Ian McIsaac

Financial Training and Consultancy


























Summaries of a selection of articles on the themes of risk, change and forecasting future events are available on this page. The articles originally appeared in newspapers or journals such as The Economist and Financial Times. Although a number of the pieces were written some time ago, they have been included because the message is just as relevant now as when the article first appeared.


Current business structures, according to John Kay, are not helpful for the long-term development of companies. He uses the example of Marks and Spencer to show that the relationship between investors and managers of corporations has become “dysfunctional”. Analysts focus on what the company will announce rather than business strategy; companies manipulate the process to present their results in the most flattering light. During the 1990s one of the foundations of the successful M&S business – strong relationships with suppliers and customers – was neglected as the management pursued unsustainable earnings growth. However, Kay argues that private equity does not provide a solution for long-term development. Although private equity is capable of financing capital-intensive businesses (which was, of course, the original reason companies became listed), he points out that Simon Marks would have had little interest in backers who planned an exit in three to five years time. His business was built around a stable family holding with disproportionate influence and the long-term support of a small group of committed institutions. This was “the environment in which, without ever having heard or uttered the phrase “shareholder value”, Marks was able to create so much of it.”


The collapses of Enron, WorldCom and the like have prompted regulators to demand that investors pay closer interest to what is going on in the boardroom. However, Philip Coggan points out that the fundamental problem of managerial capitalism remains. Institutional shareholders own shares in hundreds of companies. How can they possibly have the time to monitor the minutiae of executive actions all the time? They can, of course, set up corporate governance departments. But those who take an activist approach have to not only bear the expense but also face the “free rider” problem: investors who do nothing get all the gains of activism with none of the costs. The creation of corporate governance codes is a way round this problem. At their worst, such codes can be mere box-ticking exercises. At their best, they allow a compromise in which investors can focus on the worst cases of abuse. This, Coggan concludes, is the trend of the moment. Sainsbury, Glaxo and Disney are three examples of recent high-profile rebellions. Investors cannot fight every battle or check the ambitions of every over-powerful CEO, but they can fight a few prominent battles - just as the British used to shoot the occasional admiral to encourage the others.

A BOOM LIES AHEAD - AND SOME SURPRISES (Anatole Kaletsky - The Times, January 2004)

In his forecasts for 2004, Anatole Kaletsky believes that the US economy will expand by about 4.5% this year and that Britain will also rebound quite strongly comfortably achieving the Chancellor’s prediction of 3% growth. However, the US will not be exempt from nasty surprises. Even though interest rates will end the year in the US at say 2.5% this will be far too low to contain the inflationary threat.

Kaletsky’s most confident prediction is a collapse in bond prices round the world. With the US economy booming and inflation rising he expects bond yields to end the year at around 6%, which would make 2004 as bad a year for bonds investors as the annus horribilis of 1994. Bond investors in Britain and Europe may be spared the worst of the carnage but can expect to end the year with heavy losses. He also believes rising long-term interest rates and fears of inflation will lead to share prices in the US ending 10% below the level at the beginning of the year. The British market should do somewhat better with the FTSE 100 ending the year about where it started.


In the developed world it appears that financial crises no longer derail economies, says John Plender. The phenomenal stock market bubble in the US has defied historical precedent by spawning a modest recession and no banking crisis at all. However, painful adjustments after a financial boom period do serve a purpose.

The discipline of bankruptcy ensures that debt is written down to realistic levels and capacity is brought in line with demand to pave the way for an upturn. If the effects of financial crises are eliminated, the business cycle is extended. Asset prices continue to rise, generating wealth effects that encourage people to run down savings and borrow on the strength of the rising value of their collateral. As the Montreal-based Credit Analyst points out, the failure to correct balance sheet excesses in the downturn means that each new US expansion begins from progressively lower levels of liquidity. US household debt has gone from less than 40% of gross domestic product in 1960 to close to 80% in 2002. So with each new cycle, say the BCA editors, the stakes become higher, pushing the economy closer to a deflationary end-point.

The denouement of the debt drama is sparked by deteriorating credit quality, which exposes the vulnerability of a banking system that hitherto appeared well capitalised. If debt continues to accumulate over the next economic cycle, will central bankers and governments be able to confront a financial crisis by muddling through?

NOT THE FUTURE WE EXPECTED (John Kay, FT January 2004)

There are dissenters, says John Kay, to the widespread view that we are living through a period of unprecedented technological change. He draws attention to the work of an economic historian, Alexander Field, who concludes that the most rapid period of economic change did not occur during the 1980s and 1990s but in the period which coincides with the great depression in the US. The focus of Field’s work has been changes in total factor productivity – the part of economic growth that is unaccounted for after you have taken into account the effects of changing labour inputs, increased skills and growing capital employed. His analysis purports to show that the productivity improvements of the last decade have been unremarkable despite the advances in IT and communications. We can easily forget that there are many things apart from IT that have not changed much over the last 40 years. Cars have not been superseded by flying platforms (predicted by some in the 1960s) and our clothing is still derived from cotton and wool despite the discovery of artificial alternatives. Business gurus and management consultants have a shared interest in exaggerating the pace of change. These commentators tell us that the lessons of the past are irrelevant because the future will be so radically different from the past. Old concepts of valuation and financial control are redundant and the determinants of business success have fundamentally changed. We should take all these claims with a large pinch of salt.

THE FUTURE OF ACCOUNTS (The Economist, April 2003)

In special report on the future of accounts, The Economist asks what accounts are actually for. Accountants would reply that they are there to give a true picture of a company’s performance over a period of time. Investors, however, want more than that: they want a sense of the company’s future prospects and in particular the key risks faced by the business. Regulators also believe that there should be new sections in annual reports on intangible assets and “key performance indicators” – such as employee turnover, customer acquisition cost or inventory turnover. However, Baruch Lev, a professor of accounting and finance at New York University Stern School of Business, says that none of this addresses the deepest flaws in accounts. This is the reality that most of the numbers in accounts are estimates not facts. He points out that no amount of new accounting rules will change the fact that estimates are fragile and easy to manipulate. Mr Lev’s remedy is to separate accounts into two pieces: one “core” and one “satellite”. The core part would have the most reliable numbers (eg cashflow and, perhaps, property) and the satellite part would contain fair value numbers and intangible assets. The company would then have to state in its annual report what percentage of its numbers derive from estimates and what portion are verifiable facts: analysts might choose to apply a discount to a company with a high level of estimates. However, The Economist concludes that the weight of regulation and threat of litigation leaves companies with very little freedom to experiment. So, although accounts will probably improve over time, do not expect anything radical too soon.


What is it with the credit ratings agencies? They have been under attack since they were caught napping by the collapse of Enron and their failure to spot the Asian crisis in advance. They were condemned to shoot the wounded by adjusting their rating downward when countries were already on their knees. So everyone condemned them. John Plender believes that this a bit tough. Like bank supervisors, they are caught in a thankless trap. Corporate collapses and financial crises are part and parcel of the capitalist process. If such people had perfect foresight there would be no creative destruction. But since they do not, the rest of us have a perfect scapegoat when things go wrong.


At its heart, says Peter Martin, business is a gamble. This applies equally to a peasant planting crops to sell next year as it does to the semiconductor boss who commits his company to a US$2 billion chip plant. They are both placing the same bet: that there will be enough customers, at the right price, for what they produce. We have invented various techniques to analyse and manage these risks. But these techniques can have the effect of convincing us that the gamble has gone away. Even more dangerous is that they can distort or conceal the underlying risks. Business calculations, such as present value, are all fine but they rely on the ability to predict cash flows years into the future. However, as the problems at Energis demonstrate, we cannot sometimes predict cash flows even a few weeks ahead. A further drawback is that we are tempted to invent a future we want. This means many managers have become good at gaming the system and adjusting forecasts to produce the present value needed for project approval. Excessive optimism has resulted not only in new technologies that never lived up to their promise but also large underestimates of the future costs of present obligations. The answer is not to invent ever more sophisticated measures of risk. Simpler calculations of the value of an investment will, in the end, work better if they expose the factors that will make the difference between success and failure. Adopting simplicity as the test will have the side benefit of offering protection against those business ventures that are too complicated to be easily comprehensible.