Or a case of: Absent owners, managers that act as if they own and get paid as if they take all the risks
Since the banking crisis that became a sovereign debt crisis, the world has begun to focus on the huge salaries and bonuses that are paid to bankers and top business people. In the last week, Barclays Bank announced that over 400 of their staff earned over £1 million in the last financial year.
Whereas those who place their financial lives on the line by building their own businesses and then, if successful, reap the financial rewards – but, if not successful, may lose everything – remain in high esteem amongst most people, those that risk no financial penalties whatsoever (but take massive salaries) have slipped further and further down in the public’s esteem quotient.
Senior managers and directors of major companies (including banks) and sales staff that take home huge bonuses (especially in banking and finance) are no longer lauded for any value they bring amidst a view that their rewards are far too high bearing in mind the lack of risk that they have. This has resulted in the EU plans to limit the bonus payments to bankers – an extraordinary intervention in the marketplace.
Does the marketplace work?
Stock markets are deemed to be the best place to see demand and supply at work. There is more data collected on stock prices than anything else and it goes back hundreds of years. Constant pressure on transparency and liquidity means that markets like the US (DOW, S&P, Nasdaq) and the London Stock Exchange (and others of similar size and liquidity) ensure that supply and demand usually results in a price that means something.
While this has changed markedly with the intervention of computer-driven buying and selling as well as the fact that around 70% of stock is owned by institutions, nevertheless stock markets appear to be mainly market driven. That never means the price is “right” – markets provide a price on any day that may be driven by a myriad of reasons. However, the market price is the price and buyers and sellers are able to take legitimate decisions whether to buy or sell.
The owners of stocks and shares have, in the vast majority of cases, bought those stocks and shares in a secondary market – long after the IPO. While the majority of today’s owners of Facebook may be IPO buyers, this is only because the company had its IPO just months ago. For the rest of the publicly traded corporate sector, buying shares has little to do with the company involved.
Ownership of a share means potential increase in capital value and dividends growth – and some ownership rights which are rarely used by the individual buyer (although Martin Sorrell is facing some pressure from recently voluble fund holders). Shareholders are primarily interested in the value of the stock – almost unrelated to the company.
Robert Beckman, a well-known business writer from the 1990’s, estimated that 70% of a share’s value related to the way the market was going, 20% related to the industry and only 10% related to the individual stock. If true, this means that ownership of shares in the quoted sector is almost unrelated to the individual stock and owner responsibilities are negligible and rarely used.
In addition, the development of the joint stock company limits the risk to just the loss of the investment and no more (unless buying stocks through leveraged schemes or option trading).
Ownership means almost nothing these days when that ownership is in a publicly traded company.
Staff acting as owners
Lack of ownership in publicly traded companies (the understandable move away from the 19th Century where owners were managers), means that senior managers now act as owners. While it is absolutely true that managers spend considerable time talking to representatives of shareholders (pension funds and similar) and to others who write on their stocks (such as journalists), this is to keep the price up in the market relative to other stocks in the secondary market. It is part of the process of market transparency. Today, that is the main connection between management and owners (at least in terms of the value placed on the stock).
The Board (with non-execs here to represent the shareholders) carries out primarily a governance role and has, usually, a compensation committee. Their job is to see that senior staff are paid a salary commensurate with the market or whatever and to secure senior staff in their jobs. This crucial role has, of course, been shown to be spurious in recent years.
The banking crisis has shown that there is no such thing as market rates for top staff in major corporations. Has it been just a way of jockeying for position that seeks to provide pay at the highest levels possible? CEO’s claim that they need to be paid international salaries to stay in their UK jobs no matter how poorly their companies’ share price performs.
Recent comments from those involved in the industry show how few CEO’s move abroad or from abroad to the UK. This basic tenet is mistaken, let alone the requirement to pay huge commissions to banking staff when their risk – like those of CEO’s – is no more than to keep their basic pay (already substantial) or in the worst case lose their job. This is completely unlike the entrepreneur, who has both management and ownership, and the heaviest of financial risks – the potential to lose his / her financial assets as well as their job. Both get potentially great rewards, but their risks are completely different.
Market rates of pay are notoriously difficult to derive. Where there is a vast statistical database, then it is possible – although here the markets are driven in different directions by groups of people getting together in unions to drive up market rates (and other forms of benefits).
The shareholder / manager dilemma
This can be stated for modern corporate life (in publicly traded companies) as:
Owners that stand back too far leaving managers that act as if they own companies and get paid as if they take all the risks
The issue is important for many reasons. We now have huge and dominant multinational corporations. We have shareholders that seek high and constant returns but have no affinity to the companies they “own”. We have managers that are (too?) highly paid and have wrestled a much higher share of the companies’ income to themselves than ever could have been envisaged and (in the UK and the USA at least) with over-dominant banking and financial centres which have tended to suck the life out of the entrepreneurial sectors rather than giving it life.
Can Shareholder Activism be Re-ignited?
As the West sinks dismally into austerity and behind the newly developing economies of China and India, where corporate ownership is complicated by government (intervention or direct ownership), we need a rebalancing away not just from banking and finance to areas of real value creation. We also need incentives for owners to own and managers to understand and accept real risk before they can access the type of returns that real entrepreneurs can access.
This will (if it is possible) drive any massive returns to the holders of real risk – those who can lose everything or gain massively. This is not the lot of managers – whose risk profile is slanted to the positive and whose manipulative skills are far greater than the quasi-shareowners buying their ownership in secondary marketplace.
Entrepreneurship is at the heart of business and growth of any economy. But, it is stifled by the rise of the manager in publicly traded companies where that rise absorbs far too much of the value created.
Shareholders are slow to act as they are, in the main, too far from the action, unknowing or a manager themselves – as in pension funds.
Now, the UK coalition government will be giving shareholders the right in annual general meetings to reject senior Directors’ pay proposals. The EU is considering the same thing. So, the pendulum is swinging in the direction of shareholder activism after many years of drift and decay. On both sides of the Atlantic, it is necessary for shareholders – who actually, in law, own companies, to assert themselves in pay and other issues. Economies in the West are dividing between those who are in control of an unrealistic share of corporate income (and in 2011, FTSE Directors pay rose 49% while average pay in the UK rose just 2%) and others. The others are shareholders and other employees.
A true market can only operate where monopolies fear to exist. It is apparent that quoted company directors have been able to set their salaries within a close market situation. In a long recession that we have seen in the West since 2008, it would be remarkable for there not to be a kick-back against the ability of one sector of society to benefit so much. Asking for constraint is insufficient. Markets have to be enabled and the recent moves to encourage shareholders to be more active and to give some powers that actually work are in the right direction.
Now it is up to the shareholders (basically, the senior staff of fund-holders like pension funds) to bare their teeth – like they are doing at WPP – and show that just because they go to the same clubs and come from the same schools, shareholders can be properly represented and the market for top directors’ pay can be made efficient.
A Proposal or Three
With stocks bought in a secondary market where ultimate owners have little or no real understanding of the business or ownership responsibilities, it seems reasonable to require large owners of shares to take their responsibilities more seriously – how should secondary market shareholder activism become real? Some suggestions:
Proposal 1: all owners of more than 1% of shares of any traded company should be required to nominate a non-executive director or actively support the nomination of one proposed by another such organization.
Proposal 2: such organizations, who normally buy shares on behalf of others (pension funds, hedge funds or similar) should ask their own investors (mainly those who put their savings into those companies – not just their own shareholders) to vote on their proposals.
Proposal 3: all such organizations have to register as “major shareholders” when they accrue over 1% of stock in a company and the FSA / Stock Exchanges should monitor the job they individually do to actively monitor companies – in the same way that organizations monitor MP’s voting.
All the above relies on making this easy – e.g. online only voting within pension funds and similar (i.e. no computer access, no vote) but, in an age of digitization and where companies and owners are so disconnected, secondary markets need to become activated.