Jack Welch says shareholder value a 'dumb idea'. Last 28 years a mistake.

In an article in its 'Future of Capitalism' series the FT has interviewed Jack Welch the legendary ex-CEO of General Electric and the man widely regarded as the father of 'shareholder value'. He now rejects shareholder value as a strategy, calling it 'insane', but suggests shareholder value is an outcome of good strategy based on employees, customers and products.

This is yet another straw in the wind indicating the end of Anglo-Saxon capitalism as we know it, and it is to be hoped, the equating of 'liberal democracy' with the freedom to make as much money as possible.

Along with squadrons of flying pigs, look out for Francis Fukuyama explaining that history wasn't dead, merely tired and shagged out after a long squawk.

Costing: a warning for the unwary

A widely used text book, Jones's 'Accounting' says

... costing concerns (1) setting a price for a product or service so that a profit is made and (2) arriving at a correct valuation for stock. (p379)

This is seriously in error and we shouldn't be teaching it to vulnerable young minds. Using costs to set prices is a way of going bankrupt quickly. Prices need to be set at the price that will optimise profits, which is largely determined by the market. Using costs to set prices is likely either to set prices too cheap, in which case profit opportunities are lost, or too expensive, in which case volumes will be too low earn the best profit.

Valuation of stock is a relatively minor function of costing, since it is only about finding a number to attach to stock in the financial statements and should have no substantial economic consequences. The notion that there is a 'correct' value is something beginners in management accounting should be warned about. All management accounting valuations are essentially arbitrary to some degree. What is important is to know how the application of the arbitrary rules is likely to affect decision taking and distribution of wealth.

In my view, management accounting is firstly about maintenance of control within organisations. Costing is a process of accumulating costs so that someone is made responsible for keeping them under control.

The second purpose of management accounting is to provide information for taking decisions - but the people taking the decisions really ought to understand where the numbers come from so they can work out what is going on. Sadly, that is often not the case.

The third thing that management accounting does is to consolidate the position of those in power in the organisation, for good or ill. Not only are they provided with information that others don't have, but they also get to decide on resource allocation through the budgeting system. By labelling your group or department as being in deficit (for example by allocation of central overheads) the people in power get the chance to intervene, demand cuts, veto appointments and do all sorts of other damage. Again, sadly, people often believe deficits have more substance than they do. Management accountants like deficits. Deficits give them power. They get asked to write reports and join task forces looking for cost savings and all kinds of other exciting stuff. People defer to them and ask their opinion. When everyone is making a profit, accountants don't have much to contribute. Their role is not to comment on strategy and they don't know about marketing or product development issues so they tend to be ignored or reduced to number-crunchers.

Odd man out

Who is the odd one out?

Lord Stevenson, former chairman, HBOS
Andy Hornby, former chief executive, HBOS
Sir Fred Goodwin, former chief executive, RBS
Sir Tom McKillop, former chairman, RBS
John McFall MP, chairman of Treasury select committee
Alistair Darling, Chancellor of the Exchequer
Sir Terry Wogan, presenter of Radio 2 breakfast show.

Answer: Sir Terry Wogan. He is the only one with a banking qualification.

(Courtesy of Private Eye)

Those in power determine what counts as knowledge

The title is a summary of one of the ideas of Michel Foucault and has particular application to accounting. No better illustration of this is to be found than in the pensions debate and the current hoo-ha over the Post Office Pension Fund. We are told that the fund is in deficit, that this is a bad thing, the pensions of current pensioners and employees are at risk and urgent action must be taken. The solution is to sell off the Post Office to provide private capital, (at the same time as banks are being nationalised because of the failure of private capital).

My point, however, is that the idea of a 'deficit' is highly contestable. The deficit is the difference between the market value of the fund's assets compared with a discounted cash flow value of the fund's liabilities. Matching these two quantities is not what matters. The important thing is that the future cash flows of the fund are adequate to support the future cash outflows into the far distant future. Getting the funding of the pensions right is a serious matter, but it is not urgent.

We all know stock markets are down at present but we also know that dividend streams are far less volatile than stock prices. Pension funds used to be valued on the basis of projected future dividends interest flows and that is far more relevant to the long term solvency of the fund than temporary stock market fluctuations. We can only know the extent to which the Post Office pension fund needs long term support when someone gives us some sensible projections about future cash flows.

To the extent that there is a pensions crisis at all (I'm not convinced there is one) it has largely been caused by two things: firms taking contribution holidays when stock markets were high, because funds seemed overvalued; and, the effective removal of tax relief on dividends received by pension funds. Now, let me see, who was responsible for that? Ah yes, Gordon Brown.

For the time being, it is politically expedient to talk up pension deficits, so don't expect any sense on the matter any time soon.

How long can you wait?

Writing in the FT Managed Funds Section, John Authers reviews Elroy Dimson, Paul Marsh and Mike Staunton's 2009 edition of the Global Investment Returns Yearbook. He comments:

The FTSE-100 is still languishing far below its all-time high, set at the end of 1999. According to the yearbook, using the historical risk premium, the odds are only 50/50 that it will get back to that peak by 2018, on a capital appreciation basis.

Indeed there is a 25 per cent chance the FTSE will not even have regained its peak by 2033 (on a total return basis, with dividends reinvested, it should get there much quicker).

Numbers like this suggest anyone aged about 50 in 1999, who invested in the FTSE safe in the knowledge that stocks are best in the long term, would have reason to feel angered.

With the FTSE just over 4000 and with a P/E of about 9 stocks are selling just below intrinsic value on the basis of past history. Have we moved into a new world or will previous patterns reassert themselves? My guess is we haven't moved into a new world - new dawns are often hailed but seldom arise.

An amazing revelation?

Writing in the Financial Times, Matthew Engel reports noticing an astonishing gaffe by one of the bankers being interviewed by MPs about the Credit Crunch.

Two revelations stood out. One was a phrase that came out in mid-waffle from Lord Stevenson, who startlingly referred to “the balance between the sales culture on the one hand, and caution and integrity on the other”, thus suggesting an organisation so dysfunctional that these were incompatible.

Just how much integrity was the bank willing to sell for each pound of Sales?

What shall it profit a company if it loses its reputation?

Barclays Bank published its final results for 2008 and reported what a appears to be a healthy profit of £5.2bn after tax. However two items are worth a second look. Included in the profit is £2.4bn of gains on assets acquired from Lehman Brothers after the collapse. Marking to market can have odd effects where so-called 'bargain purchases' are made.

The second item is even more remarkable. The company recorded a £1.6bn gain on its loan notes. The reason for the gain is that Barclays credit worthiness has deteriorated since they were issued and the company is recording a profit because of it. When the EU adopted IFRS standards it originally forbade companies to treat their own financial instruments at 'fair value through the income statement'. However in 2005 the 'carve out' was removed and companies were allowed to designate some instruments as being treated at fair value.

What shall it profit a company if it loses its reputation? In Barclays' case it seems to be £1.6bn.