Mariana Mazzucato - The Value of Everything - Making and Taking in the Global Economy

Four Seasons Health Care displays many of these characteristics. The company owns the biggest chain of care homes in the UK, with 23,000 beds in 2015. But it was only a small Scottish chain until its acquisition by Alchemy Partners, a PE firm, in 1999. Having enlarged the company, Alchemy sold it in 2004 to Allianz Capital Partners, another private firm, which two years later sold it to Three Delta, yet another PE firm. By 2008, during this game of pass the parcel, the company’s external debt had ballooned to £1.5 billion, carrying an annual interest charge of over £100 million – or an unsustainable £100 per bed per week . In 2012 the company was bought by Terra Firma – you’ve guessed it, a PE firm – controlled by Guy Hands, a well-known British financier who had cut his teeth at Goldman Sachs. Despite a financial restructuring involving losses for equity holders, bondholders and banks before Terra Firma acquired the business, by 2014 Four Seasons was losing money, and a pre-tax loss of £70.1 million in 2015 deepened to £264 million in 2015. 13The cost of debt-servicing was at least partly to blame. The company blamed local authorities for freezing the amount they would pay for residents, although the authorities themselves were suffering severe budget cuts under the Conservative-led government’s austerity programme. The Care Quality Commission, the government body which monitors standards in care homes, was sufficiently concerned about the business health of Four Seasons that at one point it embargoed twenty-eight of Four Seasons’ homes, meaning that they could not take in new residents.

Similar patterns can be seen in England and Wales’s water industry, which was privatized in 1989. 14The ten water and sewerage companies (WSCs) were listed on the London Stock Exchange as part of the then government’s policy of creating a ‘shareholder democracy’. Today, only two remain listed. Asian infrastructure conglomerates own three of the companies; another is a mutual company (Welsh Water, or Dŵr Cymru); and PE firms own four – Anglian Water, Thames Water (the biggest water company), Southern Water and Yorkshire Water.

As with care homes, the ratio of debt to equity in the water companies has increased sharply: a typical feature of companies owned by PE firms, as we saw in the previous chapter. Between 2003 and 2013 average net debt rose by 74 per cent while equity fell by 37 per cent in nine of the companies: Anglian, Thames, Northumbrian, Severn Trent, Southern, South West, United Utilities, Wessex and Yorkshire. The companies with the highest net debt – about 80 per cent of capital or more – were all PE-owned. Net interest payments by the nine English WSCs went up from £288 million in 1993 to an eye-watering £2 billion in 2012. Interestingly, the company with the lowest gearing (ratio of debt to equity) and the highest credit rating was Welsh Water, which is mutually owned. The four companies with the highest gearing and the lowest credit ratings were all PE-owned.

Just like some of the care home groups, WSC ownership structures are often opaque. The combination of shadowy corporate structures and complex financial engineering may well explain high payouts to water company owners. Between 2009 and 2013 Anglian, Thames, United Utilities, Wessex and Yorkshire paid out more in dividends than they made in after-tax profits. Directors saw their share of the companies’ income rise from 0.1318 per cent in 1993 to 0.2052 per cent in 2013. Over the same period the share of the water companies’ income going to salaries and wages fell from 15.37 per cent to 10.22 per cent: in other words, the workers’ loss seemed to be diametrically opposed to the owners’ gain. It is true that the water companies have invested more than £100 billion in the country’s water and sewerage infrastructure since privatization. But the financialization of the industry was not anticipated in 1989, and neither price controls nor limits to returns on capital imposed on the companies by the Water Services Regulation Authority (Ofwat), the industry’s economic regulator, appear to have prevented what looks like value extraction.

The cases of care homes and water in Britain are not a blanket argument against PE or financialization. But they do illustrate how financial engineering of socially essential services can change the nature of an industry. It is at the very least debatable whether the opaque ownership and excessive financialization which characterize these PE-owned businesses serve their customers more than their owners.

THE RETREAT OF ‘PATIENT’ CAPITAL

Agency theory and MSV, then, are essentially straightforward concepts. The purpose of the firm is to return as much value to its shareholders – the equity owners of the company – as possible. In public companies especially, the shareholder is detached from the running of the business even though he or she is legally an owner; professional managers run it. Here is the crux of agency theory: the agents (the managers) are in law answerable to the principals (the shareholders). But, in relation to managers, shareholders are disadvantaged: they have less information about the business; they are numerous where the managers are few; and they are last in the queue for rewards – after the managers, the workers, the suppliers, the debt holders and the landlords. They only see a return for their investment after the other recipients have been paid. The shareholders are the ‘residual’ claimants, as they are assumed to be the only actors who do not have a guaranteed return from their contribution to the business. They are justified in claiming the return the company generates in excess of the costs associated with other stakeholders in the company. 15

For a public company, maximizing shareholder value is effectively the same as maximizing the value of the equity shareholders’ investment, as captured in the share price. The same is true, for practical purposes, of private companies: the owners – whether a family, PE or venture capital – will value a company by what they can expect to get for selling it or listing it on a stock exchange. That value will be substantially determined by that of similar public companies, as revealed by their share price.

MSV’s origins are often traced to the development of the ‘portfolio theory of the firm’, a popular explanation for the development of the large industrial conglomerates of the 1950s and 1960s. The portfolio theory of the firm held that companies – like other investors – could spread their risks by owning assets in diverse industries. It assumed that corporations were only a collection of asset-generating cash flows and that professional managers, who were emerging as the heroes of modern capitalism, were capable of running any type of industry equally well. Business schools aimed to train managers with exactly this purpose in mind. Perhaps the epitome of the conglomerate of the time was the Transamerica Corporation, which at one stage counted among its sprawling interests the Bank of America, the United Artists film studio, Transamerica Airlines, Budget Rent a Car and various insurance operations.

Advocates of MSV argued that conglomerates were ‘destroying’ value, because managers (however competent and well trained) could not possibly be experts in getting the best out of such diverse operations. Diversification was more appropriately left to the shareholders, with the bosses of each company ‘sticking to the knitting’ and not venturing beyond their narrow zone of expertise. Conglomerates’ inefficiency could be practically demonstrated if their constituent parts, broken up and floated separately, could command a higher total share price than the coagulated whole. Whether right or wrong, the assumption about managers’ professionalism did not address the problem that they might not always act in the best interests of shareholders. When the US and other Western economies slowed down in the 1970s, Friedman and other agency theorists argued that because principals and agents are motivated by self-interest, the inevitable conflicts could best be resolved by giving the ultimate owner, the shareholder, the overriding interest. Conventional wisdom was turned on its head and conglomerates were broken up, a step also justified by seeing corporations as nothing more than a collection of cash flows. The interests of managers and shareholders should, the agency theorists reasoned, be ‘aligned’: if managers were also paid in the company’s shares or options on those shares, the argument went, they would be motivated to maximize the interests of all shareholders.