Corporate scandals
Dj vu all over again?
Dec 18th 2003 | PARIS
From The Economist print edition
SourceThe near failure of Parmalat is raising questions about how well Europe is reforming its corporate governance
SOMETHING amazing and troubling happened in Italy on December 15th: Calisto Tanzi, chairman and chief executive of Parmalat, one of the world's biggest dairy firms, resigned. He handed full control of the group that he had founded decades earlier to Enrico Bondi, an experienced manager of troubled companies who had arrived at Parmalat as a consultant only the previous week.
Mr Tanzi's dramatic departure, along with the exits of several other family members and allies, marked the complete ascendancy of Italy's big banks over their once arrogant customer. It is rare for a family to lose control of a business so quickly, perhaps especially so in Italy. It is even rarer for the transfer of powers to be so uncontested. In essence, the banks had deserted Mr Tanzi during a sudden liquidity crisis that saw a group with 7.6 billion ($9 billion) of annual turnover unable to raise a mere 60m or so to redeem a maturing bond issue. The financial markets and rating agencies had panicked, driving Parmalat to the brink of default.
All of this has cast fresh doubt on claims that corporate governance has been improving in Europe after a series of corporate scandals and boardroom blunders that mirrored similar messes across the Atlantic. When France's Vivendi went into meltdown in 2002 it was labelled ?Europe's Enron?, after the failed American firm. That mantle passed this spring to Ahold, a Dutch retailer with accounting problems in its overseas subsidiaries.
Now, as more details have emerged, Parmalat looks as if it might provide Europe's closest imitation yet of Enron?albeit with the distinctly European twist of family ownership.
Europe's third Enron
The embarrassment was particularly acute for those Europeans who have been claiming that corporate governance has been improved, for it was no secret that Parmalat had long been a tricky client for its bankers. Like Enron, it was over-fond of elaborate bond and derivatives deals, often using complex offshore structures that involved some of its many subsidiaries. Investors and bankers alike struggled to understand its balance sheet or to gauge the true extent of its liabilities. Parmalat had acquired a reputation for lack of transparency. Over a year ago, analysts at Merrill Lynch advised investors to sell its shares on the grounds that they could not understand the need for such opaque finances.
So why did respected institutional investors continue to buy Parmalat's shares and bonds? As for the banks, why did they continue lending and arranging questionable derivatives deals? Sure, at the end of the financial labyrinth there was indeed a sound, valuable milk-processing and distribution business. But this did not justify a collective lapse of judgment.
Big investors had failed utterly to use their leverage to alter the behaviour of Mr Tanzi and his managers. Indeed, it is not yet clear whether they ever made any real effort to demand better disclosure and an end to funny financing. Yet many of them own financial instruments that will now be caught up in competing claims for priority in getting repaid. Default and subsequent restructuring cannot be ruled out. Clients' money will be lost.
Two particular criticisms can be directed at Parmalat's banks. The first is that its house banks were too close to their customer and allowed its financial managers to run amok. Although within Europe this is not uniquely an Italian problem?France's banks have occasionally been as guilty, notably with Vivendi and Alstom, a troubled engineering group?it has been especially striking in this case. The same was true last year of Cirio, a food producer that eventually defaulted on its bonds after a long struggle between managers and a modernising group of bankers who wanted to pull the plug but who faced resistance from colleagues. Parmalat has given those modernisers a new chance to clean up relationship banking. Let us hope that they will take it.
Second, respected global banks, including Citigroup, J.P. Morgan and Deutsche Bank, were only too willing to construct the derivatives deals by which Parmalat transferred funds offshore and speculated with them. These banks are not answerable to the shareholders of their customers, but earn lucrative fees. They have been involved in many of the best-known corporate scandals, in America as well as Europe. Arguably, their very presence has helped to reassure investors and rating agencies. In future it should count for less.
As with Enron, Parmalat's problems may have been ignored for longer than necessary because people were taken in by the group's constant self-promotion. Although much remains unknown, it seems that substantial assets may have disappeared from Parmalat, much as hundreds of millions of dollars were siphoned off from Enron. Bankers say that it may take months to untangle Parmalat's affairs. Mr Bondi has already assembled a team, including forensic accountants, to assess whether the firm can avoid default. Enron destroyed the reputation of Arthur Andersen, its accountant. Deloitte, Parmalat's accountant, must now explain itself.
Credit-rating agencies, yet again, have egg on their faces. Last year, a liquidity crisis led to the unravelling of Vivendi, but also revealed how tricky it was for outsiders to monitor what had been going on. Like Vivendi, Parmalat failed to disclose lots of information to Standard & Poor's (S&P), yet the agency happily issued investment-grade ratings on its bonds. Only when the firm entered crisis mode did it become clear how wrong S&P had been. Were there no warning signs at all?
Parmalat's crisis is a sour note on which to end what otherwise really had been a year of improvement in Europe's corporate governance. Various European countries have been introducing or strengthening governance laws or codes of practice. Thanks to vigorous intervention by shareholders and the banks, the firms brought down by governance failure?from Vivendi to Ahold?have mostly ended the year in far better shape than had once seemed possible. Perhaps the presence of the founding family at Parmalat had lulled watchdogs into a false sense of security. In future, they need to remain more awake.
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