Football Governance - Culture, Media and Sport Committee Contents


Written evidence submitted by Phil Gregory

SUMMARY

—  The following report, written by Phil Gregory, only focuses on three of the six "key points to address". There were various other situations that I would have liked to include but with one eye on the report length recommendations I mentioned issues that I felt were the most pressing.

—  Sections from this report have been loosely adapted into a series of articles published on "Untold Arsenal", to raise awareness of the issues themselves to a wide readership. The blog itself is a multi-contributor, fan-run website that deals with the various issues including the business of football and for which I am a regular contributor in this area specifically.

—  In the first section, I focus on "should football clubs in the UK be treated differently to other commercial organisations?" discussing how differences between football clubs and traditional businesses underline a need for supplementary accounting standards that take into consideration the complex nature of clubs. Then I look at highly leveraged takeovers, how they don't have a role to play in football and measures that should be taken to prevent them happening.

—  The second section is focused on the question "is there too much debt in the game?" Here I argue against arbitary limits on debt and illustrate that borrowing can be both good and bad, using the examples of both Arsenal's and Manchester United's respective debts.

—  The final section of the report focuses on the question "is government intervention justified and, if so, what form should it take?" Here I look at the financial gulf between the leagues caused by the television deal and the dangerous effects of parachute payments on competition and financial stability in the Championship.

In the following document, "n1" refers to the numbered notes included at the end of the main body of the report, while footnotes are used to give key references.

SECTION ONE: ACCOUNTING STANDARDS

1.  Given the complexity of football when compared to a more traditional business, I have always found it strange that it is subject to the current "one size fits all" model of legislation. Few other businesses pay vast fees to secure employees, nor do they pay their employees in a complex manner that includes basic pay, image rights and performance-related bonuses, and yet no special demands are made of football clubs to disclose this variety of payments clearly in their annual financial statements.

2.  This greatly limits financial transparency within the industry. With outside observers relying on measures such as wages as a percentage turnover to gauge a club's sustainability, the lack of breakdown of the "wage" means that any conclusions drawn are unreliable at best.

3.  A dramatic rise in wages could be because of a significant outlay on players and the resulting salaries, or it could be because of high bonus payments due to unprecedented success. For this reason, I believe it vital that club accounts at the very least list separate figures for basic salaries and bonuses. Indeed, this situation arises despite the fact that a significantly greater breakdown of the wage bill is offered to HMRC yet only a very unreliable figure "wage" is made public.

4.  The lack of transparency goes beyond salaries, however. Given the multi-million pound transfer fees paid for many players and the significant percentage of turnover this represents for many clubs, such expenditure has a bearing on the club's financial situation going forward. Despite this, there is no requirement to detail in club accounts the amount(s) and nature of incoming/outgoing transfer fees for a financial year due to the unsurprising fact that accounting regulations were simply not written with current trends in world football in mind.

5.  The sole measure of transfer spending offered in the accounts is amortisation,n1 which can be used to gauge trends in transfer expenditure but little beyond that. "Player/football trading" figures are given in club accounts but are unreliable, often including amortisation and other charges to mask the amount spent on transfers. In addition, amortisation offers the club the ability to spread the cost of a player in the profit and loss account over the life of their contract, which doesn't reflect adequately when payments are made. Of course as a cash-cost, such information should be ascertainable by looking at the cash flow statement, but figures are often hidden by being grouped with others, or seemingly not even given.

6.  It is my belief therefore that the profits or losses of a club for a specific year should reflect much more accurately the transfer expenditure for that year. There should also be specific disclosure of the total level of transfer income and expenditure during the year, with additional information given on outstanding transfer clauses that may result in future income or expenditure to aid financial forecasting of the club.

7.  Unfortunately, there are further, broader issues in regards to football and financial accounting. SSAP25, which covers the reporting of the various segments of a company's revenue, states that: "...in the opinion of directors, the disclosure of any information required by this accounting standard would be seriously prejudicial to the interests of the reporting entity, the information need not be disclosed"[1] (emphasis mine). By this, clubs can decide not to breakdown their turnover into its constituent parts if they choose not to, severely limiting the ability of an outside observer to understand the inner workings of any football club which exercised this right. In the wider business world, directors need the ability and freedom to act in the interests of their company and there are credible arguments that forced disclosure would at times be a hindrance in this regard. However I once again emphasise the fact that football clubs are unique entities with responsibilities to their supporters, and the flexibility that directors possess in other lines of business should not be granted to football. A simple solution to this issue would be the compulsory requirement of full disclosure for clubs, overruling SSAP25 in this regard.

8.  Hence it can be seen that the current "one size fits all" system of accounting standards is inadequate to accurately account for a club's various activities. The solutions proposed to the problems raised in this section could be introduced as a supplementary standard to which football clubs must satisfy, in addition to the existing regulation. Where the two standards conflict on an issue (as with SSAP25 and the option of non-disclosure) the supplementary standard must overrule the pre-existing legislation. As part of this standard, I would also add rules standardising the categorisation of match day, commercial and broadcasting revenue to ensure that financial statements between clubs are easily comparable.n2 While the suggestions here are not exhaustive and there are other issues that would need to be looked at for complete standardisation of club financial statements, these changes would be a big step in the right direction.

Leveraged Buy-outs

9.  In addition to accounting standards, there is a further area in which I believe there are substantial differences between football clubs and traditional businesses, that of leveraged buyouts (LBOs). Brought to the forefront of the public consciousness by the controversy that surrounded Liverpool FC's former owners, leveraged buy-outs are fairly common in the business world. Their primary benefit is the fact that they offer an additional way to change the management running of a company, while they also act as an incentive towards best practice for the current incumbents.

10.  A person seeking to launch an LBO does so considering the costs and benefits to themselves of such an activity. In the longer term, if the LBO proves to be successful they will benefit from profits they wouldn't otherwise have received, while conversely if it fails they suffer the costs resulting from the liquidation of their business. Such a model works well for traditional business, where the impact on society of a firm of comparable size to a "top four" football club by turnover (say a large supermarket store) collapsing is not especially significant on the national level.

11.  However, one has to consider that a football club is more than simply a business, and the effects of the liquidation of a football club are much more profound than that of a similarly-sized business. A club represents an identity for fans, who should be viewed as "emotional stakeholders" in the club, whose wishes and interests should be considered like any other stakeholders' would be. It is unthinkable that in a highly risky business venture the interests of any significant stakeholder would go completely unconsidered, yet this is exactly what happens when we consider the emotional stakeholder that every single fan is.

12.  In my view additional regulation is needed to rectify this weakness in the existing rules governing takeovers, and it would not need to be especially complex. As an LBO poses a risk to a club due to the high amounts of debt secured onto it as a result of the takeover, the solution would be to simply introduce a low limit on the amount of debt that can be used to fund a takeover, for example no more than 20% of the funds used can be borrowed. In addition to this, setting a limit on the level of dividend withdrawal would close a further avenue for withdrawal of funds to pay debt costs, as well as rectifying the FA's error in allowing Rule 34 to be circumvented in 1983.n3 This would be in line with the approach taken by UEFA in their Financial Fair Play proposals, under which dividends are included as a "relevant expense". Such fairly simple measures would render LBOs impossible, to the great benefit of the English game.

SECTION TWO: DEBT

13.  It is my view that debt in itself is not a problem when it is both cheap (serviceable by the club's cash-generating activities), long term and is used to strengthen the club in the long term. While these criteria unfortunately don't apply to much of the debt within football, I feel arbitrary limits on debt are unwise as they would prevent debt being used at all, even if the intention for the debt met the above criteria. In order to illustrate how in certain cases debt can be beneficial to the game and shouldn't be regulated out of existence, I'm going to examine the differences between the debt burdens of both Manchester United and Arsenal FC respectively, two clubs of similar standing in the Premier League.

14.  Arsenal used debt to fund the Emirates stadium project and the redevelopment of Highbury into flats. Figure one illustrates the impact this had on Arsenal's turnover, which increased by over 46% between the years 2006 and 2007 thanks to their move into the new ground. As can be seen on the same graph, this enabled wage spending to not only rise, but to do so sustainablyn4 (figure two) thanks to the turnover growth. Finance costs were low, so were no obstacle to debt repayment. The bank loans that were initially taken out were replaced by long term bonds (maturities of between 21 and 23 years), offering stability as well as saving on interest, too. Debt incurred as a result of the redevelopment of Highbury into apartments was cleared as a result of its own sales, eventually generating significant funds for the club. From this therefore it is clear to see that the debt itself was cheap and long-term, while its use is already showing signs of having improved the club's long-term financial and sporting position.

15.  Manchester United, on the other hand, gained their debts as a result of the Glazers' takeover in 2005. The majority of the funds were provided by bank loans which were secured against the club's assets, making it a leveraged buy-out. The remaining balance was contributed by the controversial "payment in kind" loans (PIKs) with a restrictive 14.25% rate of compound interest, although these are secured against a parent company rather than the club itself. In March 2010, Manchester United refinanced with a £500m, seven year bond issue which costs between 8.75% and 9% interest. When contrasted with Arsenal, Manchester United's debt cannot be considered cheap, nor particularly long-term.

16 The question of whether the debt even improved the club (by financing the takeover) does not have a clear-cut answer. Looking at Manchester United's finances since the 2005, it is clear from figure three that they have experienced a significant growth in turnover since the takeover. However, much of the growth is from TV broadcasting rights, negotiated by the Premier League. Significant commercial revenue growth is laudable, but increases in match day takings aren't given they are largely as a result of the 47% rise in ticket prices between the start of Glazer ownership and 2009.[2] Such profiteering behaviour simply prices the local fan out of supporting their team, shown by the almost total depletion of the season ticket waiting list. Given these actions are undoubtedly related to the significant funds required to service the takeover's debts, it is an unacceptable situation and should lend further weight to my earlier concerns regarding LBOs.

17.  Given this, I think it would be an error to place arbitrary limits on debt as these would have prevented Arsenal carrying out their stadium work, and similar project by other sides in the future. Moreover had the previously stated LBO reforms existed in 2005 would have prevented the debt burdens of Manchester United and Liverpool ever occuring, two of the clubs most heavily indebted during in recent times. For the traditionally smaller sides, debt is often incurred as a result of attempting to compete, a situation I will examine in depth in the next section. Overall, I believe excessive debt is merely a symptom of other problems rather than a problem in itself, and the underlying reasons for the excessive debts must be dealt with rather than simply applying the sticking plaster of arbitrary limits on debt.

SECTION THREE: TV DEALS, THE FINANCIAL GULF BETWEEN LEAGUES AND GOVERNMENT INTERVENTION

18.  In my view, much of the overspending by football clubs is as a result of the desire to get into the "promised land" of the Premier League or indeed simply stay there. With its vast TV and sponsorship deals in comparison to those of the Championship, the current season's bottom-placed side in the Premier League will get approximately £42 million. When contrasted with the £2.3 million (plus sponsorship) that the winner of the Championship will receive, it is clear why there is such a huge incentive for lower-league sides to seek promotion at any cost, literally.

19.  The prevailing reasoning amongst Football League sides seems to be that excessive levels of spending can be sustained for a few years within which promotion must be achieved. After that, Premier League-level revenues can be used to pay off all the debts accrued.

20.  There are two main flaws to such reasoning. Firstly, a club may not get promoted within the time frame nor ever, given there are many more clubs that seek to be promoted than can be come the end of the season. Secondly, upon arrival in the Premier League, most clubs spend even more in order to stay there, as well as incurring high bonus payments and basic salary increases reflecting the new Premier League status of the playing squad. Hence instead of securing the club's financial position by clearing debts, clubs continue to spend unsustainably as they now cannot afford to be relegated.

21.  Of course, such a high-risk approach is fraught with danger for the clubs, but unless a club spends on a similar level to its competitors it will struggle to be promoted. Hence promotion, by rewarding overspending, actually rewards bad practice, something that should be anathema to anyone with an understanding of economics. Arsène Wenger put it best when he stated: "Something that is more irrational in football is that sometimes non-rationality can be rewarded. But nine times out of ten it doesn't work so nine times you are in a bad situation". Unless the cause of this irrationality, the financial gulf between the leagues, is dealt with football clubs can't be expected to show restraint while their competitors have a competitive advantage due to excessive spending. Financial sanity can only be restored by eliminating the perverse incentives rewarding bad practice.

22.  Hence the problem lies in the financial gulf between the leagues, a result simply of there being too much TV money in the Premier League when compared to the Championship. The Premier League's wealth is no bad thing; it creates a spectacle seen all around the world with many of the best players plying their trade in our country, all of whom are paying vast amounts in tax to HMRC. While the Premier League is making more solidarity payments to the Football Foundation than ever before,n5 the Football League's television and sponsorship rights are simply much lower, resulting in Football League sides receiving vastly smaller payments in comparison to their Premier League counterparts (figure four).

23.  The biggest impact of this is that the payment received by a Championship side is dwarfed by that of a Premier League side, as illustrated by figure five. From this, it is clear to see that while TV money received by a League Two side is over 75% the amount of a League One side comparing a Championship club to a Premier League club gives a figure of only 5%. Considering the Premier League's distribution of its own money to Premier League clubs is highly equitable,n6 and Richard Scudamore's apparent awareness that a strong Championship is genuinely in the Premier League's interest[3] it is bizarre that they have allowed the Football League to fall so far behind in the broadcasting money stakes, given three out of 20 of Premier League are always previously Football League sides the season before. Action needs to be taken to reduce this financial gulf, but more needs to be done than additional payments from the Premier League to the Championship. My proposal would be the removal of parachute payments and the redistribution of that money to the Football League, achieved via government interventionn7 if necessary. I will explain the issues surrounding parachute payments and justify this course of action in the following section.

Parachute payments

24.  Unfortunately, the gulf between television and sponsorship alone does not account for all of the issues in the Championship, parachute payments have a large role to play too by distorting competition. Parachute payments are given to relegated clubs out of the Premier League's revenues, designed to soften the financial blow of dropping to the Championship for recently relegated sides.n8 In practice, the payments aren't used to reduce losses, going instead towards maintaining a Premier League-sized wage bill despite Championship-level revenues, in an attempt to maximise the chances of promotion. This drives other promotion hopefuls to spend yet more money they don't have, exacerbating an already unsustainable situation. Despite opposition from Football League chairmen, the Premier League decided it would be a wise idea to increase the amount of money in parachute payments to £48 million over four years from £32 million over two years.n9

25.  When these payments are added to the club's Championship television revenue, they are receiving a total of £18.3 million of broadcasting revenue against a mere £2.3 million for their competitors. This clearly gives recently relegated sides an unfair financial advantage ("financial doping" to coin an apt phrase Arsène Wenger used to describe a similar situation) in the promotion fight. The net result is the non-recipients spending more money they don't have in an attempt to remain competitive in the promotion battle, worsening an already precarious financial situation. Again, hugely distorted incentives are evident and failure is rewarded, culminating in a both economically and socially undesirable outcome.

26.  If parachute payments are a reward for failure and an impediment to good practice then it stands to reason that removing them would improve the overall situation. While clubs will have budgeted for the payments which prevents their immediate removal, I would propose doing so from as early a date as possible and redistributing the money to the Football League. I'll illustrate the greatly beneficial impact this redistribution would have on the Football League in the following paragraph:

27.  While parachute payments can total a maximum of £48 million for a single club, they stop if that team is promoted back to the Premier League, hence the amount received may only be £16 million if a side is goes back up immediately after relegation. From analysing sides relegated from the Premier League between the Millennium and the 2005-06 season,n10 it can be seen that a relegated side on average take three years to get promoted.n11

28.  Hypothetically, complete removal of parachute payments for next season would therefore save £120 million over three years that could be redistributed equitably amongst the Football League sides. Doing this would raise the amount received by every club in the league by £1.66 million in 2011-12 season, to £3.96 million, nearly doubling the size of the Football League TV deal in relation to the Premier League TV deal in the first year of redistribution (the percentage improves to 9.36%).n12

29.  The amount would increase by an additional £1.66 million for season 2012-13 and the same again for 2013-14, reflecting the additional money coming in from subsequent years of parachute payment funds being saved and added to the Football League's funds. By the 2013-14 season, the Football League TV deal would plateau at £7.3 million, which would be more than 17% the size of the money received by 20th placed side in the Premier League. Solely by removing parachute payments and redistributing the money fairly, with no additional payments required from the Premier League, the size of the Football League's broadcasting revenue has more than tripled in relation to the Premier League, reducing hugely the financial gulf between the two leagues. When that is considered alongside the benefits in terms of competition resulting from the removal of the unfair parachute payments, the financial health of the Championship going forward would be greatly improved by the adoption of these measures.

30.  Premier League clubs would naturally protest such a change, as it gives lower league sides an opportunity to break their hegemony. In addition, they could attempt to point to the large difference between Premier League and the Championship revenues as evidence that they need parachute payments. While these reforms would reduce that financial gulf, a gap would still remain and relegated clubs would have to cut their costs substantially in order to remain financially secure. Instead of an undesirable yearly fire sale of players from relegated sides, all that is needed is contract clauses whereby player wages are cut in the event of relegation. Such clauses already exist but are not universally utilised, as it may be an obstacle to a obtaining a player's signature in the first place. If this proves to be the case, it will be needed to legislated that all player contracts must include such a clause, so that clubs don't gain a competitive advantage by not using them. Such a change is perfectly in line with the wider world, as any business that experiences a fall in revenues is forced to cut costs drastically. Indeed if the playing squad gets paid more for an exceptionally good league position, does it not make sense that relegation results in wage reductions?

NOTES TO THE REPORT

1.  Amortisation is calculated as the value paid for a player divided by the number of years on their contract, High transfer spending will therefore result in high amortisation charges. The year on year changes in amortisation gives an indicator of whether transfer spending is rising or falling, but offers no insight into payments for individual players.

2.  Clubs could for example logically categorise executive box revenues as either commercial or match day income, leading to difficulty in cross-comparison of financial statements. There are also other less logical categorisations distorting financial statements, such as Birmingham listing a compensation fee received for manager Steve Bruce under "commercial revenue" when it is surely a one-off payment.

3.  Rule 34 prohibited directors from being paid salaries and limited dividend payments to shareholders. In effect, it stopped clubs being taken over and stripped of cash by their owners, ensuring football's money stayed within football. The rule can be bypassed by forming a holding company above the club itself, and so the rule is easily evaded nowadays.

4.  Wages as a percentage of turnover only exceeded 50% the year before the Emirates was opened, likely in anticipation of the jump in revenue which pushed it back down to its target range.

5.  Prior to the current agreement, 5% of the broadcasting and sponsorship revenues went to the Football Foundation. Now, after government intervention, 6% of the first £1.1 billion, 7.5% of the next £300 million and 10% of any money raised in excess of £1.4 billion goes to the football foundation. With domestic, highlights, and international rights as well as sponsorship money coming to nearly £3.5 billion, this is a vast contribution to the Football Foundation and fantastic for the grass roots game.

6.  Domestic rights are divided as: 50% equally, 25% according to number of televised appearances and 25% according to league position. All money raised by selling rights abroad is divided equally

7.  Government intervention proved invaluable in securing the changes specified in note 4, and so has a good track record of results. Labour MP and former Minister of Sport Richard Caborn negotiated directly with Richard Scudamore, Chief Executive of the Premier League to extract the concessions for the Football Foundation.

8.  The fact that such a thing even exists is testament to the gulf between the Premier League and the Championship. You don't need a parachute to drop between the leagues that make up the Football League, for example.

9.  This was dressed up as a solidarity payment, but as demonstrated in this section of the report it is actually greatly detrimental to the Championship, and Premier League clubs likely voted for it as they desired the money to get back promoted in the event of their relegation. They were simply voting to create a more closed shop and dressing it up as an act of charity.

10.  Data ended at 05/06 in order to allow sufficient time to see if a club got promoted within four years of relegation. Using any more recent seasons would have meant that the data cut off after three, two or one year(s), distorting the results.

11.  The average is slightly deceptive here, as the results tend towards the extremes, however it doesn't affect the results. The majority of clubs that get promoted after relegation do so after one year, the rest after two. The remaining clubs didn't get promoted at all, so would've drawn on the full four year allowance of parachute payments, and so were entered as a "four" for the purposes of the average.

12.  The downside not mentioned in this example is that by solely increasing the money in the Championship, the gap between that league and League One has now increased. Hence any increase in money to the Championship must also result in a proportional increase in money to the other leagues. This would slightly reduce the money available for the Championship, and therefore lower the comparative percentage against the Premier League slightly.

13.  Given the increased revenue in the Football League as a whole, perhaps 25% of the total could be paid on a performance-related basis, or in the event a club reports an operating profit (prior to the payment, of course). Such a change wouldn't distort competition but the former would reward success and the latter sustainability incentivising desirable behaviour.

APPENDIX

Figure one


Figure two


Figure three


Figure four

BEAR IN MIND THAT FOR THE GRAPH BELOW, IF A TEAM FINISHED HIGHER THAN 20TH IN THE PREMIER LEAGUE, THEY WOULD RECEIVE EVEN MORE MONEY, WHEREAS FOOTBALL LEAGUE FUNDS ARE DIVIDED EQUALLY WITHIN EACH LEAGUE


Figure five


Note how each TV deal is relatively smaller than that of its "parent" league as you go up the Football league.

January 2011


1   http://www.frc.org.uk/images/uploaded/documents/SSAP%2025.pdf Quote taken from paragraph number six, found on page 3 of the document itself. Back

2   http://www.independent.co.uk/sport/football/premier-league/manchester-united-announce-large-increase-in-ticket-prices-446230.html Yearly increases between 2005 and 2009, to a similar level as those reported in the link given, have been the norm for Manchester United fans when renewing season tickets. Accessed online 15/1/2011 Back

3   "The Premier League clubs felt a stronger Championship would be greatly beneficial to both competitions" http://news.bbc.co.uk/sport2/hi/football/eng_prem/8886558.stm accessed online 15/1/2011 Back


 
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© Parliamentary copyright 2011
Prepared 29 July 2011