Saturday, 21 November 2009
The neo-liberal proponents of unregulated free-market economics would doubtless argue that corporate mergers and acquisitions are all just a part of life under globalisation, that the benefits of such takeovers outweigh the disadvantages, and that the ownership of any one individual company does not really matter in the grand scheme of things. However, the current Director-General of the Confederation of British Industry (CBI), Richard Lambert, clearly thinks it does matter. So much so that he wants to see restrictions in the voting rights of shareholders who have owned their shares for less than six months. This restriction appears to be targeted at hedge funds which, it is claimed, have now acquired over 12% of Cadbury shares, presumably on the basis that they expect the share offer by Kraft to be increased. However, hedge funds are only doing what most market investors and speculators have done countless times before over the years. I know because I was one of them.
Back in 1992 I bought shares in Midland Bank when it was being lined up as a takeover target by HSBC. At the time the market speculation was that a counter bid would be made by Lloyds and so the share price could only go higher. It did. So you can hardly blame hedge funds or speculators for trying to cash in on what looked like a one way bet.
The problem here is not the speculation. Even if the rules on share ownership were changed to limit voting rights for short-term traders, speculators and hedge funds would still bet on the likely outcome of any takeover battle. The real problem is actually the whole issue of corporate takeovers, and in particular the destructive impact that the threat of a hostile takeover can have on the long term stability of a publicly quoted company. Unfortunately this is a problem that corporate leaders like Richard Lambert either tiptoe around, or completely fail to address; yet it is one of the most economically damaging issues facing this country, and is fundamental to addressing the numerous shortcomings of current corporate governance.
My principal objection to corporate takeovers is not that they play into the hands of speculators; it is that they are fundamentally anticompetitive and therefore, rather than being the natural bedfellows of neo-liberal economic thinking, actually distort the free markets that neo-liberals are forever proselytising. The reasoning behind this view is fairly easy to outline.
If a company takes over one of its competitors, it effectively increases its market share without having to work for it through comparative advantage. This process therefore represents an easy and lazy way for a company to appear to be increasing its profits without having to grow endogenously. Consequently, it does nothing to increase market competition and will actually act against the interests of the consumer by reducing choice and increasing prices. In fact from the perspective of the consumer, the merger process is no different in its outcome from that of a price-fixing cartel. Yet as both British Airways and the UK construction industry have recently found to their cost, such price-fixing cartels are illegal. Takeovers, on the other hand, are not. Nor do mergers and acquisitions do anything to significantly increase the GDP of the country. These, though, are not the only problems with mergers and acquisitions.
One of the most insidious consequences of the current takeover rules is the effect that the threat of takeover has on the long term stability of a particular company and its ability to plan investment in the medium or long term. In order to fend off potential predators, vulnerable companies are scared into maximising their share price on a day-by-day basis by paying ever higher dividends at the expense of future investment. So instead of investing in future research and development, money is haemorrhaged from the company to placate short-term investors. Nowhere is this more apparent than in the UK which, with its liberal takeover rules, also has one of the worst records for investment in industrial R&D of all the major economies.
Moreover, there is also a growing trend for companies that merged in the past to de-merge at a later date. As a case in point you need look no further than the company at the centre of this recent takeover controversy: Cadbury. Last year Cadbury was de-merged from Cadbury Schweppes after the two entities had enjoyed nearly forty years together, and acquired numerous other acquisitions over that period. Yet other mergers are less long-lasting. The acquisition of Imperial Tobacco by Hanson lasted barely ten years, for example.
The suspicion therefore remains that this seemingly never-ending cycle of corporate merging and de-merging may often be about as economically productive as a dog chasing its own tail. This poses some obvious questions in regard to the real shareholder benefits that can accrue from them in the longer term. If both companies in a merger and de-merger eventually end up back more or less where they were originally, who really benefits from the entire process, other than a few management consultants, merchant bankers and corporate lawyers who are generally at the heart of the whole process, and often responsible for driving much of it?
Then there is the other big driver of takeovers - debt. This is best exemplified by the tactic of the leveraged buyout (LBO) that is often associated with the takeovers made by private equity funds. In this respect the proposed takeover of Cadbury by Kraft is another prime example of how the creation of debt can be used to acquire a target company. Yet, with a debt-to-pretax profit ratio of 3.6, Kraft is already heavily leveraged. This highlights some of the inherent dangers that can arise from LBOs, and you only have to look back at some of the biggest LBOs of the 1980s to realise the scale of the problems that can arise. Given what has happened more recently, however, how can it be considered beneficial for the economy as a whole for both it and its largest companies to be saddled with unnecessary debt? After all, haven't we just seen the consequence of such practices? Nor does this growth in debt help the wider society as the interest on it is usually offset against any profits, thereby reducing the company's tax burden and thereby the government's income.
The final criticism that can be levelled at takeovers is that they are bad for free enterprise. In extremis, they result in the formation of oligopolies and quasi-monopolies. In crude terms, they are nothing more than a form of corporate cannibalism. The proponents of takeovers claim that hostile takeovers, or the threat of them, are a way of keeping management on their toes and ultimately removing poorly performing executives. But isn't that what shareholders are supposed to do? If it requires the executives of one company to purge those of another, then that merely proves that shareholders cannot ultimately hold the executives of either company to account. Executives are in effect beyond the reach of those they claim to be beholden to. That is not just an argument in favour of reforming takeover rules, but also one in favour of reforming the entire basis of corporate governance.
So, given the numerous negative impacts of takeovers on the wider economy, perhaps the question the likes of Richard Lambert should be asking is; how should we reform the rules that govern takeovers?
The first step should be to outlaw hostile takeovers, once and for all. That would then allow companies the relative luxury of being able to plan their future investment without forever looking over their shoulder to see which corporate predator was preparing to strike. It would also attract companies to the London Stock Exchange (LSE) as the LSE would then be perceived as a safe haven from corporate attack. If we are to champion greater competition and stability in our economy, however, I believe we need to go further.
As well as outlawing hostile takeovers, we should also be looking to reduce the burden of debt on public companies. That means vetoing all takeovers where a significant proportion of the finance for the takeover is provided by the creation of additional debt.
The low visibility of the Competition Commission (CC) in the area of corporate regulation in the UK is a testament to its current weakness, and an over-compensation within government towards light touch regulation. We should be setting more stringent limits on the definition of quasi-monopolies that not only outlaw hostile takeovers, but also prevent any agreed takeover between companies if the market share of either company, or the combined company, in any sector of its business, exceeds a predefined limit. For the sake of argument, I would set that limit at 10%. This is in contrast to the current regulations where the market share required for a significant lessening of competition (SLC) is not explicitly or objectively defined. This could mean that some judgements of the CC may appear to the outside observer to be too subjective in their basis, and therefore potentially prone to political pressure or bias.
In summary, the current policy towards corporate takeovers does little more than pander to corporate executive machismo, and contributes little to improving growth in GDP. Too many takeover battles are played out as gladiatorial combat at boardroom level, with the heads of the losing companies served up as trophies. It is also worth noting the scale of these mergers and acquisitions in the UK. When the FTSE 100 Share Index was introduced on the 3rd of January 1984 it was set at a level of 1000.0 while the total market capitalisation of all the 100 companies listed was barely in excess of £100bn. Twenty-five years later the FTSE 100 stood at 4434.17 while its market capitalisation stood at £1083bn. So while the FTSE 100 had risen by a factor of 4.4, its market capitalisation rose by a factor of 10. The different between those two numbers is, in a large part, down to mergers and acquisitions.
Saturday, 31 October 2009
Friday, 23 October 2009
- Was it because of higher interest rates? No!
- Was it because of higher tax rates? No!
- Was it because of increasing supply of houses? No!
- Was it because of a shortage of potential buyers? No!
- Was it because of a shortage of mortgages? Not exactly.
Saturday, 10 October 2009
The latest strike vote by the CWU workers at the Royal Mail is sending a clear message that all is not well within that organisation.
Royal Mail is a business in trouble. It has some of the lowest staff morale, one of the highest strike rates, and one of the highest rates of staff turnover of any company in the country. The unions and workers appear to have no confidence or respect for the management, and given the damage these disputes do to Royal Mail in business terms, many of them seem to have very little sense of personal investment in Royal Mail either. Maybe that is part of the problem, and so should be seen as part of the solution?
The traditional solution for ailing nationalised industries is privatisation. However, there is a lingering worry that this would actually hasten the demise of the service the Royal Mail currently provides, not improve it. The universal service would be unlikely to survive the pressure to maximise corporate profits, and experience shows that any guarantees to the contrary given before flotation rarely survive the test of time, or a change of government.
Privatisation will also leave Royal Mail workers hopelessly exposed to the downward pressure on wages from the free market. Given the nature of its business, which will always involve large numbers of postmen and women delivering thousands of letters by hand each day, Royal Mail workers are always going to be amongst the lowest paid in the economy, and increasing deregulation and competition in the industry will continually reduce their collective bargaining power.
On the other hand, continued nationalisation leaves the Royal Mail umbilically tied to the current short-term political and financial interests of the Government. If history shows us anything it is that the Government is a bad owner of business. Its attention span is too short-term, and it is more interested in squeezing cash out of businesses to fund other services than allowing those businesses to invest for the future.
So, if nationalisation doesn’t work, and privatisation is a disaster-in-waiting, what third way is there?
It seems to me that all the problems at Royal Mail are indicative of an organisation where the workers feel undervalued, powerless, and marginalised. One way to change that would be to give the workers a greater sense of ownership of the company. The answer could be to turn the Royal Mail into a cooperative partnership along the same lines as the John Lewis Partnership (JLP).
The John Lewis Partnership is a cooperative venture that was set up in the interests of its workers (or partners) by its owner, John Spedan Lewis over an extended period from 1920 to 1950. The company is run by a tripartite system of company Chairman, Partnership Board and Partnership Council. The Council is directly elected by the workers based on constituencies. Each constituency is based around one store, or a group of stores, or part of the business, and returns one member. The Council then elects five members to the Partnership Board, with the Chairman nominating another five, and two external non-executives also being appointed. The Chairman and Board run the business, but are accountable to the Council, i.e. the workers.
As in most companies, the Chairman and Partnership Board take the day-to-day business decisions and decide what proportion of the annual profits should be reinvested in the business. But unlike PLCs, the rest of the profit is paid to the workers as bonuses in proportion to their salary and not to rentier shareholders. At the John Lewis Partnership these bonuses typically range from about 8% of salary in poor years, to over 25% of salary in good ones. For people on low incomes such large lump sums would be welcome windfalls and could provide enormous financial opportunities. In addition there are other corporate benefits such as pension provision and leisure discounts. The other major area where JLP differs from most private sector companies is in its commitment to social responsibility and local communities, a commitment that is enshrined in its constitution.
The positive consequences of this arrangement are that JLP has a much lower turnover of staff than most of its main competitors, better staff morale and good industrial relations. It is also renowned for its customer service and tends to be more resilient at weathering recession. And at a time when excessive executive pay is constantly in the headlines, JLP also rewards its senior managers less extravagantly in comparison to its shop floor workers than is the case for most of its competitors. In short, JLP has all the positive attributes that the Royal Mail currently lacks.
It seems to me that the business structure and employee demographic of JLP and the Royal Mail are very similar. So applying the business structure of JLP to the Royal Mail should be straight-forward, and should result in a new postal service without most of the problems that afflict the current one.
So why not turn the Royal Mail into a partnership, with each sorting office electing one member to its Partnership Council?
Under such a scenario the Royal Mail would become an independent company, but with no shareholders, only stakeholder workers. The management would be appointed by a board that is answerable to, and elected by, the workers. The benefits for the Royal Mail of this arrangement would be:
- the company would be independent of government and so able to take its own long-term financial decisions.
- It would give the workers a greater say over the way the organisation was managed and run, and a greater sense of ownership of any changes to working practices that need to be implemented.
- The workers would reap the rewards that accrue from the sacrifices and compromises that they need to make. That would be a powerful incentive for workers to embrace business change, rather than continuing to resist it.
- Industrial relations, service quality and reliability should all improve.
The benefit to the Government would be that it would no longer be responsible for the Royal Mail pension fund deficit, nor for overseeing the business. In return for the Government relinquishing its ownership rights, the Royal Mail could pay the Government a fixed annual dividend (let’s say 25% of the total staff bonus fund) but the Government would have no voting rights accompanying this dividend. The new Royal Mail constitution should commit the company to maintaining the current universal service and an external regulator should set the price of the standard second class stamp as this is the area in which the Royal Mail has the greatest monopoly. All other pricing should be left to the management of the Royal Mail.
The strategic position of Royal Mail means that most other businesses in this country are dependent upon it by using its services. Royal Mail is therefore critical to the economic prosperity of this country, and this means that the mail service that it provides must be reliable and adaptive to the needs of its customers.
The current policy of many on the Left including Compass is to keep the Royal Mail in public ownership. As I have also argued elsewhere, I do not believe this is viable in the long term, and sooner or later a Conservative government will pluck up the political courage to either privatise the Royal Mail through flotation, or sell it off completely to a competitor. The JLP solution has the added advantage that it would protect the Royal Mail from such a fate in perpetuity as well as leading to a better quality of service and better employment conditions for the workers.