Do We Need New Corporate Performance Indicators?
Return on equity (ROE) and Earnings before interest, taxes, depreciation and amortisation (Ebitda) are two of the ratios most used to measure the performance of companies. This is not new apart from the fact that financial analysts have taken possession of these analytical concepts and promoted them to the level of dogma. Whenever the now quarterly publication of the corporate results of a listed company reveals a decline in its ROE or Ebitda, it is a fairly safe bet that its share price will tumble although the analyst more often than not ignores the underlying reasons for this erosion.
During the Internet bubble, the ‘old economy’ seized the media hype around these ratios to impose a strict diet and productivity cure because otherwise, as was believed at the time, it would never be able to compete with the yields offered by the Internet start-ups. But what is the situation 15 years later?
Although the Internet bubble has long since burst, a number of economic sectors, such as banks, are still pursuing profitability objectives that clearly defy any common sense. These have led them astray into situations like the sub-prime crisis despite improvements in banking supervising systems. Are the overseers incompetent? Afraid of being blamed for slowing down the economy? Is there a lack of genuine sanctions within the system?
The main purpose of Basel I was to safeguard a healthy capitalistic banking system in the western world, which, at the time, was competing with the communist or state-run socialist model. The fact is that the call for stricter, highly sophisticated risk management systems, increased equity provision, good governance and transparent communication have not saved us from the debacle which is forcing a considerable number of prestigious banking institutions to rebuild their capital that was devoured by those out for easy prey. Rather than creating value, they have destroyed it massively – the very value that we as beneficiaries of private pension funds are so keen to have.
True, some managers were sacked (as were many employees who were sacrificed to provide some respite to endangered institutions); but sanctions are not inherent in the system, as the greatest danger is no longer the competing ideological model but the regulator. And, like everybody else, regulators can be prone to amnesia.
I am not likely to forget the arrogance of one of the heads of a US banking regulation agency at a meeting of a Brussels think tank on Basel II about two years ago who said: “We shall apply Basel II to the top 10 US banks that do business abroad. We don’t need it for domestic banks because our systems are robust and proven.” He referred to the lessons learnt from the savings and loans crisis at the end of the 1980s. This statement caused some doubt and worry and now that concern has proven to be justified. The crisis he referred to cost the US taxpayer about US$130bn at the time and triggered the recession the US went through at the start of the 1990s, as well as the simultaneous breakdown of the property market.
Is there really no systemic sanction? Who has provided capital to the large banks that have gone astray? Indirectly, some taxpayers in the UK through the nationalisation of a mortgage credit outlet – the height of cheek in the country of ‘laissez faire’.
Although no one knows whether we have reached the end of the tunnel, it would appear that sovereign funds have contributed to the lion’s share of the liquidity needed to increase the capital. Sovereign funds from Norway, Singapore and the Emirates, who may be assumed to be interested only in investing in profitable sectors without aiming to run these companies. The Norwegian ones have made clear statements to that effect. But what would happen if sovereign funds from countries that are both capitalist and dictatorial were to play in the match?
These hybrids of capitalism and totalitarianism were extremely successful during the last decade. To such an extent that you may well wonder whether the credo whereby a liberal type of capitalism and democracy always go hand in hand still holds true. These sovereign funds are extremely rich, and it is not always easy to see what they are after. I am not convinced that they will be bothered by our concepts of governance. The very nature of banking implies that banks possess an inestimable amount of valuable economic information about their clients. Hence, if the chase after unrealistic objectives continues, the entire democratic/capitalist system is at risk. Both the schizophrenic citizen – who plays the stock exchange and has a company pension fund scheme – and our political leaders should be aware of this.
We need a change of paradigm. Does this mean that we should review the criteria for investment decisions whereby less profitable companies would be less at risk and therefore more attractive? Certainly not. Henceforth, companies must no longer be assessed on the basis of their short-term financial profitability only. We are facing a much more fundamental challenge, namely global warming. Attempts have been made to rank companies on their ethical behavior, quite successfully within Germany for one. Now the time has come for investors to base their decisions on the efforts companies make to come to grips with the challenges of tomorrow.
A while ago the artist Serge drew a cartoon for the French newspaper, Le Monde, which struck me: it showed a bunch of proverbial big bosses with their hats on and cigars stuffed in their mouths saying that they had grown rich heating up the earth and that now they would grow rich again, but this time by cooling it down! Let us prove that it is possible to be ethical and behave responsibly without forgetting about profitability.