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The Bottom Line

Evan Davis gets to the heart of the big finance stories at The Bottom Line.

Creativity is central to the human condition and gives rise to innovation and entrepreneurship in a range of domains and activities. Human beings are also deeply territorial – constantly creating and deconstructing homelands in a Phoenix-like dance through time. In Anthony Powell’s masterly opus on what it is to be English, A Dance to the Music of Time, the participants tread and re-tread over the same spaces as they attempt to make sense of their existence. In the Star Trek world of ‘boldly going’ it was claimed that space was the final frontier, but in its geographical and temporal senses, space is the first frontier we attempt to account for and create around, however unwittingly. In our dance to the current mood music, creative accounting and how we manage, operate and occupy our work spaces are pertinent. The frontiers of what is efficacious in the two areas appear to be cyclical and not particularly structural. Enron became synonymous with everything that is destructive about accounting, and the de-humanising environment of call centres with the zeitgeist of work organisation.

The Enron sign.
Picture © STANANDLOU, used under Creative Commons licence.

Accounting is a framework for evaluating resource allocation and management in organisations. It is not objective reality, whose methodologies and methods lead to optimal and efficient outcomes. This would only be the case if we lived in a world of efficient markets in which all prices equated to values. This world would correspond to the Arrow-Debreu Theorem, named after the two Nobel prize-winning economists, in which all market exchanges are matched by underlying contingent commodities within a general equilibrium framework. Differences in time and place, and thus transaction costs, are not a consideration within this framework, so the accounting profession is stuck between the Charybdis of efficiently measuring values of organisational assets and the Scylla of differences in the time and place in the transactions of these values through market exchange.

Some siren voices may claim that the profession deserves everything it gets given scandals like Enron and the recent financial crisis, as well as the tax avoidance schemes which reached their zenith in the UK in the 1970s. However, accounting isn’t the agency of these outcomes, it’s the result of unintended consequences and perverse outcomes of the structure of regulation and regulatory changes. The ingenuity of ways in which regulations can be bypassed and turned into market opportunities is manifold and legion, but you cannot regulate away creativity and innovation, unless one starts to distinguish between good and bad parts of this human condition. So, what is the distinction between good and bad creative accounting? The length of a piece of string or when the ‘perps’ get caught? As for tax avoidance schemes, well we could ‘eat the rich’, and then send the accountants and other ‘creatives’ like management consultants and advertising agencies to another galaxy on the pretext of the earth exploding, but then financial products would be created on the transactions in human flesh and ‘marked to market’ at, say, Smithfield, the meat market in London. Getting rid of one form of accounting and its creative variants would then just generate others. The creative frontiers for accounting are set by the statute and international standards. These frontiers are really thresholds, the negotiation of which can lead to deviant behaviour – which is perhaps also one of the properties of the human condition.

The question of organisational deviancy is one that arises from why firms appear to spend so much time, energy and resources in managing property. The fundamental reason is that land is both a fixed and variable form of capital and gives rise to a set of uses and values, and most of our net worth is tied to property. At the philosophical level, John Locke developed the genesis of the idea of property rights as the foundation of the modern liberty. In the hands of the Peruvian economist Hernando de Soto, these rights are the basis of sustainable economic development. So property matters.

There is also the issue of power and prestige concerning property. The management of a mutual society may look down in pride on their provincial locale as they survey it from the heights of their new building. No self-respecting bank in 1980s London was complete without occupying a building with an atrium and an internal galleria. The question of architecture has external and internal dimensions. Externally, the need for signature architecture with a Gehry, Foster or Pei designed building seems central to corporate image. Internally the complex socio-psychological relationships of workers to their spaces cuts across the human resource management, finance and estate management functions. For the latter, maximising personnel in minimum space is rational, but the ebb and flow of movement and work patterns means that open plan or Dilbert-like booths are not optimal solutions. The way in which workers seek to humanise their work spaces suggest that the deep territoriality in all of us isn’t restricted to the home, but the challenge is to manage the challenge that status being often linked to a spatial hierarchy. Many firms claim that employees are their most valuable asset, but if they don’t creatively account for and put their spatial resources where their mouth is, this claim will not stand scrutiny. If you want to stifle workers’ creativity and innovation in solving business problems, then housing them as automatons in a single open space will suffice and no amount of virtual working will change this. There are creative solutions, but these are not cheap as the frontiers between private and public spaces in the workplace are constantly crossed and re-crossed.

At the banal level, accounting for the creative frontiers of managing financial and work space resources is a question of races and riders. The bottom or winning line, however, will only reached when it is recognised that these organisational imperatives are part of complex systems in which creative spaces develop and thrive.

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About the author

Leslie Budd is Reader in social enterprise at The Open University Business School. He is an economist and has written extensively on the relationship between regional and urban economics, and international financial markets.

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Quasi-autonomous non-Governmental Organisations (QUANGOS) have been part of the UK public sector for many decades and there are often robust political and managerial debates about the usefulness (or otherwise) of these public bodies. This has been brought into focus recently by the atrocious state of Government finances in the UK and the need for the next Government (whoever it may be) to make real terms reductions of public expenditure in excess of £100 billion.

Not surprisingly when there are threats to front line pubic services such as schools and hospitals many will question whether we really need the large range of QUANGOS which currently exist and also whether we can afford them in the current economic and fiscal climate.

A well-researched document recently produced by the Taxpayers Alliance claimed that in the UK there were a total of 1162 QUANGOS and other agencies which cost the taxpayer a total of £63.5 billion. These figures seem to chime with similar figures used by David Cameron in a recent speech but differ markedly from other claims which put total QUANGO expenditure at £14 billion.

This brings us to the first issue of what do we really mean by a QUANGO. For example, the figure of £124 billion includes in its list of QUANGOS all of the NHS Trusts in the UK which deliver hospital and community services. Few would regard NHS Trusts as being QUANGOS in the usual meaning of the world. Even the TPA report includes in its list of QUANGOS the following organisations:-

• The British Museum
• The BBC
• Kew Gardens
• The National Library for Wales

I am not sure many people would regard since high profile and well known organisations as QUANGOS.

Perhaps QUANGOS can be considered in four main groups:-

• Service providers – some QUANGOS such as the British Museum provide services directly to the general public.
• Funders – some QUANGOS distribute public funds to relevant external organisations. Thus the Arts Councils distribute funds to arts projects and the Higher education Funding Council for England (HEFCE) distributes funds to universities for teaching and research. So it is misleading (as the TPA report does) to claim that HEFCE spends £7billion per annum. The vast bulk of that money, with the exception of £20million for internal administrative costs, is distributed to universities for teaching and research. Also in this category might be included Regional Development Agencies.
• Regulators and Inspectors – some QUANGOS are charged with inspecting and regulating public sector service providers. Thus OFSTED inspects schools and the Healthcare commission inspects hospitals. The Audit Commission audits and inspects a range of public bodies. Also in this category might be included QUANGOS such as the Equalities commission.
• Advisors – there are a myriad of bodies of varying size which provide advisory services to various parts of Government.

There are many questions which will continue to be asked about QUANGOS. These include:-

• What benefit do they actually produce? For example, have schools really improved as a result of OFSTED? Have inequalities really reduced as a consequence of the Equalities Commission? The evidence is often thin. Also the activities of such inspection QUANGOS often place great burdens on the public bodies being inspected.
• Could their work be done by other existing organisations? For example, many of the roles of the Learning and Skills Council (LSC) in funding post-16 education used to be done by local authorities. Also, much economic work is done by local authorities as well as RDAs. Do we therefore need these QUANGOS when local authorities might do the same work for less?
• What public accountability is there for the work of QUANGOS? The Boards of QUANGOS are not elected but appointed by Ministers who seem to closely control what they do in some detail.
• Why are so many QUANGOS based in London when their wok could be just as easily done in other parts of the UK?
• Are there too many QUANGOS? For example do we need a QUANGO to fund higher education (HEFCE) and a QUANGO to fund post 16 education (LSC)?
• Are QUANGOS just devices for Ministers to reduce civil service head count and to avoid direct responsibility?

Overall, the future of QUANGOS probably depends on how much time and energy Ministers can devote to the issue given the vast problems which will face the next Government. Some savings can probably be squeezed out of the QUANGO system but it is probably much less than currently imagined.

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Malcolm appeared on BBC One's The Politics Show talking about QUANGOs on November 8th

Get under the skin of questions of private and public finance with The Open University Business School

The final programme in the documentary series The Love of Money finishes by ascribing the causes of many financial crises, including the most recent, to a “reckless love of money”. Over the series, we have seen how reliance by banks on imprudent investments in property loans with high default risk led to the near total collapse of the world’s financial systems.

Was this the consequence of the actions of a powerful few, driven by extraordinary levels of greed and recklessness, or can the roots of the crisis be found in much more commonplace aspects of human psychology? I am going to argue that there is a great deal in common between the psychology of every day decisions about money and the psychological processes involved in the creation of this global financial crisis.

Consider two examples:

Jenny has recently lost her job, she knows that money is tight and she needs to reduce her costs dramatically, but every time she tries to think about sorting things out she feels bad and ends up by going shopping to cheer herself up.

Jared took on a 100% loan to buy a house with repayment levels he could only just afford. As he thought about this decision from time to time, he felt anxious about the possibility that he would not be able to meet the payments. He was able to avoid this anxiety by focusing on the way in which house prices seemed to keep on rising and by telling himself it was really a ‘one way bet’.

In each case there is a common factor: employing a strategy to avoid bad feelings and maintain good feelings, rather than facing the real problem or risk. We all behave like this from time to time. We all have strategies to regulate our emotions and often do so with the goal of avoiding bad feelings. However, when we feel particularly anxious or are powerfully motivated by an important goal, this tendency can cause us to ignore the important information that negative feelings can carry. Often this can involve fostering illusions about ourselves and the world around us which help us feel better.

Stock market results in a newspaper.
[image © copyright Jupiterimages]

We might imagine that professional financial decision-makers would be better at avoiding such traps. After all they work in a climate which places a great premium on rational decisions. However, in a large-scale study of 118 traders in four City of London investment banks, myself and colleagues found traders to be just as prone to these kinds of illusions as the rest of us. In particular we studied traders’ propensity to suffer from the illusion of control: the tendency to believe we are more in control of events than we really are (especially under stress). We found a significant relationship between a tendency to suffer from illusions of control and poor trader performance (including poor management of risk).

How might this relate to the causes of financial crises? One example back in the early 1990s is worth recalling. Peter Baring has been reported as telling shareholders at an AGM one year before the collapse of Barings’ Bank that, on the basis of the previous year’s performance, he had concluded it is easy to make money in the derivatives market. A year later the bank was valued at £1.

Any banker understands that there is a strong relationship between risk and return. Faced with unusually good financial performance in part of a bank’s operations, an important question to ask is “What hidden risks are we carrying that account for this high return?” However, faced with good returns, it is tempting to foster the illusion that good performance is a result of our unique skills and capabilities, while failures are due to events beyond our control. This tendency is known by psychologists as the self-serving bias.

This unwillingness to seriously question what hidden risks lay behind unusually high returns seems to have been an important factor in the recent demise of Lehman brothers and other major banks. A reckless love of money seems to have fuelled collective illusions about the risks being faced.

We need to understand more about how these kinds of emotion regulation processes work in financial decision-making. Current research is helping us understand these processes and how such blindness to risk can be reduced. The European Commission has funded me and an international group of researchers to conduct a major study looking at ways of improving financial decision-making. This study is looking at traders, investors and private citizens, and is paying close attention to the role played by emotions in their decision making.

Take it further

• Trading on emotion
• Has Robert Peston caused a recession?
• Bankers won, politicians lost

Further reading

Traders: risks, decisions, and management in financial markets, by Mark Fenton-O'Creevy, Nigel Nicholson, Emma Soane and Paul Willman, was published by Oxford University Press.

About the author

Mark Fenton-O'Creevy is Professor of Organisational Behaviour at the OU Business School. His research includes investigations into the performance of traders in financial markets, and the problems that occur when management practices are transferred from one country to another.

He is also a National Teaching Fellow, and Principal of the Centre for Practice-Based Professional Learning.

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