when I posted on twitter
The #Jago Principle http://tinyurl.com/6g7whhv #leadership #communication #gatekeeping #networking
I had already outlined what I would write within the half of the article devoted to the applications of the Jago principle within business.
well, let’s say that news, as usual, gave me the opportunity to keep the focus, but use current events as a litmus test.
therefore, both the “business side” and the “social side” (to be posted tomorrow) will acquire a wider perspective.
and now, the business side.
let’s be frank: our society is obsessed with the concept of a hit parade.
we shifted from an ethical aim, to a sport ranking- being on the top of a chart implies being the best.
it is a side-effect of a market economy- but a market economy that keeps the “invisible hand” tied behind the back.
we already saw in the past what happens when “independent”, market-based contributors to market transparency have their own (business) agenda: ask those who trusted BCCI, Enron, Parmalat with their savings- to name just a few.
the current topic is, of course, the role of rating agencies and their impact, as they have been gradually shifting from “market reporting” to “market shaping”.
I wrote a little bit on the issue before, but, before discussing how the Jago Principle applies to them, and some potential consequences, I will take a small detour- and talk about the auditing business.
I will use as a reference Arthur Andersen, not because I worked with companies linked to them, but to show how well-meaning guidelines could gradually, by application of the Jago Principle, produce unexpected consequences (in this case, Enron).
Auditing and the Chinese Wall
auditing was supposed to be transparent by definition: when I was hired in 1986 by a software development outfit of Andersen (interestingly, was only in “Latin” markets- Italy, Spain, Southern America), created to build a Chinese wall between the “consulting” culture and the “software development” one, with different career paths… the Chinese wall was immediately revealed to be a paper-thin Japanese wall.
eventually, most projects were staffed by both, and I myself was shuttled between units more than once (eventually working in the Andersen office): Accenture was the evolution, due to the increased blur of the boundaries between consulting and software development- into system integration.
and also the separation between the “auditing” side and the “consulting” side was partial- as we received a “personnel reference binder” in English that was the same used by the consulting side, and replete with clauses that clearly were linked to the auditing business (independence, prohibition to hold shares in customers, etc), supported by a form that was filed in the US.
beside the blue “personnel reference binder”, the consulting side received also what was called “ethical standards” (burgundy)- we mere software grunts did not need to read that: but, of course, I did (well, if I was supposed to respect it, better to read it).
and there, the cultural imprint of the auditing business was even more blatant.
the issue was there to be seen: how can a private business, whose purpose, as with any other company, is to improve its benefits and margins, cope with an endless string of overlapping limitations on business, due to its semi-regulatory role?
if you are not familiar with auditing: at the time, I remember being told that there was a time-limit on the auditing relationship with any customer (no more than 9 years, but my memory may fail me), and the first year was a kind of “cultural tuning”, to assess and appraise the customer.
the auditors had access to business-sensitive information, insofar that could help them to better evaluate if the accounts of their customers were delivering a fair representation of the business and the associated risks.
now, the trouble is: when you develop those number crunching skills, and have to prepare and store reports on your assessments, you can obviously develop in-house ideas on how to improve business processes, tax efficiency, and reduce costs (e.g. by streamlining the supply chain to remove waste, reduce what you get stuck in your warehouses, accelerate the product turnover, and so on).
moreover: to walk the talk, instead of letting newly hired to learn through trial-and-error, or expensive person-to-person apprenticeship, shift to group coaching, get them through a formal “knowledge transfer” itinerary, and… improve your own efficiency.
creating more business units, with “Chinese Walls” between them is a partial solution: at Andersen, eventually the clash between the auditing and system integration culture (and the distribution of power vs revenue) was terminal, and Andersen Consulting split, changing name into Accenture (chosen through an internal contest- it stands for “AC Century”- yes, it was tough to abandon the Andersen name).
nonetheless, even before the end, I already had occasional contacts with new internal consulting units that were part of the auditing/tax/etc business- a sign that a split was brewing, as they composed, “in sedicesimo”, a replica of Andersen Consulting.
luckily for Accenture, the split was “just in time”- as then Enron happened.
what was the main fault of Enron (and I am referring to both the company and all those involved, not just the auditors from Arthur Andersen)? terminal greed.
but, frankly, the original sin was assuming that you could outsource regulation to a private enterprise, while still letting them to operate as a normal, non-regulated business (e.g. allowing to create additional business lines).
in the end, Arthur Andersen was the most famous failure, but others legal brawls involving auditors followed: and also when the consequences were less severe, the damages paid by the auditors for supposed or real “dereliction of duty” was minimal, if compared with their impact on the market.
as I wrote above, the original sin was ignoring the Jago Principle: they were actually the servants of three masters (the customer who paid their fees, the regulating agencies requiring audited accounts, and their own partners/shareholders).
with three conflicting sets of interests- including their own, reached by diluting the level of expertise and increasing the ratio of junior-vs-partner, so that those really able to understand the figures were seldom involved in checking the actual data, and received information pre-digested by junior (and cheaper) bean counters, while working on as many accounts as possible.
and this was just a natural evolution: even without considering any criminal intent to conspire to misled the investors.
I could refer you to few books on creative accounting, applying some “accounting autopsy” principles to famous crises- I had to read a lot in late 1980s/early 1990s while working on number crunching- for people who usually were at least twice my age, and had a “Chief” or “Director” in front of their job title, and I updated that knowledge once in a while.
I had more than once to sit on the other side of the table- auditing projects, contracts, activities; no, not accounts- I am not qualified for that: albeit I reviewed few business plans and financial reports before negotiations that were at best selective with the truth.
and I saw first hand that while you can delegate the “typesetting” of the final report and corroborating evidence, if the senior auditor is not involved in reviewing the sources, the pre-digested information is often almost useless, as those assembling the information do not understand the business realities beyond the figures.
but now, let’s move to the other application: the credit rating industry.
Transparency and self-fulfilling prophecies
frankly (yes, third time, in this article)… I think that anything with a systemic-risk-level impact should be regulated at the systemic level: IMF, IBRD.
rating agencies are not simply private analysts writing what they think of the market
and they are still basically unregulated (show me how they are regulated on a global level, and I will amend this phrase!): who audits the auditor?
over the last few decades, their own rating decisions became part of the self-imposed regulations adopted by various investing entities- the most famous ones being some US-based pension funds.
the side-effect? whatever they say can generate a selling stampede: in my humble number-cruncher opinion, giving control of the world economy to three rating agencies is a little bit far-fetched.
moreover, when their decisions are assumed to be “objective”- but their decisions are neither transparent (did you ever see their models published?), nor so objective, as it seems that the three main agencies have often a “band wagon assault” effect.
yesterday a CCC was “granted” to Greece (i.e. junk bond-level)- with the ensuing feeding frenzy started by doomsayers.
in the end, the rating agencies are businesses whose purpose is expanding their income, not independent regulators whose aim is to increase transparency, paid by a fee.
if they were objective, they would certainly be able to disclose their models- as those models would represent objective realities, and therefore could not be “tricked” by playing around with statistics.
but are they objective? and if so, why they usually were caught sitting on the fence on many of the (private and public) debacles?
as a consequence of the recent string of rating downgrades, some doomsayers are claiming that Greece could end up as Italy and UK did in the early 1990s, courtesy of George Soros and others.
simply ignoring a not-so-insignificant difference: Italy and UK were part of an exchange rate mechanism, while Greece is integrated within a currency, with the consequent loss of freedom.
probably the end result of this crisis will be a further integration- as the Euro cannot just simply be a fair-weather currency.
and, from the numbers, Greece’s situation is more Parmalat than Enron.
Enron was almost a Ponzi scheme, while Parmalat’s crisis was mainly due to a financial mismanagement, and the industrial component was working (albeit working with no cash-flow to finance the activities usually is not advisable)- as shown by its resurrection (currently under consideration for acquisition by Lactalis).
and, please, before basing your investment decision just on rating agencies… review the history of the rating that they assigned to Enron et: way too often, forecasting the past.
therefore: are rating agencies an advisor, or are they an application of the Jago Principle?
for the time being, the immediate consequence in EU will be a tougher job for the new Italian ECB boss, the current Governor of the Bank of Italy, Mario Draghi.
he was already on a tough spot, as the next head of the ECB was originally planned to be a German, and therefore he had to be more German than the Germans to be a viable candidate.
but recently Italy announced 45 bln (the Government said 40, then the Corte dei Conti suggested 45) in cuts and savings over the next two years, an announcement overlapping with the revision of the long-term expectations by an agency.
therefore, Mr. Draghi will probably need to be even tougher with Italy than he will need to be with Greece, considering the relative size of the economy.
and cutting 45 bln in two years implies cuts up to 2% of the GDP- at a time when Italy is growing about 1% on a year-to-year basis, has an unemployment rate between youth that almost three times the general unemployment rate.
and this extends also to other Euroland countries- for more details:
just from a number crunching perspective: we have the IMF (worldwide) and Eurostat+ECB in Europe, and some of the largest investors are sovereign funds.
if private rating agencies are delivering rating decisions without transparency, they are “de facto” advocating political choices, not technical ones.
maybe it could work the other way around: by using the extensive public and transparent global information sources and the increasing ability of providing up-to-date preliminary information (instead of waiting years).
how? building a “neutral” rating model that would simply state things how they are, and show trends how they are developing, allowing each investor to either take it as is, or, if (s)he assumes that is biased, apply his/her own corrections.
a multilateral rating? well, as I wrote yesterday in “The Jago Principle”, if your trusted advisor has a vested interest (the bottom line) and cannot be replaced… counterbalance with other advisors giving a different perspective.