Economic Update about The US and Europe

 

Parasite Relation between Public and Private Sector

 

An MBA becomes PM, when the value of an MBA is questioned

 Stephen Chambers in The FT

Rishi Sunak is the first person of colour to become UK prime minister, the first Hindu and the richest premier in modern times. He is also, significantly, the first to hold an MBA degree. 

Sunak studied philosophy, politics and economics at Oxford, as so many leading British politicians have. But it is his time at Stanford’s Graduate School of Business — where he met his wife and was drilled in the finer points of competitive advantage and the capital asset pricing model — that sets him apart from his peers. 

Stanford Graduate School of Business sits at the heart of Silicon Valley, where Romanesque architecture, sunshine and social liberalism combine with libertarian and free market ideas and a core belief in the redeeming power of technology. It spans both suit-and-tie corporatism and T-shirt-and-sandal activism. Venture enthusiasm and techno-utopianism make for a heady business school environment. Two years in brutally competitive Palo Alto changes more than how people dress. 

Amid the Rodin sculptures on campus, Sunak will have absorbed Milton Friedman’s doctrine of shareholder primacy, Michael Porter’s “five forces” framework for understanding how industries work, so-called Monte Carlo simulations, the innovator’s dilemma and an emphasis on spreadsheets — all of it flavoured with Silicon Valley’s distinctive “move fast and break things” worldview. He graduated in 2006, the year Twitter was founded. The financial crisis hadn’t happened so MBAs had not yet been blamed for causing it. This was also the founding year of TOMS shoes, which gave away one pair of shoes to a child in need for every pair bought, the very model of the Silicon Valley social enterprise. 

The MBA has arguably been the most influential degree of the last 50 years. It has brought systematic discipline to practices that were previously ad hoc and weakly formalised, and serious analytical rigour to bear on starting, funding, running and advising businesses. It built a bridge between research in disparate disciplines and gave us a framework for talking about companies, competition, innovation and investment. 

But recently MBA influence has shown signs of waning. The traditionally high return on investment for the roughly quarter of a million students enrolled globally on such programmes is facing renewed scrutiny in the face of rising tuition fees, while those running the programmes have started to question their methods. What if shareholders aren’t the only people we should care about? What if markets don’t allocate resources optimally for social justice? What if the firm isn’t the most useful unit of analysis for getting things done? What if political reality isn’t captured or expressed by a spreadsheet? 

What does it mean to have an MBA as prime minister? Sunak’s Stanford education means he can run the numbers and pitch the vision. He can assess the net present value. He understands organisational behaviour and market-segmentation. But will any of this help when the rational expectations of MBA orthodoxy collide with politics and events? 

In his political career to date, Sunak has shown both TOMS shoes and Friedmanite instincts. The UK’s furlough scheme and “eat out to help out”, which he introduced as chancellor under Boris Johnson, were TOMS-ish, almost Keynesian. The austerity measures he is now contemplating suggest the opposite. And MBAs are very good at cutting costs. The economist Daron Acemoglu has suggested that employees in companies run by MBA graduates see their wages fall over a five-year period. Markets and owners like this. Employees probably don’t. 

Having an MBA in charge is reassuring if we think of the nation as a corporation. But critics of these programmes point to overconfidence, ethical lapses and a lack of real analytical or empirical evidence for widely adopted strategies. They bemoan an undue focus on case study learning, a lack of emphasis on softer skills, overreliance on corporate acquisitions rather than productivity improvements and a narrow focus on shareholder value. 

Business school admissions departments often say that their students are either “poets” or “quants”. Poets are usually humanities trained and uncomfortable with spreadsheets and valuation exercises. Quants are highly numerate, often with first degrees in engineering. Poets are comfortable with what Keats called “uncertainties, mysteries [and] doubts”. Quants are good at regression analysis. Poets sing, while quants count. Boris Johnson was a poet with a classics degree. He campaigned in poetry, and tried to govern in poetry as well. The UK’s new prime minister can clearly count, while his campaigning was done almost entirely in prose. But does Sunak’s MBA allow him to sing too?

Why executives should always listen to unreasonable activists

Andrew Edgecliffe-Johnson in The FT

When Christabel Pankhurst argued the case for women’s suffrage to members of the London Stock Exchange in 1909, the Financial Times reported that her address excited “a few remonstrative ‘Oh, ohs!’ [but] was punctuated throughout by genuine applause, as well as a good deal of merriment at her humorous sallies”. 

After three years of failing to convert such applause into voting rights, however, the movement led by Pankhurst and her mother Emmeline adopted less amusing tactics, and the business pages’ view of it darkened. Arson attacks on post boxes in the City of London in 1912 left the FT fulminating about the need for “drastic measures . . . to protect the community as a whole from the mischievous intentions of a small and insubordinate section”. 

Why dredge this history up now? Because today’s business leaders are being confronted by a new generation of agitators whose aims they consider unrealistic, whose methods they consider unreasonable but whose message will probably prove worth heeding in the long run.  

This year’s annual meeting season has seen protests over executive pay at companies from AstraZeneca to GE. Nuns have harangued Amazon over its facial recognition technology and taken on Boeing over its lobbying. Diversity advocates have castigated boards for moving too slowly to achieve racial and — a century after the suffragettes — gender equality.  

No subject has attracted more militancy of late, however, than companies’ contributions to climate change. And no clash has defined this shareholder spring more clearly than the revolt at ExxonMobil, in which Engine No 1, an activist investor with a minute stake and an aversion to fossil fuels, fought its way on to the $250bn oil major’s board.  

“This is like the shot heard around the world,” says Robert Eccles, a Saïd Business School professor. Other companies and investors are realising that “if this little hedge fund can do this to ExxonMobil then, oh, things are different”.  

Shareholders’ views of Big Oil were already shifting faster than Exxon had changed its business model, Eccles notes, but like Pankhurst’s troublemakers: “You needed the spark: they blew up the mailbox.”  

Before Engine No 1, there was the civil disobedience of Extinction Rebellion, which has dumped fake coal outside Lloyd’s of London and blockaded News Corp printing sites in the past year. Environmental campaigners had targeted the offices of JPMorgan Chase in New York and BlackRock in Paris. And Greta Thunberg had shown up at the World Economic Forum last year and rubbished Davos-goers’ tree-planting incrementalism.  

Such zealous tactics seem guaranteed to generate more irritation than applause. As Eccles puts it, “here are people who . . . don’t hold any of the cards. Unless you’re breaking the rules or using the rules really aggressively, as Engine No 1 did, you can’t get attention.” 

That makes them easy to dismiss. People on both extremes of the fossil fuels debate “are a little nuts”, Warren Buffett told Berkshire Hathaway’s annual meeting last month.  

Maybe, but from street style to fashions on Wall Street, new ideas tend to start on the fringes. The examples of the Pankhursts and successive campaigners for causes ranging from civil rights to gay rights suggest that the most powerful ideas become mainstream in the end.  

That rarely happens overnight: it took until 1928 for British women to gain electoral equality with men. But today’s irritants can serve as harbingers of tomorrow’s consensus.  

That should make them valuable to any company wanting to understand the risks and opportunities in the years ahead. Every CEO knows that society’s expectations of business are constantly changing, but few have worked out that their harshest critics might help them position themselves for those shifts. 

Society’s expectations still matter most to boards when expressed through their shareholders’ votes, and the continued growth of socially conscious investing suggests that the agendas of provocateurs and portfolio managers are converging.  

This week, for example, a UBS survey of rich investors found 90 per cent of them claimed that the pandemic had made them more determined to align their investments with their values.  

That report again underscored how younger capitalists are driving this process: almost 80 per cent of investors under 50 said Covid-19 had made them want to make a bigger difference in the world, compared with just half of the over-50s. It is worth executives asking themselves which of those demographics they are spending more time with.  

Exxon’s unreasonable activists showed it that the world had changed and it had not. The question for other companies is whether they can learn such lessons less painfully.  

Does this mean that boards should bend to every crank who berates them at an annual meeting? No, but companies should avoid dismissing every critic as a crank, and study the agitators for early warning signs of what may become groundswells.  

Executives love to talk about innovation and “first-mover advantage”. If they are serious, they should spend more time thinking about where today’s fringes suggest tomorrow’s mainstream will be. Sometimes a small and insubordinate section points the way for the community as a whole. 

Labour’s just declared class war. Has anybody noticed?

Aditya Chakrabortty in The Guardian

You’d expect a declaration of class war by the main opposition party to merit at least a mention in the country’s tabloids. After all, on Sunday night Labour announced a SIX BILLION POUND RAID ON BUSINESS – the kind of thing one might reasonably hope to be screamed in huge font across the front pages and condemned in fist-shaking, bloodcurdling editorials. But nothing. Barely a squeak.

Just why that should be I’ll discuss in a moment, but first there is the policy itself – and a big, bold thing it is. At Labour conference on Monday, John McDonnell declared that he plans to force all companies with more than 250 staff to put 10% of their equity into a fund for their workers. Each employee will then be entitled to company share dividends worth up to £500 a year. Any extra will go back into public services.

The sums involved are massive: Labour calculates that 10.7 million workers covered by the scheme will get about £4bn a year in share dividends by the end of Jeremy Corbyn’s first term in government, while the public sector will receive an annual £2bn.

This also represents a big shift in Labour’s thinking. A few days ago, I met a senior aide to the previous party leader Ed Miliband who talked for a while about how, for all the rhetoric deployed by the new team, little of substance had changed in policy. “Apart from this stuff about a worker fund,” he mused. “Now that is big.” 

Big indeed. This isn’t just about giving employees more money; it’s handing them a stake and a voice in the enterprises on which they spend most of their waking hours.

To do so, McDonnell will use the stick rather than the carrot, compulsion rather than encouragement over china teacups. His argument is that shareholders are not the only ones entitled to company profits: the employees and the rest of society (which pays for the infrastructure used by businesses and allows them the great privilege of limited liability) also have a claim. No wonder business lobby groups are furious, with Confederation of British Industry director general Carolyn Fairbairn decrying a “diktat” that will have investors “packing their bags”.

For decades, the British have practised a carelessness that lets the people wielding the biggest chequebooks buy whichever assets they like and do whatever they want. That attitude has allowed Philip Green to strip BHS to the bones, Kraft to run Cadbury into the ground, and Thames Water to be picked over by a consortium of international investors.

The rewards from all this carnage have flowed to one group: shareholders. In 2015, Bank of England chief economist Andy Haldane charted what has happened to workers’ share of national income over the long-run. He found that labour had been getting smaller and smaller slices of the pie: from 70% in the 1970s to 55% now. By his reckoning, employees get proportionately less now than they did at the very outset of the Industrial Revolution in the 1770s.

Had workers’ wages kept track with the rise in their productivity since 1990, the average employee would today be 20% better off. Or they could have three-day weekends all year long and still get paid the same.

To secure a real rise in wages will require more than waiting for the economy to recover from its decade-long slump and the labour market to return to “normal”. Hence today’s announcement. This is not to say I think it’s perfect. It won’t touch the likes of Google and Facebook, because they’re listed abroad. It’s not clear to me how it will affect Amazon, which has relatively few direct employees but warehouses full of agency workers. Labour says it has suggestions – I’m not sure Jeff Bezos will be listening. The opposition’s key challenge remains largely unaddressed, which is how to get private sector businesses to behave as if they’re part of the society in which they operate.

Like Labour’s tax on second homes, you can see what the party is getting at even while thinking that the proposals as they stand are likely to be gamed.

At the same time, it’s especially difficult for Theresa May to oppose. Don’t the Conservatives boast of being the party of shareholder democracy (even though share ownership has become less widespread since Margaret Thatcher came to power)? Didn’t David Cameron commission a report into companies owned by their employees, the first line of which read: “Employee ownership is a great idea.” ? And doesn’t all the evidence show that companies owned by their workers are more productive and stick around for longer?

The Tories’ uneasiness over how to respond accounts for part of newspapers’ silence on this Labour proposal. Add to that the agonies over Brexit that will be played out over the next two weeks of conference. But the closer Labour edge to power, the more scrutiny ideas like this will receive.

As far as I know, McDonnell’s policy has been tried in one other comparable situation. In the early 80s, Sweden’s Social Democrats promised to give 20% of company shares to workers. Named after its architect, trade union economist Rudolf Meidner, the policy was popular with the party faithful.

But in this polite and outwardly cohesive country, it caused outright war, writes Robin Blackburn in his classic history Banking on Death: “Business leaders were intensely alarmed and spent five times more money attacking the plan than the cash laid out by all the parties on the 1982 election. The privately-owned press ran a sustained and vigorous campaign … under assault, support for the scheme ebbed and the Social Democrat leaders believed that it was prudent greatly to dilute the scheme…” By the mid-90s, the policy was dead.

A warning there for all those gathering in Liverpool this week – and for anyone who believes workers should receive a greater share of the stuff we produce: get ready for the onslaught.

GKN will be stripped and sold for parts by ghouls who have no interest in making things

Will Hutton in The Guardian

 

A GKN engineer at work. The £8bn battle for control of Britain’s third largest engineering group has been won by Melrose. Photograph: GKN


The past is never dead. When the wheeling, dealing, asset-stripping Hanson Trust finally collapsed in 2007, having played a major part in the deindustrialisation of Britain – but having greatly enriched its Thatcherite founder Lord Hanson – I thought a stake had finally being driven through the heart of a particular ghoul.

Never again would our Westminster, Whitehall and City establishments indulge a glorified super-accountant who knew the price of everything but the value of nothing. And, in the name of “culture change” and rigorous “management”, had laid waste to industrial Britain. I was wrong.

The ghoul lives on, reincarnated as Chris Miller, the executive chair of Melrose, a company self-consciously cast in Hanson Trust’s image, and now the victor in the £8bn battle for control of Britain’s third largest engineering group, GKN. Miller is in fact a Hanson protege and, like his former boss James Hanson, he trained as an accountant – the perfect professional background for asset stripping.

For what glory days were those! The young Miller will have been part of the finance team working to Hanson and his chief accomplice, Gordon White, at their headquarters overlooking Buckingham Palace. It was a company wholly controlled by the two men, insisting on approving every expenditure above £500 by the companies they acquired – even while they pioneered stowing profits in tax havens and raiding pension funds of the companies they took over.

Crucially, Miller will have seen firsthand how Hanson and White stalked their takeover targets, set about winning the battles and then made a fortune from breaking up the victim company while running its core businesses to incredibly stringent financial targets. I have no doubt that, like Hanson and White, both ennobled by Margaret Thatcher who admired them uncritically, he believes in the virtue of what he does. Since founding Melrose, the financial returns have been stratospheric. Miller has yet to be named capitalist of the year by the Times as Hanson was in 1986 – but he is on his way.

But, like Hanson’s, Miller’s is a capitalism organised entirely around extracting rather than creating value. Hanson’s model was brutally simple, exemplified by the 1982 takeover of Berec, the manufacturer of Eveready batteries, and its subsequent breakup – Miller will have had a ringside seat.

Like GKN, it was a proud Midlands-based British engineering company setting about the hazardous business of becoming the international brand leader in batteries, based on high investment in research and development. Who knows? In a different business culture, Berec might now be the world’s leading battery manufacturer, set to exploit the electrification of cars. Instead, it does not exist.

For, like GKN, it made a mis-step – the share price dipped and Hanson launched his bid. The European division was sold off to its chief competitor, Duracell, thus recouping most of the cost of the takeover. Battery prices were increased across the board, so that Eveready quickly lost market share. All new investment could only be justified if the cash was returned in four years while making a 20% return. Ten years later, Eveready had been milked dry, and Hanson sold out to Ralston Purina. Its verdict on Eveready as it assessed its purchase: a company “a number of years behind the times… a business in decline… the whole infrastructure was pretty thin”.

Hanson had made a fortune – but Britain had lost another pivotal company. So it continued. Two years before he left Hanson to found his own Hanson-like shell company, Miller would have been in the thick of the 1986 bid for Imperial Tobacco – then dismembered like Eveready. But the Hanson business model was inherently unstable. To grow and maintain his own share price, he had to go for ever bigger targets to feed the beast. Hanson had an unsuccessful shot at ICI, which saw him off – but only at the price of ICI changing its declared business purpose from bettering society through science to maximising the share price. ICI then broke itself up – but so did Hanson, with the company ignominiously being sold to a German cement company.

We can foretell what will happen to GKN. Businesses will be sold to repay the £8bn. Prices will increase, and market share will be foregone: there is no other option given the millstone of debt around Melrose’s neck. R&D will be frozen at the current levels, already running at half to two thirds the rate of its chief competitors, rendering virtually valueless the promise to the business secretary, Greg Clark, to maintain it. Investment will only be allowed on Hanson-type terms – four-year paybacks and 20% returns. Yes, the company headquarters will remain in Britain – but in Mayfair, not in Redditch. In 10 years’ time, some company will buy the rump of GKN, only to find it in the same condition as Ralston Purina found Eveready.

Melrose’s future is also foretold. For all the hundreds of millions it is making, it will wind up like Hanson. Britain, which already has no major indigenous company in an array of sectors, will have them in even fewer – with all the implications for work, wages, careers and skills. For most of the young analysts at the asset management groups who took the decision to accept Melrose’s offer for GKN, the events I describe will seem like ancient history.

But the same mistakes keep being repeated. To prevent them, the government simply has to rule that only shareholders who own shares at the time of the bid can vote, so disenfranchising the arbitrageurs and hedge funds who swung the decision. But the City establishment lobbies ferociously against this move. For the City is wedded to the value extraction on which its fees depend.

Theatre of Capitalism - The Annual General Meeting

AN ANNUAL SHAREHOLDERS MEETING MAY NOT SOUND LIKE A PLACE FOR A BOLLYWOOD DENOUEMENT, BUT THESE CORPORATE GATHERINGS ARE AS RIFE WITH TRAGEDY AS THEY ARE WITH FARCE.

Sidin Vadakut in Motherland

Indian films strive for closure. In fact the single most important driving force that powers the narrative in most Indian films is the satisfactory closure of gaping wounds, wounded pride, injustice or vendetta.

Our films may navigate increasingly complex and original ways of achieving this closure. But in the end most of them achieve this through some age-old final-reel tropes. The climactic clash between the forces of good – the outnumbered hero – and the forces of evil – the bad guy and his hordes – is a popular one. The union of cleaved lovers, often involving trains, is canon. Family movies usually feature a reunified, joyous household pardoning the most heinous relatives who, moments earlier, were plotting their wholesale slaughter.

Mani Ratnam’s 2007 feature film Guru, however, ends with the most unique setting for a closing scene of any Indian film: an Annual General Meeting of shareholders.

This might seem like a bizarre choice of scenario. AGMs are a statutory requirement for companies listed on stock exchanges. In most countries in the world listed companies are required to hold at least one meeting a year where shareholders get a chance to vote on important company measures and approve annual statements of accounts.

These meetings can often be very important, highly charged and widely reported in the media. But how can they ever be interesting enough to serve as the closing act of a Bollywood blockbuster?

AGMs can be fun. But not Amitabh Bachchan or Anil Kapoor fun. Surely?

In fact it is a mystery that more blockbuster films don’t use AGMs in their plot. For when it comes to sheer theatricality some Indian AGMs can be every bit a work of performance art as Shahrukh Khan’s latest.



In the summer of 2006 I joined one of India’s grand old manufacturing companies as a consultant. Established well before India became an independent country, the company continues to be one of the best-known names in consumer electricals. Though these days it makes most of its money from industrial products like transformers. It has its headquarters in a shiny skyscraper in one of Mumbai’s most expensive neighbourhoods.

But inside it remains a quaintly old-fashioned company.

At the time I was struggling to make ends meet as a novelist – essentially an income-free profession – and hastily agreed to work for them part-time as part of a new business development team. The team consisted of two people. A vice president who thought big. And the consultant who translated these ideas into spreadsheets. It was a poorly thought-out project from the outset and no one was particularly surprised when it was shut down ten months later.

But in the interim I got paid handsomely, and used the money to get married.

One morning in July 2006, just a few months after we started work on our ill-fated project, I noticed an army of unfamiliar faces trooping in and out of our offices in the head office tower.

This was most rare. The offices mostly housed departments that had nearly nothing to do with the outside world: accounts, legal, corporate HR, statutory and reporting, insider trading, etc. Nobody visited us, not even employees from other departments.

Yet suddenly here was an eccentric group of old men and middle-aged women all lining up to meet the company secretary. Some of them needed help getting in and out of the lifts.

But this was not a company where you went around asking questions. Everything and everybody functioned on a need to know basis. If you needed to know you would know.

The next morning everyone received a directive from human resources. All employees were expected to attend the company’s AGM taking place that morning in the auditorium of a nearby school. Attendance was compulsory. Shuttle buses would be provided.

Outside the venue there was a confusing crowd of people. Schoolchildren bobbed in and out of the crowd trying to grab freebies like baseball caps, and snacks. Irritated employees coagulated into groups and promptly began to bitch about the waste of time. A few business journalists waited for the meeting to start.

But the most voluble group was the same army that had invaded our office the day before. They thronged around a side door, presumably the stage entrance, and made a terrible racket. Some were clearly having arguments.

This was the first time I’d ever been to an AGM. I wasn’t prepared at all for the chaos taking place around me. It seemed ridiculous even by the company’s ancient, peon-employing, stationary-rationing, pay-grade-based-Diwali-gift-giving ways.

Shortly before the designated start-time a series of expensive cars rolled up to the stage entrance. And the top management climbed out. “Dad’s Army” pounced. There was a huge racket as they thronged around the approaching board of directors trying to shake hands and have a quick word. It was not all that different from the way professional wrestlers walk toward the ring through a forest of outstretched hands, distributing high-fives.

What was more remarkable was that the President and the CEO seemed to know several of these rabble-rousers by name.

“Hello, Mr Tripathi? Long time!”

“Mrs Maheshwari, how have you been?”

“We meet again Koshi saab!”

I followed the rest of the employees into the auditorium, still puzzled by all this.

Inside the auditorium two very old men, both well above 60, were tearing into each other. They briefly went silent as the board of directors took the stage, and then resumed immediately.

They argued like schoolchildren. Vigorously, but insubstantially.

“You keep quiet sir! What do you know?”

“I know more than you. You please don’t irritate me today.”

“This is a free country! I will irritate you again and again. What will you do?!”

The men sat right in the middle of the front row. The army all walked in and occupied the seats around them. Not one person tried to stop their bickering. On the stage the board of directors waited for the men to calm down. They didn’t.

Finally the president of the board of directors, let us call him Mr Kumar, walked up to the very edge of the stage, and tried to mediate for peace.

“Mr Joshi I am personally asking you to please calm down.”

“Kumar saab, this man has been continuously irritating me since I came for this meeting…”

The really funny thing was that I was the only person in the entire hall cringing. Nobody else seemed to even care. The employees were fidgety and kept looking at their watches. Most of the journalists fiddled with their mobile phones.

“Who are these irritating people?” I whispered to a colleague. He chuckled into his palm and replied: “Shareholders.”

After a few minutes the old men declared a truce. Everyone settled down. The company secretary walked up to the microphone.

And then the meeting proceeded to descend into complete farce.



Deepak Shenoy, a well-known markets analyst and columnist, says that the father of the old-fashioned annual general meeting in India was Dhirubhai Ambani. Ambani was the first person to convert what was just a statutory requirement for listed companies, into an annual carnival for shareholders.

In the late 1970s and early 1980s Ambani elevated Reliance Industries’ AGMs into works of art. A unique form of capitalist theatre in a country that resisted all forms of free market exuberance.

First of all the events were often held in stadiums. Over 50 000 investors bought Reliance’s shares during its initial public offering, India’s first popular listing. Many of them turned up for AGMs. Shenoy says that meetings were held like family functions, inaugurated with ceremonial lamps being lit and prayer sessions. Proxy forms, that allowed shareholders to appoint substitutes to represent them, were in high demand and often sold for large sums of money.

This was not just because they got a chance to see Ambani, perhaps the most famous businessman in India at the time. The forms also had monetary value. Attendees got free gifts including discount coupons from Vimal, Reliance’s textiles retailing arm. All a member of the public had to show to attend these events was a proxy form or proof of ownership of a single share. “A shareholder’s proxy form to attend a Reliance AGM had a sizeable cash value,” says Shenoy, “and for many years there was a booming market for them.”

“Ambani basically created what is known as the equity cult in India,” says Govindraj Ethiraj, veteran business journalist and broadcaster. Before Ambani took Reliance public, Ethiraj explains, the idea of owning equity in
 a company was not very popular. The
 number of retail shareholders were
rare and mostly limited to the small, 
informed groups in the larger cities.

“Ambani changed all that,” recalls Ethiraj. Ambani gave the impression that he was sharing his immense wealth with the public. Thousands upon thousands of people, many of them Gujaratis, bought Reliance stock. And then they began to invest in other companies as well.

By the early 1990s, Ethiraj estimates, this equity cult had exploded to some 20 million people. Ambani was the catalyst for that explosion.

Ambani was a shrewd businessman. He was also a showman. Years before Steve Jobs perfected the art of the keynote, Ambani used his AGMs to enthral the shareholders and the press. But it was not that Ambani was a natural communicator. Ethiraj, in fact, remembers him being less than eloquent. He wasn’t particularly fluent in English. And often spoke in a mishmash of English and Hindi with smatterings of Gujarati. But he knew how to connect with his audience. Perhaps, Ethiraj says, because his delivery seemed so home grown.

There are very few online videos of Dhirubhai Ambani speaking. The rare clip of his talking to investors bristles with energy. As he speaks, Ambani thrusts his hands into the air in front of him. Suddenly he whips his spectacles off. And when he breaks into laughter he does so sincerely, deeply, with a full mouth of teeth.

Ambani made it a point to announce one new initiative at every AGM, a move, says Shenoy, that electrified shareholders in the audience. It is a strategy that Dhirubhai Ambani’s son Mukesh Ambani continues to use to this day. Though Mukesh has inherited little of his father’s aura.

Ambani senior’s theatricality slowly began to spread to other firms. While few others could fill stadiums, they did incentivise shareholders with freebies and coupons. Many meetings began to deal less and less with business and more and more with drama and reward.

It may seem like a waste of time for both parties. But Shenoy says there is a certain logic here. Many of these people who attend AGMs have owned shares for many years. But they seldom own enough to make any serious money. And because they are so small they have no say in the way the company operates. The AGM, he says, is their one chance in the whole year to mooch something off the company.

Back in the school auditorium nobody paid much attention as an assortment of executives read out passages from the annual report. A few business journalists took down notes.

And then at some point the company secretary invited questions from the audience.

There was a mad scramble to raise hands and reach for the mics that were circulating in the first few rows. These were the “mooch seats”. The army of shareholders, most of them pensioners and old housewives who came for the freebies – caps, stationary, discount vouchers – and their moments of glory.

The first question was not a question at all. But verse. A woman read out Urdu couplets that compared the President’s handsome face to the sun, the moon and the stars. There was a smattering of applause. And then another man got up: “Sir, I would also like to share some poetry…” His words were drowned in some hearty geriatric booing.

He got very upset: “Sir! Look sir. They do this every time. When Ms Maheshwari wants to recite poetry nobody complains. But when I want to recite…”

“Boo!”

Once again the President intervened. “How can I not listen to your poetry,” he consoled the poet. “You have been coming to our meetings for so many years. You are like family to me. I request the others to let him speak.”

So they did.

Next another woman got up. “Why has the company stopped the practice of taking shareholders on tours of company premises? Back in the day, when the President’s father used to be in charge, they used to conduct factory tours very frequently.”

The President had a quiver full of apologies. Did the woman have any particular plant in mind?

Of course. The factory in Goa. There was much applause. The company secretary was instructed to organise a trip as soon as possible. The mood in the mooch seats brightened considerably.

Finally there was the first question about business. Why did the company acquire a foreign plant instead of distributing the cash as dividend? This time one of the senior managers answered the question with dubious urgency and accuracy.

A colleague leaned over: “Planted question.”

And thus the next 15 minutes passed. Poetry interspersed with shameless praise of the board of directors sandwiched between planted questions. Until one terribly grumpy looking man stood up and asked why the AGM was scheduled the same day as HDFC Bank’s AGM.

“I am a shareholder in both companies. How can I attend both? You must understand…”

This finally managed to upset the President. “Conflicts are inevitable,” he said. “And if there is an overlap shareholders must pick whichever one they like.” The grumpy old man stood up, picked up a weathered old leather bag and left the auditorium.

The meeting concluded and we broke for snack boxes and tea in plastic cups.

The whole meeting was a bizarre, pointless exhibition of spoken word, poetry reading, conflict resolution, theatre and mooching.

Later some co-workers told me why so many people turned up at our office the day before: amateur blackmail. Many offered not to ask inconvenient questions, or ask convenient ones, in exchange for some petty cash or freebies.

It was a complete violation of the purpose of AGMs. But like Shenoy said, small investors rarely get another chance to capitalise on their loyalty.

Mani Ratnam’s Guru is a thinly veiled biography of Dhirubhai Ambani. Like Ambani, Ratnam’s hero, Gurukant Desai, also starts from poverty and manipulates, grafts, and in many cases intimidates his way into running one of the biggest companies in the country. The AGM is such an integral part of the Ambani legend, that Ratnam features it prominently in his movie. Choosing, even, to finish the film with a shot of a stadium full of shareholders.

Today, says Deepak Shenoy, the Ambani-style AGM is slowly petering out. A small group of front-benchers continue to wreak havoc during AGM season all over Mumbai but in most cases AGMs no longer matter. Institutional investors just pick up the phone and call up top management. Analysts get special sessions to discuss numbers. And media appearances and interviews are organised by PR companies.

“If you include TV channels, newspaper and websites there are some 31 or 32 media brands today handling business news in India,” says Govindraj Ethiraj. “This is probably one of the highest in the world.”

Saturated with so much information, many shareholders already know everything they need to.

For connoisseurs of Indian theatre, AGMs still offer good value. One share each in a handful of companies seems like a sound investment. In return you are guaranteed exclusive annual access to an artform in its twilight years. And snack boxes.

More freeloaders than free market. How Britain bails out the business chiefs

 

‘In an age of untrammelled greed, company executives are rewarded for cannibalising their businesses and bilking their staff.’ Illustration by Andrzej Krauze

 Aditya Chakrabortty in The Guardian


On Wednesday, two very different men will have to explain themselves. Both appear in London, to a room full of authority figures – but their finances and their status place them at opposite ends of our power structure. Yet put them together and a picture emerges of the skewedness of today’s Britain.

For the Rev Paul Nicolson, the venue will be a magistrate’s court in London. His “crime” is refusing to pay his council tax, in protest against David Cameron’s effective scrapping of council tax benefit, part of his swingeing cuts to social security. In order to pay for a financial crisis they didn’t cause, millions of families already on low incomes are sinking deeper into poverty. In order to pay bills they can’t afford, neighbours of the retired vicar are going without food. The 84-year-old faces jail this week, for the sake of £2,831.

Meanwhile, a chauffeur will drive Philip Green to parliament, where he’ll be quizzed by MPs over his part in the collapse of BHS. A business nearly as old as the Queen will die within a few weeks, leaving 11,000 workers out of a job and 22,000 members of its pension scheme facing a poorer retirement.

There the similarities peter out. Nicolson was summoned to court; Green wasn’t going to bother showing up at Westminster. When the multibillionaire was invited by Frank Field to make up BHS’s £600m pension black hole, he demanded the MP resign as chair of the work and pensions select committee.

But then, Green is used to cherry-picking which rules he plays by. Take this example: he buys Arcadia, the company that owns Topshop, then arranges for it to give his wife a dividend of £1.2bn. Since Tina Green is, conveniently, a resident of Monaco, the tax savings on that one payment alone are worth an estimated £300m. That would fund the building of 10 large secondary schools – or two-thirds of the annual cut to council tax benefits.

Just as Green underinvests in society, so he underinvests in his companies. The man to whom he sold BHS last year, Dominic Chappell, told MPs last week that “for the past 10 or 12 years there had been little or no inward investment in the stores”. A staple of the high street had been run down.

Then again, what incentive has he had to do otherwise? Green bought BHS with just £20m of family money and borrowed the rest. Within four years, he had pulled £400m of dividends out of the firm – 20 times his initial outlay.

He used the same tactic to buy Arcadia – stumping up £9.2m in equity and taking out £1.2bn three years later. This isn’t retailing as you might think of it, it’s balance-sheet shazam – the kind of financial engineering that posed as real business in Britain’s bubble years. And it’s enabled Green to turn major retailers into what Robert Peston, in Who Runs Britain?, calls “giant gushers of cash”.

But in today’s Britain, the poor are forced to pay the unaffordable, while the tax-avoider is honoured for his contribution to society. Green was knighted by Tony Blair, while David Cameron appointed him a government adviser.

Just as Green pretends to be a cheeky chappy even though he went to boarding school, so any charlatan in pinstripes can claim to be a businessperson – and be handsomely rewarded. The barons who run our rail services tout themselves as “investors”, but for every quid they put into their trains, they take out £2.47. That level of underinvestment ensures commuters are never sure of getting in on time and having a seat – but shareholders and managers can make a fortune.

From Margaret Thatcher through Tony Blair to David Cameron, successive prime ministers have preached the virtues of free enterprise. We’ve ended up with an economy comprised of what parliament’s public accounts committee calls “quasi-monopolies” – from water to banks to electricity to public outsourcing – and big businesses being treated as money-sponges to be wrung dry by their owners and managers.

In the 1970s, £10 of every £100 in corporate profits was paid to shareholders. Now between £60 and £70 of every £100 is handed out. Workers, companies and the economy are thus starved of investment and growth opportunities so that, as Andy Haldane at the Bank of England warns, firms are “eating themselves”.

In an age of untrammelled greed, company executives are rewarded for cannibalising their businesses and bilking their staff. The typical FTSE-100 boss is now on a total pay of around £5m, the High Pay Centre calculates, even while the average employee is still earning less in real terms than in 2008.

This is less about the free market than freeloading. The banks collapse and are bailed out. The Sports Direct billionaire Mike Ashley walks away from a collapsed business, giving hundreds of workers 15-minutes notice of redundancy – and handing taxpayers the £700,000 bill to clean up the mess. Tax-avoider Amazon receives tens of millions of public money to build warehouses, and even has a road in Swansea built for it. Richard Branson takes £28m to open a call centre in Wales.

The public pay for apprenticeships, so that companies get readymade workers. We shell out for upgrading the railways. Most of all, we top up poverty pay. Official figures show that 37% of working-age households in this country now take more from the public purse than they pay in. Not because they’re lazy or unemployed – employment has never been so high – but because their bosses can rely on the rest of us to pay their way.

Survival of the fittest? This is a deformed capitalism, barely worthy of the name – and it won’t improve by slinging a few rotten tomatoes in parliament. We need a working capitalism, where the public no longer give away their protections and subsidies for free – but instead make businesses take their responsibilities seriously.

If rail operators rely on taxpayer billions, they should train staff and pay them a living wage. Why shouldn’t big supermarkets that need public planning permission and licensing to trade be required to stock some locally sourced goods? And why shouldn’t local and central government, which allocate billions in procurement and tendering, foster a diversity of business models – from not-for-profit to mutually owned.

Some of you may think such measures impossible, others may see them as baby steps. They should be the first heaves on the pendulum, turning our economy away from the interests of the wealthy to the rest of us.

Last week Nicolson promised: “I shall start paying my tax again when they stop taxing benefits.” Good for him. The rest of us taxpayers should do the opposite: asking businesspeople what they’ll do to deserve our corporate welfare. That question should not just be put to Green and Ashley, but to those who run all our major corporations. Otherwise, we’re merely chasing out a few big names and hanging up a sign over Britain that reads: “Under new owners, business as usual.”

‘Quarterly capitalism’ is short-term, myopic, greedy and dysfunctional

Will Hutton in The Guardian


It has been obvious for years that British capitalism is profoundly dysfunctional. In 1970, £10 of every £100 of profit was distributed to shareholders: today, under intense pressure from short-term owners, companies pay out £70. Investment, innovation and productivity have slumped. Few new companies grow to any significant size before they are taken over.

Exports have stagnated. The current account deficit is at record proportions. The purpose of companies now is not to do great things, solve great problems or scale up great solutions –why capitalism is potentially the best economic system – it is to become payolas for their disengaged owners and pawns in the next big deal or takeover. Not only the British economy suffers – this process has become the major driver of rising inequality, low pay and insecurity in the workplace as management teams are forced to treat workers as costly commodities rather than allies in business building.
Regular readers of this column will be familiar with the refrain, and the stubborn resistance from the British mainstream. There is absolutely nothing wrong at all with the British private sector, runs the Conservative argument: to the extent the British economy does have problems they are rooted entirely in taxation, regulation, unions and government. But in a week when the Financial Times – a great British asset and embodiment of the best of our journalism – has been sold to Nikkei for no better reason than to support Pearson’s short-term share price, powerful and public criticism of the way British capitalism operates has come from an unexpected quarter.

Last year, the governor of the Bank of England, Mark Carney, called on firms to have a greater “sense of their responsibilities for the system”, in particular the social contract on which market capitalism’s long-term dynamism depends. On Friday’s Newsnight, the chief economist of the Bank of England, Andy Haldane, built on the governor’s concerns. He began with the seven-fold increase in the proportion of profit distributed to shareholders in dividends and bought-back shares over the last 45 years, which he said necessarily “leaves less for investment”. The explanation was simple: British (and indeed American) company law “puts the shareholder at front and centre. It puts the short-term interest of shareholders in a position of primacy when it comes to running the firm.” He thought company law that placed shareholders on a more equal footing with other stakeholders – workers, customers, clients – would work better. Dare I say it – stakeholder capitalism?

He damned the way the public limited company has developed. “The public limited company model has served the world well from a growth perspective. But you can always have too much of a good thing. The nature of shareholding today is fundamentally different than what it was a generation ago. The average share was held by the average shareholder, just after the war, for around six years. Today, that average share is held by the average shareholder for less than six months. Of course, many shareholders these days are holding shares for less than a second.”

In New York, at almost exactly the same time Newsnight was transmitting its interview with Andrew Haldane, Hillary Clinton was speaking from the same script, attacking what she called “quarterly capitalism”. “American business needs to break free from the tyranny of today’s earning report so they can do what they do best: innovate, invest and build tomorrow’s prosperity,” the Democratic presidential front runner declared. “It’s time to start measuring value in terms of years – or the next decade – not just next quarter.” She does not want to reinvent the public limited company, but she proposed the most far-reaching tax reforms of any Democrat presidential nominee to change the incentives for shareholders and executives alike. In American terms this is a revolution.

It is long overdue and the argument is beginning to get traction in the US. Free-market apologists insist that the more cash is handed back to shareholders, then the more they have to invest in innovation. The stock market is doing its job: promoting efficiency. The trouble is that everyone can see it’s 100% wrong. The market is hopelessly inefficient, greedy and myopic. When Larry Page and Sergey Brin floated Google, they took care to insulate the company from “quarterly capitalism”: they accorded their shares as Google’s founders 10 times the voting rights in order to protect their capacity to innovate from the stock market – what they considered Google’s real business purpose.

From robots to self-driving cars, from virtual reality glasses to investigating artificial intelligence, Google is now one of the most innovative firms on Earth. Meanwhile the typical US Plc, like its counterpart in Britain, is hunkering down, investing and innovating ever less and distributing more cash to shareholders for the reasons Haldane explains. Far from market efficiency, the whole system is undermining the legitimacy of capitalism.

But bit by bit influential voices such as Haldane’s are having the nerve to declare the Anglo-American system does not work. A rich collection of reflections and commentary edited by Diane Carney (Mark Carney’s wife) was published after London’s Inclusive Capitalism conference last month. Yet, except for former business secretary Vince Cable, no leading British politician has entered the lists. It will be intriguing how George Osborne reacts: one instinct will be to sack Carney and Haldane, as he has done Martin Wheatley, the head of the Financial Conduct Authority, for being too tough on the City. Another will be to co-opt the argument for the one nation Tory cause before the Labour party does.

He needn’t worry too much. One of the reasons that Tony Blair dropped his advocacy for stakeholder capitalism back in 1996 after the publication of The State We’re In was because too many leftwing Labour MPs took the Jeremy Corbyn line that the party’s mission was to socialise capitalism rather than reform it, while too many rightwing Labour MPs such as Peter Mandelson and Alistair Darling were terrified of upsetting business, as today, it seems, is Liz Kendall. He had zero internal political support, business was distrustful and the Tories were accusing him of returning to 1970s corporatism. Today the Bank of England and the likely next US president are supporters. Will one of the contenders for the Labour leadership have the courage to make the case? So far, they have all been mute. If Andy Haldane has done nothing else, he will have dramatised the poverty of today’s thinking about capitalism – in both main political parties.

Profit has never been a company’s only duty

Businesses must look after their shareholders - but they should also work in the public interest

It is not enough to be a good corporate citizen, for share ownership carries with it power and responsibility Photo: AFP/Getty Images

By Jesse Norman in The Telegraph

8:20PM BST 16 Jul 2013

The issue of taxation is never far from the headlines, and doubly so in times of austerity. So it’s hardly surprising that the likes of Google, Starbucks and Goldman Sachs have come under fire in recent years for under-payment of tax.

But how much tax should a company pay? At first glance, the answer is obvious: only as much as the law demands. The economist Andrew Lilico put the point well recently: “The assets of… a company do not belong, per se, to the company’s employees… it’s not for the managers or accountants of a company to decide that shareholders ought to pay some extra tax, not legally required of them, and then do so on their behalf.” Not only that, any claim to the contrary is an attack on private property itself: “It is, as it were, to say that all money belongs to society collectively, and 'we’ have an intention as to how much you get to use yourself and how much goes to the state, and if you avoid tax you end up using more of society’s collective money than it intended for you to use.”

This line of thought is extremely seductive, and very widely held. But it is mistaken, both in principle and in law.

First, the law. The Companies Act 2006 requires directors to promote the success of the company, but with regard to six factors: the likely long-term consequences of a decision; the interests of employees; relationships with suppliers and customers; the firm’s impact on the community and the environment; its reputation for high standards of business conduct; and the need to act fairly between shareholders. The effect is precisely to prevent managements from automatically pleading a duty simply to maximise shareholder value. While they don’t have a free hand, they do have a genuine choice as to how aggressively to avoid tax.

But the deeper point is this. Unlike small businesses, or the vast majority of the working population, larger companies (and especially multinationals) have enormous scope to avoid tax. In the absence of common, binding global standards, that scope has expanded alongside the complexity of tax law. 

For many of these firms, tax is effectively optional. In avoiding it, they are using their size to advantage themselves over purely domestic competitors – as anyone who has tried to compete with Amazon can testify. When decent people are outraged by companies that adopt labyrinthine legal structures to avoid tax —whose main effect is to enrich the lawyers and accountants —what angers them is a belief that this power, this choice, has been abused.

So, again, how much tax should these companies pay? Patently, the law cannot answer that question. But neither can economics. For economics sees companies merely as bundles of contracts, which allocate different financial incentives to shareholders, directors, managers and employees.

This can be a useful analytical tool, but it falls short of setting proper standards of behaviour. Indeed, it does the opposite: there is increasing evidence that people exposed to purely financial stimuli become more greedy, more short-term and more individualistic. Since really effective management is about inspiration and teamwork over the long term, monetary incentives often undermine, rather than reinforce, success.

In fact, all power – private and public – brings with it responsibility. In the words of the great American judge Benjamin Cardozo, “a trustee is held to something stricter than the morals of the marketplace. Not honesty alone, but the punctilio of an honour the most sensitive, is then the standard of behaviour.” So it is not enough just to be a “good corporate citizen”.

This insight demands a shift of perspective, from the language of law and economics to one of stewardship and ownership. It is a shift with profound consequences. Within companies, it implies a long-term focus resilient enough to resist market pressures just to meet quarterly earnings targets. It implies a sense of personal responsibility – indeed, contrition – from management that has been largely missing from recent arguments over tax, or the causes of the banking crisis. It also demands a degree of modesty in how directors and managers reward themselves. And it invites companies to reconsider the privilege of limited liability, and the connection – which existed from the earliest chartered companies on – between corporate activity and the public interest.

But the idea of stewardship does not end there. For share ownership also carries with it power, and so responsibility. A recent review by Professor John Kay has done much to advance such ownership; it could be greatly assisted by a vigorous collective response from fund managers. And Parliament has its own role to play in reinforcing these values. It must ensure a clear, stable yet flexible framework of law within which companies can operate; and it must ensure effective enforcement, and prosecution, when the law is broken.

What really matters, however, are shared public standards. Lew Preston, as head of JP Morgan, once circulated a memo to all staff: “It has come to my attention that some employees have been preferring the interests of their own departments to the interests of the bank as a whole. Henceforth this will be grounds for immediate dismissal.” That’s more like it.

Jesse Norman is MP for Hereford and South Herefordshire

We need a revolution in how our companies are owned and run

The second of this series on a new capitalism calls for a culture dedicated to long-term, ethical goals

• 
• • Will Hutton
  • The Observer, Sunday 30 September 2012

Rolls Royce: almost our last remaining great industrial company. Photograph: Simon Stuart-Miller/guardian.co.uk

Twenty years ago, Britain's greatest industrial companies were ICI and GEC. A third, Rolls-Royce, secured from hostile takeover by a government golden share, had a board that was boringly committed to research and development and to investing in its business. ICI and GEC, under colossal pressure from footloose shareholders to deliver high short-term profits, tried to wheel and deal their way to success. Neither now exists. Rolls Royce, free from concerns about hourly movements in its share price, has gone on to be almost our last remaining great industrial company.

Britain, as the Kay review on the equity markets reported, has far too few Rolls-Royces. Instead the report identified a lengthening list of companies – Marks and Spencer, Royal Bank of Scotland, BP, GlaxoSmithKline, Lloyds and now BAE – which have made grave strategic errors, taken ethical short cuts or launched ill-judged takeovers, hoping to benefit their uncommitted tourist shareholders. Their competitors in other countries, with different ownership structures and incentives, have survived and prospered.

It is an unreported crisis of ownership that goes to the heart of our current ills. Over the last decade, a fifth of quoted companies have evaporated from the London Stock Exchange, the largest cull in our history. Virtually no new risk capital is sought from the stock market or being offered across the spectrum of companies. A share is now held for an average of seven months. Britain has no indigenous quoted company in the fields of car, chemical or building materials. They are all owned overseas, with design and research and development travelling abroad as well.

The stock market has descended into a casino, served by a vast industry of intermediaries – agents, trustees, investment managers, registrars and advisers of all sorts – who have grown fat from opaque fees. It has become a transmission mechanism for highly short-term expectations of profit driven into the boardroom. Directors' pay has been linked to share price performance, offering them the prospect of stunning fortunes. As a result, R&D is consistently undervalued.

British companies are now hoarding some £800bn in cash, cash they would rather use buying back their own shares than committing to investment. We have allowed a madhouse to develop. An important reason why Britain is at the bottom of the league table for investment and innovation is the way our companies are owned or, rather, notowned.

It is a crisis of commitment. Too few shareholders are committed to the companies they allegedly "own". They consider their shares either casino chips to be traded in the immediate future or as no more than a contract offering the opportunity of dividends in certain industries and countries; this requires no engagement in how those profits and dividends are generated. British law and corporate governance rules demand the narrowest interpretation of investors' and directors' duties: to maximise short-term profits while having minimal associated responsibilities.

The company is conceived as nothing more than a network of short-term contracts. Any shareholder – from a transient day trader to a long-term investor – has the same standing in law. American directors' ability to defend their company from hostile takeover or German directors having to live – horrors – with trade union representatives on their supervisory boards are seen as obstacles to enterprise that Britain must not go near. But companies and wealth generation, as Professor Colin Mayer argues in his important forthcoming book Firm Commitment, are about co-creation, sharing risk and long-term trust relationships: Britain's refusal to embrace these core truths is toxic. Companies were originally invented as legal structures to enable groups of investors to come together, committing to share risk around a shared goal and so make profit for themselves, but delivering wider economic and social benefits in the process. Incorporation was understood to be associated with obligations: a company had to declare its purpose before earning a licence to trade. There existed a mutual deal between society and company.

No game-changing improvement in British investment and innovation is possible without a return to engagement, stewardship and commitment. Limited liability should not be a charter to do what you like. It must be conditional on a core business purpose, along with the creation of trustees to guard it. Directors' obligations should be legally redefined to deliver on this purpose. What's more, every shareholder should be required to vote, with voting strength, as Mayer argues, increasing for the number of years the share is held.

To solve the problem that individual shareholders – even savings institutions – do not have sufficient muscle nor sufficient incentive to engage with managements, voting rights could be aggregated and given to new mutuals. These would support directors in delivering their corporate purpose, a proposal made by the Ownership Commission I chaired. Companies would become trust companies, with a stewardship code. The priority in takeovers would be the best future for the business, not the ambition to please the last hedge fund to take a short-term position.

Stakeholders should also have a voice in how the company is run. In Germany, a company's bankers and its employee representatives have seats on the supervisory board. Why not copy success rather than continue with our failed system? The Kay review's proposals to stop quarterly profit reporting, while a useful first step, do not address the core of the problem. The company has become a dysfunctional organisational construct that needs root-and-branch reform.

As part of the reform, Britain also needs more co-operatives, more employee-owned companies and more family-owned firms. It needs to be more attentive to which foreign companies own our assets and for what purpose. It is an ownership revolution to match the revolution in finance proposed last week. Together with an innovation revolution – see next week – the British economy could at last begin to deliver its promise.

Auditors must be held to account

The shareholder spring is the perfect time to challenge the poor performance of unscrutinised accountancy firms

• 
• • Prem Sikka
  • guardian.co.uk, Thursday 31 May 2012 15.04 BST

'KPMG, PricewaterhouseCoopers, Deloitte and Ernst & Young, collectively known as the Big Four accountancy firms, audit around 99% of FTSE 100 companies.' Photograph: Action Press / Rex Features

Shareholder spring is in the air, with increasing numbers voting against fat-cat executive rewards for failure and mediocre performance. However, the same scrutiny is not being applied to the business advisers and consultants implicated in headline failures. They continue to receive huge financial rewards. Company auditors are good example.

PricewaterhouseCoopers (PwC), Deloitte, KPMG and Ernst & Young, collectively known as the Big Four accountancy firms, audit around 99% of FTSE 100 companies. These firms audited all distressed banks. At the height of the banking crisis they gave the customary clean bill of health to Northern Rock, Abbey National, Alliance and Leicester, Bradford & Bingley, HBOS, Lloyds TSB and Royal Bank of Scotland (RBS). Bear Stearns and Lehman Brothers went bust shortly after receiving the all-clear. A subsequent inquiry by the House of Lords economic affairs committee accused auditors of "dereliction of duty" (para 161) and "complacency" (para 167) and basking in a culture of "box ticking" (para 6) rather than delivering meaningful audits. Despite the damning criticisms, some partners in audit firms still charge over £700 an hour for their services.

In 2011, Barclays, the bank that forced the government to introduce retrospective legislation to combat its tax avoidance schemes, paid £54m to its auditors PricewaterhouseCoopers, including £15m for consultancy and advice on tax matters. PricewaterhouseCoopers, which once audited Northern Rock, collected another £48m from Lloyds Banking Group , including £10m for consultancy. HSBC has paid a whopping £56m, including about £8m for tax and consultancy services to its auditors KPMG, the firm that audited HBOS and Bradford & Bingley. RBS has paid £41m, including £7.4m for consultancy to Deloitte, the firm that audited Abbey National, Alliance & Leicester and Bear Stearns. Ernst & Young, the firm that audited Lehman Brothers, earned £36m in audit and consultancy fees from BP and another £28.5m from Aviva. At major companies, the fees paid to accountancy firms are larger than CEO salaries, but rarely attract sustained media attention. The auditor dependency on companies for vast fees neuters any impulse to deliver an independent opinion on company accounts. No one at any accountancy firm is ever promoted for blowing the whistle on dubious practices of companies and losing a client.

At company AGMs auditors are appointed often without any discussion. The resolutions on auditor appointment are not accompanied by any information on the composition of the audit teams; time spent on the job, audit and consultancy contracts, information obtained from directors, list of faults found with company accounts, regulatory action against auditors or anything else that might shed light on the quality of audit work or conflict of interests. With weak accountability measures, auditors deliver little of any social value.

The charges of "dereliction of duty" and "complacency" have not led to any worthwhile UK reforms though there is plenty of spin about encouraging auditors to be sceptical and tweaking auditing standards. There is no scrutiny of the basic auditing model which requires entrepreneurial accountancy firms to somehow invigilate giant corporations. The success of auditors is measured by private profits and they have no obligations to the state, or the public, which eventually bears the cost of bailouts and fraud. This mutual back-scratching has been a key factor in the debacles at Enron, WorldCom, Lehman Brothers and the banking crash. Yet no real change is in sight.

The EU is proposing minimalist reforms to check the collusive relationship between auditors and companies. These include a ban on the sale of lucrative consultancy services to audit clients and forcing companies to regularly change their auditors. At present, FTSE 100 companies change auditors every 48 years on average. Inevitably, major firms are using their financial and political resources to oppose even these modest proposals.

Major accountancy firms have got used to collecting mega fees for failure and mediocre performance. Shareholders should check that by turning the spotlight on them and demand refunds for poor performance. The government should sharpen liability laws so that auditors are forced to make good the damage done by their silence.

It's time to start talking to the City

A radical reform of the financial sector can only be achieved if we know what kind of capitalism we want

• Ha-Joon Chang
• guardian.co.uk, Monday 20 February 2012

Last week I delivered a lecture on my latest book to about 150 people from the financial industry at the London Stock Exchange. The event was not organised or endorsed by the LSE itself, but the venue was quite poignant for me, given that a few months ago I did the same thing on the other side of the barricade, so to speak, at the Occupy London Stock Exchange movement.

At the exchange I made two proposals I knew may not be popular with the audience. My first was that we need to completely change the way we run our corporations, especially in the UK and the US. I started from the observation that financial deregulation since the 1980s has greatly increased the power of shareholders by expanding the options open to them, both geographically and in terms of product choice. Such deregulation was particularly advanced in Britain and America, making them the homes of "shareholder capitalism".

With greater abilities to move around, shareholders have begun to adopt increasingly short time horizons. As Prem Sikka wrote in the Guardian in December 2011, the average shareholding period in UK firms fell from about five years in the mid-1960s to 7.5 months in 2007. The figure for UK banks had fallen to three months by 2008 (although it is up to about two years now).
In order to satisfy impatient shareholders, managers have maximised short-term profits by squeezing other "stakeholders", such as workers and suppliers, and by minimising investments, whose costs are immediate but whose returns are remote. Such strategy does long-term damages by demoralising workers, lowering supplier qualities, and making equipment outmoded. But the managers do not care because their pay is linked to short-term equity prices, whose maximisation is what short term-oriented shareholders want.

That is not all. An increasing proportion of profits are distributed to shareholders through dividends and share buybacks (firms buying their own shares to prop up their prices). According to William Lazonick – a leading authority on this issue – between 2001 and 2010, top UK firms (86 companies that are included in the S&P Europe 350 index) distributed 88% of their profits to shareholders in dividends (62%) and share buybacks (26%).

During the same period, top US companies (459 of those in the S&P 500) paid out an even greater proportion to shareholders: 94% (40% in dividends and 54% in buybacks). The figure used to be just over 50% in the early 80s (about 50% in dividends and less than 5% in buybacks).

The resulting depletion in retained profit, traditionally the biggest source of corporate investments, has dramatically undermined these corporations' abilities to invest, further weakening their long-term competitiveness. Therefore, I concluded, unless we significantly restrict the freedom of movement for shareholders, through financial reregulation, and reward managers according to more long term-oriented performance measures than share prices, companies will continue to be managed in a way that undermines their own viability and weakens the national economy in the long run.

My second proposal was that, in order to improve the stability of our financial system, we need to radically simplify it. I argued that financial deregulation in the last 30 years led to the proliferation of complex financial derivatives. This has created a financial system whose complexity has far outstripped our ability to control it, as dramatically demonstrated by the 2008 financial crisis.
Drawing on the works of Herbert Simon, the 1978 Nobel economics laureate and a founding father of the study of artificial intelligence, I pointed out that often the crucial constraint on good decision-making is not the lack of information but our limited mental capability, or what Simon called "bounded rationality". Given our bounded rationality, I asserted, the only way to increase the stability of our financial system is to make it simpler. And the most important action to take is to restrict, or even ban, complex and risky financial instruments through the financial world equivalent of the drugs approval procedure.

The reactions of my audience were rather surprising. Not only did nobody challenge my proposals, but many agreed with me. Yes, they said, "quarterly capitalism" has been destructive. True, they related, we've seen too many derivative products that few people understood. And, yes, many of those products have been socially harmful.

It seems that, as it is wrong to label the Occupy movement as anti-capitalist, it is misleading to characterise the financial industry as being in denial about the need for reform. I am not naive enough to think that the people who came to my lecture are typical of the financial industry. However, a surprisingly large number of them acknowledged the problems of short-termism and excessive complexity that their industry has generated to the detriment of the rest of the economy – and ultimately to its own detriment, as the financial industry cannot thrive alone.

The rest of us need to have a closer dialogue with reform-minded people in the financial industry. They are the ones who can generate greater political acceptance of reforms among their colleagues and who can also help us devise technically competent reform proposals. After all, without a degree of "changes from within", no reform can be truly durable.