STUART THEOBALD: Something is rotten in corporate SA as checks and balances are eroded

Collapse of National Prosecuting Authority, consulting by auditing firms and denuding of financial journalism have contributed to opening the floodgates to unethical behaviour

This column was first published in Business Day

Something is rotten in the state of corporate SA. Steinhoff is the obvious example of grand-scale theft, but much else lurks in its shadow.

Construction firm Group Five is bankrupt, one-time technology sensation EOH is plagued by corruption allegations that have scared off key partner Microsoft, sugar producer Tongaat Hulett is in trouble over land sales it banked as revenue, investment holding company Brait is a pariah for bailing out management for a share scheme that was R2bn in the red, pharmaceutical giant Aspen is flogging assets to try pay off an unsustainable debt pile, and property empire Resilient is being dogged by allegations of share price manipulation.

All of those have wreaked havoc on shareholder wealth.

These facts please some. Those on a smash-and-grab spree through the public sector love nothing more than to denigrate corporate SA. It is an attempt at a false equivalence, the scoundrel who declares “I might have done bad, but you did too” without realising the acknowledgement of guilt, a fallacy captured by the lovely Latin term tu quoque.

But we are grownups. And we must ask ourselves if something is going wrong in corporate behaviour, irrespective of how others might latch on to the conversation. Of course there has always been malfeasance and it is difficult to say scientifically whether the current spate is just more of the same, or reflects some fundamental shift in the system. Increasingly I am convinced it is the latter: something important has changed.

Many things contribute to behaviour. Thousands of pages have been written on incentives, but that seems to miss something else important: ethics. The incentives debate stems from the school of rational choice, in which all behaviour reflects the rational calculation of optimal strategy to achieve specified goals. But ethics has filled many more thousands of pages, from the ancient Greeks to today. Being ethical is a virtue irrespective of what incentives you may face. And that has increasingly been neglected in business.

Even if we accept incentives are enough, many checks and balances have eroded. The commercial crimes investigation and prosecuting capacity of the state has collapsed. Until the National Prosecuting Authority (NPA) gets its act together, SA will remain one of the easiest places in the world to get away with complex financial crime.

But there are many other role players. The accounting profession, while never perfect, has fallen dramatically. It seems that every two decades or so accounting firms cycle from being audit-focused to playing corporate adviser. As soon as this conflict leads to some or other collapse — the bubble, Enron, the financial crisis — firms excise their consulting arms into separate entities and focus returns to the audit function. We are again at the point when consulting arms need excision.

Another check is financial journalism, though it has been denuded of the resources it had two decades ago. Some exceptional individuals persist in working hard to expose malfeasance, proving in the process that incentives aren’t everything.

Another key part of the puzzle are shareholders. Public financial markets, like that which the JSE provides, are a powerful disciplinary tool. When companies do bad or badly, their share prices are pummelled. An efficient market provides the mechanism through which this works. All those companies mentioned above have indeed had their valuations thrashed, by 65%-98% of their former highs.

A share price thrashing can be too little, too late. If shareholders were more vigilant and more active in conveying their views to companies, companies might not get themselves into trouble. Shareholders’ authority over boards of directors should mean there is never a board that compliantly nods at the management’s version of the truth.

But shareholders too have been denuded of resources, with the growth of passive investment funds putting pressure on all institutional fund managers to cut costs. Fund managers have cut back on the use of external analysts to provide them with research and in the process the number of people actively interrogating companies has fallen, with those left forced to cover more, and inevitably less deeply.

It is all somewhat depressing because the solutions are not obvious to see. Certainly we need a more active NPA, and perhaps we may get a post-election ANC that delivers one (though the party’s parliamentary list contains many individuals who would detest it).

The financial media might find a new business model that re-equips it to provide a well-resourced fourth estate. Competition and regulation will force accounting to firms to rebuild public trust.

The capital markets, too, will rebuild mechanisms to discipline companies. These will not be from within the traditional institutional shareholder world, but rather from activist hedge funds and individual investors, attracted to the profit opportunities that inefficient markets provide. Such activists might be better at the task than institutional shareholders have ever been, even when their nests were much better feathered. All this, though, will take time.

And to make it resilient, we must put ethics back in the centre of corporate leadership, there as the backstop in any incentive system, by vigorously ejecting those who are found wanting.

• Theobald is chairman of research and consulting firm Intellidex.