Posts Tagged ‘Business’

Ralph believed that one of the most powerful levers he could use in building a value-creation focus throughout EG was the compensation system. At present, the package contained relatively little performance-based incentive for top managers. They did receive a bonus, but it was a relatively modest proportion of total compensation. They also received stock options, but few viewed these as significant in terms of their ability to build capital for doing a good job. It was clear to Ralph that the top-management incentives did not focus on value creation. Bonus payouts were geared toward achievement of earnings-per-share targets, which as he knew did not always correlate well with creating value. In addition, the compensation of business-unit managers was tied more closely to the performance of EG as a whole than it was to the fortunes of their particular business unit.
Ralph figured that several schemes were capable of meeting his objectives. He asked his human resources executives to consider phantom stock for each of the divisions; a deferred compensation program structured around the economic profit targets that the businesses were adopting, and using the attainment of goals on particular value drivers as a basis for compensation awards.

Ralph was convinced that one of the main reasons EG had gotten into trouble was a lack of focus on value creation in developing corporate-level and business-unit plans. Likewise, evaluations of the performance of the businesses had only a vague focus on value. Ralph firmly believed that it was the responsibility of all senior managers to focus on value creation. Ralph would ensure that company plans included a thorough analysis of the value of each of the businesses under alternative scenarios. He would also make sure that EG used the restructuring hexagon approach on an annual basis to identify any restructuring opportunities within EG’s portfolio.
This new focus on value would also require some changes in the way EG thought about its corporate strategy. For the next year or so, EG had to focus on restructuring. In the longer term, Ralph would need to develop a plan for sustaining EG’s advantage in the market for corporate control. To do this, he would need to better understand the company’s skills and assets and in which businesses they would be most valuable. Most important, he would have to ensure that the value of these skills could be identified in terms of higher margins, growth rates, and the like before building action plans around them. Too often, Ralph was convinced, EG had done a perfunctory analysis of its capabilities and entered businesses without a clear idea of how and why EG would be a better owner and able to create value for its shareholders. As a first step, later in the year Ralph would establish a task force to compile an inventory and do an analysis of EG’s skills and assets compared with its competition, as well as ideas for new businesses EG might enter.
At the business level, EG’s new focus on value would require some changes too. The restructuring review had pointed out a number of specific strategic and operating actions that the various business managers would need to take. Beyond this, management in the business units would need to think differently about their operations. They would need to focus on what was driving the value of their businesses—whether it was volume growth, margins, or capital utilization. Everyone was accustomed to focusing on growth in earnings, but what would matter in the future would be growth in value and economic returns on investment. Sometimes this would mean foregoing growth in the business that would have been accepted in years gone by. At other times, managers would have to get more comfortable with the idea of reporting lower earnings when investment in research and development or advertising with a longer term payoff made economic sense. Ralph knew that these changes would be difficult for his management group, because it had not been encouraged to think this way in the past. To help bring about change, he decided to share with the management group the results of the corporate restructuring analysis and to develop a series of training seminars for senior division management about shareholder value.

Momentum funds have a different trading approach as regards currency speculation. Rather than focusing on apparent disparities between the economics and the price, they use so-called momentum models to trigger buy or sell signals in currency pairs irrespective of the economics. Granted, one could argue that since economics affects the price of the currency, so it also affects their models and therefore their trading approach. However, it is fair to say that economics is not their primary focus. Their aim is to be disciplined to the extent that they rigorously follow the trading signals of their momentum models. As one might expect, the nature of these models varies. For instance, one such momentum model relies on technical analysis indicators to provide short-term moving averages. When a 5-day moving average crosses up through the 15-day moving average they buy and when the opposite happens they sell. Granted, this is a vast oversimplification and there are many significantly more sophisticated momentum models than this. That said, the principle is surely the correct one. Momentum models, however complex and whatever indicators they rely on, focus on changes in market prices as their key determinant for providing signals rather than economic fundamentals. Therefore, it is probably a reasonable generalization to say that they are more short term in their trading approach than macro-based currency speculators might be, depending of course on how long the momentum signal lasts.

This approach is for the most part identified with the so-called “macro hedge funds”. Broadly speaking, “macro” or macroeconomic-based currency speculators look for market pricing inconsistencies between the prevailing economic fundamentals and the long-term currency valuation, with the current market pricing. Their raison d’etre and their incentive is that current market pricing is “wrong” relative to those fundamentals and valuation, and they can earn excess returns by trading against that market pricing.
Here again, the line between the currency speculator and the “fundamental” market participant is blurred. After all, where is the difference in terms of incentive and action between the asset manager who invests in a country’s equity or fixed income markets and the macro-based currency speculator who invests in a currency because they think it is undervalued relative to fundamentals and valuation?
It is widely assumed that currency speculators only trade against currencies rather than in their favour, but this is very far from the case. Indeed, during the Asian crisis itself, a number of macro hedge funds bought Asian currencies such as the Indonesian rupiah on the view that they had overshot their fundamental value — unwisely and prematurely as it turned out. It has frequently been easier to make excess returns by trading against currencies rather than in their favour during the 1990s, not for any malign reason but simply because it was discovered that semi-pegged exchange rate regimes were incompatible with free and open capital markets. Keeping on the Asian example, to focus on currency speculation for or against Asian currencies is to ignore the fact that the Asian boom became a speculative bubble that was in any case waiting to burst, a bubble which the authorities were seemingly unwilling or unable to stop. Macro currency speculators are a stabilizing force against economic imbalance, an arbiter of government economic policies. The disruption that currency markets might experience is not caused by their activity. Whether they were capable of doing so in the past due to much greater leverage, that is certainly not the case now. They can merely accelerate the process, but they cannot cause it. The real cause is the government policy in the first place, which triggered the economic imbalance.