Thanks to the maze of intermediaries between wealth-creating citizens and the assets they collectively own, corporations have never been more divorced from their duty to serve their owners. Building on ideas from their recent book, What They Do With Your Money, David Pitt-Watson and Stephen Davis explain what has happened.
The simplest reason we call our system ‘capitalist’ is because those who own the capital decide who will run the companies in which they invest, in order to be sure that their wealth is protected. But here is a perspective that is often overlooked. The ultimate owners of company capital are millions of people around the world saving for pension and other contingencies. We typically, and rationally, delegate the job of overseeing companies in our portfolios to financial institutions that manage our money. So big fund managers such as Blackrock or Axa or Nippon Life, for example, will vote in our name on the board members of the companies in which they hold shares on our behalf.
But can we be confident that such agents are configured to put our interests first? Will they act as the best possible stewards of our capital? Observers, long focused on how companies act, are now turning the spotlight to how such investing agents behave. And what it reveals is hardly comforting.
For one, agents may have tenuous accountability to their ultimate capital providers. If we lose trust in board members of our pension fund, for instance, we may have no recourse available to us to oust them. Worse, financial agents often provide scant information on everything from their own governance, to the way they exercise rights on our behalf at portfolio companies, to precisely how much in fees they subtract from our nest eggs each year. That makes it nearly impossible for any consumer-investor to get a reading on whether an agent is truly acting free of conflicts, and is properly active in advancing our interests.
The challenge is magnified because, in the space of a generation, we have seen a massive proliferation in the number of financial intermediaries operating between us, the savers, and the companies in which we invest. That further attenuates accountability between corporate boards and ultimate owners. Moreover, funds have embraced portfolio strategies compelling them to invest in thousands of companies, but without ramping up a parallel capacity to truly oversee each of them. It is not uncommon for a big mutual fund, for instance, to employ just one or two individuals to manage voting shares in our name at 10,000 plus portfolio companies worldwide. The truth is that the investor discipline of acting as a “capitalist”—that is, overseeing the companies we own—is the most under-resourced corner of the capital market. Combine that with another trend—the shift to investing through derivatives, which can separate the economic interest in a company from its owners—and we face a double assault on the pillars of market capitalism. We are creating “ownerless corporations” with no-one responsible for overseeing their activities. And we are tolerating too many unaccountable financial agents, who separate us from our capital.
Reasons to be cheerful
There is, however, some cause for optimism. The root cause of dysfunction is not chronic fraud or dishonesty. It is market architecture that has fallen obsolete. Pragmatic fixes are at hand to re-animate the ability of owners to exercise ownership.
For starters, grassroots capital providers have new groups to champion their interests at financial bodies. ShareAction, the London-based NGO, has gained traction advocating accountability and transparency among investment agents in the UK. It is launching a related initiative—the European Responsible Investment Network—for continental Europe. Moreover, technology and social media could prove a force multiplier in advancing such efforts.
Take the example of Buycott, a free app launched in 2013, which aims to help consumers align their values with their purchasing. The first question it asks is: “Have you ever wondered whether the money you spend ends up funding causes you oppose?” You can scan a product at a store to see if the company that produced it is involved in any ethical campaign you support. Now, let’s imagine a smartphone tool that asks a parallel question: “Have you ever wondered whether the money you save ends up funding causes you oppose?” It could compare pension or defined contribution savings plans, providing you with a picture of how accountable each is, how fees compare, and how well or poorly they align with what you believe. That’s a gap waiting to be filled.
Tech approaches hold other promises. Today, those with a defined contribution pension plan can easily summon online pages filled with latest data on holdings, transactions, and stock prices. But what’s conspicuously missing are real-time updates on how the funds you own have voted in your name at portfolio companies on key issues such as CEO pay, or engaged in your name with boards on climate change. Funds now have access to technology that would make this straightforward.
Another emerging technology could help retail investors vote shares directly at companies they own. In the US, individual investors account for 27 percent of the average company’s shareholders, but they are deterred from voting by the complexity of the system. While institutions vote 90 percent of their shares, individuals vote just 29 percent of theirs. But “Advance Voting Instructions” (AVI) allow investors to vote automatically, with or against the management, or with a well-known third party such as the giant pension fund CalPERS, or with the recommendations of a proxy-voting agency. While widespread AVI is not yet available, it is being examined in the US by the Securities and Exchange Commission (SEC) and the American Business Conference, a trade group of mid-sized companies.
Empowering citizen investors
Alongside 21st century technology, tested solutions such as disclosure and best practice principles can also play a powerful role in reframing markets.
Most nations around the world now have a national corporate governance code in place for publicly traded companies. Studies show that these codes have succeeded in making corporate executives answerable to boards, and that executives behave better when they know directors are watching them.
Institutional investors are also in the midst of an accountability evolution of their own. Proliferating stewardship codes spell out how financial agents should behave as owners of public companies and, in particular, how they should monitor corporate boards.
But who is watching the institutional investors on behalf of the ultimate providers of capital, the citizen investors? So far, we have no equivalent authoritative guidance addressing that critical piece of the investment chain. And as long as we savers have little voice, the system quite rationally has no structural motivation to pay attention to us. At the end of the day, rebooting capitalism is our job.
In our book*, we propose approaches designed to empower savers. Reforms could include, first, encouraging retirement plans to disclose the equivalent of a nutrition statement, so that consumers can learn in plain language whether their agents are configured to act in their best interests. Second, fund management companies should disclose exactly how much money they deduct from client accounts.
Third, 800 years after Magna Carta asserted the accountability of government to its citizens, we suggest a Magna Carta that asserts the accountability of financial institutions to their investors. A charter would lay out what citizen investors should expect of their financial institutions, including the principle that agents act as good owners on our behalf, are open and transparent, and that fiduciaries, or asset managers, are accountable and responsive to those who supply them capital.
Taken together, these steps would enable citizen investors to restore a healthy market focus on sustainable, long-term value. The capital market cannot any longer afford investment institutions to be absent without leave.
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