A brief history of UK companies (The South Seas Bubble)
- In the early Eighteenth Century, the South Seas Company was granted exclusive trading rights in the South Seas (South American colonies) in return for helping to finance Government borrowing.
- To help grow their operations, they looked for investors and issued shares.
- Things seemed to be going well – more and more investors put money in.
- There were expensive London offices – it all looked very successful.
- Management lied about how good it was – with no information available other than what management told them, investors did not know the truth.
- In 1718, Britain and Spain went to war … and the ability to trade in the South Seas was now zero.
- But investors did not know this and kept buying shares …..
- …..whilst management secretly sold their own shares.
- Once the truth got out, there was a crash – the “South Seas Bubble” had burst. What can we learn from this?
- Investors need to be able to trust managers / directors.
- Directors have all the information.
- Investors need to be provided with complete, accurate information.
- But if the directors provide this information, they might lie!
- Directors may act to make themselves wealthy, not the investors.
- If management are selling shares, investors should be told – and be able to ask why! At the time, the UK Government reaction to this was the first “corporate governance” … THEY BANNED LIMITED COMPANIES. ISSUING SHARES WAS ILLEGAL!!! Eventually, this situation had to change. In the 19th Century, the growth of railways that needed investment, and the existence of limited companies in the USA, meant that the UK had little choice but to follow, and allow limited companies to exist again. In 1932, two economists Bearle and Means made some observations about American companies:
- Shareholders were more likely to sell their shares than speak out if they thought directors were not running the company very well. This could result in poor quality management never losing their jobs.
- Some American companies were getting very large, and with so many shareholders there was a growing gap between those who owned the companies, and those who controlled them.
By the 1950s, companies were growing ever larger – what we now know as “globalization” … the existence of large multinational companies with influence around the world was well under way.
The 1970s – 1990s saw problems starting to become common.
By the late 1980s, there were some famous corporate collapses – some due to poor management, but many due to fraud:
- Rapid growth in the 1980s took this East End company to the FTSE 100.
- Run by Asil Nadir (now in Northern Cyprus, and unlikely to visit the UK!).
- Donated money to the Conservative Party (who were in power).
- In 1990, £700m found to be missing.
- Company placed into administration.
Publishing and Newspaper empire (Daily Mirror).
- Seemed very successful.
- Run by Robert Maxwell.
- Donated money to Labour Party.
- In 1990 / 1991 company debts grew, and Maxwell used Pension Fund money to keep the companies from going bust.
- In early 1990s, traditional UK bank Barings expanded into “new” products – options and futures trading.
- Nick Leeson was given the new Singapore branch to manage.
- He had total control – he was the star trader, but also controlled the recording of these trades … no segregation of duties!
- When mistakes were made, he was able to hide them in a suspense account – his 88888 account.
- Then he started making illegal trades, partly to hide his own mistakes, and then in an attempt to make massive profits – the 88888 account became his hiding place for everything.
- Eventually he opened positions that left Barings heavily exposed if the Nikkei fell … and the Kobe Earthquake caused it to crash.
- With losses growing daily on positions he could not close … he ran away.
- Only then did Barings find out how bad the situation was, and it was too late to save the Bank … which was later to sold for £1.
Common features of these examples?
- Too much control in the hands of 1 person.
- Nobody asking questions of this person.
- This person was the only one to know all the real information.
- Personal greed
- Directors who failed in their duty to look after the company.
- Poor quality auditors who should have seen what was happening much earlier.
As we shall see shortly, these corporate failures caused the UK Government to act – and throughout the 1990s corporate governance grew in importance … but had enough been done?
- Successful US energy company, based in Houston, Texas.
- One of the top 10 companies in the US.
- Were using accounting techniques that were either illegal, or at least questionable, to hide the massive debts the company had.
- nron were borrowing through “Special Purpose Entities” that they controlled, but that were NOT consolidated into Enron’s figures.
- With much of the borrowing guaranteed against the value of Enron shares, all it needed was rumours of problems and the share price would start to fall…
- …leading to some of the borrowing needing to be repaid…
- …causing the share price to fall even more…
- …and the company collapsed in late 2001.
- Incredibly, this situation had many similarities to the previous UK examples:
- Poor quality auditing – Andersens, one of the top accountancy firms in the world, lost their reputation and collapsed as a result of Enron.
- Poor quality directors – those not involved in the fraud failed to understand what was going on, and failed to ask questions.
- Personal greed – leading Enron directors made millions from the way in which the special purpose entities were set up.
Clearly, companies / corporations need to be governed / regulated in some way.