Like a bubble sluggishly rising through murky waters, corporate governance is climbing the political agenda. Everyone intuits that something is wrong – including Theresa May and Donald Trump – but neither of them has an inkling how wrong. One glaring testimony: May’s unaccountable failure to cross-reference her governance and industrial policy Green Papers, as if there was no link between how companies are run and what they actually do. Another is her treatment of exorbitant pay as a standalone issue rather than as the outward symptom of the dry rot that is consuming the system from within.
The big thing she doesn’t get is that corporate governance isn’t a private matter for companies and directors. As the FT’s Martin Wolf has put it, ‘Almost nothing in economics is more important than thinking through how companies should be managed and for what ends’. This is because growth, productivity and employment – the macroeconomic big three – aren’t destiny, an impersonal economic force imposed on us from outside. All three are the aggregate of ‘what companies actually do’, and what companies do is the result of decisions about how to allocate resources by corporate managers and directors. Managers’ motivations matter. Corporate governance is therefore a macroeconomic, and also political issue.
Take February’s aborted $143bn run at Unilever, the UK’s third largest company, by US group Kraft Heinz. This isn’t a boring accounting exercise, albeit one expressed in stratospheric numbers. It’s capitalism’s clash of civilisations. The outcome of mega-deals like this could set the course of our economies for years to come.
Managerially, philosophically but also in terms of their practical outputs, Unilever and Kraft Heinz are, well, soap and cheese. Anglo-Dutch Unilever (2016 turnover €52.7bn, net profit €5.5bn, 168,000 employees) is avowedly about long-term environmental and social sustainability. CEO Paul Polman has pledged to ensure Unilever survives for another century. On his appointment in 2008 he invited shareholders who didn’t share his long-term aims to place their money elsewhere. Mostly they do: 70 per cent of shareholders have held their stake for upwards of seven years, against the global average of five months.
Polman was ‘appalled’ at the Kraft Heinz approach, and his no-uncertain-terms response was instrumental in provoking the bidders’ sharp retreat. Not surprising. Unilever is one of the last representatives of what economist William Lazonick has termed the ‘retain and reinvest’ school of resource allocation, under which firms keep most of their profits to reinvest in factories and human capital in the long-term interests of all stakeholders. This is precisely why it is attractive to Kraft Heinz, its exact opposite – a fiercely private-equity driven, shareholder-value obsessed serial acquirer that operates on the reverse principle of ‘downsize and distribute’. Instead of reinvesting in the business it distributes profits to shareholders in dividends and stock buybacks to lever up the share price. It doesn’t do innovation; its route to superior margins and returns to shareholders is fierce cost- and particularly job-cutting – all of which makes Unilever, with its lower margins and enormous headcount, a juicy target.
To understand what this might portend, consider Kraft Heinz's back story. Its creator and the driving force behind it is Brazilian private-equity group 3G Capital. 3G has form, having already done a job on global brewing industry. Starting with a Brazilian brewer in 1989, 3G has steadily consumed its way up the brewing drinks chain, culminating in the 2008 purchase of the world’s No 1 and and in 2016, in a $100bn deal, No 2 brewer to form AB InBev, a classic giant rootless ‘corporate citizen of nowhere’. AB InBev accounts for nearly one-third of all the world’s beer sales, and almost half its profits.
As described by Fortune magazine, 3G Capital’s ‘hard driving’ management philosophy is simple: buy, squeeze, repeat. Growth is not organic – it depends on identifying ever larger acquisitions to wring efficiencies out of. ‘It’s like the shark that has to keep on swimming,’ as one competitor put it. Unfortunately, that means the model eventually peters out when there are no more fat targets to eat or squeeze, or when even today’s feeble regulators say enough. That’s exactly what has happened in brewing. In other words, the model is inherently unsustainable. Which is why, in partnership with Warren Buffett’s Berkshire Hathaway, Kraft Heinz has been set up to repeat the roll-up in Big Food.
It’s hard to overstate the significance of this. Unilever – once described by a previous chairman as a fleet of ships, ‘the ships many different sizes, doing all kinds of different things, all over the place’ – is hardly the Muhammed Ali of multinationals, neither as nimble nor as hard-edged as some rivals. But what it ‘got’ – and was implicit in the retain-and-reinvest model that it still adheres to (albeit fraying at the edges: since the bid Polman has launched an urgent review of the group ‘to accelerate delivery of value to benefit our shareholders’) – was that jobs, far from being a necessary evil to be eliminated as far as possible, were an essential part of what made the model work: a vehicle for the redistribution of wealth and social mobility and thus the wider sustainability that Kraft Heinz and 3G airily ignore in pursuit of their narrow financial interest. In that sense, the latter are free riders on the remaining Unilevers of the world, which do care about their wider responsibility, on which they prey. No wonder Buffett is coming under fire from some quarters for the business methods used by his PE sidekicks, even if he keeps his distance himself.
Have no illusions that Kraft Heinz and 3G Capital have been despatched for good. They’ll be back – their model doesn’t give them a choice. When that happens, the issue they will want to focus on is benefits to shareholders. But behind that lie wider questions about how they do it, and at what cost to jobs, growth and long-term sustainability, and deeper ones about why, ie the motivations of those making the decisions. Those are at the heart of, respectively, industrial policy and corporate governance. A government with sovereignty on its mind should consider if we want to decide such matters ourselves or allow an Orwellian ‘UKH’ combination, or something similar, to do it for us. It may be our last chance.