Tangible Values, cat; Intangible Values aapl;

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



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




13


World Economic Order has inadequate mechanisms to prevent financial crises
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: Market value: $29.2 billion

Balance sheet assets:

103% of market value ($30.3 billion)

Goodwill: None

Caterpillar: Market value: $49 billion

Balance sheet assets: 95.9%

Goodwill: 4.1%

United Health Group: Market value: $79 billion

Balance sheet assets: 52%

Goodwill: 48%

Apple: Market value: $58 billion

Balance sheet assets: 19.8%

Goodwill: 80.2%







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50 Best Performers of 2005
Business Week


Microsoft: Market value: $279 billion

Balance sheet assets: 33.7%

Goodwill: 66.3%

Best Buy: Market value: $26.3 billion

Balance sheet assets: 39%

Goodwill: 61%

Starbucks: Market value: $27.8 billion

Balance sheet assets: 12%

Goodwill: 88%

Goldman Sachs: 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


Intangible Values


Financial Capital


Tangible Assets


(Generally Audited Financial Information)


(Generally Non-audited, Non-financial Information)


Intellectual property


Unallocated goodwill


Labor environment


Brand loyalty


Sustainability


Quality of employees


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)





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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 profitability




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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



1.

Fundamental Duties



2.

Customers



3.

Employees



4.

Owners/

Investors



5.

Suppliers/

Partners



6. Competitors



7. Communities



1. Responsi-bilities 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



Arcturus Risk Assessment Instrument – Criteria Matrix





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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)





298.1/249.1


41.4/35.0


41.2/33.6


39.6/33.6


43.2/36.5


44.0/35.2


43.3/36.8


45.4/38.4


Performance by Stakeholder


44.7/39.6


5.9/5.7


6.0/5.2


6.5/5.2


6.3/5.4


6.8/6.5


6.5/5.8


6.7/5.8


7.Avoidance of

Illicit Operations


39.3/34.5


4.7/4.0


4.4/4.4


5.2/4.2


6.3/5.6


5.7/4.4


6.0/5.3


7.0/6.6


6.Respect for

Environment


45.5/34.8


7.2/5.0


6.4/4.4


6.0/4.8


6.2/5.2


6.5/5.2


6.3/5.0


6.9/5.2


5.Support for

Multilateral Trade


44.9/38.9


6.9/5.2


6.2/5.6


6.1/5.6


6.5/5.7


6.5/5.6


6.8/5.9


5.9/5.3


4.Respect for

Rules


39.9/32.8


5.2/4.5


5.5/4.6


5.0/4.5


6.2/5.0


5.8/4.2


5.8/5.0


6.4/5.0


3.Business

Behavior


39.8/33.1


5.1/5.2


6.6/4.6


4.9/4.4


4.9/4.4


6.7/4.5


5.6/4.7


6.0/5.3


2.Economic/

Social Impact

of Business


44.0/35.4


6.4/5.4


6.1/4.8


5.9/4.9


6.8/5.2


6.0/4.8


6.3/5.1


6.5/5.2


1.Responsibilities

of Businesses


Performance by Principle


G.

Community


F. Competitors


E.

Suppliers/ Partners


D.

Owners/ Investors


C.

Employees


B.

Customers


A. Fundamental Duties





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Sample Radar Chart (Provide by CRT-Japan)


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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