The New Religion Of Finance And How It Shapes Corporate Investment

This article, written by a professor from the Harvard Business School, describes the financial metrics that determine executive compensation and shape corporate investment decisions.  There are three kinds of investments that corporations make.  One kind of investment, that he calls empowering investment, creates jobs and builds assets.  The two remaining investment types discourage investments in assets and jobs.  Return on net assets (RONA) is one the ratios that has become part of the new financial religion.  That ratio can be enlarged by increasing profits and/or by reducing assets.  It is easier and faster to reduce assets than it is to increase profits.  That has encouraged many firms to shed assets from their balance sheets.  Instead of investing in revenue producing assets, many firms have contracted with other firms to produce their products.  For example McDonnell Douglas outsourced the production of the DC 10.  This increased its RONA dramatically.  Unfortunately, this also enabled the contract manufacturers to capture the replacement part business.  McDonnell Douglas lost the recurring revenue stream that could have helped it to finance the DC 11 which was never produced.

The new financial religion has discouraged empowering investments that create jobs and grow the economy.   The religion funnels investment into the two remaining investment categories that focus on short term RONA.  The short term focus that prevails in most corporations and on Wall Street has been determined by the new financial religion that is firmly held by corporate executives and financiers.  We can't understand the global economy without understanding the new religion of finance.