Rio Tinto’s writedown is an example of Management Risk

I appreciate the operational leverage and potential returns that a company can provide its shareholders but last week’s news of Rio Tinto $14 billion writedown on its assets illustrates the handicaps that a company’s management can provide.

The result of such an announcement is that the CEO merely resigns.

Two years ago, bets were made in acquiring a coal business for $4 billion and today its value has been written down by $3 billion. Three-quarters of this coal business has been lost in 2 years, which is yet another example of company executives making large acquisitions in order to grow their business, with shareholders money.

When playing with large sums of company money, there is no downside for these executives other than losing their jobs, but their reward is large, financially and for their own personal career and resume improvement.

For these poor operational and investment decisions, management is paid very well. In Rio’s outgoing CEO’s case he also provided shareholders with a total share performance return of 2.5% during his 6 year tenure.

In Rio Tinto’s case, financial analysts are now speculating that it may embark on a $2-$4 billion share buyback to “make up for the losses”.

Rather than investing in its existing businesses, increasing its dividend payout or sheepishly attempt another equity destroying takeover, Rio Tinto could buyback its own shares, which in turn will improve the “Earnings Per Share” metric which hopefully is a benchmark that executives have their compensation incentives tied to.

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