Is Ernst & Young's Entrepreneur of the Year a Flash Crasher?

Accounting and consulting firm Ernst & Young holds an annual competition for what it calls the Global Entrepreneur of the Year. The 2010 winner is British firm ICAP, the world's largest financial middleman, and ICAP's victory -- announced at a ceremony held in Europe's gambling capital, Monte Carlo -- makes a huge statement about where the economic power lies in today's economy, and why that power is misplaced.

E&Y's Global Entrepreneur of Year Award, started in 2000, picks candidates from 135 cities in 50 countries. According to E&Y CEO Jim Turley, the award celebrates the "power of entrepreneurs whose optimism, ability to spot opportunities and sheer hard work continues to drive positive change and inspire others around the world."

ICAP uses voice and electronic networks to match "buyers and sellers in the wholesale markets in interest rates, credit, commodities, foreign exchange, emerging markets, equities and equity derivatives," according to Ernst & Young. The company's founder, Michael Spencer, started ICAP in 1986 with $45,000, according to London's Telegraph newspaper. Today, ICAP has grown to do $1.5 trillion worth of trades daily and makes its revenue from commissions on those trades. Spencer's net worth is now around $1.6 billion.

Spencer is also treasurer of Britain's Tory party. And it doesn't look so good for the Tories that earlier this year, Spencer dumped $65 million worth of his ICAP shares weeks before a February profit warning. So perhaps it's not a coincidence that he "plans to step down as Tory treasurer in the autumn," according to The Telegraph.

Rewarding a Widening Gap Between Financial Markets and Corporate Governance

While ICAP is clearly a successful company, E&Y's decision to tap a global financial casino runner for its entrepreneur award is disturbing. It highlights an enormous problem with the entrepreneurial ecosystem in many Western countries -- the disconnect between financial markets and corporate governance. Why couldn't E&Y have picked a company that makes a product or service that improves people's lives?

Before focusing on that question, let's discuss the entrepreneurial ecosystem concept. As explained in my new book, Capital Rising, co-authored with Srini Rangan, different countries have different entrepreneurial ecosystems: e.g., their policies towards human capital, financial markets, corporate governance, and intellectual property protection.

The most successful entrepreneurial ecosystems attract capital to start new businesses because of how their policies in those four areas reinforce each other. For example, to get Google (GOOG), a company that boosted the quality of Web search, off the ground, all the elements of its entrepreneurial ecosystem worked together in a balanced manner.

How so? A handful of smart people (Google's human capital) were able to raise venture funds (in the financial markets) on the strength of an Internet page-ranking algorithm (protected by a strong intellectual property regime). And thanks to strict accounting and management policies (good corporate governance), Google was able to sell its shares to public investors.

By contrast, ICAP embodies much of what has gone wrong with the entrepreneurial ecosystem in Western economies over the last decade. Simply put, finance has become the tail wagging the economic dog. Traders who hold stocks for an average of 11 seconds account for 70% of stock market trading volume. And they could care less about what a company does during their 11 second relationship with its stock.

Restoring the Conditions That Can Create the Next Google

Thus, the entrepreneurial ecosystem that helps companies like Google get off the ground is defeated. When the value of a stock has absolutely nothing to do with the company's business, the markets become unstable because there is no longer a rational basis for valuing stocks.

This erodes trust in the financial markets and discourages investors from betting on startup companies that could offer profitable products and services that people want to buy.

Instead, E&Y is rewarding a company that enables the sort of high frequency trading that contributed to the May 6 Flash Crash. Moreover, E&Y is lionizing Spencer, whose resignation from the Tory treasury post could be related to his disturbingly-timed sale of ICAP stock.

ICAP's win exalts a widening gap between financial markets and corporate governance. And as long as that gap remains so wide, it will be tough for the Western entrepreneurial ecosystem to recover the balance needed to spur the next true great entrepreneur.