P3. When they say it’s all fine, reach for the long spoon!

We have all seen immense amounts of punditry on Brexit, Trump election etc. The truth must be that since neither of these projects have anything approaching a coherent plan, even some of the very well educated guesses doing the rounds will be miles off target. In this context it is easy for supporters of recent events to claim that because the world has not immediately collapsed everything is just fine. We hear this line from the Leave camp after Brexit and expect loads more of it from Trumpland in the coming weeks. The problem of course is politicians willfully choosing to  confuse short and medium or long term impacts. The UK economy will it seems be hindered by Brexit, just because it’s not obvious yet, this does not mean that corporate spending will not move towards one of the main worldwide markets where trade agreements are already in place. Similarly if Trump and his cohorts adhere to their campaign promises there is likely to be a debt fuelled boom as borrowing heads to over 100% of GDP. The bill of course will come further down the road and may threaten us all.

Depressingly, outright lies are becoming a regular part of political campaigning and we all know that once you become a liar it’s easiest to keep right on lying!

 

P2 Whatever happened to the smell test?

I have never met Dominic Chappell, Mike Ashley or Philip Green, but I am sure they hard to resist once they are on a roll and the fact that the latter two are really rich can only add to their clout. The Parliamentary Committee hearings over the past few days have been gripping and the business conduct exposed is a reflection of our times.

One factor in this is that the borderline between plucky entrepreneur and someone pretty close to an asset stripper has become blurred and institutions are much less fussy about the conduct of businesses they are prepared to support or bring to market. Combined with a climate that encourages  the kind of businessman (or entrepreneur as the like to be known), with only a hazy idea of where the ‘line’ is, this makes for a volatile combination. It was not that pre Big Bang institutions were shy of making money or backing someone slightly racy, but their own self interest encouraged them to maintain their longer term reputation in a time before we all became short termist. The difficulty now is that the institutional imperative to preserve reputation as its future stock in trade has disappeared- markets are global, loads of buyers and sellers and.. hey everyone is doing it! Take Sports Direct, it never had any interest in strong corporate governance but the sponsors clearly did not think it was their responsibility to address this before the 2007 flotation, when the shares were oversubscribed and subsequently slumped. In the case of Phillip Green he had huge amounts of admiring publicity over the gargantuan dividends paid to his wife in Monaco, but nobody seemed to care much whether a pretty standard retail business could support such a distribution and it now seems pretty clear that it could not. The government’s admiration for this uber rich trader was subsequently recognised by making him government efficiency Czar, in the hope he could sprinkle some magic wealth dust on the complex business of government procurement. The saying goes that there is ‘no such thing as an ugly rich man’, but governments should have higher standards.

None of this is new of course, Trollope laid it all out in ‘The Way we Live Now’, published in 1875. A parable for our times that would make excellent required reading for banking and MBA students.

 

P1 Short Term Life

On the radio yesterday there was an item about how NHS Trusts are trying to deal with government funding targets and ever increasing demand. The interviewee was knowledgeable and senior and  explained the sorts of accounting tricks which are being used to meet performance targets by mortgaging the future.

This will all sound familiar to anyone involved in running a business that is underperforming. I can only imagine the sort of pressure that Health Trusts are put under to meet the share of central government budget allocated to them, but the techniques used to flex the numbers and pressurise management into agreeing to unrealistic outcomes will be similar. One favourite, which the speaker referred to,  is to play with what does and does not constitute capital expenditure.  It’s a simple process, capital gains are treated as revenue and conversely running costs are capitalised, things look much better for one period, while all that has really happened is that costs have been shuffled off into the future (next year’s results can seem  a long way off in tough times). The trickier part is getting the auditors to agree to the convoluted rationale needed to support the treatment- this is where FDs can get really creative! The government is an old hand at this, PFI was once described to me as ‘off balance sheet finance for governments’ where the future of, for example schools and hospitals is burdened by extortionate payments to the providers of finance, but the capital receipts from financing largely go straight to the government’s revenue account!

Pressure to stretch the balance sheet occurs across large and small companies and always represents a challenge to board independence. In smaller companies, where founders and venture capitalists often dominate the board, their interest is in the short term share price and they can easily persuade themselves that any problems are passing and the projected business performance they have invested in is sustainable despite any current difficulties. This can be for valid reasons such as wanting to avoid a difficult conversation with debt providers that might cause greater harm to the company, but it can also be to avoid having to explain the underperformance to their own boards. Whatever the rationale we have entered into the opaque area where senior board members start to use phrases like ‘balance of judgement’. Having decided on the kind of result needed, the next step is to get any dissenters on the board to fall in line and ‘support the company’.  What all this adds up to is often a very optimistic view of the company’s future as it now has faces the twin challenges next year of beating the inflated results and restoring a strained balance sheet.  If the anticipated upturn does not then occur the consequences are often expensive for shareholders as targets are missed and financing lines come under strain.

While not a mirror image the position with Health Trusts is similar. It is hard to imagine that they do not genuinely need to spend more than they have been allocated by an austerity led government as they deal with increased costs of treatment and an ageing population.  The speaker  finished by saying that he thought it unlikely that the auditors would pass the accounts of many Health Trusts. Presumably tomorrow’s problem and having kicked it down the road government departments will have no difficulty then in laying any responsibility with management.