Examination of Witnesses (Questions 94-99)|
TUESDAY 16 APRIL 2002
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
(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
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.