Martin J. Whitman

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Martin J. Whitman is an American investment advisor and a strong critic of the direction of recent changes in Generally Accepted Accounting Principles (GAAP) in the U.S. He is founder, Co-Chief Investment Officer, and Portfolio Manager of the Third Avenue Value Fund.

Whitman is a 1949 graduate of Syracuse University, which recently renamed its School of Management after Whitman, after a large gift from him in June 2003. He is an adjunct faculty member at Yale School of Management.

He has used the quarterly shareholder letters of his fund as a running critique of what he calls the "primacy of the income account" ("primacy of the income account" means that corporate wealth is created only by flows, i.e., having positive earnings, and/or cash flows for a period), which he argues serves only short-term speculators rather than longterm investors. For example, in his July 31, 2004 letter [1], he writes that recent developments in GAAP "...increasingly impose unneeded and counter-productive burdens on American corporations, American management and American capital markets. GAAP... ought to be geared toward meeting the needs and desires of creditors rather than the needs and desires of short-term stock market speculators... [T]he amount of money invested in credit instruments of all types in our economy dwarfs the amount of funds invested in equities." Furthermore, "Most private companies, given a choice, seek to enhance [Net Asset Value] by means other than having reported operating income, which is taxable at maximum rates."

He argues that "in GAAP... material facts [should] be disclosed in a conservative, consistent, and reliable manner", and that "Financial statements [should] be prepared under the assumption that the users of such financial statements are reasonably intelligent, reasonably diligent, and are people who understand not only the uses, but also the limitations, of GAAP... [T]he most GAAP can give... are objective benchmarks which the analyst then uses as a tool to determine his, or her, version of economic truth and economic reality."

As an example of the difference in these perspectives, he discusses the current (as of 2004) controversy over whether stock options ought to be expensed using "fair value method" or "intrinsic value method" and points out that the issue of stock dilution is "a stockholder problem, not a company problem". He points out that to a creditor there is "a world of difference in the credit-worthiness of an issuer who... pays out... $200 million per annum in cash for executive compensation... [and one who] issues stock options on a non-dividend-paying common stock with a "fair value" of $200 million" (the point being that the latter is of almost no concern to a creditor).

In particular, he cites as wrongheaded an advertisement in the Wall Street Journal of April 27, 2004, which argues that "financial statements exist to help investors make informed investment decisions". He responds, "That statement is just plain wrong from either a public policy point of view or a creditor's point of view. Financial statements exist to fulfill the needs and desires of many constituencies: managements, creditors, governments, customers, etc." (italics in original).

Contents

[edit] Criticism of the "free market" concept

Although a strong advocate of capitalism, Whitman is a critic of free markets in the sense advocated by Milton Friedman and Friedrich Hayek. For example, in a discussion of John Maynard Keynes, Friedman and Hayek, Whitman wrote that the latter two "…great economists… missed a lot of details that are part and parcel of every value investor's daily life." While calling Hayek "100% right" in his critique of the pure command economy, he writes "However, in no way does it follow, as many Hayek disciples seem to believe, that government is per se bad and unproductive while the private sector is, per se good and productive. In well-run industrial economies, there is a marriage between government and the private sector, each benefiting from the other." As illustrations of this, he points at "Japan after World War II, Singapore and the other Asian Tigers, Sweden and China today… Government has a necessary role in determining how control persons [management, boards of directors, etc.] are incentivized… [1]

He argues, in particular, for the value of government-provided credit and of carefully crafted tax laws.[2] Further, Whitman argues (explicitly against Hayek) that "a free market situation is probably also doomed to failure if there exist control persons who are not subject to external disciplines imposed by various forces over and above competition." The lack of these disciplines, says Whitman, lead to "1. Very exorbitant levels of executive compensation… 2. Poorly financed businesses with strong prospects for money defaults on credit instruments… 3. Speculative bubbles… 4. Tendency for industry competition to evolve into monopolies and oligopolies… 5. Corruption." For all of these he provides recent examples from the U.S. economy, which he considers to be in some respects under-regulated,[3], although in other respects over-regulated (he is generally opposed to Sarbanes-Oxley).[4]

He believes that an apparently "free" relationship—that between a corporation and its investors and creditors—is actually a blend of "voluntary exchanges" and "coercion". For example, there are "voluntary activities, where each individual makes his or her own decision whether to buy, sell, or hold" but there are also what he defines as "[c]oercive activities, where each individual security holder is forced to go along…provided that a requisite majority of other security holders so vote…" His examples of the latter include proxy voting, most merger and acquisition transactions, certain cash tender offers, and reorganization or liquidation in bankruptcy.[5] Whitman also states that "Corporate America would not work at all unless many activities continued to be coercive."[6]

"I am one with Professor Friedman that, other things being equal, it is far preferable to conduct economic activities through voluntary exchange relying on free markets rather than through coercion. But Corporate America would not work at all unless many activities continued to be coercive."[7]

[edit] Works

  • Whitman, Martin J. (1999). Value Investing: A Balanced Approach. New York: John Wiley & Sons. ISBN 0-471-16292-2.
  • Whitman, Martin J. & Shubik, Martin (2005). The Aggressive Conservative Investor (2nd ed.). Hoboken, NJ: John Wiley & Sons. ISBN 0-471-76805-7.

[edit] Notes

  1. ^ Martin J. Whitman, Third Avenue Value Fund letter to shareholders October 31, 2005. p.3.
  2. ^ Ibid., p.4.
  3. ^ Ibid., p.4.
  4. ^ Martin J. Whitman, Third Avenue Value Fund Letters to our Shareholders July 31, 2004 (PDF), page 2.
  5. ^ Ibid., p.5.
  6. ^ Martin J. Whitman, Third Avenue Value Fund letter to shareholders October 31, 2005. p.6.
  7. ^ Ibid., p.5-6.

[edit] References

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