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Archive January to March 2011


Freak o'Management

March 29, 2011


if you liked Freakonomics, then you are likely to like this book, Business Exposed, too. I picked it up at an airport, a rather unusual place to find a book engaging with the latest scholarly literature. However, this book provides witty insights into how to managers rally function, drawing on contemporary empirical research published in esteemed journals such as the Academy of Management Journal, yet communicated in the witty, story-telling style of an executive MBA class. Freek Vermeulen, a London Business School professor (and blogger), illustrates his ideas with evidence from solid research and examples of (in)famous firms along with personal conversations with top executives. What emerges is demystifying management.


Vermeulen does not offer an integrative theme or an overall message beyond wanting to show that managers aren't as esteemed as they pretend to be, like the proverbial emperor with no clothes. Yet, he is thought-provoking in (almost) every section, challenging readers to develop their own interpretations. However, I believe there is a common theme, namely a profound distrust of the teachings of mainstream economic analysis of the firm. Vermeulen shows that managers do not behave in the ways traditional theories (such as agency theory) suggest, and that instruments inspired by such theories create highly counterproductive incentives for managers to misbehave - essentially because few markets are as efficient as these theories assume.


While traditional theory suggests that financial incentives induce top managers to act in the best interest of the firm (and shareholders in particular), Vermeulen argues that legitimacy with their peers is often more important to them - and determines their compensation packages. This leads to counterproductive behaviours such as acquisitions of which 70% fail, management fads that lack empirical support, and managerial compensation unrelated to performance (but primarily to firm size). 


Despite (or because of) the compelling evidence, it is hard to draw specific lessons from this book for management, or for policy makers. In his conclusions, Vermeulen suggests that "more rules and regulations, and more quantitative and financial controls, are unlikely to solve the problem... Instead, organizations need to tap into the fundamental human inclination to belong to a community" (p.208). 


Another message arising is that better-designed incentive schemes with less asymmetric distribution of risk, and external directors that are truly independent would go a long way. In other words, getting a few top-notch business school professors as external director ought to help monitoring CEOs. Yet, what we learned from Vermeulen on how boards are selected (namely by insiders) suggests that professors would be highly unlikely to be appointed - which manager would want to look naked in front of his or her externals?

  • Vermeulen, Freek, 2011, Business Exposed: The Naked Truth about what Really goes on in the World of Business, Prentice Hall.


LSE and the Business of Fundraising [C9]

March 4, 2011


This morning's newspaper headlines report the resignation of the director of the London School of Economics over allegations of close relations to the Libyan regime. What is going on?


To put things into perspective, let's have a look at how universities around the world are funded. Donations play an important role in the revenues of many universities, and while this is still relatively new to the UK, it is a well established in the USA and in Asia. There, you will frequently find buildings, classrooms, research centres, or even entire business schools named after individuals that gave the university large amounts of money. While universities normally have procedures in place that are to prevent donors from influencing the content of research and teaching, it does raise ethical issues. One university that faced a serious ethical dilemma of this sort recently is Imperial College London. They had accepted a large donation from a businessmen and renamed the business school into the Tanaka Business School. However, when Tanaka faced allegations of embezzlement and fraud and had face courts in New York, the name became a burden. Eventually, Imperial settled to rename the school of Imperial College Business School, but retained the name Tanaka Building.


As universities pursue rich people to part with their cash, they tend to target alumni that already have a connection with the University, and tend to have a continued interest in the development of their alma mater. What appears to have happened at LSE is that shortly after Gaddafi junior graduated with a PhD, the LSE it attracted £1.2 million from a Gaddafi family foundation, of which £300,000 were actually received so far. As far as I am aware, there is no suggestion of the money having influenced the award of the degree. However, while rebuilding relationships with Libya was official government policy at the time in both the US and the UK, ex post accepting money from the disgraced Gaddafi family is judged unethical, and that's why the LSE president resigned.


The Guardian also lambastes the LSE on its front page for training 400 Libyan civil servants, a critique that I fail to understand. What better way to work for inner reforms of a country than to train its civil servants, and to discuss with them the practices and values of ones own society? In particular, this program was aligned with UK government policy at the time - how much can you criticize LSE for aligning its own government? (Of course, we could argue that universities ought to keep distance to governments of the day, but with the increased pressures that governments put on universities to demonstrate the 'impact' of the government grants they receive, this is unlikely to happen).


Looking forward, I would predict that we will see a lot more of such ethical conflicts. Current government policy of cutting all sorts of funds to universities, combined with pressure to get more funds "from the private sector" (especially but not only in the UK), forces universities to redouble their efforts to attract private donations. Since the funding that universities receive for undergraduate education and research are not sufficient to achieve the world class standards that both students and the wider community expect, universities have to find ways to cross-subsidize these core activities. This involves convincing rich people to part with their cash. Since individuals, especially rich ones, have the habit of attracting controversy, or even fall from grace in some sort of scandal, expect more discussions on the ethical aspect of university fund raising in the future!

  • Financial Times, 2011, "Davis quits LSE over links with Libya", and "LSE was warned of dangers of Libya cash", both March 4. (the latter article is most informative on the extensive deliberations within LSE when offered the donation)

  • The Guardian, 2011, "LSE boss quits over Gaddafi cash scandal", March 4.

  • Peng, M.W. & Meyer, K.E., 2011, "Naming Your School" (Closing Case to Chapter 9), in: International Business, London Cengage.


Analyzing the UK Trade Deficit [C5]

February 11, 2010

What is happening to the UK trade? To gain a better understanding why the international trade data for the UK are so disappointing, we need to look at the long-term trends. Financial markets and media often look at monthly changes, but they tend to tell us rather little about the underlying structural issues. I thus downloaded the data from the Office for National Statistics [Students: this is a very useful and easy-to-access source!], and generated some graphs.

Firstly, how big is the trade deficit in a historical perspective? Actually, the annual trade deficit is the biggest ever (Figure 1, green line) and the monthly trade deficit is the second biggest ever (Figure 2). The data allow us to separate trade in three categories (services, oil, and non-oil goods), which is quite instructive. Firstly, oil (blue line) turned from a regular net surplus to a regular net deficit in the years 2003 to 2005 – it seems North Sea oil is running out and the UK needs to import more of its energy (hence the discussion about nuclear recently). In the overall picture of international trade however, oil does no longer make a big difference.

Second, the trade deficit for non-oil goods ( essentially that’s manufacturing) has been rising continuously since 1998. It reached its biggest ever annual deficit in 2010, and its biggest ever monthly deficit in December 2010 (brown line). So, something rather worrying is happening here. Exports have actually been growing, but by not much more than inflation rate (Figure 3). However, imports have been rising much faster (Figure 4), and thus the gap has been widening.

Following the devaluation of 2007/08, I would have expected a J-curve effect: in the short term import prices (in sterling) rise with volumes unchanged leading to increasing (sterling) value of imports and a widening trade deficit; while in the medium term, trade pattern change as consumers adjust their behaviours and therefore import volumes fall, leading to an improvement of the trade balance. Yet, such behavioural adjustment is not happening, to the contrary the gap continues to increase. Specifically, despite being able to undercut their competitors by about 25% in euro or dollars (compared to 2007 prices), British companies are not able to export substantially more. Why? I offer my explanation in the blog of February 10.

Third, service exports have been the big success story of past decade (red line). Rising surpluses in the trade in services have compensated for the trade deficit in goods. Those service data are a bit more volatile, in August 2005 service exports sharply dropped causing the biggest ever monthly trade deficit. And at the height of the financial crisis, in October 2008 to January 2010, the service balance reached its biggest surplus of over £5 billion monthly. I am not clear why that is so.

In principle, the trade-in-services surplus points to a strength of the UK economy. However, there are two problems. One, financial services have been a major contributor to this surplus, and we all know the costs of the financial service sector to the UK tax payer in the financial crisis. Due to the crash, the sector is much weaker now, and presumably taxpayer would want tighter regulation to prevent having to pay for another big bailout. The question thus is if the export of financial services is sustainable at the pre-2009 levels.


Two, many services such as business-services (accountants, consultants, engineers), tourism and education depend on easily moving people around – either bringing your people out to deliver the services, or bringing your customers into your country. The recent policy changes that make visa applications more costly and more cumbersome for non-EU visitors to the UK is not exactly helping the competitiveness of the service sector, which made such an important contribution to the UK economy over the past decade.


Overall, my deeper digging into the data reaffirm by grave concerns regarding the long-term competitiveness of the UK economy.



UK: Exporting Needs Capabilities [C5]

February 10, 2010


Basic macroeconomic theory suggests currency devaluation leads to export products becoming cheaper abroad, while import prices rise, hence exports increase and imports decline, leading to an improvement of the trade balance. Moreover, when an economy grows slower than its trading partners, this also should improve the trade balance.


Yet, the UK experienced a radical currency devaluation in 2007/08 that is now making its way through import prices (note record inflation data), while GDP growth was negative again in the last quarter of 2010 - and the trade deficit in December was the biggest since 2005. While a small part of it may be due to one-off issues (purchases ahead of the large VAT increase on January 1st), the yearly data show a growing trade deficit. What is going on?


The government on the same day made a major announcement to support small and medium size enterprises by offering new or extended export guarantee and loan facilities, thus matching schemes common in many other countries. This seems to make sense. Curiously, the announcement also states that the scheme is to be self-funding and no new employees will be taken on by the administrating department. It's not clear how that is supposed to work. Whether this scheme is just hot air or actually can deliver on the promises, it is curing the symptoms and not the causes.


The real cause of British export underperformance are weaknesses in the underlying resource base, competences that would enable companies to produce products (and services) at qualities and prices that others would be eager to buy. Britain has a handful of companies that are world-leading in their field, from Rolls Royce in aircraft engines to branded foods like whiskey and tea. It has entrepreneurial communities developing new technologies from semiconductors, to green energy, to biotechnology. And it has top-notch universities that deliver leading edge science, engineering and business research and education. Yet, these represent only the elite in their respective field. A strong national performance you need a broad base - not just a few outstanding role models.


Yet when we look beyond those frequently cited examples, Britain faces a large resource gap. Other countries in Europe and Asia have invested heavily in the human capital base over the past generation - beyond the elite. If Britain want to catch up again with the world's leading exporters it needs a massive investment in its human capital - I am thinking here of pre- and primary education, state schools, vocational training (the backbone of the German and Nordic economies!), and competences in languages other than English, to name just a few examples.


The trade deficit cannot be fixed in the short run, structural weaknesses created since the days of Maggie Thatcher (or even longer) cannot be corrected in a few months. This is a task for a generation. Investments in human capital have to take place today to enable export performance in 10 or 20 years. And nice words and fancy schemes don't help if they are not backed up by resources. Sadly, current government policies, notable huge cuts in many of the pertinent budgets, are likely to further weaken Britain's human capital base.  


For a start, it would be useful if the newspapers actually cared to report the depressing numbers - this morning, only in the FT did I find a small column on the depressing data...


Danisco under offer from Du Pond [C14]

January 12, 2010


One of the companies that I have been following over the years, Danish food ingredients manufacturer Danisco, is under offer from US giant Du Pond, who offer a huge premium over the stock market price of the firm. What makes this erstwhile Danish conglomerate such an attractive target for an American food and chemicals business? The essence is that relentless focus on a core line of business makes the firm a good fit for a strategic investor.


Danisco was created in 1989 by merging three moderately diversified Danish business operating in businesses loosely related to the food industry. From the outset, it has been selling off peripheral businesses and strengthened their position in three lines of business, looking globally for targets: foods and food ingredients, sugar, and packaging for the food industry. Then around 1999, they make another radical change, and focused even narrower. Now their ambition was to become the global number 1 for food ingredients. Hence, they merged with Cultor of Finland, and in the next couple of years, they sold the branded food and packaging businesses they had build up over the years.


The sugar business had for many years the backbone of Danisco, and its main cash cow. However, deregulation of the EU sugar market put the writing on the wall for teh sugar industry, and Danisco sold the sugar division about a year ago to German competitor Nordzucker. So, the company became highly focused on natural food ingredients while becoming increasingly involved in biotechnology products of use outside the food industry. This now makes it a good fit for Du Pond who operate in industrial biotechnology as well as in food ingredients.


Danisco's shareholders are probably going to celebrate big wins - and for the top management a strategy persistently pursued for over a decade pays off handsomely. The offer price is DKK 665, compared to DKK 520 a week ago, and about DKK 450 at the beginning of December. It is too early to speculate if there are consequences for employees of the firm.


I had a look at the strategy of Danisco in two papers in recent the years, and it features as Opening Case of a chapter in our forthcoming textbook:


On the Du Pond-Danisco announcement see:




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