Thursday 29 December 2016

Unrealised expectations of unintended consequences - Update

A few years back I started pulling together a list of reforms that were enacted despite dire warnings of unintended consequences. As Albert Hirschman (PBUH) pointed out, despite the focus of conservative/reactionary voices on unintended consequences, an equally important question was unrealised expectations - when a policy was enacted and what was intended just didn't happen. I would say shareholder empowerment as an area of public policy probably deserves some analysis on this point, but that's another argument.

I thought I'd update the list because the Bonus Cap is a great example that we really mustn't forget.  

Reform - the Bonus Cap - bonuses in qualifying financial institutions should be a maximum of 100% of salary, or 200% if shareholders approved it.
Predicted unintended consequences - base salaries would increase to compensate (mainly) bankers, banks fixed costs would increase significantly, financial instability would increase.
Actual consequences - base salaries only rose a bit for a few bankers, fixed costs therefore did not increase materially, and financial instability did not increase either.

Reform - July 2000 Amendment to the Pensions Act requiring disclosure of pension fund policy on social and environmental issues.
Predicted unintended consequences - would make trustees the target of single issue campaign groups, would lead to pension funds screening out various types of stocks with a negative impact on the UK economy.
Actual consequences - a few more SRI mandates, though no noticeable increase in screening, more asset managers add corp gov/SRI staff (a positive unintended consequence?), no evidence (none that I am aware of) of funds being targeted because of disclosure of policy

Reform - public disclosure of shareholder voting records (ok, not an out and out 'win' yet, but there's much more data available now)
Predicted unintended consequences - would make asset managers... er... the target of single issue campaign groups, would be a major cost for asset managers
Actual consequences - some media coverage of and trustee interest in actual voting decisions (ie more accountability), negligible impact on costs (based on feedback I have received), more analysis of investor behaviour (ie various surveys)

Reform - annual election of directors
Predicted unintended consequences - would increase short-termism, could lead to entire boards being voted out
Actual consequences - too early to tell? But no examples of whole boards being voted out, and is there any evidence of increased short-termism?  

A few end of year thoughts

A few random thoughts that kept coming up during 2016...

It is not the case that different stakeholder interests within the firm necessarily align, even over the long term. As we learnt recently, for instance, some stakeholders will actively lobby against others getting a formal role in corporate governance - we have seen shareholders (asset managers) tell the government not to let workers have board representation. That is not alignment of interests, it is one set of stakeholders asserting their primacy over others in governance.

Various different models of corporate governance put different weights on various stakeholder interests, and even within countries these weightings have changed over time. (The idea that shareholders were significant players, or "owned" companies, was not taken seriously in the UK for much of the last century). There is no "end of history" with one model dominant. The endless attempts to rework incentives and time horizons within the shareholder-centric model in the UK shows that it has flaws like any system and others might be as good if not better. Our corporate governance community has shown too little curiosity about other models and falls for its own propaganda about our system's strengths.

It is unlikely, to put it mildly, that positive performance on all ESG issues is correlated with positive financial performance. Therefore if management of ESG issues is *only* viewed through the prism of generating financial performance this is likely to leave some people very disappointed. Even in simple tactical terms, it is better to argue some ESG issues as desirable ends in their own right, rather than in terms of their instrumental value for the creation of returns for shareholders (often with wobbly evidence).

If all ESG issues are viewed from the perspective of shareholder value then this obviously undermines the legitimacy of issues which don't show a positive correlation. The ESG community even has its own language for this - "materiality". If an issue isn't financially material, even if it matters a great deal for other stakeholders, then it is delegitimised as an area of shareholder focus.

If the objective of all corporate governance activity is defined in advance as the creation of shareholder value (even over the long term) then this really shackles the ability of business to play a positive role for other interests, and narrows down arguments to a ridiculous degree. If, for example, the objective of executive pay "reform" is to incentivise the creation of shareholder value, then the creation of shareholder value in firms that adopt shareholder-focused pay schemes might be taken mean that executive pay is "working", even if intra-firm pay inequality is rising.

Overall, "win wins" may not be as common as we like to believe. There may be plenty of times when choices within corporate governance involve advancing the interests of one set of stakeholders whilst not advancing the interests of another, or even damaging them. A focus on shareholder value directs boards to decide issues where interests do not align in favour of shareholders. Since shareholders do not own companies, and rarely even contribute capital to them, it is surely worth exploring (again) why shareholder interests should predominate. If a pro-shareholder settlement within firms contribute to outcomes that society finds troubling (like rising inequality) we shouldn't be surprised if public policy seeks to override it.

Asserting the public's interests as shareholders is not a straightforward issue either. Individuals in modern capitalist economies have different interests - as worker (or employer), citizen, consumer and investor. There is no inherent reason why these should pull in the same direction. As a consumer I might appreciate cheap Uber fares, but as a worker I may fear how business models like theirs seek to undermine employment protections. As a shareholder I might value greater returns in part created through lower labour "costs", as a worker (and a pensioner) I prefer higher wages. It is broadly true that the public are (indirectly) the largest class of shareholders now, but this varies greatly by country (both the extent of funded retirement system, and the extent of domestic ownership of domestic equity). In addition, the extent of an individual's shareholder interest will vary by economic background. Richer people generally have more extensive shareholder interests, those on lower incomes may rely more on state pension provision than private. So focusing on the shareholder identity has a class aspect to it (a point I'll come back to).

The way that shareholder primacy, embedded in corporate law and governance codes, is enacted in practice arguably gives shareholders more than one bite of the cherry. Shareholders have limited liability, so have nothing at stake other than the value of their investment. They are also provided with control rights to ensure that they can keep management focused on their interests. And in practice management prioritises keeping shareholders happy - ensuring that earnings targets are hit even if it means delaying projects, prioritising buybacks over investment etc. The effect of focusing management attention on shareholder interests above all others means that in practice they even come at the front of the queue in terms of claims on the company - this is not how the public company with limited liability is supposed to work.

Those who assert that "political" intervention is usually counterproductive and we should leave it all to the market often overlook how much of what we take for granted was the result of previous political intervention. For instance, shareholders are generally too weak and insufficiently motivated to gain extra powers for themselves. Shareholder voting rights and corporate disclosure of information across the board has been mandated by the state because market pressure was insufficient to deliver it. More recently the state has stepped in to promote "stewardship" - an activity is supposedly in shareholders' self-interest. Markets, and market participants, need politics and politicians for the world they operate in to function.

Rather than denigrating politics and politicians, corporate governance could learn from it. Politicians in general seem to have a much better understanding that most decisions don't involve identifying obvious win wins, and settling on one ageless objective. Decisions involving lots of people and various interests are often messy - and temporary -compromises where at least one stakeholder doesn't benefit, or even loses out. This is true in Big P politics, we should accept the reality in the micro politics of the firm too, and see what we can learn from elsewhere.

We should much more careful with language about "unintended consequences", and the implication that fiddling about policy always mucks up. Aside from the fact there are positive unintended consequences, and that predicted unintended consequences often don't occur (I need to update this list - auto-enrolment & levelling down, bonus cap and salary/fixed cost rises), often claims of "unintended consequences" reflect woolly thinking about who is doing what. If I undertake action X to get you to undertake action Y, and you know I want you to undertake Y, but you choose instead to undertake action Z, is your action Z an unintended consequence of my action X, or an intended (by you) consequence? Show your working...

Trying to redesign performance-related pay is a fool's errand. We keep failing to get the targets right. There is evidence that extrinsic reward drives out other motivations. Making people wait for reward - the aim of "long-termism" advocates - reduces its value in the eyes of most recipients (so rem comms make it larger to compensate). Variable pay has also been the source of most growth in executive reward. Our system is a mess that few really believe "works" and the emphasis on performance pay is at the root of may of our problems. I think this is a very difficult problem, and it's very unlikely, in my view, that it will be solved by more of the same.

CG/RI is shot through with the biases of those that work within the field. Hence the priorities reflect the sort of wealthy liberalism that has also dominated politics. Perhaps it's just a coincidence that asset managers focus more on paying execs more like finance industry players, and making boards more meritocratic, and very little on fair pay and voice for workers. Or maybe it reflects what economic background they come from, are part of, and expect to remain in.

Saturday 3 December 2016

ASOS AGM action!

This week saw some great campaigning by the GMB as part of their ongoing battle against poor working practices within ASOS, which has had a particular focus on the distribution centre in Barnsley run by XPO. The GMB had a "Catwalk of Shame" outside, and a workers' annual report was handed out to shareholders. On the same day there were also claims that ASOS may not be playing by the rules in terms of pay for new warehouse staff.

Interestingly, on my turf, the company was also hit by a sizeable vote against executive pay, with 33% opposed. This generated further negative media coverage. The vote against was also double the level of opposition (16%) at the 2015 AGM, so there might be something significant going on. Notably, ASOS has not commented on the size of the vote or how it will respond. As a reminder, the UK Corporate Governance Code says (E.2.2):
When, in the opinion of the board, a significant proportion of votes have been cast against a resolution at any general meeting, the company should explain when announcing the results of voting what actions it intends to take to understand the reasons behind the vote result.
In practice, larger listed companies seem to make statements when they get votes against of about 20%+. ASOS is AIM-listed so it does not need to follow the Code. Nonetheless you might think that given all the adverse commentary - and the scale of the vote - it would be a sensible thing to do. And actually ASOS does make commentary about shareholder support for remuneration in this year's annual report (page 47):

At the AGM last year, 84% of shareholders voted in favour of the Directors’ Remuneration Report, providing an important level of public accountability for the Board with the suitability of our remuneration policy and its implementation. We hope that you find this year’s Remuneration Report equally informative around how ASOS leadership is remunerated, and some of the changes that we have made during the year. I look forward to seeing shareholders at the AGM, and hope that I can count on your continued support on our pay arrangements.

So it looks like they may have something to say in future reporting.

Finally, we can dig into the voting data a bit. One thing that looks likely is that the company's major shareholder, Danish retailer Bestseller, did not oppose the remuneration report. According to the list of major shareholders disclosed on the ASOS IR site, Bestseller owns 23m shares. And according to the RNS statement on the AGM, just under 14m were voted against the remuneration report. I think it's likely Bestseller either voted all of its shares or none.

If Bestseller DID vote for the remuneration report, then a very large majority of the remaining shareholders who voted will have voted against. The RNS statement shows a bit under 28m shares supporting the remuneration report, if you take 24m out, you are left with 4m in favour and 14m against.

Just to complicate things, it's worth registering that former ASOS CEO Nick Robinson owns 7m shares. Which means that it does not look possible that both he and Bestseller voted their whole holdings (23m + 7m) in favour of the remuneration report. I suppose it's possible one or both has sold down a bit, but it looks a bit strange on first glance. If Bestseller didn't vote at all, but Robinson did, and voted for, then the level of independent shareholder opposition must have been around 40%.

It's too early to get any public voting data on this AGM, but looking back to the 2015 AGM, we can see that Baillie Gifford, the largest shareholder after Bestseller, voted against the remuneration report. (PDF here, if that doesn't work then look for Q4 2015 voting disclosure report here - you will need to accept terms and conditions). You can also see that ASOS was part of Baillie Gifford's engagement in the same quarter (look at the Engagement Report for Q4 2015). My gut feeling is that, given the increase in opposition this year, Baillie Gifford probably took the same position, but that is just a guess.

We can also see that one of the UK's local authority pension funds - West Yorkshire - also opposed the remuneration report at the 2015 AGM. See page 119 here, from the fund's voting disclosure site. Here's the blurb explaining the vote:

For Nick Beighton’s promotion to the role of Chief Executive, the Committee determined that the annual base salary level should be set at £550,000, which is £50,000 higher than his predecessor, and the annual bonus opportunity increased from 100% to 150% of base salary. The increases have not been adequately justified. Likewise, to secure the recruitment of Helen Ashton the Recruitment Committee bought out a proportion of her current long-term incentives from her existing employment, by making a one-off cash payment of £204,000 and a grant of a long-term incentive award under the ASOS Long-Term Incentive Scheme, worth £340,000 as at the date of grant. The awarding of a cash payment on recruitment, without any performance conditions attached, is not considered appropriate. 
I will keep digging around for info on how shareholders have voted this year and last, and why. I will post up what I find.

So, to sum up, we have a high-profile retailer whose working practices in one of its warehouses have been subject to critical media coverage. We also see, despite a large chunk of shares accounted for by insider ownership, the same company experience significant shareholder opposition over corporate governance concerns at multiple AGMs. Remind you of anyone?

Sunday 27 November 2016

The forward march of shareholder oversight halted

I'm going to stop blogging about corporate governance reform for a bit, as I'm starting to bore myself as I keep ending back at the same place. But the endless discussion about executive pay has helped me crystallise a couple of thoughts that I thought I would share with you lucky people. These are that a) executive pay has become a political problem of a type that is similar to immigration (though obviously a very different issue in numerous ways) and linked to this b) the next time there is a serious attempt to reform executive pay shareholder oversight won't be the major part of it.

So, first, the comparison with immigration. I think there are a number of similarities here. Most obvious is the chasm between "informed" or technocratic opinion and the public. The former argues variously that we shouldn't worry too much about exec pay because it's a small part of company expenditure; that structure is what we should look at not scale; that we should leave it up to shareholders to sort  out etc etc. The public seems to think execs are just paid too much money and have no self or external restraint. There is very little common ground, and neither pole of opinion considers the other is serious.

Technical specialists and policy makers argue that we have to proceed with caution - radical action might backfire, or could damage the prosperity that highly-paid executives apparently create for us. When political parties that try and push a little harder are attacked as "anti-business". It feels very similar to the "elite"/corporate lobbying around both the EU referendum and the Scottish independence vote. The public, righty or wrongly, hears scaremongering - Project Fear if you like.

This leads to another similarity with immigration a political issue: the gap between what politicians say and what they do in practice. Politicians recognise the public anger, but also hear the lobbying of powerful vested interests and the views of technocrats. So they try and steer a path between them. Almost invariably this leads to rhetoric that is far more fiery than the policy that is delivered. I've been through several rounds of "reform" of executive pay, or the threat of it. Each time the reforms are briefed to the media (which largely duly repeats the line) that this is a "crackdown" on "fat cat pay". Each time the actual policy proposals are modest at best, and always based on the same old same old of shareholder empowerment and greater disclosure.

I suspect to most ordinary people who don't follow this stuff closely, these kinds of reforms don't really register as a "crackdown" at all. That might involve people being fined, convicted or that kind of thing. Disclosing a bit more in an annual report and getting the very occasional vote against doesn't really move the needle.

It obviously isn't helped by the fact that despite policymakers giving shareholders ever more information and greater powers they seem to rarely use this to challenge companies. Let's be serious here: if the belief is that there is a problem with executive pay then the record of shareholders in challenging it is absolutely pathetic. Yes there are some investors that do try and push hard, yes there are a few (but very few) scalps a season. But overall there has been little serious pushback. And I personally believe this is unlikely to change.

So what the public hear politicians say - "crackdown" - and what they see in practice - exec pay going up, very little shareholder challenge - are in obvious contradiction. The impression given is that politicians are actually being shifty - making a lot of noise but not really delivering on the issue when they claim to be listening to public concern. We cannot be surprised if the public stop (or have stopped) taking the rhetoric seriously.

This leads on to my second point - what politicians will do about it. We can see with immigration that  politicians have felt the need to take more and more radical action as public belief in their commitment to act has evaporated. Eventually, and unfortunately in my personal opinion, politicians have felt compelled to take action that matches the words they use - hence the (failed) cap on immigration numbers, and now our edging towards tighter rules on freedom of movement. I suspect the development of public policy around executive pay is a few stages behind immigration, but I think it will follow the same path. Technocratic policy fixes will not be enough to convince ordinary people that the issue is being dealt with.

This leads me to conclude that the next serious attempt to tackle executive pay won't rely principally on shareholder oversight as a mechanism. I'm playing the "no true Scotsman" trick a bit here, as by definition I no longer consider that reforms largely relying on shareholders will make a dent and thus aren't serious.

I think we are (just) still in the phase with executive pay where politicians believe that using strong rhetoric will be enough, even if the policy is mild. And I don't think this can last. One thing I am pretty sure of is that another round of more disclosure and more shareholder powers will not make enough difference to change public perceptions. Not enough shareholders are motivated to act most of the time in a way that would really have an impact. I don't see any reason why a model we have been trying for 20+ years (and a shareholder vote on exec pay in the UK for almost 15) will suddenly start to work differently. Nor do I put faith in the idea we can "dissolve the people and elect another" by creating "better" shareholders through different portfolios or mandates or whatever. This is a sign of desperation caused by running out of options within the current approach.

So, sooner or later, the game is up, and politicians will look for something that really does make a difference and can be seen to be doing so. It won't happen in the imminent consultation, but I think it's in the post. Having both been through the executive pay reform process several times now, and seeing how politics is playing out these days, I am pretty certain the need to be seen to be intervening in a serious way inevitably points to something quite different. What this will look like I really have little idea, but if you think disclosure of pay ratios and employee representation on remuneration committees (which is what the Tories are talking about now) are dangerous radicalism then I suspect you're in for a bumpy ride.

Friday 18 November 2016

Has UK corporate governance swung to the Left?

Continuing on from the theme of recent posts on workers on boards, despite some of the pushback from expected sources, what is really striking is how much corporate governance policy has shifted towards policies largely articulated by the Left in recent years.

Workers on boards is the most obvious example. It is an important policy for the labour movement in general, supported by major unions of different political orientation, the TUC as the national centre, and the Labour Party. As I've blogged previously, it's also supported by the Greens, the nationalists and the Lib Dems.

This was a policy that was on the fringes of the corp gov debate for years. Now it has been consulted on once already by government (by BIS, as was, under the Coalition) and is about to be again, plus it's being looked at by the BEIS committee. Something will change, and even if the govt cops out this time the door is open for the first time since the 1970s.

I've also blogged before about disclosure of intra-company pay ratios. Again, this has been pushed by the TUC and others for a long time. It was resisted for a long time, partly on the basis that the info wasn't any use to shareholders. Now both investors - like Hermes and Legal & General - and the asset management trade body are pushing for ratios to be disclosed. It is therefore very likely to happen either through voluntary company disclosure or, if that doesn't happen, intervention.

This is tied to a shift away from the assertion that what matters is structure rather than scale in executive pay. Pressure over the scale of executive pay hasn't just come from the Left, though it is more prevalent on my side of politics. And it was an initiative of a Left think tank (Compass) that led to the creation of the excellent High Pay Centre. Investors weren't supportive in the past - not that long ago most asset managers would argue publicly that overall amounts don't really don't matter, it's performance linkage that is most important. They don't do that any more. Perhaps this is just tactical silence, but it takes a "brave" corporate governance wonk to argue for prioritising structure over scale in the current environment.

There is also a consensus building around the need for equal treatment for workers and execs in relation to pension provision. This is one of the most unjustified aspects of exec pay in my opinion. Once more, the pressure for change had for many years come principally from unions, though there was a joint NAPF-LAPFF letter to companies about it a few years back. Now both LGIM and Hermes explicitly call for a move to equal treatment (See page 5 here and page 3 here).

Getting into the guts of executive pay, there is also growing scepticism about the value of performance-linkage on its own terms, because of the growing evidence about the mixed results of incentive pay. This one is perhaps harder to claim for the Left, though its use in the corporate governance context has again tended to come from my side of the fence. We have now seen both rem consultants and the CIPD produce interesting work on this topic. This report from last year is worth a read for example. I don't think the message has entirely got through. After all, a really behaviourally-informed approach to exec pay (and exec psychology more generally) should put LESS emphasis on long-term reward and more on the short term. But that's for another day.

We might also look at the way that policy is shifting away from disclosure as a tool. Until relatively recently it was the default position that all we need to do to correct a problem like exec pay is make more information available to market players and they will sort it for themselves. Pensions policy has shifted away from this (in large part due to the influence of behavioural economics). Corp gov is playing catch up, but the idea that it's just a disclosure/transparency problem is pretty much dead.

And finally the big one: shareholder primacy. For the whole time I've worked around corp gov this fundamental approach has been taken for granted by most people in investment and assumed to be non-ideological. But it has been increasingly attacked from the Left as a poor way of granting rights, distributing rewards and framing decision-making. The TUC again has done great work here.

As I blogged at the time, shareholder primacy was explicitly questioned during the parliamentary commission on banking standards. At the time some of those giving evidence acknowledged the weaknesses in the model, including the IoD, but the govt did not act. But since then a number of high-profile people including Andy Haldane and John Kay have also been critical. As I blogged quite a lot in the past, we've also seen regulators take a more interventionist stance in respect of financial organisations in a way which raises the question of whether shareholder primacy really exists in that sector in a meaningful way now.

What we may also be starting to see is a loss of faith on the part of people who work for investing institutions themselves. On this point, it's worth looking at the submission from Guy Jubb (former head of corp gov at Standard Life) to the BEIS committee. He says, for example:
Shareholders, in general, and institutional investors, in particular, should be efficient and reliable agents for accountability and change when boards and directors are failing to fulfil their responsibilities but often they are not. Policymakers and regulators, including the FRC, should re-calibrate their assumptions to recognise the limitations of investor stewardship.
 the nebulous concept of enlightened shareholder value, lacks grit, is unduly focussed on shareholders and fails to provide an effective basis for legal accountability
This is someone who was directly involved in the interaction between companies and investors for many years remember.

When you stand back and look at all of this, it is hard to resist the conclusion that the Left has won some battles, and that the centre of gravity on a range of corporate governance issues has shifted in our direction. I think this one area where the experience of the financial crisis has had much more impact than previously realised, perhaps most of all by exposing the weakness of shareholder oversight.

Whether this heralds a decisive or lasting lasting shift remains to be seen. What happens on the question of worker representation in corp gov is pretty critical in my view. Policy wonks may give up on shareholder primacy without shifting to a stakeholder model. Previously I would have said we were moving into a more regulatory governance model, but the shocks from Brexit, Trump and who knows what next may make this look like too much of an "insider" solution.

Nonetheless, in the whole on the policy front it definitely looks like we've made some progress from the Left. Onwards and upwards!

Saturday 12 November 2016

Workers on boards: handle with care

Before I get into the detail of this post I just want to make one thing clear: pension funds' assets exist to fund pensions for the people that work for organisations - the workers. Those assets were also created by the labour of those workers - it is their deferred pay. So those assets should act in the interests of those workers. In addition those that manage but do not own those assets only have influence through other people's money.

With that in mind, let's consider two things. First, how are those that manage that capital, but to whom it does not belong, using the influence that derives from those assets to influence the discussion on whether workers should be represented in corporate governance, specifically through board membership? Second, how are those arguments being made?

Submissions to the BIS committee inquiry into corporate governance, which has specifically asked for views on worker representation on boards, gives us a perfect opportunity to look at both points.

Aberdeen Asset Management

Not opposed, suggests alternative:
There is a significant body of evidence showing that mixed teams make better decisionsThe best boards feature a mix of gender, ethnicities and socio-economic backgrounds.  Any board that believes it cannot be enhanced by the inclusion of views from significant parts of society is clearly suffering from closed minds in more ways than one... An alternative route for workers to have an influence on executive pay might be for an annual meeting to take place between the workforce and the remuneration committee... Worker representatives as full members of the board are possible in UK law without undermining the unitary board structure, and can add real value. FirstGroup has demonstrated this very effectively. 

Not opposed:
We do not have a strong view on this. A number of our international holdings already have such mechanisms in place, and there is no consistent discernable differentiation in terms of performance or stakeholder outcomes at these companiesWorker representatives could potentially add value, but it would depend on the skillset and motivation of the individual.

BlackRock believes all directors should first and foremost strengthen the competency of the board.  Directors therefore should bring skills and expertise in more than just one area.  Equally, directors should act in the best interests of long-term shareholders as a whole, rather than one particular subset of stakeholders, such as employees.  The latter risks the creation of special interest groups, which can act against the best interests of the company in the long term.  Instead, alternative mechanisms should be designed to ensure stakeholder feedback into the board. 

It has been suggested that employees should be represented on Boards and remuneration committees.  We are fully supportive of the principle that the voices of employees should be adequately represented at a senior level, but for the reasons given above we would be concerned with the appointment of employee Directors or any differentiation in the responsibilities of existing Directors.  We would nonetheless encourage the creation of mechanisms which facilitated the incorporation of employee and consumer perspectives into Board debates.  These could take a variety of forms but might include the creation of dedicated Board committees to address these issues.

In favour
...we believe it is appropriate that employees be given greater voice in UK governance arrangements... In the first instance we favour a non-legislative approach to promote the inclusion of employees in governance structures... In order to shift current practice, the UK Corporate Governance Code could be amended to provide an expectation that board composition includes employee representation and associated guidance included within the FRC’s soon to be updated board effectiveness guidance. Whilst we would not class employee directors as independent they would have the same fiduciary duty as their fellow directors to act in the interests of the company and not any one specific stakeholder
The Code’s criterion for board independence may need to be adjusted as would the stipulations around board composition and the guidance should be clear that the inclusion of a sole employee director should be avoided.

Opposed? Suggests alternative
The introduction of an employee sitting on a Board or establishing a shareholder committee, in our view, would significantly change the current roles and responsibilities of directors and shareholders. We continue to support the Unitary Board model in the UK and focus our efforts on how Board effectiveness can be improved within the current governance structure.
 In saying this, we also understand that directors should be accountable to other stakeholders including employees. 
One way in which there can be better alignment between employees and shareholders is for Boards to better understand the sentiment of employees in the organisation. This can be done by nominating one of the current independent Non-Executive Directors (a “Nominated Employee Non-Executive Director”) to be held accountable for seeking out employees views in the business. This nominated director will have responsibilities to meet with staff at different levels and report back to the Board the findings. Furthermore, in the Annual Report, the Nominated Employee Non-Executive Director should also provide a statement and report back to shareholders at the AGM or Annual Report of what he/she has done to fulfil their remit.

Whilst there is evidently a case for greater employee oversight, we believe that mandatory placement of an employee representative on boards will be unhelpful in the long-term. 
The role of executives is to drive a company forward for shareholders, employees and customers; to take account of the wider environmental, business and market factors. An employee representative would quite rightly be concerned with the welfare of employees, not necessarily that of the health and strategy of the business. 
It is the nature of businesses that employees focus on the short-term and day-to-day aspects of their roles rather than the long-term. The expertise required to set a remuneration policy for a global company is something that is restricted to those that have experience in the area. This is not to stay that they should not have to justify their decisions to their employees. It has become increasingly clear that employees should have a greater voice and the board in turn should have much greater oversight of the conditions of the employee base. 
In a few cases employee representatives on boards works. An example of this is FirstGroup where they have successfully incorporated an employee nominated director onto the board.

So, as you might expect, there isn't a lot of support from those who manage the assets of workers' pension funds for allowing workers to have representation in the corporate governance of UK companies. To restate, the only reason asset managers exist, and have the influence they do, is because generations of workers have deferred their wages and put them into pension funds. Therefore I find it troubling that those that manage workers' capital are arguing against greater representation for workers.

It's also worth looking at how these arguments are being made, as they reveal some issues that everyone should consider carefully, whatever your view about worker representation.

For example, to argue that workers shouldn't have board representation because they might act too much in the short term, or act only in their interests, not in the interests of the company, opens up the question of whether different interests within the firm align, or not. After all, over recent years we've been encouraged to believe that actually all our interests (those of the company, workforce and investors) are the same, at least over the long term. Here's some Mckinsey blah on this point:

in truth there was never any inherent tension between creating value and serving the interests of employees, suppliers, customers, creditors, and communities, and proponents of value maximization have always insisted that it is long-term value that has to be maximized.

But if the case is now being made that workers have different interests that might conflict with those of others if they get a formal role in corporate governance, then we surely have to explore the question of whose interests should predominate. If there is a conflict of interests then what is the case in favour of shareholders having more influence than employees? 

To my mind, employees have far more firm-specific risk than investors, and are acutely aware of the need to act in a way that does not damage their known "investment" in the business. In contrast, especially where the "shareholder" is an intermediary, investors have far less at stake in any given company, and can often act in a very short-term fashion to their own benefit, whilst the long-term interest of the company might be different. After all, the whole "short-termism" debate is about the interaction between companies and investors, not companies and their workforces.  

The current debate in the UK over corporate governance is hugely helpful for opening up these issues that have for a long time - in our system - been taken as settled. For far too long too many people involved in corporate governance in the UK have confidently asserted we have the optimum model. This has obscured the fact that any governance model involves a choice about whose interests come first (this book, which is broadly pro the shareholder-centric model, is all about this question) and that other ways of prioritising these interests which might be as good or better. Andy Haldane made this point very well in a speech a could of years ago. It's interesting that it's when defenders of the status quo argue against giving others a real voice in corporate governance that they expose the cracks that have been papered over.

As I blogged previously, I am sceptical that the Government will hold its nerve on this one, and you can see the soft alternative being put forward by the corporate/financial vested interests as a compromise - have a NED who has responsibility for talking to the workforce. But the idea of worker representation in corporate governance is now taken much more seriously than it has been at any time in my adult life, and I doubt it is going away.

Keep pushing.

Tuesday 8 November 2016

Labour, labour and workers on boards

A very quick point about how, in my opinion, Labour should position itself in relation to the question of workers on boards. Obviously it should support the idea, but the issue is how to argue this in public.

In general terms, I would steer clear of trying to argue this on a technical/business case basis at all. It gets too complex too quickly, someone will start talking about Germany, which really isn't helpful for various reasons, and it will have zero resonance with the public. Rather, I think we should go for something like this...

Labour will give working people a say in the businesses they work for because we believe they deserve recognition for what they contribute to the success of the modern economy. In our party we value labour - the contribution of the people of Britain make when they are at work - and we believe that contribution deserves recognition in the way business is run.

Currently British workers miss out. In many major economies working people have the right to representation at the top of business through board membership. The systems differ but the idea is the same - business relies on its workforce for its success, so it's right that employees get a say in how companies are run. 

But Britain is different. Our system does not recognise the contribution of working people. In fact, it only gives power to faceless financial institutions. They alone have the right to elect people to the boards of our biggest companies.  

Labour believes this model belongs in the last century. It creates a closed circle of influence between corporate and financial interests while denying a say for working people. 

It doesn't even make sense on its own terms. In most companies investors do not contribute to the business (not even capital) most of the time. And in fact the 'shareholders' who are given power are most often intermediaries, often from outside the UK, who invest in thousands of companies and have no loyalty to any particular one. Yet currently investors alone are given a voice in business, whilst those that work for business are not.

We know from media reports that behind the scenes the business and financial vested interests are already fighting tooth and nail to defend the current governance establishment. They prefer a system where it is only the City speculators who get a say on who runs your company and whether it gets sold, or broken up. They are happy with a system riddled with conflicts where it's the lavishly paid hedge fund managers who decide whether the executives who run our companies are paid too much. And as we all know, those investors routinely rubber stamp even the most exorbitant fat cat pay deals put in front of them. 

We hope the Government holds its nerve and does not give into the corporate and financial lobbyists. But we should not be surprised if they buckle.

So Labour believes this system must change. It is time to recognise the contribution of the British workers whose labour creates the products and services that businesses sell. We should give them real influence in the businesses that they work for. We should modernise company law to correct the imbalance that denies employees a say, but gives power to hedge funds. If we give powerful voting rights to overseas investors that speculate in the shares of our major employers, then it's right to give the programmer or secretary or driver or picker who works for those businesses some power too.  

As employees you have made a very real commitment to a business, and have contributed to its success, and the Labour Party will recognise that by ensuring you have have a voice through mandatory board representation. Nothing less is fair, and anything less from this Government will represent a huge climbdown under pressure from their corporate and City paymasters.

But Labour will stand firm. We believe this reform can create a new deal - forging an alliance between the workforce and management within business. We believe this will help business take a more long-term perspective, rather than chasing the short-term demands of financial markets. This will be good for all of us, and for our economy. But most of all we will do this because it is right, and because it's fair to you, the working people of Britain. 

Wednesday 26 October 2016

The (investment) world turned upside down

These are just a few initial sketchy thoughts, but I see some signs that something interesting is starting to happen in the world of corporate governance, and institutional investment more generally. A couple of years back I blogged a bit about a "regulatory turn" away from shareholder primacy, as, in response to the financial crisis, governments became much more sceptical about shareholder oversight as restraint on corporates and looked for other options. But overt change hasn't happened until now.

The mood music has been right for a while. A few people have clocked John Kay's claim that the era of shareholder value is closing. Justin Fox was riffing on a similar theme a couple of years back. I think we might be now seeing the first policy moves that diminish the relative position of shareholders.

To take a pretty bland example, the abolition of quarterly reporting by companies is the one thing that all "sensible" people agree should happen. Here's the CEO of Morgan Stanley on this theme just yesterday. But, if you think it through, if getting rid of quarterlies does have an impact - through reducing short-term pressure on companies - this means that investors were using the information, for example in response to analysts' takes on the numbers.

So its disclosure was not pointless, the numbers are/were being used by investors, we are just uncomfortable with the impact this was having on companies. So to get rid of quarterlies is essentially tilting the system a bit back towards companies and a bit away from investors.

We can see something similar at work in the emerging discussion over worker representation on boards that is taking place in the UK. To be honest, this has been creeping up the agenda for a while, the shock about it is that it is the Tories who are actually making it happen. If you look back to last year's party manifestos Labour, the Lib Dems, the SNP, Plaid and the Greens all committed to worker representation on boards. This is more than a detail - it shows that there is no political constituency opposed to workers on boards.

However you cut it, having worker and consumer representation on the board of a PLC strengthens the relative position of stakeholders other than investors. I know the government has talked about a further binding shareholder vote on pay in the same breath, but personally I'd take board representation over tweaked powers (that many asset managers probably won't use effectively) any day.

Possibly the most interesting aspect of the workers on boards debate is the relative lack of criticism from business. Perhaps this because no-one wants to be seen to be opposed to the idea now it looks like the government is going for it, perhaps they are sill shocked by the Brexit vote, and perhaps they are lobbying frantically against - or at least for a milder version - in private. But in public in the tone has been pretty mild. This round-up in the FT is very illustrative.

It will be very interesting to see which way the CBI jumps on this. Perhaps its members are willing to tolerate stakeholder representation in return for less shareholder pressure? We do tend to forget in the UK that there are other corporate governance models out there and that they too are capable of delivering successful businesses whose leaders seem comfortable with it. Perhaps, just perhaps, companies will review the merits of the New Industrial Compact that Tony Golding describes emerging in the 80s and 90s (I included his description of it here).

But that's only half the story. Look at what is happening in institutional investment. After years of getting fleeced, our pension funds are starting to look at whether the billions they pay over to intermediaries is well spent. And many are concluding that it is not. Big funds in the UK, US, Netherlands and elsewhere are cutting their exposure to high-fee hedge funds and private equity managers, cutting the total number of external managers and investing more on a passive basis. This is quite a sharp shift from the positions some groups in the UK took pre-crisis. (and I take my hat off to Mr Meech at Unison for making costs and charges in the investment system an issue for the labour movement, and for stirring Labour out of inaction on this too.)

These moves also open up some interesting issues. For example, if our pension funds invest an increasing proportion of our assets passively then they are giving up on the idea that whatever insight asset managers have this is insufficient to generate outperformance. They are simply seeking exposure to the market in aggregate. To boil this down further, our pension funds expect public companies overall to generate returns, but they do not think it is possible and/or worthwhile to pay an intermediary to identify which companies will perform better.

In such a scenario, where our pension funds do not believe asset managers have insight into companies that is worth paying for, there is no reason why our funds should delegate their voting rights. More fundamentally, if they are giving up on the idea of stock picking, there is no reason for a fund's RI policy to be squeezed by the constraints of trying to develop a case for doing the right thing. that is justified by relative performance. Instead, provided that trustees believe that, for example, companies respecting human rights will not damage investment returns, their RI policy could be based on the promotion of international norms. This is much preferable to fashioning some blah about long-term returns to act as cover for engagement that is really about values.

I will chuck out a point here that I have made before too. These are OUR pension funds. They are not the personal fiefdoms of CIOs and other investment staff any more than asset managers. So it is reasonable for us to expect that these policies promote the interests of beneficiaries. It is great that funds are starting to clamp down on wasteful costs and charges that eat into our retirement income. Now lets make sure these funds work in our interests while we are at work in addition to when we are retired. This means as much emphasis on the S as on the E and G, and more focus on workplace issues in particular.

Overall, there is a real opportunity for the Left here if we think big. If confidence is failing in shareholder primacy then we should be on the front foot in setting out what a good alternative is. Forget the tinkering with corporate disclosure & shareholder powers that characterised the New Labour settlement. What does a stakeholder model of the company look like in the 21st century? And what is our vision of an investment system that both delivers a decent income in retirement and promotes our interests in the accumulation phase?

Thursday 20 October 2016

Sky vs Sports Direct

As most people will be aware, last month the non-executive chairman of Sports Direct Keith Hellawell failed to receive the support of a majority of non-insider shareholders (though he received the support of the majority of all shareholders, including Mike Ashley). This vote was clearly driven by corporate governance concerns.

Because he is designated as an independent director, this triggers a re-run of his election. This time he faces a straightforward for/against vote, and with Ashley's backing will clear it easily. But by triggering the vote re-run (for the first time at a UK PLC) shareholders have given their engagement force, and increased board accountability.

Last week, the non-executive chairman of Sky PLC James Murdoch failed to receive the support of a majority of non-insider shareholders (though he received the support of the majority of all shareholders, including 21st Century Fox). This vote was also clearly driven by corporate governance concerns.

However, because Murdoch is NOT designated as an independent director, there will be no re-run of his election.

A lot of companies with controlling shareholders can be dismissive of minority shareholders' concerns about governance. Being a bit cynical, if I was on the board of such a company looking at these two examples, I'm not sure I would designate my chair as independent. What's the upside?

I think this regime may need a tweak or two...

Tuesday 20 September 2016

Sports Direct shifts again

Just a quick update, the process of reform at Sports Direct has obviously just started, but some welcome news today. The company has committed to a fully independent review of the business, including employment practices. Whilst it had previously said that it would use its existing legal adviser RPC, now it has agreed to take a genuinely independent approach.

As a reminder, the Trade Union Share Owners resolution called for an independent review of employment practices. TUSO also argued in communication with shareholders before the AGM that RPC should not undertake any review as it was not independent of the company.

Full statement below -

20 September 2016 

SPORTS DIRECT INTERNATIONAL PLC ("Sports Direct" or "the Company")
Independent Review and Workers' Representative update 
Having given careful consideration to concerns raised by independent shareholders, facilitated by the Investor Forum, Sports Direct today announces that the forthcoming '360-degree' review of working practices and corporate governance which was announced on 6 September 2016 and which was to be led by RPC will now be led by an independent party other than RPC.
The Board has made this decision after listening to shareholder feedback at the recent AGM/Open Day and during subsequent consultation with a number of the Company's long-standing shareholders via the Investor Forum. 
The Board will continue constructive dialogue with the Company's independent shareholders in order to reach agreement regarding the specific nature and timing of the review. 
RPC will continue to be a valued legal advisor to Sports Direct, and the Board would like to thank RPC for its work on the existing Working Practices Report, which was compiled to the highest standards. 
The Company today further announces that the selection process for the Workers' Representative on the Board of Sports Direct (as also announced on 6 September 2016) shall be via democratic staff elections, in which it is anticipated that all staff directly engaged or employed by Sports Direct may vote, further details of which will be announced at a later date.

Sunday 11 September 2016

Sports Direct: time for change

As you may have noticed, Sports Direct had its AGM this week, and meeting was totally dominated by how the board intends to overhaul its workforce practices. The treatment of the workforce at Sports Direct's Shirebrook warehouse has become a national story, and the company has come under pressure from the press (led by The Guardian), politicians (the BIS committee) and investors.

It was a very pleasing AGM for those of us who work on capital strategies in the UK. A resolution filed by Trade Union Share Owners (TUSO) received a majority (52%) of the vote of independent shareholders, despite the board recommending opposition. This is the first time a shareholder resolution filed by unions in the UK has received a majority of the non-insider vote. This has put TUSO on the map, and we hope this is just the start.

A majority of independent shareholders also voted against the chairman Keith Hellawell (something TUSO had called for at last year's AGM), which means that he will face re-election within 90 days. This increases pressure on him to meet the demands of investors, otherwise he could face another embarrassingly large vote against.

The Investor Forum's role has been important here. After a prolonged period of engaging behind the scenes, the Forum decided to go public with its concerns about governance and working practices. It has disclosed that it organised a meeting between the full board and major institutional investors after the AGM. The Forum has also made clear that it wants a genuinely independent review of the company's practices, rather than relying on law firm RPC. So the board is under significant ongoing pressure for real change.

It's important to restate how central trade unions have been to the Sports Direct story. If Unite were not working with the largely temporary workforce at Shirebrook then none of what has subsequently come to light would be known. We also hope that TUSO has played a useful role in making sure that these employment practices have been a central issue in engagement between the board and shareholders.

Therefore it's important that the trade union's understanding of the company is both part of the review that is undertaken, and that Unite's recommendations for change are given proper attention. For example, the abuses that Unite was able to expose are directly related to the nature of employment at Shirebrook. The vast majority of the 4,000-ish workers are on temporary contracts and employed via two agencies, rather than being direct employees. This, plus the now infamous "Six Strikes" policy makes workers much more reluctant to challenge bad behaviour.

Businesses need some flexibility, but even allowing for seasonal changes in demand the size of the workforce at Shirebrook does not seem to change that much, so there is no functional reason why Sports Direct needs to have some many temporary workers. Instead it means that Sports Direct uses precarious work to keep costs down and workers feel reluctant to speak as a result. Therefore any lasting solution to the problems at Shirebrook must involve shifting a large proportion of these workers from temporary to permanent contracts. Sports Direct should sit down with Unite and discuss how to achieve this as a matter of urgency.  

We had a great result this week. Investor pressure, political intervention and serious media scrutiny have given the company a real jolt, and a record result. Now it's important that this translates into real change.

Monday 5 September 2016

For short-termism in pay and against shareholder empowerment

Everyone knows we should tie executive remuneration to long-term metrics and give shareholders more powers to oversee pay policies, right?

Yeah, except that if we make execs wait for rewards they sharply discount them (if some really put much value on them at all) so we have to pay even more money, so says this guy. I would go further, the implicit psychological model in incentive schemes is behaviourism. If you want more of Behaviour X - profits, share price appreciation whatever - you need to reinforce that behaviour to encourage execs to repeat it, and incentives are the reinforcer. Only, behaviourists seem to think that for it to work effectively you need to apply the reinforcer close to the behaviour you want to be repeated. Making awards literally years after the behaviour that is being rewarded this seems to fall way short. So actually long-term incentive schemes face two big challenges on their own terms, even ignoring the intrinsic/extrinsic motivation debate.

OK, but we all agree that greater shareholder powers to tackle pay are a good idea, right? Well, no actually. What the ICSA say here is spot on - we've tried tooling up shareholders several times in the past 15 years or so. But most shareholders don't really seem that arsed about using them to challenge companies. So why would we expect another round of the same thing to deliver any different results?

“Since 2002 the UK has been pursuing a regulatory approach based on a combination of transparency and voting rights. Despite both elements of the approach having being strengthened since then, it has done little or nothing to prevent an escalation of directors’ fees and bonuses.
“The issue is not that shareholders lack the rights that would enable them to hold companies properly to account, but that they are often reluctant to use them. Looking at the five largest shareholder revolts this AGM season, it is striking that the average vote against the report was 54 per cent but the average vote against the chair of the remuneration committee was less than 1.5 per cent. Unless investors become more willing to use the powers they already have, it may be necessary to consider different – and possibly more radical – reforms.”  

I've said it before, but there isn't any road left for the 1990s vintage corporate governance model. This means both abandoning the fool's errand of redesigning exec incentive schemes, and accepting the reality that most shareholders (asset managers in the main) think most exec pay schemes are OK most of the time - so giving them even more powers won't make any difference. Genuinely new thinking is required.   

Friday 2 September 2016

Sports Direct AGM on Wednesday 7th September

Next Wednesday see the AGM of Sports Direct take place. Since I last blogged about this it has become clear that a major investor revolt is underway.

The company has been publicly criticised by the Investor Forum (a first), which has called for a thorough overhaul of corporate governance and employment practises, plus related party transactions and so on. The Forum is very mainstream so a public statement of this nature is pretty serious, and an sign of exasperation.

A number of investors and investor advisers have publicly announced their voting intentions, including their support for the Trade Union Share Owners resolution. Amongst those that we know are supporting, or recommending supporting, are Legal & General, LAPFF, Aberdeen, ISS, CalPERS, CalSTRS and Ontario Teachers and PIRC.

These are just the publicly-known voting positions on the resolution, it is very likely that other shareholders are also supportive of the resolution.

If the TUSO resolution gets a strong vote at the AGM this will put serious pressure on the company to undertaken a proper, independent review of its workforce practices. If it can be shown that even major institutional investors believe this is required then the position of Sports Direct workers and their representatives will be enormously strengthened.

So this is a last shout out to union members who are pension fund trustees or have any other role overseeing capital, if you have shares in Sports Direct Please Vote FOR Resolution 19.

Friday 26 August 2016

Asset managers and Deliveroo drivers

I've been banging on for a few years about incentives and motivation. It's been interesting to watch as the common sense that performance-related pay is A Good Thing has lost legitimacy. However even despite the growing awareness of problems with relying on incentives the practice has continued to expand. Some people in Responsible Investment are enthusiastic advocates, believing that tying ESG metrics to exec pay (for example) would deliver better behaviour. I'm sceptical to say the least.

A couple of recent examples demonstrate why this is a live issue. First up is the news that Neil Woodford and his firm have decided to stop paying bonuses. This decision has been argued in terms that will be familiar to anyone who has been following this debate - relying on incentives to get people to do things can actually encourage some pretty dodgy/damaging behaviour and/or crowd out intrinsic motivation to do the right thing. The Woodford example is particularly striking as it comes from the sector - finance - where reliance on incentives is most extreme. But perhaps we shouldn't get too excited. There's a good blog from Chris Dillow on why others in finance may be unlikely to follow.

And this leads on to the other recent story where performance-related pay was a big factor: the Deliveroo strike, which was ultimately victorious. At its heart was a new incentive structure. Rather than being offered basic flat rate with a small incentive on top, the company was proposing paying couriers entirely on performance - i.e. a payment for each delivery. This is of course simply piece work, and I know other delivery firms have used it, but it is dressed up by Deliveroo as somehow more "flexible" for staff. Essentially this model is 100% performance related.

If I remember rightly, the founder of Deliveroo comes out of investment banking so he is likely to be used to big incentives, and might be perplexed as to what all the fuss is about. It reminded me of a conversation I had with a private equity manager when he was hugely enthusiastic about paying bar staff entirely in tips. Why wouldn't anyone want to be paid like that, he asked?

This adds even more complexity to the incentives discussion - what if some people simply don't like being paid on performance-related basis? This is probably partly context. In the case of Deliveroo couriers, or any low-paid workers, this style of remuneration might simply represent an economic threat. If you can't deliver the performance at an effective rate you could lose out financially and be pushed close to the edge. This, of course, has been a big bit of the piece rate story through time. Rather than offering more to the worker, it just ends up being exploitative, or degrading. (The power dynamics around rich private equity types getting people to work for entirely tips don't feel quite right do they?)

But people also have different intrinsic attitudes to risk, competition and so on. No doubt there's an interplay here. People can learn to behave in a more competitive/self-interested way, and the use of incentives can facilitate this (let's leave aside whether this is desirable or effective, even in profit-driven organisation). But some people won't ever want to have more risk in their remuneration, even if they are well-paid - this was picked up by research done by PwC a few years back. It might actually only be a minority of people (maybe even executives) who like a large variable element of pay.

When you think about it, this is an even stranger part of the performance-related pay story. We are increasingly encouraged to expect to be treated as individuals, with our own tastes, values and so on. So why do companies/sectors employ a blanket approach to remuneration where often faulty assumptions are made about what we want and how we might respond to the use of large incentives?

Personally, I think that we will only get into a more productive discussion about remuneration when we abandon the assumption that "performance linkage" is an unqualified good, and an inherently desirable objective in pay design. That still seems like a long way off.

PS - Even where we have a company that needs entrepreneurial talent, and even where the executive(s) are amongst those that DO like a large variable element, we should not assume this marries well with what performance-related pay "reformers" are offering. I think it is likely that many entrepreneurs are incentivised by relatively short-term success. I think they may have to be a bit "short-termist" in their thinking to get over over all the barriers that face them. I don't think they are likely to be incentivised by share schemes that are locked up for years. But then that's another argument for not adopting a blanket approach.