Transcript Moral Capitalism and the Future of The Sustainable Corporation

Modern Capitalism as the
Solution to the Financial
Crisis:
The Caux Round Table Approach
Stephen B. Young
Global Executive Director
The Caux Round Table
Belgrade, December 2008
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Financial meltdowns are a systematic
Dysfunction of capitalism
• Tulip mania – 1620
• Mississippi company France1719/1720
• South Sea Company London 1711/1720
• Wall Street 1929
• Junk bonds 1980s
• Dot.coms/telecom 1990s
• Sub-prime mortgages/CDOs
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• "Men, it has been well said, think in herds;
it will be seen that they go mad in herds,
while they only recover their senses
slowly, and one by one!" Charles Mackay
• “Irrational Exuberance” Alan Greenspan
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• Charles MacKay, Extraordinary Popular Delusions and
the Madness of Crowds, with a foreword by Andrew
Tobias (1841; New York: Harmony Books, 1980).
• Mike Dash, Tulipomania: The Story of the World's Most
Coveted Flower and the Extraordinary Passions It
Aroused (1999)
• Peter M. Garber, Famous First Bubbles: The
Fundamentals of Early Manias (Cambridge, MA: MIT
Press, 2000).
• Charles Kindleberger, Manias, Panics, and Crashes: A
History of Financial Crises (Wiley, 2005, 5th edition)
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What Causes a Financial Crisis?
• Mis-pricing of risk
• Increases in real risk are not captured in
nominal market prices
• Asset prices become irrational
• Valuation becomes unrealistic
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Present value reflects the risk of actually
receiving future income
Capital value is a function of income!
Misjudgments about future income distort
present capital values
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In financial bubbles, mis-pricing is sustained
by infusions of debt
Higher and higher asset values are
supported by borrowed funds
Excess liquidity – based on future promises
to pay – transforms investment into
speculation; a trading mentality takes over
the markets; prudence loses out to greed;
illusion trumps reality – for a time
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• "Of all the offspring of Time, Error is the
most ancient, and is so old and familiar an
acquaintance, that Truth, when
discovered, comes upon most of us like an
intruder, and meets the intruder's
welcome."
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Dynamics of the Current Crisis
• Sub-prime mortgage loans made, more and more
against future resale value of the home, not against real
income
• Mortgage loans packaged and sold to global capital
markets
• Collateral Debt Obligations (CDOs) issued to finance
purchases of packages of sub-prime mortgages and to
invest in hedge funds
• Credit Default Swaps invented to give added value to
CDOs
• Debt upon debt upon debt
• Low interest rate environment
• Incentive structure driven by fees not investment in long
term returns
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Current Crisis is Global
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AIG
Fortis
Iceland
EU guarantees bank deposits
UK takes over two banks
Equity markets in Asia tank
Price of Oil drops by 50%
Real economies lose employment and
consumer demand
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• When financial markets implode,
capitalism loses liquidity, exchanges of
goods and services fall, output is reduced,
employment is cut
• Debt must be taken out of the financial
system
• Asset values have to be reset at lower
levels
• Asset owners loose wealth
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• World Economic Order has inadequate
mechanisms to prevent financial crises
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WTO
IMF
World Bank
G8
OECD
Bank for International Settlements
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• Central Banks must step up and inject
liquidity into the global system of financial
intermediation
• Government budgets must inject new
capital in financial institutions
• Bankruptcies must eliminate amounts of
liquidity – both equity and debt
– Bear Sterns - $80 to $2
- Lehman Brothers - liquidated
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What is the fair value of an
investment in business?
• Quality Income Stream
• High net present discounted value
• Good capitalization multiplier
Good Corporate Value
(Warren Buffet would buy it)
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Today where does most corporate
value come from?
Intangible Assets!
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50 Best Performers of 2005
Business Week
Burlington Northern Santa Fe:
Caterpillar:
United Health Group:
Apple:
Market value: $29.2 billion
Balance sheet assets:
103% of market value ($30.3 billion)
Goodwill: None
Market value: $49 billion
Balance sheet assets: 95.9%
Goodwill: 4.1%
Market value: $79 billion
Balance sheet assets: 52%
Goodwill: 48%
Market value: $58 billion
Balance sheet assets: 19.8%
Goodwill: 80.2%
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50 Best Performers of 2005
Business Week
Microsoft:
Best Buy:
Starbucks:
Goldman Sachs:
Market value: $279 billion
Balance sheet assets: 33.7%
Goodwill: 66.3%
Market value: $26.3 billion
Balance sheet assets: 39%
Goodwill: 61%
Market value: $27.8 billion
Balance sheet assets: 12%
Goodwill: 88%
Market value: $61.7 billion
Balance sheet assets: 1.1%
Goodwill: 98.9%
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What is the Most Common Form of
Intangible Wealth?
Government Issued Fiat Money
Its value is to be used as legal tender
What is a Dollar worth today?
A dollar bill has no tangible worth; what is the
value of ink on paper?
Its value lies in the mind of whoever will take it.
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What is Another Very Desirable
Common Form of Intangible
Wealth?
Stocks and Bonds
Who Determines their Values?
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Financial Meltdown of 2008
Bear Stearns:
on Friday, $80 per share book value;
on Sunday sold for $2 per share
Lehman Brothers:
Billions in balance sheet assets;
liquidated as no one wanted to buy them
on a going concern basis
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What is a company worth?
How to we measure its value?
• Most simple calculation:
Discounted net present value of future
income X capitalization multiplier
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First Fundamental Conclusion
You cannot establish value without
putting risk into the calculation
– What is the risk of not achieving predicted future
revenue? How certain are estimates of future
income?
– What are the risk factors that determine the
capitalization multiplier? A higher risk demands a
lower multiplier
Higher risk > more uncertainty > lower present value
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Note:
Each source of risk drives
business value up or down
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Second Fundamental Conclusion
Management of Risk Enhances Enterprise
Value
- Risk management leads to more certain
income
- Risk reduction leads to higher valuation
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How do you manage risk?
-Each risk hides in a relationship
- customers
- investors
- government regulation
- employees
-Each relationship is an intangible asset of the
business (Assets can Appreciate or
Depreciate).
-Lowering risk for each relationship enhances
the quality of intangible assets and increases
business valuation
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CSR & Valuation
Intangible Assets = CSR Stakeholder
Relationships
• Customers
• Employees
• Owners/Investors
• Suppliers
• Competition Strategies
• Community Support
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Tangible Values
Financial
Capital
Tangible
Assets
(Generally Audited
Financial Information)
Intangible Values
(Generally Non-audited,
Non-financial Information)
Intellectual
property
Quality of
employees
Sustainability
Brand loyalty
Labor
Unallocated environment
goodwill
Community
support
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Growing Importance of Intangible Wealth
Change in US Employment: Dec 2007 - Nov 2008
tangible sector (manufacturing, construction, natural resources, real
estate, wholesale and retail, transportation and warehousing)
- 1,791,000 jobs
intangible sector (education, health care, computer system design,
finance and insurance, scientific research, etc.)
+ 515,000 jobs
all other services
- 635,000 jobs
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To improve company valuation,
Improve CSR relationships!
Good CSR Relationships Lead to
The Sustainable Corporation
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How to measure CSR Relationships
Use CRT Arcturus
Risk Assessment Instrument
New metrics for enhanced
profitability
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How to Manage for
Sustainable Value?
• CRT Theory of the Firm
• Arcturus
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Theory of the Moral Firm
(self interest considered upon the whole)
Finance
capital
INPUTS
Reputational
capital
Physical
capital
Conversion
processes
OUTPUT
Goods/services
Customers
Social capital
$;
sustainable
profits;
low beta;
maximum
value
Human
capital
Return on Capital
(preserve adequacy of capital inputs)
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Capital Accounts
Capital Accounts are your defense against risk and
your resource base for competitive initiatives
Finance Capital
Physical Capital
Human Capital
Reputation Capital
Social Capital
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FINANCE CAPITAL
Traditional capital account – stock of ready
money and amount of sunk cash
investments
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PHYSICAL CAPITAL
Traditional capital account
• Plant and equipment
• Tools of the trade
• Sub account really of financial capital as
purchased with monies raised in the past
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HUMAN CAPITAL
Non-traditional capital account
- intangible asset
- vital for success in services and high
tech businesses
- takes care of customer needs and
demands
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REPUTATION CAPITAL
(brand equity; goodwill)
- needed for quality income
- needed to get low cost of capital and the
best employees
- gets you through rough times
- avoids commodity pricing/builds value
added
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SOCIAL CAPITAL
Internal:
- culture
- leadership
- strategy
External:
- rule of law/no corruption
- education
-public health
- public goods: market regulation, transportation, etc.
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Inter-relationships among
capital accounts
Social Capital + Reputation Capital +
Human Capital
>>
Finance Capital + Physical Capital
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Stakeholders:
-Customers – moral compass for capitalism
-Employees – moral agents, not parts for a machine
-Owners and Investors – fiduciary duties of loyalty and
due care
-Suppliers – friends, not foes
-Competitors – compete with quality and innovation, not
price
-Communities – enhance social capital to enhance future
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profitability
Stakeholders and
Capital Accounts
Internal Social Capital =
owners/employees/suppliers/competitive
strategy
External Social Capital = Community
Reputation Capital = customers/employees/
owners/suppliers/community
Human Capital = employees
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Taking Due Care of Stakeholders
Enhances Capital Accounts;
Undermining Stakeholders Puts
Capital Accounts at Risk
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How Can you Measure
and, therefore, Manage
Stakeholder Relationships
And all a company’s
Capital Accounts?
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ASK QUESTIONS!
Assess the Quality of your
relationships
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Category
Arcturus Risk Assessment Instrument
– Criteria Matrix
1.
Fundamental
Duties
2.
Customers
3.
Employees
4.
Owners/
Investor
s
5.
Suppliers/
Partners
6.
Competitors
7.
Communiti
es
1. Responsibilities of
Business
Criterion
1.1
Criterion
1.2
Criterion
1.3
Criterion
1.4
Criterion
1.5
Criterion
1.6
Criterion
1.7
2. Economic
and Social
Impact of
Business
Criterion
2.1
Criterion
2.2
Criterion
2.3
Criterion
2.4
Criterion
2.5
Criterion
2.6
Criterion
2.7
3. Business
Behavior
Criterion
3.1
Criterion
3.2
Criterion
3.3
Criterion
3.4
Criterion
3.5
Criterion
3.6
Criterion
3.7
4. Respect for
Rules
Criterion
4.1
Criterion
4.2
Criterion
4.3
Criterion
4.4
Criterion
4.5
Criterion
4.6
Criterion
4.7
5. Support for
Multi- lateral
Trade
Criterion
5.1
Criterion
5.2
Criterion
5.3
Criterion
5.4
Criterion
5.5
Criterion
5.6
Criterion
5.7
6. Respect for
the
Environment
Criterion
6.1
Criterion
6.2
Criterion
6.3
Criterion
6.4
Criterion
6.5
Criterion
6.6
Criterion
6.7
7. Avoidance of
Illicit
Operations
Criterion
7.1
Criterion
7.2
Criterion
7.3
Criterion
7.4
Criterion
7.5
Criterion
7.6
Criterion
7.7
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Assessment Framework – Criterion/Benchmark Example
CUSTOMERS (Section B)
1B - Beyond Shareholders towards Stakeholders - Customers
Does the company provide its customers with quality products and services at reasonable prices, and on fair terms, while protecting
their health and safety and their physical environment, and respecting their culture and individual dignity?
POINTS TO CONSIDER – The company seeks customer feedback on its practices, monitors impacts, and is prepared to modify
production or service as a result, plus provides relevant training of staff.
Point(s): Please circle
1
2
3
4
5
6
7
Please write down any concerns, explanations or additional comments on how or how not, the company is performing.
__________________________________________________________________________________________________________
__________________________________________________________________________________________________________
2B - Economic & Social Impact of Business - Customers
Do the company’s products and services contribute to the economic and social advancement of its customers and to the well-being
of their communities?
POINTS TO CONSIDER – Quality of product/service development; product quality and safety; adherence to relevant customer,
safety and environmental codes; products / services positively impact living standards?
Point(s): Please circle
1
2
3
4
5
6
7
Please write down any concerns, explanations or additional comments on how or how not, the company is performing.
__________________________________________________________________________________________________________
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__________________________________________________________________________________________________________
The Corporate Improvement Cycle
Performance Improvement
Performance Feedback
to Management
Management Action
CRT Assessment
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Who Participates?
• Board of directors
• CEO
• Senior management
• Division heads and group managers
• Unit managers
• Employees
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Sample Gap Analysis between Managements and Employees
(Provided by CRT-Japan)
A.
Fundamental
Duties
B.
Customers
C.
Employees
D.
Owners/
Investors
E.
Suppliers/
Partners
F.
Competitors
G.
Community
1.Responsibilities
of Businesses
6.5/5.2
6.3/5.1
6.0/4.8
6.8/5.2
5.9/4.9
6.1/4.8
6.4/5.4
44.0/35.4
2.Economic/
Social Impact
of Business
6.0/5.3
5.6/4.7
6.7/4.5
4.9/4.4
4.9/4.4
6.6/4.6
5.1/5.2
39.8/33.1
3.Business
Behavior
6.4/5.0
5.8/5.0
5.8/4.2
6.2/5.0
5.0/4.5
5.5/4.6
5.2/4.5
39.9/32.8
4.Respect for
Rules
5.9/5.3
6.8/5.9
6.5/5.6
6.5/5.7
6.1/5.6
6.2/5.6
6.9/5.2
44.9/38.9
5.Support for
Multilateral Trade
6.9/5.2
6.3/5.0
6.5/5.2
6.2/5.2
6.0/4.8
6.4/4.4
7.2/5.0
45.5/34.8
6.Respect for
Environment
7.0/6.6
6.0/5.3
5.7/4.4
6.3/5.6
5.2/4.2
4.4/4.4
4.7/4.0
39.3/34.5
7.Avoidance of
Illicit Operations
6.7/5.8
6.5/5.8
6.8/6.5
6.3/5.4
6.5/5.2
6.0/5.2
5.9/5.7
44.7/39.6
45.4/38.4
43.3/36.8
44.0/35.2
43.2/36.5
39.6/33.6
41.2/33.6
41.4/35.0
298.1/249.1
Performance by
Stakeholder
Performance by
Principle
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Sample Radar Chart (Provide by CRTJapan)
Vision not yet fully embedded across the
company.
No integrated local community
development program across
different countries.
Company internal
communication is poor on the
issue of environment.
Customers' trust is weak.
Communication with suppliers/partners is
poor.
High level of compliance, risk management and internal
audit have been achieved.
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How Do Companies Create
Value?
-The Good
-The Bad
-The Ugly
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The Good
(Moral Capitalism)
• Risk Assessment/continuous Risk
Reduction
• Optimize Stakeholder Benefits
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The Bad
(Brute Capitalism, Crony Capitalism)
•
•
•
•
Feed Shareholders, Abuse Stakeholders
Commodity pricing/ compete on pricing/low costs
Rent seeking (market power)
Take the money and run: short termism
Unsustainable Valuations Eventual Failure
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The Ugly
(Punting on the trading floor)
• No net wealth creation; speculation in trading
(Rob Peter to pay Paul)
• Irrational Exuberance
(Market traders/short termism)
• False Valuations
(Enron: Ponzi Scheme; sub prime mortgages, CDOs,
CDSs)
• Encourage unsustainable pricing of securities
(CDOs, CDSs)
INEVITABLE FINANCIAL MELTDOWN
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Thank You
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