands is limited by the number of available volunteers and by funding. Since the programs are provided at no cost to schools, the actual cost of each program must be fully funded by donations. In tough economic times like these, charitable giving is harder to come by, when by definition, donations are needed the most.

Notwithstanding, Junior Achievement continues to grow and flourish as more and more people are coming to realize the importance of what JA has been doing for nearly a century now. Happy 90th birthday, Junior Achievement!

More information about volunteer opportunitites with Junior Achievement can be obtained at http://www.ja.org/ .


- Craig Everett is a classroom volunteer for Junior Achievement and also serves on the board of directors of Junior Achievement of Greater Lafayette.

Treasury to Modify Failing Foreclosure Prevention Program

With nearly 15% of all home mortgages being at least 30 days past-due or already in foreclosure, it has become clear that Obama administration efforts to assist homeowners have been largely ineffective to date.

The promised loan modifications have been elusive for most troubled homeowners. The crux of the problem is that banks have little incentive to do these modifications. When they crunch the numbers, most often it is in the banks' best interest to foreclose or do a short-sale, rather than modify the loan.

What many homeowners do not know is that in many states, banks can go after defaulting borrowers for up to six years for any principal that they lose on the loan. So a foreclosure or a short sale is not the end of the borrower's obligation, unless so decreed by a bankruptcy judge or explicitly written into the short-sale or deed-in-lieu-of-foreclosure contract.

Under the current loan modification program, borrowers must make at least three payments under a trial loan modification program before the modification can become permanent. Transition to permanent modification status also requires additional documentation that many find onerous. More than 600,000 borrowers have begun the trial program, but very few of those have received permanent loan modifications to date.

Unfortunately, under the current program, most troubled borrowers don't even qualify to start the trial modification plan.

Details of the new administration plan are still murky, but comments from Assistant Treasury Secretary Michael Barr hint at the possibility of sanctions and penalties for banks that do not start making more loan modifications.

The administration, of course, is missing the point that the banks' primary responsibility is to their shareholders (otherwise the stockholders will sell and take their investment dollars elsewhere) and therefore the banks will not, as a rule, act against their own financial interests. Imposing penalties is clearly one way to make foreclosure less attractive to banks. In a free-market system, however, carrots often work better than sticks. A better approach might be to offer the banks more positive incentives to perform loan modifications.

The most rational approach from a free-market standpoint, though, is to just let it all play out on its own:

• No bailouts of banks -- increase the FDIC insurance levels and let the bad banks fail. There will be plenty of smaller good banks around who will be glad to take their place.
• No bailouts of industry -- again, economic downturns are traditionally the crucible that separates good companies from bad ones. The failure of big firms is the impetus that drives small innovative firms with good management and good ideas to rise up to take their place.
• No bailouts of individuals -- if homeowners made bad decisions, then they should live with those decisions. Bankrupcty is a reasonable option that allows the person to mostly erase their mistakes and start again under a probationary seven-year period. Given the magnitude of the mortgage problem, my guess is that having a bankruptcy on your credit report will not represent nearly the stigma that it has in the past, since so many people will share that particular blemish.

Maybe it's just the cynic in me, but whenever the government rides up on their white horse to save the day, I cringe a little. It just seems that whenever a bureaucracy tries to fix one thing, they break two other things in the process. With the loan modification program, let's hope they get it right.

New Jersey Passes Financial Literacy Law

Last week Governor Corzine of New Jersey signed a bill into law that will create a three year high school financial literacy pilot program in six school districts across the state. The intention is that the six districts chosen will represent a cross-section of urban, suburban and rural students. Curriculum and materials will be provided by the NJ Dept. of Education. A grant provided to each test district will offset the cost of instruction.

Evaluation of the success of this pilot program will determine if it will be subsequently rolled out to the entire state.

Indiana Now Requires Financial Literacy Education for Kids

Effective July 1, 2009, Indiana became the latest state to require that each public school and accredited non-public school incorporate financial literacy education into its curriculum. The law was entitled "Dollars and Sense for Hoosier Children." Section 20-30-5-19 of the Indiana code now mandates that instruction concerning financial responsibility be given in grades six through twelve.

This is a good thing. It is widely understood that the 2008-2009 financial crisis was mainly caused by the subprime mortgage crisis, and many believe that the root cause of the subprime crisis was financial illiteracy. Kids need to learn at a young age how business, economics and finance works. Any steps taken to increase the financial wisdom of the next generation will help ensure that we don't experience a repeat situation of millions of borrowers taking out loans that they had no chance of repaying.

Hopefully, the financial literacy training adopted by schools in Indiana will be a program like the excellent one provided by Junior Achievement (JA). JA has age appropriate financial literacy classroom seminars for the entire grade span mandated by this new law. What I like about JA's program is that it is largely based on a small-business / free enterprise approach, with a lot of hands-on reinforcement of basic financial concepts.

There are other financial literacy curricula out there from other non-profit organizations that are also excellent and age-appropriate. Whatever the state and local school boards decide, it will likely be a step in the right direction to ensure a healthy financial future for our children.

Craig Everett is a financial researcher, an advocate for financial literacy, and a board member of Junior Achievement of Greater Lafayette.