In our review of corporate governance last year, we took the view that the UK should move from its primary focus on ‘creating shareholder value’ to a broader stakeholder-focused economy that does not privilege shareholders over everyone else.
It is gratifying to see that the Financial Times is now also calling for a change in the social contract between business and society.
Our argument was based on the idea that the privileging of shareholders over all others was causing significant damage to the economy while driving ever increasing concentration of wealth.
We also argued that there is no coherent group of ‘shareholders’ whose interests can be served. Shareholders are a diverse group with multiple different objectives. Which of these are company directors supposed to serve?
We also briefly made the point that ultimate shareholders have no voice. This point is particularly well explored by Mihir Desai in an excellent book titled The Wisdom of Finance: Discovering Humanity in the World of Risk and Return (worth a read). Desai elegantly lays out the complexities of the interaction between Principals and Agents. He describes how, in a shareholder economy, company managers are assumed to be agents of shareholders.
Investment houses and activist investors (who paint themselves as the shareholders) are actually agents for (mainly) pension funds. And the pension funds themselves are agents for all of us whose money they are holding in trust. Yet, along the whole chain, everyone has a different set of incentives to maximise their own interests rather than that of the ultimate principals (you and I). “In short, capital markets begin to look like a daisy chain of principal-agent contracts, each with significant problems and conflicts,” according to Desai.
In short, it’s our money and our investment. But how many investment managers and pension funds are asking us what we want from our investment and how we want the companies we invest in to behave? And if they did, they would likely get as many opinions as there are people making the whole thing impossible. The whole idea of acting in the interests of “shareholders” is, in today’s world, nothing but a sham.
The net result of the current system is embedded short-termism, wealth that is not created but largely transferred from one part of the system to another, and a financial system that is in a position to extract a significant chunk of value for itself. Desai argues that most of the problems we are seeing with capitalism in its present form can largely be explained by the Principal-Agent issue gone wrong.
It’s not a question of blaming this or that party in the chain. Everyone is acting according to the incentives and the opportunities open to them. What is needed is re-thinking the system to make it more fit for purpose. And that is not as difficult as it might seem.