Competition after the crash – Press release

The financial position of many larger companies is poor, but has been improving since the crash.

Wrong incentives are delaying the recovery of Icelandic business life.

Among other consequences, corporate restructuring does not proceed quickly enough, companies often emerge from restructuring over-leveraged, and great suspicion and uncertainty prevail in the markets. It is necessary to take action on this.

The Competition Authority publishes its report today. „Competition after the crash“. The report presents the Competition Authority's investigation into the financial position and financial restructuring of 120 large companies in selected markets. The report also provides an update on various projects concerning the restructuring of companies and the competitive situation in Iceland following the collapse.

The situation for many companies is poor but is improving.

The crash has had a significant impact on competition within certain industries and on the competitive position of companies. The financial restructuring of companies, debt agreements and bankruptcies lead to changes in the position of companies relative to one another. This is inevitable. There are pressing public interests in responding swiftly to the debt problems of viable companies.

Banks control almost half of the shareholding in companies, according to a study by the Competition Authority of 120 large companies in selected markets. This includes companies that are in a very poor financial position and do not control their own destiny. Specifically, the share of banks is 46%, individuals 29%, resolution boards 7%, pension funds 7% and others 11%. The banks' share peaked at 68% immediately after the collapse. The situation is therefore poor but improving. There is therefore still cause for great vigilance, as there is a consensus that banks are unsuitable owners of commercial enterprises and that various competitive problems can be associated with such ownership.

The financial position of nearly half of larger companies is very poor, according to the Competition Authority, while about a fifth of companies are in a good position. Nearly a third of companies have completed financial restructuring, while the same proportion of companies do not believe they need to restructure.

The problem for the business community lies in the excessively slow process of corporate financial restructuring, dissatisfaction with its implementation, and a lack of trust and transparency. Furthermore, according to an analysis by the Competition Authority, the financial situation of around half of the companies that have completed financial restructuring is nevertheless very poor.

There is a risk that competition will significantly decrease in the long term because over-indebted companies lack the capacity to compete and new entrants lack the capital to enter markets where barriers to entry are high.

Wrong incentives

In the view of the Competition Authority, there are several incentives in the system that pull in the wrong direction and delay the process of corporate restructuring and the recovery of the economy. In summary, the wrong incentives are primarily as follows:

1. „Management difficulty“ (Temptation difficulty I). This is reflected in the fact that the parties who work to resolve the problems earn considerable income from it and make their livelihood from it. Despite good intentions, their interests in generating income and job security conflict with the public interest in a swift resolution.  This involves liquidators, staff in the banks' resolution processes, employees of the relevant companies, etc.
2. „Management problem“ (Temptation problem II). It consists of those who run businesses under the control of banks becoming accustomed to them as owners or backers and not having the necessary discipline when making decisions about the companies' operations. It can also consist of the company's managers not having sufficient incentive for the business to perform well, as they may even intend to buy the company themselves from the relevant bank in the future at the lowest possible price.
3. „Ownership problem“. It consists of the fact that the banks' creditors are often in effect their owners and have an interest in getting as much as possible from the claims they hold against the companies. Those interests are, in themselves, a normal feature of a bank's operations, but it is worse when the short-term interests of bank owners in recovering losses override the long-term interests in building business relationships and thus fostering a solid foundation for business operations and a strong economy. There is a risk that many creditors take too short-term a view on this matter, although many will no doubt appreciate the importance of not being too harsh on future customers.
4. „Decision-making dilemma“. It consists of the fact that, in light of experience, bank managers and staff want to avoid making mistakes at all costs, whilst also living with constant criticism for the decisions they make regarding corporate restructuring.  This is also largely true of government decisions concerning the economy. Bank managers, at least initially, had a unclear mandate for decision-making.
5. „The problem of fairness. It consists of the strong demand for fairness and equality in the financial restructuring of companies. As is further detailed in the report, the emphasis on protecting companies from the negative consequences of their competitors' debt relief can delay and diminish the necessary deleveraging of companies with sound underlying operations. Furthermore, it should be noted that it is extremely difficult to define what constitutes fairness and equality in this area, as the difficulties and circumstances of individual companies can vary greatly.

The Competition Authority believes that these incentives must be addressed to prevent stagnation, such as that which occurred in Japan following the banking crisis in the early 1990s. That decade has often been called the „lost decade“ in that country. The problem was that banks did not cut off companies with overdue loans or carry out necessary restructuring; instead, loan terms were extended and facilities increased. These companies have been referred to as „zombie firms“. The companies have been given this name to describe the fact that they were not only heavily indebted but also inefficient and unprofitable.

In the views of various parties who have expressed themselves to the Competition Authority, there is considerable criticism of ethical failings in business life and the inaction of the government. In this regard, mention can be made of company shell-gaming without comment or consequence, poor implementation of procurement policy and failures to file annual accounts with the Companies Register. Furthermore, there is great suspicion towards the banks due to what is perceived as a lack of fairness and equality. This needs to be addressed, as negative attitudes and a lack of trust in the business community work against recovery.

Suggestions

In light of the report's findings, the Competition Authority emphasises the use of its supervisory powers to accelerate this process. Three points are mentioned in this regard:

1. It must be ensured that the banks' real control over companies is brought to light.
2. Direct ownership to be restricted with deadlines
3. Monitoring of profitability targets will be strengthened

   The Competition Authority also puts forward the following proposals which could help to resolve this problem:

4. Banks and liquidators should systematically and publicly disclose the restructuring of larger companies, in order, among other things, to counter the mistrust that prevails in the business community.
5. Banks should better separate in their accounts between ongoing operations and corporate restructuring.
6. The government is creating an incentive that works with the aim of accelerating the recovery.
7. The government should establish a forum for discussion with banks and businesses.

See the report of the Competition Authority – Competition after the crash.