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Reputation and regulation: the risk of record profits

By Jessica Tasman-Jones

This article is brought to you by Agenda, an FT Specialist publication that focuses on corporate boards

Procter & Gamble's share price rallied last month when its quarterly results revealed profit margins were up. While sales volumes were down, net sales increased as prices for its products rose by about a tenth.

The results pleased markets, but executives were forced to defend price hikes as consumers face a cost of living crisis.

Proctor & Gamble was “just starting” to “dig our way out” after margin erosion in successive earlier quarters, according to Andre Schulten, its chief financial officer. “There is no broad-based relief in terms of input costs," he added, pointing to the rising prices of caustic soda and ammonia as examples.

At its last rate meeting, European Central Bank president Christine Lagarde noted that firms in some sectors "have been able to increase their profit margins on the back of mismatches between supply and demand and the uncertainty created by high and volatile inflation".

In the US, inflation currently sits at 4.9 per cent. Yet data from the Bureau of Economic Analysis shows corporate profit margins reached 10.7 per cent after tax in the second quarter of 2021. This was their highest point since 1947 when adjusted for inventory valuation and capital consumption – and they have only decreased about a percentage point since.

“When corporations are so flush with cash, why are they raising prices?” former US Secretary of Labor Robert Reich said during a 2022 congressional testimony. “Yes, there are increased costs. But in a competitive economy, corporations enjoying record profits would absorb these costs… But instead, they are passing these costs on to consumers in the form of higher prices. Why? Because they can.”

Now some policymakers, bankers and academics are calling out so-called "greedflation”.

"Customers expect price rises because of what they see in the press about surging commodity prices," a note from Societe Generale said last year.“Companies have clearly ‘taken advantage’ of rising inflation expectations to put through rises well in excess of cost increases.”

Likewise, a recent academic paper found little evidence that factors driving inflation in the 1970s – such as excess aggregate demand, loose monetary policy or rising wages – were to blame now. Instead they found it is "predominantly a sellers’ inflation that derives from… the ability of firms with market power to hike prices.”

Record profits come with reputational and potentially legal risks that boards should be aware of. Directors should ensure they have had a robust conversation on pricing strategy, says Nir Kossovsky, chief executive of Steel City Re, an insurance intermediary and risk adviser for reputational risk.

“The other thing boards should do is communicate that the firm’s risk management process — which is where the pricing bump vs. risk conversation should be taking place — is thoughtful, dutifully overseen, and applies to everything that is mission critical.”

Policymakers are starting to face calls to look into “greedflation”.

Farm Action, an advocacy group for farmers and other agricultural producers, has urged the Federal Trade Commission in the US to “promptly open an investigation into the egg industry, prosecute any violations of the antitrust laws it finds within, and ultimately, get the American people their money back.”

“These companies are taking advantage of geopolitical and supply issues, which are real issues, but they are hiking up prices beyond what’s necessary to accommodate these issues and instead are increasing their bottom line,” said Angela Huffman, a co-founder and vice president of Farm Action.

And in the UK Liberal Democrat leader Ed Davey urged the government to launch a Competition and Markets Authority investigation into whether supermarket giants are "profiteering" amid a cost of living crisis.

However, ING says "we cannot know entirely" whether greedflation is driving profit margin inflation. Companies could be making up for losses during the Covid-19 lockdowns or to increase financial buffers, it suggests.

This article is based on a story written for Agenda by Varvara Budetti.

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