Ideoblog

Google's plunge

Google went down more than 50 bucks, or about 12%, in after hours trading yesterday following an earnings disclosure. This was despite strong results, because Google missed its numbers – a big problem when you’re flying as high as Google is.

According to the WSJ, Google’s blaming this on a higher effective tax rate resulting from allocating more expenses to international operations and therefore shifting net to the US, where taxes are higher.

Well, it’s nice to see that Google apparently isn’t manipulating earnings to meet expectations. But did Google have material undisclosed information? Probably not. A company doesn’t have to disclose every bit of information every second. A big problem with such disclosures is that they may be more misleading than helpful, and that could get the company in trouble.

From a business standpoint, should Google have been more forthcoming with analysts that Google knew were wrong? That’s not Google’s business model. And it certainly makes sense for a company not to get to “entangled” with analysts’ estimates, thereby building a market expectation that Google will always correct mistakes and creating a risk of holding Google responsible for their mistakes.

There’s a middle ground: Google could have private conversations with the most expert and active analysts and tell them more about what’s going on, including the tax issue. But Google can’t do that because of Arthur Levitt’s pride and joy, Reg FD. Here’s some of what I’ve had to say on that.

All of this is to say that disclosure presents very complex issues, and they differ from firm to firm. One arguable goal of disclosure is to get information into the market so that you don’t get lurches like what happened yesterday, which increase risk and therefore the cost of capital. You can decide from the above whether the government’s myriad rigid rules on disclosure further this goal.

Update: The WSJ discusses the effect of Google's lack of analyst guidance on the price swings of its stock, and the costs and benefits of that practice.  It reports some institutional dissatisfaction, but notes that lack of guidance is a "growing trend."  Nothing about the possible regulatory causes of this trend.

Do we have the optimal amount of Bainbridge?

Over at his blog, Steve Bainbridge has this post up:

Jeff Jarvis has a very funny rant against Google and other RSS cachers, whose humor masks an important point: A lot of Internet portals, but especially Google, are basically ripping off content providers. As an author, I'm already annoyed by Google's relentless drive to make my books available on line for free to all and sundry, which seems to be where they eventually want to get. As a blogger, it's less of an issue, but the larger point is that Google's disrespect for content providers has already caused it problems through litigation and may cause society problems if disrespect for intellectual property rights by Google and its ilk leads to a reduction in output from content providers and/or reduced access to new content. Where's the incentive for authors to write, for example, if Google's getting rich giving away the authors' product without compensating the author?

I think he might be joking, but if not, I'm sure his take is a bit overblown.  Here's a couple of things in response: 

• Google's "disrespect for content providers" is at worst a double-edged sword:  The service would go a long way toward reducing search costs, and even Bainbridge would be a beneficiary of that.  In the end no one can be certain which way it will (or would) cut, but it isn't all bad.
• I would think that the issue demands at least a passing glance in the direction of transaction costs.  Google's "disrespect" is intimately related to the thorny problem of opt-in/opt-out license in such a system.  If the idea has any merit at all (and plainly it does), it's not at all clear which regime is better from a social welfare perspective:  The one that preserves the author's veto at high cost and thus at the expense of completeness, or the one that recognizes an exception (say, fair use) for the sake of completeness.  I'm not suggesting I know which is preferable, but there's a powerful defense of the latter that doesn't turn on Google's rapacious disrespect for authors.
• The best part is the claim that, absent maximal enforcement of copyright, we'll have fewer works by profit-maximizing lawprofs out there.  First off, I say, "if only!"  Secondly, however, I am certain that there are other incentives for lawprofs to create.  (I know Bainbridge's comment was not limited to lawprofs, but as he is clearly concerned primarily with his own books, I'm just going to focus there, as well).  And as I frequently remark to my law and economics class:  It's not that we want maximum incentives; it's that we want optimal incentives.  In fact, I'd say those incentives are already beyond optimal.  As one data point, I ask you to look at the copious amount of crap produced in our law reviews.  A little less incentive might do some good.  (I know, I know -- few profs get royalties for law review articles.  But I have to imagine that the number of lawprofs and the level of their output are affected on the margin by the prospect of book royalties.)  I'm not saying enforcement of copyright should be weakened, I'm just saying that if your concern is that we'll get less output without that right, in some cases that may actually be a good thing. 

I understand that, as an author, Bainbridge wants compensation for his work.  I support that entirely -- it's really a question of how much compensation.  And I'm as big a supporter of property rights as the next guy (well, that may not be true once Henry starts blogging).  But the claim that society will crumble under the weight of innovations like Google's strikes me as, shall we say, insufficiently nuanced.

The Google bubble?

As Google goes past $400 a share, some folks are having problems with this, saying its “fair value” may only be $250.

This leaves me in an awkward position, having been skeptical about Google from the beginning.  I guess I should say that this sounds like the tech bubble revisited.

One difference is that this particular bubble is not driven by phony hype.  One Google analyst notes in the W$J story linked above that  "they have absolutely no communication with Wall Street."
This lack of communication isn’t too surprising in the post-Sarbox/post-Reg FD era, especially when the Street is willing to fill the blanks in Google’s favor. 

In a more perfect world, Google would be freer to talk about itself without worrying about draconian liability in the event the market collapses for any reason (see my paper on this general topic).  This might lead to some misleading statements, but it can also produce information that robustly incentivized stock traders can verify.

But we don’t have a perfect world.  So, what’s Google worth? My best guess as of right now:  $400/share.

Microsoft v. Google

The other shoe has dropped on the most over-hyped company in recent history -- Google.  Microsoft has released the beta version of its new search engine. Although the linked article is skeptical. Walt Mossberg of the WSJ says it looks good.

Many people have believed the trust-busters' line that Microsoft's success to date involved illegal leveraging of its operating system. But Liebowitz and Margolis, in Winners, Losers and Microsoft, punched a big hole in that story, showing that Microsoft simply had better applications, and that as these improved, so did its market share.

Now we'll see what Microsoft can do against a dominant and entrenched competitor where Windows does not give it a significant advantage. As for me, I would not want to be one of the investors sucked in by the Google craze (see my Google archive for more thoughts on that).

Google: the good, the bad and the options

Holman Jenkins echoes my skepticism about Google.

But Barron's has a more optimistic take.

To get to that judgment, and understand the extent of Google's success so far (as well as its tax liability), Barron's had to unwind stock option expense back into earnings. Not surprising, in light of my post about the obfusctory effects of expensing stock options. Hopefully the big numbers of the Google offering will focus attention on the silliness of requiring expensing.

More on Google's prospectus

In my post on Google's prospectus I observed that the prospectus is "the only document the SEC wants you to read about Google."

"SB" (I don't think it's Steve Bainbridge) comments:

What class do you play this game in? I hope it is not an MBA class. This is not the only document the SEC WANTS you to read, it is the only one it REQUIRES you to read to satisfy itself that you are abreast of the the nature and terms of the IPO. It is YOU who should do more investigation including seeking an independent and possibly an expert opinion on whether an investment of this nature suits your financial circumstances and your present situation and future goals. You see, that's what IPO documents are for. They are not there to tell you anything and everything about a company or its business activities, past present and future. You need to determine those things for yourself.

Wrong on several counts.

The SEC obviously doesn't require anybody to read anything. The whole public offering process under the Securities Act of 1933 is to ensure that the investor relies only on the prospectus. To that end, the most reliable source of information about the company -- the company itself -- is squelched for the "gun-jumping" period leading up to the finalization of the prospectus (i.e., the "gun"). Sure, the SEC can't prohibit investors from getting other information, should they choose to put themselves to the trouble. But a big point of the regulation of the public offering process isn't to provide information to the investor, but to limit the information investors get.

Of course investors should get other information about the company, but the disclosure process is based on the silly assumption that investors are relying on their own judgment and not on experts.

No, I don't play this game in an MBA class, but in a law school. I think MBA students would be better off, and avoid some of the fixes they have gotten themselves into, if they understood more about law.

SB goes on to remark in response to my comment that Google has only one brand that Coke, too, only has one brand. True. I didn't say Google would fail on that account alone, or on any other account. But it's foolish to compare Google's nascent brand with Coke's proven one. The point is that Google presents substantial risks, and I'm not sure those are highlighted in the selling document that the securities laws have so meticulously designed over the last 70 years.

Wealth-maximization and altruism

I recently pointed out that the Google's promises not to do "evil" might be good marketing. But if the founders are compromising corporate value for the "good of society," consider this WSJ ($) story on Bill Gates' $26 billion foundation and its work on AIDS prevention in India.

Microsoft's aggressive business practices, just like Rockefeller's, made the money, and now, like Rockefeller, Gates is giving it away. A company might be aggressive yet responsible and well-governed. But a "responsible" company might just be ineffectually dribbling away profits that could be used for real social benefit. Where Google fits in all this is not yet obvious.

Back to the 50's with Google

Reading all about Google (as in this story in Monday's WSJ) and over at Google central has gotten me nostalgic for the 50's: Strong, entrenched managers (in this case, all locked up with dual class stock), awash in managerialist sentiment about doing good for society, nicely dispersed shareholders in the Berle-Means mode (the Dutch auction will deter institutional participation), and no obsession with Wall Street short-termism.

It's just like all those nasty leveraged buyouts never happened, and we were back to the good old days of Executive Suite. The only concession to modernity is that, instead of William Holden, the man from the factory floor, the nerds are in control.

Selling corporate responsibility

My recent Google post expressed some skepticism about the value of the founders' emphasis on treating employees well, not being "evil" or "conventional," and intent to "make the world a better place." But that doesn't mean there's no value. In other words, there's an aspect of the Google offering that bears closer examination: Is this about corporate social responsibility, or is it about adding market value to its brand? In my view there's no distinction.

As I noted, Google's problem is that it has just one product, and looks forward to competing against Microsoft, among others. To survive, Google will have to be a service company, a la Amazon, not a technology company.

Consistent with this objective, Google is advertising that it is investing in "reputational bonding" -- that it will forego sharp competitive practices in order to earn brand loyalty. Google can tangibly gain in the form of market share and pricing power. Google customers, suppliers and employees, in effect, pay a premium for "cheating insurance" when they deal with Google. They know that if Google backs off from its promise it will suffer a penalty, not in the courts or an administrative market, but in the repricing of its product to reflect the weakening of the reputational bond.

Because Google has made its promises so salient, its public offering may give us an opportunity to observe the market's valuation of this approach to branding. Google is really pretty close in many respects to Yahoo now, and to other firms later. If its shares sell at a durable premium over those comparables, we can guess that reputational capital is a lot of the difference. The first Google scandal (e.g., cheating on search efficiency to help advertisers) should knock down that premium.

On this theory, Google is selling corporate social responsibility. Less visibly but still importantly this is true for many other companies that advertise their eco-friendliness, working conditions, etc. For all that "social responsibility" is supposed to represent a departure from market hegemony, in fact Google's promises ultimately will be tested in the market, just like any other product.

This analysis has many implications. Importantly, Nike sought First Amendment protection for its defense against sweatshop allegations. Certiorari in the Supreme Court was dismissed as improvidently granted, but five justices noted the entanglement of political and commercial aspects of the speech. Google presents, and will present, significant data in this ongoing discussion.

P.S. Gordon Smith has an extensive post on Google's "social responsibility." I would prefer to be less cynical than Gordon. (Of course Gordon might just be down about that May snow in Madison.) It's just marketing, and the more sincere-sounding, the more valuable the reputational bond.