AN OVERVIEW OF CONTRACTS AND WHY THEY ARE IMPORTANT TO BUSINESS AND SOCIETY
Contracts govern all transactions whether they are between firms or between firms and private individuals. Indeed, in most of the developed world, any transaction or commercial exchange is usually not undertaken without a contract. This trend is also catching up in the developing world where contracts are increasingly becoming the norm. The importance of contracts to our daily existence has been recognized by the awarding of this year’s Nobel Prize in Economics to two economists for their work in contract theory.
WHAT IS A CONTRACT?
So, what exactly is a contract
and what does it mean for the various parts involved. According to Wikipedia, “A
contract is a voluntary arrangement between two or more parties that is
enforceable at law as a binding legal agreement. Contract is a branch of the
law of obligations in jurisdictions of the civil law tradition”
- EXPLAINING A CONTRACT
The terms to note are voluntary,
agreement, parties, enforceable, and legally binding. In other words, the
decision to enter into a contract is voluntary meaning that parties to the
agreement are not coerced or pressurised in any manner to sign the contract.
The next term agreement refers to the mutually acceptable terms and conditions
that are part of the contract. Again, do note that the terms and conditions
have to be agreed upon beforehand and once codified in the contract; they can
only be changed with the consent of all parties.
The next important terms are
enforceable and legally binding. These are perhaps the most important aspects
of a contract since the very purpose of the contract or contracts is to protect
people and the parties involved from fraud and cheating by the other parties.
In other words, unless the terms and conditions of the contract have legal
sanctity and they can be enforced in a court of law, the whole purpose of
drawing up the contract is meaningless and futile.
- BREAKING OF CONTRACTS
Thus, we can now turn to what
happens when either party or both parties renege or go back to the terms and
conditions that were agreed upon. In such cases, the parties can approach the
courts for enforcement meaning that the penalties in case of non-compliance can
be levied upon the offending party. In other words, what this means is that in
case one or both parties feel that the other party is
not performing according to the
terms and conditions agreed upon in the contract, they can then approach the
courts for justice.
However, this is easier said than
done since proving non-compliance is not that straight and one needs to have
the best legal team possible for proving such a case. Indeed, in the context of
the developing world, it is often the case that the judicial system takes its
own time to reach a judgment on the issue and by this time, the plaintiffs and
the defendants or the accusers and the accused is either willing to settle out
of court or have lost interest in pursuing the matter further.
- ARBITRATION CENTRES AND THEIR
USES
Having said that, it is not
always the case that contracts are unenforceable in most of the countries in
the world. Indeed, without the legal protection, firms and individuals would be
unwilling to enter into contracts with each other. Just that, more often than
not, large firms and multinational corporations usually choose a jurisdiction
for arbitration wherein specialized courts or arbitration courts hear such
cases and decide quickly. A popular arbitration centre for most Asian firms is
Singapore because of its proximity as well as the reputation as a quick and
smooth in addition to effective and efficient centre for arbitration.
To conclude, this brief overview
would help you understand the basics of a contract and what they mean for the
various parties involved.
THE PITFALLS OF QUARTERLY CAPITALISM
Creating the maximum possible
shareholder value had always been the cornerstone of capitalism. All economic
theories had always been aimed at maximizing long term shareholder value.
However, in the late 90’s
and early 2000’s, this situation changed rapidly. Instead of reporting annually,
companies had to report their profits or losses on a quarterly basis. It is
believed that such a reporting would provide the shareholders with more up to
date information and enable better decision making. However, there were also
side-effects to this phenomenon of quarterly reporting. The biggest side effect
was the beginning of what is colloquially called as “quarterly capitalism”. In
this article, we will understand what quarterly capitalism means and what its
effects are.
THE MEANING OF QUARTERLY CAPITALISM
Quarterly capitalism refers to
policies created with a short time frame in mind. The name is derived from
the fact that most executives are unwilling to take decisions that hurt the
company in the short run but benefit it in the long run. Hillary Clinton once
famously mentioned in her speech that most executives believed that markets and
activist shareholder groups would negatively affect them if they pursued
policies that prioritized long term interests over quarterly benefits! This
should send alarm bells ringing for any value investor who thinks and buys long
term.
FACTORS THAT LED TO THE RISE OF QUARTERLY CAPITALISM
Quarterly results have been a
mere enabling factor in this trend. The following factors also played a
significant role.
- Drop in CEO Tenure: The average CEO tenure is all the major companies have gone done from 8 years to 4 years. If the CEO is staying in the company for a shorter period, then the policies being implemented will also be myopic in nature. The success and failure of any CEO are known by the quarterly results that they produce. Hence to maintain the illusion of their success intact, CEOs tend to focus a lot more on short term results than they otherwise would.
- Payoffs Linked to Quarterly Results: The top management executives in any corporation have a huge chunk of their compensation linked to the quarterly result. Taking a hit in the short-term results means taking a hit in their immediate compensation. Better results might accrue over the long run. However, the management might have changed till then. It, therefore, makes no sense for the executives to devise and follow through with long term plans.
EFFECTS OF THE RISE OF QUARTERLY CAPITALISM
- Innovation Takes a Hit: Innovation and research are bound to take a hit when the focus is on obtaining short term results. Most research takes place over the long term. In the quarterly results, innovation may appear to be a needless expense that needs to be minimized. However, companies that spend generously on innovation and ensure that the money is well spent are the business leaders of tomorrow. With the advent of quarterly capitalism, innovation has been outsourced to startups or private companies in Silicon Valley. The larger corporations are no longer at the forefront of the technological revolution.
- Investments: Capital investments also need to be made with the long term in mind. 10 to 15 years is a pretty small-time frame as far as mega decisions like building a factory or a plant are concerned. These decisions are semi-permanent in nature. Hence, if the quarterly obsession influences these decisions, the organization may not be able to make the most optimal use of their resources.
- Diversion of Resources: Quarterly reporting is a gigantic administrative task. Even with the advent of all sorts of technology, there is still a lot of work that needs to be done. Precious scarce resources are diverted towards regulatory and administrative tasks. Reporting less often is simply a more efficient way to do business.
- Increased Volatility: Quarterly reporting has started causing increased volatility in the system. Companies release guidance and target every quarter. Based on whether or not such targets have been met, the price rises or drops. This puts immense pressure on the management to use any means necessary to protect their stock from market volatility. The culture of quarterly capitalism has also been blamed for being the enabler in many stock markets scams such as Enron and WorldCom.
AN ALTERNATE SOLUTION: SEMI-ANNUAL REPORTING
One possible solution to this
problem is if the stock exchanges mandate that companies declare their results
semi-annually instead of quarterly. This will help organizations maintain a
slightly
longer term focus and avoid some
of the pitfalls mentioned in this article. However, the response is expected to
be varied. Tech companies from Silicon Valley are unlikely to accept this
mandate and so are other companies that are in the middle of a bull run. When a
company is doing well, it needs every opportunity to broadcast its performance.
Such public announcements have a positive effect on the company’s stock price
and the promoter’s net worth. Mature companies like utility companies are
likely to accept this mandate. Their reports are likely to be similar
regardless of whether they are published quarterly or annually.
To sum it up, quarterly
capitalism has started a culture wherein companies have to be short sighted!
Far sightedness and strategic thinking are penalized in this bizarre culture.
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