These Negative Stocks Aren't Positive Investments

Over all, there are now more people under "correctional supervision" in America -- more than six million -- than were in the Gulag Archipelago under Stalin at its height.
--
Adam Gopnik's "The Caging of America," published by The New Yorker

The traditional concept of a sin stock often brings to mind tobacco, booze, and gambling. Oh, please. Those industries are absolute child's play compared to some of the infinitely more negative corporate channels through which investors can try to make money these days.

Take the market for incarceration. It's difficult to conceive of a more negative way to turn a profit than imprisonment of human beings, and the mind reels at the endless possibilities for abuse, corruption, and a litany of perverse incentives.

The new state of sin
In the years following the financial crisis, more and more ethical investors should consider that some industries' perverse incentives may inflict more widespread damage than more traditional "vice" industries. I'd certainly argue that "too big to fail" banks Goldman Sachs (NYSE: GS  ) and Bank of America (NYSE: BAC  ) should be defined as new-school sin stocks.

The for-profit prison industry reveals a new low in the ways some corporations (and their investors) can make big profits, though. And let's not forget, when there's a profit motive involved, there also may be a whole heck of a lot of behind-the-scenes work going on to make sure more and more people are put behind bars in America.

The Bureau of Justice Statistics has said private prisons represent nearly 10% of all state and federal prisoners in America. Suffice it to say, the privatized prison industry would like to see a state in which it could widen the pool of potential inmates and its share in this negative market.

The biggest for-profit prison outfit is Corrections Corporation of America (NYSE: CXW  ) . Bloomberg BusinessWeek conducted an in-depth expose last year, revealing allegations that lobbying for contracts with agencies like the Immigration and Customs Enforcement have helped bolster this company's bottom line. ICE pays Corrections Corp. about $90 every day for each immigrant it keeps behind bars while they are processed for potential deportation.

Illegal immigrant issues are big business for companies such as Corrections Corp. and rivals such as the Geo Group (NYSE: GEO  ) (formerly known as Wackenhut) and privately held MTC. Corrections Corp. lobbied for Arizona's Senate Bill 1070, which allows police to haul in and hold suspected illegal immigrants. Clearly, that widened the pool of people who could be put away in private prisons.

Really, any more stringent law that increases prisoners helps these companies. Take mandatory minimum sentencing laws and "three strikes and you're in the big house" rules. Incidentally, right now efforts are under way to narrow the terms of California's three strikes law, aiming to make early release a possibility for nonviolent third offenses.

Cost savings...at what cost?
The aforementioned issues are just a tip of the iceberg when it comes to ethical considerations regarding the for-profit prison industry. Some critics contend that private prison companies actually devise ways to collect the more mellow lawbreakers for their facilities, since they're easier to handle (and therefore "cheaper"). In other words, they'll leave more difficult cases to the state.

Speaking of states, the economic environment may be helping these companies. That's not just because of the upswing in desperate folks who break the law, but also because a new trend may be building in which private prison companies buy up beleaguered state-run facilities in the zeal to balance government budgets. Corrections Corp. recently purchased a state facility in Ohio.

On the other hand, some states are actively blocking these privatized prisons' attempts. Florida's Senate recently shot down these contractors' attempts to do business there.

Granted, violent criminals who hurt and trespass against others do need to be put behind bars. Illegal immigrants should pursue legal status to pursue their dreams or better their lives in America. Regardless, an industry that has a profit incentive that's directly linked to locking people up is a frightening thing to contemplate.

Worst of all, though, the business model relies on some of the most tragic elements of society. Some people commit crimes because they're desperate, some because they suffer from untreated mental illness, and some because they simply don't care about others. Our society does require discipline and consequences for serious negative actions. We do need to underline that some choices are the wrong ones, and individuals must be held accountable for the serious, harmful ones.

However, there's a fine line between reasonable, rational sentencing and simply creating financial incentives to lock more and more people up whether it makes sense or not.

Avoiding negative business models
Many investors have no qualms about investing in sectors like this one. William Ackman's Pershing Square Capital Management was a Corrections Corporation of America shareholder until last summer, for example. The stock is also a Motley Fool Stock Advisor recommendation, so obviously some of my most respected investor colleagues aren't too squeamish about this industry.

However, we investors always have a choice about which companies we'll invest in and why. I hope more investors will think long and hard about the ways in which the companies they invest their hard-earned money in generate their profits. And then take one more step, and ask what these business models really mean

I know what this business model means for me: The for-profit prison industry isn't fit for my portfolio. Maybe I'll miss some stock returns, but at least I'll be able to sleep at night.

Check back at Fool.com every Wednesday and Friday for Alyce Lomax's columns on environmental, social, and governance issues.

Editor's note: A previous version of this article mistakenly said that Pershing Square still had a position in Corrections Corporation of America. The Fool regrets the error.

Alyce Lomax does not own shares of any of the companies mentioned. The Motley Fool owns shares of Bank of America. Motley Fool newsletter services have recommended buying shares of Corrections Corporation of America and Goldman Sachs. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


Read/Post Comments (13) | Recommend This Article (15)

Comments from our Foolish Readers

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  • Report this Comment On February 15, 2012, at 4:22 PM, TMFCop wrote:

    Alyce,

    I guess this will be one of the very few issues we'll find ourselves on opposite sides.

    First, CCA does not and has not lobbied for any law one way or the other. That was a meme started by critics of private prisons but it's simply not true. CCA has "unequivocally" stated it nor anyone representing the company has lobbied for passage of a crime bill. It just didn't happen.

    Second, I don't get the opposition to housing prisoners at private facilities. It's not as if CCA or GEO are going out and rounding up people on their own and warehousing them, these are people that have broken the law and the government is simply finding the cheapest means of confining them.

    And, yes, private prisons ARE cheaper. What most studies conveniently ignore when they show private facilities at best being comparable to government-run jails are the huge, huge pension and benefits costs for employees. When those very real costs are included, private prisons are far and away the cheaper alternative.

    Now there have been instances of abuse at some private prisons, but those examples are routinely trotted out as if nothing ever happens inside government prisons. The difference is, though, private prisons can typically fire the employees found guilty of abuse; 'taint so easy to fire a government employee backed by powerful unions.

    So it should be no surprise that it was the Florida government prison unions who were most vociferous in their opposition to privatization, a move that would have saved taxpayers millions of dollars. I believe this will be just a temporary setback, though it hurts CCA right now.

    Again, there aren't too many issues where you and I will disagree Alyce. This, though, is most definitely one of them.

    Rich

  • Report this Comment On February 15, 2012, at 5:12 PM, TMFLomax wrote:

    Hey Rich,

    Yeah, I also doubt we disagree on too many issues. And you make a lot of very valid points and I'm glad you shared them (including criticisms of the critics, ha). Plus, I can definitely see the point about some of the high costs in the public sector (and the difficulties in firing employees).

    Regardless, overall the idea of investing in for-profit prison stocks turns me off on a lot of levels, maybe mostly on the philosophical one. There are some things I really just don't have the stomach to invest in and try to make a profit off of, and this is definitely one of those areas. Doesn't fit into my view of responsibility (which, of course, is my view... I'm sure some people would find, say, tobacco stocks more reprehensible).

    Thanks for adding the thoughts to the discussion! They're important to be included (and I'm of course totally fine with people disagreeing with me on this). Good rebuttals help all us investors weigh information and make our choices.

    Alyce

  • Report this Comment On February 15, 2012, at 5:35 PM, gdett2 wrote:

    Alyce,

    This article is confusing to me.

    <i>However, there's a fine line between reasonable, rational sentencing and simply creating financial incentives to lock more and more people up whether it makes sense or not.</i>

    What exactly does a privately run vs government prison have to do with sentencing? You do realize the government, yours and mine, makes the laws, hires people to enforce those laws, elects/hires people to prosecute offenders of those laws and at the very end of the process, relies on the prison system to house those offenders.

    Prisons are the containers at the end of the process. They do not make or enforce laws or hold trials. They only deal with the result.

    Complaining about the people who might wrongfully be placed in prison in the light that the prison is somehow at fault is just not a very rational argument. It reminds me of someone blaming the hotdog vendor because their favorite team lost the game.

    Gene (Normally love your articles)

  • Report this Comment On February 15, 2012, at 8:09 PM, TMFLomax wrote:

    Here's the NPR report on allegations of sort of sneaky back-door lobbying and influence on lawmakers:

    http://www.npr.org/templates/story/story.php?storyId=1311915...

    Readers can take it or leave it, but I have no doubt this sort of thing goes on. In fact I believe during the health care debate there were allegations health companies were doing this sort of thing, too. Ah, the corporate people. ;)

    Gene, thanks for your comments and thank you for normally enjoying my articles; sorry we don't agree on this issue. Privatizing entities having to do with law enforcement and public safety make me uncomfortable because, like I said, the incentives kind of change and boil down to that profit motive. I agree that there are layers of this that also need to be scrutinized (and I've written about my negative feelings about lobbying's influence on lawmaking and regulations before), and of course some problems exist in the public sector for these services too. Still the fact that there's the sense that the prison "industry" in America could be a "growth industry" is disturbing to me in a lot of ways. At some point maybe somebody *could* be put away for years for stealing a loaf of bread and a corporate entity could make a tidy profit off it. These are not positive incentives.

    Best,

    Alyce

  • Report this Comment On February 15, 2012, at 11:28 PM, TMFCop wrote:

    Alyce,

    I guess I'm just not getting your concern over the profit motive here. CCA wouldn't have made the law that put the thief in jail, it's just running the facility that houses him. Why is that bad?

    Maybe asked another way, why would it be good if the government was running the jail he was in? Considering the noted inefficiencies of government-run anything, the excessive costs and cost overruns, the inability to make needed change because of burdensome work rules, the bloat and payroll padding that goes on, why is that a superior model to want?

    Criminals, like the poor, will always be with us. Whether it's a growth industry or not, those same forces will be at work regardless of whether the government runs the prisons or a private company does.

    You're always so consistent in your views that this flaw in your constitution disturbs me. :)

    Rich

  • Report this Comment On February 16, 2012, at 12:30 AM, Johnlatasa wrote:

    In California the Prison Guards Union is driving the need to privatize with their extraordinary compensation. They also have a strong incentive to increase incarceration rates.

  • Report this Comment On February 16, 2012, at 12:47 AM, gdett2 wrote:

    Alyce,

    When you say:

    "At some point maybe somebody *could* be put away for years for stealing a loaf of bread and a corporate entity could make a tidy profit off it. These are not positive incentives."

    How does the prison decide who goes to jail for stealing bread? I realize things are different here in Texas, but we do have judges, juries, district attorneys and citizens who decide who goes to jail and for how long. We don't leave any of those decisions to the prison. The prisons do not decide when to let them go either. That is the parole board, a state function.

    So I guess I see prisons as good things, not evil. The contain the murderers, thieves, rapists, child molesters and others that would harm us. I don't really want them walking around loose.

    On the lobbying issue, do you actually believe any company of any reasonable size does not have some association with a PAC/Lobby, either directly or indirectly through some other organization.

    I am a board member of a tiny water supply company, non-profit. One of the organizations we belong to does some lobbying to protect our company and our customers(who are the owners) from regulatory harm. Our electric and telephone co-ops also have peripheral lobby contacts. I have 2 mortgages through a land bank and all the rest of my financials through USAA. Both have lobby connections. None of these are for-profit companies. They are all member owned. Even our fire department and firefighters are members of the SFFMA for certifications and they lobby the state for better enforcement and other matters. Lobbyists have always been with us and not all are bad. If the do something illegal, they should be fined or put in prison like any criminal.

    Gene

  • Report this Comment On February 16, 2012, at 5:27 AM, wax wrote:

    Alyce;

    What is really the difference between CCA and Goldman or CCA and BAC?

    They all make their money from incarceration.

    Wax

  • Report this Comment On February 16, 2012, at 9:29 AM, TMFLomax wrote:

    Hey everybody,

    Rich it's funny you mention my "constitution" - you know how I feel about the government's role in things. ;) However, I can say this: when I read "The Machinery of Freedom" years ago, one of the things I totally strongly disagreed with while I was reading was the idea that privatized law enforcement or public safety functions wouldn't become "like the Mafia." I remember thinking I didn't buy that. There wasn't a very good argument for why they wouldn't.

    Not all lobbying is bad, but some is, and if it relates to things like detaining people on "suspicion" of things, or maybe the three strikes stuff, I get worried. The impression I get about the flaw in "three strikes" is that if the last felony is shoplifting a pack of gum or having a joint, that could trigger it, and that's totally different than dangerous, violent offenses. I'm not saying people should run around shoplifting or carrying illegal drugs, but just to make the point, a petty shoplifter isn't putting society in *that* much danger, and the person with the joint is probably not going to do anything worse than spout a bunch of pipe dreams and eat all your Cheetos. There should be penalties, but certainly not years of incarceration. Things like this contribute to prison overcrowding and then the private outfits swoop in because, again, a market is being created for long-term imprisonment. Dangerous precedent here. (And Gene, I also want murderers, rapists, child molesters put away. I don't disagree with that at all. They are very dangerous to all of us.)

    I also will definitely agree that true, the public sector certainly also have some incentives to increase incarceration, and that should also be addressed.

    I have a feeling we're not going to agree on this one. ;) Like I said in the article though, all of us investors have our different views on what we construe as proper "growth" or "risk" that we weigh when we're making our decisions. I find this sector distasteful... obviously plenty of investors don't. But I always think it's good to have the discussions!

    Alyce

  • Report this Comment On February 16, 2012, at 10:55 AM, corant123 wrote:

    While I don't necessarily agree that this is a negative sector, the message of this article is one I hope doesn't get lost in the argument over whether it is or not. While it's easy to get lost in looking at the numbers when making investment decisions, it's also important for us to look at what the companies we're investing in are going to do with that money when choosing where to place our funds.

  • Report this Comment On February 16, 2012, at 12:14 PM, TMFSelena wrote:

    Rich and others --

    My problem with privatized prisons is that when a for-profit company is running prisons, it seems like they'll be extra likely to try and wring every dollar of profit possible from the situation, thereby reducing the quality of conditions there, for example. They will also be motivated to maximize their customer base and keep them in prison as long as possible, for the revenue. Yes, sentences and such aren't their department, but they can lobby and influence the legal process, which they seem to be doing.

    And all government-run operations are NOT inefficient. The Veterans hospital system, for example, is pretty impressive, and even Medicare itself. And inefficient systems can always be improved instead of swapped out for privatized services.

    I think that some services are best run by the government or gov't-related agencies, not by for-profit companies -- and among them would be prisons, the postal system, schools, etc.

    Some frightening details:

    http://www.businessweek.com/magazine/content/11_13/b42210762...

    We'll probably have to agree to disagree. :)

    Selena

  • Report this Comment On February 16, 2012, at 3:04 PM, motleylorenzo wrote:

    Alyce,

    Mr. Ackman sold out of his position last summer.

  • Report this Comment On February 17, 2012, at 7:43 AM, stein919 wrote:

    Hi Alyce,

    Your concerns regarding private prison companies are well placed. Please see this recent press release for just one example of how cost cutting in areas such as staffing, employee training and employee wages, in order to boost profit margins, has real consequences for prisoners held in for-profit prisons:

    http://dbapress.com/wp-content/uploads/2012/02/HRDC-Draft-pr...

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