03 November 2014
There is excessive focus on shareholder value, says Anthony Hilton
A few years ago the fund manager turned academic Raj Thamotheram published an article explaining how BP’s Gulf of Mexico accident was a preventable disaster. He said that the warning signs were there in advance because the business had a culture where these things were liable to happen.
Re-reading the article in light of the current debacle at Tesco, which culminated in the announcement that profits had been overstated by £250 million, one is struck by the similarities. At Tesco, like at BP, it appears to have been as much a cultural as a financial problem.
His analysis isolates six separate drivers which lead to this kind of crisis, the first of which is regulatory capture. This hinges on the fact that the company is a powerful and successful player, often a major source of political donations and one where the leaders are seen regularly at Downing Street or chairing government task forces. In such circumstances lowly paid regulators rarely challenge the business on small things so companies are under little pressure to conform. This has the effect that when something is big enough to be challenged then it is really serious – but before that, there is complacency all round. Thus, Tesco’s chairman is a former chairman of the Inland Revenue and more of its subsidiaries are located in tax havens than any other British supermarket.
Next comes what Thamotheram calls organisational learning disabilities which comes in two forms. First, the people at the top in BP’s case refused to acknowledge that the company was taking too many risks – as did the investors. The real issue however is the tone from the top and the way it puts pressure to perform on middle management. If juniors are told that they must hit the numbers no matter what then they will do so – and that is how you get phone hacking, manipulation of the Libor rate, PPI mis-selling and over-inflation of profits.
The next category, leadership and governance failings, has been well documented over the years – in BP’s case, originally by Lord John Browne, at RBS Fred Goodwin and at Tesco Sir Terry Leahy. The problem stems from an over-successful CEO, rather than an over-dominant one. It is not that these people bully the board; it is that the more successful they are, the more the board believes they will continue to be successful. Gradually they do not get challenged enough or get too easily brushed aside and that is when you get over-stretching, for example, the ABN Amro acquisition for Goodwin and the Fresh & Easy American adventure in Tesco’s case. This can merge into an arrogance which breeds a casual attitude to risk and this makes the business vulnerable to low probability but high impact events – like the Deepwater Horizon oil spill or the horsemeat scandal.
Another warning sign is a company that does not care what people say about it or dismisses criticism as being the price that has to be paid for the good things it does. For example, Tesco delivered low prices to consumers, so dismissed complaints about how it treated farmers. People flocked to its newly opened stores which it used to justify ignoring a minority of local objectors who did not want a supermarket. It failed to acknowledge the huge build up of resentment and its bad reputation in these circles – although ultimately it means the business is unsustainable.
Finally, and in many ways most importantly, there is an excessive focus on shareholder value. Investors should be alert to these non-financial danger signs but they are often seduced by the steadily rising profits. Far from issuing warnings that the focus on short-term performance was storing up long-term problems, shareholders egg the company on – or at least hint that they are not too worried provided the dividends keep growing. They then have the temerity to complain when the business blows up – and the company tells its customers that it is not their fault because no one could possibly have seen it coming.