3 ms·

I mean, if companies like that didn’t run such a huge deficit, they might be able to get more favorable loan terms.

by yladiz 3y ago

lokar 3y ago
It’s not about running a deficit (most are free cash flow positive), it’s about improving returns on capital with leverage.
- sterlind 3y ago
  I'm financially illiterate, but what does this mean? Companies have the revenue to pay their employees, but they choose to terminate them instead, because... why?
  - WorkerBee28474 3y ago
    Hey, SWE who happens to have an MBA here. Theoretically, if a company has money to pay employees it keeps them if the present value of their project is positive, and terminate them if the present value of their projects is negative. Let's say an employee earns $100K this year. The project they're working on this year will generate 40K of revenue in 1 year, 2 years, and 3 years. Is the project worth doing? Let's assume the discount rate is 5%. A dollar now (which we call 'present value (PV)') is worth $1.05 a year from now ('future value (FV)'). And 1.05^2 in 2 years. And 1.05^n in n years. And a dollar in n years (FV) is worth 1/(1+discount)^n dollars today (PV). It's a mechanism similar to inflation, or paying interest. (IRL the discount rate is the WACC + some factor for riskiness, but that's too much to talk about.) Let's say the discount rate is 5%. Is the project worth doing? The present value (PV) is -100K + 40K/1.05 + 40K/1.05^2 + 40K/1.05^3. So if you approve the project, the future profits and expenses are as if you earned $8,930 today. You approve the project. Let's say interest rates go up, and you now need to use 10% as the discount rate. -100K + 40K/1.10 + 40K/1.10^2 + 40K/1.10^3 = $-526. If you approve the project, you will lose money. So you don't approve the project. Now you don't need the employee anymore, and you get rid of the them, by reassignment, reorganization, or layoff.
    - tsunamifury 3y ago
      It's a lot simpler than that, firing people was earning 30x return in stock price. Almost no one's actual revenue to the company was worth that. The market has created negative human incentives.
      - gen220 3y ago
        The person you were replying to is explaining why firing people "raises the stock price". And yes, it really is that complicated. Firing people whose salaries have a dramatically positive ROIC for the company does not raise the stock price, it lowers the stock price. The mistake, in retrospect, is the executives': they should not have over-hired in 2020. I know it's a bizarre silver lining, but to the extent there is one, workers got capital (in the form of SBC and cash) that they otherwise "shouldn't" have. If those companies had been run more effectively, most would have never been hired in the first place. It's kind of a crap silver lining, because we psychologically feel loss [of a job] 10x more than gain, but the realistic "market-optimal" alternative was not "I have this cushy, high paying job forever", it was actually "I have never had a cushy, high paying job".
    - sterlind 3y ago
      But won't the projected value of the project go up with the discount rate? Why would the project still only make $40K on year 3, rather than now making $40K*1.10^3?
      - Jensson 3y ago
        Rent changed in that scenario, not inflation. So the project wouldn't make more since money isn't worth more, you just get more ROI on external investments making internal investments less lucrative in comparison.
      - gen220 3y ago
        In reality, the projected value of many such projects were either never accurately measured, or allowed to differ from the "measured" value for a very long time. The projections would go something like $0 two years ago, $5k last year, but then $100k next year, $5mm year after that. One day? $1B, easy. There'd be precious little evidence to support the exponential growth hypothesis, while having 10 assigned engineers earning as much as their peers in more predictable domains. It's easier to justify such ideas in a big, rich company when the risk free rate of return is near-zero and the profit center of the company is compounding (the growth in Ads justifies the negative ROIC everywhere else). But when your profit center is wavering and showing worrying signs of stalling out (as Google and Meta did in 2021/22), the calculus shifts dramatically. When you manage a company not for "growth" but for "value" (which is an inevitable part of the corporate cycle), these projects and the employees behind them are decreasingly seen as a potential source of future profits and more as a waste of increasingly valuable cash.
  - gen220 3y ago
    Basically, it's not about piles of cash. It's about the rate at which those piles are changing, and how you can allocate capital to min-max those rates of change. In an environment where the "risk-free rate of return" is secularly-higher, the floor of minimal necessary productivity goes up. Let's say the ROIC of investing $300k "into" an employee is $310k (3.33% rate of return). If the risk free rate of return is 1%, you take that employee. If it's 5%, you fire that employee. I think the reality is that the typical ROIC was above the typical salary, but that there was an inflection point that they crossed in the hiring spree of 2019-2021. If you're a capital allocator (CEO), your responsibility is to maximize ROIC for shareholders over the long run. In environments where you're not absolutely confident that your eventual, steady-state employee ROIC will trounce (i.e. 2-5x's) the risk free rate of return, you should generally favor returning capital to shareholders (with dividends or buybacks) instead of putting good money after bad.

I mean, if companies like that didn’t run such a huge deficit, they might be able to get more favorable loan terms.

by yladiz 3y ago

I mean, if companies like that didn’t run such a huge deficit, they might be able to get more favorable loan terms.

It’s not about running a deficit (most are free cash flow positive), it’s about improving returns on capital with leverage.

sterlind 3y ago
I'm financially illiterate, but what does this mean? Companies have the revenue to pay their employees, but they choose to terminate them instead, because... why?
- WorkerBee28474 3y ago
  Hey, SWE who happens to have an MBA here. Theoretically, if a company has money to pay employees it keeps them if the present value of their project is positive, and terminate them if the present value of their projects is negative. Let's say an employee earns $100K this year. The project they're working on this year will generate 40K of revenue in 1 year, 2 years, and 3 years. Is the project worth doing? Let's assume the discount rate is 5%. A dollar now (which we call 'present value (PV)') is worth $1.05 a year from now ('future value (FV)'). And 1.05^2 in 2 years. And 1.05^n in n years. And a dollar in n years (FV) is worth 1/(1+discount)^n dollars today (PV). It's a mechanism similar to inflation, or paying interest. (IRL the discount rate is the WACC + some factor for riskiness, but that's too much to talk about.) Let's say the discount rate is 5%. Is the project worth doing? The present value (PV) is -100K + 40K/1.05 + 40K/1.05^2 + 40K/1.05^3. So if you approve the project, the future profits and expenses are as if you earned $8,930 today. You approve the project. Let's say interest rates go up, and you now need to use 10% as the discount rate. -100K + 40K/1.10 + 40K/1.10^2 + 40K/1.10^3 = $-526. If you approve the project, you will lose money. So you don't approve the project. Now you don't need the employee anymore, and you get rid of the them, by reassignment, reorganization, or layoff.
  - tsunamifury 3y ago
    It's a lot simpler than that, firing people was earning 30x return in stock price. Almost no one's actual revenue to the company was worth that. The market has created negative human incentives.
    - gen220 3y ago
      The person you were replying to is explaining why firing people "raises the stock price". And yes, it really is that complicated. Firing people whose salaries have a dramatically positive ROIC for the company does not raise the stock price, it lowers the stock price. The mistake, in retrospect, is the executives': they should not have over-hired in 2020. I know it's a bizarre silver lining, but to the extent there is one, workers got capital (in the form of SBC and cash) that they otherwise "shouldn't" have. If those companies had been run more effectively, most would have never been hired in the first place. It's kind of a crap silver lining, because we psychologically feel loss [of a job] 10x more than gain, but the realistic "market-optimal" alternative was not "I have this cushy, high paying job forever", it was actually "I have never had a cushy, high paying job".
  - sterlind 3y ago
    But won't the projected value of the project go up with the discount rate? Why would the project still only make $40K on year 3, rather than now making $40K*1.10^3?
    - Jensson 3y ago
      Rent changed in that scenario, not inflation. So the project wouldn't make more since money isn't worth more, you just get more ROI on external investments making internal investments less lucrative in comparison.
    - gen220 3y ago
      In reality, the projected value of many such projects were either never accurately measured, or allowed to differ from the "measured" value for a very long time. The projections would go something like $0 two years ago, $5k last year, but then $100k next year, $5mm year after that. One day? $1B, easy. There'd be precious little evidence to support the exponential growth hypothesis, while having 10 assigned engineers earning as much as their peers in more predictable domains. It's easier to justify such ideas in a big, rich company when the risk free rate of return is near-zero and the profit center of the company is compounding (the growth in Ads justifies the negative ROIC everywhere else). But when your profit center is wavering and showing worrying signs of stalling out (as Google and Meta did in 2021/22), the calculus shifts dramatically. When you manage a company not for "growth" but for "value" (which is an inevitable part of the corporate cycle), these projects and the employees behind them are decreasingly seen as a potential source of future profits and more as a waste of increasingly valuable cash.
- gen220 3y ago
  Basically, it's not about piles of cash. It's about the rate at which those piles are changing, and how you can allocate capital to min-max those rates of change. In an environment where the "risk-free rate of return" is secularly-higher, the floor of minimal necessary productivity goes up. Let's say the ROIC of investing $300k "into" an employee is $310k (3.33% rate of return). If the risk free rate of return is 1%, you take that employee. If it's 5%, you fire that employee. I think the reality is that the typical ROIC was above the typical salary, but that there was an inflection point that they crossed in the hiring spree of 2019-2021. If you're a capital allocator (CEO), your responsibility is to maximize ROIC for shareholders over the long run. In environments where you're not absolutely confident that your eventual, steady-state employee ROIC will trounce (i.e. 2-5x's) the risk free rate of return, you should generally favor returning capital to shareholders (with dividends or buybacks) instead of putting good money after bad.