The Veblenian credit economy and the corporatization of American meatpacking

Since the 1970s, American agriculture has experienced both horizontal and vertical integration. Elements of this reorganization are apparent in the rapid growth of large industrialized livestock facilities and in the use of tying contracts to backward integrate processors, wholesalers, and primary

producers. William Heffernan (1999) and Mary Hendrickson (2001) have described the recent emergence of conglomerate businesses that integrate all stages of the food system from production inputs to the grocery shelf. This general trend is evident in the meatpacking sector, with substantial consolidation and changes in the methods of producing and processing poultry, beef, and pork. In their quest to expand, many beef meatpackers are controlling input prices for labor and cattle while extending their influence over the retail end of business.

In this paper, we argue that Veblen's understanding of industrialization and corporatization can be fruitfully applied to the current reorganization of the meatpacking industry. Through innovation meatpackers have more fully integrated production and increased the earning potential of their physical assets. These changes have created increasingly complex (and valuable) networks of ownership, contracts, and influence, as evidenced by the growing significance of goodwill and other intangibles in their corporate balance sheets.

A case study of IBP, the world's largest producer of fresh beef, pork, and related products, reviews the company's history of expansion and acquisition. As suggested by Veblen's theory, the value of its intangible assets increased relative to all other assets as the firm acquired businesses with brand names in wholesale and retail markets. Additional focus is directed to the issues of accounting irregularities at IBP and new standards at the Financial Accounting Standards Board (FASB). IBP's use of alternative accounting methods, such as the pooling method, for several large acquisitions drew the attention of the S.E.C. and almost derailed its 2001 merger with Tyson Foods. Specifically, IBP's use of pooling accounting lowered its recorded value of goodwill, making it more difficult to determine the purchase price of certain physical assets. The techniques used by IBP are no longer acceptable according to the new FASB standards for acquisitions and accounting for goodwill.

Veblen's Theory of the Credit Economy

In his analysis of the rise of the modern corporation during the last decades of the nineteenth century, Veblen explained the changing nature of corporate finance and the role of goodwill that allows a corporation to expand its use of credit. According to Veblen, the corporation is focused not on production but on salesmanship. Through a more complete integration of production, firms increase net earnings by increasing the vendibility of their products (Veblen 1964, 83). Greater control over input prices and the use of cost-plus pricing for finished branded product increases the reliability with which a firm can generate profits. Consequently, vertically integrated firms involved in the distribution and advertising of their products are able to earn a higher return on their investments because they have some measure of control over retail prices and an increased stability in sales volume. To explain or justify this increased profitability without discussing the existence of market power, the convention of intangible assets was developed. If a firm is able to generate net earnings on some set of physical assets that are greater than the earnings of another firm with an identical set of assets, the corporation is said to have acquired or developed its intangible assets. These intangible assets include items such as goodwill or patented processes. Because a firm endowed with goodwill earns a larger return on some stock of tangible assets than other similarly equipped facilities that do not have goodwill, the concept of goodwill can be conveniently described as capitalized market power. As Veblen explained:

In any case so much seems clear-that goodwill is the nucleus of capitalization in modern corporation finance.... In this capitalization of earning-capacity the nucleus of the capitalization is not the cost of the plant, but the concern's good-will ... compris[ing] such things as established customary business relations, reputation for upright dealing, franchises and privileges, trade-marks, brands, patent rights.... All these items give a differential advantage to their owners. (Veblen 1978, 117, 139)

Our case study of meatpacking provides strong evidence of Veblen's perspective. The early stages of integrating the meatpacking and processing stages of production did not directly increase IBP's recorded values of goodwill, as the assets acquired or built did not have a differential ability to generate excess earnings. On the other hand, we found that goodwill became an increasing portion of firm assets as the company forward integrated into distribution and the development of brand names during the late 1990s.

IBP History

Two former Swift executives, Currier J. Holman and A. D. Anderson, formed IBP as Iowa Beef Packers in 1960. From the beginning IBP was driven by what Eric Schlosser described as a "fast food mentality obsessed with throughput, efficiency, centralization and control" (2001, 164). IBP opened its first plant in Dennison, Iowa, in 1961. The sprawling one-story plant was complete with the latest capital equipment and located near large supplies of grain-fattened feedlot cattle (Skaggs 1986, 190). Founder A. D. Anderson stated in Newsweek in 1985 that IBP had tried to take the skill out of every step of the butchering process (Broadway 1995, 18-19).

IBP opened its second plant in Dakota City, Nebraska, in 1967. The plant was designed to produce a new product, boxed beef. IBP trimmed the bone and fat from the meat and shipped the cuts in vacuum-packed portions. The packaging appealed to both consumers and to wholesalers and retailers who were able to reduce labor costs by eliminating skilled butchers (Broadway 1995, 19). Over the next seven years IBP built similar plants in West Point, Nebraska; Luverne, Minnesota; Emporia, Kansas; and Amarillo, Texas (the world's largest beef-packing plant at the time). An even larger plant with a capacity of 3,700 cattle was opened in 1981 in Holcomb, Kansas (Skaggs 1986 191).

IBP minimized labor costs by locating plants in states such as Iowa, Kansas, Nebraska, and Texas that outlawed union shops. They also acquired companies that had declared bankruptcy to circumvent the problem of high union wages, as in the case of Wilson Foods (Hayes 1984). Although IBP often paid the highest industry average wages it steadfastly refused many benefits demanded by unions (Skaggs 1986, 192-193). IBP's first large-scale pork processing plant in Storm Lake, Iowa, further reflects IBP's attitude toward union workers. The plant had operated as a Hygrade Food Products plant with about 600 union workers at the time of its shutdown in 1981. Following the plant's reopening by IBP in 1982 the workforce was soon characterized by a high rate of turnover and was dominated by South East Asian refugees, Latin American immigrants, and other low skilled workers. Only thirty of the former Hygrade employees were hired by IBP. Union activity was an important consideration in the hiring decision (Grey 1997).

IBP was acquired by Occidental Petroleum group in 1980 and operated for the next six years as a wholly owned subsidiary. In 1986 IBP reemerged as a publicly traded company when Occidental sold its majority stake, a divestiture completed with the sale of its remaining 49 percent stake in 1991. During the 1990s, IBP continued to acquire and expand its meatpacking and processing lines of business. By the mid 1990s, it began a series of twenty-two acquisitions that allowed IBP to further integrate its packing and processing with private, wholesale, and retail brands (SEC 10-K Report, December 30, 2000).

IBP acquisitions in the 1990s

Using publicly available information from annual reports and other SEC disclosures, we developed a summary of IBP financial reports (table 1). We also compiled a list of the twenty-two firms acquired by IBP in the 1990s, with information regarding the extent of the target firm's forward vertical integration, method of accounting for acquisition, type and value of assets acquired, and purchase price (figure 1). As Veblen's theory of the credit economy would suggest, the results show an increasing reliance on goodwill as a component of company assets.

During the early 1990s IBP primarily expanded existing plant and processing facilities, acquiring additional packing facilities in 1994, 1995, and 1996. While IBP continued to acquire processing facilities in 1997 and 1998, IBP was more focused on forward vertical integration. From 1997 to 2000, it acquired nine firms that produced wholesale and retail branded merchandise.

As shown in table 1, Assets of IBP, recorded goodwill declined from 1991 to 1996. The ratio of goodwill and other intangibles relative to cash and net physical assets (G+OA/C+NPA) decreased from .25 to. 19 during this time. Even though some acquisitions added to the goodwill account in 1994 and 1995, the total value of goodwill added to the books was less than the annual amortization charges. On balance, the value of goodwill fell. When the majority of the IBP's acquisitions occurred from 1997 to 2000, however, the intangible/tangible ratio increased steadily from . 19 to .60. Similar results can be seen in the ratio of goodwill to net physical assets (G/NPA), where the relative importance of goodwill increased from .32 to .79.

IMAGE TABLE 11

Table 1.

The positive relationship between goodwill and the degree of forward integration is more apparent in figure 1, IBP Horizontal and Vertical Acquisitions 1994-2001. IBP acquired companies in production, processing, and distribution. Production begins with the first stage of packing, continues into value-added processing and wholesale supplying, and ends in the marketing of wholesale and retail branded products. Indeed, ten of the twenty-two firms acquired held valuable trademarks for either wholesale or retail products.

In agreement with Veblen's theory, we see that the difference between the purchase price and the book value of assets acquired (goodwill acquired/purchase price) increases for each step further forward in the vertically integrated chain. In the first two stages, packing and processing, the typical method of acquiring materials involved straightforward purchase of tangible assets, with little reporting and zero allocation for the acquisition of goodwill.

The next stage of processing produces goods to be sold to a second party for eventual sale under private brands, such as grocery store brands like Kroger's sausage. As noted by Thorn Apple executives, while this form of production adds considerable value, it does not provide the higher earnings associated with finished products sold under the company's retail brand names (SEC 10-k TAVI, May 29, 1998). The average ratio of goodwill acquired to purchase price for private brand suppliers purchased by IBP was .29.

With each step forward in vertical integration, the earning capacity of assets increases, and consequently the price paid by IBP to acquire these assets also had to increase. The average goodwill/purchase price ratio rises from .35 for wholesale suppliers up to .51 for private brand and retail suppliers, and ends with the highest ratios of goodwill/purchase price for those firms engaged in wholesale brands (.71) and retail brands (.66).

Under-Reporting of Goodwill in IBP acquisitions

Even though the results in table 1 and figure I provide dear evidence of the increased significance of goodwill in IBP's corporate accounts, IBP's goodwill could have increased by an even greater amount relative to tangible assets in 1999 and 2000. In these years, IBP made several large acquisitions in which no additions to goodwill were recorded, despite the fact that the cost of acquisition was greater than the net assets acquired. According to the most common accounting technique for acquisition, the purchase method, this excess expenditure should result in an addition to the goodwill account.

IMAGE ILLUSTRATION 16

Figure 1.

This did not happen in the purchases of either Thorn Apple Valley Inc. (1999) or Corporate Brand Foods (2000). In the case of Thorn Apple, it was acquired shortly after it was forced into bankruptcy by a recall of 30 million pounds of tainted meat that exhausted its cash reserves (IBP Agrees, June 26 1999). At the bargain price of $110 million, IBP acquired valuable brand names and processing facilities without having to pay a premium to Thorn Apple's shareholders. Even at that low price, IBP paid $30 million dollars more than the pre-recall value of Thorn Apple's cash and net physical assets.

In the February 2000 acquisition of Corporate Brand Foods, IBP used the pooling method of accounting for the merger, as opposed to the more traditional purchase method. In purchase method accounting used by IBP in all other late 1990s acquisitions, the value of goodwill was the difference between the purchase price and the net assets acquired. In this way, purchase accounting ensures the cost of acquisition is made explicit in the accounts. It is then possible to determine if management is exhausting valuable credit to purchase assets at exorbitant prices.

Determining the approximate value of goodwill acquired by IBP in the Corporate Brand Foods (CBF) acquisition is made difficult by its use of the pooling method. In the absence of clear reporting, the next best alternative would be the review of Corporate Brand annual reports, but because it was a private company they are not available. Luckily, CBF was the only acquisition by IBP in 2000, and so it is possible to review IBP's accounts to calculate their increase in cash and net physical assets. A conservative estimate of goodwill acquired would be the difference between CBF's purchase price ($550 million) and IBP's increase in net physical assets ($218 million). Using this method, we see that IBP spent at least $300 million dollars that could be attributed to the acquisition of goodwill.

IBP Practice and Changing Accounting Standards

There are reasons to avoid the purchase method of accounting for acquisitions. By adding to the value of goodwill whenever a target firm is acquired at a price greater than the value of net assets, the firm increases the value of goodwill that must then be amortized. These amortization charges represent another charge that must be made against the total earnings of the firm. In Veblen's time, this was actually seen as one of the benefits of acquiring goodwill. Because depreciation charges lower reported net earnings while the addition of goodwill expands the value of firm assets, the return on invested capital is lower, reducing the chance that abnormally large profits could be construed as evidence of the corporation's excessive control over the market (Hatfield 1919, 167-169).

The pooling method of accounting allows two firms to merge their balance sheets with no record of the actual cost of acquisition. This reduces the depreciation charges associated with goodwill, while also making it very difficult to determine the exact cost of acquiring a target firm's assets. When it comes to the use of goodwill, clear and consistent accounting rules are valuable for those concerned with evaluating business activities, especially when goodwill is becoming an increasingly valuable portion of firm assets. As noted in the FASB Statement of "Financial Accounting Standards no. 141, Business Combinations," in June 2001,

Users of financial statements also indicated a need for better information about intangible assets because those assets are an increasingly important economic resource for many entities and are an increasing proportion of the assets acquired in many business combinations. While the purchase method recognizes all intangible assets acquired in a business combination (either separately or as goodwill), only those intangible assets previously recorded by the acquired entity are recognized when the pooling method is used.

IBP's use of the pooling method of accounting coincided with a larger debate about modifying accounting standards in acquisitions. In June 2001, the Financial Accounting Standards Board decided to clarify the techniques used for acquisition accounting and the recording of goodwill. For the reasons described above, the FASB decided to drop the pooling method entirely. While it originally planned to standardize the rules for depreciating goodwill, a mandatory twenty-year amortization, it dropped this standard after protest from the profession. A more flexible approach, unlimited retention of goodwill with annual testing for impairment that could then lead to depreciation charges, was adopted in Standard 142 (Heeson 2001).

For corporations engaged in acquisition and merger, reporting of goodwill will be made more transparent under the new standards. However, it will also be possible to retain goodwill on the books for considerably longer periods, thus further inflating the value of goodwill in corporate reports and increasing the growth of the credit economy.

The IBP-Tyson Merger

IBP's control over the consolidation of meatpacking ended in a flurry of hostile acquisition offers, lawsuits, and an investigation by the SEC. Ultimately, IBP was acquired by Tyson Foods, a deal that merged the nation's largest producer of poultry with the nation's largest beef packer and second largest pork packer. While IBP management initially offered to acquire the company in a leveraged buy-out in the fall of 2000, this route was made more difficult by the simultaneous filing of seven lawsuits charging IBP management with fraud and manipulation of stock prices. An initial offer by Smithfield Inc., the number one US producer of pork products, was quickly surpassed by Tyson's $4.7 billion dollar stock and cash offer (Heffernan 1999, 17; Tyson Foods Extends Offer, January 30, 2001).

Although Tyson Foods and IBP quickly signed a legal agreement outlining the merger, IBP eventually had to take Tyson to court to force Tyson to finish the acquisition. Tyson's reluctance to finish the deal was clearly linked to the SEC investigation of IBP that began with a letter on December 10, 2000. Most of the letter's forty-five points concerned IBP's use of the pooling technique, specifically, the Corporate Brand Foods merger of 2000. While the contents of the letter and their resolution are not publicly available, it is reasonable to suggest that IBP's use of the pooling arrangement in 2000 was designed to limit public awareness of the excessive price paid for the assets of Corporate Brand Foods. Under the purchase method of accounting, this excessive price would have shown that IBP acquired a large quantity of goodwill, without the theoretically consequent improvement in earnings.

Conclusion

This brief sketch of IBP can be described from Veblen's perspective on the industrialization and the rise of the credit economy. Essentially, the process revolutions-the standardization and routinization of tasks, reorganization of production, and the growth of branded products associated with corporatization-have arrived in the meat industry. In meatpacking, the primary changes include the speeding up and de-skilling of disassembly line work. Non-union and increasingly immigrant workers have replaced urban unionized employees. The introduction of boxed beef has reduced the need for grocery store butchers and has increased the packer's control over wholesale prices. Lastly, IBP expanded its control over final distribution of its products by acquiring firms that produced and sold value-added meat products with valuable wholesale and retail brand names.

Veblen's theory of the credit economy, a system of corporate finance based on the expected earning capacity of a firm-a system which equates excess earning potential with the ownership of intangible assets-provides useful insight into IBP's late 1990s acquisition of retail and wholesale manufacturers. To acquire firms whose earning capacity was more a function of vendibility than the value of the physical assets used in production, IBP had to pay a large premium. This premium then entered the corporate record as an addition to IBP's goodwill. Each progressive step forward into vertical integration required an increase in the payments for goodwill relative to the payments for tangible assets.

These developments allowed the more complete integration of agricultural production while increasing the profitability of existing assets. As Veblen noted, this expansion of profitability, according to the practices of corporate finance, is embodied in intangible assets and consequently becomes available as collateral for further extensions of credit. The expanded use of credit continually increases the purchasing power of the corporation, as each new acquisition of goodwill expands the base of assets which can be further capitalized, starting the next round of acquisitions, increases in net earnings, and expansion of goodwill. This spiral of consolidation, expansion, and growth continues as the credit economy expands. Ultimately, the significance of goodwill as the primary source of corporate value is increasingly apparent.

REFERENCE

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AUTHOR_AFFILIATION

Eric R. Hake

and

Martin Bruce King

AUTHOR_AFFILIATION

The authors are Eric R. Hake at Eastern Illinois University, Charleston, Illinois, USA, and Martin Bruce King at Illinois Stewardship Alliance, respectively. This paper was presented at the annual meeting of the Association for Evolutionary Eco. nomics in Atlanta, Georgia, USA, January 4-6, 2002.