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(https://www.forbes.com/sites/shivaramrajgopal/2022/02/21/why-does-corporate-disclosure-fail-to-
answer-even-the-most-basic-questions-a-high-school-economics-textbook-poses-about-a-
company/?sh=49bac08c3685)

Feb 21, 2022

Why Does Corporate Disclosure Fail To Answer Even The Most Basic Questions A High School
Economics Textbook Poses About A Company?

Shivaram Rajgopal, CFO Network

I am the Kester and Brynes Professor at Columbia Business School and a Chazen Senior Scholar at the
Jerome A. Chazen Institute for Global Business.

Have investors interested in fundamentals been pushing regulators and companies for disclosure on the
right kind of questions?

Columbia Business School just moved to a breathtaking campus in Manhattanville. But with every move,
come boxes of possessions, which in my case, happen to be many packages filled with books. In my pile,
was an old high school economics textbook. Bored with unpacking, I began browsing through the
textbook. I was immediately struck by how I would struggle to answer many of the basic questions
raised in a high school economics textbook for a specific company, say Netflix.

This is because financial reporting disclosures, encompassing the 10-K, 8-Ks, the proxy statement, the
sustainability report, four conference calls a year, many investor-road shows collectively produce
hundreds of pages of material but do not provide straight answers to many of these questions. I have
compiled a list of some of these questions organized by the chapter of the high school economics
textbook, applied to Netflix to fix ideas in the reader’s mind:

1.0 Choices in production

· What is the production possibilities curve for Netflix? A production possibilities’ curve is a graphical
representation of the alternate combinations of goods and services a firm can provide. What
combination, for instance, of U.S. and local programming can Netflix produce in each of its large regional
markets such as Europe, Asia and so on?

· What is Netflix’s comparative advantage in producing content versus getting into video games, its
latest segment?

2.0 Demand and supply

· What is the demand curve for Netflix’s products?

· What does the supply curve for Netflix’s products look like?

· What impact do demand shifters, namely customer preferences, prices of related goods, consumer’s
disposable income, demographic changes, and consumer expectations, have on the demand for Netflix’s
products?

· How much do substitute products of Netflix sell for (we know that by looking at the prices at which
Disney plus etc.) and how do consumers trade off demand for Netflix versus Disney Plus, for instance?

· What impact do supply shifters, namely changes in the prices of the factors of production such as
cost of talent for instance in Netflix, returns from alternative activities such as gaming, changes in
technology (what would a metaverse do to shows and movies that Netflix streams), natural events
(Covid lockdowns stretch longer) and the number of sellers in the space, have on the supply of products
that Netflix puts out?

3.0 Elasticity

· Price elasticity of demand refers to how responsive is the quantity of the product demanded to
changes in the product’s price. What is the price elasticity of demand for Netflix’s products? In at least
some of the big markets?

· How does the price elasticity of Netflix’s demand get affected by the availability and pricing of
substitute services (the so-called cross price elasticity of demand), and when household incomes grow
or shrink in different markets (the so-called income elasticity of demand, which may happen when the
expected interest rate increase or current inflation hurts disposable incomes)?

4.0 Surplus

· What, if any, is the consumer surplus or the difference between what a customer pays for Netflix,
relative to what she is willing to pay? These questions are increasingly becoming important in measuring
“stakeholder” value.

· What, if any, is the producer surplus or the difference between total revenues and total costs of
Netflix (income statements certainly help here)?

5.0 Consumer choice

· What is a typical Netflix consumer’s indifference curve related to consuming Netflix versus another
good? What is the marginal rate of substitution between these two products relate to the prices paid by
the consumer for these two goods?

6.0 Production and cost

· What does the total product curve, which plots the relation between the quantity of product
produced and factor of production used (talent, mostly in Netflix’ s case), look like for at least a certain
class of shows or for purchased shows? When does diminishing marginal returns set in, relative to factor
input? In the short run and the long run?

· What is the marginal product (additional show made) for every factor of production used?

· What does the total cost curve, defined as total fixed costs and total variable costs, look like?

· What is Netflix’s average total cost, average fixed cost and average variable cost? I cannot compute
this now as I do not know the total number of shows Netflix produces although that data can potentially
be obtained. However, as mentioned in earlier pieces, I do not know the fixed versus variable
components of Netflix’s total costs.

· Specifically, what is the marginal revenue product of labor (or the additional revenue that Netflix
can generate for a unit of labor)? Labor is explored later in greater detail.

· How does Netflix choose its factor mix? That is, the combination of in-house labor versus external
labor to produce its shows?

· What is Netflix’s long run average cost curve? Does it experience increasing, decreasing or constant
returns to scale?

7.0 Market structure

· What kind of market structure (perfect competition, monopolistic competition, oligopoly) does
Netflix face in its key sub-markets such as North America, Europe, and Asia?

· A related point, do we know the revenue and cost curves in these sub-markets? Are these markets
expanding, contradictory or stable? Are costs increasing, decreasing or constant in these sub-markets?
Do output prices in these sub-markets change in response to cost of production in these sub-markets?

· What does the entry and potential exit of Netflix’s competitors look like in these sub-markets?

· If Netflix has pricing power in these sub-markets what might be the source of such power be? Is it
economies of scale, high sunk costs, costs associated with entry, restricted ownership of key inputs,
government restrictions, exclusive franchises, licensing, certification requirements or patents?

· Is the source of pricing power either in outputs or inputs likely to be subject to regulatory scrutiny?

· In oligopolistic sub-markets, do we observe implicit or explicit collusion among sellers?

· How does the firm use advertising to deal with competition in sub-markets to create brand loyalty
and creating barriers to entry? Does that advertising influence pricing or quantities of output sold?

· Does Netflix use price-discrimination in sub-markets (selling the service at $3 a month in India for
example, relative to the $15 a month fee in the U.S.)? Is the strategy working by identifying consumers
whose price elasticities differ to avoid resale of service among consumers (password sharing in Netflix
accounts is a concern)?

8.0 Wages and employment

· What is the marginal revenue product curve for labor employed by the firm (or the additional
revenue generated per unit of labor)?

· What is the overall market for labor? In specific sub-markets?

· How does the marginal revenue product curve for labor compare with the marginal factor cost paid
for labor (or the additional labor cost incurred by the firm per unit of labor)? I have argued before that
the marginal cost of labor for Netflix is much higher than what the financial statements report.

· How much of the marginal product revenue added by labor is retained by labor? This question is at
the hard of negotiation between labor and management in today’s tight labor market and the call for
greater disclosures about human capital of the firm

· How have changes in technology (say work from home), changes in complementary inputs or a
substitute input or a change in the number of firms that employ labor (sprouting of so many competing
streaming services vying to employ Netflix’s labor) affect the market demand for labor?

· How does Netflix’s labor trade off price of leisure with wages? How does this trade off affect the
supply of labor available to Netflix?

· How much does Netflix invest in improving its labor human capital?

· Does the firm deal with unions? Netflix has recently agreed to be part of the SAG-AFTRA union for
actors and support staff. How does such an arrangement affect demand and supply for unionized and
non-unionized labor?

· How does the firm deal with fairness issues associated with labor: income inequality across the
various sectors of labor in the firm, poverty, if any, it comes across in its realms of work and
discrimination among its labor force?

9.0 Interest rates and market for capital

· What is Netflix’s demand curve for capital? Netflix is pejoratively referred to as “Debt”flix for a
reason. The on-balance sheet carried by Netflix as of its 2021 annual report is around $23 billion. Off-
balance commitments are almost as high at $22 billion.

· How will an increase in interest rates affect Netflix’s demand for capital and its ability to sustain
debt-funded content creation?
10. Natural capital

· How much of natural resources, exhaustible or renewable, does the firm use? Scope 1 and 2
emissions, if one were to focus just on carbon, are relatively small for Netflix. We do not know enough
about their scope 3 emissions and the natural capital consumed by its production teams.

· What is the marginal revenue product from consumption of the natural resource and the price paid
for such use by the firm?

11. Taxation and lobbying

· What is Netflix’s marginal tax rate for an additional dollar of income earned? Although tax
disclosures are opaque, a diligent analyst should be able to compute the marginal tax rate for Netflix.
Computing this for foreign jurisdictions is important but nearly impossible to do given the state of
current disclosures.

· How much does the firm pay in terms of taxes based on ability to pay (income taxes, sales taxes,
excise taxes) or on the principle of benefits received for the payments made (property taxes)? Ability-to-
pay taxes should ideally count for more in assessing the firm’s contributions to society relative to taxes
based on the principle of benefits received.

· How much of these taxes are passed on to customers, employees, suppliers or by the shareholders
of the firm?

· How much does the firm invest in lobbying or affecting pollical process to capture public surplus or
avoid regulatory intervention?

Who should produce such information? Should it be mandated? What are the costs and benefits
associated with producing mandated disclosures and who should bear those? These are tough questions
to be wrestled with some other day with the caveat that these apply as much to new regulatory
disclosures proposed today as the aspirational ones I have listed above. Having said that, a few
piecemeal answers to these questions are expected of firms as per the mandates set by the FASB and
the SEC and are at least strongly recommended by many of the sustainability related standard setters
such as the SASB and the CDP. Investment banks and hedge funds attempt to discover information
related to some of these questions using big data or alternate data sources. But, by and large, its’ a
tough slog. I would have a very difficult time finding answers to the questions I pose for a typical
company.

In particular, take a close look at the disclosure questions that the financial regulators are currently
grappling with. How much of an overlap do you find between the elementary questions posed in a high-
school economics textbook with the disclosure related regulatory agenda of financial regulators? Not a
whole lot. Why? Are we, as investors interested in fundamentals, getting lost in minutiae instead of
finding answers to basic but important questions that we teach our high school students in our entry
level microeconomics textbooks?

My friends tell me that firms will simply refuse to play ball claiming most of the data underlying the
questions I ask are “proprietary.” Remember that firms said something similar when they refused to
disclose even data on sales revenue before the SEC was set up back in 1929. Think of this as a 25-50 year
struggle to get investors they information they truly need to decide whether their capital is being
deployed well by the firm. On a more optimistic note, I suspect private information intermediaries,
especially using big data, will ferret out good approximate answers to my questions way before then.