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McCain's plan bumps up against the age of austerity

There are two sides to the Maple Leaf Foods story, and they couldn't be more different. One holds chief executive Michael McCain as a sympathetic figure, valiantly trying to overcome global economic forces (a high Canadian dollar) and tragedy (the listeriosis debacle) in a brutal industry. The opposing narrative sees an executive who is overpaid for poor performance by a board stacked with cronies and friends, and whose restructuring plans will waste more of the company's cash.

This gulf of opinion wouldn't matter except that the shareholders of Maple Leaf, one of Canada's largest consumer products companies, might soon be asked to choose which one they believe. It's a referendum on the McCain era. It's early days, and Mr. McCain's skills as a communicator may yet save him. But by my reckoning, the tide is against him, not because of tainted meat or the size of his paycheque but because, so far, he has failed one of the simplest (yet most important) tests of effectiveness - and the business environment is not in his favour.

What makes an effective CEO, anyway? Modern corporate leaders must play many roles - strategist, psychologist, market analyst - but the most important part of the job description is investor. Any company that earns money has a clear choice: it can pay it back to its owners or put it back into the business. And it shouldn't do the latter unless it can earn a better return than the owner could get elsewhere.

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The time period for measuring this isn't one year, or two. But after many years, it becomes pretty clear who is creating value and who isn't. In Warren Buffett's world, it's known as the "one dollar test": Does every dollar reinvested in the company lead to an increase of at least one dollar in the company's value (we emphasize: over the long run)? And the hard truth for Maple Leaf is that while the amount shareholders have put in has increased a lot (shareholders' equity is up about $850-million since 1998, according to S&P/Capital IQ), the value of Maple Leaf has not followed along. In other words, the market has already voted on Mr. McCain as an investor, and its verdict is not good. You can understand why, when he proposes to spend another $1.3-billion on modernizing Maple Leaf's bakeries and processed food plants as he did this week, he faces a skeptical audience.

There is a large membership now in the club of those who flunk the one dollar test. How could it be otherwise? For the U.S., it has been a lost decade for equities; Japan has endured a lost generation. Worldwide, there are now thousands of companies that can't pass Mr. Buffett's test. (The list of those that fail it as resoundingly as Maple Leaf is somewhat shorter.) Here's a short roll call of companies whose shareholders are poorer than they were 10 years ago: General Electric, Pfizer, Bombardier, Sprint, Safeway, Tyco, Cisco Systems, Texas Instruments, Home Depot, Loblaw, Oracle, Harley Davidson.

Sure, these companies invest. But the only thing their owners have seen in return are some dividends. Which - along with fear and uncertainty about the global economy's health - provides a partial explanation for one of the great investment topics of the moment: Why are corporate balance sheets so stuffed with cash?

While households pile on the debt, the private sector's balance sheet has rarely been in such good shape. In the U.S., non-financial firms have piled up close to $2-trillion in cash and other liquid assets. Debt-to-equity ratios at Canadian companies have been tumbling. At some big-cap U.S. companies (Google, Apple), you can hardly close the door to the vault, it's so full of billions. All this despite interest rates lower than Lindsay Lohan's public standing.

In the bigger picture, this creates a real problem for central bankers and politicians. To get the economy rolling, they need the private sector to expand, hire, build new factories (to improve productivity, as Maple Leaf is proposing to do). But the real owners of those trillions - investors - aren't screaming for any such activity. On the contrary. If anything, they've been clamouring for higher dividends. It may be the age of the monster deficit in government, but it's still the age of austerity in business. That's what Michael McCain and his $1.3-billion plan are up against.

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