Celebrating a new year might provide a momentary respite, but 2021 will offer many of the same concerns CFOs faced in 2020, including productivity challenges, a remote workforce and pressure from markets to put excess liquidity to work.
“Even if vaccines roll out smoothly and the economy substantially recovers from COVID during the first half of 2021, there are still several important issues for companies to navigate in 2021, including a new U.S. president, the threat of higher taxes, labor force decisions about who can work from home and what jobs can be automated, among other issues,” said John Graham, a finance professor at Duke University’s Fuqua School of Business and director for The CFO Survey, a quarterly measure of CFO sentiment. “If there are any hitches in vaccine timing or efficacy, then there will be virus-related economic turmoil on top of these underlying issues.”
Graham collaborated with corporate finance expert Marc Zenner, a former professor at The UNC Kenan-Flagler Business School and former global co-head of J.P. Morgan’s Corporate Finance Advisory, to provide some perspective on the most pressing issues CFOs will contend with in 2021. Graham also discussed the year's upcoming challenges for CFOs on LinkedIn Live (see video).
Last spring, with financial markets in turmoil and the economy at a new low, many companies raised extra liquidity to ride out the pandemic – an appropriate strategy at the time, Zenner said. Nine months later, many are still sitting on those funds and in many instances, he said, they appear excessive.
“Having too much liquidity is costly due to the opportunity cost of holding unused funds,” Zenner said. “Senior decision-makers must now decide whether to keep the excess liquidity, to use the funds to invest or acquire, to repurchase shares or pay dividends, or pay down debt. Boards will need to carefully weigh the pros and cons of the various alternatives.”
Gaps in downside planning
“The events surrounding COVID-19 led to an unprecedented and extreme negative shock,” Graham said. “Considering the recession in 2000 and the global financial crisis a decade later, this is one more example of underestimating the severity of negative shocks in corporate downside planning. Planning for the downside should not just include negative scenarios that are more severe – downside planning should also include a fortress balance sheet and operating flexibility to manage through a crisis.”
Managing a remote workforce
Nearly half of CFOs indicate that at year-end 2021, their firms will still have much of their workforce working from home, according to third-quarter results from The CFO Survey. This has implications for productivity, creativity, corporate culture and real estate markets, Graham and Zenner said.
“Many companies will downsize the footprint of their office space,” Zenner said. “Companies with employees who can effectively work from home will shift their spending towards equipment to facilitate a virtual workforce. Companies that can’t sustain an effective remote workforce will spend on automation, decreasing the relative importance of their labor force.”
The threat of higher taxes
The 2018 Tax Cuts and Jobs Act (TCJA) reduced federal corporate income tax rates, from 35 percent to 21 percent, with the intent of increasing the competitiveness of U.S. businesses. Lower tax rates have especially been a boon for domestic-focused firms. President-elect Joe Biden has proposed increasing the corporate tax rate by one-third to 28 percent.
“Biden also proposes introducing minimum tax rates on foreign profits and increasing capital gains tax rates on investors,” Graham said. “Collectively these measures will reduce corporate cash flow and increase the cost of capital. Senior decision makers should understand how various proposals could affect them specifically and how to optimize investment, financing and capital allocation in this new environment.”
The dividend yield of the S&P 500 is about 2 percent, Graham said. Many firms trade at higher yields. For some highly rated firms, the after-tax cost of borrowing is less than the firm’s dividend yield, he said.
“In today’s market these firms can borrow, repurchase shares and increase net cash flow to shareholders,” Zenner said. “This extra cash could in turn allow these firms to increase dividends. This may be a viable strategy, but is higher corporate leverage the right decision in today’s uncertain economic environment?”
Stock price perfection
“Despite a weak and uncertain economy, the stock market continues to flirt with record high levels,” Graham said. “These high valuations mean that the shares of many firms are priced for perfection. What are the implications of such valuations for mergers and acquisitions and fundraising? What will be the cost if actual performance ends up disappointing investors?”
The influence of ESG criteria
Executives are navigating environmental, social, and governance (ESG) criteria in a world with many different ESG measures, the experts said.
“CFOs will have to determine how they will quantify the hard-to-quantify, and how they will balance needs to invest, grow, be competitive and provide returns to shareholders,” Zenner said. “All while they may face potentially contradictory demands from investors to rely on ESG to guide their choices.”
Zero interest rates
In the Western world, rates have been low -- even close to zero -- for more than 10 years, Graham said. Firms must consider whether they should lower their investment hurdle rates, if they haven’t already, and how they will evaluate new projects and their capital structure.
“There is concern that this interest rate environment could give some executives a false sense of comfort,” Graham said. “What would happen to the corporate sector if there were a sudden and steep increase in rates?”
Supply chain challenges
“Uncertain political relations, trade barriers and COVID-19 restrictions have highlighted the perils of relying too much on one country for a firm’s supply chain, and every firm is weighing how much reliance is too much,” Zenner said. “Firms are being forced to consider whether to bear the costs today to reduce supply chain risk as an investment for the long term.”
Financial policy, post-COVID
Many of the sectors deeply affected by the COVID crisis responded by raising debt and equity and by cutting their dividends and buybacks, the experts said.
“When the economic storm clouds recede, firms will have to decide on their new priorities,” Graham said. “Paying down debt to restore the balance sheet means shareholders will have to wait longer for capital returns. Furthermore, issuances of new capital and the recent rebound in stock markets means that the enterprise values of even some of the most affected companies are about what they were a year ago, before COVID. It will be interesting to see the implications this could have on financial policy.”