In a 2015 article titled “The Social Cost of Dishonesty”, we showed how imperfect markets – for example, where some parties have more information than others – require the intervention of impartial authorities to adjust the balance of power and maximise the public good. The social cost of dishonesty is even higher when such authorities are absent or when they’re captured by economic, corporate or electoral forces. We concluded with a number of questions that these issues raise in the worlds of journalism and finance.
In this article, the matter at hand is the ability of independent authorities to discipline a publicly traded company, Disneyland Paris, that is possibly being managed solely in the interests of its majority shareholder, The Walt Disney Company.
The agency theory, developed in the pioneering work of Michael Jensen and William Meckling, asserts that honest and efficient corporate governance, through properly designed incentives, can reduce the risk of one party’s making decisions that are contrary to the collective good in order to maximise its own interests.
Good for me, not so good for you
In financial economics, such “harvest strategies” often crystallise around obvious conflicts of interest, which can increase the risk of moral hazard or adverse selection. When corporate management fails to correct such problems, it is the responsibility of outside authorities to restore a level playing field or, if necessary, sanction any misconduct or market abuse.
In the case of Disneyland Paris, the risk of conflict of interest is obvious given that The Walt Disney Company (TWDC) is simultaneously its largest shareholder (39.8%); the holder of the park’s license, for which it collects generous royalties (€61.9 million for 2014 alone); its sole supplier, with no possible competition for new rides, decorative elements, etc; and, since the company was restructured in 2012, its sole creditor. Note that TWDC also controls 51% of the consolidated variable interest entities.
Suffice to say that from the beginning, TWDC has been in full control of the choices made by its French subsidiary, allowing it to set the broad strategic objectives, make crucial decisions, determine the level of royalties and even appoint members of the executive board (which are often employed by TWDC itself). At the same time, the company is unlikely to be exonerated of structural losses of the consolidated group or avoid its legal or moral obligations.
This being the case, it’s illuminating to look at Disneyland Paris’s corporate governance. The manager (in this case, TWDC) is remunerated on the basis of a fee set at 1% of annual turnover (€12.9 million in 2014), to which are added royalties for the use of intellectual property that vary between 5% and 10% of turnover depending on the products and services in question (this constitutes nearly 57% of the park’s net losses over ten years). To this one we can add the considerable advantages that the European amusement park gives TWDC for its service activities (merchandising, video-on-demand subscriptions, film receipts, etc) as well as the boost that the park’s colossal advertising and PR expenses (nearly 10% its annual revenue) provide to its galaxy of affiliates (Disney Hachette Presse, The Disney Store, as well as TWDC France via the Disney Channel and DVD publishing).
It should be noted that the CEOs appointed by TWDC in recent years have succeeded in boosting both Disneyland Paris’s attendance (up 18.3% since 2000) and its sales (up 33.4%). But at the same time, the park has shown an annual profit just once, in 2008, and then only because of the sale of assets.
Royalties or profits?
From the economist’s point of view, this intriguing situation – in which growing receipts are accompanied by rising deficits – has only one possible explanation: rising marginal costs bear witness to diminishing returns from the goods and services sold. In other words, under Disneyland Paris’s business model, each new customer costs more than he or she brings in.
Moving from this realization to suspecting that Disneyland Paris is subsidizing its customers for the sole purpose of increasing the company’s turnover, paying hefty royalties to its parent company (suspected to pass through Luxembourg in complex tax-avoidance scheme) and devaluing its stock price (down 95% since 1989) so that it can cheaply buy back shares is not a great leap. It is one that Charity & Investment Asset Management (CIAM) did not hesitate to make. This month it filed a complaint with France’s Autorité des Marchés Financiers (the equivalent of the SEC in the US) and others demanding €930 million for damages suffered by minority shareholders because of biased actions taken by the park’s management.
While it is not for us to play the judge in this case, there does seem to be a preponderance of evidence from an economist’s point of view. Who benefits from the crime, after all? The intentional increase in Disneyland Paris’s turnover has allowed TWDC to reap substantial returns. The park’s repeated financial losses and the endless fall of its share price have, in turn, paved the way for the buyout of third parties: the park’s creditors in 2012, and a substantial portion of minority stockholders in 2015 after yet another recapitalization. This now gives TWDC ownership of nearly 82% of the company’s shares. At the same time, remaining minority stockholders – for whom the payment of hypothetical dividends now seems like a fever dream – received a proposition from Disney for a mandatory buy-back at €1.25 per share. CIMA has challenged this calculation, which it said intentionally undervalued the company.
A good source of taxes
During this time, the French government examined its own situation with Disneyland Paris. It has no hope of tax receipts on nonexistent corporate profits and had already provided an endless series of gifts to the US company, including subsidized infrastructure, 4,800 acres of land sold at cost and loans at sub-market rates. In this situation, does it still have the ability to discipline – should such a thing happen – a company that pays millions of euros annually in local taxes and VAT, provides thousands of direct and indirect jobs, and which constitutes one of the top tourist destinations in France?
And even as this question reminds us of the debates around corporations that are so large or important that they can’t be subject to any decisions or actions that might weaken them – the famous “too big to fail” – the words of French playwright Jules Renard resonate: “It would be beautiful indeed to see an honest lawyer request the conviction of his own client.”
Translated from the French by Leighton Walter Kille.