Thursday 28 January 2016

Agency theory versus "shareholders are owners"

Here is Eugene Fama an early paper on agency theory:
ownership of capital should not be confused with owner- ship of the firm. Each factor in a firm is owned by somebody. The firm is just the set of contracts covering the way inputs are joined to create outputs and the way receipts from outputs are shared among inputs. In this "nexus of contracts" perspective, ownership of the firm is an irrelevant concept. Dispelling the tenacious notion that a firm is owned by its security holders is important because it is a first step toward understanding that control over a firm's decisions is not necessarily the province of security holders.

Tuesday 26 January 2016

Reassuringly bad arguments

I haven't blogged about the High Pay Centre for quite a while. They have successfully managed to establish themselves as a sort of mirror of the Taxavoiders Alliance, with the same kind of well-evidenced but populist campaigning stance. Which is great because it gets right up the noses of TPA supporters.

But I thought it was worth giving them a plug as the reactions to their latest work on Fat Cat Tuesday give a real insight into the strengths/weaknesses of certain arguments. More specifically, I think the counter arguments that are coming from organisations like the Adam Smith Institute are reassuringly bad. It suggests that they either just don't understand the turf as well as the HPC, or they are really struggling to overturn what the HPC is managing to define as "common sense" about executive pay. Either way it's a good sign.

I won't tackle the whole of the ASI's response, as Paul Marsland at the HPC has done a good job of that here. I just want to focus on the question of shareholder involvement - the argument that we should leave executive pay up to shareholders, because it's "shareholders' money".

I think this is wrong-headed on several levels. First, let's be clear on the process here - "shareholders' money", as it relates to distributions from a specific listed company, is only "shareholders' money" when companies decide it is, for example when they pay it out to them in dividends. And this is after wages costs etc have been covered. The company decides the distribution, and by definition what it parcelled out to executives and shareholders respectively is their money. At no point are wages for FTSE100 companies, for execs or shop workers or whoever, "shareholders' money". They are separate and one does not have claim on the other. Shareholders can, and do, challenge the distribution, but not on the basis of legal ownership. Essentially they are arguing for their share in the same way unions do.

That is important because, of course, what is being suggested here is that shareholders DO have an ownership claim on the company's assets, so the money that the company gives to its executives belongs to shareholders beforehand. But this is well-trodden ground and the legal reality is that shareholders own shares, which give them some rights, but they don't own the issuer of those shares or its assets. This point has been demonstrated in practice when shareholders have received limited compensation when the government has bought them out. They are compensated for the value of their investment, not for a claim on the assets of the organisation.

Public companies are separate legal entities, limited liability means shareholders aren't exposed for anything other than the value of their investment, but it also means that they don't legally own the company. They are only a residual claimant when a company is wound up. You don't have to be a raging Lefty to believe this, I think it was Eugene Fama who attacked the idea that shareholders own companies in an early paper on agency theory (I will dig out the reference to this).

Even the prioritisation of the creation of shareholder value as a corporate objective is not hard-written into company law (though the UK Companies Act comes close, and companies often act as if it is and genuflect to it to defend controversial decisions).

In practical terms shareholders might be adding to executive pay inflation because they generally do not consider the impact on the market as a whole. So they may be making a series of individual decisions that are seemingly rational, but which add up to higher costs overall. With large investors that hold the market, they might be essentially bidding against themselves for executive "talent". Don't take my word for it, here's what Blackrock said a few years back:
One of the difficulties we face as investors is that we (rightly) assess a company’s arguments for pay changes or increases in light of that company’s circumstances. Generally, companies do present strong arguments for the changes they wish to make. But our assessment tends not to take into account the impact it will have on the trend overall.  
Finally, as Paul, me and many others have blogged at length, it isn't even the case that the "shareholders" are deciding on executive pay. In reality it is almost always the intermediary making these decisions, not the asset owner, let alone the underlying beneficiary. That intermediation brings it's own conflicts, biases (asset managers are well paid) etc. Politically this provides critics of the system with great campaigning lines - the Right wants hedge funds to decide how much corporate executives should be paid, what's the worst that could happen etc.

The reality is that in the modern public company there is no fundamental reason why shareholders should be given a privileged role in the determination of executive pay. It isn't their money, they might not be good at it, and most often the "shareholders" are highly-paid intermediaries.

These days there's a decent amount of people on the Left who do understand quite a bit about the operation of capital markets, who the players are, how their decisions are made, and how this interacts with corporate law and company objectives. So the proposition that we leave executive pay to the market because it's "shareholders' money" is easy meat. In fact it feels like it's about 10 years out of date. If this is really the best that those on the Right who wish to defend current levels of executive pay, and how it is overseen, can do then I am optimistic that we are winning this fight.

Wednesday 20 January 2016

Union rights as an ESG issue

I've blogged a little previously about what I see as a general failure of labour issues to make it very high up the ESG agenda. As someone who has worked with and for trade unions in different ways for much of my adult life I find this frustrating, particularly as it contrasts sharply with progress on environmental issues in responsible investment. So I thought I'd go into a bit more detail.

One of the things that troubles me is the apparent tolerance some people in responsible have for poor behaviour by companies on labour rights. I very much doubt this sort of behaviour would be tolerated in respect of other ESG issues. I think it is worth restating, as obvious as it should be, that labour rights are human rights. Therefore, where unions raise concerns about companies' not respecting labour rights this should not be seen as a "difference of opinion" between employer and employee, but a potential violation of human rights. Also, unions are very often able to provide specific breaches of labour law by companies. The consequences of such breaches vary considerably between jurisdictions but the key point is that companies are breaking the law, often repeatedly.

Seen in these terms, I question why investors do not take alleged labour rights violations more seriously. Aside from the danger in being seen as tolerating abuses of human rights, I would argue that investors should see this as a serious hazard warning. If a company is breaking the rules over and over even if you don't personally like/support unions you should be concerned about whether this is indicative of a wider management attitude.

However, for some reason this message doesn't seem to get through. I doubt a company that could be shown to have repeatedly violated environmental regulations would be given the benefit of the doubt by many ESG folks, but this does happen with labour rights. To take a real life example, imagine the reaction if a company stated that it would lobby aganst certain environmental standards because it was bad for business, and if it repeatedly used lawyers to frustrate attempts to make it more environmentally responsible. I think we know that most RI people would think this was intolerable.

Yet this is exactly what happens when unions try to organise within companies. It is far more acceptable in the ESG world for a company to oppose unionisation, even when this strays into alleged breaches of the law, than it is for it to decline to adhere to voluntary environmental initiatives or targets. I have even seen an asset manager with some ESG credibility report publicly that it supports a company's right to campaign against unionisation because it thinks this is in the interests of the business.

I genuinely get it that the working lives of retail workers, or dockers, or bus drivers are to most people in the the RI world a less interesting thing to look at than climate change, particularly if those workers live in developed countries and sound a bit thick. Engaging over these issues maybe doesn't have quite the same feeling that you are contributing to something important. But actually the ability of workers to bargain for a fair share is closely linked to inequality, surely quite an important societal issue.

It's a bad news story really: the decline of trade union strength is closely correlated with increased inequality, as an IMF paper pointed out last year. The effects might be two-fold, weaker unions mean that labour is less able to bargain for a fair share, but also reduce the countervailing power that once held corporate management in check. Is it any wonder that the US, with its weak labour law and numerous anti-union companies (and union-busting firms that advise them) is so unequal? So if you are concerned by inequality you should be concerned by companies that try to prevent or reverse unionisation.

Finally, I think it's important to flag up the issue of beneficiary interest and representation. I genuinely believe that RI policies and practices should reflect beneficiary concerns where possible.
There is a lack of good info on what beneficiaries really want to see in RI policies but some of the limited info we have suggests that they put more emphasis on basic employment-related issues than the ESG community as a whole does. If this is broadly correct this may be because they see a self-interest in it. We also know that beneficiaries want to get a decent return and are worried about getting ripped off. Therefore an RI policy that was generally rooted in beneficiaries' interests might have more to say about workplace terms and conditions on the one hand, and fees and charges on the other. To state the obvious we are long way from that, although this is broadly the territory that unions seek to occupy.

I do worry a bit that the priorities expressed in responsible investment can sometimes look like the liberalism of the well off and successful. We're very good at flying around the world to conferences and signing up to global initiatives. In contrast, bus drivers complaining about shift patterns or faulty heaters can seem rather dull. If you've never done a menial job, or struggled to get on at work, you may well consider some of the complaints that union members raise to be trivial, or whiny. But these are the people whose money makes responsible investment possible. Without their pensions you and me don't have jobs. I think they have a right to expect that their voice gets a better hearing than it does currently.

Another Fidelity-Conservative Party link?

Looking at the Electoral Commission register of party political donations I can see that there are a number made by someone called Simon M Haslam. This name also turns up in the register of interests for the current Secretary of State for Transport. If you Google the name Simon M Haslam and look at the Bloomberg profile it turns up you will find someone of this name is chair of Colt Group, and a board director of Fidelity. And if you look at the Q1 2015 list of people attending a meeting of Tory donors outfit the Leaders Group you will find Simon Haslam representing Fidelity (or FIL Holdings as it appears in the list). Pretty likely it's the same person, eh?

If you don't want to use an asset manager that has numerous links to and is a major donor to the Conservative Party then don't employ Fidelity.