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Moral Capitalism and the Future of The Sustainable Corporation

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					Modern Capitalism as the
Solution to the Financial
         Crisis:
The Caux Round Table Approach


         Stephen B. Young
     Global Executive Director
      The Caux Round Table
     Belgrade, December 2008
                                 1
Financial meltdowns are a systematic
      Dysfunction of capitalism
            • Tulip mania – 1620
   • Mississippi company France1719/1720
  • South Sea Company London 1711/1720
              • Wall Street 1929
             • Junk bonds 1980s
         • Dot.coms/telecom 1990s
       • Sub-prime mortgages/CDOs
                                           2
• "Men, it has been well said, think in herds;
  it will be seen that they go mad in herds,
  while they only recover their senses
  slowly, and one by one!" Charles Mackay

• “Irrational Exuberance” Alan Greenspan



                                                 3
• Charles MacKay, Extraordinary Popular Delusions and
  the Madness of Crowds, with a foreword by Andrew
  Tobias (1841; New York: Harmony Books, 1980).
• Mike Dash, Tulipomania: The Story of the World's Most
  Coveted Flower and the Extraordinary Passions It
  Aroused (1999)
• Peter M. Garber, Famous First Bubbles: The
  Fundamentals of Early Manias (Cambridge, MA: MIT
  Press, 2000).
• Charles Kindleberger, Manias, Panics, and Crashes: A
  History of Financial Crises (Wiley, 2005, 5th edition)


                                                           4
    What Causes a Financial Crisis?

           • Mis-pricing of risk
• Increases in real risk are not captured in
           nominal market prices
     • Asset prices become irrational
     • Valuation becomes unrealistic

                                               5
Present value reflects the risk of actually
         receiving future income

  Capital value is a function of income!

Misjudgments about future income distort
         present capital values
                                              6
In financial bubbles, mis-pricing is sustained
                by infusions of debt
      Higher and higher asset values are
           supported by borrowed funds
Excess liquidity – based on future promises
       to pay – transforms investment into
  speculation; a trading mentality takes over
  the markets; prudence loses out to greed;
        illusion trumps reality – for a time
                                             7
• "Of all the offspring of Time, Error is the
  most ancient, and is so old and familiar an
  acquaintance, that Truth, when
  discovered, comes upon most of us like an
  intruder, and meets the intruder's
  welcome."


                                           8
     Dynamics of the Current Crisis
• Sub-prime mortgage loans made, more and more
  against future resale value of the home, not against real
  income
• Mortgage loans packaged and sold to global capital
  markets
• Collateral Debt Obligations (CDOs) issued to finance
  purchases of packages of sub-prime mortgages and to
  invest in hedge funds
• Credit Default Swaps invented to give added value to
  CDOs
• Debt upon debt upon debt
• Low interest rate environment
• Incentive structure driven by fees not investment in long
  term returns
                                                              9
 What is a company worth?
How to we measure its value?
• Most simple calculation:
  Discounted net present value of future
   income X capitalization multiplier




                                           10
        Current Crisis is Global

•   AIG
•   Fortis
•   Iceland
•   EU guarantees bank deposits
•   UK takes over two banks
•   Equity markets in Asia tank
•   Price of Oil drops by 50%
•   Real economies lose employment and
    consumer demand                      11
• When financial markets implode,
  capitalism loses liquidity, exchanges of
  goods and services fall, output is reduced,
  employment is cut
• Debt must be taken out of the financial
  system
• Asset values have to be reset at lower
  levels
• Asset owners loose wealth
                                            12
• World Economic Order has inadequate
  mechanisms to prevent financial crises
    •   WTO
    •   IMF
    •   World Bank
    •   G8
    •   OECD
    •   Bank for International Settlements



                                             13
 • Central Banks must step up and inject
 liquidity into the global system of financial
                  intermediation
  • Government budgets must inject new
         capital in financial institutions
• Bankruptcies must eliminate amounts of
       liquidity – both equity and debt
            – Bear Sterns - $80 to $2
           - Lehman Brothers - liquidated
                                             14
    What is the fair value of an
     investment in business?
• Quality Income Stream
• High net present discounted value
• Good capitalization multiplier

            Good Corporate Value
         (Warren Buffet would buy it)
                                        15
Today where does most corporate
       value come from?

      Intangible Assets!


                              16
          50 Best Performers of 2005
               Business Week
Burlington Northern Santa Fe:   Market value: $29.2 billion
                                Balance sheet assets:
                                103% of market value ($30.3 billion)
                                Goodwill: None
Caterpillar:                    Market value: $49 billion
                                Balance sheet assets: 95.9%
                                Goodwill: 4.1%
United Health Group:            Market value: $79 billion
                                Balance sheet assets: 52%
                                Goodwill: 48%
Apple:                          Market value: $58 billion
                                Balance sheet assets: 19.8%
                                Goodwill: 80.2%
                                                                       17
         50 Best Performers of 2005
              Business Week
Microsoft:          Market value: $279 billion
                    Balance sheet assets: 33.7%
                    Goodwill: 66.3%
Best Buy:           Market value: $26.3 billion
                    Balance sheet assets: 39%
                    Goodwill: 61%
Starbucks:          Market value: $27.8 billion
                    Balance sheet assets: 12%
                    Goodwill: 88%
Goldman Sachs:              Market value: $61.7 billion
                    Balance sheet assets: 1.1%
                    Goodwill: 98.9%
                                                          18
   Financial Meltdown of 2008
Bear Stearns:
  on Friday, $80 per share book value;
 on Sunday sold for $2 per share
Lehman Brothers:
  Billions in balance sheet assets;
  liquidated as no one wanted to buy them
  on a going concern basis
                                            19
 What is a company worth?
How to we measure its value?
• Most simple calculation:
  Discounted net present value of future
   income X capitalization multiplier




                                           20
First Fundamental Conclusion
   You cannot establish value without
     putting risk into the calculation
– What is the risk of not achieving predicted future
  revenue? How certain are estimates of future
  income?

– What are the risk factors that determine the
  capitalization multiplier? A higher risk demands a
  lower multiplier

Higher risk > more uncertainty > lower present value   21
Note:
• Each source of risk drives business
  value up or down




                                        22
 Second Fundamental Conclusion

Management of Risk Enhances Enterprise
 Value

- Risk management leads to more certain
  income
- Risk reduction leads to higher valuation

                                             23
    How do you manage risk?
-Each risk hides in a relationship
  - customers
  - investors
  - government regulation
  - employees
-Each relationship is an intangible asset of the
  business (Assets can Appreciate or
  Depreciate).
-Lowering risk for each relationship enhances
  the quality of intangible assets and increases
                                                   24
  business valuation
          CSR & Valuation

Intangible Assets = CSR Stakeholder
  Relationships
• Customers
• Employees
• Owners/Investors
• Suppliers
• Competition Strategies
• Community Support
                                      25
  Tangible Values                              Financial
                                                Capital
    (Generally Audited
  Financial Information)                       Tangible
                                                 Assets

                                      Intellectual      Sustainability
                                       property
  Intangible Values                                  Brand loyalty
                                  Quality of
(Generally Non-audited,           employees              Community
                                            Labor         support
Non-financial Information)
                             Unallocated environment
                              goodwill                                   26
To improve company valuation,
 Improve CSR relationships!

Good CSR Relationships Lead to
 The Sustainable Corporation


                                 27
How to measure CSR Relationships


         Use CRT Arcturus
    Risk Assessment Instrument

     New metrics for enhanced
           profitability


                                   28
How to Manage for
Sustainable Value?
• CRT Theory of the Firm
• Arcturus




                           29
                                               Theory of the Moral Firm
                                        (self interest considered upon the whole)


                                       F in a n c e
                                       c a p it a l
             R e p u t a t io n a l
             c a p it a l
                                                                                                                                                        $;
                                                                                                                                                s u s t a in a b le
IN P U T S




                                                        C o n v e r s io n           O U TP U T
                                       P h y s ic a l                                                                        C u s to m e r s      p r o f it s ;
                                                        p ro c e s s e s        G o o d s / s e r v ic e s
                                       c a p it a l                                                                                              lo w b e t a ;
                                                                                                                                                m a x im u m
             S o c ia l c a p it a l                                                                                                                 v a lu e


                                       H u m an
                                       c a p it a l




                                                                             R e t u r n o n C a p it a l



                                                                             ( p r e s e r v e a d e q u a c y o f c a p it a l in p u t s )
                                                                                                                                                 30
           Capital Accounts
Capital Accounts are your defense against risk and
 your resource base for competitive initiatives

  Finance Capital
  Physical Capital
  Human Capital
  Reputation Capital
  Social Capital

                                                31
FINANCE CAPITAL

 Traditional capital account – stock of ready
 money and amount of sunk cash
 investments




                                           32
PHYSICAL CAPITAL

 Traditional capital account
    • Plant and equipment
    • Tools of the trade
    • Sub account really of financial capital as
      purchased with monies raised in the past




                                                   33
HUMAN CAPITAL

Non-traditional capital account
 - intangible asset
 - vital for success in services and high
 tech businesses
 - takes care of customer needs and
 demands
                                            34
REPUTATION CAPITAL
    (brand equity; goodwill)
 - needed for quality income
 - needed to get low cost of capital and the
 best employees
 - gets you through rough times
 - avoids commodity pricing/builds value
 added
                                           35
SOCIAL CAPITAL
Internal:
   - culture
   - leadership
   - strategy
External:
   - rule of law/no corruption
   - education
   -public health
   - public goods: market regulation, transportation, etc.

                                                             36
            Inter-relationships among
            capital accounts


Social Capital + Reputation Capital +
   Human Capital
        >>
Finance Capital + Physical Capital




                                        37
Stakeholders:
-Customers – moral compass for capitalism
-Employees – moral agents, not parts for a machine
-Owners and Investors – fiduciary duties of loyalty and
     due care
-Suppliers – friends, not foes
-Competitors – compete with quality and innovation, not
     price
-Communities – enhance social capital to enhance future
                                                        38
    profitability
            Stakeholders and
            Capital Accounts
Internal Social Capital =
  owners/employees/suppliers/competitive
  strategy
External Social Capital = Community
Reputation Capital = customers/employees/
      owners/suppliers/community
Human Capital = employees

                                        39
Taking Due Care of Stakeholders
  Enhances Capital Accounts;

Undermining Stakeholders Puts
   Capital Accounts at Risk

                                  40
 How Can you Measure
 and, therefore, Manage
Stakeholder Relationships
   And all a company’s
    Capital Accounts?


                            41
    ASK QUESTIONS!


Assess the Quality of your
      relationships



                             42
                                Arcturus Risk Assessment Instrument
  Category
                                    – Criteria Matrix
                      1.              2.          3.           4.           5.          6.            7.
                  Fundamental     Customers    Employees    Owners/     Suppliers/   Competitors   Communiti
                     Duties                                 Investor     Partners                     es
                                                               s


1. Responsi-        Criterion      Criterion    Criterion   Criterion    Criterion    Criterion     Criterion
bilities of            1.1            1.2          1.3         1.4          1.5          1.6           1.7
Business


2. Economic         Criterion      Criterion    Criterion   Criterion    Criterion    Criterion     Criterion
and Social             2.1            2.2          2.3         2.4          2.5          2.6           2.7
Impact of
Business


3. Business         Criterion      Criterion    Criterion   Criterion    Criterion    Criterion     Criterion
Behavior               3.1            3.2          3.3         3.4          3.5          3.6           3.7



4. Respect for      Criterion      Criterion    Criterion   Criterion    Criterion    Criterion     Criterion
Rules                  4.1            4.2          4.3         4.4          4.5          4.6           4.7



5. Support for      Criterion      Criterion    Criterion   Criterion    Criterion    Criterion     Criterion
Multi- lateral         5.1            5.2          5.3         5.4          5.5          5.6           5.7
Trade


6. Respect for      Criterion      Criterion    Criterion   Criterion    Criterion    Criterion     Criterion
the                    6.1            6.2          6.3         6.4          6.5          6.6           6.7
Environment


7. Avoidance of     Criterion      Criterion    Criterion   Criterion    Criterion    Criterion     Criterion
Illicit                7.1            7.2          7.3         7.4          7.5          7.6           7.7
Operations

                                                                                                                43
                     Assessment Framework – Criterion/Benchmark Example


CUSTOMERS (Section B)
1B - Beyond Shareholders towards Stakeholders - Customers
Does the company provide its customers with quality products and services at reasonable prices, and on fair terms, while protecting
their health and safety and their physical environment, and respecting their culture and individual dignity?
POINTS TO CONSIDER – The company seeks customer feedback on its practices, monitors impacts, and is prepared to modify
production or service as a result, plus provides relevant training of staff.
Point(s): Please circle
1              2             3              4              5              6              7
Please write down any concerns, explanations or additional comments on how or how not, the company is performing.
__________________________________________________________________________________________________________
__________________________________________________________________________________________________________
2B - Economic & Social Impact of Business - Customers
Do the company’s products and services contribute to the economic and social advancement of its customers and to the well-being
of their communities?
POINTS TO CONSIDER – Quality of product/service development; product quality and safety; adherence to relevant customer,
safety and environmental codes; products / services positively impact living standards?
Point(s): Please circle
1              2             3              4              5              6              7
Please write down any concerns, explanations or additional comments on how or how not, the company is performing.
__________________________________________________________________________________________________________
                                                                                                         44
__________________________________________________________________________________________________________
The Corporate Improvement Cycle



Performance Improvement      Management Action




      Performance Feedback
      to Management             CRT Assessment


                                                 45
        Who Participates?

• Board of directors
• CEO
• Senior management
• Division heads and group managers
• Unit managers
• Employees


                                      46
 Sample Gap Analysis between Managements and Employees
                 (Provided by CRT-Japan)
                           A.           B.          C.          D.          E.           F.            G.
                                                                                                                Performance by
                       Fundamental   Customers   Employees    Owners/    Suppliers/   Competitors   Community
                                                                                                                   Principle
                          Duties                             Investors   Partners

1.Responsibilities
                        6.5/5.2       6.3/5.1     6.0/4.8     6.8/5.2     5.9/4.9      6.1/4.8       6.4/5.4     44.0/35.4
 of Businesses

2.Economic/
  Social Impact         6.0/5.3       5.6/4.7     6.7/4.5     4.9/4.4     4.9/4.4      6.6/4.6       5.1/5.2     39.8/33.1
  of Business

3.Business
                        6.4/5.0       5.8/5.0     5.8/4.2     6.2/5.0     5.0/4.5      5.5/4.6       5.2/4.5     39.9/32.8
  Behavior

4.Respect for
                        5.9/5.3       6.8/5.9     6.5/5.6     6.5/5.7     6.1/5.6      6.2/5.6       6.9/5.2     44.9/38.9
  Rules

5.Support for
                        6.9/5.2       6.3/5.0     6.5/5.2     6.2/5.2     6.0/4.8      6.4/4.4       7.2/5.0     45.5/34.8
 Multilateral Trade

6.Respect for
                        7.0/6.6       6.0/5.3     5.7/4.4     6.3/5.6     5.2/4.2      4.4/4.4       4.7/4.0     39.3/34.5
  Environment

7.Avoidance of
                        6.7/5.8       6.5/5.8     6.8/6.5     6.3/5.4     6.5/5.2      6.0/5.2       5.9/5.7     44.7/39.6
  Illicit Operations

Performance by
                       45.4/38.4     43.3/36.8   44.0/35.2   43.2/36.5   39.6/33.6    41.2/33.6     41.4/35.0   298.1/249.1
Stakeholder
                                                                                                                             47
       Sample Radar Chart (Provide by CRT-
                    Japan)
                                      Vision not yet fully embedded across the
                                      company.




                                                    No integrated local community
                                                    development program across
                                                    different countries.
Company internal
communication is poor on the
issue of environment.

                                        Customers' trust is weak.
                                        Communication with suppliers/partners is
                                        poor.



                               High level of compliance, risk management and internal
                               audit have been achieved.
                                                                             48
How Do Companies Create
        Value?
  -The Good
  -The Bad
  -The Ugly




                          49
            The Good
         (Moral Capitalism)
• Risk Assessment/continuous Risk
  Reduction
• Optimize Stakeholder Benefits




                                    50
                    The Bad
      (Brute Capitalism, Crony Capitalism)

•   Feed Shareholders, Abuse Stakeholders
•   Commodity pricing/ compete on pricing/low costs
•   Rent seeking (market power)
•   Take the money and run: short termism


        Unsustainable Valuations -
           Eventual Failure

                                                      51
                  The Ugly
        (Punting on the trading floor)
• No net wealth creation; speculation in trading
   (Rob Peter to pay Paul)
• Irrational Exuberance
    (Market traders/short termism)
• False Valuations
    (Enron: Ponzi Scheme; sub prime mortgages, CDOs,
      CDSs)
• Encourage unsustainable pricing of securities
      (CDOs, CDSs)

INEVITABLE FINANCIAL MELTDOWN                          52
Thank You




            53

				
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