Financial Daily from THE HINDU group of publications
Monday, Jun 10, 2002
Heroes with clay feet
Are corporates subordinates to their CEOs?
IT IS, indeed, remarkable how heroes of yesterday of American business lore have fallen flat in the aftermath of Enron. There was a time when American Chief Executives were most admired and frequently on the cover of business magazines and hogged the attention of business TV channels. "Mugs" sell mags was a well-accepted mantra of the media. Business executives were oft-quoted and feted.
All this has undergone a sea-change, mainly in the aftermath of the dotcom crash and the collapse of Enron. CEOs have generally fallen low in the estimation of the public. Capitalism has discovered that its heroes have feet of clay and are vulnerable.
For a society that has blind faith in the magic of CEOs, the latest revelations that disclose their vulnerabilities must be a bitter learning experience. For instance, Mr Jack Welch had become a synonym for the unfailing and profit-oriented Chief Executive, who, by his often autocratic, but result-oriented way, refashioned General Electric. Mr Welch succeeded in making GE the darling of Wall Street. But some of his methods were unacceptable to those who are used to more austere accounting practices, even as they were unpalatable to his staff whom he "downsized" with a vengeance. It is, however, a fact that until his recent humbling experience with a HRR editor, Mr Welch was a byword for success and achievement both in America and abroad. He found fervent imitators in countries, as distant as Japan and India.
In the backlash to the rise of CEO cult, there has been a series of revelations about erstwhile successful chief executives. Many successful chief executives have apparently left a cupboard full of corporate skeletons. While GE had been acclaimed as world's most admired company, today, Mr Welch's successor, Mr Jeff Immelt, is struggling to explain to critics certain alleged manipulation of accounts and other shenanigans. The present increased concern about transparency in accounting following the Enron/Andersen expose has increased suspicions that GE has also been concealing its risky ventures. Reputed analysts have pointed out that GE itself being big and running many financial businesses finds it easy to hide the prospects of losses in one or the other of its many ventures.
Doubts have been cast on the credibility of the reported profits of GE itself, although they have stayed high over the years. Significantly, one of the most prominent buyers of commercial paper in the American financial markets has accused GE of dishonesty. This has had adverse impact on GE. The scorching pace of growth of GE Capital, the financial service arm of GE itself is, the critic's say, founded on the capital base of GE as a whole. The recent industrial decline is reflected in the slow down of power equipment demand, which is at the heart of critics' concern. The legendary heroes of yesterday have become the subject matter of controversies today.
Business leaders have contributed, by their own behaviour, to this fall of credibility. Critics have focussed on glaring failures, like that of Mr Michael Armstrong, who was once hailed by management scholars as a "visionary" in the Welch mould. He, however, took AT&T, a giant among US corporates, to the cleaners. He injected his costly vision into AT&T, a vision which was to convert AT&T into a new economy enterprise. In so doing, he destroyed the company. Its $140-billion. shareholders value was almost totally destroyed and AT&T is to pay for the megalomania of Mr Armstrong.
I recall another famous legend among the global chief executives, Mr.Percy Barnevik, CE of ABB. I had an occasion to meet him in early 1980s at his headquarters in Sweden. I was then Secretary (Power) to the Government of India. We were investigating a prospective offer by Asea, a company of which Mr Barnevik was the Chairman and Chief Executive. The offer was for installation of a high voltage DC transmission system in competition with Brown Boveri. In the brief encounter that I had with this legendary figure, I could recognise that modesty was not his strong suit. Mr Barnevik was hailed as Europe's answer to Mr Welch. Mr Barnevik successfully masterminded the merger of Asea with not only his Swiss competitor, Brown Boveri, but other enterprises also and built up ABB as Europe's biggest power corporation.
But the merger turned out to be a marriage of inconvenience. ABB had unprecedented losses last year and a shareholders' revolt led to the exit of Mr Barnevik. The "disgrace" was particularly expedited because of a revelation that Mr Barnevik had not only turned out to be incompetent but also greedy. He had assigned to himself substantial retirement benefits of more than $100million, in spite of the losses of the company. (It is only fair to mention that Mr Barnevik offered to refund part of his admittedly large pensionary benefits.) While the fall of Mr Barnevik is a tragedy, it is a sign of the times. No individual by himself can be trusted with unlimited powers to run a company and fashion its future, unconstrained by a fully empowered and informed board.
As if to compound the failure of Chief Executives has come the failure of the corporate watchdogs the auditors. The case of Enron has shown how easy it is to manipulate the financial statements of companies. The latest Economist narrates yet another bizarre story, this time of a company listed on Germany's new stock exchange, which treated its shareholders with even greater disdain than Enron. The company, Comroad, invented two-thirds of its total revenue, from non-existent clients. It threw dust in the eyes of its auditors, the internationally well-known KPMG and succeeded in inventing an imaginary client in Hong Kong. Sad to say, the renowned auditor did not verify the existence or otherwise of the principal source of revenues of the company. The story of Comroad is an interesting but inexcusable variation on Enron.
The combination of an arbitrary and megalomaniac CEO and an irresponsible set of auditors is a regulator's nightmare. The question arises as to how we in India are placed in regard to such manipulations. SEBI has, indeed, laid down strict and comprehensive standards of corporate governance. The Institute of Chartered Accountants and the Company Law Board have established rigorous codes governing accounting standards. While the Audit Committee has been given a pride of place in the code of governance, much depends on the composition of the Audit Committee itself. Since a great deal depends on the interpretation of technical standards laid down by the Institute of Chartered Accountants, it would seem to be desirable that every Audit Committee includes at least one qualified chartered accountant. Conditions regarding avoidance of conflict of interests, which means separation of consultancy business from that of auditors, also deserve to be rigorously enforced. Where there is an incipient conflict, it should be brought out explicitly in the Directors' report.
The machinery of capitalism depends on the successful performance of the stock market, which in turn, depends on investors receiving the correct signals from the statement of accounts and from the leadership pattern of Chief Executives. If both these are flawed, it is doubtful if, and how, the mechanism of stock market can induce growth. While it is not my intention to suggest that more regulatory intervention per se can improve corporate governance, I feel it is necessary to infuse greater awareness of business ethics and the need to adhere to high standards of transparency if market-based capitalism has to succeed.
While a flashy CEO like Mr Welch, who impressed the market with his autocratic behaviour and result-orientation, may still be necessary, he cannot be the basis of general steady economic growth. Management ultimately involves routine work. CEOs, who are a flash in the pan, can often become too costly a burden for the economy in general. Costly megalomaniac projects are often the result of CEO's misadventure. Just as in politics, the philosophy of a man on a horse- back has not succeeded in business also. Dictatorships may temporarily solve problems, but dictators as leaders have left more problems than they have solved both in politics and business.
It is necessary to introduce safeguards to ensure that enthusiastic CEOs do not ride hard over sane corporate objectives and destroy shareholders' value by ill-conceived plans of expansion, while hiding the costs thereof by accounting manipulations. The current codes of corporate governance do not go far enough to elicit the long-run costs, which such expansionary executives thrust on their enterprises. Accounting standards should be expanded to bring out the implicit costs of "capital" misadventures, which CEOs embark on. There is need not only for post facto scrutiny by audit but careful surveillance by a competent Board of Directors of the expansionary impulses of ambitious CEOs, who count not the cost of their ambitions. Many a corporate has been sunk in the morass caused by over-ambitious visions of the gods that have failed.
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