Tag: corporate governance

Role of stakeholders in purposeful business

The second session in the British Academy Future of the Corporation – Purpose Summit took place earlier this afternoon, with a focus on the role of stakeholders in purposeful business.  The proposition in the Escondido Framework that what most people call stakeholders should be thought of as customers of the firm is at odds with conventional stakeholder theory, but for the purpose of this review I will talk about stakeholders as conventionally understood.

Some of the richest material in the session came from Victoria Hurth from the Judge Institute, although perhaps I reach this conclusion because the language she employs comes closest to that used in the Escondido Framework model of the firm.  She framed her introduction to the session by talking about the relationship of corporate purpose to stakeholders being one in which the role of the market is to mediate the pressures from stakeholders.  She also talked about tapping the wisdom of shareholders to give meaning to the purpose of the company, which may be another way of looking at the Escondido Framework view that the organisation exists to resolve the symbiotic needs of the stakeholders.  She wrapped her introduction with an argument about need for diversity on boards to help with a paradigm shift away from a shareholder value driven model of the firm to one driven by purpose in the service of stakeholders – but without demonstrating the logic behind her argument.  There may well be plenty of meat underlying her assertion, but today she did not have the time to make this part of her case.

Frances O’Grady, from the TUC, made the case for hearing the voice of the workforce on the boardroom, referring back to Theresa May’s proposals for changes to corporate governance and the subsequent review that I contributed to and commented on in 2016 and 2017.  She explained that she is agnostic about whether worker representation should be in the context of a unitary board or a two tier board following the model in some northern European countries.  She also argued for a change to directors’ duties, by implication beyond those set out in Section 172 of the Companies Act requiring them to take account of all stakeholders, to require more focus on the long term.

Dan Labbard, CEO of the Crown Estate (an organisation whose roots go back to 1066 and  William the Conqueror) addressed the question of whether a focus on purpose creates additional risk to the corporation.  He argued that a focus on purpose equips the corporation to recognise and then organise to address risk, in contrast to a primary focus on profit.  He build on this argument by encouraging organisations to proactively go out to their stakeholders with a purpose led strategy, rather than merely responding to stakeholders, and to look at risk through a stakeholder perspective.

Jim Snabe chairs two of Europe’s biggest corporations, Siemens and Maersk.  He framed his concerns around the impact on companies of globalisation, technological change and the climate crisis.  He argued for leadership anchored in corporate purpose, which describes as explaining why your organisation exists.  Leading two companies with two tier boards, he is an enthusiast for this model, explain that the “management board drives the bus” while the supervisory board “sets the GPS”.  He sees four roles for the supervisory board: ensuring the strategy is correct by asking the right questions; ensuring that the strategy is aligned with the United Nations strategic development goals; promoting the next generation of leadership; and defining success in terms of addressing the needs of all stakeholders.

Colin Mayer opened the responses to questions by observing that it is difficult, notwithstanding the variety of means that can be considered (different board structures, consultative bodies, citizen juries), to capture the views of stakeholders. (for the Escondido Framework perspective, visit the section of this site addressing governance and some of the relevant earlier posts).

Investors should look below the bottom line – says the FT

“This newspaper has welcomed the shift among corporate leaders from a narrow focus on shareholder value to the pursuit of a broader purpose — for a hard-headed reason: when business takes a broad perspective, it can leave everyone more prosperous, including shareholders. Rejecting the dogma of shareholder primacy is not a question of bleeding hearts, it is a matter of enlightened self-interest.”   So says the FT editorial board in a powerful opinion piece today, before going on to argue that investors should follow suit.

The FT argues that there are two reasons for the investors to look beyond the bottom line and consider the impact of business decisions on climate and the environment and on workers and the communities they operate in.  The first is that by ignoring the impending crises facing us, a corporate focus on shareholders alone contributes to the political neglect of the problems and can stand in the way of solutions.  The second relates to the way that many investments are held by shareholders, through diversified portfolios intermediated by managed funds.  The result of this is the ultimate investors (people like me with investment through pension funds, insurance policies and ISAs[1]) are in effect “universal investors” exposed to hundreds or thousands of individual companies, fortunes.  As the FT team observe: “Their returns depend on that of the private sector overall. When one company profits by “externalising” its costs, that may flatter its bottom line only by losing investors more money in other companies which pay the price.”

Consequently, investors and company leaders both have an interest in internalising the externalities rather than ignoring them.  But the FT finds that both company and investment managers feels constrained in doing so, and it argues that government should look at ways of changing the legal frameworks that shape behaviour by corporate leaders and fund managers.

My own belief is that there is evidence that some corporate leaders and some fund managers (notably Baillie Gifford who I got to know well over a period of nine years as the finance committee chair of an asset rich charity) do take the wider perspective and longer term into account and, in the UK at least,  what is at issue is not so much the legal framework but the career paths, knowledge bases, incentive mechanisms, cultural biases and social norms in the City and in our board rooms.

[1] Individual Saving Accounts – the UK tax sheltered scheme for smaller retail investors

“A slow dawning that most companies are run pretty badly”

Sarah Gordon has written a memorable reflection today on her 20 years writing for the FT.

She reflects on a career with the paper that started with writing about what were in the early years of the millennium breaking technologies but which have been mainstream for so long that we can’t imagine life before them, which continued through the years of the Financial Crash and the great depression and bull run that has followed.  She writes about the routine reports of company news stories and mind-numbing performance data, and the occasional more gossipy pieces that appear to have been what the readers found more engaging than the hard news.

She found clearing her desk brought back memories of the events and personalities that have filled the business and company pages of the paper of the past two decades, and anyone reading the article be a share in the trip down memory lane.

Reflecting on these years, she reaches very strong conclusions about shortcomings in governance in response to the accretion of overweening power at the heart of companies.  She cites Dick Fudd at Lehman Brothers.  He is an easy target, but her description of what went wrong is compelling: “board members neither delved deeply enough into the real activities of the bank, nor did they challenge the person running it sufficiently. Being on the Lehman board, it seemed, was a social honour rather than a fiduciary responsibility.”  Writing of people like Martin Sorrell, who spent 33 years at the top of WPP, she observes: “Business bosses who enjoy too long a tenure lose self-awareness. They become reluctant to promote people around them who will challenge their point of view. Meanwhile, questioning a boss who enjoys such stature becomes all but impossible, encouraging hubris, and leading to bad business decisions.”

Gordon reflects that such problems, with accompanying shortcomings in governance, are not restricted to the private sector.  She cites the example of Camila Batmanghelidjh and the failure of Kids Company in 2015.  I reflect also on the ignominious departure of Sir Leonard Fenwick would was finally dismissed for Gross Misconduct by the board of Newcastle upon Tyne Hospitals NHS Foundation Trust, where he had been chief executive since 1998 having previously led one of its predecessor organisations since 1992.

She also reflects on the poisonous value destruction in so many big corporate deals, which appear to be motivated by executive greed and supported by a flawed network of advisory institutions corrupted by perverse incentives.

Her time at the FT was a journey of personal discovery and growing disillusion (albeit one shared by most of in parallel in other parts of our lives) : “As a child, lucky enough to grow up in comfortable circumstances in London, I simply assumed that the world was run efficiently by the grown-ups. It has been a slow — and sometimes painful — dawning that in fact most companies are run pretty badly.”

Gordon is hardly less critical of other institutions, regulators and politicians.  She also appears to despair that the wider lack of economic and financial literacy, and the gullibility of much of the general public.  She suggests that a public that feels exploited and even robbed by corporate excesses does, in some part, have itself to blame.

But she stresses that it is not business itself, as opposed to individual businesses, to blame, but it is within the power of business to improve popular understanding and dispel the blame:

“Many businesses are badly run, but business is not bad. Most people running companies whom I have met over the past 18 years care about the people they employ. Most entrepreneurs believe that there is a purpose to running their company which is greater than just making money.

“The voices of big business, and the big business baddies, too often drown out the stories from the millions of small companies that make up the bulk of employers in the UK and across the globe. I’ve interviewed many of them in the past few years, in Scotland, outside Cambridge, in Bilbao and Munich. Many are family-run, on the second or third generation, focused on building sustainable businesses. Unlike the UK’s big supermarkets, gouging dairy farmers with ever lower milk prices, they have long and mutually dependent relationships with their suppliers. They look after their staff, turning apprentices into engineers and keeping people on their books during extended periods of illness.

“The popular caricature of business, filled with profiteering bankers and gig economy exploiters, simply does not reflect the reality. But it is up to business to dispel it.

“……  business needs to do more than change its culture. It must challenge itself on what its purpose really is, not just what its investors want. It must be prepared to tackle the great ills of our time, such as climate change or modern slavery. And it must be louder in explaining why it matters.”

Corporate Governance Code: “the mountain in labour has brought forth a mouse”

Parturient montes, nascetur ridiculus mus[1]

It’s bit harsh to describe the Financial Reporting Council’s new Corporate Governance Code as a “ridiculous” mouse, but after the hopes raised by Mrs May on the steps of Downing Street two years ago for real reform to corporate governance and the effort expended in consultation since, this reform is timid, diminutive and disappointing.

It is hardly surprising. The Prime Minister’s original challenge to the corporate world was muddled.  She faced plenty of reasoned opposition to specific ideas she floated.  The scandals that probably spurred her to fly the kite for reform have faded with the passage of time.  Brexit has diverted attention from almost everything else.

Nonetheless, the new code includes some steps forward. There is a some modest recognition of the wider duties of the company beyond those of the shareholders in the new Principle A:

“A successful company is led by an effective and entrepreneurial board, whose role is to promote the long-term sustainable success of the company, generating value for shareholders and contributing to wider society.”

There is a further new provision which requires that a board should:

“…..understand the views of the company’s other stakeholders and describe in the annual report how their interests and the matters set out in section 172 of the Companies Act 2006 have been considered in board discussions and decision-making.”

The reminder to boards of their duties under Section 172 is welcome, but the new code falls well short of the proposals described on this site for the creation of a commissioner with power to refer companies to the Secretary of State, on application from stakeholders who could demonstrate that companies had failed to engage with Section 172. The provision in the 2018 Code has a declaratory value and will focus the attention of company secretaries and communications teams on crafting suitable words, but it lacks the backup of teeth or sanction.

The 2018 Code contains some new provisions for remunerations committees, but they are weak and do little to address the problems of runaway executive pay. Encouragement of “review of workforce remuneration and related policies and the alignment of incentives and rewards with culture” and the requirement that chairs of remuneration of committees should first have served for at least 12 months on a remuneration committee is unlikely to make one iota of difference to outcomes. These are unlikely to shift the behaviour of remuneration committees, which requires changes to the accountability of directors (as addressed elsewhere in the Escondido Framework) and a more courageous and challenging approach by the members of remuneration committees to the settlements that they are expected to endorse.

The 2018 Code pays lip service to the Prime Minister’s support in 2016 for the 1970s panacea of worker representation on boards:

“The board should keep engagement mechanisms under review so that they remain effective. For engagement with the workforce, one or a combination of the following methods should be used:

  • a director appointed from the workforce;
  • a formal workforce advisory panel;
  • a designated non-executive director.

 

“If the board has not chosen one or more of these methods, it should explain what alternative arrangements are in place and why it considers that they are effective.”

We have explained the drawbacks of these approaches elsewhere: conflicts of interest, undermining of the unitary board, challenge of adequately representing the diversity of workforce, and – core to the model of the firm described the Escondido Framework – a failure to understand the relationship of the firm to all its “stakeholder” groups.

However, if any company is looking for “alternative arrangements” that address the criticisms set out above of the Code’s approach to workforce engagement, we commend the approach described in our letter to the Financial Times on 3 November 2017 and response the Green Paper on Corporate Governance.

[1] “the mountain in labour has brought forth a ridiculous mouse” Horace: Ars Poetica, 136–9

It takes a village to maintain a dangerous financial system – and a corporate governance system too

Hillary Clinton popularised the African proverb “It takes a village to raise a child” when she adopted it as the title for her 1996 book. A lawyer representing victims of abuse by Catholic priests in Boston extended when interviewed in 2015 by observing that “If it takes a village to raise a child, it takes a village to abuse a child.” Anat Admati, George G.C. Parker Professor of Finance and Economics at the Graduate School of Business at Stanford University, translates this sentiment to the financial sector in her in chapter in Just Financial Markets? Finance in a Just Society, a collection of essays edited by Lisa Herzog, published by Oxford University Press[1].

Admati’s focus is on the banking system. Her thesis is that the failings in the system, illustrated by the 2008 crash, are a result of the failures of a wide range of players, not just those working within financial institutions, but a host of regulators, commentators and other stakeholders. Very powerfully, she comments on the contrast between the finance industry and other industries (eg aviation) where safety is paramount and all consequently all the stakeholders work together to design effective regulation and where the case for compliance is compelling. But, as she points out, even the most obvious case for regulation to drive safety may require disasters and egregious failures before regulation and compliance catch up with the need (eg in nuclear power and the motor industry).

Her chapter provides a compelling account of the “wilful blindness” of principals, stakeholders, regulators and commentators on the financial system and suggests that even after the dangers inherent in the design, operation and lack of necessary regulation of the banking system were revealed in the crisis, the underlying problems remain unaddressed.

Her arguments are applicable far more widely. She has written an important paper about that should be read with an eye to how her observations can be applied to other industries and, indeed, beyond the commercial enterprises into public sector organisations and not for profit bodies.

[1]Chapter 13, It Takes a Village to Maintain a Dangerous Financial System. Abstract: I discuss the motivations and actions (or inaction) of individuals in the financial system, governments, central banks, academia and the media that collectively contribute to the persistence of a dangerous and distorted financial system and inadequate, poorly designed regulations. Reassurances that regulators are doing their best to protect the public are false. The underlying problem is a powerful mix of distorted incentives, ignorance, confusion, and lack of accountability. Willful blindness seems to play a role in flawed claims by the system’s enablers that obscure reality and muddle the policy debate.

Is Capitalism Killing America?

I was stopped in my tracks this morning by an email from the Stanford Graduate School of Business with the subject line “Is Capitalism Killing America?”. It is not the sort of thing that the world’s top business school (at least that was how it was rated forty years ago when I was there) normally sends to its alumni.

The key feature in the email newsletter was an article with the subheading “Young & Rubicam Chairman Emeritus Peter Georgescu says it’s time to end the era of shareholder primacy[1] which reviews Georgescu’s new book Capitalists Arise! End Economic Inequality, Grow the Middle Class, Heal the Nation (Berrett-Koehler, 2017). Georgescu, a fellow Stanford GSB “alumn”, is looking to chief executives to think about how, and for whom, they run their companies.

Capitalism is an endangered economic system, Georgescu says. He cites by economist William Lazonick, who studied S&P 500 companies from 2003 to 2012 and discovered that they routinely spend 54% of their earnings buying back their own stock and 37% of their earnings on leaving just 9% of earnings for investment in their business and their people.

“Innovation is the only real driver of success in the 21st century, and who does the innovation? Our employees. How are we motivating them? We treat them like dirt. If I need you, I need you. If I don’t, you’re out of here. And I keep your wages flat for 40 years,” says Georgescu, who points out that growth in real wages has been stagnant since the mid-1970s.

Georgescu continues by noting that the lack of investment in business and their people feeds back into demand, undermining sales growth. With median household income in the US less than 1% higher today than in 1989: “There’s no middle class, and the upper middle class has very little money left to spend, so they can’t drive the economy. The only people driving the GDP are the top 20% of us”. 60% of American households are technically insolvent and adding to their debt loads each year. In addition, income inequality in the U.S. is reaching new peaks: The top layer of earners now claim a larger portion of the nation’s income than ever before — more even than the peak in 1927, just two years before the onset of the Great Depression.

Georgescu blames the ascendency of the doctrine of shareholder primacy.

“Today’s mantra is ‘maximize short-term shareholder value.’ Period,” he says. “The rules of the game have become cancerous. They’re killing us. They’re killing the corporation. They’re helping to kill the country……..

“The cure can be found in the post–World War II economic expansion. From 1945 until the 1970s, the U.S economy was booming and America’s middle class was the largest market in the world. In those days, American capitalism said, ‘We’ll take care of five stakeholders,’. Then and now, the most important stakeholder is the customer. The second most important is the employee. If you don’t have happy employees, you’re not going to have happy customers. The third critical stakeholder is the company itself — it needs to be fed. Fourth come the communities in which you do business. Corporations were envisioned as good citizens — that’s why they got an enormous number of legal protections and tax breaks in the first place.

“If you serve all the other stakeholders well, the shareholders do fine,” he says. “If you take good care of your customers, pay your people well, invest in your own business, and you’re a good citizen, the shareholder does better. We need to get back to that today. Every company has got to do that.”

It’s refreshing to hear this from one of the grand old men of the commercial world in the United States. But in his critique of “shareholder value”, he fails to single out the principal beneficiaries, the chief executives and top management teams themselves (including our fellow business school alumni) who have exploited the system to cream off an ever increasing share of the rewards in salaries, bonuses and options, all the while failing to invest in productive assets, innovation, securing long term positions with customers and local communities, and in the people who work in the companies themselves.

[1] https://www.gsb.stanford.edu/insights/capitalism-killing-america?utm_source=Stanford+Business&utm_medium=email&utm_campaign=Stanford-Business-Issue-122-10-1-2017&utm_content=alumni

At last, spine stiffening among investors on executive pay

It may be the height of the August “silly season”, but who can fail to welcome the news in today’s Financial Times that:

“Shareholder anger over executive pay switched from FTSE 100 to FTSE 250 companies during the annual general meeting season, as large investors protested with greater force over individual pay packages and company remuneration policies”;

and that a report

“from the Investment Association, the trade body representing UK asset managers, found a doubling to 29 in the number of FTSE 250 companies that had 20 per cent or more votes cast against remuneration policies.”?

The bad news is that after an increase in voting against remuneration reports in the FTSE 100 last year, there was a downturn this year. But at least there have been a few significant defeats, such as at Pearson, which may be a welcome sign that at last there may be a stiffening of spines in the City.

Jawbone, another unicorn washed away

And Noah looked out through the driving rain, Them unicorns were hiding, playing silly games.They were kickin’ and splashin’ while the rain was pourin’, Oh, them silly unicorns!

There was green alligators and long-necked geese, Some humpty backed camels and some chimpanzees.Noah cried, “Close the door ’cause the rain is just pourin’, And we just cannot wait for no unicorn!”

The ark started moving, and it drifted with the tide, And them unicorns looked up from the rocks and they cried.And the waters come down and sort of floated them away, That’s why you never seen a unicorn to this very day.

But you’ll see green alligators and long-necked geese, Some humpty backed camels and some chimpanzees.Some cats and rats and elephants, but sure as you’re born, You’re never gonna see no unicorn![1]

I advise a fitness monitoring technology company[2] and consequently have followed the rise and, as of this week, demise of Jawbone, which has run through $1 billion and was at one point valued in 2015 at $3.3 billion.

The company started out modestly, founded as Aliph in 1998, in the first dotcom boom. It started out making mobile phone headsets, launching a wireless version at the Consumer Electronics Show in 2007 prior to raising $5 million from Khosla Ventures later in the year and $30 million from Sequoia Capital in 2008. Bluetooth headsets followed (I think I may have had one) in 2009, and the Jambox, a Bluetooth compact speaker and speakerphone, in 2010.

Things started to go crazy in 2011, with three rounds of funding bringing in $160 million, new product launches and, most critically, entry into the into the lifestyle tracking market with a wristband product called UP by Jawbone. Product enhancements, acquisitions, awards for design, and citations – and the TED talks – for founder and CEO Hosain Rahman[3] all followed. May 2013 brought the addition of a heavyweight corporate board: Marissa Mayer, CEO of Yahoo!, and Robert Wiesenthal, COO of Warner Music Group as directors and Mindy Mount, corporate vice president and CFO for the Online Services division of Microsoft, as president of the company (although she was gone within 12 months) A further round of funding later in 2013 brought in $20 million more equity and $93 million of debt, followed by another round in 2014 bringing in $250 million and finally another $350 million of debt from Blackrock in April 2015.

A flurry of new product introductions, expanding into other areas of monitoring including heart rate and sleep – but complaints from consumers and technical criticism, and intellectual property suits from market leader Fitbit and a dispute with a manufacturing supplier in 2015 suggested all was not well. Later in the year a market research report suggested that Jawbone’s share of the fitness tracker market was only 2.8% and in November the company started to announce lay-offs.

After Reuters marked last week’s announcement that the company had placed itself in liquidation with a report titled “Death by Overfunding”, Jonah Comstock of Mobile Health News put out a call on Twitter to mobile health pundits for their views. Opinions included the company having too much money to spend and consequently under pressure to chase investor expectations with a need to do stuff – innovate (“random pet projects and pilot collaborations go no where and suck up precious engineering resources….. too pie in the sky- not enough rubber-meets-road”), launch new products, invest in marketing – probably ahead of its ability to deliver quality, and with the volume of activity generating internal turmoil and lack of focus, in marked contrast to the laser sharp strategy of rival Fitbit.

I’m not sure that this can be the whole story. But what is without doubt is that

  • the efforts of what I assume were bright and capable people on the front line – probably poorly led, directed and managed – failed to deliver output that delivered products and services that customers valued
  • the company burnt through a lot of money in a very short time, with the result that some very big investors destroyed a lot of value for the investors upstream of them
  • the presence of a board of heavy weight external directors did very little to secure the future of the enterprise.

(And perhaps sometimes it’s better to settle on being a green alligator, long-necked goose, humpty backed camel, chimpanzee, cat, rat or even elephant that can deliver value sustainably than a unicorn left “kickin’ and splashin’ while the rain was pourin’”)

[1] Shel Siverstein, 1962 (extensively covered, eg byThe Irish Rovers, Val Doonican and many others)

[2] HRV Fit Ltd, manufacturers of ithlete https://www.myithlete.com/

[3] Fortune magazine’s 40 Under 40; Fast Company magazine’s most creative people; Vanity Fair magazine’s New Establishment; TIME 100’s most influential people of 2014

Evidence at Pearson for management hi-jack at the expense of shareholders

News of a shareholder revolt at Pearson over chief executive pay illustrates the Escondido Framework analysis of the company as an entity owned by no-one, but open to hi-jack by the management.

Pearson’s shareholders have struck out at the company’s and its remuneration committee by voting down the proposed 20% pay increase to chief executive John Fallon after he presided over record £2.5 billion loss for the group last year. Meanwhile, employees are laid off and the returns to shareholders are in freefall. The comment of the company, that it was “disappointed” by the vote but that the pay increase goes ahead, supports the underlying Escondido Framework thesis of management capture.

“Naturally, we acknowledge this feedback and thank those shareholders who have already spoken with us,” the company said. “The remuneration committee is committed to continuing dialogue with our shareholders to help shape the implementation of our remuneration policy going forward.

“Mr Fallon said his £1.5m payout in 2016 was a matter for Pearson’s board and its remuneration committee, but added he had used his £343,000 bonus, net of tax, to buy shares in the company on Friday morning.”

The FT notes that the vote at Pearson was the biggest investor revolt against executive pay at a major UK company so far this season, with the next nearest being a 40 per cent vote against the remuneration report at AstraZeneca. FTSE 250 housebuilder Crest Nicholson is the only other large listed UK company to have suffered a defeat on pay this season, with 58 per cent of votes cast against its pay report.

It can only be regarded as good news that the FT further reports that other FTSE 100 companies that faced pay protests last year, including BP and Reckitt Benckiser, have cut remuneration packages in an effort to avoid similar difficulties at their shareholder meetings this year – and indeed make an effort to reposition the companies against the market interface with their investors.

Response to Corporate Governance Reform Green Paper

I have submitted a response today to the Corporate Governance Reform Green paper.  The essence of the response is firstly support for the proposals submitted in a letter dated 23rd January to the Prime Minister by the Institute of Directors, the TUC, the ICGN (international Corporate Governance Network) and ICSA representing Company Secretaries which urges the Government at a minimum to:

  • Create a mechanism which allows those whose interests should supposedly be protected by the law, to make complaint and find an appropriate remedy.
  • Ensure investors and stakeholders are appropriately involved in the governance of that mechanism.
  • Strongly encourage, or mandate larger private companies to apply the principles of independence and transparency which have worked for public companies.
  • Help encourage frameworks for executive pay which are more broadly acceptable, and recognise that it, like other aspects of corporate governance will require a long term focus, from directors, investors, stakeholders and government.”

The second core element of the response is to call for employees to be polled alongside shareholders to approve the appointment of directors, as proposed in the letter published by the FT on 3rd November.

To see the text of the full response, follow this link:  Tom Hayhoe response to the Green Paper on Corporate Governance