Tag: shareholders

Employee activism: what does the Escondido Framework say?

Staff at Wayfair, the online furniture and household goods company, have been protesting at their employer selling furniture to a company equipping migrant detention centres in the US.[1]  What does this say about the relationship of companies to their staff, about limits on the ability of shareholders to exercise power over the behaviour of that conventional theory suggests that they own, and about the rights and responsibilities of every one of us in relation to the organisations that we work for?

The relationship of companies to their staff

An organisation should consider ethical and political behaviour as part of the marketing mix when it thinks about its strategy towards its employees.  Charities and other not for profit organisations are generally able to employ staff at a lower cost than organisations without an ethical mission because their staff make trade-offs between the income they receive in cash and feeling that they are achieving something for the wider good.  As I have written elsewhere, when I headed up the buying and merchandising for the UK’s largest retailer of stationery in the 1980s, I argued to my bosses that the halo effect of developing environmentally responsible product ranges would be to enhance our standing among the students graduating from universities where we were recruiting.  By selling to a company equipping detention centres, Wayfair has effectively shifted its positioning on one of the marketing dimensions of its interface with employees.  This decision may blow over, but in the longer term Wayfair needs to consider whether to adopt a clear stance about the larger customers it sells to or it may ultimately have to accept that is will need in some way or other to change.  This might involve paying staff a bit more in order attract staff to replace those who don’t want to be involved doing something they view us unethical.  Or, if we make the assumption that one of the benefits of employing ethically informed staff is they are more trustworthy, it may need to put controls in place to cope with the risk that staff who are not as ethically sensitive to offset a lower level of trustworthiness.  Or, if the values of the staff protesting against the sales for the detention centres reflect cultural norms in the location of the offices or warehouses in which they work, Wayfair may need to go to the expense of moving its operations to locations where the local population is less sensitive to such issues.

Limits on company owners

Ownership is a complex subject.  Ownership of a piece of paper that says you have a share in the common stock of a company gives you a right to residual profits of a company and (assuming it is voting stock) in decisions about the appointment of directors of the company.  And even if you are the owner of the entire voting share capital, it does not give you the ability to dictate everything that the company can do.  Others who interact with the company can exercise their rights too.  The Wayfair employees have made it clear their views and are attempting to limit the ability of the company’s owners to sell to whoever they wish.  It is not a matter a law, or at least not law alone, the practical balance of power between an incumbent workforce, the managers and directors, as well as those of people who have invested in the company all come into play.  In the case of a company with publicly traded shares that offer the opportunity to exercise votes once a year, if at all, and then only as a very blunt instrument, the shareholders can hardly been exercise ownership rights in relation to decisions about whether to sell to the developer of a migrant detention centre.  The managers and directors will have to consider what is best for their own interests: do we concede to the employees’ demands, or do we shift the company’s market positioning in relation to the explicit and implicit interests of the workforce?

Our rights and responsibilities in relation to the companies we work for

The workforce at Wayfair may have put their jobs at risk.  Those who have walked out are likely to have breached their contracts of employment.  But acting in line with your conscience is not a matter of exercising a right as discharging a responsibility.  The staff at Wayfair will be making trade-offs (or need to realise that this is what they are doing) between doing what they believe is right and their immediate financial self interest.  The level of risk they take will reflect their own market power: can their employer find substitute staff with the requisite skills at a price that it can afford, or will it respond to the pressure from the protest, and furthermore, are they supported by the legal framework surrounding their employment or not?

[1] “Activist employees pose new labour relations threat to bosses: Wayfair walkout shows CEOs cannot duck political risks by claiming neutrality” FT 4th July 2010

 

“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

Revisiting Colin Mayer’s “Firm Commitment”

I first read Firm Commitment[1] when it was first published in 2013 and found the opening chapters – which include a well-constructed critique of the shareholder value paradigm – offered the tantalising prospect that Colin Mayer might be about to expound a theory similar to the Escondido Framework description of the firm occupying a solution space bounded by market interfaces. Unable to recall where his diagnosis of the failings of the modern firm and his prescription for addressing them departed from my own, I recently revisited his book.

Returning to Firm Commitment, I rejoiced again at much of the description in the early chapters of the shortcomings in the classical model of the firm, in which share ownership is linked to provision of investment capital and the assumption of risk. In common with the Escondido Framework, he describes the company as an structure independent of ownership and sees one of its purposes being long term survival, delivering value to society at large. He comes close on occasion to describing some of the other risk bearing parties, the market related transactional considerations and the interests of different stakeholders. In particular, he bemoans the failure of corporations to engage with wider social and environmental concerns.

But rather than continuing down the path developed in the Escondido Framework he focuses on the shareholder and sees the failure of the modern corporation lying in the lack of commitment of shareholders to the company. His prescription is reform to tie in shareholders to the company, to increase their commitment to the firm – hence the book’s title. In contrast to our model, Mayer remains committed to a view that shareholders “own” the company, rather than owning pieces of paper that entitle them a share in the profits of the company and which have a value reflecting a market perspective on the discounted value of the expected future cash flows. What he is unable to explain is how tying in shareholders in this way will improve the quality of decision taking by managers, enhance their accountability, or contain their ability to extract economic rent in the form of salaries, bonuses and equity incentives.

[1] Firm Commitment, Colin Mayer, Oxford University Press 2013

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

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.

“Shareholder value ……. the biggest idea in business” – Really?

The Economist has published a useful analysis of the place of “Shareholder Value” in contemporary thinking about business and the firm (Shareholder Value: the enduring power of the biggest idea in business*, The Economist, 2 April 2016).

The article describes the evolution of the idea that the purpose of the firm is to maximise shareholder value, its primacy first in the Anglo Saxon world, but its pervasiveness today globally wherever commerce is practised. It also cites the objections to capitalism of a society that sees corrupt and failing businesses and widening social inequality.

It describes the challenges faced by Shareholder Value. The first that is it

“is a licence for bad conduct, including skimping on investment, exorbitant pay, high leverage, silly takeovers, accounting shenanigans and a craze for share buy-backs, which are running at $600 billion a year in America”

but the Economist then argues that these are essentially perversions of Shareholder Value:

“These things happen, but none has much to do with shareholder value. A premise of “Valuation” is that there is no free lunch. A firm’s worth is based on its long-term operating performance, not financial engineering. It cannot boost its value much by manipulating its capital structure. Optical changes to accounting profits don’t matter; cashflow does (a lesson WorldCom and Enron ignored). Leverage boosts headline rates of return but, reciprocally, raises risks (as Lehman found). Buy-backs do not create value, just transfer it between shareholders. Takeovers make sense only if the value of synergies exceeds the premium paid (as Valeant discovered). Pay packages that reward boosts to earnings-per-share and short-term share-price pops are silly.

“Outbreaks of madness in markets tend to happen because people are breaking the rules of shareholder value, not enacting them. This is true of the internet bubble of 1999-2000, the leveraged buy-out boom of 2004-08 and the banking crash. That such fiascos occur is a failure of governance and human nature, not of an idea.”

The second is the challenge of the stakeholder model:

“that firms should be run for all stakeholders, not just shareholders. In a trite sense the goals of equity-holders and others are aligned. A firm that sufficiently annoys customers, counterparties and staff cannot stay in business.”

The Economist then goes on to describe the difficulty finding an objective to replace shareholder value, including risk of potentially unintended consequences of placing too much emphasis on specific stakeholder, for example by protecting employment to the point that a company goes under. It then concludes that “For these reasons shareholder value—properly defined—will remain the governing principle of firms” but with the qualification that “shareholder value is not the governing principle of societies. Firms operate within rules set by others.”

The Escondido Framework turns a lot of this thinking on its head. Maximising shareholder valuation is not an absolute objective: rather the management of a company need to deliver sufficient shareholder returns, including the prospect of returns, to secure the capital the company requires and to satisfy shareholder that they would not be better off using such influence as they have in the financial instruments they hold to replace them with other managers. This is fundamentally no different to the task they face setting terms of employment to secure the necessary workforce, and designing products and services and setting prices to attract and retain customers. The Escondido Framework also argues that other, non-financially mediated markets have also to be considered, to keep regulators on-side and to maintain a favourable climate among the public at large who may ultimately influence the behaviour of governments or even do such perverse things as consequence of their alienation as to cast votes to leave a continental economic union that underpins the welfare of the economy.

One of the underlying conclusions of the Escondido Framework is that shareholder value is not the governing principle of firms. This is a descriptive not a normative statement. Firms are managed to keep shareholders of management’s backs. Inefficiencies in capital markets and corporate governance result in perverse and/or satisficing behaviours by managers in relation to shareholders, as evidenced by the lack of control of executive salaries and value destroying M&A activity. Firms that are successful in the long term in terms of market presence, satisfying customers and being places that employees report as attractive places to work, whose standing and reputation with the public helps reduce pressure for adverse regulation from government, happen also to be those who are successful in providing returns to shareholders over the long haul that attract long term investors who, like Warren Buffet, manage to generate superior returns. The deal works this way round, not the other way!

*The authors regrettably seem unaware that Jack Welch once described Shareholder Value as “the dumbest idea in the world” – see blog post 10th April 2010

Failing the marshmallow test

The BBC World Service is the insomniac’s salvation. If you are lucky, a background of talk radio helps you back to sleep. If you are luckier still, you stumble on a piece of quality programming that Auntie has chosen to share with the rest of the globe but not with its domestic listeners.

“In the Balance”, a business programme presented by Andy Walker at 03:30 GMT on Sunday 2nd November, included a first class discussion of short termism between Bridget Rosewell, Geoffrey Franklin and Richard Dodds, following an interview with John Kay that marked the second anniversary of the publication of his report for HM Government on short termism in equity markets.¹

The essential conclusion of the Kay report [reference needed] was that there is too much short termism in UK corporate life at the expense of addressing long term competitive advantage. The top management of quoted companies focus unduly on hitting 3 monthly targets, which are a poor measure of management competence, and have been rewarded accordingly. The 1990s featured attempts to align management incentives with the interests of shareholders, but the net result was that “many people who were quite incompetent made quite a lot of money”. Kay concludes that regulation is not the solution, but that a change in culture is required, but that it is hard to know how to do this, and harder still to measure progress.

Kay expanded on the culture change required and the inherent difficulties. He referred to the “marshmallow test”, an experiment with 4 year old children. Most, when presented with a marshmallow and told that if they wait 5 minutes before eating it they will be given a second one, will eat it right away. (A celebrated study of children subjected to the marshmallow found that those who exhibited a lower personal discount rate and exercised sufficient self control to win the second marshmallow – or maybe just had the insight to understand the challenge facing them – prospered more in later life). Andy Walker asked John Kay whether he was saying that executives simply need to grow up, to which Kay responded “a lot of company directors would fail the marshmallow test.”

In the ensuing discussion among the panellists, Bridget Rosewell blamed her profession (economists) for promulgating the view that all the information about the future prospects of the company is captured in the share price, and consequently many board level remuneration packages have been structured around movements in the share price, and the panel as a whole seemed to conclude that we have spent years telling people to focus on the wrong thing. Further, Rosewell also observed that “All markets exist in institutional contexts and cultural contexts.”

Is John Kay right? Undoubtedly yes. But the supplementary questions are more interesting: why do so many fail the marshmallow test; and what can we do about it?

There are probably could be three underlying reasons for the behaviour Kay describes.

One is that, notwithstanding the experimental data that suggests that people who come out on top in later life are  those who as small  children passed the  marshmallow test, perhaps some of those who make it to the upper reaches of commercial organisations respond disproportionately to short term signals. (Or maybe, by the time that they have reached the upper reaches they are no longer capable or responding to anything other than short term signals?).  This is not something that I have observed myself, but there may be some revealing academic research lurking in the nether regions of a business school somewhere that addresses the personality types of chief executives and points to this failing.

A second explanation could be that human timeframes and organisational timeframes may be intrinsically misaligned. “In the long run, we are all dead.”  The career time horizon for a typical chief is only exceptionally longer than twenty years on first appointment.  Even then, the time horizon within the specific appointment is only exceptionally more than ten – and probably for very healthy reasons including personal boredom thresholds and the benefit from time to time for a fresh set of eyes on a problem.  Whether it is desirable is irrelevant, it is entirely reasonable for individuals to consider the rewards – both material and emotional – that will flow from what is deliverable and measurable within their own term of office. And although they may also be concerned for their own legacy in the role, they also have to reflect that they have little power to stop those who come after them frittering it away.

The final explanation relates to the institutional and cultural frameworks about which Kay and the “In the Balance” panellists agonised. The evidence here is compelling (although I would not go as far as Rosewell in condemning the argument that share prices capture all the information about a company – the point, for discussion in more depth elsewhere, is that the prices of traded financial instruments are corrupted because they also capture information about expectations about trader behaviour (in an economist’s version of Heisenberg’s Uncertainty Principle). Many management teams have been presented by academics, consultants, brokers, investment bankers, and journalists, arguably in error, that they must respond to and seek to affect short term share price performance, and the regulator environment has encouraged rather than discouraged this.  Given that the possibility that the first of these three explanations holds true for some executives, and the probability that the second of these three explanations holds true for most, it is all the more pernicious that the we have aligned cultural and institutional frameworks in this way. Instead, we need to bend over backwards to create a culture and institutional framework as a counterweight to the possibility that personal discount rates – driven by hardwired human appetites and instincts – are higher than those of companies and organisations in general, and society overall.

So, who’s eaten my marshmallow?

 

¹ The Kay Review of Equity Markets and Long Term Decision Making, July 2012

“Shareholders do not own companies, nor do they own the assets of companies”

Six academics,  from law schools and business schools in the US, UK, and continental Europe, have written a first class letter to the Financial Times today, printed under the headline “Acknowledge that companies remains separate legal entities”.

They take the Business Secretary to task for slipping into the trap of asserting, in the course of the controversy over bankers’ pay, that shareholders “own” banks.

Kent Greenfield and his colleagues write:

“….the notion that shareholders own companies is simply incorrect.

Shareholders do not own companies, nor do they own the assets of companies.

Shareholders own shares of stock – bundles of intangible rights, most particularly the rights to receive dividends and to vote on limited issues. 

Unfortunately the erroneous notion….that shareholders own companies seems to have side tracked the discussion, and policy formation, around corporate governance leading to an inappropriate and ultimately counterproductive focus on shareholders. 

…..companies are separate legal entities, without owners, and effective corporate governance involves the consideration of a variety of parties not, necessarily, shareholders.”

Signatories to the letter:  Kent Greenfield (Boston College Law School); Andrew Johnston (University of Sheffield); Jean-Philippe Robé (Sciences Po Law School, Paris); Beate Sjåfjell (University of Oslo); Andre Spicer (Cass Business School); Hugh Willmott (Cardiff Business School)