To invite disappointment or worse : governance, audit and due diligence in the Ferranti-ISC merger

Accounting

Further details

Abstract:

Ferranti was a large, long-established and family-controlled British electronics company with a management tradition which emphasised innovation and engineering excellence in a decentralised group structure.  It fell under government control in 1975, but recovered, refloated on the London Stock Exchange (LSE) and pursued a conservative strategy until a radical departure in 1987, when it merged with ISC, a US company also listed on the LSE.  Within two years a massive fraud at ISC was exposed and by 1993 the group had been dismantled and the remnants had fallen into receivership.

Although it is well-established that mergers and acquisitions frequently destroy shareholder value, and that UK companies have a poor record in US deals in particular, outcomes are rarely so calamitous as in this case.  In this paper we examine how and why Ferranti pursued this major corporate transaction.  Ferranti entered into the merger for apparently sound strategic reasons, but was handicapped by its inexperience in such transactions and a due diligence process that was clearly inadequate in an era marked by a dramatic increase in merger and acquisition activity.

Ferranti’s corporate governance arrangements appeared to conform to contemporary norms, and in several respects anticipated the reforms which followed this and other major scandals which marred Britain’s ‘casino capitalism’ of the 1980s and early 1990s.  But we argue that Ferranti’s corporate governance failed to constrain its executive decision-making, which by the time of the merger had become highly-centralised around Derek Alun-Jones, the managing director appointed after the mid-1970s crisis.

The Ferranti family, still represented on the board of directors and the largest shareholders, were effectively frozen out of the decision-making process.  Institutional shareholdings were widely dispersed when the government’s stake was sold, and shareholders were either supportive of management’s strategy or passive.  The non-family non-executive directors were either new to the board or had a long-standing business relationship with Alun-Jones.  Ferranti’s principal bankers, represented on the board for several decades until the mid-1970s, no longer had a board representative.  Determined to pursue the merger, Ferranti relied heavily on ISC’s own professional advisers who had been misled by ISC’s carefully-contrived fiction.

Our analysis of the Ferranti case, seen in the light of recent corporate failures such as the Royal Bank of Scotland, leads us to question whether corporate governance mechanisms can ever act as a fully effective constraint over the flawed and dictatorial decision-making of dominant individuals.