PARMALAT – 'SOME FOOD FOR THOUGHT'

The food giant / dairy group from the small town,  Parma in Southern Italy, has joined the ranks of fallen angels.  In fact, the Financial Times  termed it Europe's Enron - stating that it has ramifications far beyond Italy.  The 'hole' in Parmalat's financial statements may well exceed Euro 10 billion!

In good times, such off-balance sheet risks (OBSRs) generate fee income and add to the return on equity (ROE). Conversely, when OBSRs come home to roost,  they do not hit the balance sheet but the bottom line; with a hell has not seen the fury of a balance sheet scorned.  Parmalat created special purpose vehicles (SPVs) and invested in a private mutual fund; that the Cayman authorities now believe was not registered but may have merely used Cayman as a jurisdiction.

Parmalat's Chairman and CEO, Mr. Calisto Tanzi was "hands-on" in business oversights, but relied heavily on his previous Chief Financial Officer (CFO), Mr.  Fausdo Tonna, who in turn, did few things without consulting his lawyer, Mr. Gian Paolo-Zini. Mr. Zini is reported to have developed a larger than life role in what happened, because of the implicit trust placed in him. He fancied himself to be more than just a lawyer and his law firm's website contained Christopher Columbus's famous words,   "I should not proceed by land to the east, as is customary, but by a westerly route, in which direction we have no evidence that anybody has gone". Metaphorically, Mr. Zini and his devoted friends / colleagues at Parmalat went down a Southerly (downward) direction! Even if this was not done with any malicious motives, and only innocently with a view to boosting the perceived profitability, the intentions were, clearly, not honourable.

"What a tangled web, we weave", said Shakesphere and this is exactly what some multi-national corporations (MNCs) seem to be doing. For regulatory reasons and because some risks can be smoke-screened behind convoluted corporate veils, these public companies take recourse to SPVs. They have accountabilities to shareholders who may be naively looking for superior and risk-free returns year after year; if possible! 

Those that have invested in common equity or high risk debt, seem to be satisfied with nothing less then multiple digit returns, even during low inflation or recessionary environments - when 'real' interest rates are low. The sheer pressure of having to satisfy the stake holders time and time again, makes some CEOs clutch at every trick in the book.

In the 'real' commercial world, profits are not predictable and Murphy's law holds sway i.e. that "what can go wrong will go wrong"!  In these juggling acts, the lawyers and the offshore locations with the lax oversight,  feed the greed and grease the ease with such  'opaque' structures that are set up. The eminent professional firms of the world conspire with the CEOs; sometimes with good intentions (of wanting to reward stakeholders) but end up tying the corporations into knots - a multi-chained maze, from which it is well nigh impossible to  emerge / eject out during times of difficulty.  The entities are thus boxed into corners and suddenly the exit routes (previously 'marked' as such) seem to disappear one after another. Even small liquidity pressures then snowball into a mega / series of default. The house of cards or paper pyramids soon begin to collapse; with a vengeance. 

Parmalat's bankruptcy filing has put the cat among the pigeons. Several bond investors in Europe and in the U.S. invested on the strength of its debt ratings.  S&P has now defended its downgrade of  this once 'A'-rated entity to multiple notches downwards (all in a matter of a few days) by citing its misleading disclosure standards and stating that rating agencies are not auditors or investigative agencies. Parmalat Group's auditors are reported to be Deloitte & Touche at the parent level and Grant Thornton at the subsidiary level. Both had relied on seemingly authentic counterparty confirmations.  For the second time, Deloitte & Touche are auditors to drop down meteors. Earlier their client, Ahold, the large Dutch retail chain, had started the year and the trend of  'gaping holes' syndrome in Europe. The financial gaps were thus greater than what even the U.S. Gaap(s) earlier was in evidence! Some blame Parmalat as an opaque, family-owned European company that emulated Enron-style derivate play.  The criminal investigations may indicate how a whole body of investors, rating agencies, regulators, accountants, lawyers and bankers managed to 'miss the wood for trees' and now have  eggs on their faces.

The  CDO (collateralised debt obligations) structures – in vogue in the financial markets are coming under a cloud because of a rash of corporate bond defaults. CDOs are, in some instances, linked to "first to default" - whereupon the issuer of the CDOs can deliver any debt of the defaulting entity. Even though, for example, the investors may have bought into a five year maturity CDO, they could go 'stuffed' with longer maturity default paper.

The right lessons can indeed be learnt and applied from all these.  But following each disaster, and after a while, market pressures begin to tell on CEOs and the temptation to obfuscate is hard to avoid or eschew. For many in the corporate world, ethical conduct, on a sustained basis, is extremely difficult. Knowing that all this is easier said than done, and without wishing to take moral high ground, in my view, what might help,   is to try and lower expectations among all concerned i.e. not yearn to be the best, biggest and brightest in the corporate galaxy. To have to constantly justify corporate superiority may attract constant media attention, but impact ratings and scrutiny of  published accounts. Stock market pressures result in every single news from a corporation and its competitors,  impair or inflate stock market prices. All these add up to a constant adrenaline-pumping process at the corporate level. The CEOs that get on to this step-aerobics machine then are required to run to standstill. They in turn crave for huge bursts of growth-boosters. 

It is similar peer pressures and shareholder accountabilities that drive the property and consumer finance companies, retail banks etc. to advertise extensively. Practically speaking, there is price war in the financial sector. Without wishing to suggest excessive controls that can stifle creativity, what is needed is a balanced blend of performance (and expectations) management; whereby the executives are not encouraged to put more risks on the books, merely to add to the bottom line. The CEO's accountabilities and budgets ought not to be dictated down and corporations should not, year after year, expect to exceed the organic growth of the economy. The modern (free-wheeling & laissez faire) corporate world may not roll and hark back to the old time-tested ways of doing business. That would be a sad reaction to such shenanigans and besides, a reverse pendulum swing or a throw-back would not necessarily be prudent.

This scenario is no different from an athlete who quietly takes steroids but ends up failing dope tests. Thus the sad spectacles of corporate collapses that we see globally today are due to this pressure to perform at any cost; even by attempting at subverting the system; albeit unsuccessfully. The authorities at a macro level ought to find ways to lessen the pressures.  For instance, companies need not provide quarterly or half yearly results or give mid-point forecasts  /  outlook. Another measure is to introduce certain 'caps' on performance-related pay (say 40%)  irrespective of significant / superior performance in any one year. Possibly, a combination of such relaxations (!) could  help ease the feverish rat race and reward longer term loyalty by stakeholders and consistent corporate performance. A five-year horizon in itself will help dampen down unrealistic shareholder expectations.

In the evolutionary process of  converting information into knowledge, and knowledge into wisdom, the right lessons will have to be learnt from such corporate scandals. This is best done by analyses /  syntheses and not through catharsis. Some good introspection is a good meditation technique and tonic for all body corporates. Everyone should realize that only a few can come first in the academic, athletic and corporate worlds. There is nothing wrong in being inherently good but an  "also ran"; and the society / business communities should not perceive "also-rans" as 'mediocrity. As long as there is honest effort, all contributors (and not just the brilliant) need to be encouraged but without  being rewarded excessively. Consistent performance itself is a  reward and occasional failures need not be put down. Nor should the people be shown the door and made to feel that mistakes are shameful. Otherwise, the problems will be pushed under the carpet and deviousness and desperation will propel executives to excel (?) by hook or by crook. Surely, that will turn out to be a poor reflection and perverted values in the corporate world.

The author is General Manager of Emirates Bank.  However, the views expressed in this article are not necessarily shared by the Bank.

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