Dumb Investment of the Week: For-Profit Prison Industry by Ben Strubel

Strubel Investment Management‘s Dumb Investment of the Week for this week focuses on the private for-profit prison industry.

Since you know I happily invest in tobacco companies, alcoholic beverage manufacturers, and defense contractors, you know that the private prison industry must be pretty rotten if even I won’t invest in it.

The industry appears to operate a fundamentally flawed business model and seems thoroughly corrupt from top to bottom. We believe it is just a matter of time before Chaucer’s old adage about evil deeds being found out (“Murder will out, certain, it will not fail”) comes true.

Corrections Corp Of America (NYSE:CXW), referred to hereafter by its better known industry acronym CCA, G4S plc (LON:GFS) (OTCMKTS:GFSZY), and The Geo Group, Inc. (NYSE:GEO) are the three main publicly traded companies that operate private for-profit prisons and detention centers.

These companies rode the dual wave of the war on drugs and deregulation/privatization (a better term might be “confiscation”) of public property and resources in the 1980s into a prominent political and financial force in the prison industry. A wave of overbuilding and lawsuits threatened the industry in the late 1990s, but the terrorist attacks of September 11 and a new focus on locating and detaining so called “illegal” immigrants have vaulted the private for-profit industry to record profits.

We believe the combination of a flawed business model and rampant abuse in the private prison industry will eventually outweigh the lobbying savvy of the companies and lead to the decline of the industry.

Industry Is Vulnerable to Abuse

The private prison industry stands unique among almost all other sectors of the economy in that the nature of its “customers” brings a very high risk of abuse.

It’s easy to take advantage of incarcerated persons. In many cases, the conviction of a crime strips individuals of certain right, their freedoms are severely restricted, and reduces or negates any sympathy society may feel toward them.

For instance, imagine if some large company perpetrated some abuse on my 80-year-old grandma. Well, let’s take a step back. First, it would be difficult for anyone to take advantage of her. As a free person, no company can truly force her to do anything. In addition, she has many family members, including my father and me, looking out for her. But, let’s suppose something did happen. As a non-convict and non-incarcerated person, she enjoys maximum rights under the law and would have a fairly easy time righting any wrongs through legal means. Also, as an 80-year-old widow and upstanding member of the community she presents a very sympathetic figure. Any media organization would eagerly take up her cause and be happy to publish a story on how some evil, faceless corporation took advantage of her. The community would likely be outraged and rally to her cause. Any local politician would be eager to help as well to show the voters how he’s “standing up for the little guy.”

With incarcerated people, the situation is very different. They are stripped of many rights. The operator of the prison system has almost complete control over their behavior and their daily lives. Many incarcerated people have less robust family support systems than mine, and the media and many politicians are going to be much less likely to champion the cause of a wronged convict than of my grandma.

It’s this dynamic that creates an enormous potential for abuse as we will show later throughout this article. Prisoners are easily taken advantage of and the for-profit nature of private prisons creates an overwhelming incentive to neglect the well-being of prisoners in exchange for increased profits. With public companies, the pressure of meeting investor and Wall Street expectations may make the temptation even greater.

Business Model Depends on Cutting Corners

In many, if not most, businesses there are multiple ways a company can increase profitability. Take Ford Motor Company (NYSE:F), for example. Management has many options to increase profitability. They could design and build better cars than their competitors and take market share away. They could try charging more for their vehicles if they thought they were better than the competition. They could develop a new small, urban-friendly vehicle targeted to millennials living in cities, which would increase sales by enlarging the total pool of potential car buyers. They could develop more efficient manufacturing processes and cut costs thereby increasing profitability, or they could spend more money on advertising, which might lead to more sales. The point is that for a company like Ford that makes things that are useful to consumers and that consumers actually need and want, there are many levers managers can pull to improve the profitability of the company.

The private for-profit industry is an entirely different beast. The companies are paid a per diem rate for each prisoner at the prisons they own and operate. From Corrections Corp 10-K: “We are compensated for providing prison bed capacity and correctional services at an inmate per diem rate based upon actual or minimum guaranteed occupancy levels.”

Unlike Ford Motor Company, there is nothing a private for-profit prison operator can do to increase their top line “sales” figure without increasing bed capacity. They are compensated a fixed rate per prisoner. So, the only way that a private for-profit prison operator can increase profitability is cut costs. The less they spend per prisoner the greater their profit.

This means that private for-profit prison companies are highly incentivized to do the following:

  • Incarcerate the maximum number of people for as long as possible
  • Build and maintain prisons as cheaply as possible
  • Staff prisons as leanly as possible
  • Compensate staff as little as possible
  • Minimize the amount of medical care utilized by prisoners

Every dollar saved from staffing costs and prisoner care results in another dollar added to the company’s bottom line. Unfortunately, it seems that this pursuit of profit has led to unsafe conditions and systemic abuse of inmates at private for-profit prisons.

Abuses of the System and Mistreatment of Inmates

The abuses in the private prison industry are literally too numerous to mention. In the following sections we will present several examples and anecdotes in each category of abuse and neglect as well as a summary of any relevant statistical information that shows how that type of abuse is rampant across the entire private prison complex system.

Maximize Incarceration Rates

Private prisons are most profitable when operating at maximum occupancy rates. While many private prison contracts specify minimum occupancy guarantees (an issue we will address later in this article), the rate guarantees are usually less than 100%. Many private prisons have resorted to other tactics to keep their prisons filled.

The most notorious case might be the “kids for cash” scandal where two judges in Luzerne County, PA, were found guilty of and sentenced to 17.5 years and 28 years, respectively, for taking over $2.6M in kickbacks from Mid Atlantic Youth Service Corporation to sentence youths convicted of minor crimes to jail at the their private prison facility.

A study of New Mexico prisons showed that prisoners at private prisons run by CCA lost “good behavior” time, or reductions in their original sentence, at a rate EIGHT times higher than inmates in New Mexico state-run prisons. It’s important to keep in mind that CCA is

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