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Smart Investor: what can we learn from the Barclays debacle?

The ongoing debacle surrounding Libor fixing has thrust the actions of senior management into the limelight once again.

 
Smart Investor: what can we learn from the Barclays debacle?

Heads have rolled, some more will probably roll over the coming weeks, politicians will jump on the bandwagon, and the media will increase the number of column inches dedicated to discussing the obscene pay levels of FTSE 100 executives.

Interesting as they are, these events are of little practical value to the private investor. You may find them entertaining, but they offer little guidance as to whether a particular company should be bought, held or sold – an investor’s only options.

Do chief execs matter?

Moreover, in spite of what various commentators will inevitably say about the prospect of investing in Barclays (BARC.L) or another bank involved in the Libor scandal, a rotten chief executive does not matter as much as you may think. Of course, a leader who is inadequate in terms of their ability or honesty is no good thing for a company, but one must remember than an investment is being made in the company, not in the management.

For instance, a company may have an excellent track record, high return on equity, be financially sound and have a substantial economic moat through providing a unique product. Then the chief executive may change and things may begin to go downhill. However, this does not mean that the company is not worthy of investment.

Its performance may suffer in the short run, but when purchasing a slice of the company, an investor buys a slice of the net assets and a portion of goodwill and nothing more. It is up to management to decide how assets are used and, if they are not being used efficiently, then changes to management will eventually be made.

The problem, then, comes when ineffective management are not given their marching orders in spite of poor performance. There are any number of companies where this is the case, where the asset base and products are far better than the company’s performance and profitability suggest.

Case study: Greene King

In addition to performance, a company’s financial viability is the responsibility of senior management. My recent piece on pub operator Greene King highlighted its large pile of debt; although this is quite common in the pub industry it is evidence that management (past or present) has done a poor job running the company.

Again, inadequacies in this arena should not be tolerated by boards.

Boards must take action

The issue of boards tolerating poor performance, lax financial management or dishonest practices may be the most worrying aspect to come out of the Libor-fixing scandal. It appears that boards are somewhat lacking in guts when it comes to standing up to the aforementioned failures.

Companies such as Xstrata (XTA.L) and Thomas Cook (TCG.L) spring to mind, with Xstrata’s board happy to sign off ludicrous retention payments to Xstrata/Glencore management. And Bob Diamond only stepped down once political pressure made his leadership untenable.

So, the best thing that can come out of the ‘shareholder spring’ is, in my view, not for senior management pay levels to fall, but rather for boards to receive a substantial kick in the derriere.

This would mean that if assets are not being used efficiently, if debt is becoming a problem, if a company’s profitability is not adequate, if dishonesty is present on the current management’s watch, then the board shows no mercy and swiftly finds a replacement.

Otherwise, one might reasonably ask, exactly what purpose do non-executive directors and the boards they sit on serve?

4 comments so far. Why not have your say?

David Harvey

Jul 06, 2012 at 12:55

We can learn that Capitalists are Capitalisms worst enemy.

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Sinic

Jul 06, 2012 at 13:08

All well and good, but most CEO's, certainly of FTSE 100 companies, have pre-negotiated golden parachutes in place at least as obscene as their remuneration packages so they are in a win/win situation. Some walk away after just a few years of mediocrity or outright failure with a pay off exceeding what the average working man makes in a lifetime of toil. The culture of rewarding failure almost as generously as success must change, and the first step on the way to doing this is to reform the cosy reciprocity of non-execs controlling the remuneration committee.

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David Harvey

Jul 06, 2012 at 16:10

The way I see it is that we have a capitalist government that is pushing capitalism as our way out of this. Frankly I see no sign of it. The average voter has had a cat walk of bad behaviour not just from the banks but also from politicians. While that same average voter is bludgeoned with austerity to a point where he can't contribute to growth, these people are allowed to avoid no end of tax via various loopholes and the money they are accruing at an astonishing rate is not helping the country recover.

What effect will this have on the next election? Why can't our leader clean up his own capitalist back yard? Will capitalism begin to appear to be the problem? When will they stop blaming the previous government?

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Jeremy Bosk

Jul 08, 2012 at 18:19

Non-execs are appointed by the permanent directors, not the shareholders. They know which side their bread is buttered. The shareholders have to vote on this at the AGM but are usually very diffuse and getting together to make the board behave is very difficult and time consuming. It is much cheaper and easier to simply sell the shares in a badly led company. Not to mention that small shareholders are effectively disfranchised by pooled nominee accounts.

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