John Kay - Corporate values are not just a calculation

Corporate values are not just a calculation

The last fortnight may have been the most damaging period ever for the reputation of large British businesses. GlaxoSmithKline, the pharmaceutical group, was fined $3bn for abusive practices in marketing drugs in the US. Royal Bank of Scotland and its subsidiaries failed to process their customers’ transactions. Both companies must have been relieved that Bob Diamond and Barclays successfully dominated the headlines. And these events follow BP’s disaster in 2010.

Conspiring to rig interest rates is probably fraudulent; failing to report the side effects of a drug is severely reprehensible but probably not illegal; cutting corners on an oil installation is negligent; systems failure in a computer system seems like bad luck. The degrees of culpability vary as do the incidents themselves. But is there a common underlying cause?

All four companies made decisions that benefited them in the short term but came back to haunt them. And yet to describe the problem as short-termism, though true, is not to get quite to the heart of the problem.

Some commentators have suggested that the $3bn fine on GSK was less than the profits the company made from its misconduct. BP clearly made a bad call, but we say that with hindsight. On the strong balance of probabilities, the well would have been fine and the consequential damage was far larger than could reasonably have been expected. What would we think of GSK, or BP, if we discovered that the companies had weighed the costs and benefits and decided to go ahead anyway with doctors’ spa weekends and cutting corners on the rig installation?

Not much, because the Ford Motor Company was – and is still – pilloried for acting in this way. The Pinto is notorious as one of the worst cars Ford – or any company – ever made. But it is more notorious still for its exploding fuel tank. Ford knew how to fix the problem at a cost of $11 per car.

But they estimated that only 180 people would die, and if you value life at $200,000 per head (including $900 for funeral expenses and an extra $10,000 because burning to death at the roadside is pretty unpleasant), it is cheaper to let accidents happen.

The calculation is beyond parody or contempt. And yet while it is easy to say that safety, or human life, is priceless, in the real world trade-offs have to be made. Every cheap car could be made safer, but then it would cease to be a cheap car, and people who take a modest risk every time they leave the house (or, more dangerously still, stay at home) would not be able to benefit.

But as soon as that calculation was disclosed, Ford’s case was lost: both in the court where the relatives of a Pinto victim were suing the company, and in the court of public opinion. Not because we think the value of life is actually $500,000 – the level at which the calculation breaks even – or because we think the discount rate used is too high, but because we find unacceptable the instrumentality of making the calculation at all.

We detest what it tells us about the values of the company. In Ford’s case this is unfair because, as the company tried vainly to persuade the court, the cost-benefit analysis was not its own idea: the analysis was a requirement of the National Highway Transportation Safety Agency, which was staffed by young enthusiasts for cost-benefit analysis.

That points to the real issue at GSK, RBS, Barclays and BP. We are not interested in whether these companies made good or bad calculations. We are interested in what these incidents tell us about the values of the companies concerned. We need to be able to trust pharmaceutical companies. We expect banks to be run and populated by honest people, to keep our money safe, and to give us our money back when we need it. We want oil companies to have a strong culture of engineering professionalism and commitment to health and safety.

If we are ever to have confidence in these companies, we want them to pursue these objectives, not because they are good policy, but because such goals are integral to the companies’ identity. Otherwise their literal or figurative licences to operate will be in jeopardy. The common mistake of all these businesses was to raise doubts about their values in the instrumental search for earnings.

 

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