The Corporation in the 21st Century- John Kay

PART 1: The Background

1: Love the Product, Hate the Producer

“Some of these billionaire executives are no superstars: individuals such as Philip Green, who extracted nine-figure sums from retailer BHS before selling the company to multiple bankrupt Dominic Chappell for £1, Mike Ashley, the domineering boss of the retailer Sports Direct, and Eddie Lampert, who inflicted similar destruction on Sears, for a century America’s leading store chain. The lifestyle of these executives contrasts with the fate of their businesses. The 90-metre yachts of Green and Lampert make good newspaper pictures. Green’s is moored in the harbour of the tax haven of Monaco, where he is resident, while Lampert’s is named Fountainhead, after Ayn Rand’s turgid paean to individualism.

A new management team and its advisers devised an all too common 1990s business strategy: to sell off boring bits to fund exciting acquisitions. But, like other companies, ICI found it easier to overpay for new businesses than to make rewarding disposals of old ones. Burdened with debt and finding growth elusive, the stock price was only a fraction of what it had been a decade earlier. What remained of Britain’s leading industrial company of the twentieth century was acquired in 2007 by the Dutch company AkzoNobel. Blair resigned the premiership in the same year.

23: The Finance Curse

“But between 1981, when Welch took control at GE, and 2005, when Lampert took control of Sears, a new approach to business developed. Managers like Sir Denys Henderson and Simon Marks, Alfred Sloan and Owen Young, had seen themselves as public figures with associated responsibilities to a wide range of constituencies. The generation that succeeded them had a narrower conception of their role. A successor generation of corporate executives paid close attention to quarterly reporting and the stock price.

If you had invested in these household names in the 1990s era of shareholder value, you would have lost all your money in GEC and Sears and most of it in the others. Your least bad bet would have been on ICI, whose shares were acquired in 2007 for about one-third of their price a decade earlier. Both GE and Marks and Spencer subsequently lost more than 80 per cent of their peak value. Almost all financial advisers would have agreed in 1995 that a portfolio that consisted of these stocks was a safe and conservative, if unexciting, choice. And that advice would have been spectacularly wrong.

In every case, the activities that analysts and investment bankers applauded diverted attention from the central issues facing the operating businesses, and this diversion was the source of the long-term decline of the corporation. All of these companies cut costs and raised prices in ways that reduced the long-term attractiveness of the business, as exemplified by Marks & Spencer. They engaged in earnings management, effectively borrowing money from the future to enhance reported profits now. As in GE’s financial services businesses. They adopted accounting practices that accelerated the recognition of profits that might be earned in the future but often were not. As at Enron. They were enthusiastic dealmakers, engaging in activities that excited the investment community but which rarely created value and frequently destroyed it. As exemplified by GE. In each case, the short-term boost to the share price was followed by a lengthy – or, in the case of GEC, abrupt – decline. The leaks from the pipes became a flood. Some companies were able to resist the demands of share-holder value. Notable among these stand-outs were some of the leading producers of fast-moving consumer goods (FMCG): corporations such as Proctor and Gamble, Colgate–Palmolive, Coca-Cola, Unilever and Nestlé. The culture of these businesses was and still is dominated by marketing people, for whom responsiveness to the needs of customers is a preoccupation. And that responsiveness is the key to the durability of these companies.

Dismantling the leveraged buyout industry would get rid of an overhanging threat across the entire managerial class; it would open up a huge space for different models of corporate governance.

But how would you go about doing that? If someone thinks that they could run a company better than the existing management, they’re allowed to spend their money buying it; preventing that from happening would involve a great disruption to the system. You can’t stop the management of a company from taking on debt, either. A lot of the time, taking on debt — even risking bankruptcy — is the correct and necessary thing for a company to do. As soon as you start trying to design regulatory regimes to prevent ‘excessive’ corporate borrowing, or distinguishing between companies on the basis of their owners, you quickly start to realise that this is a case where the law of requisite variety is telling you the project is doomed* —the variety of financial situations that a company can be in is much greater than anything that could be written into a rule.

*Buried here, in this footnote towards the end of the book, is probably the most useful and valuable piece of advice in all its pages: checking whether Ashby’s law of requisite variety has been respected is a great way of spotting a doomed project. It will even tell you if the project is going to fail because of insufficient resources or fail because it’s an impossible thing to achieve.