Tuesday, January 16, 2007


What Links the “Hold”-Strategy to the Swissair case?

Last monday’s NZZ (January 8, 2007) ran a very interesting article on financial analysts in Switzerland. The article reports on a study carried out by StarMine concerning buy recommendations made by Swiss financial analysts. The study shows that Swiss financial analysts recommend more often than financial analysts in other countries to “hold” shares rather than “buy” or “sell”. In fact the hold strategy is the most common recommendation in Switzerland! A hold strategy implies, so the journalist argues, that the analyst recommends a shareholder who possesses already the share in question not to sell it, but other clients who do not have shares from the same company, not to buy them. Different clients get hence contrary advice from the same analyst, which shows that a hold strategy is theoretically not justifiable. Either a share can be expected to out-perform the market in the future, in which case the analyst should suggest a buy strategy, or it will under-perform, in which case the shareholders should sell out their stake.

What is interesting is the explanation the journalist gives for this phenomenon: “Switzerland is a small country, and the smaller a market is, the stronger are personal ties. The probability that a financial institution in a small country that recommends selling a given share is at the same time a creditor of the company in question is much higher than in a large market. […] The fact that in a small country like Switzerland everyone knows each other is enough to result in a situation where none wants to put the other’s nose out of joint” (my translation). Hence, a tendency of Swiss analysts to recommend – following an age-old Swiss penchant for compromises – the “hold”-strategy.

The “hold”-strategy phenomenon is indeed an excellent example of how the Swiss business system works. It shows a central feature of the Swiss economy, i.e. the existence of the “Filz” (“sleaze”). This term designates the multiple interweavements of the members of the Swiss business elite among each other and their connexions to other sub-spheres of the society such as politics and – in the past – the army. Switzerland seems in fact to illustrate very well the concept of the “power elite” – a term coined in 1956 by C. Wright Mills – which controls not only the economy but also other sub-systems of society. This phenomenon, i.e. the same people are influential in different spheres, is not necessarily a conscious strategy – although it can – but the simple fact that the elite is very concentrated in this country leads to situations where close personal ties become inevitable. This becomes particularly clear when looking on board overlaps between companies. Philippe de Weck, former CEO of the Swiss Bank Corporation once stated:

“[i]t is correct that there is in human nature a certain tendency to form clubs and that this tendency is maybe stronger in Switzerland than elsewhere. […] And we also have clubs of boards of directors. This tendency is maybe more pronounced in the German part of Switzerland than in the French-speaking part. In several parts of German-speaking Switzerland, the mentality of the population is still very much affected by the corporations. One can feel that there has been an age-long tradition of trade guilds. And the natural tendency of clubs is to be somewhat closed. In my opinion, this is the reason why, during the years of the economic boom between 1950 and 1970, a certain club mentality developed – certainly without deliberateness - concerning board of directors. I meet you here, so why don’t you come there; I know you, I know how you think; if we take someone else, I don’t know him, maybe it won’t work out with him, etc.” (de Weck 1983: 93; my own translation)

Regarding this “club mentality” and the fact that the board of directors of Swiss companies overlapped – until recently – very strongly, the role of banks is usually considered being particularly important. In fact, due to the importance of banks for non financial companies banks are regularly suspected to take profit of industrial companies in order to satisfy their own, purely financial interests. Thus, Rudolf Hilferding criticised in 1910 already the power of banks and their influence on other companies through their presence on the board of other companies and through their role as capital provider (later on, in 1928 more precisely, however, he started to consider the concentration of capital as a step towards an organised form of capitalism and towards the Stamokap (Staatsmonopolkapitalisum) (see for the question of the socialist criticism of the concentration of economic power since the late 19th century the excellent essay by Martin Höpner). Louis Brandeis criticised in 1914 how US investment bankers used “other people’s money” in their own interest. Sergei Illitsch Ulianow was enthusiastic with both Hilferding’s and Brandeis’ analyses and argued – in a book called “Imperialism: the Highest State of Capitalism” published in 1916 – that the situation in Germany was not much different from the one described by Brandeis. This debate reached eventually also Switzerland. The socialist author Fritz Giovanoli analysed and critisised in his book from 1937 “Libre Suisse, voici tes maîtres” (“Free Switzerland, here are your masters”) board overlaps and the concentration of power in the Swiss business elite. Since then, the debate about the power of banks re-emerges periodically.

Be that as it may, several facts show that the “power of banks” is not as complete as political propaganda suggests. In fact, Swiss banks seem at least as useful to industrial companies as the other way round. To name but one example, Swiss banks controlled usually large amounts of votes during the Annual shareholder meeting of industrial companies because the bank clients who held shares in the company in question could delegate the voting right to a bank representative. This gave banks a considerable potential power of non financial companies. However, as a rule, banks always cast their votes in favour of the board of directors’ propositions to the AGM. During long time, they did so even if the bank client wished that her votes be cast against the board! This shows that banks were loyal to the management of the company and clearly not acting in their own interests. This is of course by no means a self-forgetful behaviour of the banks, but shows that banks – or rather bankers – conceive of themselves as part of a very cohesive business elite.

This cohesion has actually once again made it to the front pages of Swiss newspapers. In fact, this morning started the process against the former directors of the national airline Swissair. In the graph below, I try to illustrate this cohesion. In fact, I took the former directors of Swissair who will appear in court starting from today. Based on a data base on the board compositions of the 100 largest Swiss firms, I looked what board overlaps between Swissair and other large Swiss companies the accused former directors created. (The data base was actually created at the Universtiy of Lausanne in relation with a research project funded by the Swiss National Science Foundation in which participated prof. Thomas David, Dr. André Mach, and lic hist Martin Lüpold).

The people whose board seats I took into account were the following defendants: Philippe Bruggiser, Mario Corti, Gerhard W. Fischer, Jacqualyn Fouse, Bénédict Hentsch, Antoine Höfliger, Eric Honegger, Andreas F. Leuenberger, Lukas Mühlemann, Thomas Schmidheiny, Georges Schorderet, Verena Spoerry, Gaudenz Stählin, , Andreas Simmen, Andreas Länzlinger, Scott Cormack, and Karin Anderegg Bigger. The snapshot takes into account board positions in 2000, i.e. just one year before the debacle. The lines symbolise ties that are created by a director sitting at the same time in two companies. Thicker lines indicate that the companies in question shared several directors:

What does the graph show? Well, it certainly shows that the people that appear in court starting from this morning are not some strange outsiders with dodgy business practices….these people are the very core of Swiss business. This is no big surprise since it has been repeated over and over again since the grounding of Swissair in October 2001. However, what the graph shows visually is how delicate this corporate failure is for the Swiss economy as a whole. In fact, at least ten major companies are directly linked to one of the accused. Hence the dilemma linked to this case: if the accused – or some of them – are guilty, the integrity of the whole business elite will be put into question. If they are not guilty, however, the failure of Swissair is not due to criminal behaviour but to… incompetence, which of course puts the whole business elite not less into question. Maybe, this explains why one of the few things that Gerhard W. Fischer said to the judge this morning was that the debacle would not have occurred without 9/11! Someone has to be guilty after all!

Be that as it may, all this very much confirms what Peter Katzenstein said in 1985 about small states in world markets: The elites in small countries seem to close ranks in order to face threats from outside…

The Swissair case shows that still around 2000, the main function of the board of directors was not to control and verify the work of the management, but something else (what else? Preventing outsiders from stepping into the meeting rooms of the Swiss elite?). At least as Swissair is concerned, this finding seems to be true. Still today, Swissair directors talk in a very traditional way about their duties: Andreas Leuenberger (at the time also chief of the peak association of the Swiss economy, Economiesuisse) said (NZZ 18.1.2007) that is was not possible for part-time directors to examine the proposals of the management in detail:

“Er betonte, nebenamtlichen Verwaltungsräten sei es nicht möglich, komplexe Vorlagen der Geschäftsleitung, die zusätzlich noch von Gutachten renommierter Büros untermauert würden, detailliert nachzuprüfen oder Alternativen zu entwickeln.”

In other words, the Swissair directors fully trusted their managers and did not have a proper, independent opinion on how the firm should be run. Already in 1931, the social-democrat MP Emil Kloeti complained in a parliamentary debate concerning the company law reform that whenever a firm collapsed, the directors explained that they had not known the details about the firm’s business:

„Es geht aber nicht an, dass, wenn die Gesellschaft zusammenbricht, die Verwaltungsräte wie unschuldige Kinder erklären können: ‚Wir wissen von allem nichts; wir haben gar keinen Einblick in die Geschäfte gehabt.“

Other “traditions” can be added to that one. For instance, also in 1931 a social democrat writer tried to find out how much company directors earned (director of a large bank had about 600.000 Franks a year, whereas a worker earned 3000 franks a year). For lack of disclosure, it was very difficult for him to find out what he wanted. On the other hand, the Ethos foundation did the same inquiry in 2006 – still, they had pretty much the same problems. For instance, they could not say how much the CEO of one of the large banks earned – for lack of disclosure. Only from January 1st, 2007 on firms are obliged, according to an amendment of the Company law, to disclose the remuneration of the single directors and top executives (for the parliamentary debate in 2005, cf.: http://www.parlament.ch/ab/frameset/d/n/4707/119238/d_n_4707_119238_119398.htm ).
To sum up: Despite the seemingly increased transparency, corporate governance during the 1990s until 2006 was not so much different from the one in the 1930s….
Gerry, I like the visualization of the connections (or "Filz")... It gives a much clearer picturer of the historic board room situation around Swissair than words ever could.

I guess this image also shows that we should listen to foreign analysts when we buy shares of Swiss companies...

Warm hello to London, Alex
Limpid exposé. That database you gathered proves a fruitful investment, and I concur with Alex that it makes a vivid representation. Just a suggestion now. What you write about the "Filz" in Switzerland gives the idea of a "tightly coupled" system, as Perrow would say. This implies strengths, in particular in terms of control, but also some kind of vulnerability to rare combinations of failures which might actually push the whole system (rather than only the failing component) to a catastrophic outcome. Of course Perrow was talking about nuclear power plants, spacecraft and stuffs like that. But he recently suggested applying his framework to finance. Also the idea of coupling was applied to non-technological systems, such as universities, by Karl Weick. Actually all this echoes with the last lines of your post: the Filz might make the whole system enduring, and yet also vulnerable...
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