(fwd) FT article, corporate mafia

Mervyn Hartwig mh at jaspere.demon.co.uk
Wed Apr 17 16:23:51 MDT 2002

'Behold, I teach you the Superman.' - Nietzsche

It must be getting pretty grim when the corporate mafia are exposed in
one of the leading organs of finance capital. The historically
unparalleled grab for private wealth and power is of course the other
side of the coin of 'full spectrum dominance' and the surplus extraction
from all over the globe that it promotes.

Mervyn Hartwig

COMMENT & ANALYSIS: A buy-out without the buying: Institutional
investors are waking up to the privileged position that senior managers
have acquired, and they are not happy
Financial Times, London; Apr 16, 2002

We have seen it in a thousand gangster movies. Scene: the Little Italy
of an anonymous big city. A family restaurateur has a visit from a
sharp-suited young man who offers him a cheap laundry service, just as
his traditional laundry supplier mysteriously goes out of business.

He signs up, and then the price starts to rise to levels that affect the
performance of the business. The restaurateur says he wants to change
suppliers again, but is told that unpleasant things happen to former
customers. To ram the point home there are a few acts of vandalism.

So the restaurateur makes the best of a bad job, and abandons his
attempt to escape. The news is warmly welcomed by the man in the sharp
suit. But his parting words are ominous: "You've got a new partner now".

Institutional investors in recent weeks must have been running through
the same gamut of emotions as the fictional restaurateur: anger, denial,
fear, realisation that there is no one to turn to, reluctant
accommodation and long-term, slow-burning resentment. For they too have
a new partner now - senior management of the companies in which they are
shareholders, who have deftly inserted themselves into the gap between
the owners and the business.

This process has been going on for a few years, but the comparison with
Little Italy has only become clear in the past few weeks as companies
have reported their 2001 results. For, as with the Gambino family, the
partnership enjoyed by the most senior managers at some of the world's
biggest companies is not a true one. They do not share fully in the
downside, as the comparison between miserable earnings reported to
shareholders and healthy rewards accruing to managers make clear. They
are ersatz partners, like those in gangster movies - suppliers of a
routine service who have arrogated the privileges of partnership without
suffering the drawbacks.

Institutional investors have been grumbling about top management pay for
some time, as have politicians, trade unions and ordinary workers. But
although there was - and is - a debate to be had about equity and
morale, the economic impact of high salaries has always been limited. As
a proportion of the total value created by the company, the pay of top
managers was small.

That is much less true after the huge pay inflation of the 1990s and the
apparent ability of top managers to hold on to those gains, even though
returns to shareholders have weakened with the end of the bull market. A
calculation of US bosses' remuneration carried out by Mercer Human
Resource Consulting for the Wall Street Journal includes some eye-
watering numbers. James McDonald of Scientific-Atlanta last year gained
Dollars 86.6m (Pounds 60.2m) mainly by exercising share options; Tony
White of Applera, the biotechnology company, received a total of Dollars
61.7m; and Douglas Daft of Coca-Cola Dollars 54.9m. Total shareholder
return for the year was negative at each of these companies.

Before I am inundated by lawyers' letters from senior managers ("My
client has never participated in the laundry business . . . his brother
is not, contrary to your defamatory suggestion, unusually clumsy . . .
there have been no suspicious fires in the neighbour-hood . . . he does
not even like Frank Sinatra . . .") let me shift the comparison.

Another way to look at what has been taking place as a management buy-
out, without the "buy". When an MBO takes place, the conventional equity
relationship, in which outside shareholders own the company and managers
act as their agents, comes to an end. It is succeeded by one in which
most of the equity is replaced by debt. The managers are no longer
salaried agents but principals. They own the shrunken equity, along with
their outside financiers.

When managers are able to extract very large, asymmetric payments from
the company, the MBO comparison is relevant. The only difference is that
the historic equity holders are not paid off and do not exit. Instead,
they surrender a portion of their equity rights to the managers, who
start acting more like principals than agents. Over time, I suspect, the
return to the historic shareholders will start to take on some of the
debt-like characteristics of MBO finance: capped returns and a steadier
flow of income, modified by the possibility of default.

Another striking change is the way the route to riches has altered.
Traditionally, great wealth accrued to genuine entrepreneurs - Bill
Gates, Rupert Murdoch, or Larry Ellison of Oracle - who created their
businesses from nothing.

The entrepreneurial personality is not the easiest to deal with, but
persistence, tolerance for risk, flexibility and willingness to recover
from disaster deserve exceptional rewards. Since relatively few
entrepreneurs succeed on a grand scale, and many fail, the risk-reward
ratio seems socially tolerable. For such people, the route to the top is
both simple and brutally demanding. As Barry Riley once memorably wrote
in these columns, there is only one way to become an entrepreneur - pick
up the phone and start dialling.

The route to corporate riches, through today's new ersatz partnership,
is quite different. The victor is the courtier or the civil corporate
bureaucrat, the graduate not of the academy of hard knocks but Harvard
Business School. Of course, to get to the top of a big company you have
to be intelligent and hard-working, too. But the essential skill, the
one that distinguishes the ordinary divisional manager (who by and large
does not share in the wealth) from the handful of top managers who do,
is the ability to clamber upwards through an organisation. Is this a
skill that we wish to reward on such a scale?

I don't know society's answer to that. But I have a pretty good idea of
institutional investors' view (at least as long as they can set aside
their chances of rising to the top of their own hierarchies and so
entering the wealth zone themselves.) As with the Little Italy
restaurateur, they are starting to wake up, with a dull but growing
resentment, to what they have allowed to happen. They see nobody to turn
to for help. Corporate governance codes, like the complicit police force
of a Mafia-ridden city, offer no real solution.

In the movies, the victimised small businessmen have no option but
rebellion, with all its risks, and the recruitment of a new set of
policemen who can enforce a new and stronger code. In time, investors
will learn the same lesson. But do not expect them to act any time soon.

peter.martin at ft.comCopyright: The Financial Times Limited 1995-2002


Mervyn Hartwig
13 Spenser Road
Herne Hill
London SE24 ONS
United Kingdom
Tel: 020 7 737 2892
Email: <mh at jaspere.demon.co.uk>

There is another world, but it is in this one.
Paul Eluard

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