Sunday, 30 April 2017

Non-alignment of interests

I've recently found something that captures important points relating to competing interests within the firm: this news story about American Airlines. More specifically, the quote from the analyst is almost perfect:
“This is frustrating. Labor is being paid first again. Shareholders get leftovers,” Citi analyst Kevin Crissey wrote in a note to clients. Investors showed their displeasure by sending American Airlines Group Inc.’s stock down 5.2% to $43.98 on Thursday. 
Why do I like it so much? First, as I've bored on about at length, there's a strain of corporate governance boosterism that seeks to deny that there is really any tussle between competing interests at all. The best/worst example I have seen, in a piece about long-termism, is this godawful claim from McKinsey:
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.
"never any tension" FFS!

Yet in this news story we see an obvious tension between the interests of labour and the interests of investors (or those speaking on their behalf). I know some may retort that these aren't the real investors and/or if they were taking a long-term perspective then maybe they would support higher wages. But in Actually Existing Capitalism, public companies consider that asset managers are the "investors"/"shareholders" (as asset managers generally do themselves), and analysts are seen as providing insight to assist investors. What's more the tension is made absolutely explicit by the analyst: if labour gets more investors get less.

Secondly, the analyst also provides a very good expression of shareholder value mission creep. The complaint is that labour is getting paid first and shareholders are getting 'leftovers'. But this is how the model is supposed to work. The company pays all necessary costs and then distributes what is left to shareholders. Yet the analysts seems to think that this is somehow out of order. This is exactly the point Colin Crouch made a few years ago:
In theory, shareholders’ earnings, their dividends, based on profits, are the residuum in a firm’s trading activities, the last claim that is made on a firm after all claims from bond-holders, employees, creditors, investment needs and other requirements have been met. This is the risk-bearing activity at the heart of capitalism that enables firms to be innovative and that justifies shareholder maximisation: if the shareholders must wait until all other contractual claims on a firm have been met then they need to be able to have the final say over how the firm is managed. Also, their rewards from successful transactions must be high, as these must compensate them for the losses that will come from risks that go wrong. 
This principle remains valid if a firm goes bankrupt; shareholders have the last claims on any assets. But during routine operations of a viable company it has been heavily compromised by the emergence of profit expectations within today’s highly volatile stock markets. Ideas spread as to what short-term return on profits ought to be available in the market; remember shares are being bought and sold with an eye primarily on the secondary markets. There will therefore be a flight from shares of firms not meeting the prevailing idea of a good return. Such firms become vulnerable to hostile takeover, something which senior managers are keen to avoid, as it often leads to them losing their jobs. Managers are therefore under strong pressure to meet or exceed a target level of return to shareholders. If necessary, investment plans, customer service and employee compensation will have to be held back to meet this target. Once this occurs, distributed profits are no longer a residuum but are an early call on a firm’s earnings.
It's obvious that the directors should not pay employees less than they think is necessary to recruit, retain and motivate them. If the board prioritised paying investors over paying staff what they think is necessary to meet the needs of the business I think that would be a breach of directors' duties. So, in technical terms, employees should get paid first and shareholders should get "leftovers" - that's the model.

Assuming the analyst knows the basics of corporate law and does not mean this literally, I guess the point is really that the board should have thought more about shareholder interests when making pay awards, with the implication that employees should have got less. Which again suggests that there are indeed conflicting interests (and note that the stock did take a hit).

So, in today's capitalism, it is clear that employees' and investors' interests can indeed be in conflict. It may not always be the case, and I do think investors often would benefit directly from employees having better terms and conditions. But there is conflict there.

In light of this, the recent discussion about worker representation in corporate governance looks even more pointed. If asset managers are responding to a consultation arguing that workers should not get any formal role they are, essentially, simply asserting that their interests should (continue to) come first in that arena. I'm not sure, to put it mildly, that those of us who want to rebuild labour's share of the wealth created within the firm have much to gain by strengthening shareholder rights further in the UK. And we should be arguing relentlessly for employees to gain more power and resources within the firm directly, because experience shows that investors (as they are currently constituted) in the main aren't reliable supporters. Or at least not yet.

In my opinion, it would much better if we were open in our discussion of corporate governance and related issues that not all interests pull in the same direction all of the time. Then at least we could make more honest decisions about who gets what, rather than pretending we can all win and, in doing so, obscuring who actually does (clue: for the last 30 years or so it hasn't been labour).

As the late Tony Judt put it:

“Societies are complex and contain conflicting interests. To assert otherwise – to deny distinctions of class or wealth or influence – is just a way to promote one set of interests over another. This proposition used to be self-evident; today we are encouraged to dismiss it as an incendiary encouragement to class hatred.”

PS. There is nothing new under the sun, the idea of praying "long-term interests" in aid of better corporate behaviour is an old one, not some startlingly fresh insight from McKinsey.

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