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May


Short-term gain, long-term pain

Sun, 30th Oct 2005

THE FT reported last Tuesday that salaries for senior City of London staff rose 9.2 per cent in the year to September - before the annual bonus round, which promises to be high. On the next page, an international productivity comparison showed that in financial services - covering high street banks, pension and insurance advisers, international banks and investment institutions - the UK ranked 14th out of 15 countries.

Some mistake surely? The official line is that financial services are one of the UK's most profitable and internationally competitive industries, a pointer to the sunny uplands of post-industrialism. Meanwhile, in accord for once, the Prime Minister and Chancellor lose no opportunity to laud the City of London for its exports, job creation and power of attraction - British dynamism at its best. In short, the City is the UK's jewel in the crown.

That's the authorised version. But the gap between feeble productivity on one side and soaraway profits and salaries on the other supports a quite different construction that puts a less comforting slant on the Square Mile.

In this interpretation, the City doesn't give a used fiver about productivity, either its own or that of its clients in the wider economy. For itself it doesn't have to, being an oligopoly that can charge fat margins whatever its methods: 'The usual relationship between inputs and outputs doesn't apply,' notes Don Young (www.havingtheircake.com), one-time Redland director and now consultant and author.

To the contrary: the enormous profits and salaries that are the norm in investment banking are the result of 'perhaps the biggest case of market failure the world has ever seen', in the words of Evening Standard City editor Anthony Hilton. Witness the inability of either savings institutions on one side or client companies in the 'real' economy to keep the banks' eye-watering fees in check. In truth, they have no incentive to. It's not the institutions' money, after all, and since their fortunes, and the salaries of their fund managers, depend on measuring up well against their rivals in the next comparative league table, they are willing to pay almost any price for a good deal that puts them ahead.

As for company executives, they are in no position to counter the influence the City wields over their investment strategies. City and media pressures to meet performance targets now govern senior executives' lives, research shows, while governance codes have become more 'investor-centric'. At the same time that going against the City grain is career-limiting, those who comply with its dictates can expect rapid elevation to the elite of super-earners, albeit not quite on City scales, since that is what they are measured on.

In this context, clients' productivity is simply irrelevant, since institutions are no longer investors in any real sense. Short-term pressures on fund managers mean that 'churning', as opposed to long-term holding, is rife. This has been given a mighty boost by the rise of the hedge funds, which are now estimated to account for up to 45 per cent of stock market trades in London and New York.

Unregulated, opaque, with close ties to or sometimes owned by the banks themselves (conflict of interest, anyone?) - hedge funds, Young points out, don't even pretend to invest in the future of companies. They bet on the movement of share prices, often not even owning the shares they are speculating with, borrowing them instead.

The results of the de facto collusion between the City and top management are incalculable. One, in whole or in part, is the pensions crisis. Pleasing the institutions has been a powerful if unspoken reason why managers have rushed to close their defined benefit schemes with such unseemly haste (albeit ensuring that their own schemes remain largely untouched). How else to account for the fact that last year, at the height of the pensions concern, the top 100 UK companies paid out pounds 39 billion in dividends, nearly four times as much as they invested in their final pension schemes?

Another consequence is the emphasis on the deal. Hence City veneration for companies such as Rentokil and Hanson, and in the US Enron and WorldCom, even as they run themselves into the ground. Never mind the evidence that they mostly destroy value: deals provide fee income for investment banks and share movements for hedge funds to bet on. They are the only conceivable way that companies can reach the short-term targets that institutions have obliged them to set - and if they don't, well, breaking up the company will do just as well. 'If your company doesn't enable me to meet my short-term investment objectives, no matter how misguided my judgments, it is the company that must give way - even if it is destroyed,' as Young sums up the institutional attitude.

As usual, Keynes had it right when he predicted that capital development as the offshoot of a casino was likely to yield dodgy results. The deal-orientated, short-term form it has taken in the UK leaves no time, money or understanding for the patient organisation-building work that is the foundation for enduring companies and real wealth creation, nor for large-scale investment in technology. It is no accident that the UK supports so few big high-tech firms (farewell, Marconi, dismembered and sold off last week) and noticeable that the exceptions, the pharmaceutical and aerospace companies, have what is effectively a regulated relationship with one of their main buyers: the government.

The City retains barely a shred of its initial purpose of supplying capital for long-term corporate development, now only for deals, which may be why the number of SE-quoted companies is shrinking. Yet its influence is pervasive. It is the spiritual home of asshole management, the source of the relentless demand for overperformance that demoralises employees, causes managers to jeopardise their companies and, as City court cases demonstrate, can easily tip over into bullying and harassment.

The tail is wagging the dog, the means has become the end. It's symbolic that the vast bonuses announced for City accountants last week have been generated not by creating new enterprise but by compliance work - policing the governance rules that have been installed to control the excesses of the deal culture itself. Alchemy or what? No wonder the government loves it.

The Observer, 30 October 2005


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