Vince Cable’s proposal to give shareholders a binding vote on CEO pay will do nothing to alter the short-termism of which it is both symptom and cause.
It’s true that short-termism is now ‘system-wide, with contributions from and interdependency among corporate managers, boards, investment advisers, providers of capital, and government,’ as an Aspen Institute report put it in 2009 (one of the signatories being Warren Buffett, who should know). But investors should remember who triggered the inexorable rise of CEO pay in the 1980s by complaining that bosses weren’t being short-termist enough: they did.
Their solution was to make managers act like shareholders by loading them up with stock-options and equity-based incentive plans.
Unfortunately, since then shareholder attitudes have become more, not less, short-termist. Long-term UK investors such as pension funds hold perhaps 40 per cent of shares on the London Stock Exchange. The average holding period for a share is now seven months, down from seven years in the 1970s and 10 in the 1940s. High-speed traders buy and sell within the space of fractions of seconds. Expecting fund managers, themselves subject to the same pay incentives as corporate executives, acting for short-termist shareholders, possibly in a minority, to promote long-term stewardship on chief executives is fanciful in the extreme.
And so it has proved. Fast forward two decades. From 1998 to 2011, reports John Chapman in the FT, ‘rewards of FTSE 100 chief executives grew at 12 per cent a year ... as they sought to deliver on short-term performance targets’. But there was a casualty of this single-minded focus on shareholders: everyone else. The labour share of output has tumbled, and although profit levels on both sides of the Atlantic are touching record highs, investment in the US and UK, the champions of shareholder primacy, has fallen further and faster than other developed countries.
Now we have reached the point where, as the Bank of England’s Andy Haldane put it: ‘A publicly listed UK company may well view dividends as the target and investment as the residual’ instead of the other way round, as in the past. The difficulty with that is that calibrating performance in terms of equity is deeply problematic. Either the measures are as likely to reflect general movements of the stock market as firm performance or they are easy to game in ways that unfailingly undermine the company in the long term – whether by share buybacks (which by shrinking the number of shares in circulation improve return on equity without the inconvenience of having to devise better products or services), increasing leverage and bumping up dividends on one hand, or slashing R&D, investment, advertising and now pensions on the other. Hence the well-known paradox that a company is never as profitable as when it is about to go bust. Look no further than the banks for a good example.
In the real world, of course, companies aren’t financial abstractions. They are complex human organisations which succeed not through short-term financial engineering but the hard work of organisation-building that fosters contribution from all the resources necessary to make and improve products and services that customers wish to buy. Shareholder value is the by-product of the efforts of employees and customers – as überguru Gary Hamel puts it, shareholders ought to want CEOs to be aligned with them, not outsiders who may have the same relationship with hundreds of other companies and no real knowledge about how the company actually works.
The fact is that governance based on shareholder primacy when shareholders can’t or won’t exercise stewardship responsibilities and don’t in any real sense own companies anyway, is an exercise in the manifestly absurd. As Sir David Walker remarked in his review of bank governance, ‘as a matter of public interest, a situation in which the influence of major shareholders in their companies is principally executed through market transactions in the stock market [ie selling their shares rather engaging with companies they invest in] cannot be regarded as a satisfactory ownership model…’ In the absence of engaged shareholders to police the contracts, the agency model is a runaway train, guaranteed to produce increasing short-term returns to chief executives and short-changing everyone else.
One of the most pernicious creations of the fundamentalist ideologues on whose theoretical musings the shareholder value creed is based is the Efficient Market Hypothesis. Taken literally it implies that to maximise shareholder value executives don’t need to worry about the long term, since all available information about future prospects is incorporated in today’s share price. That investors with hindsight are regretting the effects of such arrant nonsense is perhaps not surprising. Alas, they should have been more careful what they wished for.