Sunday, 15 June 2008

Re-reading Going Off The Rails

In order to get up to speed for a project I'm about to start working on, I thought I would re-read a few books I found useful over the past few years. One of them is Going Off The Rails by John Plender.

Here's a great bit on the conflicted role of fund managers:

Too little attention is paid to the carrots and sticks that influence human behaviour. This is true for everyone in the system, including the moguls who invest the money. The biggest chunk of money in the US and the UK is in defined benefit pension schemes that are, in effect, controlled by the management and run largely according to management's requirements. Where investors do have a direct stake in the stock market, as in mutual funds, they have only a limited say in how their money is run. Meantime the elite of corporate managers and fund managers who are in charge are only weakly accountable and their incentives are not well aligned with those of the ultimate investors...

[M]any professional fund managers are more concerned with managing their own business risk than those of the ultimate investors. They pursue relative rather than absolute returns on a short-term basis because it is their performance relative to their competitors that determines whether they retain their pension fund clients. Such behaviour... contributed to the stockmarket bubble. And because the absolute returns generated by such professional investors have been unimpressive, the field has been left wide open for hedge funds that pursue absolute returns, but on an even more short-term basis. This is as true of the US as the UK, despite tougher legislative requirements on US fund managers to observe their fiduciary obligations to pension scheme members. The concept of responsible ownership, meantime, is alien to hedge funds. Most have no interest in playing a role in corporate governance.

The market has changed a bit since then, for example funds have generally moved away from peer group benchmarks. But to be honest I don't think the pressures on fund managers to deliver short-term returns have significantly changed. And hedge funds still appear to have little interest in governance.

And on a separate point here's a bit on fixing management incentives to share price:

The bizarre irony here is that the shareholder value movement has ended up replicating the errors of socialist planners in the old Soviet Union who imposed targets on industrial managers that were frequently met by fiddling the figures or doing damage to some other aspect of the business. By fixing on a single managerial incentive – the share price – the Anglo-American system has encouraged management to maximize short-term profits at the expense of longer term growth. When managers found that they could not generate enough short-term profit to satisfy investors and stock market analysts in the bubble period, they resorted to takeovers as a means of keeping one step ahead of the baying hounds of the financial community. And when takeovers became more difficult to pull off in the depressed stock market conditions that followed the bubble, they took to window-dressing the figures either within the rules or fraudulently as at WorldCom.

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