Why do apparently substantial and successful companies suddenly crash, asks Martin Vander Weyer, and how can a cast of thousands - the advisers, non-executive directors, accountants, analysts and bankers - allow it to happen?
Hindsight is the best of all management tools. A major corporate crisis never fails to provoke - from journalists, investment managers and fellow businessmen - a chorus of exemplary wisdom after the event. The writing was on the wall months ago, the pundits will claim, you had only to walk down any high street to see it. Surely you could see that the board was incompetent, the management deceitful, the auditors complacent, the advisers gutless, the banks irresponsible. In the great number of cases where the company concerned happened to have been led - first to stardom and then to disaster - by a glamourous, autocratic, '80s entrepreneur, the inevitable cry is: why didn't they stop him before it was too late?
Why didn't 'they' stop George Walker from buying the William Hill chain of betting shops from Grand Metropolitan in 1989 for £689 million, later pinpointed by Walker himself as the deal that broke the Brent Walker empire? Why didn't the colleagues and advisers who read the draft of Gerald Ratner's 1991 speech to the Institute of Directors, stop him from uttering the throwaway line which ruined him, the notorious claim that he could sell a sherry decanter for £14.95 because it was 'total crap'?
The answer is that Walker was overwhelmingly persuasive, that the banks were slavishly keen to back him, that analysts were prepared to argue that a chain of betting shops - with their abundant cash-flow - represented a brilliant addition to the Brent Walker portfolio; and that no-one at the table had a crystal ball. In Ratner's case, his upmarket audience thought the decanter joke was both funny and true; it was the next day's tabloid newspapers which exposed, fatally, the implication of mocking insincerity towards the customers who had made Ratner his fortune.
And for both men, the particular errors of judgment were merely symbolic of greater forces at work; it was the underlying economic tides of the '80s boom and the early '90s recession which really determined their destiny. If they had been reasonably cautious businessmen, always willing to listen to sober advice, they would never have reached their zeniths in the first place; having got there, only superhuman foresight and restraint could have prevented the fall.
This is the starting point for an examination of why the wheels can suddenly fall off what appear to be substantial and successful companies: why the early warning signals - so obvious with hindsight - have so often been ignored, or gone unnoticed. And why, instead of shouting 'stop', the combined force of non-executive directors, auditors, advisers, investment analysts and journalists has so often been complicit in encouraging chief executives to believe in their own infallibility.
These are circumstances which affect most especially the kind of entrepreneurial, share-price-driven companies which came to fame in the 1980s, and the problems which afflict them tend to be essentially financial rather than operational. In some famous cases, outright fraud has weakened the company, while concealing the damage until it is too late; in others, excessive appetite for acquisitions, or exposure to property, has stretched the balance sheet to breaking point; in a third category, clever, well-focused businesses - such as GPA (in air-craft leasing) and Tiphook (in containers) - are suddenly revealed to have misread the downturn in their own highly specialised markets.
The common thread is that in almost every case, there is one man in charge, usually the founder of the business, a natural optimist, risk-taker and autocrat, perhaps with no more than two or three long-standing associates whom he really takes into his confidence. Roy Barber, a veteran company doctor, says pessimistically that 'if there's one reliable indicator of a company that will eventually head into trouble, it's having a charismatic, high-profile executive chairman'. Tiphook's founder-chairman Robert Montague, sun-tanned, Ferrari-driving sponsor of the Conservative winter ball, was a classic example.
Such figures are, of course, notably difficult to prise out of their positions of power. George Walker fought tooth and nail to stay at the helm at Brent Walker, and was finally escorted from the building by his own company secretary at four in the morning, at the conclusion of one of the most acrimonious board meetings in modern corporate history. Such intransigence, based on the belief that the founder and driving force has a uniquely valuable understanding of his own business - is the first and biggest reason why the depth of a company's true difficulties are often revealed too late.
Ian Bond, a partner of Cork Gully and past president of the Society of Practitioners in Insolvency, believes that the most common misjudgment made by companies in incipient difficulties is that 'they aren't quick enough to change the man at the top. The one sure way to buy the company time when it's on the edge of trouble is to appoint a new chief executive. So long as he can put up a reasonable new business plan, the banks will almost always give him six months.' Once the chief goes, some or all of his chosen directors may follow, and no holds are barred for the incoming rescue team. But while the ancien regime remains in charge, the likeliest pattern of behaviour is one of delusion - that all is well, or will be well again very shortly - or worse, of collusion in the concealment of evidence to the contrary. 'Often a company's problems are obvious to those on the inside and yet they still don't believe it,' says Roy Barber, who has led rescue attempts for four companies, including the engineering groups Thomas Robinson and Bimec, and is a non-executive director of the kitchen-maker, Spring Ram, now clawing its way back from the edge of catastrophe.
It is perhaps understandable that men such as Spring Ram's founder, Bill Rooney, who had enjoyed a dozen years of relentless profit growth and seen his company described in The Economist in 1990 as possibly 'the most successful manufacturer in Britain', should be slow to recognise that the wind had changed. And the parties that might have triggered the alarm - the board of directors, the auditors, the banks, the City's eager analysts - all notably failed to do so.
Spring Ram is in fact a rare case in which no blame has been attached to its non-executive directors - for the simple reason that it did not have any until Barber was appointed, through institutional pressure led by the Prudential, in May 1993. But in many other cases, the non-execs are often first to be criticised, sometimes because, as the most famous people involved, they make the best newspaper copy: in the troubles of GPA, much attention focused on the boardroom role of Lord (Nigel) Lawson and Sir John Harvey-Jones. Similarly at Queens Moat Hotels, 'City anger' was reported to have turned on former Conservative cabinet minister David Howell. At Tiphook it was former Thatcher aide Sir Charles Powell. While we may sometimes wonder what useful function such figures perform, it may be harsh to blame them first for not spotting impending disaster.
According to Diana Scott-Kilvert, director of Pro Ned, the Bank of England-sponsored agency for non-executive directorships, the real weakness of the non-exec's position is that, 'However diligent he or she is, the management can always conceal the true picture. In the final analysis, it all really hinges on the quality of information he receives. It's a matter of knowing what it is he wants to know. He has to make the effort to research the company before he joins: if his questions aren't answered at that stage he should be very suspicious.' The days of lords (and other notables) adorning boards as no more than what Tiny Rowland of Lonrho once called 'Christmas tree decorations' may be past, but in practice the non-execs' capacity to interfere in the running of a troubled business is still very limited. 'They're not part-time executives, it's not their place to get involved with detail,' says Scott-Kilvert.
Non-execs are unlikely to see the minutiae of subsidiary accounts or monthly cash-flow statements, unless they specifically ask for them. And their contribution is not usually expected to delve too far below the level of grand strategy. Sir John Harvey-Jones, who in his televised Troubleshooter role became famous for the robustness of his opinions about other people's companies, has acknowledged that 'one certain way to ensure that your advice is rejected is to prescribe exactly how the problem should be dealt with'.
When things go wrong, says Roy Barber, 'The company has to have gone critical before non-execs can do very much: if they're brave they can start soliciting support for change from institutional shareholders, but most are very passive. Some people would say that the German system (in which a non-executive supervisory board has the power to dismiss the whole of the executive board if it thinks fit) is the ultimate solution.' The Cadbury guidelines on corporate governance may have clarified the responsibilities of British boards and many lessons should by now have been learned from experience, but outside directors remain an unreliable force when it comes to policing entrepreneurial companies - particularly those which have grown rapidly, without due attention to management structure and financial reporting or without a professional treasury function to keep a sharp eye on the all-important cashflow.
Nor are managers at lower levels likely to be in a position to blow the whistle. Antonia Pierson was an acquisitions manager first for British and Commonwealth, then briefly at Polly Peck: 'When problems are looming, the chances are that only a tiny number of people at the top of the company really know the true picture. Lower down we just became gradually aware that bank lines were being used up, that the money we thought we had for acquisitions was no longer there. Then all of a sudden we were called in and told the bad news.' So who does know what's going on, apart from the chief executive and his close coterie? Auditors, for instance, should have a complete and wholly objective view of the state of the company's finances, and yet time after time they too appear to have been taken by surprise. It is clearly not the auditors' job to broadcast their clients' difficulties to the world - but the accounting profession has often seemed in recent years to be devoting its skills to designing accounts which flatter or plainly mislead, and failing to see the wood for the trees.
At Queens Moat Hotels - which astounded the City with a record-breaking £939 million loss for 1993 - the audit had been entrusted to a tiny Essex partnership, Bird Luckin, whose former head happened to sit on the QMH board. But even the grandest accounting firms have slipped into unhealthy habits, most commonly the practice of justifying the booking of profits which do not yet exist and of accepting valuations of stock or property which disguise underlying decline. Arthur Andersen was the auditor to Spring Ram, whose problems included 'serious misrepresentation and false accounting' in one major subsidiary, Baltersley Bathrooms, and group results massaged by a combination of optimistic stock valuation, early recognition of profits and the intermingling of property deals with genuine sales revenues. Previously thought to be ungeared, the group also suddenly revealed, under its new management, that it had £35 million of debt.
Effectively in league with the accountants in this process of obfuscation has been the one party involved which might have been expected to be most vigilant for truth - the banks. Neil Harland, co-chief executive of bank finance at Barclays, observes that, 'Accounts are rarely transparent in the old way. A whole industry has built up around creative accounting, making them less and less useful. The banks themselves were busy designing "off-balance-sheet" lending products to get around disclosure, or forms of securities which look like capital but turned out not to be enduring capital at all.' Harland also believes that excessive competition in the corporate lending market drove banks to compromise their principles in a way which was as unhelpful to the borrowing companies as it was disastrous to the banks themselves. 'We started moving down the credit risk spectrum: lending to non-asset-owning companies, without proper covenants in the documentation. Good covenants don't get you your money back but they do act as an early warning mechanism, make you sit down with the borrower and start talking before things get out of hand. When you've waived all the covenants to sell the loan, you get little or no warning when things go wrong. And the patient has to be virtually terminal before you have any rights to do anything.' Old-fashioned corporate banking also depended on a real depth of relationship between bank and borrower. But with British, Japanese and American banks in the London market falling over each other to lend, Harland says, 'The companies no longer felt they needed us, and the banks often no longer really knew the management they were dealing with.' Combined with loose documentation, that meant that banks rarely knew how many other banks were lending to the same customer, and how much. At the moment of Rupert Murdoch's worst financial crisis in late 1990, he was revealed to be dealing with 146 different banks around the world; Queens Moat had 62. Ian Bond of Cork Gully says that 'the debt positions exposed in investigating accountants' reports into these multi-banked companies is often greeted with astonishment by the banks themselves'.
Last in the list of those who ought to be able to signal trouble ahead, but rarely do so, are the City investment analysts, often the most active conduit of information between a company's management and the rest of the world. The skill of the stockbroker is to talk a stock up when there is a good story to tell, but to help his clients to sell quickly and quietly if he thinks the stock is about to go down. Phrases like 'fantastic and probably unique' were appearing in brokers' circulars about Spring Ram until a matter of weeks before it was discovered to be in desperate straits. Some analysts, such as Terry Smith, author of the controversial Accounting for Growth, are smart enough to see through the obfuscations presented to them. But others, two or three years out of university and totally inexperienced in the real business world, are inclined to accept company information at face value. And they are more than just commentators: their influence can eventually become dangerous to the company's health.
'A lot of them never make the effort to understand your business,' says Antonia Pierson, who now works once more for ex-B and C chief John Gunn, 'but if your rating is based on successful acquisitions in the past, you can get into the disastrous position of having to look for one more acquisition just to keep the analysts happy.' As the full extent of the disasters of the past three years became apparent, so the pendulum has swung in many aspects of corporate governance. Of the sun-tanned generation of '80s entrepreneurs, only the shrewdest, toughest and luckiest remain in unfettered charge of their businesses. Institutional shareholders are no longer impressed by ex-politicians and grandee socialites in the boardroom. Within the accounting profession, the fashion shifted so far towards rigorous standardisation that there is now beginning to be pressure for more flexibility again.
In the banking world, proper lending principles, including early-warning covenants, were restored. But as conditions improve the pendulum shows signs of swinging back where it came from. According to Harland at Barclays: 'Now the balance of supply and demand has almost been restored in the lending market, companies have been moving back towards close relationships with just a few banks. But as the market begins to revive, you can see the terms beginning to loosen again. Renewed competition is already chipping away at the good things that have come out of the last two or three years.' Corporate crashes may sometimes resemble the plots of Tolstoy's novels, in which human ambitions and frailties are simply overwhelmed by the great tides of history - in this case, a boom which made it all too easy followed swiftly by recession, crippling interest rates and collapsing property values. Or they may be more like Greek tragedy, in which the central figure sows the seed of disaster at the moment of triumph. Either way, it is almost always the entrepreneurs who build the businesses who ultimately bear the major responsibility for their own downfall, whether through over-optimism, conceit or simple bad luck. The rest of the cast - accountants, analysts, bankers and all the rest - do little or nothing to help but are merely accessories after the fact. As for noticing when the wheels were about to fall off, the combined strengths of all those professions seem to have been barely more effective than the general public, who could see for themselves when shops were empty, prices slashed and houses unsold.
It remains to be seen whether the lessons of the recent recession will be remembered long enough to deter the next generation of entrepreneurs from repeating the same mistakes and the next generation of financial experts from missing all the vital signals. Hindsight and human nature suggest that they probably won't.