There's a well-worn path for those who wish to head up a sizeable UK quoted company. Start with a small quoted company, make acquisitions which will - or can be structured to - drive up earnings per share (eps) and keep going until the company has reached a satisfactory size, defined, perhaps, as the point at which a significant salary and share option package for the CEO will have a minimal impact on the company's results. Back in the '70s and '80s, the path was smoothed by appallingly lax accounting standards and by a stock market that was happy to entrust capital to anyone who could keep earnings per share moving ahead, no matter how the figures were constructed.
At last, however, the Game appears to be over. The Accounting Standards Board has eradicated many of the financial engineers' worst practices (see Going for the Juggler, p36). Institutional investors have also developed sensible tools which enable them to assess the true returns being achieved.
And the final resting place of the old eps-driven firms is revealed by the underperformance of Hanson plc over the last decade and the sterility of the businesses it now encompasses (see The Hanson Inheritance, p30).
Not before time. The financial engineers have a lot to answer for. When a company is only as good as its eps growth, its management develops a cock-eyed focus on the bottom line. This approach throws up an attitude to investment which works against genuine wealth creation. Anything prone to damage short-term performance, such as investment to develop new products or markets, is viewed with suspicion; if it could adversely affect earnings per share in the near term, it is rarely justifiable. The key yardstick for many managers in such companies becomes return on capital employed, a figure which is often the basis for substantial bonuses. Such a measure, however, gives managers every incentive not to invest, particularly in projects with a lengthy investment lead time. Far better to stick to old, heavily depreciated equipment where the low level of capital employed makes the achievement of appropriate returns far easier. Why seek out opportunities for growth which involve hiking the business's capital requirement and where returns are uncertain? Thus have the financial engineers strangled the companies they run.
And yet they have been celebrated. Lord Hanson is renowned as Lady Thatcher's favourite businessman, and young Turks still talk of finding a vehicle to emulate his performance. British industry deserves better: it needs the 'animal spirits' drive to build empires, but these must be built on the entrepreneurs' willingness to risk the commercially uncertain ventures on which wealth creation thrives. Britain cannot afford those who take as their role models the financial engineers of the last 25 years.