The American business model part 2: Transparency

Once upon a time, business depended on trust. You trusted your partner or supplier not to cheat you. Why? Because you knew each other. Deals were verbal understandings: a man’s word was his bond. It was care for his reputation that kept the businessman honest: if he was known to cheat, he was finished. It was allowed to cheat a stranger, but not one of your own. Much of the world’s business is still done on this basis: in the mosque, the souk, or the banya.

Transnational businesses were built up from family or racial connections. An 18th century writer wrote of the Jews: ‘They are become the instruments by which the most distant Nations converse with each other and by which mankind is knit together….’ Dispersed family and ethnic networks were the channels through which capital flowed. It still does. That is why immigrants are often so successful at business. They do their business in the shadows, not in the light of day. In the development of the modern economy, trust comes before contract, kinship before law.

Modern business theory is quite different. Trust has been replaced by transparency. ‘We define corporate transparency’ writes Suraj Srinivasan of the Harvard Business School ‘as the quantity and quality of information a company provides its various constituents…We measure this transparency using the corporate disclosures a company makes’. Transparency is the great antidote to fraud. An organisation called Transparency International has a Corruption Perception Index which rates relative corruption levels across countries. Finland is the least corrupt, Russia comes 86th, the Ukraine 106th. Russia clearly has a long way to go.

The transparency drive has behind it powerful forces. There is the efficient market hypothesis of contemporary economics, which holds that the efficiency of markets is a function of the quantity and quality of the information supplied: opaqueness is a ‘market imperfection’. An increasing fraction of the world’s business today is between strangers. Transactions take place not between people but between prices, and we need to be sure that the prices set reflect the real values being traded. The hitherto successful East Asian model of ‘crony capitalism’ was heavily discredited in the business crash of 1997-8. In the new global business environment, corporations and banks have to be naked to their customers and investors if they are to flourish.

This is the theory. Yet in all this we are in danger of underestimating the value of trust. The trouble with relying only on figures is that figures can lie. The language of transparency comes out of accountancy, and, as many recent corporate scandals have shown, accountancy is not an exact science. There are ‘generally accepted accounting standards’ (GAAP) for measuring profits and for presenting cash balances and income flows, but there are plenty of opportunities for managers to massage the numbers and cook the books in order to make profits seem better than they are. For example, they may manipulate discretionary expenditures to ‘smooth incomes’, keep key expenses ‘off balance-sheet’, accelerate sales revenue. Shell has just seen £5bn wiped off its market value and the resignation of its chairman in the wake of massive overstatement (by as much as 20%) of its oil and gas reserves.

Another problem is information overload. Knowledge and information are not the same. Drowning investors in more and more data does not make companies more transparent. In fact, the opposite is often true. The gap between the information available and the ability to use it effectively is huge and growing. Adding more information on top of the existing glut can actually subtract from knowledge. The fiercer the demand for transparency, the more the real business will be done in the shadows.

Numbers can complement, but not replace, trust. This is true in all walks of life. When Margaret Thatcher met Gorbachev in 1985, she reported to Reagan: ‘We can do business with this man’. This caption, together with the photograph of their first conversation, should hang above the desk of every business consultant.

 

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