Tim Harcourt | The Airport Economist

The Asian white paper is a great chance for Australia to explore the opportunities our closest neighbours offer us, and education is the key: as it offers great points of engagement with Asia and longer lasting and deeper relationships.

The long-awaited Asian Century white paper was released on Sunday. Ken Henry’s paper covered a broad range of issues including education, language skills, technology and security in the fastest growing region on the planet.

Australia has been earning big dollars through rocks and crops – now we’ve got to do a bit more learning through education and service exports. But I argue that now it is vital for Australia’s trade that the white paper lifts our engagement with Asia, and identifies opportunities for government and business.

Just speaking an Asian language whilst helpful is not sufficient – we need to be Asian business literate, and understand the economies of our Asian partners to succeed in our engagement.

As younger Australians engage with Asia through education and exchange, technological advances and social media, the nature of their relationship with Asia will be different from that of previous generations. Demographic change in Asia will mean more opportunities for Australian services providers in the traditional areas of education and tourism but also in areas focused on wellbeing.

We should be at the forefront of offering financial services to Asia, and Australia could become the dominant financial centre in the region. Australian capability in financial services will be critical in the fourth wave of our economic engagement with Asia, as finance is the fuel that lubricates international trade. Financial services trade volumes picked up substantially in 2011 after four years of stagnation, rising by 22 per cent.

Tim Harcourt is the JW Nevile Fellow in Economics and an adjunct professor in International Business Strategy, at the Australian School of Business, the University of New South Wales (UNSW) & author of The Airport Economist:  www.theairporteconomist.com.

From the Knowledge@Wharton today blog.

Austerity in Spain and most of Europe has failed, according to Wharton management professor Mauro Guillen.

Further proof came this week with the announcement that the Spanish economy’s downward spiral continued, with GDP shrinking by 0.4% in the third quarter — the fifth-straight quarterly decline — and unemployment hitting a record 25%.

Despite the government’s attempt to put off a eurozone-led bailout of public debt, expect Spain to accept terms within two to three months, says Guillen.

In this video, he addresses the question: Have attempts at economic reform in Spain worked on any level?

This post was previously posted in Knowledge@Wharton today blog: Spain Sputters as a Bail-out Moves Closer

Peter Swan

Common sense suggests company boards are best composed of directors who hold shares in the business because any poor performance is effectively ‘skin in the game’ as a cost to the director as well as to shareholders. Director’s interests align with shareholders. Directors who mismanage pay a severe price. Evidence also implies this is the case.

During the global financial crisis when the ASX200 index tumbled nearly 40%, incentivised boards suffered fewer relative stock price falls. Yet this advantage can be lost if a company’s board has too many outside directors or if the board members are too compliant to the chief executive. They fail to ask the tough questions. The size of boards is also an issue. Having executive board members who share ownership directly benefits firm performance and lowers CEO pay – but less so when ownership is combined with large boards. It seems when a firm performs poorly, too many independent directors can impede critical action – such as firing an underperforming CEO. A ‘smallish’ board of five or six highly incentivised directors, with a low proportion of outside directors who are prepared to monitor and not just advise management, is optimal, according to my research done in conjunction with Serkan Honaine.

Poor governance can squander a firm’s wealth and our study into how well the interests of independent board members and shareholders are aligned in larger Australian companies suggests large boards of eight-plus members can be very destructive for shareholder value. The average market-to-book ratio of companies with smaller boards of seven or less directors is 50% higher than those with eight or more, and nearly 40% higher when debt-financed assets are included.Our research based on an analysis 284 major Australian listed companies over the decade to 2010 shows that if businesses with large boards behaved like firms with fewer directors, they would improve their performance substantially. Reducing the size of the average large board (nine directors) of Australia’s top 200 firms in 2010, to the size of the average small board (six directors), could boost an individual company’s performance by as much as 50%.

In all likelihood, a large board indicates that management is in control with little effective supervision by shareholder representatives. Naturally, management is reluctant to give up its privileges and drastically reduce board size despite huge cost savings. Poor board monitoring and weak decision-making is collectively costing shareholders hundreds of millions of dollars. Part of the solution is to replace large boards with smaller boards that do not try to usurp the role of management by micromanaging and to focus on the important task of hiring and firing the CEO.

Risk Aversion and Big Boards

Larger boards appear to substantially drag on overall firm performance through a variety of mechanisms, such as reducing non-executive director (NED) incentive pay and raising base pay for outside directors. Such actions encourage a board, dominated by outside directors who have no incentives, to entrench poorly performing CEOs. Large boards are also more cautious because they can have more difficulty reaching a collective decision. This constrained risk-taking results in slow responses to new circumstances and slower release of new information. The resulting reduced stock price volatility appears harmful to shareholder value.

Bigger boards, dominated by outsiders unlikely to be informed of company affairs, have a tendency to keep growing. Large, externally dominated boards appoint more and more directors like themselves with little or no regard for the wishes of shareholders, who are then hit twice. Shareholders not only pay for the salaries of surplus directors but also suffer performance decline into the bargain.

Our research measured performance by comparing companies’ market values to book values. (The market-to-book ratio attempts to identify undervalued or overvalued securities by taking the market value and dividing it by book value. As a rule, the more the ratio exceeds 1, the better the performance while those below 1 are considered undervalued or poorly performing.)

We find that, based on 2010 values, property group Westfield and National Australia Bank (NAB) had below-average market-to-book ratios of 1.34 and 1.39, respectively, and 13 board members each. Publisher Fairfax Media, with 11 board members, carried a very depressed ratio of 0.58, which is well below 1 (and far lower still in 2012). National airline Qantas had 10 members on its board and its value ratio was less than 1 (at 0.83) with its ratio continuing to deteriorate.

Investment and financial services provider Macquarie Group had 10 members with a ratio of 1.03. In contrast, with only five directors on their boards, investment fund Platinum Asset Management and high technology company, Silex Systems, had ratios of 11.7 and 9, respectively.

Meanwhile travel brand group, Wotif, and electronics retailer JB Hi-Fi, each with six directors, had ratios of 13.2 and 7, respectively.

Challenging Independent Director Dominance

In theory, Australian boards appear to be wide open to influence by outside directors. Unlike the US corporate landscape, no chief executive was chairman of a big Australian publicly listed company board. As a result, non-executive directors have a greater ability to intervene in a firm’s activities.

Shareholders have greater power too. Only 40% of Australian shareholders vote at company meetings on proposals from the directors – half the rate of the US. So large shareholders of Australian companies may not need as much stock to maintain control and can make critical decisions, which puts the onus on independent directors to apply greater scrutiny.

We suggest the findings on the harmful effects of outside directors’ dominance and large boards are directly contrary to the views held by regulators, which have been shaped by big corporate collapses. Virtually every country in the world has mandated a majority of independent directors based on little more than what may be simply a coincidence: the failed US energy company, Enron, happened to have a majority of executives on their board.

We challenge the trend for corporate governance councils around the world to introduce policies for a majority of independent directors on boards. Full-time executives, especially those with shares providing skin in the game, know a great deal more about the company and where it is heading than do outside directors. Moreover, typically they stand to lose a great deal more than do part-time directors if the company fails. This may include their jobs and livelihood.

Part-time, outside directors typically have little background in the industry. If the company fails, they may lose their director’s pay that in some cases is little more than a sinecure for turning up to board meetings. If prominent in the community, they may also suffer reputational loss.

We also question the regulators’ decision – in Australia and other countries – to make share ownership a barrier to independence. The Australian Securities Exchange’s (ASX) listing rules require the majority of directors to be ‘independent’, which is defined as not being a substantial shareholder (by holding less than 5% of stock in the company) or not having worked in an executive capacity for the company or another group member for at least three years. This seems counter intuitive because large shareholders have the most to lose from bad managers. They therefore have an economic incentive to gather information and actively monitor the chief executive.

If protecting shareholder interests is the task non-executive directors are facing, then surely alignment with, and not independence from, shareholders is ideal. The New York Stock Exchange (NYSE) and NASDAQ listing rules adopt a neutral stance: stock ownership per se is not a barrier to independence, and they set the barrier at 10% of stock for directors taking on an audit committee role because of the Sarbanes Oxley Act.

It would seem that regulators, in their quest to free management of burdensome shareholder concerns, have taken Australia way out of the mainstream at a huge cost to investors and forno apparent reason other than to appease the privileged managerial class at the big end of town.

Regulators’ Response

The ASX does not see this as a burning issue. When the ASX Corporate Governance Council recently reviewed its Corporate Governance Principles, roundtable discussions were held throughout the country with representatives of directors, management, institutional and retail shareholders, proxy advisers and others with an interest in how corporate governance practices are developing, no change was recommended.

The council chair, Malcolm Starr, said the consensus view was to leave well alone because the present system was working well. He acknowledged the viewpoint that it was counter intuitive to limit non-executive directors’ shareholdings because ownership should encourage better monitoring of company management. Yet there was another opinion that complete independence (through no shareholdings in a company) was the better way to go, Starr insisted.

The Australian Institute of Company Directors agrees. “Non-executive (or independent) directors are seen as ‘custodians of the governance process. While they govern an organisation on behalf of the shareholders or members by whom they are elected, their role is to act in the long-term interests of the company, not shareholders per se, and certainly not particular shareholders,” says spokesman Steve Burrell.

We say independence is undermined by other factors – such as by the old boys’ network that traditionally has appointed directors in the first place. In theory, outside directors should confront management and champion shareholder concerns, but in practice, their motivation is suggested to be more about behaving in ways that will bring more lucrative directorships.

Non-executive directors who are often appointed through friends on the board would be more partial to showing allegiance to their friends and overlook activities by management to expropriate the wealth of shareholders. Directors who do ask questions of management are likely to be either ignored or ostracised. They face the prospect of being denied the right to stand for reelection.

Paper independence aside, high levels of fixed compensation for attending scheduled meetings, along with the barriers to equity ownership provide for little incentive for non-executive directors to exert the extra effort that would add value to the firm. Likewise, the low level of variable forms of compensation to non-executive directors provides little incentive for them to seek and endorse strategies that add value to a company, as the non-executive directors would receive little in the way of the fruits for their labour.

Yet there could still be an incentive for non-executive directors, who may be motivated to perform their role more effectively by both the lure of new directorships from other boards and the financial incentive of being a corporate insider.

Why board size counts

We show that company performance diminishes with reduced monitoring of management by directors, while future firm performance increases when executive and non-executive directors own shares in the company – but not when the board is big. Weak monitoring by large boards, in combination with a high proportion of non-executive members who do not effectively own or take responsibility for decisions – the ‘free rider’ problem – was also found, particularly when boards consisted largely of non-executive directors without shares in the company.

A standard justification for large boards may be the need for these knowledgeable or well-connected outside directors to act as advisers – particularly in big complex companies. Yet it has been long believed that companies with larger boards suffer in performance because of their difficulty reaching consensus on decisions.

Greg Medcraft, the new chairman of the Australian Securities & Investments Commission (ASIC), has warned boards they will be held to account. “For instance, in the Centro case, Mr Medcraft has said publicly that ASIC acted where it believed directors’ behaviour did not meet the expectations of the law,” emphasises an ASIC spokesman. The Federal Court recently found directors of the Centro property group breached their duties when they failed to notice multi-billion dollar errors in the property group’s accounts.

Medcraft, who was appointed in May 2011 for a five-year term, says directors play an important role and they must not uncritically adopt the work of management on major issues for which they are responsible. “The key elements of the financial position of the company are things that directors should understand,” he says.

Conclusions

Our findings are a challenge to the ASX and ASIC, which discourage outside directors from owning shares in companies they hold board roles on for fear it undermines their independence. Ownership can be a tool to help align shareholder and manager interests and is linked to a firm’s positive performance. It is only likely to be fully effective if the board size is restricted to no more than about five or six. If management needs advice then it should simply hire consultants, not create large unwieldy structures made up of so-called ‘advisors’ kowtowing to management.

Before accepting a board role, a prospective director needs to signal his believe in the board’s monitoring role either by substantial personal shareholdings or taking his pay in the form of escrowed shares during his tenure. He may also need to negotiate funds set aside to assist board members in their monitoring role as boards need access to resources independent of day- to-day managerial control, especially when dissatisfied with the CEO’s performance.

Professor Peter Swan AM FASSA is a Professor of Finance, Australian School of Business, The University of New South Wales. This opinion piece was previously published on the ASA Magazine.

From the Knowledge@Wharton today blog.

When Burberry recently reported that sales at stores open a year or more were flat, and suggested that profits are likely to be on the disappointing side, some people began to wonder if Burberry might be the canary in the coal mine – a harbinger of lower sales in the luxury sector over the coming months.

A Wall Street Journal article today supports that theory, noting that diamond sales in China are expected to grow more slowly this year than last, while Daimler AG has announced that its Mercedes-Benz division would miss its profit target in China and expects lower sales for its Porsche division.

Is London-based Burberry indeed an example of what we will see in the luxury goods market? What are the implications for the global economy and, equally important, for the upcoming holiday season?  

Burberry suggests that its slowdown is “a sign of an upcoming trend in the luxury segment,” says Wharton marketing professor Barbara Kahn. “Although it is hard to know for sure, there is some indication that this might be a correct analysis.”

Much of the ability of the luxury segment to maintain steady growth has been due to strong performance in China, she adds, and “recently, this growth has slowed down for several reasons. First, as the Chinese luxury consumer gets more sophisticated, [his or her] need for purchasing high-end visible status symbols slows down. Many of Burberry’s products are high status — and visibly so, due to the famous ‘check’ [design].” Now that consumers are gaining more confidence “in their own positions of wealth, these types of purchases may decrease.”

In addition, Kahn says, China’s economy is slowing down, “and there are indications that the government will not provide substantial stimulus mechanisms, as they have in the past, to keep up the growth levels.”

Burberry, a luxury fashion house that sells accessories and clothing for men, women and children, has approximately 235 stores and outlets, and can be found in more than 200 upper-end department stores worldwide.

An article in The New York Times noted that Burberry’s main customers, “known in the industry as traveling luxury consumers, [include] just over a third in Asia, a quarter in the Americas and a little less than a third in Europe.”  The article, published shortly after the disappointing figures were announced by the company, quotes Burberry CEO Angela Ahrendts acknowledging that “the external environment is becoming more challenging,” and suggesting that Chinese consumers may be slowing down their luxury purchases only temporarily, waiting to see how the upcoming leadership changeover in China affects their purchasing power. 

Wharton marketing professor Z. John Zhang has a slightly different take. “I don’t believe that the overall consumption of luxury goods in China is going down, and even if it is, it will not last for long,” he says, adding that economic downturns typically do not affect many luxury goods consumers, “especially in a country where the income disparity is huge. If anything, in a downturn, you need to look even better to impress your peers.”

Burberry’s lower sales could be due to a number of reasons, according to Zhang. “First, more and more people in China are going abroad for shopping. The people who could afford to travel abroad are those who could afford to buy luxury goods, and there will be a substitution effect. Second, there may be more fake luxury goods in the Chinese market. After all, during a downturn, you do what you must to survive. The supply of fake goods may have increased considerably now that the economy is getting tougher.”

The worst outcome for Burberry in China, he adds, is that “it is no longer on the top of the Chinese customer’s list of luxury goods [to purchase]. These consumers are constantly looking for new ways to distinguish themselves and to stand out in a crowd. It is an arms race [among] luxury brands to find new ways to provide exclusivity to their customers.” The disappointing news from Burberry could reflect the fact that the company “is losing favor with exacting Chinese consumers.”

So what’s ahead for Burberry and other luxury goods retailers?

“The luxury retail sector was the first to recover after the recession, partly due to strong demand from China,” says marketing professor Stephen Hoch. “Maybe they are now at a pausing point.” Any weakness that is evident, he adds, “would be due to Europe and China rather than the U.S., where the rich seem to be doing just fine relative to everyone else.” In China, if the new stores — where you would expect the biggest increase in same store sales since they are new — showed any weakness, “then this could be a big contributor,” he points out. “It is hard to predict whether Burberry is a harbinger of anything else. I tend to doubt it, but we will see.”

Kahn notes that the continuing uncertainty in Europe is definitely a factor in lower luxury goods purchasing. In addition, she has read reports suggesting that the new Chinese leadership team – expected to begin transitioning as early as next month – “is not likely to provide as much stimulus to the economy as they have in the past.”  Finally, if Burberry’s slowdown is indeed a general trend, and not unique to Burberry, “I would expect to see similar slowdowns in other highly visible status luxury purchases, such as LVMH and Chanel.”

And the outlook for the luxury goods sector during the all important holidays? “As usual, it is hard to predict the upcoming holiday season,” Kahn says. “The back-to-school season was reasonably strong — relative to our new, more moderated expectations — so people are cautiously optimistic. I think the current thought is that we should see a holiday season fairly similar to last year – which is reflecting the slow but steady growth patterns.”

This post was previously posted in Knowledge@Wharton today blog: Is Burberry the Canary in the Luxury Coal Mine?

Vic Edwards

Is China in a worst state than official figures suggest? Maybe – but the overall picture is mixed.

China’s manufacturing has experienced a slump in orders – but inflation slackened more rapidly than expected. China’s manufacturing activity has fallen to its lowest level in more than three years as the global economic slowdown continues to weigh on the world’s largest exporter.

The Chinese government has tried to boost the economy with interest rate cuts and by lowering the amount of reserves that banks must keep on hand in a bid to spur the kind of lending that could stimulate a rebound, however contagion from Europe is impacting China, and that is causing pressure on Australian exporters, particularly the miners who are dependent on China importing vast amounts of coal and iron ore.

China is the world’s biggest energy consumer and steelmaker. However new Chinese export orders contracted last month at the sharpest pace since March 2009 while employers cut jobs at the fastest rate in 41 months.

I recently visited China, and saw that China’s exporters are facing increasing difficulties amid stronger global headwinds. At the same time the dynamics of Australia’s relations with China are undergoing a rapid process of change, and this will reshape international and foreign policy between our two countries. This comes as China prepares its 12th Five Year Plan – an unstable time for its economy.

A series of weaker than expected economic data has resulted in China cutting interest rates for two months in a row, and its central bank has been injecting cash into money markets to ease credit conditions to support the economy after it notched a sixth straight quarter of slower growth.

A blow-out in China’s trade deficit raises concerns about the country’s future economic growth, raising questions about whether the country’s economy is tailing off more rapidly than anticipated. The only bright economic star was that inflation slackened more rapidly than expected.

China has eased monetary policy to bolster growth – but the central bank is being cautious to emphasise a “prudent” policy stance for fear of re-igniting property and inflation risks.

I feel – despite recent speculation in the newspapers – it is unlikely China will release a package on the scale of the stimulus spending and lending that occurred in 2009 and 2010 in response to the global financial crisis.

Vic Edwards is a Visiting Fellow in Banking and Finance at the Australian School of Business.

Professor Fariborz Moshirian

Plans for the Eurozone’s rescue fund are to go ahead, following a ruling by the German Constitutional Court at Karlsruhe. This was a much anticipated landmark ruling watched around the world, delivering a momentous decision with far-reaching implications for the euro’s future. It means Europe can finally sign the European Stability Mechanism (ESM) and fiscal pact.

The German Bundesverfassungsgericht Constitutional Court overturned a number of legal challenges aimed at preventing two crucial economy boosting tools into law.

The ESM was set to replace the temporary European Financial Stability Facility (EFSF) and should have been in place by the beginning of July. However it needed Germany’s share of the rescue money to function and that was really held up pending the court ruling.

The European Stability Mechanism is a fund backed by the 17 countries that use the euro, with those members paying 80 billion euro up front, and pledging 620 billion euro as a backup. Its purpose is to support countries that have got into financial trouble and just can’t borrow money on the normal money markets. The 700 billion would enable the fund to sell highly rated bonds.”

It is designed to come to the aid of debt-stricken countries such as Spain and Italy. The court’s rejection of thousands of injunctions from Germans objecting to participation in the European Stability Mechanism will help smooth the way for the Eurozone to attempt to contain the debt crisis.

The present turmoil in Europe may continue for some time to come, however I think major economies should avoid sinking into recession as long as European policymakers intensify their efforts to address the Eurozone crisis.

Professor Fariborz Moshirian is the Director of the Institute of Global Finance at the Australian School of Business.

Les Hems | CSI Blog

In April last year I wrote in The Conversation about an innovative financial investment mechanism called Social Impact Bonds, that was designed to address some of society’s wicked problems by engaging government agencies, not-for-profit organisations, private investors and financial institutions.

At that time only one of these SIBs was operating in the United Kingdom. After what seems to have been a long pause, the increasing levels of interest and rhetoric have turned into some tangible products, including here in Australia.

In the last weeks two new SIBs have been launched in the United States – one in New York and the other in Massachusetts. Meanwhile in NSW, three SIB propositions are now under negotiation.

The most interesting aspect of these new initiatives is how the basic SIB concept developed in the UK has been adapted in different jurisdictions.

As I have explained in my previous story, the way a SIB works is by a bond-issuing organisation raising capital from investors, based on a contract with government, to deliver improved social outcomes that generate future government costs savings.

As well as repaying the principal, investors are paid a reward if the agreed outcomes are achieved.

The growing interest in SIBs is driven by a number of factors. Firstly, Governments are developing long-term outcomes focused “payment by results” or “payment for success” mechanisms to replace inefficient and ineffective mechanisms such as contracts, fee-for-service or grant-in-aid mechanisms.

Secondly, not-for-profit organisations are increasingly focused on delivering long-term social impact. However, many not-for-profit organisations are “permanently failing” – with demand for services outstripping supply, they are under-capitalised, use a short term revenue funding model, and rarely use debt finance.

Thirdly, investors of all shapes and sizes are increasingly seeking to achieve an appropriate balance between commercial returns and the social and environmental value created.

There is now a shift from ethical and socially responsible investing – based on screening out investments associated with social and environmental damage – to social impact investing where commercial returns are blended with the creation of social and/or environmental value.

This shift chimes with Professors Michael Porter and Mark Kramer’s vision of creating shared value.

SIBs offer the potential to harness these three drivers and re-engineer the traditional relationships between government agencies, not-for-profit (NFP) organisations and investors to create social benefit

Given this positive analysis it might have been safe to assume that first UK SIB focusing on recidivism would be rapidly replicated in other jurisdictions and across other policy fields.

However, the UK experience showed it takes a long time to develop a SIB proposition and measuring success is not only complex, but absolutely essential in order to find a point where all partners will agree to proceed.

The first UK SIB is reportedly progressing well and is on schedule to deliver the target outcomes.

But it’s most striking attribute is that it is an “all-at-risk” investment; where the failure to achieve the target reduction in recidivism leads not only to investors losing the reward payment for use of their capital, but also losing the principal.

Government has therefore achieved a complete transfer of risk to the private investor – although it has to be acknowledged that it is difficult to assess risk in such an innovative mechanism.

It is therefore unsurprising that all the investors in this innovative mechanism are philanthropic institutions – trusts and foundations – which can rationalise the downside risk as a donation as well as a failed investment.

Trusts and foundations traditionally use the financial returns on their investments to provide grants with the goal of achieving social value. The SIB mechanism offers them a mechanism to also use their corpus to achieve social value. However, if accessing commercial investment capital is a SIB goal, then arguably the UK SIB has failed.

The deal was formulated by a specialist intermediary – Social Finance; they hold the contract with government to deliver the agreed outcomes and are responsible for the ongoing management of the SIB.

Social Finance sub-contract the delivery of the intervention programs to a number of not-for-profit organisations. Finally, the reward payment and repayment of the investors’ capital will come from an innovation fund rather than the mainstream service delivery budgets.

The New York SIB is also in the field of recidivism, but with some significant adaptations to the original UK SIB, particularly around the nature of the risk sharing and the involvement of a commercial investor.

For instance, in the NY SIB, the prime investor is investment bank Goldman Sachs, along with with Bloomberg Philanthropies – the charity of New York major Michael Bloomberg – which is providing a credit guarantee that limits losses to a quarter of the invested capital. A further adaptation is a research centre – the MDRC – is coordinating the delivery of the recidivism program.

In Massachusetts, two “payment-for-success” based initiatives are under development which relate to recidivism and homelessness.

At this stage it is not clear what structures may be used, but it is interesting to note that the process is being driven by government and is following a traditional procurement process.

This is also the case with the Social Benefit Bond (aka Social Impact Bond) trial in NSW.

Three proponents are now involved in a negotiation process and while the full details aren’t known, at least one proposition includes two mainstream financial institutions, another involves a specialist intermediary, and all three have on-board very large not-for-profit organisations.

An overarching conclusion is that in these early stages, social impact bond propositions will need more “trials” to better understand stakeholder behaviour as well as how to optimise incentives.

In these early stages the costs of the measurement and research must also be borne outside of the SIB mechanism, or else transaction costs will undermine their financial viability.

In the UK there are a range of institutions and funding sources, including BIG Lottery, NESTA and Big Society Capital. In the US, President Obama established a fund of US $100 million to develop “payment for success” mechanisms.

But in Australia there are no similar sources of funding to support measurement, research and development. If SIBs are to become more widely used here, this is a significant gap that has to be remedied.

This article was previously posted on The Conversation and on the CSI Blog under: Will social impact investing finally pay dividends?

From the Knowledge@Wharton today blog.

The Indian aviation sector may be in turbulence mode, but that hasn’t shaken the spirits of G.R. Gopinath, the father of low-cost air travel in India. Gopinath, who sold India’s first low-cost airline Air Deccan to Vijay Mallya, the owner of Kingfisher Airlines, is gearing up for action once again. “I have been preparing for a national launch for the past year, and I hope to be ready next year,” an upbeat Gopinath told India Knowledge@Wharton.

The provocation for Gopinath to take to the skies again is simple: Kingfisher is in a financial mess. The airline is running a sharply reduced service, and if it does not manage to raise funds, it could shut down anytime. Gopinath, who sold Air Deccan to Mallya in 2006, sees this as an opportunity for his re-entry into the sector. He points out that when Kingfisher bought out Air Deccan, the two brands together had 36% market share. “I believe that the market is still largely untapped. This is an unfinished story, and I see a huge opportunity still there.”

In the meantime, he has reentered the skies with a different avataar. Gopinath recently launched Deccan Shuttle, a regional airline in the state of Gujarat in Western India. Gopinath points out that apart from the big cities and towns that are connected by the Airbuses and the ATRs, India has around 500 small airstrips which are not well connected. “Gujarat, for instance, has nine airports. While all of them are linked to Mumbai (India’s financial capital in the neighboring state of Maharastra), they are not linked to state capital Ahmedabad, or to each other. My idea is to open up a new market. I am passionate about providing easy access and connectivity.”

Gopinath has launched Deccan Shuttle under the banner of Deccan Charters, an aviation services firm that he set up in 1995. This was his first venture in the aviation sector. It currently has 20 aircraft (helicopters, turboprops and business jets) and operates out of 16 locations. Under Deccan Shuttle, Gopinath will begin by deploying around six 10-to-18-seater aircraft in Gujarat. Over the next three years, he plans to have 25 such small aircraft across five states. Gopinath’s plan is primarily to offer intra-state connectivity. But in routes where there is significant demand due to cultural or trade reasons, he will also look at inter-state connectivity.

Other recent entrants in this space include Air Mantra, a unit of the Religare Group. Air Mantra launched in July, connecting Amritsar and Chandigarh in North India. Spirit Air, which operates in Eastern states like Jharkhand, Bihar and Orissa, is planning to start operations in the Southern states soon. Air Pegasus, from Décor Aviation, an airport ground handling agency, is expected to start operations later this year.

Analysts are watching the space keenly. “There is a lot of potential in the regional airlines business provided the states offer the required infrastructure and policies, and the companies have the appropriate business model by way of routes, pricing strategy, etc.,” says Vishwas Udgrikar, senior director and partner, infrastructure and transport at consulting firm Deloitte. He warns, however, that “given the current environment in the country’s overall aviation sector, players need to be cautious and enter the regional airlines sector with the right preparation.”

Jasdeep Walia, an analyst at Kotak Institutional Equities, suggests that running a regional airline could be tough. “For distances of around 250-300 kilometers, the demand will be limited, especially if the roads are good and people can cover it by car. And for distances of 500 kilometers to 600 kilometers, there is always the risk that as the demand picks up, bigger airlines will [step in].”

Gopinath’s comeback is also evoking interest. Udgirkar points out that any new entrant at the national level, despite prior experience, will find it very challenging. “There are inherent challenges in this sector and formidable competition, too.” Walia adds: “This space is very competitive, and the government policies are not at all conducive. And Gopinath could not sustain his earlier venture. ”

Gopinath’s Air Deccan changed the face of aviation in India, but as a business per se it got grounded. His foray into logistics with Deccan 360 also ran into trouble. Whether or not he can take off this time round remains to be seen.

Professor Peter Swan

The bribery scandal and apparent cover-up revealed in yesterday’s ABC’s 7:30 Report and The Age that is now engulfing the Governor of the Reserve Bank of Australia (RBA), Glenn Stevens, his former deputy, Rick Battellino, now retired, and the RBA Board had its origins in one of Australia’s great technology success stories. This was the invention of plastic (polymer) bank notes in the 1980s. Having successfully protected its property rights despite fears of reverse engineering by overseas note printing interests, the RBA and two offshoots, Note Printing Australia (NPA) and Securency International, involved in polymer note printing and marketing, have been accused of covering up the scandal that involved payment of large bribes (secret commissions) to politicians and officials in a number of Asian countries.

When senior RBA officials were given a detailed memo providing details of the bribery scandal as early as 2007, the matter was not taken to the Australian Federal Police and there seems to have been no public acknowledgement of the problem until press reports raised the issue about two years later.

Although this is the second major bribery scandal involving exports to foreign governments, the kick-backs on the sale of wheat to Saddam Hussein of Iraq by the Australian Wheat Board being the first, this appears to be the first that has sparked a major police investigation and large-scale prosecution of officials involved. Corrupt payment of bribes is illegal in Australia, even to foreign officials and politicians, even though it is an accepted part of doing business in many parts of the world. In fact, many would regard it as a necessary cost of doing business and way to promote Australia’s exports.

As is usually the case, the bribery and corruption pales into insignificance relative to punishment metered out to those who cover-up. Richard Nixon was forced to resign, not for hiring the ‘plumbers’ in the first place but rather for his failed cover-up attempt.

The involvement of the most senior officials of the RBA and possibly the Board in the cover-up, even if they were unaware of large-scale bribery prior to 2007 in the bank-note offshoots, is an exceedingly damaging development for an organisation that until recently has retained a reputation for integrity and exceptionally good monetary policy in recent years.

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There is an ongoing investigation into the Bank of England’s oversight of the rigging of the LIBOR interbank rate by Barclays and other British banks at a time when the Bank of England was facing the prospect of further massive public bailouts of the banks. Mr Bob Diamond, Barclay’s CEO who was forced to resign because of the scandal, explained to a senior Bank of England official at the time that “not all banks were providing [LIBOR] quotes at the level that represented real transactions.”

By this he meant that a number of banks including Barclays were deliberately understating their borrowing costs to make it appear they were more solvent than they really were. Lack of response from Bank of England officials, who claim not to have interpreted the conversation in this light, was taken by Barclays as implicit acknowledgement and support by the Bank of England for LIBOR rigging.

In the case of the US Federal Reserve, lax monetary policy and their success in bringing the cash rate down to close to 1% after the bursting of the internet bubble and 9/11 has been blamed for exacerbating the credit crisis that led to the GFC. Certainly, FED oversight over the lead-up to the GFC and the US NINJA loans scandal was weak. It has only recently been revealed that RBA and other Australian regulators were almost equally lax in allowing Australian banks and mortgage providers to push huge numbers of ‘low-doc’ loans on impecunious investors who had little or no prospect of repaying. Banks and mortgage providers seem to have secretly filled out forms to make it appear that borrowers were in a far more financially sound position than they were in reality.

The plastic banknote bribery scandal and cover-up places the largely very distinguished business people making up the RBA Board in an exceedingly difficult position. Did they know of, or should they have known what was going on at the time of the presumably secret 2007 Memo or even earlier?

In the CENTRO case, the court found that non-executive directors cannot uncritically accept advice from either management or auditors. Directors must take ultimate responsibility for company affairs. Of course, unlike CENTRO, the RBA is not a listed company with shareholders. It is the Federal Treasurer and Government that appoints directors to the RBA Board and thus should play an important role in its oversight. The Treasurer also appoints the Governor of the RBA. I should imagine that the Governor is accountable to the Treasurer, the Government, and perhaps ultimately to Parliament.

It is tragic that the scandal and apparent cover-up has damaged the reputation of the Governor, senior officials, board members and the RBA as a whole, despite the high regard for its conduct of monetary policy. The best we can hope for now is a quick end to the cover-up, if there really was one, and a speedy resolution of this very sordid affair. The successful setting of monetary policy is very much dependent on the reputation of the RBA. This needs to be repaired as quickly as possible.

Professor Peter Swan is the Professor of Finance at the Australian School of Business. This article first appeared in the Australian Financial Review.

From the Knowledge@Wharton today blog.

Shareholder activism has never really taken hold in India. Annual general meetings have been occasions for praising the chairman and the company management, asking for higher dividends, having tea and going home. But ever since an analyst at Kotak Securities started the unraveling of Satyam Computers by questioning why the company was keeping US$550 million in current accounts, equity research firms and foreign investors have begun taking on the role of defenders of the lay investor.

In March of this year, it was U.K.-based The Children’s Investment Fund Management — an investor in Coal India Ltd — which threatened to sue the company’s management for giving in to the Indian government’s demands on coal pricing and, in the process, ignoring the interests of its own shareholders. Then it was the equities research arm of Australian bank Macquarie questioning the accounting policies of HDFC, India’s largest housing finance company and one of the most respected firms in the country. Now, it is a report by Veritas Investment Research of Canada that has created quite a storm.

The latest Veritas target is the Gurgaon-based Indiabulls Group. In a report titled “Bilking India,” dated August 1 but released later, the research firm contended that Indiabulls management had thrown corporate governance to the wind to enrich a select group of shareholders. “We believe that disclosures at Indiabulls Real Estate Ltd (IBREL) and Indiabulls Power Ltd are unreliable and that the sole purpose of IBREL is to bilk institutional and retail investors for the benefit of select insiders,” says the report. “The controlling shareholders are running the organization as a piggybank, while proclaiming propriety and espousing credibility.” The report warns Indian financial institutions that lend to the group to “watch out” and advises investors to “sell all Indiabulls Group stocks.”

In June, Veritas had come out with another report — titled “A House of Cards” — questioning the accounting policies of Reliance Communications (RCom). RCom management responded by saying that the report was “sensational” and reflected Veritas’ complete lack of understanding of RCom’s assets and businesses. “Veritas is systematically working to destroy confidence in Indian capital markets through sensationalist reports,” said RCom.

The Indiabulls management has gone beyond a mere verbal denial. It has issued full-page advertisements in the newspapers giving its side of the picture. It has disputed the numbers and the analysis. “The heavy bias for creating sensationalism for personal profiteering is the reason [for the report],” alleges the company. The firm has filed a police complaint against the Veritas analysts. The police, in turn, have issued summons to the Canada-based analysts for a personal appearance. Indiabulls has produced emails which are claimed to show that Veritas asked for money to delay publication of the report.

Nothing is likely to happen to Veritas, however; the law in India moves very slowly. But Indiabulls Group shares have plunged on the stockmarkets. Indiabulls Financial Services, for instance, is down to Rs. 190 (around US$3.40) from its 52-week high of Rs. 267 (US$4.60). Meanwhile, Morgan Stanley Singapore bought 10.1 million shares of Indiabulls Infrastructure & Power at the height of the controversy. The purchase was made at Rs. 6.17 per share. It is now quoted at Rs. 5

This blog was previously posted in Knowledge@Wharton today blog: Equity Research Firms and Foreign Investors Take on India Bulls.