Turnout tales

If recent events tell us anything, it's that voting matters... With that in mind this is a quick post on something that caught my eye this year: sharp changes in voting turnout at a number of companies. Some of the more striking examples have been at companies that have got into financial trouble, like Thomas Cook, Interserve, Kier Group and so on. Here are a few examples (excuse my poor Excel skills). I've included publicly available data on short positions at the same time as the relevant meeting, as I think that the impact of shorting might be part of the story.

For completeness, take a look at Premier Oil, where a huge short position has recently been reported (it seems this one might be hedging).

But it's not just about shorting, there are some interesting results at companies that have been in the middle of other activity. Have a look at Provident Financial, which was facing a bid from Non-Standard Finance earlier this year. I have half an idea here that it could be the result of people taking a punt on the takeover succeeding using equity derivatives, hence banks ended up on the register as counterparties but didn't vote (as I believe there is a tax issue). I'm interested if anyone can tell me if I'm talking gibberish, or not.

And if we look back at Whitbread over the past couple of years, when Elliott had a large derivative position and was pressuring the company to restructure, we also see a drop in turnout. I'm not clear why this sharpened in 2019, though it's worth noting that it bounced back at this month's EGM. Press reports suggest Elliott wound down its position in July.

 

I'd love to see what the turnout at Melrose Industries March 2018 EGM was like, as I suspect we'd see the impact of hedge funds there too. But it's the one set of meeting results not available on its website.

And with that, I'm off... Happy Xmas and see you in 2020!

The dog that didn't bark

To be honest, I'm not looking forward to election day tomorrow. If the polling is right we can expect a Conservative majority and Brexit to go ahead, neither of which are my favoured outcomes! I thought the same would happen in 2017 and it didn't, so who knows.
Also in 2017 I blogged about how in my corner of the world a broadly 'Left' take on corporate governance was winning, even as it looked life the Left was losing in the Big P political field. This trend has only continued in the following 2 years. Positions that were once only advocated by the likes of the TUC, High Pay Centre etc have become fairly standard.
Another thing I've blogged before is that the political value of business endorsements in election campaigns has declined significantly. It might even be a net negative now. And this is a point on which Boris Johnson, a politician who seems to have no guiding purpose except getting into power, is obviously alert to.
In this respect it's interesting to note that in this election one of the previous staples of Conservative campaigns is missing (no, not Jacob Rees Mogg...): the collective statement from business leaders warning against a Labour government. This was literally a front page attack in the 2015 campaign. So where is it this time? I can't believe that the Conservatives couldn't organise a similar joint letter now, when Labour is positioned further to the Left and advocating taking some businesses into public ownership. Perhaps some feel it is too dangerous to speak out, but there must be a reliable core of party funders and friends that could be put together.
So my gut feeling is that the Conservative campaign team may think that such an endorsement (or, seen the other way, corporate attack on a particular outcome) would be a net negative. Certainly you can imagine Labour immediately trying to flip it into evidence that corporate interests dominate Right politics. If my hunch is right, then it's just a bit more of an indication of how politics has changed from the 1990s, and from the crash in particular. It has some interesting implications for those of us in ESG land, which I'll return to at some point.

PS - VOTE LABOUR.

Shorting and voting

As some people will be aware, I've been looking into changes in voting turnout at companies in trouble. Short version: turnout has fallen at several such companies, in some cases significantly. Why this might be is another question. Since several of these companies were also been heavily shorted there's a potential explanation. Perhaps investors lending shares to those shorting were not recalling them in order to vote.

So I've had a look at public shorting data (which I know is limited) and plotted this against turnout. The charts below are v basic. I've just looked at the short position on (or shortly prior to) the date of the relevant meeting. Really I ought to put more shorting data in, as obvs the shares don't get lent out and shorted immediately before meetings.

Anyway, it looks like there is a bit of a correlation, although the Debenhams example does not show that at all. So it's possible that something else is going. Perhaps changes in the register explain it - as companies get into trouble big institutions who are more likely to vote are no longer there in numbers. Or perhaps some investors just give up - if you're an indexer who has to hold the shares, but know the company is doomed why vote? Why not at least get a bit of lending income? So not a straightforward story.

PS - Premier Oil obvs not in the same category as the others. I included it as the story about the massive short in the company is in the press today.

Labour and Capital

It's election time. I'll have a look through party manifestos when they're out to pull together policy commitments that are relevant to this blog. In the meantime, here are a few rehashed thoughts about what I'd like to see as a Left platform.

1. Employee representation at board level.

The Conservatives' botched reform in this area has left the door open to further reform. As the failure of most companies to appoint employee directors shows, this is not going to be achieved through 'comply or explain', especially when some asset managers will likely lobby against. So legislate for it. Minimum of two on each board.

2. Redefine directors' duties.

This is straightforward, but important. As I saw someone comment recently, Section 172 as it stands actually made shareholder primacy explicit, even as it was pitched as 'enlightened shareholder value'. Check out the previous version (which put employees on a par with shareholders) to see how it changed. I am comfortable with the idea that the duty it simply to promote the success of the company, taking account of all stakeholder interests. If you don't think the current version is a problem, have a read of some justifications for exec pay and tax avoidance that prey Section 172 in aid.

3. Pre-distribution.

Pretty obvious that the big battle over the future of the firm is about different claims on resources. Pre-distribution got a bad press when Ed Miliband floated the term back in 2010-2015 parliament, but the idea is a sound one. Ensuring that labour gets a fairer share up front, rather than relying heavily on transfers, is likely to be much more politically durable. This suggests enhanced bargaining power (so let's make it easier for workers to form unions, and easier for unions to gain recognition and bargain).
But we also need to look at other mechanisms for ensuring a greater share of wealth goes to working people at the point it is created. Labour's Inclusive Ownership Funds provide one interesting model, and would create a who new class of investors which could have some interesting corpgov outcomes (for example in takeover situations). I see a lot of people speak positively about greater employee ownership in theory, so this idea ought to be popular. Those who criticise it should come up with alternatives. And if an IOF style scheme isn't applicable there should be mandatory profit-sharing.

4. Radical executive pay simplification.

Everyone in corpgov these days says they support pay simplification, but in practice most companies still have several incentive schemes. Nor am I convinced that deferred share awards get us anywhere because I don't think they will have much of a motivational effect (and I'm impressed by Sandy Pepper's work in this area). I'd scrap as much variable pay as possible. If we can't get rid of it all restrict the variable bit to small short-term cash bonuses with clawback and malus provisions. Much easier for all to understand, and hopefully easier to reclaim if something goes wrong.

5. Rebuild democratic control of capital.

Several trends in UK pension provision have served to less or remove democratic control of pension assets. The 'professionalisation' of governance is a good thing in general, but if it serves to cause the link with beneficiary interests to be broken we have a problem. In the ESG world I worry that this has led to priorities being adopted that are more aligned with the interests of those running money than those of whose money it is. So I would like to see reinvigorated member/beneficiary involvement in all types of pension provision.  

6. Democratise shareholder voting

I can't see any good reason why asset managers can't find a fintech solution that allows asset owners, or retail investors, to vote in pooled funds. The current situation is ridiculous, especially in a world where more and more money is managed passively. If I'm only employing you to hold the index, not pick stocks, why should I be forced to adopt your views views on corporate governance? It makes no sense.

7. Radical disintermediation.

One for a decade ahead. Will we actually need asset managers in the future as they exist in their current form? Could passive management be a utility? Could we do it ourselves?

Alignment in exec pay

There's a lot of commentary from a lot of sources these days arguing against a shareholder-centric corporate governance model. So far, the commentary is far ahead of any policy, and certainly in the US there is scepticism about the motives of those - like the Business Roundtable - who have almost overnight become advocates of a more stakeholder-orieted model.

One thing that, as far as I am aware, hasn't been discussed in detail is what all this means for executive pay. I raise this because the dominant ideas relating to executive pay in markets like the US and UK are derived from agency theory, and the version of agency theory that is applied envisages the boards of companies as agents of shareholders. Leading on from this, pay is structured in a way that aligns directors' interests with those of shareholders. Hence there is a lot of emphasis on both variable pay and equity.

But if we are looking at a future in which other stakeholders are also part of the governance of companies, and in which directors' duties are no longer conceived as being solely owed to shareholders (and thus directors are not agents of shareholders) this seems open to challenge.

If pay was aligned with the interests of the workforce, for example, it would surely have a much lower variable element and more emphasis on fixed, though perhaps also expanded short-term profit-based awards (provided these are shared across the workforce).

In addition, questions about how executive pay is decided and approved might also be contestable once more. After all, if directors are not solely accountable to shareholders the fact that only shareholders vote on who they are remunerated might seem a little outdated.

So I could imagine quite a shift in various aspects of pay - provided that the nature of corporate governance itself changes.

Problems with performance pay

It's been a few years since I read in depth about reward and motivation. I basically got to the point where I think most performance-related pay is junk, as are most of the 'reforms' advocated, because there is little attempt to engage with the psychology obviously sitting behind all these idea.

Over the summer I read a couple of books (this one and this one) by Sandy Pepper and it's reignited my interest. He comes at these issues from a similar perspective and his books are a treasure trove of further reading ideas.  He's very much of the view that mainstream agency theory, and the executive designs that flow from it, are flawed and that to correct them we need to take account of human psychology. His work is also useful in that he undertook a large-scale survey of executives to gain a better understanding of how they think about incentives. His research confirmed that executives sharply discount deferred rewards. Another couple of fascinating nuggets from the research are that younger executives are less risk averse but higher time-discounters and that financial services executives were both *more* risk averse than those working in other industries and high time-discounters.

Notably Pepper comes down in favour of short-term, simple cash-based incentives. This is a long way from the conventional wisdom - even in the ESG world - that we should be pitching at long-term equity-based incentives with lots of targets (including ESG KPIs).

Anyway, I won't try and summarise his arguments here, so below are just a handful of snippets from The Economic Psychology of Incentives that I particularly liked.

"[I]nvestors are driven by relative measures. They are selecting stocks based on relative performance by category and are worried about beating the average in the shape of an index. However, an HR director pointed out that the starting positions of managers and investors are not the same: 'Most shareholders hold a portfolio and are therefore insulated against the capricious nature of shareholder returns. We as executives are not.'"

(this is a point I was sort of getting at in my third bullet in this blog)    

"The effect of non-paying LTIPs is not merely neutral - it can be positively demotivating to hold an incentive instrument which you believe will never pay out. An HR director with particular experience of this problem described it this way: 'If you get reward wrong it is a much bigger de-motivator than it can ever be a motivator. It's like walking around a china shop with a sledgehammer in your hands.'"

"[B]oards of directors, acting on behalf of shareholders, increase the size of long-term incentive awards to compensate them for the perceived loss of value when compared with less risky, more certain and more immediate forms of reward. In other words, I argue that part of the explanation for the inflation in executive compensation is a consequence of the form in which compensation is provided."

"[I]s it possible to to alert certain features of long-term incentives in order to increase their perceived value? For example, complex performance criteria appear to increase the level of risk and uncertainty in long-term incentives and hence reduce their perceived value. Executives might be more effectively motivated by receiving smaller rewards which do not have complex performance conditions attached. Most radically, might it prove to be both more effective and efficient ti arrest the trend of placing increasing reliance on high-powered long-term incentives."

Are unions coming back into favour?

Perhaps I'm grasping at straws, but I can't shake the feeling that attitudes toward trade unions are shifting amongst some key groups, and that this might point to a more hopeful future.

In politics the direction of travel is most clear. Obviously Labour has adopted more union-friendly policy positions that it has held for the past 20+ years, union leaders have more influence on Labour, and Labour MPs are now far more openly pro-union. But it's happening in the US too. Both Bernie Sanders and Elizabeth Warren talk a lot more about unions - and how to make them stronger - than Obama ever managed.

But there's also increasingly discussion of bargaining power (or the lack of it) and how this affects inequality / distribution of wealth to capital v labour etc in other areas too. Leo Strine's piece in the FT last week was particularly striking. In the detail of the critique of the failure of investors to look at what happens to workers, and some 'governance-y' reform ideas (like setting up board committees on fair treatment of employees) he calls for labour law reform to give unions a "fairer opportunity to represent and bargain for their workers".

More generally, an increasingly widely-held view is that the growth in economic inequality is at least partly about falling levels of union membership and collective bargaining (it's not just about technology, global shifts etc). And the flip side of this is that more policy wonks are attracted to the idea of more flexible ways of affecting distribution of rewards than trying to determine this all via legal / regulatory interventions (which can always be reversed). Unions look like a pretty good fit there too.

To be clear, this is all mood music, and mood music never won anything for anyone. If Labour and the Democrats don't win, nothing changes, at least for now. Trump won't lift a finger to make it easier for workers to unionise. And the sort of people that Boris Johnson surrounds himself with are more likely to think unions still have *too much* power, not too little.

And we also need to be open-eyed about the challenges to unions. They need to recruit a lot of younger workers just to stand still. Yet experience of, support for, knowledge of unions is not part of the cultural fabric, or passed down through families, in the way it would have been a few decades back. This is a deep problem to address.

However, overall it does feel like there should be grounds for some optimism. A bit of luck with politics, perhaps a big dispute or two that demonstrates that inequity working people still face on the job, and some principled leadership could start to reorient politics and policy around unions.

Patisserie Valerie and BlackRock

Just a bit of Excel fun on a Sunday lunchtime. In its relatively short life as a public company, Patisserie Holdings didn't issue that many market announcements, so it's easy to pull together TR1 notices. I know that BlackRock had a big long position that it cut right back last April. The TR1 notices it triggered show that the holding was attributed to BlackRock Investment Management (UK).

In addition the only notifiable (0.5%+) short in Patisserie Holdings history on the public market was also tagged to BlackRock Investment Management (UK). It appeared in late 2017 and dipped back down below the disclosure threshold in mid May 2018.

So I just stuck the two together in the chart below. NB - I've only recorded what I know, obviously there could have been more shorting below 0.5%. And the last position on the long side is 4.9%, as all I know is that they went under 5% (it could have gone to zero).

The position disclosed in the TR1s doesn't actually match the disclosure in Patisserie Holdings' 2017 Annual Report & Accounts:

It's possible that the annual report listed the position net of lending, and that BlackRock had lent out a couple of percent or so. But I'm just guessing.

Just another small thing I noticed. BlackRock discloses that it voted at the company's EGM in November last year, as it appears in the iShares voting record, with 3 ETFs holding it at least. One of these disclosures is below. However nothing turns up for Patisserie Holdings via its US mutual fund disclosures.

Because BlackRock doesn't leave historical votes online in a searchable format (sigh.....) I had to look on the SEC site to try to find out how it voted at the January AGM. But there is no disclosure for that meeting (which fell into the prior year's reporting period for the NPX form), so I'm guessing that the same ETFs did not hold the stock at that point.

So I'm a bit stumped as to how I can find how it voted at the January 2018 AGM. I assume that it voted for everything since, even it only voted the 7.2% disclosed in the annual report a vote against or abstention of 7m+ shares would have shown up in the results (as total issued shares stood at a helpfully round 100m). And there's nothing like that in the results.

Final point on those AGM results. The turnout was a paltry 29%, or 29m shares, at the 2018 AGM, down from 66.2% (66m shares) at the 2017 AGM. Luke Johnson's holding was 38.6% according to the annual report, or 38m shares. So at the least he didn't vote all his holding in 2018. And 29 + 38 gets you to 67%.

Zygmunt Bauman, again

I read this recently, which is worth checking out. Here are a few quick chunks that feel very relevant (all from Bauman):

"[T]he mistrust of all and any order, synchronic and diachronic alike; questioning of the idea of 'order' as such; the tendency to raise 'flexibility' and 'innovation above 'stability' and 'continuity' in the hierarchy of values; melting with no moulds prepared in which to pour the molten metal. All this suggests the prospect of the present interregnum lasting for a rather long time. And let's remember that one of the most prominent traits of a period of interregnum is that anything, or almost anything, can happen, though nothing, or almost nothing, can be done with any degree of confidence and self-assurance."

"Our fathers could quarrel about what needs to be done, but they all agreed that once the task had been defined, the agency would be there, waiting to perform it - namely, the states armed simultaneously with power (ability to get things done) and politics (the ability to see to it that the right things are done). Our times, however, are striking for the gathering evidence that agencies of this kind are no longer in existence, and most certainly not to be found in their previous usual places. Power and politics live and move in separation from each other and their divorce lurks around the corner. On the one hand we see power safely roaming the no-man's-land of global expanses, free from political control and at liberty to select its own targets; on the other, there is politics squeezed/robbed of nearly all its power, muscles and teeth."

"Our 'interregnum' is marked by the dismantling and discrediting of the institutions which have till now serviced the processes of forming and integrating public visions, programmes and projects. After being subjected, together with the rest of the social fabric of human cohabitation, to the process of thorough deregulation, fragmentation and privatisation, such institutions remain stripped of a large part of their executive capacity and most of their authority and trustworthiness, with only a slim chance of getting them back."

Continuous contestation

I like this (from this):

To affirm the perpetuity of contest is not to celebrate a world without points of stabilisation; it is to affirm the reality of perpetual contest, even within an ordered setting, and to identify the affirmative dimensions of contestation. It is to see that the always imperfect closure of political space tends to engender remainders and that, if those remainders are not engaged, they may return to haunt and destabilise the very closures that deny their existence. It is to treat rights and law as part of political contest rather than as the instruments of its closure.

Dividend trades and voting

Obviously, I've not been blogging much lately, but something I've been spending a bit of time looking at is dividend arbitrage. In it its most well-known version, this is the practice of shifting stock around the ex dividend in order minimise tax payable. There is a variety of different trades, and at one end of the spectrum some of them are the subject of legal cases. (great piece on Macquarie's involvement here).

What all of them involve is stock lending. I recommend having a read of this paper from Richard Davies IR, which opened my eyes to the scale of lending that is going on in the UK. 20% to 30% of stock is going out on loan around the ex dividend dates of major UK PLCs, which immediately makes me think about the potential governance impact.

It's very hard to pin down who is involved. But one thing that can happen with large movements in stock is that they trigger regulatory announcements because voting rights thresholds are crossed. These are are the TR1 notices, which appear with the title "Holding(s) in company" if you look on sites like Investegate.

So one of the things I did was look at TR1 notices issued around the ex dividend dates of a few companies. And I can see some, Blackrock in particular seems to be triggering them on a regular basis. These appear to show a shift in allocation of voting rights a few days before the ex dividend date and back again a few days after it.

Where it gets particularly interesting is when the ex dividend date is close to the AGM. If this shuffling of stock involves lending some to another party then there *might* be an impact on voting turnout if shares aren't returned in time to vote. I have identified cases where voting turnout has gone down (very significantly in one of them) when the ex dividend date has been close to the AGM date.

I can't say for certain if the stock-lending is a) linked to a dividend trade or b) resulting in lower voting turnout. But it's a bit of a coincidence.

Out of touch, out of mind

Something I've been thinking about a bit lately is how disconnected responsible investment is from the rest of the world. There is a tidal wave of marketing for ESG products and services currently storming through the financial services industry, yet it still feels distant from society.

I've also been re-reading a lot of Zygmunt Bauman and realise just how well he articulates a number of issues that trouble me. So I thought I'd try and combine the two - the excerpts quoted are from Globalisation: The Human Consequences, which is over 20 years old and well worth a read.

To start with a specific example, I spent a lot of time looking at Ryanair over the last few years. I have had countless meetings, calls etc with investors and advisory services over the period. At the same time it was obvious that the company was going through a very difficult time in respect of labour relations.

Yet, despite this, the amount of proactive contact from investors seeking to understand what was going on was limited. I can think of a couple of asset managers that were more on the ball, plus a couple of research/advisory houses. Arguably the most interested (and certainly the most knowledgable) were mainstream sellside analysts who were purely focused on potential financial impact, rather than ESG factors.

I also know there was significant engagement (some of it collaborative) going on between some shareholders and the company, including on labour issues, but without including the company's workforce itself. I come at this with a very specific background, but I find it hard to comprehend that anyone can think they are engaging meaningfully with a company about workforce issues without also at least trying to talk to members of that workforce.

This suggests to me a conception of engagement within the investment industry which involves senior people on the corporate side talking to specialists from asset managers. My gut feeling is that this is likely to lead to a very one-sided view of issues. For example, an investor might read a media report about employee complaints about precarious work at a given company, they might engage with the company and get the response that "it's complicated than that, and many workers like the flexibility" and basically be happy with that.

To take one specific example, I came across an interview (published before the labour crisis hit) where someone from Robeco claimed that Ryanair's employment model was a good thing for younger workers. Yet the nature of employment contracts was one of the animating issues amongst striking cabin crew just a year or so later.

Cue Bauman:

"What looks, however, like flexibility on the demand side, rebounds on all those cast on the supply side as hard, cruel, impregnable an unassailable fate: jobs come and go, they vanish as soon as they appeared, they are cut in pieces and withdrawn without notice while the rules of the hiring/firing game change without warning - and there is little the job-holders and job-seekers may do to stop the see-saw. And so to meet the standards of flexibility set for those who make and unmake the rules - to be 'flexible' in the eyes of investors - the plight of 'suppliers of labour' must be as rigid and inflexible as possible - indeed the very contrary of 'flexible': their freedom to choose, to accept or refuse, let alone to impose their own rules on the game, must be cut to the bare bone." 

If your views about the state of industrial relations at Ryanair, and the likely impact of strikes, were formed principally on the basis of engagement with the company I think you'll have had an uncomfortable 2018. In fact there was money to be made betting against the company's narrative during the period, and to my knowledge at least one hedge fund successfully did so.

A related aspect of the RI industry that makes it feel detached from society is its global nature. The increasing consolidation of the asset management industry (which we can only expect to continue, especially with the growth of passive management) means that the organisations that responsible for policing these issues are the UK outposts of global giants. Asset managers increasingly advertise their  global reach, including in engagement on ESG issues. There is also an international conference circuit (PRI, ICGN etc) that quite a few ESG people are part of. This points to an emerging globalised class of ESG specialists.

Yet beneficiaries remain resolutely stuck at a local level. On the one hand, most people have no expectation of international travel as part of their job. Asset managers jet across the world to speak on panels about stakeholder engagement and human capital management. That 'human capital' itself, however, cannot attend or have representation.

On the other hand, the way that globalisation affects employment is likely interpreted in a very different way. The relocation a job to a different country might present an exciting career opportunity to someone in finance, whereas it means a P45 to someone in a call centre or on a production line.

Bauman again:

"The fashionable term 'nomads', applied indiscriminately to all contemporaries of the postmodern era, is grossly misleading, as it gloss over the profound differences which represent the two types of experience and render all similarity between them formal and superficial.
As a matter of fact, the worlds sedimented on the two poles, at the top and bottom of the emergent hierarchy of mobility, differ sharply; they also become increasingly incommunicado to each other. For the first world, the world of the globally mobile, the space has lost its constraining quality and is easily traversed in both its 'real' and 'virtual' renditions. For the second world, the world of the 'locally tied', of those barred from moving and thus bound to passively bear whatever change may be visited on the locality they are tied to, the real space is fast closing up." 

Just to be clear, I'm a Remainer, I live in London and really enjoy living in a global city. But I also feel the pull of the 'local' and as such some of what I see in the field in which I work troubles me.

Bauman makes repeated reference to the fact that one factor - capital - has no spatial limits. (Indeed attempts to impose any, to limit mobility or liquidity, are guaranteed to generate the strongest rebuke from the finance sector.)

Among all [those] who have a say in the running of the company, only 'people who invest' - the shareholders - are in no way space-tied; they can buy any share at any stock exchange and through any broker, and the geographical nearness or distance of the company will be in all probability the least important consideration in their decision to buy or sell.In principle there is nothing space-determined in the dispersion of the shareholders. They are the sole factor genuinely free from spatial determination. And it is to them and them only, that the company 'belongs'. [well, not really, but...] It is up to them therefore to move the company wherever they spy out or anticipate a chance of higher dividends, leaving to all others - locally bound as they are - the task of wound-licking, damage-repair and waste-disposal. Whoever is free to run away from locality, is free to run away from the consequences. These are the most important spoils of victorious space war.  

We have to be clear now that it is 'our' own pension funds, increasingly shorn of member control or representation ('good' governance in this world means technocratic efficiency, not democratic accountability) that are often in the mix. 'Your' pension fund may have been built up over a few generations from the deferred wages of workers from your area, but don't have any expectation that it is accountable to you. Even when it is active on ESG issues it is likely to be in pursuit of objectives that align little with the interests of workers in the local area, whose labour created the assets that are being utilised.

Finally, the recent expansion and development of the RI industry has increased both complexity and obfuscation. In the current environment there is almost no way for a non-specialist to make sense of who the 'good guys' are. Every manager can offer you an ESG product, even if most people have no expectation of understanding how it differs from any others, or whether it really makes a difference. Some firms/services (Morningstar etc) seek to 'rate' them, but these ratings must in turn be based on a view of what matters - and how many ordinary punters will ever seek to understand fund ratings methodology?

The net result is likely to be (as with financial services in general) that a lack of understanding on the client side results in an unaccountable sector that is able to set its own terms. We expect these firms to act as 'stewards' of companies but without any realistic expectation that they can themselves be held accountable. Does this sound unrealistic? Three words: Woodford Investment Management. Look how long it took for even sophisticated clients to realise something was wrong and kick up a fuss. Some in the system who ought to be relied upon by the unsophisticated did not even have the incentives to make a noise. Something similar seems very likely to happen in RI land at some point.

More when I can summon up the energy...

Workers on boards: high-risk inaction

Over the past few weeks there has been quite a lot of interest in the extent to which UK companies are giving employees a say in corporate governance. As most people will know, the revised UK Corporate Governance Code that came into force this year encourages companies to say/do more in respect of 'workforce engagement'.

Although Theresa May originally said she wanted workers on the boards of all companies, the revised Code actually offers three options - a worker director, a NED nominated to handle workforce engagement, or a workforce advisory panel.... or some other  mechanism chosen by the company, or explaining why you don't comply.

Once this fudge (which was supported/encouraged by some investors) was put into the Code, everyone's expectation was that the large majority of companies would choose the nominated NED option. With a handful of exceptions that is what has happened. Capita, Mears and Sports Direct have all appointed employee directors, but the large majority of PLCs have indeed just tagged a NED. There are some really awful examples out there - like Mediclinic, which appointed its former CEO as the NED responsible for workforce engagement.

Unsurprisingly, this outcome has led to some criticism in the press including both the Mail on Sunday and the Independent. The basic message is that companies have resisted change and have made a mockery of the original idea.

I think this outcome, whilst hardly unexpected, is probably the worst thing that could have happened for all concerned. I actually think that in the medium- to long-term opponents of employees on boards have most to fear, but more of that in a minute. There are (at least) three key reasons why this outcome is bad. First up, employees have denied an historic opportunity to have a voice in the governance of organisations where they spend a large part of their life. Second, boards have made it look like they are resistant to change and/or aren't too fussed about workforce engagement. Third, it makes the UK Corporate Governance Code look ineffective.

On this last point, it's notable that the FRC saw this potential outcome a long way off. Here's Stephen Haddrill in front of the BEIS committee a few years back:

The full-blown worker-elected director model should not be done through the corporate governance code. That is quite a big shift and requires parliamentary weight behind it to get it done. There is a risk if we try to do it through the code that we would have a very high level of non-compliance. That would cause the code to come into some discredit.

Well, that's just happened, hasn't it? I would add to this that we should not expect that monitoring of the Code on this point is likely to lead to any change. Many asset managers are unconvinced about or opposed to employee voice in corporate governance, so they are unlikely to be pulling companies up for nominating a NED instead of appointing employee directors. 

This is part of the reason why I think this outcome is actually *bad* news for people who really want to stop this policy. A bit more willingness to play ball on the part of PLCs might have convinced people that a 'let a thousand flowers bloom' was a reasonable approach to take. But the fact that the overwhelming choice is to stick with the status quo makes things look very different.

I don't think any future government that is supportive of employee voice is going to look at where we are and think PLCs have really picked the best or most appropriate model. I think they are more likely to conclude that a corporate foot-dragging, unchallenged or tacitly encouraged by asset managers, is a block on progress.

They are also likely to think that using the UK Corporate Governance Code to implement employee voice is ineffective. This makes it more likely that employee representation is sought through a change in the law. This would (obviously) be a significant shift away from 'comply or explain' towards a regulatory approach to governance. But current practice seems to point towards this kind of conclusion.    

Monopoly industries, monopoly owners

One of of the things I find myself spending time reading and thinking about lately is the interaction between concentration of companies (or oligopoly) within industries, and concentration of ownership of those same companies.

There have been a number of books in recent years that look at growing industry concentration. Cornered by Barry C Lynn and The Myth of Capitalism by Jonathan Tepper and Denise Hearn are the two I've been reading recently. Both tell a similar story of how the number of companies within a number of industries has become increasingly concentrated, undercutting the proposition that actually existing capitalism is really all about competition and innovation.

US airlines are often cited as an example where there is a very limited number of companies, with de facto regional monopolies. Lynn provides a bunch of other interesting examples, like the domination of opticians by Luxottica, a company most of us have probably never heard of. Or try buying certain products - in person, rather than online - without going to Walmart (online, obviously, Amazon dominates). He describes this as Hydra-like - multiple heads on the same body - which is a nice way of describing it.

So far, so familiar. But what both books, and others I've been reading, also focus on is the concentration of ownership of those monopolies. For example, Tepper and Hearn cite research showing that in 1980 if you paired any two US firms 75% of them would have no common shareholder. By 2012 that figure had dropped to 8% (which actually sounds quite high to me).

Obviously the growth of passive investing, and therefore the growth of passive managers, is a major part of the story. For example, the proportion of shares of the S&P 500 held by the Big 3 - BlackRock, Vanguard and State Street - has risen from 9.1% in 2002 to 18.4% in 2018. Between them hold roughly 15% or more of all the big US banks. And we can see similar things at work in other countries, if not quite so pronounced.

But why does it matter? There are differing views on this in the books I've been reading, so here are a few arguments.

1. There's a risk that concentrated/cross-ownership of oligopolies reduces competitive pressure even further. Here's a take from the Left (from The People's Republic of Walmart):

"An investor who has holdings on one airline or telecom wants it to outperform the others: to increase its profits, even if temporarily, at others' expense. But an investor who owns a piece of every airline or telecom, as occurs in a passively managed index fund, has drastically different goals. Competition no longer matters; the overriding interest is squeezing the most out of customers and workers across an entire industry - no matter which firm does it. In principle, capitalist competition should unremittingly steer the total profits across a sector dow, ultimately to zero. This is because even though every firm individually aims for the highest possible profit, doing so means finding ways to undercut competitors and thus reduce profit opportunities sector-wide. Big institutional investors and passive investment funds, on the other hand, move entire sectors toward concentration that looks much more like monopoly - with handy profits, as firms have less reason to undercut each other."

Tepper and Hearn make the same point:

"Concentration of ownership is problematic because it distills the control of entire industries into a few players' hands. But even more concerning is that recent studies are suggesting that common ownership incentivises firms to avoid competing with each other altogether... In a situation with horizontal share ownership, where firms are trying to please the same owner, firms can tacitly collude to maintain high corporate profits by swelling total industry performance. Investors make money when the industry (not individual companies0 makes money. The easiest way to do this is to raise consumer prices."

They go on to use the example of US airlines and banks where concentrated common ownership is correlated with increased prices / fees. They also suggest that industries with concentrated  common ownership tend to invest less and spend more on stock buybacks.  

2. Barry Lynn argues that the shift to indexing puts more power back in the hands of corporate leaders:

"[T]he mutual funds socialised the small investors' ownership stake by broadening it to the point of destroying any sense of common interest between the average small investor and any one company. As a result... the real power shifted way from us to the fund managers and the financiers, who supposedly did our bidding but who instead used our gold to forge the fetters with which to bind us."

3. What about intangibles? A really interesting line of argument comes from Jonathan Haskel and Stian Westlake in Capitalism Without Capital.  They argue that highly diversified investors will be more open to investment in intangibles that has spillover effects, as they own all the shares in an industry and thus while value might be lost in the firm making the investment, it is gained by those taking advantage of it. But they also point out that diversified means thinly spread, so only those with concentrated ownership will have the incentives to put the time in to understand and value intangible investment.

"The greater uncertainty of intangible assets and decreasing usefulness of company accounts put a premium on good equity research and on insight into fund management. This will present a challenge to investors, partly because funding equity research is becoming harder for many institutional investors as regulations are tightened, and partly because of the inherent tension between diversification (which allows shareholders to gain from the spillover effects of intangible investment) and concentrated ownership (which reduces the costs of analysis)."

Of course, as outlined earlier, what we see with the growth of passive management is the combination of diversification and concentration. Passive managers are often the largest shareholders, and as a block hold a major chunk. In such a scenario my strong feeling is that the diversification aspect is going to easily trump the theoretical reduced research cost.

Think how much more research would cost on all the stocks where BlackRock is a major (say 5%+) shareholder. And while you are thinking about that, also consider the price war on index funds. Blackrock uses stock lending to keep its fees low. Vanguard uses 'heartbeat trades'. I've seen some examples where passive managers are almost giving the product away to big clients. These do not look like firms that are going to spend a lot of money on research. Which is why I asked previously what business some asset managers are actually in.

Of course there will always be active managers out there which take big positions and do the research. But overall they are going to be outweighed by the assets of low-cost index-trackers. I don't see widespread quality analysis of intangibles emerging from this any time soon. If there's no encouragement to invest, because there's an oligopoly in the industry and firms can find other ways to make money, and investors are unlikely to do the research that would put a value on intangibles anyway, well....

For my part, my gut feeling is that, overall, the rise of indexation results in less scrutiny of public companies, certainly over business-critical issues. BlackRock's role in Carillion was a good example here, where it engaged over remuneration with a business clearly facing an existential threat. As such I'm drawn to Lynn's argument that the net result is a re-concentration of power in the hands of corporate leaders.

I actually think that's OK on one level. If we want cheap way to get equity returns, then low-cost passive funds are a good option. But I think that we ought to question why asset managers need to be involved in voting and engagement at all in such a scenario. If you're holding UK stocks purely because they're in the FTSE, why do you need to follow what Larry Fink's team's views on, say, how much the directors should be paid?

But that's another story...

Infrastructure investment politics

I was interested to see a piece in City AM recently from Robert Colvile of the Centre for Policy Studies about Labour's plans for nationalisation of utilities. I'm interested in this issue as it cuts across politics and ownership, which is, obviously, right up my street. The CPS has previously issued a report containing some very large figures about the costs public ownership, authored by Daniel Mahoney.

What caught my eye in the City AM piece was this stray line:

It would also rip off the 5.8m UK pension pots that the Global Infrastructure Investment Alliance has calculated are invested in the water industry – as well as millions more in the energy grid, Royal Mail, the trains, and so on.

I am dimly aware of the GIIA due to having done some work on infrastructure investment. So I had a quick trawl of its website to see if I could find a source for this stat. That can be found here, but I also found this announcement:

• Daniel Mahoney joins as Senior Policy and Research Adviser from one of the UK’s leading think tanks, Centre for Policy Studies (CPS). In his role as Head of Economic Research he has authored a number of reports and articles on infrastructure related topics. Prior to this role, Daniel was a senior researcher at the House of Lords and for the Global Warming Policy Foundation.

Useful to know.

Funnily enough, last month London First ran a piece attacking Labour's public ownership plans in City AM which included an interesting stat:

Pension funds have a clear stake here. There is no doubt that many UK pension pots would be affected by a proposal to renationalise on the cheap. Data from the Global Infrastructure Investor Association shows that 7.67m pension pots would be exposed to losses in sectors that could be put back into state hands under a Labour government.

And by coincidence, London First's Programme Director for Infrastructure is Daniel Mahoney.

None of this is inherently wrong. Everyone involved in policy / politics does this kind of thing to some degree. Just most of the time the links aren't quite as obvious.

Corporate governance, again

There have been a few developments over the past week or two that play into the argument I've been making that 1990s-style corporate governance is come under serious pressure to change.

1. Polling from the resolutely centrist Progressive Centre UK, which found strong public support for policies like a mandatory maximum worker-to-CEO pay ratio, caps on bonuses, workers on boards etc. 

2. A report out today from the High Pay Centre shows that shareholders in UK companies are *still* not using their legal rights to control executive pay.

3. Research by LAPFF found that the large majority of companies are choosing NOT to appoint worker directors to their boards.

4. The launch of the ace-a-tronic Common Wealth, which is going to focus on questions of ownership in various fields.

You can pull this all into quite a coherent picture: the public thinks executive pay is too high; shareholders have been given powers to tackle it but don't seem willing and/or able to do the job; companies have been encouraged to give workers a say at board level, which might help tackle it, but have stuck two fingers up in response; as a result public policy experts are looking at other more radical interventions.

As I've said before, I think we can see the bones of an alternative approach to corporate governance. It's primarily come from the Left, but I think it is rapidly becoming 'common sense' across a large range of people who look at policy in this area. To repeat it, I think we're looking at a shift away from shareholder primacy (so more action on corporate purpose, perhaps legal changes to directors' duties), stakeholder representation in corporate governance (workers on boards etc) and more diverse forms of ownership (again, a greater stake for employees looks to be pretty central).

Again I'm repeating myself, but at the 'ideas' level, things seem to be moving pretty quickly. I was genuinely surprised at how far Chuka Umunna's pamphlet went on issues like co-determination and employee ownership, for example. And I recently stumbled on this speech by the head of the New Zealand financial / capital markets regulator explicitly arguing against shareholder primacy.

Something is up.

The loyalty 'penalty'

A few months back I blogged some initial thoughts about the idea of loyalty. To recap, I find it jarring that various bodies increasingly try and encourage us to be disloyal. While I get that it's silly to be 'loyal' to a utility provider (or insert your own product/service provide), there's something about encouraging disloyalty that feels weird.

As I've blogged previously, if you look at moral foundations theory loyalty is one of the core pillars, though apparently it resonates a lot more with 'conservative' people (this obviously assumed you have confidence in any psychological research, which is a question for another day). So I am not at all sure that telling people that loyalty is stupid - basically what Which? and others say - is going to make them 'disloyal'. I think they will just become cynical about providers.

A piece by Jonathan Ford in the FT this week covers similar ground and adds a couple of points that are worth clocking. He notes that there is now even a term - the 'loyalty penalty' - for the way that providers screw over long-term customers by offering them poor deals (indeed this is language the CMA uses). He says the scale is vast - an estimated £4bn a year - and that the worst offenders are in concentrated/oligopolistic markets. Interestingly he also links it to the need to keep financial stakeholders onside, at the expense of others:

Whether you agree with that or not, it's hard to argue with the conclusion that the net result is further damage to the reputation of those businesses involved, and to belief that the market can sort it all out.

To circle back, this is why I find the "don't be loyal" messaging by the likes of Which? a bit odd. It feels like it's saying it's your own stupid fault if you trust providers, of course they are going to try and scalp you. And that the responsibility is on you to avoid getting ripped off, rather than on the provider to not to try and rip you off in the first place. And combine that with monopolies like utilities, where "shopping around" just means choosing a different logo on your bill. I have to choose between one of these firms, but I can't rely on them not to rip me off, so I should assume I will have to engage in a tactical battle of regularly switching with them to avoid it, even though the product I receive at the end is the same.

As I blogged last time, I don't believe that faced with all this people are going to think that it is their 'loyalty' that is a bad thing, I think they are going to conclude that the system is a swindle. Arguing for regular switching in terms of not being loyal is going to feed a sense of distrust. It's only going to increase support for radical intervention, be it tighter regulation or changes to the nature of ownership.

Shareholders vs bill payers

I blogged last year that I thought the position of shareholders relative to other stakeholders was going to come into sharper focus in politics. Here's a piece from my favourite newspaper this weekend to make the point:

It's a pretty simple message: more cash for shareholders means higher bills for customers.

This sort of positioning is no longer restricted to utilities. For example, look at the way the story in the Guardian about dividends paid in Q1 is framed - the payment of dividends is counterposed with wages.

Something's up.

Talking to my family about politics

Easter is one of those special times of the year when we get to spend time with family members we don't see often enough... and to be deeply shocked at how differently even close relatives view the world.

I'm a fully paid-up metropolitan lefty Remainer. Most of my family are not. None of my immediate family live in cities, and several of them voted Leave. My Stepdad, who voted Remain, doesn't want a second vote (because we've voted already) and says he'd vote to Leave now if there was one because he's sick of it all. My mum, who is a floating voter, has torn up her polling card because she thinks all the parties are useless. They both argue that failing to carry out Brexit means democracy is undermined.

These are genuinely and deeply-held views. My family aren't bad people and, much as we've argued about Brexit a lot, I'm not going to fall out with them. So I try to listen to why they feel the way they do even if I don't agree.

One theme that repeatedly comes up is the loss of sovereignty. This is an issue that a lot of Leavers raise, but which people on my side don't really engage with. Somehow, although we all know that there is a decent point in there, the idea remains too abstract ("tell me which laws you're talking about"!) for us to bother with. Because it seems to be a vague idea, rather than something that can be evidenced (and thus rebutted with well-evidenced bullet points...) it's not worth the effort to take seriously.

This makes me think more generally about the way we engage (or fail to) with people who have different views when we're trying to make change. It's hardly a novel insight that we seem to be in an age when there is a stronger impulse to attack and/or deride people with different views. But, especially in light of Brexit, seeing as we don't seem to be able to reach even a temporary 'settlement' that would enable us to move forward, it feels like putting a bit more effort into listening might be worthwhile.  

Because there are areas where there does seem to be quite a bit of agreement. Just trawling online this morning I came across several pieces about panicky corporate leaders (in the UK, US, and Australia) worried about the future of capitalism. Talking to my family members is instructive here. On issues like corporate tax avoidance or executive pay there is barely any difference between us. My mum thinks there should be a maximum wage!

I'm reluctant to fall for the comforting belief that Brexit, Trump etc are "really" about concerns about capitalism, but there is something going on here. I know he's not everyone's cup of tea, and I don't share his politics, but Jonathan Haidt's work on moral foundations theory keeps popping up in my mind. Issues like executive pay and tax avoidance seem to fall most obviously under the Fairness/Proportionality heading, but I wonder if it might also register under Authority/Respect and Loyalty/In group.

Thinking about tax avoidance, corporates that do this are obviously going to be seen by many as behaving unfairly, but are they also seen by some as failing to respect authority, and being disloyal to countries where they operate ("you make profits here, but don't pay tax here")? The more I think about this, the more I think there is quite a powerful brew here, which may explain why some "anti-business" views are held across quite a wide spectrum of the population. Polling around the 2015 election found UKIP voters holding some quite 'Left' economic views.

To it bring it right back to Brexit, it also raises a big question mark over the tactics of corporates issuing warnings (or threats) during and after the referendum that they might relocate jobs. Are Leavers who see jobs leave the UK going to conclude that the problem is Brexit, or that corporates have no loyalty to the UK, and no respect for its democratic decision to leave the EU? Are they going to think relocation of jobs is "fair" or "just"? I really doubt it somehow. If anything I can imagine it turbo-charging sceptical/negative views about capitalism.

Anyway, back to the easter eggs...

Bauman and consumer loyalty

a little snippet from Globalization: The Human Consequences:

Ideally, nothing should be embraced by a consumer firmly, nothing should command a commitment till death do us part, no needs should be seen as fully satisfied, no desires considered ultimate. There ought to be a proviso 'until further notice' attached to any oath of loyalty and any commitment. It is but the volatility, the in-built temporality of all engagements, that truly counts; it counts more than the commitment itself, which is anyway not allowed to outlast the time necessary for consuming the object of desire (or, rather, the time sufficient for the desirability of that object to wane. 

More workers on boards news...

Wisconsin Democrat Senator Tammy Baldwin has issued a report calling for workers to elect a third of the board of directors.

The aggregate evidence from comparison countries provides strong support for the theory that worker empowerment can foster several key economic benefits, most notably: higher wages, improved firm performance, increased investment, less offshoring, lower income inequality, and greater socioeconomic opportunity. In order for firms to achieve better performance, workers must have truly board-level representation that allows them to influence corporate decision-making. Research from Larry Fauver and Michael Fuerst, referenced in Exhibit 2, shows that results only become significant once workers have voting representation equal to at least one-third of the board. In other words, simply providing workers a forum to blow off steam will not yield results. Requiring that workers directly elect one-third of corporate boards will ensure that value creators are able to reap the rewards of their labor. Workers invest their time, skill, and effort in the company and depend on managers both to generate a return on that investment and to share that return in the form of increased compensation. Workers also face much higher switching costs than shareholders (the average job hunt is currently over 20 weeks).48 And while shareholders are given the ability to ignore the day-to-day operations of the company, the workers live those operations in their personal as well as their professional lives—workers almost always reside in the community in which their employer operates. Finally, because taxes on wages make up an increasing percentage of federal revenue, workers are also representatives for the interests of taxpayers on corporate boards.

Notably the report is also critical of the "shareholders first" or shareholder primacy model of governance (and banning buybacks is the other big idea Baldwin floats).

Meanwhile, back in the UK, the BEIS committee has issued it's long-awaited report on executive pay. As has been widely reported, the report argues for employee representation on rem comms. And it does so in a way that makes clear that investor oversight of executive pay can only be part of the solution.

It is instructive that whilst there have been many significant displays of dissent on pay reports (which are non-binding) there were only two pay-related resolutions actually defeated in 2018. We welcome the increased attention on executive pay but recognise that much more than engagement will be required to drive a more enlightened and acceptable approach on executive pay

There are a couple of other points I would note. First, this on directors' duties:

We recommend that the new regulator monitors how remuneration reports and better reporting against section 172 of the Companies Act meet the aims of increased transparency and alignment of pay with objectives.

And secondly, the report talks repeatedly about tying executive and employee pay more closely together, and expanding profit-sharing schemes to achieve this.

So, worker representation, a renewed focus on directors' duties and a greater emphasis on profit sharing. That reminds me of something...

Workers on the board at.... Walmart?

If there were any doubt the idea of employee representation at board level is gaining momentum in some unusual places, then take a look at this:

Murray believes that, if there had been a meaningful number of people with a stake in Walmart’s longer-term health—such as store associates—involved in the business decisions, some of these changes wouldn’t have happened, and the company would be better off. This led Murray, with the help of a worker’s-rights organization called United for Respect, to join in drafting a resolution that she plans to present to Congress on Tuesday—and, later, at Walmart’s annual shareholders’ meeting—urging the company to place a significant number of hourly retail employees on its board of directors so that they might have input on major corporate decisions.

I think corp gov radicals are going to win this one.

What business are asset managers in?

Another issue I am starting to look at in more detail is the overlap between stock-lending, shorting and other activity. I was recently pointed in the direction of some of BlackRock's literature on stock-lending and it fed my sense that at least parts of its business are not necessarily all about asset management as we might typically understand it.

Here are a couple of excerpts:

The first bit shows you how it works (in this case for Exchange Traded Funds). You deposit money with Blackrock in an ETF invested in a stock index. Blackrock lends some of the stock (for a fee, obvs) to an institution and uses the collateral provided in return to potentially get a return from a money market fund. Blackrock splits the income generated with you and offsets this against the management fee. In some cases the lending income you get is larger than the management fee.

What's Blackrock's cut of the lending income? About a quarter to a fifth according to the blurb:

(incidentally, Blackrock looks like it takes a bigger cut of lending income from European funds, but that's another story)

So if we assume that the 73.5% figure applies to the top 3 Russell 2000 ETFs in the list, then that suggests that the total lending income from these funds is 35bps, 27bps and 19bps respectively. That would make total lending income 40%+ higher than the management fee in the first two cases, and 21% lower in the third. If that 73.5% is correct then Blackrock's cut of the lending fee (26.5%) adds a reasonable chunk to their overall income.

iShares Russell 2000 Growth ETF - Management fee (24) + lending fee (9) = 35bps
iShares Russell 2000 ETF - Management fee (19) + lending fee (7) = 26bps
iShares Russell 2000 Value ETF - Management fee (24) + lending fee (6) = 30bps

There may even be a dribble more income for Blackrock as I assume that they would use their own money market fund to stick collateral in, so perhaps another management fee there?

If the actual level of stock-lending income in some of these cases is higher than value of managing the portfolio of assets, that suggests that there must be quite a lot of lending going on. Does it also suggest that the funds don't hold own the stock in the index they notionally track for prolonged periods? I don't know anything like enough to comment sensibly.

But what is quite obvious is that this looks like a nice business to be in. You take the clients' money to put in, say, a US smallcap ETF. You loan the stock out to someone who wants to borrow (for whatever reason) and take a decent cut from the income from renting assets bought with your clients' money. And you might even be able to make a few crumbs managing the collateral the lender gives you while the stock is out on loan.

Questions this raises for me are what is Blackrock really selling (and what are you really buying), and how does it see the business? It would be really interesting to see how much of the stock is out on loan at any time, because to me it looks a bit like in some cases Blackrock runs a stock-lending service facilitated by having an asset management offering. If the total income generated (though not Blackrock's cut) is higher from the former than the latter, how is it seen internally?

It's also important in the current context where asset management fees are in the spotlight. Based on the fees above, it looks like they are giving the asset management away for free for some ETFs - a very tempting offer. In reality they are actually earning more than the headline management fee, from two sources. And it only hangs together because the client provides the money to make it work and because lending is lucrative.

Some of this reminds me of the origins of asset management. Back in the 70s and even into the 80s, asset management was not a big deal in a lot of markets. Banks provided it as an add-on service alongside more profitable areas of work. Peter Stormonth Darling's book on the history of Mercury Asset Management is fascinating on the early history of that manager (which ultimately ended up as part of.... Blackrock). Warburgs were pretty much willing to give the business away to Flemings at the end of the 1970s, but couldn't. It was only when they realised that they could get away with charging a lot for the service that the industry really took off, and created what we see today.

Perhaps now that fees are (finally) under serious scrutiny we'll see more of this kind of activity as managers look to try to make money elsewhere to keep the fees they charge down. But as I say, it does raise some questions about what the business really is. And this is without even getting into the question of Blackrock's numerous short positions, and where the stock comes from for them.

Outsourcing hell - continued

If anyone were in anyone doubt that the outsourcing sector is in big trouble, Friday saw Interserve's precarious position finally resolved. The major shareholder - US hedge fund Coltrane Asset Management - voted against the proposed debt-for-equity swap, which in turn will lead to the company going into administration. Already a couple of other outsourcers are sniffing around to see of it's worth trying to pick off some of the better bits of the business.

Ultimately Coltrane and the board of Interserve played a game of chicken and in the end neither side blinked. As usual in these circumstances it is tempting to see the US hedge fund as the bogeyman. So it's important to remember that the leadership of Interserve (like Carillion before it) got the company into this mess, the hedge funds didn't create it. Nonetheless, when faced by pleas from management not to vote against the de-leveraging plan, with the knowledge that this would trigger administration and create huge uncertainty for the workforce, Coltrane's stance is not going to win many fans. 

The role of hedge funds in this one was interesting as Coltrane and Davidson Kempner were on opposite sides (the latter on the debt side) rather than, as you might expect, shorting. It's also notable that Coltrane had previously shorted Carillion and is currently shorting Mitie Group (interesting, given the latter's interest in bits of Interserve).

I guess they must think they can sort the wheat from the chaff in the outsourcing sector, but their experience with Interserve must have been pretty painful.

So first Carillion, now Interserve and Kier Group wobbles along after a rights issue flop and a new upward revision in its debt. To state the obvious, there's a sectoral problem and it looks like consolidation is likely. That in turn might start to sharpen the questions about what we've actually achieved with all this outsourcing. If we end up with an oligopoly of outsourcers it will become a bigger political problem. But we aren't there yet.

I haven't seen much coverage of what's going from the corp gov / ESG world (would be interested if anyone has seen some). There is a sectoral problem, with jobs and service provision potentially at risk. Maybe it will get more attention from here on, it surely deserves to.

Also, what does stewardship mean in this context? As far as I can see Coltrane doesn't make or need to make any kind of Stewardship Code statement. On the other side of the Interserve story, Davidson Kempner uses a version of the same generic blah as dozens of other hedge funds that neither the FCA nor FRC seem to have shown any interest in challenging. These are firms that can have a huge influence on major employers, but don't need to say anything about what they do and why. I does kind of make you wonder what the point is. The Stewardship Code sometimes seems to be more about reporting / promotion than what's under the bonnet.

Interserve & hedge funds

The ongoing battle at Interserve is grimly fascinating. The company's biggest shareholder is hedge fund Coltrane Asset Management which is trying to scupper the board's plans for a debt-for-equity swap. This would (obviously) be bad news for existing shareholders, but it looks like the company would go into administration if its plan does not proceed as planned.

There is come great coverage in the Sunday Times today, including an interview with the chief exec Debbie White. She argues: "People seem to have lost sight of 68,000 people's livelihoods [and] thousands of clients and suppliers for whom Interserve is an integral part of their lives."

I'm interested in Coltrane's role as a shareholder, as I've primarily come across them on the short side. They had a smallish short position in Carillion before it failed, and currently has a fairly sizeable short in Mitie Group. Here are its current shorts above 0.5%:

Funnily enough, there's another hedge fund I've come across several times - Davidson Kempner - on the debt side of Interserve.

By the by, Davidson Kempner currently has no shorts listed in the FCA list. In fact it hasn't had any in the list since April 2018 when it wound down its long/short merger arbitrage trade around the takeover of GKN by Melrose. Perhaps it's not shorting anymore, or perhaps it has some sitting at 0.49% or below. The more I dig into this stuff the more I wonder why the FCA sets the bar so high for disclosure.

Changing of the guard in corporate governance

I have been blogging a lot recently about employee representation on boards. This is partly because I'm an advocate of it, partly because no-one else seems to be tracking the issue properly and partly because I think the issue is part of a significant shift that deserves more scrutiny. So I thought I'd write something a bit longer than usual looking at a few interlocking themes.

1. Employee representation at board level, state of play 

Just a quick recap, there are now four UK-listed companies with employees in their board structures:

FirstGroup
Mears Group
Sports Direct
TUI

The last one is unusual as it's incorporated in Germany but listed in the UK (and in the FTSE100). Because of its size it is required to have the co-determination model of governance, so it has a supervisory board with half employee reps, including union officials. None of the TUI employee reps are from the UK as far as I can see.

Of the the other three, two are female and one male. For completeness there is also a female UK employee director on France-listed ATOS. So I think there are (at least) four UK employee directors, three of them female. There will be more. We also know that Capita is recruiting two employee directors (which will make it the first UK PLC to have multiple reps), and there may be others going down this route that we don't know about yet.

As for companies choosing alternative models, here are those that have made public that they are designating an existing NED to represent employees:

Diageo
Hays
Legal and General
McKay Securities
Ted Baker

But there will be plenty more choosing this option. For now...

2. Opposition to and biases about employee representation 

It is worth restating that employee representation at board level has been opposed by a lot of powerful players in mainstream corp gov. This has varied from outright opposition to putting forward much weaker alternatives (like designated NEDs). I think that publicly-articulated views have been toned a bit over the past couple of years, but here's a reminder of some asset managers' positions. I'm also struck by the tone of this comment from the ICGN:

In Provision 3, we believe it does make sense for boards to understand views from the workforce, and it is important that flexibility is granted about which approach would work best for individual companies. The workforce is a critical stakeholder for long-term company success, but companies and workers must remember that the workforce of one of a number of important stakeholders—and the workforce should not become the board’s proxy for all stakeholders. 

And here is another mainstream corp gov view from Eumedion:

Although we understand these proposals [for workforce engagement] in the UK context, we believe that these proposals can have unintended consequences as they can increase tensions between stakeholders themselves and between the board and the various groups of stakeholders. Those tensions will typically appear in stretching situations, such as in the situation of an unsolicited takeover proposal or in the situation of pressure from specific short-term oriented shareholders to change the company’s strategy and policy. 

It is worth anyone interested in corporate governance probing these arguments, as there are some meaty issues (and assumptions) buried within them. I am frequently shocked by the patronising tone that many people adopt when discussing these questions, revealing a low opinion of employees. The implications are often that employees lack the ability to contribute anything constructive, or to think long-term about the company they work for, or to pick representatives who will be effective.

It reminds me of a speech I saw once by a trustee of (I think) WH Smith pension fund. He had previously been an exec at the company (possibly FD?) but had ended up becoming a member trustee for some reason. He said he found it eye-opening because he realised when he was wearing the "company" hat he simply could not see pensions issues independently, even though he thought he could. His views were shot through with the biases that came from his position. He didn't realise this until his position changed.

My point is simply that we are all biased, and we all have views that are shaped by the interests that derive from our current position. I am obviously biased, for example, because of my experience in the labour movement (see note at the end for more info about how this can screw up the way I look at things!). My argument is that in this particular discussion mainstream corp gov organisations often seem to reflect quite deep biases. Perhaps, like the trustee, they can't even see them from their current position.

3. The 'centre' has shifted to the Left, even if corp gov hasn't noticed 

Again, I have blogged about this before, but it is striking that in public policy the idea of employee representation at board level is totally mainstream. All the major political parties have committed to it, and it is the Conservatives who have made the first attempt to introduce it. We can also see from polling - in the UK and US - that the idea is popular with the public, including quite a few Right-leaning voters.

The idea is attracting more attention because of the increasingly widely held view that workers in countries like the UK and US have had a pretty rough time of it in recent history and that capitalism has to change a bit if we're to prevent political problems. We're also starting to see quite frequent pieces questioning whether shareholder primacy is part of the problem. A theme I'm trying to work on is what comes next - I think (at least) it will involve reformed directors' duties, employee representation and greater pre-distribution through ownership, profit-sharing etc. I've also argued that shareholder primacy in utilities is under threat.

I think it's entirely fair to say that these views have come almost exclusively from the Left up until the last five years or so. But now they are pretty much the centre ground in public policy.

Enter Chuka Umunna, of the newly-formed Independent Group (TIG) of MPs, who has published a new pamphlet on what 'progressives' (bleurgh!!! hate that term) believe. I'll just pull out a few relevant bits:

What would this “British model” look like? It could take as its foundation northern European elements: employee ownership trusts; workers on boards and public-spirited non-executive directors, moving towards a form of co-determination as a way of decision-making in the workplace; trade unions; incentives for innovation within firms; long-term financing; and a National Investment Bank with a network of regional banks driving Britain’s public investment rate to the G7 average of 3.5%... The defining characteristics of this hybrid model would be: collaborative workplaces and competitive practices in innovative firms that pay a decent wage, share profits with workers, and give security to those who work within them.

.....

For example, the “British model” could create new tax incentives and legal certainty for mutuals and a vast roll-out of employee ownership because the evidence shows this would encourage long-term ownership and diversify ownership of capital. It would forgo the automatic assumption that nationalisation improves performance in favour of taking a “foundation” share in privatised utilities to force them to serve public good. It would incentivise widespread membership of collaborative unions and employee representatives on remuneration committees.

.....

Too many of the rewards of these new technologies accrue to a relatively small number of individuals, exacerbating inequalities. New ownership structures must be developed to ensure greater distribution of the benefits both to workers and wider society. Employee ownership trusts can be used to spread the rewards in such companies beyond the founders to the workers at large. 

.....

An incoming progressive government could legislate to force companies providing key public services to write the provision of public benefit into their constitution, taking precedence over profit-making. It can then insist on taking a "foundation share" in each company as a condition of its operating licence. This share can be used to install non-executive directors tasked with seeing that the company delivers its newly enshrined public purpose. This would be a smart use of government power for the common good – with shareholders retaining their shares, though now constrained by the primacy of public benefit over shareholder return.

This stuff is well to the Left of New Labour, and even significantly to the Left of Labour's Miliband era shadow business secretary... if anyone remembers him? But TIG is positioning itself as very much in the centre (the pamphlet is published by Progressive Centre). And I think views of this type is pretty much where the centre is going to be in the future.

Mainstream corp gov is simply not here yet, and as such is more likely to be affected by change than to shape it. Look forward another decade and I would not be surprised to see that employee directors are common on UK company boards, that employee ownership and/or profit-sharing has become more widespread. I would like to hope that there is some kind of push to reinvigorate unions too, but I am less confident on that front.

What I don't think will happen is that most UK companies designate an existing NED to engage with their workforce and it will end there. I don't think that a future government will observe companies avoiding having proper representation and think "this is fine, job done".

-----------------------------

Mea Culpa - as an important aside, I have to remember not to blog when I've got strong emotions about a subject! When TIG split off I thought I shouldn't blog about it as I have too much emotionally invested in the state of the Labour Party. I could see a lot of people predicting how TIG would position themselves - partly out of anger, partly trying to bomb their planes before they take off - and could see it was pointless. But because my emotions got the better of me I felt compelled to write something. And because I want to see a certain outcome I projected this. Bad mistake, made worse by the fact that I knew I was making it.