The Ownership Disconnect – Managers, Shareholders, Risk and Markets

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.

Secondary markets

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.

 

Liberalism and politics – short-term thinking or the fight for ideals?

In the UK, the Liberal Democrats are holding their Spring conference this week. I declare an interest. That party represents the closest thing to the ideals that I hold – the belief that monopolies of any type are bad in principle and that the state (and other potentially totalitarian groupings) should be limited in scope and the individual in society provided with the best chances to succeed.

This overly-simplified outline of Liberalism (probably not social democracy) – at least to a British formula – where society is seen as individuals and groups that must be enhanced and where over-bearing accumulation of power is to be resisted – is nevertheless a strong reason why I pay my annual subs to the party.

Against the centralist doctrines of the Labour party (where state is still seen to be the best judge of everything) and Conservatism (difficult to assess but primarily a “market is best” doctrine allied to a notion that old institutions must be conserved no matter what), Liberalism should be the politics of the 21st Century. It shouts for the spirit of individuals and civil society making changes for the better against the rigid institutions set up in the 19th and early 20th Centuries. It should be capturing the spirit of the internet age – where freedoms to communicate should be elevating transparency and openness to a new generation (and convincing the old as well). It should be screaming about how the UK fits into the future of a world that continues to change (and not always for the better), where the rise and development of China threatens the drive to democracy and transparency that has been in place since the defeat of Nazism and totalitarianism after World War II and since.

Today’s Politics

Tragically, politics in the UK is all about shopping baskets. All our attention is drawn to GDP and austerity. These issues are important – especially to those living (or just about surviving) on low incomes. The drive to change taxation at the margin (and we always talk about changes at the margin – not true in the US where a real debate on dramatic changes in taxation are taking place – see John Mauldin’s latest on this) is a proper argument but the focus on taxation and its short-term impact blots out everything else.

Liberal Democrats believe in a wide range of issues. Moving in with the Conservatives as part of the Coalition Government has been a brave move that is hitting the party hard – based on recent polls. Shifting the tax burden to free those earning low salaries to a wealth tax (although the shift is tiny) is seen by senior Liberal Democrats as working to define the party.

Ask a voter what the Liberal Democrats stand for and they will probably answer with comments about university tuition fees or other short-term decisions made during this parliament.

Today’s politics, the politics of short-term economics and counter-terrorism (or long-standing views on how to counter the perceived threats that international terrorism poses) is our staple. Politicians (and we are not blessed with the cream of intelligence in that area – they usually became bankers in the 1980’s) are hooked on short-term ideas and the next election. It was ever thus.

GDP slaves, taxation dummies, election addiction, five year parliamentarians that act like five-year olds.  In the UK we may have been better off than our EU colleagues in Greece (we do have a society that respects to a greater extent tax collection as a cornerstone) but minor modifications to our lives emphasize the conservatism of the nation –  conservatism that is likely to propel the UK backwards and means that our influence is greatly lessened as the 21st Century progresses.

Tomorrow’s politics

Political parties are under threat. Their short attention span means they are missing the evidence that is before them. People and groups in society are pursuing single initiatives to great effect. Whether these groups are organized as NGO’s or small societies or other types of organization, civil society (propelled by new technologies) are able to have a greater influence on politics than ever before. Politicians and government has to be aware of that change and make efforts to respond to it

That response has to mean that decisions must be allowed to take place at the lowest level possible not at the highest.

It must mean that politics has to “open up”and be more inclusive – that means helping those in society to understand what parties stand for – really stand for – and the world that they see ahead.

It must mean that the political parties must continuously work to make themselves relevant.

For Liberal Democrats fighting to show themselves as sufficiently different so that voters provide them with a future beyond this parliament, it seems pretty important to use the remaining three years to do two, crucial things.

First, sure – secure the short-term changes that (even if at the margin) show benefits to that area of society that is bleeding because of the poor economic conditions.

Second, and far more important in the long term, ensure that Liberal Democrats shout about the society that the party wants to have in place and the UK’s place in the world. This is not about minor taxation shifts. This has to be a society where individuals and groups have a bigger say but also where the opportunities to develop (in terms not just of how many makes of designer trainers one can buy but in terms of real education opportunities, real quality of life from birth to death, a society where large, monopolistic groups which threaten that society from inside or outside are not tolerated) are maximized.

Liberal Democracy (or at least the Liberal part of it) has a strong tradition in all these areas. The message has been obscured in its pro-Europe and pro-euro fervour and over-reliance on short-term tax issues and the obscuring of its longer-term reason for existence and how it should want to change the world.

Nick Clegg’s speech back in December at the Open Society Institute made an attempt to voice some of these issues (see https://jeffkaye.wordpress.com/2012/01/01/liberalism-and…e-21st-century/).

Politics needs to motivate and excite in the 21st Century as large movements (such as the labour movement in the late 19th Century and early 20th) are not so obvious – that does not mean it is not happening.

The movement is now about individuals and groups within civil society using whatever tools are available (and which technology is supplying) to make their case. For Liberal Democrats, the aim should be to show how it supports that key change in society and can help and nurture it and maybe lead it and make it work.

Civil Society – Its Place in the 21st Century

Vern Hughes, Director, Centre for Civil Liberty in Australia, has produced a manifesto for the Mobilisation of Civil Society. Its ten tenets are:

1. Understanding the World Outside States and Markets
2. Personal and Social Relationships
3. Self-Help and Mutual Support
4. Small is Beautiful
5. A Leaner State with Less Bureaucracy
6. A Market Economy without Concentrations of Corporate Power
7. Social Enterprise in Finance and the Exchange of Capital
8. Entrepreneurship and Innovation
9. Social Enterprise in Education Health and Social Services
10. A Renewal of Democracy

and the full proposition can be found on:

http://www.civilsociety.org.au/Manifesto%20for%20the%20Mobilisation%20of%20Civil%20Society.pdf

This links so well with my own philosophy that, this week, it makes sense to show the Manifesto and my own comments on it – which is also displayed on:

http://www.linkedin.com/groups/Manifesto-Mobilisation-Civil-Society-wed-4137855.S.93363203

My own comments:

Vern, this is a courageous attempt to frame a new society and one that, in principle, has a great weight of sense behind it. The manifesto should consider some more variables – which you may already have done.
One is how Civil Society fits in a fractured world made up of democracies (however imperfect) and many states where even the simplest form of democracy does not exist. China is a major player now and the basic forms of democracy (and civil society) play no part. Economics as measured imperfectly by GDP – which ignores all “externalities” – is to the fore on a Maslow index where the basic needs are still to be met. Political change (in the way you suggest and in a way that makes much sense) is well behind in terms of priority.
Second, civil society works (or attempts to work) within the decision-making processes to effect change. Having spent five years in an NGO (until very recently at Global Witness, a pro-transparency and anti-corruption / conflict NGO), the key to any success is operating to make change. But, NGO’s and civil society organisations are unelected and the danger of a civil society in this form taking a dominant role (it already has a very key role) is not obvious.
Third, I agree that in modern society where information is available and transparency should be, the drive to more local decision-making is critical for most decisions. Large, centralised and almost totalitarian agglomerations (monopolies) should not be tolerated. However, the newly developing nations of China, Russia and Brazil (as examples) will see this as a secondary issue. Developed nations will stress the need to compete – this is a major challenge.
Fourth, reducing the state through localism is important but the state’s role needs to be better explained and will vary from country to country. The state has a role to play (such as being the guardian against monopolies across the spectrum) as well as traditional issues of defence and security. These roles are tough to assess.
Fifth, I argue in my own blog – https://jeffkaye.wordpress.com/ – that the economics and politics of the 19th Century is still dominant and need massive revision. I therefore support in principle the direction of change from your own NGO with economics being in the centre of the change. Apart from the inclusion of key externalities such as climate, waste, quality vs quantity, pollution that 19th Century economics ignores (except on the periphery of substitution and pricing – with massive disconnects throughout), politics and politicians are too short-term and too focused on the next election to build successful futures. That is why the Chinese and their lack of democracy appears more economically successful today. But, that is not the direction to travel.
So, good luck with this manifesto as a starting point for an urgent process of change!