[A-List] Enron: regulatory crisis
Michael.Keaney at mbs.fi
Tue Feb 5 05:09:24 MST 2002
John Kay writes a column for the Financial Times that usually consists
of some homespun cheerful ruminations on the essential goodness of our
economic system. Usually a couple of paragraphs is all my weak stomach
can take. The near collapse of Marconi (formerly GEC), however, has
prompted Kay into some fairly robust advocacy. For those not in the
know, Marconi was once a highly regarded industrial conglomerate with
interests spanning arms, telecoms and consumer durables. When Arnold
Weinstock retired a new team took over that decided to follow the
"shareholder value" route by specialising in one area of business and
thereby ride the telecoms boom. Of course it did this just as it was
going bust, hence Marconi's fall from grace. After having been removed
six months ago, former finance director John Mayo was given three days
coverage in the FT to give his side of the story. It was a remarkable
piece of special pleading showing how earnest he was in striving for
"shareholder value", and how the others were simply not as committed as
he was to that principal end. Kay, however, having built his reputation
on consultancy and books such as "Foundations of Corporate Success"
(OUP, 1994 or thereabouts) thinks differently, and provides a useful
perspective on the fundamental contradictions of the joint stock company
and its social costs -- although it has to be said that Thorstein Veblen
was highlighting the contradictions between "business" and "industry"
around a century ago. Enron is mentioned as an equivalent case, and
Kay's argument brings to mind Warren Buffett's dictum about investing in
companies only if you know exactly what business they are in. It's a
fair bet that Kay and his arguments will be shaping whatever agenda we
can expect to unfold from the Financial Services Authority and its
regulatory regime -- something that The Economist, in its Christmas
issue, pointed to as a growing threat to corporate autonomy. All of
which suggests a fundamental crisis of legitimacy unfolding before our
A vital item is missing
When managers lose sight of the basic function of their business,
trouble lies ahead, says John Kay
Financial Times, Jan 29 2002,
Successful businesses are more effective than their competitors in
delivering goods and services that their customers want. They add value
if their superior delivery enables them to command a premium price or if
they design their operations in such a way that they meet these needs at
The job of the corporate executive is to achieve these objectives.
These points seem so basic to any understanding of business that one
feels embarrassed about writing them down. If they are worth repeating,
it is as a reminder to those who have been reading John Mayo's account
of his stewardship of Marconi in recent issues of the Financial Times.
As I see it, Mr Mayo has a quite different perception of his role, in
which the director of a company is a meta-fund manager, managing a
portfolio of businesses for his shareholders. His function differs from
that of an investment trust manager only in that the investment trust
manager buys and sells stakes in companies while the company manager
buys and sells the companies themselves. And - as with an investment
trust manager - the executive's job is to buy cheap and sell dear. It is
on his success in doing so that he believes he should be judged.
Since the costs of buying and selling companies are much higher than the
costs of buying and selling shares in companies, great skill and fine
judgment are required to make money in this way. Unfortunately for
Marconi's shareholders, Mr Mayo and his colleagues lacked those
qualities. They bought telecommunications companies at very high prices
and they and their successors will have to sell them at lower ones. But
the problem is not just that they did the job badly. It is the wrong
It has been said that the only reference to teaching in C.P. Snow's
extended series of novels about the University of Cambridge is when one
of the dons agrees to postpone a tutorial to enable him to devote more
time to politicking. And Mr Mayo's attitude to the operational
activities of the company of which he was a director is similar. There
are few references to products, customers or employees. Or even to
profits, except in the context of managing stock market expectations.
Now, in Mr Mayo's defence it must be acknowledged that he was the
company's finance director: the bursar of the college rather than one of
its tutors. But this is a weak defence. Even the most foolish bursar
knows that finance is a function that makes the activities of the
university possible, rather than the object of the university itself.
But Mr Mayo and those who think like him believe business is different.
The portfolio shift he masterminded was the company's central strategy.
And Mr Mayo asserts that the measure of performance - the company's
performance, not just the finance director's - should be the total
shareholder return. He devotes a lot of space to an elaborate
calculation of that measure.
The paradox to which this gives rise is found in Mr Mayo's description
of his principal disagreement with his boardroom colleagues. In February
2000, he explains, it was obvious to him, as it was to others, that
telecoms stocks were absurdly overvalued. At that point, he concluded,
the right thing to do was to sell the company. His logic was impeccable.
But the conclusion to which it led was so absurd that he could not bring
his fellow directors to agree with it.
Even more absurd is the lesson he draws: that you should never buy a
business without an agreed exit strategy. Sensible advice to a fund
manager. Ludicrous advice to a businessman, dependent on the loyalty of
customers and staff.
If Mr Mayo had been a fund manager, rather than the finance director,
his recommendation to sell Marconi shares would have been appropriate
and well timed. But a company director is not a fund manager. His job is
to run a business that adds value by means of the services it provides
to customers. If he succeeds, it will generate returns to investors in
the long term. And this is the only mechanism that can generate returns
The problem is that the equivalence between value added in operations
and stock market returns holds in the long run but not the short. Share
prices may, for a time, become divorced from the fundamental value of a
business. This has been true of most share prices in recent years and
was true of Marconi's share price during Mr Mayo's tenure.
In these conditions, attention to total shareholder returns distracts
executives from their real function of managing businesses. And their
reactions in fact reduce the ability of the corporate sector as a whole
even to generate total shareholder returns on a sustainable basis. This
the price we pay for the hyperactive capital markets of recent years.
What a fund manager needs most is a bull market - and the meta-fund
managers, such as Mr Mayo, did well in the great bull market of
1982-2000. Marconi, Enron and Swissair will not be the only businesses
run in these ways that will come to grief as the rising tide that once
raised all boats gradually ebbs. Perhaps we shall move into an age in
which senior executives again understand that managing companies is not
about mergers, acquisitions and disposals but about running operating
businesses well; and that corporate strategy is about matching the
capabilities of the business to the needs of its customers.
Full article at:
Mercuria Business School
michael.keaney at mbs.fi
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