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Never too early to start developing human capital

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When this blog discusses human capital, we tend to do so from the perspective of human capital in the workplace.  Today we’ll look a little earlier.  In his weekly column today, David Leonhardt of the New York Times highlights a new academic study on the effects of kindergarten on future outcomes.

The research, by Raj Chetty and colleagues, examined what’s happened to almost 12,000 children who were included in a large educational experiment in Tennessee in the 1980s.  They find that students who learned more in kindergarten went on to earn more money and were less likely to become teenage parents (as well as a variety of other positive outcomes).

Extensive research has been done on the positive economic effects of education, but almost none of it has reached all the way back to kindergarten.  As Leonhardt notes, this new research suggests that early education may be an example of a long-term investment that has benefits that don’t fade away.  We should always be on the lookout for how to take advantage of those sorts of opportunities.

Are US companies eating the seed corn?

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Today’s New York Times features an article entitled “Industries Find Surging Profits in Deeper Cuts.” The article notes that:

Among the S.& P. 500 companies that have reported second-quarter results, more than one in 10 had higher profits on lower sales, nearly twice the number in a typical quarter before the recession … Even at corporations where both the top and bottom lines are expanding, the focus remains on keeping profits high, not rebuilding work forces decimated by the recession. 

One possible interpretation of this ongoing “right-sizing” is that large, U.S.-based firms are adjusting to the “new normal” by finding ways to remain sustainably profitable in the face of permanently lower demand. 

Alternatively, it may be that many of the companies exhibiting this behavior are engaging in the corporate equivalent of eating “the seed corn” (the seed saved from one year’s harvest to use for planting in the following year) by grabbing whatever short-run profits they can get their hands on, despite the negative long-term consequences.

In either case, the implications for investors are the same.  While firms that are exhibiting this behavior will generate tidy returns in the short-run, they are a much riskier bet in the long-run.  Eating the seed corn is never a smart strategy – unless your existence is in peril.

Quadrophobia: the strategic rounding of earnings data

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I just stumbled across a fascinating article by academics Joseph Grundfest and Nadya Malenko that examines the “first post-decimal digit of EPS” (earnings per share) data of nearly 489,000 quarterly earnings records for 22,000 companies over a 27-year period. 

In a data set this large, the last digit of EPS measured to the one-tenth of a cent (for example, the number “6” in $0.516) should be evenly distributed between 0 and 9.  But Grundfest and Malenko find that is not the case.  Rather, they found that the number 4 appeared only 8.5% of the time (instead of the expected 10% of the time), and the numbers 2 and 3 are also under-represented. All other numbers were over-represented.

This suggests that some publicly-traded firms are expending effort to manage revenues and costs in such a way that allows them to “round up” their earnings (e.g., from $0.516 to $0.52) rather than “round down” (e.g., from $0.514 to $0.51), improving their apparent earnings and making it more likely they’ll meet Wall Street expectations (or exceed those expectations by one cent).

Not only does this represent an economic inefficiency (in that it requires an expenditure of resources without any increase in “real” economic value), but Grundfest and Malenko find that firms that suffer from so-called “quadrophobia” are also more likely to be subsequently charged with accounting violations.

The obsession that Wall Street has with short-run earnings continues to be a destructive force.  We need to develop alternative measures that help to focus investors’ attention on long-run value creation.  That’s one of the reasons that the emergent field of human capital analytics is so important.