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Raiders make it impossible for companies to act

Sun, 4th Mar 2007

THE COMPANY is a remarkable invention - in its public, limited-liability form, it is capitalism's most influential social and economic innovation, a crucial component of the modern economy. The organisational revolution triggered by the joint stock company in the mid-18th century was just as important for the take-off of British living standards as the more familiar industrial one.

The historic genius of the 1862 Companies Act was to enshrine a bargain in which shareholders won the controversial prize of a limit to their liabilities if the company got into trouble, while the company was granted a distinct legal personality. In return for a lessening of their responsibilities, shareholders forfeited the claim to outright company ownership the company's overriding obligations are to itself, including all its members.

It is to this delicate balance of interests that the company owes its resilience, its ability to co-opt and amplify diverse inputs, and its record of distributing its benefits widely. But it is also this balance which is now under attack, ironically not from anti- but from ultra-capitalists - top managers and their City counterparts who, in the name of short-term efficiency, are undermining the institution's long-term role as the engine of economic progress.

Some of the besiegers are external and evident, notably the private equity (PE) and hedge funds hogging today's financial headlines. Others are internal, in the shape of firms' own senior managers. At first sight - and according to conventional theory - these two groups are in competition for the right to direct the firm's resources on behalf of shareholders. This is the assumption behind today's corporate governance, which sees the board's job as ensuring management's devotion to the shareholder's cause by drawing up and monitoring performance contracts. Tighter ownership control over management is also one of the most important arguments made in favour of private equity.

A more persuasive diagnosis, however, is that internal and external groups are in cahoots, not primarily to create value, but to grab it from the company they are meant to be serving - a task eased by the fact that the heist takes place in private.

Out of the public company limelight - and conveniently unacknowledged in mainstream finance theory - a growing group of actors around the top of large companies - not just PE and hedge funds, but also investment bankers, traders and professional advisers - have a strong vested interest in what Karel Williams and other academics have christened the 'economy of permanent restructuring': a continuous round of deals, capital reorganisations and financial engineering that generates not only lucrative transaction fees but also, and increasingly, capital gains for intermediaries such as investment banks through their own PE and hedge funds.

You wouldn't guess it from the self-congratulatory hype surrounding the City's activities, but this asset-shuffling provides no benefit for investors as a whole (Warren Buffett, perhaps the world's canniest investor, estimates that intermediaries and advisers now relieve equity investors of 20 per cent of the earnings of US business they would otherwise have received: 'For investors as a whole, returns decrease as motion increases').

Worse, by concentrating only on present efficiencies, the attackers make it harder for companies to focus on their most important job, which is to bring about as yet unknown future efficiencies through innovation.

The ultras view companies simply as a bundle of contracts and revenue streams, to be bought and sold like any other commodity, 'a continuation of market relations by other means'. But enduring performance is more than an economic enterprise. Innovating means forgoing a portion of current returns to create the opportunities for greater returns in the future. To make it bear fruit in practice requires nurturing security, trust and the kind of stable human relationships that allow risk and experiment and tolerate mistakes. It requires treating all stakeholders as investors, not just shareholders - and reporting to them publicly.

If the public company didn't exist, it would have to be invented. Even the raiders need it: without public equity, there would be no material with which private equity could have its way, and no way for it to sell its purchases back to the retail investor. Accountability is still the best way of ensuring that the company pays its dues to employees and society as a whole, rather than to shareholders or unscrupulous owners - which, of course, is what creates advantage for the raiders in taking it private.

The public company has its faults, but none so bad as when it adopts the balance-destroying methods of the raiders. Bad as they sometimes are, its inefficiencies pale beside the lack of transparency and monstrous distribution inequalities of the alternatives.

The Observer, 4 March 2007


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