DESTRUCTIVE PREDATOR OR SACRED COW?

The Stock Market is failing us all, yet reform seems impossible.

For some time, it has been apparent that the number of companies quoted on the main London Stock Exchange has been in dramatic decline. The line put out by the market has been that the reduction - from about 1200 listed companies in the year 2000 to some 900 now, has been due to 'cyclical' factors. The fact that other stock markets seem not to be suffering from the same degree of 'cyclicality' rather gives the lie to this fairy tale. The story is even worse when it becomes apparent that the number of quoted non-financial companies halved between 1997 and 2004. Included in 'non-financial companies' are a large number of technology-based businesses.
Additionally, the notion that investor pressure is the best way to stimulate high performance is undermined by the fact that one in five listed companies is making a loss, a 60% increase since 1997, according to research by Cranfield School of Management.
The Cranfield researchers, led by Professor Richard Taffler, have estimated that 40% of companies in media, telecoms, aerospace and software (all industries that need investment in innovation, technology and people) are at risk of failure.
The wholesale destruction over the last 20 years of most larger London-quoted companies in advanced technology industries is further evidence of the damage that has been caused by investors and top managers working in unison.

The fact that seismic changes are occurring in the equity markets has not escaped the notice of commentators and the press. However, the phenomenon is treated by many as only worthy of passing comment. Observers of a 'neo-Friedman/Thatcherite' persuasion continue to peddle their opinions as axioms - market forces will ensure a correction to negative trends, the primacy of ownership by 'shareholders' gives them rights to dispose of companies as they wish, the forces of 'creative destruction' will eliminate the inefficient etc, etc...

Some very intelligent people seem to be programmed to repeat the mantra, 'shareholders own companies and there's nothing anybody can do about it' (even if it wrecks the economy...).
This is a real conversation with one of them:
Young, "The stock markets seem to be going haywire, did you know that some 40%+ of traded volume in shares was by Hedge Funds and other speculators".
Highly intelligent colleague, "That makes it pretty hard for management, but there's nothing they can do about it, shareholders are the owners and can do what they like. Management must do what they want or suffer the consequences".
Young, "But there's a real danger that this will destroy any company that needs a consistent stream of investment to prosper! We'll lose a large slug of modern value-creating industry".
Colleague, "'Fraid there's nothing anyone can do about it - we'll have to leave it to the Germans and Japanese"
Young, "So we can't stop them undermining the industrial economy?"
Colleague, "They're the owners, nobody can stop them".

This encounter caused some reflection. Our friend and colleague had been born into a property-owning family, solidly embedded in the old establishment. He therefore had an understandable respect for property and ownership rights. As far as he was concerned, financial and legal ownership rights were paramount.
Maybe, deep down, there are strong undertones of feudalism in the views of some about financial ownership. It is not all that long ago landowners had people hanged for poaching deer. Only a few centuries before that, people were tied to the land - which represented the ultimate form of ownership. Land ownership was superseded by the ownership of capital, which became the dominant force in our society. The mass of people didn't get much of a look in under feudalism or industrial capitalism. Now things are changing again and knowledge is becoming the most important source of value - problem is, people are the source of knowledge creation and one can't own them like physical assets.
Deep down, many people may fear the consequences of passing power to people, not realising that effective power has already passed from the old British financial establishment to foreign investment banks with the 'Big Bang' in 1986.
Perhaps we are seeing the beginnings of the last-ditch struggle of the old property-owning class as the tectonic plates of the economy slowly shift?
There has to be a deep reason for people like our friend to believe that speculators and gamblers with other peoples' money represent 'ownership' - such convictions certainly aren't driven by rationality!
Of course, there is another, simpler reason. Our friend, as an experienced top manager, knows full well that incurring the displeasure of the 'shareholders' (institutional investors) means the end for executives. He knows how downright vindictive the 'pack' of investors, analysts, supported by a willing press can be.
The combination of deep rooted beliefs in the sanctity of money and property, plus simple self-interest is pretty potent medicine.

More recently, another tone of voice has appeared. This development can best be typified by a metaphorical shrug and a good old British, "We know its awful, but heigh-ho, mustn't grumble, it could be worse..."

This tendency is succinctly exemplified by a piece in a major financial journal. (Lex column, Financial Times, March 5, 2005):
Pity the poor executive. Creating shareholder value is one thing, but it is increasingly difficult to determine who those shareholders are and what they want. .......Increasing Hedge Fund ownership of U.K stocks is an important development, especially as traditional pension funds and insurance companies have moved away from equities .... Between 1993 and 2003 the proportion of UK plc owned by 'other financial institutions' - which includes Hedge Funds - grew from less than 1 per cent to over 11 per cent. Unofficial estimates suggest 45 per cent of traded volume (of shares) in London can be traced back to Hedge Funds.
The article ends on a cheerful note: Executives fretting over the nefarious influence of hedge funds would do well to recall the words of Warren Buffet: If a business does well, the stock eventually follows.

Even more noticeable is the tendency of senior politicians to pretend that all is well and the City is a jewel of incomparable value in the national economic crown.
Over to Mr. Gordon Brown, the U.K Chancellor of the Exchequer.....
Here is his most recent message about the London financial markets, delivered to one of his series of conferences on enterprise and innovation: At the forefront of world financial services, Britain to-day exports four times more financial services than we import.
So, all's well - not a hint of critique of the behaviour or performance of the almost entirely foreign-owned London the investment markets there.
Mr. Brown's boss, premier Tony Blair, seems to go further in his praise of the financial markets. In a speech at the London HQ of U.S Investment bank Goldman Sachs, (subject, along with other big banks to investigations in New York for dubious practices), to a glittering audience of City luminaries, Mr Blair was effusive, thanking Goldman Sachs for having their staff devote a day a year to charitable activities: What is being done here at Goldman Sachs, indeed the emphasis placed by more and more companies on corporate social responsibility, symbolises the recognition that prosperity is best achieved in an inclusive society. He went on, according to Polly Toynbee in the Guardian, to report that personal tax was: Lower than in most of Mrs Thatcher's years. This 'inclusivity' must have been a comfort to Hank Paulson, CEO of Goldman (pay $21.4 million) and his London staff. Polly Toynbee in the 'Guardian' described Mr. Blair's speech as: A cringing appeasement of the rich and powerful.

However, some do say it as they see it.....
Anthony Hilton, City editor of the 'Evening Standard', has quite different convictions. Back in May 2004, he reported: The City pressures companies to promise growth as a precondition for taking an interest in the shares. When the company fails to live up to the promises it has been pressurised into giving, it is savagely punished.
....The stock market is where people with an interest in backing companies meet people who need capital to develop their businesses. That is its reason for existence.
Hedge funds and the prime brokerage activities of investment banks are turning the place into a casino where genuine long-term investors and companies are overwhelmed by their superior financial resources.
....The City spends a lot of time considering plans to reward executives with shares.
The premise is that the growth in the share price will be a reflection of the medium-term success of management in growing the business.
Hedge funds and prime brokers are destroying the nature of that premise, and if they continue unchecked they will destroy popular support for the stock market itself. Meanwhile, they simply devastate the morale of managements who see share price movements that bear no connection to the work they are actually putting into the business.

On 30 November 2004, he returned to the subject:
So, while the Chancellor (U.K finance minister Gordon Brown) will no doubt repeat the message that British economic growth is stronger, more consistent and longer lasting than any other leading economies, few of the results show through in the stock market. Shares now provide a pretty poor home for the nation's savings - a fact that has unpleasant long-term implications if it is not reversed.
The brutal message that the market delivers is that Britain is no longer good for business because of the progressive erosion of the entrepreneurial culture and the loss of position in international competitiveness. If Brown disagrees, as he surely must, perhaps he could use some of his speech to explain why.

John Plender writing in the 'Financial Times' of April 18, 2005 is quite clear about the impact of loose cannons such as Hedge Funds. Describing the reaction of Elliott Associates, a US Hedge Fund to the fact that their punt on Woolworths didn't work out, he says: ...."The US hedge fund manager said, in effect to the Woolworth's directors: We took an exceptionally ill-judged punt on your stock and suggest that you help us recoup our losses by putting yourself up for auction forthwith, engage in some hurried do-it-yourself asset stripping and wreck the balance sheet by raising debt to pay as much cash as possible to shareholders. Or else..."

And some don't....
What Mr Blair and Mr Brown seem to have overlooked is that Goldman Sachs and their peer Investment banks are some of the biggest players in the Hedge Fund game.
Most politicians in the U.K remain eerily silent about the damage being wrought by the financial markets. Presumably this is because they don't understand or are frightened to be seen as unfriendly to the City, or some combination of both.
Perhaps some are cheerfully convinced that the behaviour of the City represents the free play of market forces and all must therefore be well, whatever the signals to the contrary. Others, of course, are already aboard the City gravy train, or have high hopes of future reward for being 'business-friendly'.

The message of cheer in the Lex column - seemingly based on the inaccurate notion that good companies and managers will be left in peace to get on with their business by the investment banks and sundry speculators - and that all must therefore be for the best in this best of all possible worlds - can be rapidly demolished by a short examination of some other things that Warren Buffet and his mentor Benjamin Graham have had to say about the Stock Markets:

Choosing to quote Warren Buffet as if the great investor is some sort of apologist for the behaviours of contemporary stock markets is grossly misleading - Buffet and his fellow investors have been almost universally critical of the behaviour of players in the markets.

So, let's hear it for the truth of the matter:
The London Stock Market is in a state of serious decline for reasons connected with the self-interest and speculative short-termism of those who are coming to dominate it.
Speculation and gambling are throttling genuine investment in companies. Relentless demands for over-performance are having the opposite effects. Gross inconsistency is corroding the very fabric of companies and short -termism sapping their competitive stamina.

The central premise in these days of emerging dominance by institutional investors seems to be:
If your company doesn't enable me to meet my short-term investment objectives - no matter how misguided my judgments may have been - it is the company that must give way. Even if it is destroyed.

The impacts of the investment markets are the most significant influence on the performance and competitiveness of larger British companies, especially those in complex high-technology industries. It is not Trades Unions and government bureaucracy that are the prime causes of under-performance. Otherwise, how could foreign-owned companies perform so much better in the U.K than British-owned ones?
It is under-investment and short-termism - driven by an obsession about financial ownership and financial results rather than investment, customers and motivated employees that is the unspoken root of poor U.K competitiveness in advanced industries.

And, while we're at it, those companies that flee the stock markets for the sanctuary of private capital are unlikely to find a more positive home - the requirements of venture and private capital in the U.K are very high returns with a 3-5-year exit through a trade sale or stock market flotation - not much hope for long-term investment there......

We are not anti-capitalist or hostile to responsible investment - but the current financial market model is inadequate to meet to-day's needs. The global product/customer markets are stimulus enough to make companies have to be competitive in modern industries, without additional destructive pressures from speculators. Real investors should be prepared to support and help the enterprises they own - that way they will also achieve better long-term returns.
Reform of the current system is needed and is unlikely to come from inside - too many are riding on the gravy train.
There is a desperate need for new sources of intelligent, understanding and long-term capital for knowledge-based industry right from the incubation stage to support of vigorous mature larger companies.

Without them Britain will not succeed in the modern world. That is the truth

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