Can investors be relied upon to police corporate behavior (governance) and guide the companies in which they invest to take decisions likely to create enduring value, and bring wider benefits over and above short-term profitability gains?
Can investors - which I take to include institutional investors like pension funds and intermediaries such as asset-management companies - be trusted to guide corporate managements around the Scylla of self-destructive behavior that might flatter short-term share prices but be catastrophic in the long-term, and the Charybdis of the pursuit by management of self-enrichment at the cost of long-term shareholder value?
Increasingly, I'm beginning to doubt it. Even though the UK and US governments still seem to believe that investors can be trusted to do such things, and despite all the hype surrounding the UK's “Stewardship Code”*, and the rise of movements such as socially-responsible investment and environmental and social governance, the answer to these questions is sadly "no" and "no".
There are clearly exceptions. A minority of institutional investors (including the California pension fund CalPERS, Dutch pensions giant ABP and the "Sage of Omaha" Warren Buffett), plus a select band of asset-management companies (such as Hermes Pensions Management and Fidelity in the UK) have a track-record of responsible intervention/activism with an eye on long-term sustainability.
But most CFOs and directors of listed companies tell me that the voices of responsibility are invariably drowned out by the baying hoard of more rapacious short-termist investors including hedge funds and high-frequency traders. And their time horizons are myopic.
There is a also as huge body of 'absentee landlords' out there - investors who routinely vote with management, never turn up at annual general meetings and only display their distaste with management by selling the shares.
I spoke to a couple of CFOs of FTSE100 companies late last year, and they told me that the UK government is naïve to assume that oversight of “corporate governance” can be outsourced to the investment community. It's about as dangerous as entrusting the care of your toddler to a known paedophile, they implied.
In their experience, the bulk of investors don't give a damn about what's good for a company in the long term - they just want to egg on management to follow the strategy that is most likely to generate short-term share price gains - and to hang with the consequences.
This reminded me of an interview I did with Catherine Howarth, chief executive of Fair Pensions (recently published as a QFINANCE Viewpoint) in which she said:
"Fund managers have forgotten about their encouragement of behaviors and business practices in the banking sector which fueled short-term profitability but in the long term saw players like Northern Rock self-destruct … If you look at fund managers’ voting behavior in the run-up to the financial crisis, it’s impossible to describe them as having acted as a brake on risk-taking."
Catherine also pointed me towards an interview that Terry Leahy, who recently stepped down as chief executive of Tesco, gave to the Sunday Times (published on September 26, 2010 but behind the paywall). In this Leahy accused institutional investors of forcing business leaders to take a narrow short-term perspective.
“Executives who constantly have to look over their shoulders to satisfy analysts’ and investors’ short-term expectations, and do what is “right for the market”, can develop an aversion to risk and be distracted from doing what’s needed to deliver value in a few years’ time.
Leahy also said that, at most meetings with institutional investors, the investors "are simply seeking information to populate a spreadsheet", adding:
"The penalty for not having greater shareholder engagement — and “ownership” in the broadest sense — is that management can fall into the trap of always looking over its shoulder, taking the least risky option, thinking only about the next results announcement, not the next business cycle or beyond. And if that happens, a vacuum of ambition is created."
A similar theme was taken up by Anthony Hilton in an article published in the Evening Standard last week. In this, Hilton questioned whether the Stewardship Code - trumpeted at a recent NAPF conference by Baroness Hogg, chair of the Financial Reporting Council, and to which 147 investors have already signed up - will make the blindest bit of difference.
He alluded to the problem of ‘intermediation’ (which I covered in an earlier blog post, that also explored the misalignment of incentives between the “end users” of investment services and the asset managers who are incentivized for next quarter’s performance). Hilton believes the Stewardship Code will only work if:
“Shareholders are committed to using this power and the authority which comes with it - and using it proactively and strategically to engage constructively with companies on a regular basis, rather than simply reacting aggressively when things go wrong.”
He's right. Personally I'm not holding my breath.
*Some observers of the UK financial scene are convinced the UK's Stewardship Code is an exercise in window-dressing, whose sole purpose is to pre-empt draconian corporate governance legislistion being put together by Michel Barnier EU commissioner for the internal market.
Further reading on corporate governance reforms:
- Managing 21st Century Finances by Terry Carroll [best practice]
- 'Big Oil' driven into blind alley by myopic investors and 'resource nationalism' by Ian Fraser [blog post]
- Viewpoint: Jay W. Lorsch Lessons From the Credit Crisis: Governing Financial Institutions
- Corporate governance reform: Cable means business by Ian Fraser [blog post]
Tags: asset management , corporate governance , environmental and social governance , ethical investing , EU , institutional investors , short termism , socially responsible investing