Incentives Matter

Posted by Jeff Carter
on September 21st, 2010

The Reformed Broker in his blog today brings up a great point. Earnings. If you bought rumors and sold facts you made money. October should be a good month for earnings again if history is a guide.

Why are earnings so good when it seems like the nation’s GDP, and world GDP is slowing? Incentives. All the talk about keeping the Bush tax cuts for a couple of more years hasn’t become policy and law yet. Until it does, companies will be forced to recognize revenue this year that they might have recognized in ensuing years.

Incentives. Obamacare severely penalizes companies that have more than 50 employees. If your company is close to that line, you are trying to lay off employees to get under it. If you are approaching the magic number, companies are trying to stay below it. Hence, unemployment remains stubbornly high.

Incentives. Cash has built up on company balance sheets. They have to do something with it. A large cash balance makes a company cheaper to buy. M+A activity is up. This provides a bid to the stock market.

Incentives. Because top line revenue growth is relatively stable, companies are seeking to drive higher profit through more efficient operations. This is not bullish for employment.

Incentives. Watch. December 31, there will be a higher than normal amount of deaths in the US if the “death tax” is reinstated. People respond to incentives.

Incentives matter. The table has been set, and companies, and the public are responding.

UPDATE

Incentives matter. Here is a concrete example. Tip of the hat to Instapundit.com. Insurers will stop offering insurance policies for children because of government regulations. The new regulations have changed the risk/reward of extending insurance to kids. The government regulation actually forced kids to become uninsured, not the other way around.

Another longer term example is Sarbanes-Oxley legislation. It increased the cost significantly to become a public company. Hence, we have fewer initial public offerings (IPO), and more privatization of existing companies. Incentives matter.

Until they pay attention to economic incentives with policy decisions in DC, we will continue to get more bad policy.

The information in this blog post represents my own opinions and does not contain a recommendation for any particular security or investment. I or my affiliates may hold positions or other interests in securities mentioned in the Blog, please see my Disclaimer page for my full disclaimer.