Fin-economics revisited
September, 2015
Fan LiJi Ran
Finance relates to the art of government in ancient China,and is a philosophical matter in ancient Greece
Comments :
• Guan Zhong: “let merchants livetogether […] investigate the price andstock of goods”
• Shan Mo Gong: “if your people losemoney (after a devaluation), they willleave and threaten your dominance”
• Fang li: “regulating prices is good forthe market and to lever tax”
• Aristotle: without the framework ofvirtue, prosperity leads to vulgar pleasure
Aristotle
715 - 645 BC ~520 BC 322 BC
Shan MoGongGuan Zhong
Philosopher
Politicaladvisors
Market Money Stability
Virtue andProsperity
436 - 448 BC
Finance is the eldest daughter of economy but has distanceditself from humanities to join the exact science league
Comments :
• Economy as we know it today wasborn in the 19th century
• Three factors contributed to thedecline of the moral component
− The emergence offormalization (Maths)
− Positivism
− Moral was seen as preaching(religious)
AdamSmith1
Aristotle322 BC
Natural sciences
Moral Sciences
EconomicsMaths
Psychology, Geography …
Justice, equity,religion
18th century(mercantilism)
13th centuryScholastic economics
20th century(positivism)
Finance
1. The publishing of the « Wealth of Nations » in 1776 is often considered the date of birth of modern economics.
The [ abridged ] list of Western financial andaccounting scandals is quite long
Medici Bank (1494)
Mississipi Cie (1720)
South Sea Cie (1720)
Overend (1866)Fried. Krupp AG (1873)Dantbank (1931)
Allied Crude VegetableOil Refining Cie (1963)Herstatt Bank (1974)
Texaco (1987)Qintex (1989)Polly Peck (1990)
BCCI, Nordbanken (1991)Carrian Group (1993)Barings Bank (1995)Bre-X (1997)LTCM (1998)Equitable (2000)
HIH Insurance, PGEC,One.Tel, Worldcom,Enron, Chiquita (2001)Kmart (2002)Adelphia Com (2002)
Arthur Andersen (2002)Parmalat (2003)MG Rover (2005)Bayou Hedge Fund (2005)Refco (2005)Bear Sterns (2008)Northern Rock (2008)Lehman, AIG, RBS (2008)Washington Mutual (2008)ABN Amro (2008)Nortel, Anglo Irish (2009)Arcandor (2009)Schlecker (2012)Dynergy (2012)Banco Espirito Santo (2012)Tesco (2015)
Bardi, Peruzzi (1343-44)
Banco Ambrosiano (1982)
As an example, the Tesco accounting scandal reveals thequiet nurtering of a predatory financial culture
Recent and classic misbehavior case …
• The Tesco accounting scandal is a classic for whatappears a case of « cooking the books »
• Tesco chief executive, says he has discovered thatprofits for the six month to the end of August wereoverstated by £263 m due to the « acceleratedrecognition of commercial income an delayed accrualof costs ».
• Tesco was boosting profit by deducting cash fromsupplier’s trading account or extending payment dateswithout notice
• Tesco also started charging £ 30 per product forsuppliers to keep their products on eye-level-shelves
This type of behavior is nurturing a predatory financial culture
The case was uncovered after a whistleblower approachedTesco’s General Counsel
A thin line from dodgy practices to fraud
• A whistleblower, and staff member, approachedTesco’s General Counsel to tell him that somethingwas array in Tesco’s accounts
• Since the Enron scandal, aggressive accounting is onlyaccepted within clear and rather strict limits
• The market reacted to the announcement and Tescoshare price felt by 10%
• A number of British institutional investors have signedup with lawyers to pursue compensation for lossesrelating to the supermarket’s profits overstatement
• An investigation of the Serious Fraud Office (SFO) isgoing on and will have a material impact on the firm
This type of behaviour is nurturing a predatory financial culture
This event has resulted in serious consequences for Tesco:A loss of £ 20 Bn value since 2013
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Market Cap. : GBP 15.2 BnHigh-Low loss: GBP 20.1 Bn
Scandal announcement
SFO investigation
Aversion to sure risk is a major problem that lies at the heartof every MNC or financial institution
Rogue Traders :
• Nick Leeson (Barings, 1995): USD 1.3Bn loss leading to the bank collapse
• Yasuo Hamanaka (Sumitomo, 1996):USD 2.6 Bn loss
• John Rusnak (Allied Irish Bank, 2002),USD 691 m loss
• Chen Jiulin (China Aviation Oil, 2005)USD 550 m loss
• Jerome Kerviel (SG, 2008) USD 5.5 Bnloss
• Kweku Adoboli (UBS, 2011) USD 2.3Bn loss
People on a « special mission » can quickly lose sense ofcommon sense and basic ethics
Comments :
• The importance placed on a “specialmission” compared to rules is a suresign of danger
• Magic is referring to supernaturalcapacity to beat the odd and distancefrom reality
• One can conclude that he has completeruling power on deciding what isacceptable or not
• It is the equivalent for finance of whatpilots call “spatial disorientation”
« We are doing something special. Magical. Itisn’t a job – it is a mission. We are changing theworld. We are doing God’s work. »
Jeffrey Skilling, former CEO of Enron
Sound finance is only based on free market economy, and ithas to be guided by an ethical framework and the rule of law
Comments :
• Finance needs marketeconomy to work properly
• Market economy works on acertain set of conditions
• When those conditions arenot met, finance mechanismsare disfunctional
• This does not mean thatoperations are impossible
• But they come with a muchhigher risk than perceived:this impact pricesTrustAtomicity, Fluidity,
Mobility, Homogeneity,Transparency
Over-simplified accounting creates a « tunnel vision » on thevalue of a hidden production factor, often unaccounted for
Oversimplified accounting
Assets Liabilities
Comments :
• In spite of its complexity, the accountingsystem does not capture the value of thecommon good in the production process,and treats it as an exogenous factor
• However intangibles assets are alreadypart of the balance sheets, but there areno intangible liabilities, only potentialliabilities (usually unconsolidated)
The common good is a production factor which is never accounted for butmandatory for the sustainability of the economy
As a starting point, the management of sovereign ALM riskhas been over-simplified to a GDP / Public Debt approach
Comments :
• NNW captures the real country wealth, areserve available to invest in the future. Itis the difference between Total Assetsand Total Liabilities
• Total assets are not only monetary assetsbut also the common good including lifesupporting assets
• Total liabilities are the private andsovereign debt plus the remedy cost todamages caused by human activity to“life” supporting assets
• GDP often used to measure wealth usesvalue added flows only, and sometimesmisses important ones (e.g. unreportedfin. transactions)
Net National Wealth - NNW
NNW surplus
Assets Liabilities
The purpose of economic development is to prepare for abetter future worldwide
Comments :
• (a) stands for total tangibleand intangible assets(excluding G)
• (g) stands for the commongood stock
• (l) stands for liabilities, and(lp) for potential liabilities
• THW is the consolidation ofall NNW
• Must be consolidated for allcountries, to calculate a worldconsolidated picture
CommonGood
LiabilitiesAssets
NNW = a + g – (l + lp)
Net National Wealth acts as a monetary and nonmonetary capacitor to prepare for our future
In the 21st century, the main purpose of finance is to act as a« progress storage system » to prepare for a better future
Comments :
• Qf is the expected productionat the (inter)national level
• min is, minimum of the sumof individual expectations asa floor (> 0)
• T stands for individual andcollective talents, (previouslyL)
• K stands for accessiblecapital
• G represents the commongood (factor) needed for theproduction
Talents CapitalFuture
Qf (min is) = c. Tα . Kβ . Gγ
Labour CapitalProduction
Q = c. Lα . Kβ
Classic Cobb – Douglas production function
UCD - Updated Cobb Douglas production function
Common Good
CSR is a regulating mechanism, it helps keep the system’sat the desired set point and facilitates smooth evolution
Promoting a CSR culture emphasizes the importance of managing properly earthlife supporting assets
Sustainability,Shared responsibility
Socialism,Market economy
CSR
Comments :
• CSR is a major enabler fortransforming the economic growthmodel
• CSR helps mitigate business risksand strengthen corporategovernance
• CSR is seen as a powerful tool toenhance corporate brand
• Creates Shared Value (CSV), nowthe ultimate frontier for CSRpractitioners
Olivier CoispeauMaverlinn, Founding Partner
www.academia.edu
Leading a world of change, together