An understanding of how value and its interpretation ultimately affects humanity is needed – a poignant lesson that corporate governance attempts at teaching us.
On the 20th anniversary of the LeisureNet collapse and subsequent revisions in corporate governance and legislation protecting whistle-blowers, South African stakeholders are regrettably still experiencing losses at the hands of unscrupulous characters.
At the height of LeisureNet’s (once termed the ‘darling of the Stock Exchange’) period, one of the execs is believed to have used the phrase ‘eat your children!’ − a statement made famous by boxer Mike Tyson that would leave Lady Macbeth’s soliloquies sounding like innocent lullabies. The statement was intended to encourage staff to act beyond reasonable (and ethical) ambitions to grow the business.
Here, the actions of two men affected countless people with the whistle-blower (who is a chartered accountant) having to self-exile in London earning money as … a beggar! LeisureNet became the ‘darling of the Stock Exchange’ because value was reduced to a target, which in this instance and many others was achieved, albeit through manipulation.
Sustainable value creation
Managing a corporate necessitates that decisions be made more swiftly to create, preserve, or increase value. Structures to enable this are in place, but a recalibration of what value is and how it encompasses more than just a target financial metric is needed. Even while pursuing once in a lifetime opportunities such as those seen during the dotcom era, management must be mindful of the board’s view of long-term sustainable value creation. Tensions seem to arise when companies conflate short-termism with value creation, which leads to stakeholder interests being put in jeopardy. By analysing the majority of corporate crashes, we can contend that one of the arteries that feed the heart of corporate collapses is a self-seeking focus on short-term gains.
Different corporate, same scandal
With each wave of corporate scandals comes a renewed appreciation for sound governance. However, even with the revisions made to governance practices and dozens of business leaders relaying their commitment to a more inclusive value-creation approach, collapses and looting are still rampant. The more recent being the Wirecard collapse and its missing €1,9 billion which resulted in a more than $12 billion erosion of market capitalisation. The collapse of Wirecard also affected its affiliated banking service providers, with one pensioner lamenting that he learned of Wirecard’s suspension from trading while at the supermarket, baffled that his card had been declined while purchasing bread. Wirecard’s collapse exemplifies the classic tale of the ‘flight of Icarus’ − it had all the markings of a collapse in waiting but these were ignored. This begs the question: when corporate failures play out, are the failures because of inadequate rules or are the rules simply poorly implemented? More than 140 years later and the collapse of Wirecard can still be likened to the collapse of the City of Glasgow Bank in 1878, and though history never exactly repeats itself, it’s always worthwhile to study the past as it offers salutary lessons.
A case of prisoner’s dilemma
Many theories have been developed to determine where corporate governance ultimately translates into value. The three most prominent of these include the agency theory, the stewardship theory and the stakeholder theory. Each theory outlines the conflicting interests of the stakeholders. The agency theory assumes that managers and shareholders have inherently conflicting interests. The stewardship theory assumes that management should put the long-term best interest of a group ahead of the individual’s self-interest. The stakeholder theory assumes that the core friction in the good performance of a company relies on the contributions of many different parties. These stakeholders all have an interest in the company and can therefore choose how to prioritise their stakes based on available information about the company.
Each theory has its shortcomings, but wisdom from each should be noted and applied together. What is important to note here is that the prioritisation of good corporate governance practices in an organisation leads to a combination of structures and mechanisms that support the interests of all parties involved and ensures the voice of stakeholders is recognised and a fair distribution of information is achieved.
These structures and mechanisms promote a commitment by all stakeholders to align their ambitions and work together towards a common goal that is focused on sustainable value and an understanding that the achievement of that goal rests on socially responsible behaviour.
A multidisciplinary view of value
Corporate governance and the proper functioning of a business relies on human behaviour. With trust being the ethos from which the economy runs, the trust of regulators, auditors and executives underpins much of where money is invested. Sound governance therefore plays an important role in ensuring that men of straw do not exploit this trust. Through time, we have learned that using the bourse as the sole proxy for a company’s value can be a misleading and rather expensive lever. A host of other qualitative and quantitative metrics need to be considered when determining a company’s value. It should be borne in mind that a numeric convention is not the only indicator of value: although it is the least complex, it is also more prone to manipulation. What is noted is that management too often fixate on short-term performance metrics such as earnings per share rather than on the creation of value over the long term. By interpreting (or, more aptly, mischaracterising) shareholders’ best interests as simply ‘beating analysts’ estimates’ of quarterly or mid-year earnings, the financial system can be seen as attempting to inculcate a model that is focused on short-termism and all but ignores the future. The other issue with exchanges is that crowd behaviour can sometimes result in the mispricing of securities, which leads to financial bubbles such as Tulipmania. (Tulipmania was the first reported financial bubble and took place in 17th-century Holland, where tulip prices increased beyond reason and then wilted just as quickly as the petals.)
From this we gather that reliance on a single source of data which is highly affected by sentiment can be detrimental. In addition, reducing value creation to an arbitrary target for managers to achieve leads to decisions that will seek to achieve the target and not necessarily benefit stakeholders. This concept extends to each identifier of value and not just financial metrics. During the probe into the VW carbon emissions scandal, Alfred Rappaport stated: ‘Why would a company such as Volkswagen lie to its customers and government emission testers? Conventional wisdom places the blame squarely on the pursuit of shareholder value which, it is claimed, has fuelled pernicious short-term thinking and irresponsible behaviour.’1 From this we understand that the key actors in the VW emissions scandal knew exactly what the target integer should be, and this led to shortcuts to achieve this, ignoring how harmful their decisions were to their customers and the climate. Therefore, much like using one measure, outperforming targets cannot be the sole determiner of value creation.
Corporates as social change agents
In a society such as South Africa with its high unemployment rate and an income disparity that is on a persistent upward trajectory and which is further stressed by under-resourced and impoverished communities mushrooming everywhere, what can be agreed on is that stakeholder value which is more inclusive can be used as one of the levers for social reform. With an ever-widening income gap, the narrative of ‘who the richest person is’ needs to morph into stories of how this wealth is being used to support under-resourced communities in South Africa. Of particular importance at this time of global reflection on the virtues and depravities of capitalism, managers and board directors must have a clear understanding of what value creation means not just for shareholders but for all stakeholders (the climate included). Corporates must understand that the problem of unemployment, poverty, under-resourced communities, etc, is not just a societal issue: it is an ‘everybody and corporate’ issue. As asset managers and investors become increasingly concerned with how the climate can affect financial performance and therefore their returns, more importance has been placed on responsible investing. From a global perspective, this shift in thinking has motivated reforms by corporates, which have led to increased confidence as can be seen with exchange-traded funds (ETFs) that track sustainable indices performing at near record-setting returns. Further to this, the influential investor group Climate Action 100+ wrote to the world’s largest greenhouse gas-emitting companies to demand they implement a net-zero strategy by 2050. On a local front, we can dovetail from these initiatives and apply more pressure to corporates to exemplify the principles as contained in the UN Sustainable Development Goals. This can result in an increased commitment to ensuring that resources are invested in bettering societies.
A shift in focus
When we look back on the countless corporate collapses, it is clear that the attention should shift from a view of how much the company has lost in market capital to how many people − like the pensioner who could suddenly not afford bread or the heroic whistle-blower turned London beggar (whose life has returned to a pseudo ‘normalcy’ after the sentencing of the pair) − are affected by decisions made by key individuals. From this, we learn that one of the objectives of corporate governance is a return to ‘humanity’ and the appreciation of how one’s actions affect multitudes.
1 Alfred Rappaport, What managers misunderstand about shareholder value, Financial Times, 14 August 2016, https://www.ft.com/content/4a25dc30-1eaa-11e6-b286-cddde55ca122.
AUTHOR | Ando Bobani CA(SA), Independent Non-executive Director at the University of Zululand, Risk and Governance Specialist at OML and OML GF Young Board Member