short termism – Escondido Framework

Shifting the dial on purposeful business: what can we learn from crises, past and present, in solving the problems of people and planet?

The fifth and final session of the British Academy Future of the Corporation – Purpose Summit was a disappointment after some of the high points of the earlier sessions, but was rescued by an inspiring closing contribution from Mohamed Amersi, whose Amersi Foundation is one of the principal sponsors of the Future of the Corporation programme.

The essential shortcoming of the session was that it failed to address its intended subject or answer the question set in its title. I was left with the impression that, particularly with the backdrop of the Covid-19 pandemic, the organisers felt that they would be failing to notice the elephant taking up most of the room if they didn’t address business purpose in times of crisis. As keynote speaker, Mark Carney tried to combine his experience as a central banker through the financial crisis and its aftermath with his appointment as UN Special Envoy for Climate Action and Finance. He made the case for a strategic reset to deliver “Net Zero” to address climate change, argued for corporations to be required to disclose how they contribute towards reducing carbon emissions, but did not manage to articulate how this relates corporate purpose. In Escondido Framework terms, the appetite of investors and consumers to do business with organisations that are addressing climate change and the restrictions and/or incentives provided by governments reduce carbon emissions shape the market interfaces of the firm, and the interest of the firm in its own sustainability should encourage it to behave sustainably, but they don’t change the corporate purpose.

Following Carney’s contribution, the session moved onto a panel discussion. As CEO of SSE, an electricity utility, Alistair Phillips-Davies had an easy job relating the changes made to his company’s corporate purpose in relation to the climate crisis. He further argued that clarity of corporate purpose helped everyone in his company respond appropriately to the current Covid-19 crisis, albeit that this sounded like a general statement about how it was good for the company’s reputation to be seen to behave responsibly when this latest crisis hit. The session then wandered, as it seemed unclear whether the discussion should be about how companies respond to crises, in particular whether they should be holistic and strategic or driven by short term financial optimisation, or whether companies should become principals in addressing the crises themselves, which seemed to be the line adopted by Ngaire Wood of the Blatavnik School.

I was left frustrated as Colin Mayer tried to sum up both this discussion and the material covered over the three days of the summit, ultimately feeling that we were left with a laundry list rather than an understanding of purpose, and that this final session had left the impression that the purpose of the organisation had been reduced to steering the organisation through the crisis. This may be consistent with the thesis that an organisation can be viewed as an organism whose purpose is to survive, but it falls short of the Escondido Framework understanding the purpose of the organisation is to create value for society than cannot be created through a set of atomised transactions.

Mohamed Amersi was given a few minutes to wrap up the summit and, for me, saved the day. He referred back to the 1850 charter of his family’s business which stated its duty to its “superior creator”, suppliers, those served [ie customers], the state, shareholders, surroundings and society. He described the challenges we face today as planetary sustainability, inequity and technology. He spoke of modern society by way of an analogy with an apartment block containing a flooded basement, crowded middle floors and a growing penthouse, but with a broken elevator. He despaired of top-down organisations in which no-one is actually in control and argued that is up to everyone to act – “If not you, who? If not now, when?”

How can technological change serve society through purposeful business?

This third session of the on-line British Academy Future of the Corporation – Purpose Summit was anchored in an interview with Satya Nadella, CEO of Microsoft and, as became clear, a living embodiment of the importance of purpose to business.

He conveyed a strong commitment to the resilience and survival of the corporation, and the place of purpose within this. Early on, he stated “A company should not outlive its social purpose. Its social contract should be sustained.” His final remark, in response to a question about what he wanted to achieve at Microsoft, was that measure of the contribution of leaders to their companies was that they left them with the institutional strength to outlive them. These two observations together add up to a compelling view of the role of the leader to ensure that the company’s purpose, in terms of what it provides to society at large, creates value for society. By implication, strategy is about adapting to ensure that the company’s purpose continues to achieve this.

Nadella, in common with Alan Pole of Unilever in an earlier, reflected on the importance of a company’s purpose in relation to meeting he challenges of the climate crisis and inequality. He spoke of the need for economic growth, but that it needs to serve everyone, to be anchored in popular trust, and to be sustainable – “you can’t have growth and break the planet.”

Nadella spoke repeatedly about the need to earn and maintain the license to operate, a particular concern for the very largest technology companies. They need to be more sophisticated in avoid the harm that is a consequence of their scale – not least to keep regulators and would be regulators off their backs. He spoke of the need for companies like Microsoft look upstream of themselves and see what they can do to ensure that through an embedded culture and value system of their own they do what they can to shape their external environment so that “we can be customers of good stuff”.

He was asked whether the pressures of quarterly reporting imposed short term pressures on Microsoft and compromised its corporate purpose and own long term strategy. He acknowledged that quarterly reporting was a constraint but only insofar as it forced the company to explain what it did and why. He explained that he had no difficulty, for example, justifying to his shareholders why Microsoft invested in local housing projects in Washington since the company need to support its wider workforce, not just highly paid software engineers but also people in blue collar service roles keeping the local economy operating.

Chair of the House of Commons Science and Technology Select Committee and former minister, Greg Clark, had to follow this tour de force. He reflected on the how the Covid-19 pandemic had accelerated some technology trends such as video-conferencing but also commented on the degree to which the recent experience surrounding the popular responses to apps to tracking infected patients had highlighted the importance of face to face contact in service activities.

The third contributor to this session was Ngaire Woods, Dean of the Blatavnik School of Government at Oxford who focussed on the role of government in regulation and the limitation of self regulatory codes in prevent a “race to the bottom”. It was apparent that her underlying thesis is that, notwithstanding the sense of purpose adopted by some business leaders, regulatory intervention is necessary – citing as her example the need for Robert Peel to secure the legislation to ensure widespread adoption of the standards in factories that Robert Own had pioneered. She also highlighted the need for appropriate regulation, in that the cheap solution is not always the best (using the example of the alternative approaches to preventing oil spills: the inexpensive solution of a fining system was ineffective whereas the policeable and expensive solution of requiring tankers to have a double skin has been highly effective). In answer to questions later, she also argued that governments should be prepared to use their power as lenders of last resort in the pandemic to secure responsible and purposeful behaviour by business – an answer that unwittingly brought us full circle back the issue addressed by Nadella of the license to operate.

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

Purposeful finance – in ancient Ephesus

I have always been interested in long lasting institutions. I attended Corpus Christi College, Cambridge, established by the city’s townspeople in the aftermath of the Great Plague, and lived for a year in a room in its Old Court, built in the 1350s. There was something very special about occupying a room that had seen young men* engaged in the same endeavour for over 600 years. A few years later, living in west London, I relished the occasions driving when I found myself behind removal vans owed by the local branch (sadly since renamed because the branding confused the locals) of the Aberdeen Shore Porters Society, that proclaimed its foundation in 1498.

Esra Turk wrote a fascinating article in the FT on 20 August about an even longer lasting institution, a bank rather than a college or a logistics business, albeit one that was abolished 1600 years ago by a Roman emperor, a Christian intent on stamping out pagan beliefs. The Artemision was one of the earliest known banks, operating within the great temple of Artemis (as known to the Greeks, or Diana to the Romans) at Ephesus, one of the seven wonders of the ancient world. Its origins were as a place to deposit wealth under the protection of the deity and predate Croesus, the first ruler to issue gold coinage, and man synonymous with great wealth and an early depositor in the Artemision.

Turk recounts how the Artemision developed to become more than just a safe deposit facility for the mega rich to evolve “into a much more sophisticated regional and international financial institution, operating not only as a reserve and depository bank, but also undertaking fiduciary and mortgage business. The accumulation of earnings and reserves were of such magnitude that it became known as the Bank of Asia”.

What was the behind its success and its longevity? As every pre-digital retailer will tell you, the first was location – Ephesus was the central junction of the ancient world. But beyond that, Turk spells out three great strengths: purpose, leadership and a clear view of risk.

Regarding purpose, Turk observes, its “sophisticated banking functions were always carried out in the sacred service of a goddess with a strong ethical code. Similarly, banks today need a guiding purpose that looks beyond financial performance and provides a clear and sustainable ethical framework”. It may be a stretch, but is there anything in the waxing and waning of some of high street financial institutions in the UK to link the points at which they have exhibited most resilience and placed themselves at great risk to the strength or weakness of their links to heritage of their Quaker and Non-conformist founders?

Regarding leadership, Turk tells us its “governance was characterised by high levels of personal and collective accountability, trust and connection to the society in which it operated”. Leadership was initially jointly vested in the high priest and priestess of the temple and later in the sole charge of a high priestess. Turk wryly describes this as “an experiment not much emulated in the subsequent 16 centuries, but perhaps worth revisiting”. Not so much the 30% Club as the 100% Club. Gender may have played its part, but I think Turk’s core message is that accountability and trust embodied in the priesthood and accountability to the deity was key to the longevity of the bank.

Regarding the clear of view of risk, Turks suggests that bank was a model of prudence and caution, deploying its own capital as well as the funds of its depositors, and restricted itself to low risk lending because the money help under the goddess’s protection had to remain inviolable. No sub-prime activity in the Artemision!

*Corpus Christi only started admitting women undergraduates in the 1980s

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