Traps remain as rising sun sets

PUBLISHED : Tuesday, 19 February, 2002, 12:00am
UPDATED : Tuesday, 19 February, 2002, 12:00am

SUCCESS PRODUCES its own justifications. Twelve years ago the business shelves of bookshops were stuffed with panegyrics on the superiority of the Japanese way.

Japanese workers were selfless and disciplined, unlike their decadent and individualistic Western counterparts. Japan's consensual society and statist industrial structure enabled it to set and pursue long-term objectives in a way that was impossible for fractious and free-wheeling Western economies.

Japan's economic march, the thesis generally concluded, was destined to leave the West in the dust.

We all know what happened next. The 1990s belonged not to Japan - the turn of the decade marked the apex of its ascendancy - but to a resurgent United States.

The US boom produced its own orthodoxy, in which the enlightened chaos of unfettered markets and individual entrepreneurialism were re-enshrined.

Now, as in Japan a dozen years ago, things turn out to have been not quite what they seemed.

The Enron debacle is causing a reassessment of the comfortable certainties underlying the US' decade of strong economic performance.

The outcome of this process may have significant implications for the future of investment and corporate governance in Asia, and investor perceptions of the region in general.

At last month's annual corporate governance symposium hosted by the Chinese University of Hong Kong, most speakers mentioned Enron only in passing.

That was a little surprising, at least to this writer. The developing scandal goes to the heart of assumptions underlying the direction of reforms in Asia.

This year's symposium carried the theme 'The Impact of Globalisation'. Implicit in the linking of corporate governance to globalisation is the idea that Asia should, or must, adopt Western models of disclosure and transparency - particularly those of the US.

Yet it is legitimate to ask whether any market should seek to model itself on a system that has allowed such abuses to occur, and which has allowed such patent deviations from the business creed it has espoused.

If a single phrase captures the corporate zeitgeist of the past decade, it is 'maximising shareholder value'.

On one level, the phrase is plain common sense. Traditional accounting does not consider all costs - particularly, the cost of equity financing.

A company increases its value only when it earns more than its cost of capital, which reflects the riskiness of the businesses it invests in.

In mathematical terms, commitment to maximising shareholder value simply means that companies invest only in projects that promise to earn more than their cost of capital. In other words, firms devote themselves to increasing the wealth of their shareholders rather than to other activities - such as empire-building growth in revenues, assets or even profits which may not increase value.

However, 'shareholder value' is not simply a matter of corporate practice. It carries cultural connotations which reflect the recent supremacy of US business. It evokes the deification of markets and investors in an era of mass stock-market investing and seemingly endless rising prosperity.

Investors and businessmen around the world bought into the idea that there was some kind of magic ingredient in the US way of doing things, just as many did with Japan a decade earlier.

The power of Enron is that it shatters this myth of superiority. It may also have given succour to those who resent the hegemony of US frontier-style capitalism.

Enron talked the same shareholder-value creed as other big multinational companies but in its behaviour was more like a heretic.

Executives pocketed millions of dollars from selling stock as the company's employees - locked in by US pension rules - saw their life savings disappear down the drain. As an unjust transfer of wealth it holds a candle to the worst abuses thrown up by the Asian financial crisis.

Meanwhile, the smoothly growing earnings that underpinned Enron's once-richly valued stock turn out to have been a product of accounting smoke and mirrors rather than genuine business expansion.

This has already produced tremors in the US stock market, as investors have taken flight from any company with even a whiff of accounting irregularities. When even General Electric - the company once headed by the US' most revered business leader, Jack Welch - has to defend its disclosure practices, you know something significant has changed.

In fact, the damage to the psychological landscape of US financial markets could in time be even more profound.

To quote from a late 1990s article by Abby Joseph Cohen, the highly influential Goldman Sachs analyst: 'This current period is extraordinary in part because the quality of earnings has surged.'

Another word for 'quality' in this context is 'smooth'. Earnings that jump around all over the place are riskier, and therefore lower quality.

In this respect, Enron should be no surprise. In the 1990s, Wall Street demanded smoothly growing earnings, so companies delivered them.

However, if the rise in US equity valuations in the 1990s was indeed underpinned by the 'higher' quality of earnings, as Ms Cohen suggests, then it is only a matter of time before investors realise that they have been robbing Peter to pay Paul. As Enron shows, you can mask the uncertainty of business for a while, but you cannot remove it.

The damage wrought by Enron will depend on the extent to which it is seen as a solitary rogue company or one of a breed. Intuition and the cockroach theory (if you see one, you know there must be others hiding) suggest the latter.

The way many companies have managed to beat Wall Street expectations by the merest sliver quarter after quarter (Cisco Systems is the prime example) is beyond credulity. As US investor Warren Buffett told Fortune magazine last week: 'No large company can grow earnings 15 per cent quarter after quarter like that. It isn't the way business works.'

So what are the conclusions for Asia? The answer is: surprisingly benign.

The myth of Asia's superiority was exploded in the 1997-98 crisis. Disclosure and transparency levels are poor and the enforceability of shareholder rights is often weak but at least there are no illusions.

Relative to the US, Asia just became a more attractive investment - not because Asian risk is any lower than it was, but because US risk has gone up.