Select Committee on Treasury Minutes of Evidence

Examination of Witnesses (Questions 94-99)




94.  Could I welcome you all to the Committee this morning and thank you for the papers that you produced and for your appearance here this morning. For the sake of the shorthand writer, could you introduce yourselves, please.

  (Mr Brandt) My name is Richard Brandt; I am a Research Fellow at the University of Portsmouth; I was a former partner of Grant Thornton where I was Head of Audit for nine years.
  (Mrs Fearnley) I am Stella Fearnley; I am a Reader in Accounting at the University of Portsmouth and I am also an elected member of the Council of the Institute of Chartered Accountants in England and Wales.
  (Professor Beattie) I am Professor Vivien Beattie; I am a Professor of Accounting at the University of Stirling in Scotland and I also hold the part-time post as Director of Research at the Institute of Chartered Accountants of Scotland.
  (Professor Sikka) My name is Prem Sikka; I am a Professor of Accounting at the University of Essex; I am also a Trustee and Director of the Association for Accountancy and Business Affairs which is a non profit making body.

95.  Thank you all very much. From your papers, we have had a good flavour of debate and the issues involved and there are different views introduced by yourselves in the paper. Therefore, some of our questions this morning will be general to everyone and other questions will be particular questions directed at one of you. I will start with a general question and ask you, what is your general assessment of the overall way in which public limited companies are run and should we be drawing a degree of comfort from the relative rarity of major corporate collapses as an indicator that the present system in this country is broadly effective? Can you I start with you, Professor Sikka.

  (Professor Sikka) Thank you, Mr Chairman and it is a pleasure to be here. How well are companies run? Companies cover all sorts of dimensions: there are some well run businesses, large ones and small ones, and some not so well run ones. Certainly the public attention is captured by Equitable Life, Independent Insurance, Barings and many others. So that raises major questions about the protection which is afforded to stakeholders. Within the companies, there are problems in relation to corporate structures. It is good to see that the company law review has been trying to address some of those, but I fear that they do not go far enough. If I can give one example relating to non-executive directors. Non-executive directors frequently happened to be hand-picked by the executive directors and that creates a problem in terms of their accountability and relationship with the management. During the parliamentary debates on the Companies Act, 1989, I noted that one of the amendments was that the non-executive directors should be directly elected by the stakeholders, that is employees, individual shareholders and institutional shareholders, in the hope that this will give them a firm basis and they will need to be accountable to the stakeholders, and also I believe that we need to place some limits on the number of companies that a non-executive director can be a director of because corporate operations are fairly complex and it is not possible for the same person to spend one day or two days a week and actually fully get to grips with the affairs of that particular company. So, that is at the corporate level. Also, I believe that we need a major sea change in Britain because, when we look around at major companies in Britain, there has been a fundamental shift. Corporate growth is now fuelled by debt rather than equity. Whether we look at NTL, Vodaphone or British Telecom, the debt is huge and this is not the old style debt of mortgage, bank loans, overdraft, this is a debt whose value is not fixed. In other words, at the balance sheet date, whatever number you put in, it is going to be something different a week later. Also, companies themselves are speculating in the money market, speculating on the movement of money to make money. Enron was one of the biggest traders in derivatives and the same could be said for many other major companies. This really poses fundamental questions about what is to be accounted, by whom, when and how, and I have always felt that if we had a companies commission which was pro-active and looking at the direction of corporate control, how companies are funded and what the issues are, we would have a much, much better and controllable economy. At the moment, most of the companies outside the financial services sector do not really have a regulator at all. DTI is supposed to be a regulator but it is not really a regulator. Perhaps I will let the others have a say in case you are getting bored with me!

96.  Perhaps we will come back to the issue of non-executive directors because I know that one of my colleagues wishes to ask that question. Professor Beattie's submission mentioned that non-executive directors were the key to the effectiveness of corporate governance. That is obviously a very big issue which we will come back to. On the general question, could you provide me with your views, please.

  (Professor Beattie) In terms of how well companies are run and the issue of failures, I think one has to look at the whole nexus of structures and process involved in business. The particular areas that we have studied over the years would be the areas of financial reporting, corporate governance and particularly auditing and the relationship between companies and their auditors. What one finds is that we have a pretty robust system in place but there are always areas where improvements can be made and that must be true of every walk of life. One is always seeking to try to prevent rogue individuals from causing problems. The general situation that we have found in the work we do is that just about all parties in the process are trying to act quite properly and make sure that good outcomes arise. In each of these areas of financial reporting, auditing and corporate governance, we have identified problems and some matters could be addressed there. I will not go into particulars just now if you want me to just give a general view.
  (Mrs Fearnley) I think we have to recognise that, in the UK, we have the second largest capital market in the world and overall it is reasonably effective. We do get corporate collapses and, as Professor Beattie has said, we will never be able to create a regulatory framework which completely prevents corporate collapses because it would simply be too expensive and you would actually stifle capitalism if you tried to control everything in great depth. That is simply not a runner because you cannot stop people trying to be dishonest. The best thing you can do is to have a framework which does its best on a cost benefit basis to inhibit as much of this behaviour as we possibly can and also comes along, captures and beats up the people who do attempt to mislead investors and do all these really bad things. I think that is what we really have to aim for. Certainly one of the issues that has very much come out of our research is that, where you get a corporate collapse, it is a combination of circumstances which have come together in one company that have actually created that. It is not just one thing, it is a set of circumstances and these are the matters that we really need to be looking at to see whether there are any of these circumstances that do come together to create these problems that we can improve upon.
  (Mr Brandt) I do not think that we want to sound complacent because that would be wrong. On the other hand, I think that we do have a basically good system. I think it has vastly improved since the reforms in the 1990s on accounting standards, auditing standards and so on and the regulatory structures that we have. Do not let us sound complacent because things do go wrong as Mrs Fearnley has said. Everybody involved here is human and it is human to err and some of us do, and we have to pick up the pieces and the Regulator is there to limit that. However, we are always going to have these problems.

97.  Certainly from the submissions that we have had and, in my case, conversations with quite a number of people in the city, there is a wide spectrum of views and some would say, "We err. That is life and it has to go on. We can do our best." Others would say, "There is a real crisis in the accountancy profession", and it does not stop at the accountancy profession. The whole spectrum has to be looked at: investment bankers, lawyers, analysts and whatever and that needs a fundamental approach. For instance, in your paper, Professor Sikka, you mentioned the regulatory authorities as 23 and you pose the question, can you do a good job? From our Committee's point of view, we want to know whether a good job is being done or what more can be done. I do not think the public mood would stand to say that we err and we just have to get on with it and do something. It seems as if something more fundamental is required and that is where we are starting our approach in this Committee. On the aspect of the public limited companies, could I ask what degree of responsibility analysts, including financial journalists, have in terms of ensuring that companies' figures are properly assessed and whether the institutional shareholders can be expected to do more.

  (Mrs Fearnley) In our submission, we referred to the whole process of motivation and incentivisation which runs right through the capital market system. I would contest very strongly that we have a market failure in the UK. They have a big problem in the US and I do not think anybody is going to deny that and we cannot ignore the fact that it is a big problem in the US because that is the biggest capital market in the world. I think the reason that this has swept over the world in the way that it has is that the US market was the one market where people did not believe that this could happen because everybody looked to the US market as being the strongest and in fact what we do have there is a situation where the biggest and most powerful regulator in the world has actually failed to pick up a major disaster. That really runs through the standard setting, the oversight of auditors and the oversight of filings. I think we cannot say that we have a market failure in the UK at the moment, but that does not mean that we could not have one in the future if we do not address the way the markets are working at the moment. The way the markets work at the moment is that you have incentives running all the way through from the investment banks and the fund managers right through to the auditors. I think this is something to which this Committee could very valuably address itself to see whether the way in which these incentives are working are actually driving people in the wrong directions because you have the mixture of people wanting to make a living compared to the necessity of serving the public interest and not misleading investors. I think this is a very important issue for us all to look at. One of the concerns, if I can just speak on a personal issue, is that I think the Enron affair has been very much inflamed by journalism, as journalism does always build things up and then another story comes along and something else will take over. I think it has been blown up as being a very big issue in the US; I do not think it is quite such a big issue in the UK at the moment but we have to think about our own markets here too.

98.  Surely it was a catastrophe in the US. You are not saying that anyone, not just journalists, made this up.

  (Mrs Fearnley) No, it was a catastrophe in the US but I think the issue of how big a catastrophe it is in the UK is another issue altogether. We cannot ignore it because it threatens our world market.

99.  That is why we are setting up a committee to look at the implications on the market.

  (Mrs Fearnley) Yes.
  (Mr Brandt) You raised the question of analysts. In this context, American experience at the moment of the New York attorney who is suing Merrill Lynch in relation to the Chinese walls not being adequate and the analyst being the poodles, if you like, of the investment bankers, hoping to sell investments. That of course has just started and how it unrolls we will have to just wait and see. The same situation basically is with us here in London.

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