A key feature of the UK infrastructure sector is the dominant focus on shareholder value; rather than managing the company to maintain its value for the life of the asset/long term, the focus is on how to maximise immediate shareholder value, largely for investors who do not necessarily envisage holding the investment long term. While of course this is an over-generalisation and there are many exceptions to prove the rule, it is a dominant feature and has fundamental consequences:
• Financial engineering - irrespective of the long-term impact on the utility or PPP's flexibility or ability to absorb risk, they are incentivised to refinance post construction or regulatory settlements to pay dividends, adopting aggressive, highly-leveraged finance structures. This is a particular problem with infrastructure which delivers long-term stable cashflows which are particularly suitable for aggressive refinancing. But it is precisely these windfalls that are seen as so invidious in the context of public assets.
• Return requirements - much of the UK's infrastructure is owned by investors whose return requirements far exceed the returns that could be earned by infrastructure companies themselves in the long term. Those investor returns can only be delivered therefore through high capital gains, through a sale once risk has been reduced or earnings increased or through refinancing gains. Management is similarly incentivised.
• Drive to increase short term earnings - new investors buy at a multiple of the earnings evidenced at the time of purchase, so management will look to maximise short term earnings in a lead up to a sale. But with infrastructure this could lead to a risk that it can be under-maintained; short term this will not impact performance - it takes years for problems to manifest themselves - but may not be sustainable long term.
Similarly, striving to increase earnings will encourage aggressive outsourcing and use of lower cost labour, to the detriment of longer term loyalty, training and employee trust.
It is hard to engender trust if employees perceive companies prioritise short term profit over a commitment to the long-term health of the company and assets.
• Focus on compliance not customer satisfaction - to maximise profits, companies aim to just meet contractual or regulatory requirements; 'what is the lowest cost at which these are satisfied?', rather than on customer satisfaction; 'what is the best service we should deliver?' This is seen as a particular issue of PFI contracts.
All of these could be described by the private sector as simply being economically efficient; it is what the private sector does. But all of them are increasingly less accepted by the public in the context of public sector assets and delivering public services.
An increase in contractual controls or regulation would not solve these issues nor re-build trust in the private sector; it would lead to a worse, less stable relationship.
Over time we have transferred the ownership of large swathes of infrastructure assets to shareholders who either have no institutionalised commitment to long term ownership or have an explicit short-term investment horizon. In turn, this has led to a toxic combination of investors looking to profit maximise set against increasing levels of regulation or contractual controls, introduced to monitor and control such behaviour.
The impact of increased regulation has been for the regulated to increase focus on how to minimise or circumvent the impact of past or impending regulation; the regulator has more impact on the bottom line than customers. We have slowly transitioned to a world of regulation, standards, contracts, compliance and a focus on what the regulator will think or the contract stipulates, rather than one of corporate purpose, compassion, integrity and a focus on what the customer wants. The impact of increasing regulation and onerous contracts is to distract management further from the true purpose of their respective companies.
Would a more onerous contract make you focus on the goals of your company more or on ensuring the contract is met? Are the two the same? Clearly not.
But this leads to a regulatory conundrum. With less contract or regulation, companies have the opportunity to profit maximise with the risk of the short-term behaviour described above. With increased regulation or contractual controls, that will be management's focus, rather than on running the business.
With the current direction of travel, the regulated model feels close to the edge; increased regulation has not addressed many of the perceived failings of utilities and has soured the relationship and public perception of utilities, whilst aggressive financial engineering by utilities may test the solvency of some of the largest amongst them and short-term profit maximising behaviour is still seen to prevail.
Now that most PFIs are in the operational phase, the successful delivery of each project is easily forgotten, and the focus is on how well they perform against contract, or how flexible and customer focused they are, rather than just satisfying the contract, where by design the PFI structure or actual performance is falling short.
How can change be introduced so that management focus is on the goals and values of the company, its customers and stakeholders, not its shareholders, contracts or regulators?