Thursday, 29 December 2016

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.

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