Issue: Oct 2010/Jan 2011
Toward people’s capitalism
The great divide between company ownership and control, long entrenched, is being bridged. Welcome the recognition of shareholders, through their representative institutions, in bridging it. There’s a caution, however.
It’s hard to fathom who, if anybody, actually speaks for members of retirement funds. This is a rather absurd and unwholesome situation, given that it’s their money at stake in the multitude of temptations to which it’s exposed. In several respects, the problem is more easily stated than resolved.
Of course, there is a string of organisations entrusted with particular roles. There’s the regulator, the service providers and the fund trustees who’re all differently involved in various protective capacities. But there’s none actually to petition for the 10m or so members themselves.
Take the brouhaha on each occasion that there’s a move in interest rates. Invariably, downward adjustments are applauded from the rooftops. It’s as though consumers’ pockets are the be-all and end-all, no matter how the pockets of fixed-income dependents are depleted.
Or take the ownership codes on black economic empowerment. Rarely is a voice heard against the unconscionable exclusion of retirement funds, the biggest single repository of black people’s savings. Invariably, these members of the most broadly-based collective vehicles have been ignored. As existing shareholders in the largest category of JSE investors, they’ve been disempowered with each transaction by dilution of their proportionate shareholdings and hence of their dividend receipts.
Voiceless as a lobby, and vulnerable as an interest group, fund members’ muscle has atrophied. Until now. In one vital respect, they’ll be bench-pressing as they might never have dreamed.
Thank the proposed code for institutional investors (see Cover Story). One of its groundbreakers is in creating a bridge across the conventional divide between corporate ownership and control. It’s a call to arms for the stewards of savings. The more that institutions assert their ownership rights as direct investors, on behalf of indirect investors, the more that unfettered control is prised from company boards.
This is all rather revolutionary, but certainly in line with attempts through other western jurisdictions to reform a financial system whose loophole-riddled governance has been exposed. Banks, which own asset managers, are heavily to blame for the huge debts forced on taxpayers and the dire unemployment (not to mention pension-fund losses) that’s resulted around the developed world. They’re having to rethink their post-meltdown responsibilities.
In some countries, the shake-up is partly driven by legislation. Even so, it isn’t a case of poachers being turned into gamekeepers. The institutions themselves are owned by other institutions, significantly pension funds, and so are equally subject to shareholder interventions.
By a mix of good fortune, good judgment and good regulation, in comparison with their peers abroad SA institutions have emerged from the sub-prime and sovereign-debt crises as shining knights. Their rethink is of a different nature. Voluntary reforms as per the code are pervasive for potential impact. A gazetted Financial Sector Charter, with additional social obligations, is still to come.
What runs through the reforms is an emphasis on long-termism, consistent with such internationally-recognised beacons as the Global Reporting Initiative. It embraces the concept of ‘sustainability’, consistent with the long-term investment approach required of pension funds, as well as the concept of ‘stakeholder’ that covers a wider societal grouping than shareholders alone.
In modern corporations since the 1930s, ownership has been divorced from control. It implied that, as owner-managers (like the Rockefellers, the Oppenheimers) came to be replaced by dispersed shareholders (like pension funds, unit trusts), companies were essentially ownerless. Boards of directors are supposed to advance the interests of company owners, but where companies are effectively ownerless (with impotent shareholders) directors have too frequently proven a capability to advance primarily the interests of their own.
This is facilitated by boards’ self-perpetuating nature. Despite the exhaustive public disclosures required, their accountability is of the take-it-or-leave-it variety. Witness some of the avaricious remuneration packages, or short-term tactics calculated to boost short-term share performance that coincide with the payout of executive bonuses and directors’ share options notwithstanding the longer-term consequences. The supposed alignment of directors’ and shareholders’ interests has a mythological aura
Shareholders have only a limited ability to pass a verdict on board performance. Their rights have been pretty much confined to receiving dividends and attending shareholder meetings. The latter right is rarely exercised because voting is often pointless.
But once these dispersed shareholders band together as institutions determined in investors’ and stakeholders’ interests to promote long-term sustainability – inclusive of environmental, social and governance (ESG) factors -- the picture changes. Ultimate responsibility then comes to reside not in boards’ sole discretion, but in boards being tangibly accountable to agents of the end-beneficiaries; in other words, through institutions to the ultimate investor.
This revamped structure puts institutions – the stewards and the trustees – into the front line for corporate oversight. So far, so good. There’s a lot further to go. The prickles ahead are predictable.
For institutions themselves come in different shapes and sizes; hedge funds and arbitrageurs, by way of example, have time horizons completely different from pension funds. Also, within any particular institution, there can be conflicts; for instance, between the asset-management division wanting to vote against a company which is a client of the corporate-finance division.
And then there’s the sensitive matter of remuneration. Asset managers and consultants can’t seek for others the standards that their own employers don’t apply to themselves, and for themselves, unless they’re intent on forcing a lower benchmark for their own pay levels in so enviously-rewarded an industry. Might more modest packages and the end of bonuses for short-term performance yet be in sight?
The bigger picture is the elevation of corporates’ ESG practices in investment priority. Application of the investors’ code will be facilitated by the accelerating consolidation of smaller pension funds into larger, with heavier weight. It presages enhanced professionalism at the level of trustees and principal officers. This in turn will lead, may it be confidently anticipated, to more properly-structured institutional mandates and widely-adopted commitment to the exercise of shareholder ownership.
However, ownership too must have constraints. Competition and companies legislation come into play, as do JSE requirements and Securities Regulation Panel rules.
WHAT ‘SUSTAINABILTY’ IS
Both the King III corporate-governance report and the draft Code for Responsible Investing by Institutional Investors in SA provide the classic definition:
Sustainability of a company means conducting operations in a manner that meets existing needs without compromising the ability of future generations to meet their needs. It means having regard to the impact that the business operations have on the economic life of the community in which it operates. Sustainability includes environmental, social and governance issues.
Were a collusion of institutions able to fire a board, a change in control might be effected with attendant consequences that aren’t intended; for example, to force an offer to minorities and then for these institutions to run the company. Or for consequences that might be intended, say to boost the price of a share in institutional portfolios, but not necessarily be best for the company and its broader stakeholders; for example, to force an assets disposal.
A middle course is in its infancy. The SA code is a start, for institutions to vote in accordance with explicit ‘responsibility’ guidelines. The US is going further, where institutions that have held shares for a minimum period can get together in support of a limited number of their nominees for directorships. These are early days and the waters are untested. The tide is moving in one direction.
That much was predicted almost 20 years ago by management sage Peter Drucker in his Post-Capitalist Society: “Pension fund capitalism will become the universal ownership mode in developed countries. (It) is fundamentally as different from any earlier form of capitalism as it is from anything any socialist ever envisaged as a socialist economy . . . Pension fund capitalism is capitalism sans the capitalists....Wage earners are the main beneficiaries of the earnings of capital and of capital gains. We have no social, political or economic theory that fits what has already become reality.”
Bring it on.