PIC risks corrupting the entire process by paying outrageous and indefensible fees
Fair market value (FMV) is at once a complex and simple concept. Never mind trying to value a company from first principles, in its simplest definition FMV is the price at which a transaction concludes between a willing (and able) buyer and a willing seller. Willing buyers and sellers transact if supply equals demand — this follows from even the most rudimentary understanding of economic theory.
It is this equilibrium that clears the market, that drives the efficient allocation of scarce capital. It is a founding principle, which, if meddled with, will undermine the efficient working of the free market. It has been meddled with in SA.
A recent report that summarised fees (transactional and advisory) paid by the Public Investment Corporation (PIC) has found its way into the public domain, and its specifics have been well commented on.
The information contained in that report shows unquestionably that grossly extravagant payments were made to parties for services that no track record could justify as being even vaguely defensible if the rule of FMV is applied.
Transactional fees for intermediaries are mostly regulated and defined in financial markets. This is probably so because a fair price had to be reckoned on behalf of less sophisticated retail market participants who trade in the financial markets, to prevent them being ripped off by unscrupulous trading houses wanting to exploit their relative ignorance. Even without regulation though, market norms for intermediary commissions (such as estate agents) have developed over time and even those are negotiable. Imposed intermediaries compound the problem.
Advisory fees are a little more complex to pin down. The value of the advice may not always be obvious to either side at the time of dealing, certainty often only found with hindsight. But even so, there are boundaries of acceptance that competition within the industry helps to manage.
Some of the fees paid as reflected in the PIC summary are, however, nothing short of outrageous, indefensible, ridiculous, suspicious and probably downright fraudulent. While two informed and willing counterparties may well be able to deal at any price they wish, if there is a demonstrable transfer of wealth, it must have happened knowingly and consensually.
If you are doing such a transfer (at more than FMV) on behalf of people whose money you are legally mandated to manage — responsibly, to the best of your ability, in compliance with your fiduciary duty (and other laws and regulations) — you are surely breaking the law, let alone violating your own conscience.
If you then participate in any way in this mispriced deal, you’re an outright crook.
The evidence made public in the PIC report would suggest exactly such circumstances, and the punishment should fit the crime.
The imperative of transacting at FMV, however, goes beyond the specifics of this case.
If we don’t get this right, culturally, then the otherwise technical analysis of it is impotent. There must be, in the first instance, the desire to deal at FMV, the desire to seek it out, as a point of departure to all negotiations. Any process of dealing that doesn’t regard FMV as axiomatic will not best serve its participants.
In the end, even those initially favoured by cheating will find that their ill-gotten gains don’t provide any enduring satisfaction. On the contrary, they’ll simply call for more and more, as the marginal utility of disguised theft soon diminishes, to give way to guilt and new levels of greed, incapable of being satisfied.
Systemically, the market prices of affected goods and services become skewed. At some point this destroys value across the entire economy — people can’t survive on bubbles of air. Systems and procedures may nudge behaviour in the right direction, but they don’t solve the problem.
Putting the provision of services or the supply of assets out to tender matters little if you don’t know the FMV of what you’re looking for before you start.
There is little point in awarding the tender to the highest or lowest bidder (depending on whether you’re selling or buying), unless you know the price, at least more or less. FMV obviously includes fair margins.
Collusion, or even simple opportunism (let alone outright and obvious theft), will catch you out if you don’t know the right price.
Anyone presiding over the award of such contracts has a duty to determine FMV. In the absence of such knowledge, parties are disqualified from exercising final judgment.