vol. XV no. 3

				The Roots of the Problem Frazier currently serves on the boards of R.J. Reynolds and Apache Corp. Because of his move to Caremark Rx, he recently resigned from the board of Magellan Health Services, on which he served for many years, because of a potential conflict of interest with his new position. He also previously served on the board of Rock-Tenn Co. He emphasized that the current crisis did not start in a vacuum. Enron, Arthur Andersen, WorldCom, Global Crossing and Tyco did not suffer from spontaneous combustion. Their problems grew out of an era when stock prices went through the roof. CEO salaries skyrocketed, too, with the blessings of directors who believed the executives had caused the boom. The rewards were enormous, and man-on-the street investors shared the wealth - for a while. Today's problems, Frazier said, are the outgrowth of evolutionary changes in the way businesses began to change following World War II, when the United States had the highest production capacity in the world. America was a manufacturing powerhouse. Life was good. Inflation was low. Eventually, many of the manufacturing jobs that gave birth to the boom in the American middle class moved offshore. The nation began to evolve into a service economy while corporate leaders began creating a new type of corporate entity. "The focus of corporate assets became the conglomerate," Frazier said. "Multi-industry conglomerates were all the rage. Disparate types of companies were coming together. GE succeeded at it, but very few did. "That evolved into breaking up the conglomerates in the 1980s with leveraged buyouts (LBO). And I think the imagination of financial people who created new ways to structure financing is part of what we are feeling the effects of today," Frazier said. The LBO era gave rise to the conventional wisdom of the time that it was smart to break up a company that was worth more in parts than as a whole. Corporate financing gradually grew slicker. By the 1980s, companies were getting hooked on debt - using huge amounts to finance acquisitions based on a forecast of earnings. "It is that phenomenon that sets the stage for what we would call a wheeler-dealer corporate marketplace," Frazier noted. "Financial engineering is the modern term. It gave people who really had nothing but a good idea a real opportunity to get it financed and put it into a stock market and then a marketplace that was encouraging equity investments." Twenty-five years ago, he recalled, it was rare to find a story about the stock market on the front page of any newspaper. Today, it is regular front-page fare for every newspaper. Frazier cited the seismic shift in the average American's interest in the stock market as a turning point in the cycle. In the 1980s, people tended to work for companies most of their lives. The companies had defined benefit plans that included retirement benefits. That began to change because of the cost. "The company itself was making the investments - and most of it was debt, bonds - to finance retirement plans. That became horrifically expensive, and we moved to the defined contribution era. People began to be offered mutual funds as a device for managing their own retirements. They became familiar with owning stock assets managed by investment advisors and more comfortable with actually buying and selling or reallocating asset investments. They became a lot more savvy and knowledgeable in investing in corporations as opposed to simply buying treasuries." Frazier said the late '80s and early '90s marked the beginning of an era of individual stock ownership and momentum investing. Millions of individuals bought stock. Discount brokers were already established and became wildly popular. The man on the street picked up terms like "buy on the rumor and sell on the news." The peak of the era came during the dot-com and telecom phenomena when, in March 2000, NASDAQ reached its all-time high of 5,048.62. "The stock market was the place to be. It was exceeding inflation. It was generating double-digit returns. The people who drove it up saw it keep going up and up, but the underlying economics really didn't support the kind of growth rates that were embedded in these stock prices," he said. As stock price became the end-all and be-all of business, such measures as earnings growth and cash flow became less important in the eyes of investors. "Add a little fear and greed in there, and you have the circumstances that we are trying to deal with today and that we are wringing out," Frazier said. The way corporations were run began to change as stock prices soared. The CEOs who delivered higher and higher share prices "felt like they should be paid for doing that," Frazier said. "And corporate boards led them to be paid for doing that and encouraged them to be paid for doing that, so the treadmill started getting faster and faster. In some cases, corporate management said 'We've got to keep the stock price up no matter what.' " "For a director sitting on a board who sees the stock price go from $10 to $30, it is easy to believe that investors are getting a real value, so they say, ŒLet's keep on doing whatever it is we're doing.'" And now that era has ended, just as Frazier re-enters the corporate side of the world once again. He is comfortable there. In fact, it was his service on a board of directors that led to his new position at Caremark Rx Inc. Frazier was a director of Atlanta-based Magellan Health Services when it was run by Mac Crawford, now the chairman and CEO of Caremark, which is a much larger organization than the Chicago Stock Exchange. It's a better fit, Frazier said. Top | Previous Page

Copyright © 2003 Robinson College of Business/Georgia State University.