Coronavirus poses big test of capitalism’s stakeholder conversion

Outbreak will show whether there is substance behind pledges to manage for the long term

Andrew Edgecliffe-Johnson 
web_stakeholder value under pressure
© Ingram Pinn/Financial Times



How stakeholder-friendly will companies feel in a falling market? The corporate consensus has shifted remarkably quickly to the idea that executives must manage for the long-term benefit of employees, consumers, suppliers and the planet — rather than focus only on meeting investor expectations for the next quarter.

Yet this rebuke to the old doctrine of shareholder-primacy has come during a long bull market.

Record profits have made it easier for chief executives to think magnanimously about constituents who have no power to oust them if they miss forecasts.

The coronavirus outbreak offers a stark reminder that such benign conditions will not last. As stock prices whipsaw and global supply chains seize up, capitalism’s recent conversion faces its biggest test.

Central banks have moved quickly to cushion the economic impact of the outbreak, and most CEOs still hope that their profits will rebound. But the coming weeks will be fraught with unfamiliar risks for companies that have come to define themselves by their socially responsible credentials.

This heavily marketed support for a new way of doing business has raised expectations among staff and customers to a point that many of the belt-tightening moves that executives have deployed in past crises could do lasting brand damage. A sustained downturn would also leave them with tougher choices than in previous reversals.

Harsher conditions always prompt CEOs to cut the nice-to-have: 61 per cent of executives would cut discretionary spending to avoid missing their profit forecast, according to a survey by FCLTGlobal, a group formed to encourage corporate long termism.

When choosing between addressing a long-term environmental crisis and more imminent supply chain upheavals, many companies will shelve the less pressing demand. But doing so now will expose executives who have embraced the environmental, social and governance demands of a growing universe of “ESG” funds to uncomfortable scrutiny.

“We always get that question: in a downturn, does ESG keep going?” says Martin Whittaker, the CEO of Just Capital, which ranks companies by how they treat stakeholders. “In a riskier world, some people are . . . not going to think long-term,” he warns, predicting a shake-out that will expose “those that are in it for the marketing”. WeWork’s claim to be dedicated to “the energy of we”, for example, has rung hollow since it outsourced 1,000 cleaners’ jobs.

Even business as usual can look callous when conditions change as sharply as they have in recent weeks. Raising the prices when in-demand products are in short supply is rational in normal times; in a crisis it looks like gouging. Amazon this week deleted thousands of product listings that flouted its fair pricing policy, and a New York state senator proposed penalties for retailers hiking the price of face masks.

Similarly, disparities in the benefits companies offer different workers pose unexpected reputational risks. It is one thing to tell office dwellers they can stay home with their laptops, but minimum-wage staff at Walmart and McDonald’s and the gig economy workers on which DoorDash and Uber depend do not have that choice.

As infection concerns boost remote working, “everybody in New York thinks they’ll sit at home and get takeout, but nobody who delivers takeout or Amazon parcels gets paid sick leave,” points out Alison Taylor, executive director of NYU Stern's Ethical Systems centre. An ethical business should extend such benefits to contract and gig economy workers, she argues: “Do I think there’s a hope in hell they’ll do that? No way.”

The case for companies staying focused on multiple stakeholders’ long-term interests — even in a crisis — is getting stronger. Deloitte estimates that half of all actively managed funds will have ESG mandates by 2025, and a growing body of research suggests that companies which manage to longer horizons outperform regardless of the economic cycle.

“The numbers show that acting in a long-term fashion can shield a company from the lasting effects of a market downturn,” says FCLTGlobal CEO Sarah Williamson. Companies such as PayPal which have improved benefits for people at the bottom of their org charts have won investors’ backing.

So what companies should do is clear. What they choose to do will determine which ones emerge strongest.

Even with support from longer-term ESG investors, CEOs face intense pressure to put shorter-term shareholders’ demands first. If they yield to it by slashing jobs, short-changing suppliers or backing away from environmental commitments, their actions risk being seen not as inevitable responses to hard times but as corporate hypocrisy, shattering the public’s already shaky trust in business.

In 1963, the Stanford Research Institute defined “stakeholders” as “groups without whom the organisation would cease to exist”. It took decades for executives to come around to the idea that constituents other than their investors play such an existential role.

Now they must show the substance behind their professed conversión.

Coronanomics 101

In the fight against the COVID-19 pandemic, economists, economic policymakers, and bodies like the G7 should humbly acknowledge that “all appropriate tools” imply, above all, those wielded by medical practitioners and epidemiologists. Coordination, autonomy, and transparency must be the watchwords.

Barry Eichengreen

eichengreen139_STRAFP via Getty Images_coronavirushospitalpatient


BERKELEY – Last week, G7 finance ministers and central bank governors vowed to use “all appropriate policy tools” to contain the economic threat posed by the COVID-19 coronavirus.

The question left unanswered is what is appropriate, and what will work.

The immediate response took the form of central bank rate cuts, with the US Federal Reserve fast off the mark. Though central banks can move quickly, however, it is not clear how much they can do, given that interest rates are already at rock-bottom levels. In any case, the Fed’s failure to coordinate its rate cut with other major central banks sent a negative signal about the coherence of the response.

Moreover, monetary policy can’t mend broken supply chains. My colleague Brad DeLong has tried to convince me that an injection of central bank liquidity can help get global container traffic moving again, as it did in 2008. (Now you know the kind of elevator conversations we have at UC Berkeley.) But the problem in 2008 was disruptions to the flow of finance, which central banks’ liquidity injections could repair.

The problem today, however, is a sudden stop in production, which monetary policy can do little to offset. Fed Chair Jerome Powell can’t reopen factories shuttered by quarantine, whatever US President Donald Trump may think. Likewise, monetary policy will not get shoppers back to the malls or travelers back onto airplanes, insofar as their concerns center on safety, not cost. Rate cuts can’t hurt, given that inflation, already subdued, is headed downward; but not much real economic stimulus should be expected of them.

The same is true, unfortunately, of fiscal policy. Tax credits won’t get production restarted when firms are preoccupied by their workers’ health and the risk of spreading disease. Payroll-tax cuts won’t boost discretionary spending when consumers are worried about the safety of their favorite fast-food chain.

The priority therefore should be detection, containment, and treatment. These tasks require fiscal resources, but their success will hinge more importantly on administrative competence. Restoring public confidence requires transparency and accuracy in reporting infections and fatalities. It requires giving public health authorities the kind of autonomy enjoyed by independent central banks. (Unfortunately, this is not something that comes naturally to leaders like Trump.)
Still, expansionary fiscal policy, like expansionary monetary policy, can’t hurt. Here, Italy has shown the way, postponing tax and mortgage payments, extending tax credits to small firms, and ramping up other spending. The US so far has shown less readiness to act, failing even to encourage people to seek testing by helping them pay their medical bills.

One obstacle to fiscal stimulus is that its effects leak abroad, because some of the additional spending is on imports. As a result, each fiscal authority hesitates to move, and governments collectively provide less stimulus than is needed. This justifies coordinating fiscal initiatives, as G20 countries did in 2009. But, by that year’s standards, the recent G7 communiqué promising “all appropriate action” was a nothingburger that did little to bolster confidence that governments would take the concerted steps called for by worsening global conditions.

Then there are fiscal hawks and monetary-policy scolds who claim that any official intervention will be counterproductive. They warn, for example, that financial systems will be impaired if central banks push interest rates deeper into negative territory. But while there surely exists an interest rate sufficiently below zero where this is the case, all the evidence is that current rates are still very far from this point.

In addition, we are cautioned that fiscal stimulus by governments with heavy debts will undermine confidence, rather than bolster it. Japan, it is said, is already dangerously over-indebted. This exaggerated argument ignores the fact that the Japanese government has extensive public-sector assets to offset against its debts.

Likewise, we are reminded that the US has a looming entitlement burden, an argument that ignores the fact that the interest rate on the public debt is perennially below the economy’s growth rate. And while China’s state-owned enterprises may have massive debts, the tightly controlled financial system limits the risk of the kind of financial crisis that the country’s critics have been erroneously forecasting for years.

Central banks and political leaders, faced with a global crisis, should ignore these fallacious arguments and use monetary and fiscal policies to ensure market liquidity, support small firms, and encourage spending. But they must recognize that these textbook responses will have only limited effects when the problem is not a shortage of liquidity, but rather supply-chain disruptions and a contagion of fear.

Today, economic stabilization depends most importantly on the actions of public-health authorities, who should be given the resources and leeway to do their jobs, including freedom to cooperate with their foreign counterparts.

In the fight against the COVID-19 pandemic, economists, economic policymakers, and bodies like the G7 should humbly acknowledge that “all appropriate tools” imply, above all, those wielded by medical practitioners and epidemiologists. Coordination, autonomy, and transparency must be the watchwords.


Barry Eichengreen is Professor of Economics at the University of California, Berkeley, and a former senior policy adviser at the International Monetary Fund. His latest book is The Populist Temptation: Economic Grievance and Political Reaction in the Modern Era.

Coronavirus and debt: a toxic mix

The combined supply and demand shock could not have come at a worse time

Hung Tran

A firefighter wearing protective clothing, mask and goggles, sprays disinfectant on Tabia’t bridge pedestrian overpass in Tehran, Iran, on Monday, March 9, 2020.
A firefighter in protective clothing sprays disinfectant on a pedestrian bridge in Tehran, Iran © Bloomberg


The spread of the coronavirus is likely to tilt 2020 global economic growth below the OECD’s base-case estimate of 2.4 per cent (already below the 2.5 per cent threshold marking a global recession) towards its worst-case estimate of 1.5 per cent.

This disease-induced shock to supply and demand could not have come at a worse time for a world economy awash in debt: $72.7tn (92.5 per cent of global gross domestic product) for sovereign borrowers and $69.3tn (88.3 per cent of GDP) for non-financial corporate borrowers, according to the Institute of International Finance. Many highly indebted sovereign and corporate borrowers will be in distress.

The obvious casualties are countries already in debt crises before Covid-19 hit. Besides Venezuela and Argentina, Lebanon has just defaulted on its maturing $1.2bn eurobond and is looking to restructure all of its $31.3bn eurobonds. With about $90bn of public debt, equal to 155 per cent of GDP, the crisis-stricken country has been going through its own version of the sovereign/bank doom loop — domestic banks hold most of its public debt.

Also hard hit are the sub-Saharan African countries, almost half of which have been in debt distress according to the IMF and the World Bank.

Zimbabwe is in an economic and humanitarian crisis, with a painful economic contraction last year. Half of its population reportedly experience food insecurity, while the newly introduced Zimbabwe dollar has lost most of its value due to triple-digit inflation. Arrears to external creditors add up to more than 30 per cent of GDP.

Zambia is also struggling, with record external debt of $11.2bn at the end of 2019. The country continues to run a fiscal deficit of minus 9 per cent of GDP on a commitment basis, making it difficult to engage with the IMF to restore debt sustainability.

Having posted a record debt-to-GDP ratio of 118 per cent in 2017, the Republic of Congo secured an IMF package of $449m last July after it was able to extend maturity (with no principal haircuts) on its $2.5bn debt to China — showing a way for China’s loans to sub-Saharan African countries to be tackled.

Mozambique’s restructuring agreement with 60 per cent of its eurobond holders remains mired in litigation. Angola’s public debt has reached 102 per cent of GDP. South Africa was in recession during the second half of 2019 — serious fiscal deterioration will soon raise government debt to 70 per cent of GDP.

At present, only Somalia, Sudan and Eritrea remain in the pre-decision point phase of the Highly Indebted Poor Countries (HIPC) debt relief programme; perhaps more should be added.

The elephant in the room in terms of sovereign debt risk, however, is Italy. The parts of the country in lockdown account for 40 per cent of its GDP; the economic disruption will probably push Italy into its fourth recession since the global financial crisis, lifting the 2020 fiscal deficit above the budgeted 2.2 per cent of GDP and government debt beyond $2.5tn, or 135 per cent of GDP.

Low interest rates can help for now but zero growth combined with high and rising debt is not sustainable. While the probability of an Italian sovereign debt crisis is still low, it is not negligible and is rising, representing a high-impact risk to the global economy and an existential threat to the eurozone.

With expected corporate profit growth this year being slashed to zero or negative for many mature and emerging market economies, corporate borrowers with low interest coverage ratios (ICR) will increasingly come under pressure.

A recent study by the US Federal Reserve Board estimates that for US corporations, the average ICR is a rather low 3.7 and the percentage of debt at risk  (with ICR<2) is a non-negligible 31.7 per cent.

South Korea merits particular attention: aside from being hard hit by Covid-19, it has a high corporate debt-to-GDP ratio at 101.6 per cent — and high household debt ratio of 95 per cent.

China posts the world’s highest ratio of corporate debt to GDP at 156.7 per cent. Most of the debt is domestic. However, it has plenty of state-owned assets, including forex reserves of $3.1tn and a relatively low level of government debt, at 54 per cent of GDP. China can use its sovereign balance sheet to absorb corporate debt losses if necessary.

Beijing will probably continue to direct state-owned banks to evergreen loans to state-owned enterprises, and state-owned asset management companies to conduct debt-for-equity swaps, allowing a controllable number of bankruptcies for demonstrative purposes. In other words, while China’s corporate debt problem is serious, its potential losses and impact will be stretched far out into the future — debt resolution with Chinese characteristics!

In short, expect to see more cases of sovereign and corporate debt distress in the months ahead. While many distressed borrowers are individually small and non-systemic, if a sufficient number of them default at the same time, it would cause a shock to global financial stability.

That is, until Italy falls into debt distress!


Hung Tran is a non-resident senior fellow at the Atlantic Council, and former executive managing director at the Institute of International Finance.

A U.S. Economic Contraction And Bear Market Highly Likely

by: James A. Kostohryz


Summary
 
- A significant contraction of US economic activity in 2Q 2020 is now virtually assured.

- Although a full-fledged multi-quarter recession is not certain, the pathway to escape this outcome is very narrow, indeed.

- My best-case scenario for US stocks is a peak-to-trough decline of roughly 31%.

- Full-fledged recession scenarios - according to severity and length - will most likely entail US equity market declines of greater than 50%.

 
For reasons described in this article, a significant contraction in US economic activity in the second quarter of 2019 is highly likely. Furthermore, a bear market in US equities, associated with this US contraction and a broader global recession, is highly likely.

An Economic Contraction is Virtually Certain in 2Q 2020

If you are personally inclined to think that COVID-19 poses economic threats that are not significantly greater than the flu, then I strongly urge you to read this article.

By reading this article you will come to understand that COVID-19 poses massive threats (which are not yet widely understood by the public) to the economy of any area of the world in which there's a major outbreak.
 
Various areas around the US are currently on the verge of major outbreaks, and these actual and potential outbreaks already are having serious economic impacts. These impacts will only grow in the next few months.
 
I will briefly review the factors that will drive a US economic contraction in 2Q 2020.
 
1. Global economic recession. I highly recommend that you read this article in order to understand why a global economic recession driven by severe recession in China is now a certainty.
 
This global economic recession will have major direct and indirect spill-over impacts on the US economy, via supply, demand and impacts on the financial system.
 
2. Investment freeze. As a result of disruptions in both supply and demand, producers and entrepreneurs will cancel or otherwise postpone planned investments. A collapse in non-residential investment expenditure will likely subtract 1.0% to 1.5% from GDP in 2Q 2020. The only real question is: How severe or for how long?

3. Manufacturing contraction. Major global supply chain disruptions, particularly out of China, will induce a major contraction in activity in the US manufacturing sector – and all of the economic activity which is associated with US manufacturing production.
 
This will have several impacts. First, this will severely lower sales of manufactured goods in the US. Second, there will be substantial layoffs in the manufacturing sector associated with idled production. It's important to understand that it only takes one missing part to grind the entire mass production line of a manufacturer to a halt.
 
This, in turn, impacts both the upstream and the downstream businesses that depend on US manufacturing.
 
The direct and indirect impact of US manufacturing on the US economy amounts to about 30% of GDP. In a relatively benign scenario, I estimate that the (non-investment) supply-based and demand-based shock emanating from the manufacturing sector will not subtract less than 2.0% of GDP in the second quarter. This would be a best-case scenario.
 
4. Service sector contraction. “Social distancing” will be the new catch-phrase for 2020. Conventions, business gatherings, concerts and sporting events will be cancelled. First, companies and individuals will drastically reduce travel and all associated consumption in the hospitality industry.
 
Second, in order to protect themselves and their families against the risk of contagion, individuals will drastically reduce their consumption at restaurants, shopping malls and any commercial establishment that induces contact with other people.
 
The magnitude of the hit to US consumption activity depends on the extent and breadth of the spread of COVID-19 in the US. However, in a best-case scenario, I estimate that overall service sector final expenditure will contract by at least 3%, implying roughly a 2% hit to GDP.
 
5. Imports and exports. US exports will collapse in the third quarter of 2020 due to the decline in global demand and due to the disruption of global supply chains.

However, imports also will collapse due to supply chain issues. Thus, the net “accounting” impact on GDP from net exports is difficult to estimate.

However, it should be apparent that a collapse in imports (caused by supply-chain issues) which may “inflate” the net exports line item in GDP, will significantly lower the consumption and investment line items. In order to understand this, it's important to note that imports indirectly enable and generate a great deal of economic activity.
 
First, “intermediate” imports are key inputs in the production process of “domestically” produced goods. Second, imports of final goods generate much economic activity in the transportation and retail industries.
 
6. Relative price distortions. The prices of many goods will decline due to the collapse in global demand.

However, due to supply chain disruptions, the prices of many goods will increase – in some cases, very substantially. The resulting relative price disruptions will cause serious economic problems for businesses.
 
Price distortions also will have deleterious effects on both business and consumer confidence. In this latter regard, it should be noted that rising prices (especially upward price “shocks”) will negatively impact the psychology of business and consumer spending to a far greater extent than falling prices will positively impact businesses and consumers.
 
It should be noted that I fully expect aggressive fiscal and monetary policies. I expect aggressive monetary policies by the Fed (rate cuts and QE) and massive expenditure bills to be passed by Congress and signed by the executive.
 
I fully expect that these measures will somewhat offset the contractions in investment and consumption caused by COVID-19 supply and demand shocks. (Although I will note that these policies will actually make the relatively price distortions even worse.)
 
Overall, regardless of how effective these expansionary fiscal and monetary policies actually are (and I do assume that they will be as effective as they can be), they will certainly not prevent a contraction in economic activity in the second quarter.
 
For example, no amount of fiscal or monetary stimulus is going to persuade consumers to go to cinemas, restaurants and shopping malls in areas impacted by COVID-19. These measures also will not alleviate supply chain disruptions.

Thus, although the depth of the contraction in 2Q economic activity depends on how severe and widespread the COVID-19 becomes, a significant contraction in 2Q is virtually assured.
 
Note that I'm explicitly not applying the “R” word. A recession generally implies a contraction in economic activity that's more widespread, severe and prolonged than that which we can confidently estimate going forward based on our limited estimations related to 2Q 2020.
 
What Will Happen to Economic Activity in 3Q 2020 and Beyond?
 
It's exceedingly difficult to forecast US economic activity beyond 2Q, at this point in time.
 
However, below are some key factors in the analysis.
 
1. Reaction of COVID-19 to weather. There's reason to believe that the rate of COVID-19 contagion will significantly decelerate in the summer. Probabilistic inferences along these lines are justified due to the known behavior of other strains of coronavirus and also due to the relatively low rates of propagation (apparently) witnessed thus far in warm nations.
 
If, as a result of lower levels of contagion/propagation during warm months, consumers are able resume their normal consumption habits by July of 2020 and global supply chain issues are alleviated by then, it's possible that the US economy will resume growth in Q3 2020.
 
However, it's far from certain that the rate of contagion of COVID-19 will slow down enough such that US consumption returns to normal and that global supply chains will be back to normal by that time.
 
2. Will COVID-19 come roaring back in fall 2020? It's unlikely that a vaccine for COVID-19 will be available to the public before February of 2021. In this context, based on the behavior of other viruses, there's substantial reason to believe that COVID-19 will cause a second and potentially more destructive wave of infections in the fall and early winter of 2020. Surely, governments and the population will have ample time to take preventative measures, which will ameliorate the impacts.
 
However, it's precisely these sorts of preventative measures by governments and the general population which are likely to impair US GDP growth substantially in the fourth quarter of 2020 and first quarter of 2021.
 
Assuming that COVID-19 does not simply disappear before a vaccine is massively distributed some time in 2020 (an unlikely scenario), then it seems highly likely that this virus will be causing havoc in the global and the US economy at least through the first quarter of 2021.
 
I have not officially published a forecast of a US recession in 2020. However, a Best-Case scenario for the US economy for the remainder of 2020 will be a significant contraction in 2Q, followed by a significant rebound in 3Q, then followed by a major slowdown in 4Q.
 
It will not take much for me to eventually rule out such a best-case scenario and officially call for a full-fledged recession which encompasses the entire four quarters spanning from Q2 2020 through Q1 2021. I have outlined the factors above which would eventually trigger a full-fledged recession forecast on my part.
 
Stock Market Impact
 
US economic recessions are virtually always accompanied by bear market declines of 20% or more in the S&P 500. Although a US recession is not yet a certainty, due to the fact that a global recession is virtually assured, it's my view that a full-fledged US recession will not be required to trigger a stock market decline of 20% or more.
 
It's important to recall that roughly 40% of S&P 500 revenues and earnings are driven by direct foreign sales. If we add sales that, indirectly, are highly dependent on global economic conditions, this figure would likely rise to over 65%.
 
I will cite only a few examples of indirect impacts from global factors. First, consider the domestic sales of energy and materials sectors of the S&P 500 which are dependent on the pricing of internationally commercialized commodities (e.g. crude oil), the pricing of which are determined in international markets.
 
Second, consider that roughly 80% of all drugs sold in the US by the pharmaceutical industry (impacting S&P Healthcare and Consumer Staples) require international inputs, primarily from China.
 
Third, consider that the production and domestic sales of the S&P industrial sector almost is entirely beholden to global supply chains.
 
Finally, please consider that domestic sales by the S&P Consumer Discretionary sector (e.g. autos and luxury goods) largely depends both on critical inputs and demand from non-US sources.

Thus, my Best-Case scenario for the US stock market, which depends upon my best-case macro-economic scenario (outlined previously) is for the S&P 500 to merely “re-test” the 2018 low of 2351.
 
This would represent a peak-to-trough decline of roughly 31%. A decline of this magnitude would be roughly in line with the “average” cyclically-induced major declines experienced in the US since World War II (average of 28.6%).
 
This scenario looks considerably “rosy” considering that the earnings prospects, and the “equity risk premium” used to discount those earnings, are considerably worse than they were in December of 2018 (when the low of 2351 was made).
 
However, if the spread of COVID-19 causes a severe contraction in consumption in 2Q and there's a major second wave of global infections in the fall of 2020, then it will become necessary to factor in a deep economic recession in the US and globally which lasts at least 12 months.
 
In this scenario, considering valuation issues and other risk factors, I would expect the S&P 500 to eventually decline by at least 50%, with potential for declines of 65% or more.