The big men of the corporate West aren’t listening. Politicians have told them they have to cut back on their take of the world’s profits. Academics and journalists have told them. For the last couple of years their shareholders have been telling them too.
Yet their take still isn’t falling. This week the FT announced that top US and European bankers have just seen pay rises of 12%. “High pay persists despite poor performance,” said the paper. Overly high pay expectations aren’t just about banks – those in doubt need only look at the saga of Xstrata. How, you might wonder, can this be, given that no one (except the CEOs) likes it? The answer comes down to limited liability and the 1980s.
The idea that you could start a business but limit your losses was frowned upon well into the 19th century: so much so that if you wanted to start a UK limited liability company you needed a royal charter. Why? Because people worried that if non-owners ran businesses they would take too much risk and that if investors’ liability was limited, they would fail to supervise managers properly.
Those worries were gradually overcome as businesses began to need capital for large-scale investments. Limited liability firms became the norm and instead of destroying capitalism they moved it to a new level. Most people got richer; and for many years the risk problem didn’t appear to arise.
Then, as firms got too big for any one owner to control and the original entrepreneurs gave way to professional managers, it did. Two ideas from the 1980s marked the change. The first was that managers should always maximise profits. The second that manager interests should be aligned with those of shareholders on the upside via share options. The result? Managers set about pushing up short-term profits and share prices by squeezing everyone else – workers, suppliers and the taxman in particular. It worked. Share prices soared, as did profits.
But it came with a downside, one we’re now suffering the long-term effects of: rising inequality, static wages, falling investment and low economic growth. The pursuit of shareholder value has, says economist Ha-Joon Chang, been a disaster. Even Jack Welch, who all but invented it, now calls it the “dumbest idea in the world”.
The problem now is that it seems all but impossible to make it go away. Most managers like things as they are. Most fund managers are too short term to care. But the financial crisis has brought attention to the success of a group of managers who do focus on long-term quality and governance – managers such as those at Troy and at Fundsmith.
If we are lucky, the rest of the industry will notice how fast their funds (and hence revenues) are growing and follow suit, something that might begin the long process of reversing the problems caused by the dumb ideas of the last three decades.