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CBI implies hefty bonuses contributed to credit crisis

24 April 2008 / by Joy Tibbs
Director general of the Confederation of British Industry (CBI), Richard Lambert, spoke about private equity at the British Venture Capital Association's 25th anniversary summit yesterday.

During his speech, Mr Lambert suggested that although city bonuses were not the sole cause of the credit crunch they may have helped fuel the crisis.

Mr Lambert pointed out that some investment banks had disregarded basic risk management in their haste to make money. He added that several had also allowed some employees to make risky decisions. "It’s clear that a number of investment banks had overlooked basic risk controls in their drive to increase profits," he said.

"This pattern of behaviour has been exacerbated by a remuneration structure which has encouraged some employees to take spectacular short-term risks, confident that if things work out well they will reap huge rewards, and if they don’t, they won’t be around to pay the price.

"If it had been their own equity at risk, things might have played out differently. And that, of course, is the way that private equity works."

He said that recent changes in economic conditions mean that the private equity industry must now prove its core business model works, as highly leveraged debt and rising asset prices are no longer there for the taking.

Mr Lambert said: "The spectacular returns generated by some private equity houses over the past half dozen years have been derived from three sources. High leverage. Rising asset prices. And a business model that cuts out the agency problem inherent in listed companies, by aligning exactly the interests of owners and managers.

"It’s never been entirely clear which of these three elements was the most important. Now in today’s changed financial climate, the first two of these three drivers for high returns – high leverage and rising asset prices - are going to be much less powerful.

"Producing above average returns in the next few years is going to be more challenging and will have to rely much more heavily on private equity’s business model."

However, Mr Lambert said that changes had been made in the private equity sector since the start of the credit crisis, and that these changes will be lasting ones. "The big lesson learnt by the industry over the past 12 months has been about the necessity of communicating with a wider public than that of its immediate stakeholders. This is going to remain just as high a priority in the years to come," he said.

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