Outlook: Tyco's Kozlowski finds himself painted into a corner

Interest rates; Sell in May ...

After the Enron affair, corporate America needed another scandal like a hole in the head. But just six months later and along comes Tyco's Dennis Kozlowski and the curious case of the unpaid taxes. This one may lack the scale of Enron, which engulfed the energy trading company and led to the dismemberment of its auditors, Andersen. But what it lacks in size it more than makes up for in colour and sheer incredulity.

For a start there is the basis of the tax evasion charge which centres on grand master paintings, of all things. The charges include conspiracy, tampering with physical evidence, falsifying business records and sales tax violation in the purchase and delivery of at least six works by artists such as Renoir and Monet.

The indictment makes cracking reading, alleging that the Tyco man, who resigned at the weekend, bought the paintings and then made it look as if they had been shipped out of New York state where they would not liable for local sales tax. In fact, so the charge goes, they were hanging on the walls of Mr Kozlowski's Manhatten apartment all the time.

The first point to make here is that Tyco has looked like an accident waiting to happen for a while. It has been subjected to informal investigation by the Securities and Exchange Commission on accounting before. And as recently as this February it admitted failing to notify shareholders of 700 acquisitions worth $8bn over the previous three years. How no one spotted these deals in the first place is open to question, but that's another matter.

The fact is that Tyco's corporate governance stank to high heaven. Mr Kozlowski was both chairman and chief executive and the non-executive directors could in no way be classified as independent. John Ashcroft owned a large number of shares having sold his ADT security business to Tyco in 1997. Other non-executives included a lawyer whose firm has done years of legal work for Tyco and another who was paid $10m last year for helping on a deal. Being registered in Bermuda hasn't helped either.

What we have here is an aggressive boss dominating a company to such as extent that no one was saying boo to the proverbial goose. The "independent" directors were further compromised by taking much of their remuneration in share options, something that wouldn't be allowed to happened here.

The second point is that this scandal could become just as much a company affair as a Dennis Kozlowski one. It is alleged that some of the paintings were bought by Tyco on Mr Kozlowski's behalf and that they continued to be owned by the company. Just why the company was doing this is anyone's guess but again the non-executives will be asked who knew what and when. The third point is the independence of the company's audit. Tyco paid PricewaterhouseCoopers a thumping $13m for audit work last year plus millions more in consultancy fees. All this echoes the Enron affair where the independence of the audit was compromised by the sheer size of the fee ($25m) and additional consultancy work ($27m).

The fourth point is what implications there are for corporate governance and accounting standards in the US and here in the UK. As far as corporate governance is concerned, UK institutions have got hot under the collar about collapses such as Marconi. But our boardroom structures are far preferable to those in America where there are often only two executive directors (the CEO and the finance director) and share option programmes have limited performance targets, if any.

Under Sir David Tweedie, the International Accounting Standards Board is currently developing a new set of accounting regulations. It is hoped that these will be adopted by the European Union from 2005. The Americans have been dragging their feet over adopting stricter standards. But as investors become increasingly concerned about lack of transparency, that case looks a lot weaker now.

Interest rates

The housing market has a mesmerising effect on the British public and media. May's record-breaking monthly increase of 4.2 per cent has set alarm bells ringing over the likelihood of a hike in interest rates from the Bank of England later today.

Certainly such a move would come as less of a surprise now than it would have done a week ago. There are signs the housing market is getting out of control and an early hike might both quell the exuberance and nip inflationary pressures in the bud.

However, there are a number of reasons why this might not be the best – or most likely – outcome. The Bank has consistently been calm about the housing market, even welcoming the growth in the domestic economy to offset declines elsewhere. This culminated in remarks by the MPC's David Clementi that the Bank would hike rates simply to quell a housing boom. An unforeseen hike might carry too much shock value.

The question, therefore, is where – other than the housing market – are there signs of inflationary pressure that would threaten the Bank's target two years' hence? Not in industry, where manufacturing is suffering its worst slump in output in a decade while prices leaving factory gates are falling. Prices are also still in decline on the high street. The recovery in both manufacturing and services could be stifled before it has had a chance to make an appearance in the official statistics. Certainly a rate hike would also be hard to justify after six months of economic stagnation, if the figures can be believed. There is still good reason to wait for the new Bank inflation forecasts in August before raising rates, although July is undoubtedly more likely now.

But whatever happens to rates the real worry is the imbalances in the economy. The Bank has simply complied with its statutory task by stimulating a consumer boom to keep inflation on target. The problem of resolving the imbalances rests with the Chancellor.

Sell in May ...

The slump in the FTSE 100 below the 5,000 barrier raises fresh questions about the pace of the global economic recovery. There may be fewer reservations about the bounce-back than in the immediate aftermath of 11 September. But the markets seems to disagree. We are almost midway through the year and the FTSE 100 is still slightly down on where it started in January. At this rate it will spend the rest of the summer struggling to clamber back above the psychological 5,000 level.

There were even renewed fears yesterday that a further weakening of equity valuations – perhaps forced by hedge funds – would again force pension companies to stop their losses by dumping equities and switching into bonds as happened after 11 September. That would only depress the markets further. On the one hand, investors are afraid the recovery will be characterised by dwindling margins and lacklustre profits growth. On the other, Enron and, latterly Tyco, have made them doubt the validity of company accounting altogether. The summer is traditionally a weak period for the stock market but a rapid revival looks rather unlikely.

n.cope@independent.co.uk