$25 Amazon Gift Card Giveaway

In order to promote my book TOBY GOLD AND THE SECRET FORTUNE, we are giving away a free $25 gift card from Amazon.com.  All you have to do to enter the contest is become a fan of the Toby Gold Series facebook page.  Contest ends on December 31, 2012.

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No, Natural Disasters Do NOT Help Economic Growth

Every time there is a large natural disaster, inevitably someone in politics or the media will say something like, “Well, the upside of this disaster is that the rebuilding efforts will spur economic activity and help the economy.”

This is absurd and patently false.  Anyone with an ounce of common sense can feel it in their gut that property destruction cannot possibly have a positive net economic benefit.  If destruction were ultimately good for the economy, then the best stimulus would be for all of us to burn our houses down.  Let me explain the fallacy at work here.

We’ll start with the Rockwellian image of a group of boys playing baseball in the backyard.  The catcher signals fastball to the pitcher, who complies.  The hitter, anticipating this, connects solidly with the pitch with a resounding CRACK of the bat.  The ball sails over the back fence and crashes through the neighbor’s large plate glass window.

The destruction has now occurred and must be addressed.  Some economists would have us believe that this is a good thing.  The owner of the house must now hire the local glass company to come and replace the window.  Let’s say that this will cost the homeowner $200.  This new economic activity will pay the wages of the person doing the glass replacement.  Then, part of the $200 will go to the glass manufacturing company, part of it will go to the receptionist at the glass company that took the order, and part of it will be used to buy the gas in the truck.  All of the above businesses  and individuals will pay taxes on their respective piece.  All of this wonderful economic activity will happen as the result of that one errant baseball.

Gee, with such positive results, we should just forgo the unpredictable baseball and use the bat directly to bust out all of our windows.  So what is the problem with this story?  The problem is opportunity cost.

The homeowner’s $200 did not appear out of nowhere.  By being forced to spend the $200 on the window, he was not able to buy that lawnmower he was planning to purchase.  That’s $200 that the local hardware store will now NOT be receiving.  They would have used it to pay their employees, suppliers and taxes.  So the broken window did not generate economic activity, but only diverted it from one business to another.

If the baseball game had not occurred, the homeowner would have had both a window and a new lawnmower.  Now he only has a new window but no lawnmower.  His wealth has decreased by $200.

But what if he had insurance?  Insurance pools risk, so if insurance paid the $200, then the homeowner will have both the lawnmower and the window.  But who actually bears the cost?  If there are 100 policy owners, then effectively each of them pays $2 toward the new window.  There is still $200 of wealth lost, but now it is being taken proportionally from 100 people instead of 1 person.

But what if the government pays for the window with their new “Baseball Relief Fund?”  Well, this is effectively the same as the insurance scenario, except the cost is spread among all the taxpayers instead of just the insurance policyholders.

But what if the government funds the Baseball Relief Fund by printing money instead of by raising taxes?  This is ultimately just like the taxpayer scenario, except it is more regressive.  All holders of dollars pay for the new window as inflation decreases the value of their savings.

So now back to the natural disaster.  Yes, we will see lots of new economic activity in a disaster zone.  Some of it will be funded by the homeowners, who will just be diverting spending from other activities, so there is no net benefit to the local community or overall economy. 

Some of it will be funded by insurance companies, who will be taking funds from policyholders outside the affected area.  So this will just be economic activity shifted from unaffected communities to the affected communities.  There will be no net benefit to the economy overall.

Some of it will be funded by the federal government, who will pay for it by raising taxes, printing money or borrowing money.  Regardless of the funding mechanism, it will still result in no net positive benefit to the economy, but rather a shifting of economic activity from unaffected areas to affected areas.

Of course we should help communities that are devastated by natural disasters.  But let’s not be fooled by those who say that this is a positive thing for the overall economy.  If there’s 10 billion dollars in damage, then this is a 10 billion dollar loss in national wealth.  All the communities that are rebuilding will indeed experience a flurry of new economic activity, but this will be offset by loss of economic activity elsewhere. 

We all know instinctively that destruction of property cannot possibly be a good thing economically.  Let’s not be fooled by those trying to tell us it is.

Craig R. Everett, Ph.D.

Associate Director, Pepperdine Center for Private Capital Markets
Graziadio School of Business and Management
Pepperdine University
Malibu, CA
- Author of youth financial literacy thriller Toby Gold and the Secret Fortune

Pre-Launch Reviews of Toby Gold and the Secret Fortune

As many of you know, tomorrow is the release date for my debut novel, Toby Gold and the Secret Fortune.  It is a fantasy adventure for children ages nine and up that introduces financial literacy principles.

Thanks to everyone who has reviewed the book during these past weeks leading up to the launch, which will be occuring tomorrow morning at the Access to Capital Conference at the Westin Bonaventure Hotel in Los Angeles.  The following is a sample of the reviews so far...

"Unique children’s lit that cleverly tackles interest rates, endowments, fluctuating commodities, bullying and identity."  - Kirkus Reviews

"This book was a fast-paced, enjoyable read, and I can’t wait to give it to my  boys for Christmas... I would definitely recommend it to anyone looking for an  entertaining, yet educational read."  - Couponing with Boys Blog

"This book is a great teaching tool for tweens and teens. What a fantastic way for teens to learn about being responsible with money. There is also an entertaining action story to go along with these thoughtful lessons. You couldn’t ask for a better combination than this!"  - LDS Women's Book Review

"This 256-page book is sure to fully captivate even the most picky readers."  - Say This Write Blog

TOBY GOLD AND THE SECRET FORTUNE is now on sale online, and will be on sale in bookstores tomorrow.  Here are the links to buy it at Amazon.com or Barnes & Noble.

Illinois Becomes Eleventh State to Allow Benefit Corporations

On August 2, 2012, Illinois governor Pat Quinn signed Senate Bill 2897 into law, officially recognizing benefit corporations  in the state. The bill had previously passed the house and senate by  votes of 66/47 and 30/21, respectively.

The new corporate entity type will be effective January 2013. Existing firms will be able to switch to this new entity type with at least a two-thirds shareholder vote.

The provisions of this Illinois statute are generally consistent with the boilerplate benefit corporation legislation promoted by B Lab, a non-profit corporate social responsiblity (CSR) auditor based in Pennsylvania.  Firms incorporating under this law must adopt and be assessed under an independent third party CSR standard, such as those provided be B Lab, Ceres, Green Seal, GRI, People4Earth, etc.

The only substantive difference in the Illinois statute is the removal of the requirement for the corporation to file its annual report with the Secretary of State each year.  This change may be prescient, since most other benefit corporation states have not yet implemented a process for receiving these annual reports, leaving BenCorps in their respective states no way to comply with this particular provision of the law.

BenCorps in Illinois must provide a "specific public benefit." They must also consider the needs of many constituencies above and beyond financial returns for shareholders.  The lists of these public benefits and constituencies is identical to those of Louisiana, therefore please refer to previous article about Louisiana's new benefit corporation statute for more detail.

Illinois is the eleventh state to adopt benefit corporation legislation, following California, Hawaii, Louisiana, Maryland, New Jersey, New York, South Carolina, Vermont, Virginia, and Washington State.

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

South Carolina Becomes Tenth Benefit Corporation State

On June 12, 2012, South Carolina become the tenth state to adopt benefit corporation legislation. The new corporate entity type is effective immediately. Existing firms can switch to this new entity type with at least a two-thirds shareholder vote.

The provisions of this South Carolina statute are consistent with the boilerplate benefit corporation legislation promoted by B Lab, a non-profit corporate social responsiblity (CSR) auditor based in Pennsylvania.  Firms incorporating under this law must adopt and be assessed under an independent third party CSR standard, such as those provided be B Lab, Ceres, Green Seal, GRI, People4Earth, etc.

Benefit corporations in South Carolina must provide a "specific public benefit." They must also consider the needs of many constituencies above and beyond financial returns for shareholders.  The lists of these public benefits and constituencies is identical to those of Louisiana, therefore please refer to yesterday's article about Louisiana's new benefit corporation statute for more detail.

In approving benefit corporations, South Carolina becomes the tenth state to do so, following California, Hawaii, Louisiana, Maryland, New Jersey, New York, Vermont, Virginia, and Washington State.
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

Lousiana Recognizes Benefit Corporations

On May 31, 2012, Louisiana become the ninth state to adopt benefit corporation legislation. Effective August 1, 2012, firms will be able to incorporate as "Benefit Corporation," or existing firms can convert to this new status with at least a two-thirds shareholder vote. All corporate actions, including approval of acquisitions, require a two-thirds vote.

Firms incorporating under this law must adopt and be assessed under an independent third party standard for corporate social responsiblity (CSR), such as those provided be B Lab, Ceres, GRI. etc.  Benefit corporations in Lousiana must provide a "specific public benefit," which may mean any of the following:

• Providing low-income or underserved individuals or communities with beneficial products or services.
• Promoting economic opportunity for individuals or communities beyond the creation of jobs in the normal course of business.
• Preserving the environment.
• Improving human health.
• Promoting the arts, sciences, or advancement of knowledge.
• Increasing the flow of capital to entities with a public benefit purpose.
• Conferring any other particular benefit on society or the environment.

Benefit corporations are similar to traditional FOR-profit firms, except that in additional to seeking profit, there is also some goal related to social responsibility. The idea is that officers and directors of these firms are no longer required, either explicitly or implicitly, to exclusively pursue shareholder financial profits.  The statute in Louisiana, in fact, requires directors to take all of the following constituencies into consideration while discharging their duties:

• The shareholders of the benefit corporation.
• The employees and work force of the benefit corporation, its subsidiaries, and its suppliers.
• The interests of customers as beneficiaries of the general public benefit or specific public benefit purposes of the benefit corporation.
• Community and societal factors, including those of each community in which offices or facilities of the benefit corporation, its subsidiaries, or its suppliers are located.
• The local and global environment.
• The short-term and long-term interests of the benefit corporation, including benefits thatmay accrue to the benefit corporation fromits long-term plans and the possibility that these interests may be best served by the continued independence of the benefit corporation.
• The ability of the benefit corporation to accomplish its general public benefit purpose and any specific public benefit purpose.
• May consider other pertinent factors or the interests of any other group that they deem appropriate.

In approving benefit corporations, Lousiana becomes the ninth state to do so, following California, Hawaii, Maryland, New Jersey, New York, Vermont, Virginia, and Washington State.  Washington State is not included in some lists of benefit corporation states because of a few differences in their legislation from other states.  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.  I, however, include Washington in my list because they clear the primary hurdles of allowing firms to adopt a legally recognized social purpose and also allowing firms to adopt a third-party CSR standard.  Thus, if a firm in Washington state desires to become a benefit corporation, it can do so in every meaningful sense of the term.

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

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.