How can executives credibly demonstrate that they will uphold the interests of anyone other than their short-term shareholders? If they cannot do so, then their good intentions will carry no more conviction than they have done in the past.
My interest in the need for companies to restore trust among their stakeholders has spiked since early February when Barclays’ CEO Antony Jenkins announced his intent to shred his bank’s culture, which he derided as “too short-term focused, too aggressive and on occasions, too self-serving.”
Oddly enough, Jenkins’ bold announcements coincided, almost to the day, of the publication of Colin Mayer’s new book Firm Commitment: Why the Corporation is Failing Us and How to Restore Trust in It. Mayer’s assessment of the corporation (failure) and his remedy on that count are blunt and thoughtful. Perhaps his most thought-provoking point is that failures of risk management are not the actual source of recent corporate scandals (those routinely attributed to risk management failures).
Mayer, a professor of management studies at the University of Oxford, took time outfrom a promotional tour to address several questions, including one on what Barclays needs to do to make good on its CEO’s decree.
Business Finance: I hear a growing number of business thinkers describe a pervasive and growing level of mistrust as one of the largest problems businesses confront. One of my favorite thinkers bemoans the high transaction costs that mistrust –among civil society, business and governments –generates. What do you see as some of the most damaging business outcomes of declining trust?
Colin Mayer: The crisis of trust is being felt no more acutely than in business. People do not trust business to do anything other than to promote the interests of their owners and senior executives. Everyone else – customers, employees and communities – are viewed as pawns to the promotion of shareholder and executive wealth.
The consequences are threefold: first, a growing reliance on contracts and litigation to substitute for trust, which they repeatedly fail to do, despite the inordinate expense incurred. Second, a greater cost of doing business as we demand higher wages to compensate for greater job insecurity, cheaper products whose reliability and quality we doubt, and higher returns on savings on which we fear we will be defrauded. Third, we turn away from business altogether preferring to invest our money ourselves rather than rely on financial intermediaries to do it for us, stop eating foods that we believe to be contaminated, and choose to be self-employed rather than be employed by others.
Let’s talk a bit about some of the conventional ways we seek to restore trust, such as creating new business regulations. What is your take on recent corporate reforms, such as the Dodd-Frank Act, in terms of their ability to restore trust and also, more specifically, to prevent the decisions and behaviors that threatened the national—even global—financial systems?
Mayer: The one and only tool available to policymakers to correct a breakdown of trust and seek to re-establish it is regulation. All crises in confidence—the financial crisis, pollution scandals and contaminated food revelations—prompt cries for strengthened regulation. Politicians are incapable of resisting these calls; on the contrary, they seek to exploit them to political advantage.
But regulation, for example the Dodd-Frank Act in the U.S. and proposals to ring-fence retail banking in the UK, promote regulatory avoidance. Financial institutions do less of the activities that are regulated, such as lend money which we want them to do, and more of the unregulated activities, such as selling derivatives which we may not want them to do. They do less through regulated institutions, such as banks, and more through unregulated institutions, such as non-banks. They do less domestically and more overseas. The reason for this is that far from promoting ethical compliance, regulation encourages instrumental avoidance. Corporations employ compliance departments, which are in fact avoidance departments, and the more we try to regulate them, the more they seek to avoid it.
I’ve been impressed by the public pronouncements the CEO of UK-based Barclays has made in the wake of his company’s bad behavior. Whether or not Barclays exhibits those intentions in practice, of course, remains to be seen. Do you think there are applicable lessons within the ways leaders and their organizations respond to the costly misjudgments and reckless behavior (if not outright fraud) that they exhibited in the recent past? If so, what sort of lessons should we seek to observe and apply from these situations?
Mayer: “Our failures are a reflection of a culture and style of management which once pervaded our organization but is now a thing of the past” is a phrase that rolls effortlessly off the tongues of newly appointed CEOs of failed institutions. Getting stakeholders back through the doors of their institutions may indeed be the genuine goal of these CEOs. The question is: can they deliver?
There are two problems that they face in doing this. The first is that in all likelihood they will no longer be around in five or ten years’ time to ensure that they do. The second is that even if they are, their paymasters and shareholders may have very different views about what they should be doing. They may, for example, in the case of banks, be encouraging their executives to resume spending sprees on acquisitions rather than concentrating on restoring trust amongst their retail investors and small corporate borrowers.
The question that needs to be addressed is: how can executives credibly demonstrate that they will uphold the interests of anyone other than their short-term shareholders? If they cannot do so, then their good intentions will carry no more conviction than they have done in the past.
Almost all of the post-scandal investigations conducted by interested third parties conclude that scandal-stricken companies suffered from a “failure of risk management.” Yet, it is fair to say that many—if not most—large companies have invested substantial care, money and brainpower strengthening their risk management capabilities in the past decade. Do you see recent scandals as being a result of risk management failures or do you feel there are other root causes?
Mayer: Chief risk officers (CROs) and risk committees are as much a fashion of corporate boardrooms today as audit committees and independent directors were a few years ago. This is a response to a perception that the underlying problem in financial institutions, and banks in particular, was excessive risk taking. It was. But it is necessary to understand the root cause of that.
The excessive risk taking reflects a fundamental conflict of interest that exists between shareholders and the creditors (the depositors and bondholders) of a bank. Shareholders benefit from upside gains when the bank does well; and creditors take the losses when the bank does so badly that it goes bankrupt. From the point of view of shareholders it is, “heads I win, tails you lose.” Shareholders like to flip the coin, and they want their banks to engage in risky investment. They incentivize their management to do so and as a consequence, the financial crisis was a reflection of a conflict between the shareholders and creditors of a bank. That problem will not be resolved by CROs or risk committees. It requires that the fundamental conflict between an institution that has 90percent debt and directors whose primary duties are to the 10percent shareholders be corrected.
In your new book, you argue that the corporation no longer serves the interests of society at large and has been hijacked by one particular interest group, its shareholders. Why has this happened, and what do you suggest that the corporation and society among other stakeholders do to remedy this situation?
Mayer: The reason that its shareholders have hijacked the corporation is that as corporations expanded they issued equity to finance their growth and acquisition of other companies. As they did this, the ownership of the founders was diluted and companies came to be widely held by dispersed shareholders, none of whom owned many shares in a corporation.
To overcome the resulting problem of corporate governance, (the agency problem of who will monitor and manage the executives), a variety of mechanisms were employed to re-align the interests of managers with their shareholders. These included high-powered incentives that related managerial remuneration to shareholder returns, takeovers that threatened to replace failing management and more institutional activism.
But what these have done is exacerbate the conflict with other parties—employees, customers and communities—and between short-term shareholders who want immediate returns and long-term shareholders who seek returns over longer periods. To resolve these conflicts, the control of corporations should be in the hands of long-term shareholders and independent boards should be responsible for balancing the interests of the different parties.
Some of the most successful corporations in the world, such as Bertlesmann, Robert Bosch and Tata, are industrial foundations that demonstrate exactly these principles. The foundations are long-term investors with boards whose primary responsibility is to resolve the conflicts that exist between the different parties of the firm and ensure that they abide by the principles and values of the foundation.