Who do you trust? And how much? Back in 2006 the answers to these questions were pretty much as you’d expect. According to a series of YouGov surveys, over 90% of people trusted their family doctor to tell the truth; 81% trusted the BBC; and 65% trusted journalists on “upmarket” newspapers.
They didn’t much trust their MPs (44%) or trade union leaders (32%). But they really, really didn’t trust “people who run large companies” (23%). After the financial crisis, the chief executives were, oddly, the only group that didn’t see a decline in perceived trustworthiness — holding steady at 23%. I think we can now dismiss that as a blip. It’ll be zero in the 2015 survey.
We had a Volkswagen Golf until we had kids. Then we had a Passat – we still drive that ten-year-old Passat. But on the school run this week, I treated it with rather more suspicion than affection. Ask me if I trust corporate management this year and the answer will be “rather less than I did last year”. There’ll be a lot of people feeling the same about their (mostly newer) Passats — and wondering how it is that things so often go so very wrong inside the world’s biggest listed companies.
The answer, I think, comes down to two things. The first is the blurred lines of ownership of listed companies. Back in the 1930s, people worried that the rise of the small shareholder was creating “ownerless corporations”, companies that would end up being run for the ends of their managers rather than those of their shareholders.
Andy Haldane, chief economist at the Bank of England, gave an interesting talk on the subject this year. He noted that the response to these worries has been to legally hardwire shareholder primacy into “companies’ statutory purposes”: managers are obliged to act in the interests of shareholders. That’s nice, but it hasn’t worked very well.
Why? The “co-ordination problem” among shareholders remains. Most have only modest stakes in a company, so they have more incentive to sell than to take corporate action when they aren’t happy. That’s particularly the case now that so few shares in the UK are held by individuals (it was 50% in the 1960s, it is 10% today).
Most of us invest via intermediaries, so we know nothing of the companies in which we invest. And if the technical owners of a company are just thousands of inert fund managers who aren’t exercising their rights of ownership over that company, who effectively owns it? Is it the shareholders or the management, who make all the decisions about how the assets are used? And if it is the latter, how can we be surprised when they use those assets to fly their kids in a private jet to the company-owned hunting lodge?
The classic response to this agent/principal problem has been an attempt to align the interests of shareholder and manager by making managers into huge shareholders. In 1994, notes Haldane, US chief-executive compensation was one-third stock and stock options. By 2006, that had risen to 50%. This doesn’t work either — or help with the private jet problem.
If you use the jet for your kids, 100% of the benefit accrues to you. If you don’t, the £100,000 odd boost to profits is shared by everyone. No incentive there. It also opens up the question of which shareholders managers are best serving: is it the long-term holders (the savers of the world), or those who get more shares in their incentive deal if management pushes the share price or some other metric above a random-seeming target on some random short-term date? Quite.
This brings me on to the second reason why good companies turn bad: money. You could argue that VW, having one huge family shareholder, is mostly immune from the agent/principal problem. You can’t argue it has been immune from the money problem. Martin Winterkorn, the former chief executive, earned nearly €16m last year. And he is leaving the company with a €28.5m pension. The “align the interests” nonsense of the last few decades has changed the amount of money that top chief executives can earn from “a lot” to “enough to transform the fortunes of a family for generations to come”. This matters.
Max Rendall, author of Legalize: The Only Way to Combat Drugs, once explained to me how drug cartels succeed so brilliantly everywhere. They have almost infinite amounts of money and everyone has a price. So all a cartel has to do is to find the price of every customs official and politician they want onside and pay it. Job done.
Chief executives are just as vulnerable to super greed as anyone else. If you were in line for an effective bonus of $20m if you hit a target (say for international sales of diesel cars) might you tell a lie? Push a lousy product? Maybe you would. Maybe I would.
My point here is simple: ownership confusion and the corrupting effects of skewed financial incentives mean that the current model of shareholder rights is close to broken. That isn’t new news, but I suspect it will be brought into sharp relief by the VW scandal. There is no shortage of ideas as to how the system can be changed. But it is time to change it.
There is one silver lining here. I have often pointed out here that if governments really wanted cash (to spend or to get other people to spend) they would have to find it on the balance sheets of big companies — simply because that’s where it is.
The PPI scandal was interesting in this regard, as the huge volume and scale of the compensation payouts from the banking sector to consumers did represent a whopping transfer of cash from banks to ordinary people. This cash was commonly spent on cars — registrations went up 30% in April 2013 at the height of the payout period.
This takes us on to the rather marvellous bit of the VW scandal: those affected could soon find themselves with fistful of compensation cash. The payouts are, sadly, unlikely to include the owners of ten-year-old diesel Passat saloons, but they will include a huge number of those who bought cars in the great PPI boom. They might not spend the billions on cars this time round. But they’ll spend it on something. Who needs idiot politicians and their helicopter money to boost spending when you have idiot corporates and their fraud to achieve the same thing?