InvestmentsOct 19 2015

It is not all about shareholder value

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The investment industry is governed by a flawed, overly simplistic logic, which states that investors should seek out companies that give absolute primacy to the interests of their shareholders.

By doing so, the rationale continues, investors can rest assured their interests are being served by armies of loyal senior managers and executives, whose daily lives (and bonuses) are shaped by the need to maximise shareholder value.

It is the same pervasive logic that fuels the persistent and equally overly simplistic argument levied against responsible investment. By seeking out companies that do not give absolute primacy to shareholders, responsible investment products must, by their very nature, sacrifice or compromise returns.

In reality, the reverse is true. Responsible investment mitigates risk and encourages growth and returns in the long term, while shareholder primacy encourages short-term, inherently risky ways of doing business.

In her compelling book The Shareholder Value Myth, US law and business professor Lynn Stout equated the hold of shareholder primacy thinking to “a dogma, a belief system that was rarely questioned, seldom explicitly justified and… so pervasive that many of its followers could not even recall where or how they had first learned of it”.

Indeed, Ms Stout’s analysis suggests today’s all too familiar mantra of maximising shareholder value is a modern construct, emerging as a minority view in the 1930s and not gaining any real traction or influence until the 1970s.

She showed how by the close of the millennium, shareholder primacy thinking had reached something of a zenith, permeating not only corporate behaviour and decision making, but also legislative and regulatory frameworks.

It does not take an economic historian to know what happened next. The near perfect storm that began to engulf the global economy in 2008 was, in part, the result of a myopic mindset fixated on nothing more than the day’s share price.

Short-term earnings linked to shareholder value took precedence over any other sensible business goal, whether investment in innovation, quality of end product to the customer or a company’s positive impact on the wider community or environment.

Ironically, putting the interests of shareholders first has achieved the opposite. It has perpetuated a smash-and-grab model of investment, blurring the line between investor and speculator and failing to deliver improved returns for investors, who are forced to contend with deeply entrenched cycles of boom and bust.

Once considered the preserve of dissenters and mavericks, responsible investment acknowledges that building a successful business necessitates serving the interests of a wide range of stakeholders. Maintaining a balance between customers, investors, employees and the wider community are vital to growing businesses and societies capable of delivering long-term returns. Sacrificing returns has absolutely nothing to do with it.

Another perverse outcome of the primacy approach is its contribution to the growing misalignment of shareholders’ interests and industry leaders. The growing trend towards linking executive pay to share prices inevitably influences behaviour and decision making that does more to bolster short-term prices than longer-term performance.

While average returns have fallen in recent decades and productivity has fluctuated, the remuneration and wealth of senior managers and executives has grown exponentially. During the 1970s, the chief executives of FTSE 100 companies received around 20 times the pay of average UK workers, a figure that had risen to 183 times by 2014. And that gulf in wealth for those at the top has created a gulf in values.

There are few investors who would consider this to be in their interest, which raises the question of what is meant by the term shareholder interest. The idea that they are all motivated by the same obsession about the latest share prices, ignores the myriad other interests and values that could be influencing them.

To reduce all investors to self-interested, short-term, single-minded speculators completely lacking in empathy for anything other than the next payout seems a bit far-fetched. The investment industry has been incredibly slow to recognise and harness changes in consumer behaviour that proactively seek to mitigate risks to people and the planet.

If we want long-term sustainable businesses, then we need sustainable societies. To achieve this, businesses need to be a part of the ecosystem – feeding back into it, and not just sitting on the side looking to extract short-term profits above all else.

Paul Robinson is chief executive of Alquity