Tag Archives: companies

Power sharing

Shareholders don’t really “own” firms, so why do they call the shots?

We all like to read stuff in the papers we agree with, but it’s particularly satisfying to discover an idea that gives intellectual ballast to something you believe instinctively. For me, this was the case with Prem Sikka’s piece on corporate power and funding in yesterday’s Guardian.

British Motor Corporation share certificate from 1959.
A share certificate issued by the British Motor Coporation (forerunner of British Leyland and Rover) in 1959. Should possessing one of these give you dominance over other providers of capital, effort and knowledge?

Prem is professor of accounting at Essex University (stay with me). His point is simple but revolutionary: the idea that shareholders “own” firms is wrong. In fact, shareholders provide only a small fraction of total capital for most large firms – around 5% to 7% for major banks, and less than 50% for almost all FTSE 100 firms. Most capital – including what accountants call “intangible assets”, like knowledge and brand loyalty – comes from other stakeholders, including workers, suppliers, customers and society at large.

Given this, “there is no logical or financial reason to prioritise the interests of shareholders over other stakeholders in large companies,” says Prem. “In an era of universal suffrage, enabling only those with financial interests to elect directors is unsound.”

(This prompted me to dig out the accounts from my own small business. We are by no means a heavily indebted firm but, sure enough, the capital from other people – creditors, the bank and the goodwill of our clients – would probably add up to rather more than I and my business partner have put in.)

Last summer, I wrote a piece asking why, when we have so many models in the public and “third” sectors, we still only have one clapped-out model in the private sector: the shareholder-controlled, profit-maximising corporation. Shareholders are the one stakeholder in a firm whose sole interest is maximising profits in the short-term. And yet we let them run the whole shooting match. I didn’t pick up on Prem’s argument about shareholders not really owning firms and having no moral right to control them, but he’s the professor of accounting, not me.

His solution is “to get rid of shareholder supremacy from company law”. Yes, we need to promote alternatives to the conventional corporate model – mutuals, co-operatives, not-for-profit organisations and the like – but we also need to rethink what a “company” is, and what it’s for.

We might also be able to get rid of the awkward distinction between the “private sector” and the “third” or “not-for-profit” sector. Many small private firms already operate informally on a kind of “third” sector model, with goals other than just maximising profits (I know mine does). This is because of the choices their owners make about what they want to achieve, how they want to live their lives, or simply because they want to treat their workers with respect. No doubt these small businesses are what the serious “entrepreneurs” on Dragon’s Den dismiss as “lifestyle businesses”.

But large firms are locked into this one corporate model which forces them, sooner or later, to behave in the same way – running cartels, rigging prices, avoiding tax and ripping off their workers and customers. It’s only through these “institutional abuses” that companies can meet the inflated profit expectations of the stock market and the equally-inflated salary expectations of their directors, argues Prem.

Like me, Prem believes “the primary purpose of a corporation is to serve society” in whatever way works best. Supporters of the status quo will argue that shareholders’ ruthless pursuit of profit does this by bringing prosperity and creating jobs. But workers and other stakeholders want those things too. Why do we think here-today-gone-tomorrow shareholders, who often have little involvement in the company they’re supposed to “own”, know better than all the people who work in it, depend on it and, just perhaps, actually care what happens to it?

Empty vessels

Many British firms are just investment vehicles with nothing inside.

I run a small business. We don’t have a mission statement and we’re not about to write one. But I do sometimes think about what the purpose of our business is. I know it’s not to maximise profits. It might be to make enough profit so my business partner and I can earn a reasonable living. It might be provide us with work we enjoy. Or to work with clients we like and whose aims we respect. Or it might just be a way of dodging the routines and vicissitudes of corporate life.

It’s probably a bit of all of these things and more. We have a variety of purposes and a range of motivations, some of which probably conflict with each other, and the relative weight we give to them probably changes from time to time. I suspect most very small businesses are like this — their purposes directly reflect the lifestyle choices and shifting enthusiasms of their owners and workers.

Large companies, with thousands or millions of anonymous owners, inhabit a different universe. Shareholders demand returns, and increasingly the returns they want are quick ones. Fewer and fewer investors in our hyperactive financial markets are interested in long-term earnings from anything as boring as dividends; they want higher share prices and they want them now. That way they can cash in their winnings double quick and don’t have to stick around for when things go south.

Maximising shareholder value is the only game in town. This means prioritising short-term profits over long-term growth and sustainability, ramping up asset values, constant image makeovers and rebranding exercises, hyping up mediocre or under-developed products and a mania for acquisitions and mergers (since takeover speculation tends to inflate share prices – I will write more on the Anglo-American obsession with takeovers, which many executives seem to see as some sort of virility test.)

The problem of short-termism in British firms has been well recognised, even by business insiders. But I think we’ve gone beyond short-termism. The problem is no longer just that companies think too short-term to achieve their purposes, it’s that they often don’t seem to have any meaningful purposes at all.

If shareholder value is all that counts, then firms are nothing more than financial products – effectively they are all part of the financial services industry which dominates the British economy. Many big British firms seem to be conglomerates of convenience, flashy investment vehicles cobbled together to catch the eye of speculators. It doesn’t seem to matter much to their owners or top executives what they actually do or make.

Writing in the Observer about the phone hacking trial last month, Will Hutton said: “Companies in general, and media companies in particular, must put a sense of purpose at their heart.” Even some business moguls can see the problem. Hutton quoted Elisabeth Murdoch (of all people): “It’s increasingly apparent that the absence of purpose, of a moral language within government, media or business could become one of the most dangerous own goals for capitalism and freedom.”

Good, but looking at the published strategies of FTSE 100 companies is still dispiriting. Capita and Wolseley are two (not untypical) examples. Capita tautologically describes its “business goal” as “building a sustainable business that meets the needs of our stakeholders”. Capita “generates and supports growth” by “targeting growing markets”, “securing organic growth and acquisitions” and “building our capacity and scale”. Capita grows by growing. This is a firm which seems to have no other purpose than to get bigger.

Wolseley, which (I think) has something to do with building materials, has a “vision statement” on it’s website: “Wolseley creates enhanced value for all stakeholders by leveraging the considerable strengths of its individual businesses.” That’s it. At least it’s short, but it’s no more meaningful than Capita’s.

Nothing about what they produces or the services they offers, nothing that shows any pride or interest in the work of their staff, nothing about what the firm aims to do for people or to contribute to society. It’s as if these companies exist in a separate world called “business” and have no relationship at all with the society in which they operate. Simply replacing the word “shareholders” with “stakeholders” doesn’t really cut it.

Does this matter? I think it probably matters a great deal. I have a small hunch this sort of attitude, coming from the top, has something to do with Britain’s notoriously lousy productivity, and a big hunch that it’s behind our rubbish levels of staff engagement. Certainly its hard to see how many workers will be enthused by concepts as remote and meaningless as “leveraging strengths” or “enhancing value”.

The free-market eats itself

Pfizer’s putative takeover of British pharma giant Astra Zeneca exposes yet another intellectual paradox of free market economics. Left to their own devices, firms will always try to takeover other firms or force them out of business. But every takeover (or bankruptcy) by definition reduces competition and choice, which is supposed to be the whole point of the free market in the first place.

It’s always seemed to me that the three top dogmas of free market economics — rational behaviour, perfectly functioning markets and government non-intervention — contradict each other. If companies and firms always act rationally in their own self interest, they will always try to subvert the free market, unless the law stops them (and sometimes not even then). But in a free market, the government is supposed to stand aside. How can this work? Imagine a football match in which all 22 players are determined to commit as many fouls as they can get away with. Then send the referee to the stands.

Free market fundamentalists are always trying to kid us that firms are falling over themselves to "compete" for our custom. They aren't. Occasionally some business people will claim that they “welcome” competition. They don't, or if they do, their shareholders or owners certainly don’t. They don't want competition. They want, if possible, a monopoly, or as close to one as they can get. Is there any example, anywhere in the world, of a joint stock private company willingly giving up its stranglehold over a market? I tried really hard, but I couldn't think of one.

So how can “free” markets ever work perfectly, or even near perfectly, if every firm in the market has an existential urge to make sure they don't? It’s an idea that, as soon as it’s set in motion, destroys itself from the inside out.

As usual, free marketeers have little to say when the weird contradictions in their beliefs come to the surface. Some do admit that enforcing the rules of the free market might be a legitimate role for strong government, but they always seem to cry foul whenever a real government proposes to act — for example by blocking a takeover like Astra Zeneca which, whatever other damage it will do, will definitely reduce choice and competition.

In theory, a real free market government should not allow any takeovers at all, except where the target firm is seriously at risk of failure. But then it wouldn’t be a free market any more, would it?

This 18th century monolith is ripe for reform

Hardly an hour passes without talk of some new reform in the public sector. For at least thirty years change has been a constant in public services. Indeed the job of a public sector leader – perm sec, chief executive or whatever – seems to involve little else but going round telling everyone how much the organisation needs to change. You wonder how they find time to do whatever it is the organisation is supposed to do when it is not reforming itself or being reformed.

The joint-stock company model remains essentially unreformed since the time of the South Sea Bubble in 1711. Pic: Library of Congress.
The joint-stock company model remains essentially unreformed since the time of the South Sea Bubble in 1711. Pic: Library of Congress.

Any failure in a public sector body – or sometimes even by a single public servant – is met with instant and shrill demands for the entire system to be changed. Mid-Staffs was not just a badly run hospital; it was symptomatic of a disease afflicting the entire NHS (if this were true, of course, there would have been no Francis Inquiry, as Mid Staffs wouldn’t have stood out). For these people, it doesn’t matter how much public services have been buggered around with, they are always ‘unreformed’. Only one reform counts: making them more like the private sector, preferably by transferring them to the private sector altogether. This is so widely accepted – even by people on the left – that an outsider would imagine our private sector to be a gleaming model of efficiency and service.

Actually, quite a lot of the private sector is rubbish. Banks, insurance companies, supermarkets, the railways and the utility and oil companies are among the most despised and distrusted organisations in the country. If you can’t find somewhere affordable to live, if your broadband doesn’t work, if your pension scheme isn’t delivering what was promised, if you can’t get a seat on a suffocating train, if an elderly relative has been abused in a care home – it’s the private sector that has failed, not the public. It’s private sector firms that brought you horse burgers, phone tapping, Windows 7, incendiary fridges, PPI, ‘self-checkouts’ and – the daddy of all cock-ups – the great recession itself.

This is the culture we cherish so much we’re extending it further and further into our lives. If you can’t get a GP appointment, your local school is failing, escaped cons are roaming your neighbourhood – even if your Boris Bike breaks down – it’s more and more likely that a private sector firm is responsible (usually Serco). We hear a good deal about the failure of big ‘government’ IT contracts – but a good deal less about the firms who failed to deliver what they were contracted to do. So why do we only ever talk about reforming the public sector, never the private?

Most private firms would wilt in minutes under the kind of scrutiny public sector managers have to deal with every day. There’s no Francis Inquiry into the obviously systemic failure of the banking sector, just a compliant Parliamentary commission under former banker and oil executive Andrew Tyrie. Ministers mull over prosecuting nurses for poor care, but pass over evidence of criminal fraud (LIBOR, PPI or pensions for example) by banks and insurance companies. There’s no shake-up of our greedy utility companies, no probe into BT’s monopoly stranglehold on broadband, no action on the eternal failure of the railway companies to provide the service passengers pay through the nose for. Just tame regulators, stuffed with industry insiders, presiding over cosy cartels that fob us off with the same products and the same lousy service under different brand names.

When Serco was caught overcharging the Ministry of Justice – ripping off you and me – justice secretary Chris Grayling said it was ‘indefensible and unacceptable’, but he didn’t do anything. After fraud and mismanagement were uncovered in the welfare to work scheme run by A4e, the company was eventually sacked. Good. But where was the inquiry? Where was the policy review? Where is the evidence that ministers have learned anything from their mistakes? (The employment minister at the time was, incidentally, one Chris Grayling.)

At most, you get the Daily Mail or government ministers railing against individual firms for their failings. But you can’t blame Scottish Power for putting up its prices, or care provider Southern Cross for trying to make a quick buck out of its property portfolio. This what those companies do, it’s what they have to do. They have one objective and one only – maximising shareholder value. And they’re not always very good at that.

There are many models in the public sector, but only one in the private. The joint-stock profit-maximising company is simply not fit for purpose in many areas. It has proved a hopeless way to run natural monopolies like railways and utilities. It’s not up to providing health or social care, as has been proved time and time again. It cannot manage competing priorities – the way public services have to do every day – because it has only one priority. Why do we think this creaking 18th century model is so perfect, so superior to everything else, that it can never be challenged and must be applied to everything we do as a society?

With only one model, all large corporations are forced into the same mode of behaviour: short-termism, cost-cutting, service degradation, price hiking, misleading marketing and pressure sales tactics. Even charities have started to behave like this. But why do all companies have to be profit maximising? Some, while needing to generate profits to stay in business and invest for the future, might have purposes other than squeezing the last ounce of profit out of their suppliers and customers. Might some have social interests, or the interests of their workers or clients at heart? Actually, many small businesses have such diverse priorities because of the way their owners choose to run their businesses or live their lives. But big corporations, with only one model to follow, have no choice but to behave the way they do.

Cameron: "There is such a thing as society, it's just not the same thing as the state." It's not the same thing as SERCO either.
Cameron: “There is such a thing as society, it’s just not the same thing as the state.” It’s not the same thing as SERCO either.

If he’d meant a word of it, David Cameron might have been onto something with the Big Society. No, it doesn’t always have to be the state, but it doesn’t always have to be the big private corporation either. And might not the ‘third sector’ also be an alternative to the private sector as well as the public?

There are failures in both private and public sectors. But where the public sector is expected to innovate and reform in response to failure, the private sector gets away with shrugging its shoulders and wringing its hands. It’s as if the private sector was created by God 300 years ago, and must be left unsullied by human hands. It’s time we changed that.