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27 November 2010

Two Leading Ladies

Tag(s): Boards, People, Politics & Economics

In the past week I have had the pleasure of hearing two excellent speeches by two outstanding ladies who have both had major careers in British public life.

First, at an intimate gathering of business figures Ruth Lea, the distinguished economist, gave her views on the current economic crisis.

Ruth Lea is currently Director of Global Vision and Non-Executive Director and Economic Adviser to Arbuthnot Banking Group. Ruth was Director of the Centre for Policy Studies from 2004-7. She was also head of the Policy Unit at The Institute of Directors between 1995 and 2003, before which she was Economics Editor at ITN, Chief Economist at Mitsubishi bank and Chief UK Economist at Lehman Brothers.

She also spent 16 years in the Civil Service at the Treasury, the Department of Trade and Industry and the Central Statistical Office. She has served on the Council of the Royal Economic Society, The National Consumer Council, and the Nurses’ Pay Review body, the ONS Statistics Advisory Committee, the ESRC Research Priorities Board and the Retail Prices Advisory Committee.

She first spoke of the crisis in Ireland and claimed to have forecast it many years ago. In the early 1990’s she was on a panel of economists in Dublin with representatives from Germany, France and Ireland. She was alone in foretelling the terrible things that would happen to Ireland if it joined the euro and tied its economy to that of Germany. She was practically run out of town for this blasphemy but she now insists that she was right in that very disparate economies cannot coexist in a single monetary framework.

Of course, Ireland has compounded that error by guaranteeing the debts of its banks thus raising public debt to an unsustainable level. She sees no choice but for Ireland to leave the Euro while recognising the intense political support all round Europe to maintaining this house of cards.

And what of the UK? Here she was more circumspect holding reasonable hope for a sustained recovery. However, her concerns are that because of the announced slowdown in public expenditure, whilst interest payments increase by 50% over the next four years, the burden of growth will fall on the private sector. It has achieved it before but since then the UK has considerably hampered its competitiveness through increased regulation and tax and a very expensive energy policy. ( Afterwards I told her that this was the only thing with which I could disagree in her speech as I could not detect a policy.) She also deplored the lack of broad understanding of economic matters in the media with too much focus on a few indicators while vital metrics like the Balance of Payments, which of course is horrendous, is rarely talked about.

Next I was privileged to hear Baroness Hogg deliver the Annual Marketors’ City lecture at the London Chamber of Commerce. The daughter of Lord Boyd-Carpenter, the former chief secretary to the Treasury and paymaster general, she is married to Douglas Hogg, the Tory politician and former agriculture minister. A life peer in her own right Baroness Hogg is chairman of the Financial Reporting Council and of Frontier Economics Limited, Senior Independent Director of BG, a Member of the Takeover Panel, Senior Adviser to the Financial Services Authority and a Governor of the London Business School. She has been on the board of 8 major companies including a stint as Chairman of 3i. Baroness Hogg is a former head of the Prime Minister’s Policy Unit from 1990-95 and has extensive experience of the media leading the economics coverage of The Economist, The Times and The Daily Telegraph and serving as a Governor of the BBC.

Baroness Hogg chose to speak on Governance and Reporting- Creating and Sustaining Trust. We had to recognise that as a result of the credit crunch business, and particularly the financial services sector, had lost trust to a grave degree. The biggest lesson from the crisis was that we should follow best practice. There was no single cause of failure but it was necessary to raise our game.

Equity markets run on trust. Investors need to be confident in how the companies in which they invest are run. There are three main ownership models. Private equity requires commitment from investors and there is little problem of agency between investors and management. In family businesses there is intergenerational continuity and, while succession has to be managed, if it is trust will be implicit.  Quoted companies provide liquidity and continuity but may destroy trust. Equity capital must flow and shareholders must not see their rights flow to regulators as is being advocated in Europe.

She wants to see a renewed emphasis on the Board’s responsibility for risk, both in terms of risk appetite and risk control. After all the Board came into being to deal with the issue of agency between shareholders and managers. The FRC has reissued its code but with continued emphasis on the principle of “comply or explain”, thus giving the Board the freedom to run its affairs as it sees fit provided it is transparent in the process.

Baroness Hogg believes that trust is fundamental to economic growth. She outlined three trust models. In small societies the repeated gain model worked on the basis that I will only do business with you if I can trust you and this is reciprocal. This evolved into “my word is my bond” but Big Bang may have destroyed this in financial markets. The legal model works in that we trust the legal framework rather than each other. If something goes wrong we can sue. While there is evidence that a legal framework is necessary for economic growth to protect property rights, for example, when taken to extremes, as in the litigious US, it may actually be a brake on growth as Boards are hemmed in by legally inspired advice. The third model which she advocates is transparency. The trust gulf should be bridged by openness. This is related to the “comply and explain” principle of governance. There are several limitations to this model too as recent history shows. The coalition government has just issued extensive details of expenditure but too much information may not be helpful and irresponsible journalists can play fast and loose with bits of data taken out of context. It may lead to sofa government rather than well recorded meetings to avoid paper trails that are open to freedom of information requests. And it can lead to the leaden weight of boiler plate language.

This model of “comply and explain” is being pioneered by the UK while the US sticks to its rule based culture which never prevents the crooks but may catch out the innocent in unintended mistakes. Meanwhile Brussels is sceptical of shareholder rights and continues forward on its dirigiste path seeking for example to take the decision on who is the auditor away from Boards which can only undermine their accountability. The FRC now advocates a stewardship code and this is indeed a global first. Shareholders, insists Baroness Hogg, can be responsible owners and 75 major investment houses have already signed up to the code. The question now is how to elevate this to an international level and Baroness Hogg remarked with a chuckle that she had heard EU officials starting to mutter about “Le Stewardship”!

What these two outstanding ladies have in common is not just their intellect and deep understanding of economics; nor their ability to explain complex issues to an audience that may lack their technical understanding. No, for me their really exceptional quality is to see the complex issues from a holistic perspective. What is needed on Boards is that ability. Too many Boards select their directors for specialist knowledge but in the assessment of risk what is needed is the insight to link apparently disconnected factors and show how they do connect and thus cause systemic failure.

Copyright David C Pearson 2010 All rights reserved

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