Before commenting on The New Capitalists, I should set out my view on the question of investors' responsibilities,. That is that institutional investors have a responsibility to encourage the companies in which they invest to adopt higher standards of corporate governance and corporate responsibility, and to encourage these companies to develop and implement strategies to ensure the longer-term sustainability and success of the business. This book - written by Stephen Davis, Jon Lukomnik and David Pitt-Watson, who have been among the leading corporate governance advocates in the US and the UK - should prima facie speak to many of my prejudices.
The book sets out with the objective of explaining why and how individual investors - through their participation in collective savings vehicles such as pension funds - can exert influence on institutional investors and thereby ensure that companies are run in the long-term interests of their ultimate owners. The authors present examples of corporate excesses and failings, and identify a range of causes, including the failure of investors to discharge their proxy voting responsibilities, conflicts of interest in the investment industry, inappropriate incentives for asset managers and weaknesses in accounting frameworks. They argue that individual investors are starting to exert influence directly on the companies (in particular through proxy voting), on politicians and policy-makers (through lobbying for corporate regulation and greater public access to information) and, perhaps most significantly, on their pension funds and asset managers.
Yet, disappointingly, I think that the book fails to do justice to these issues. It has four major problems: the first is that the book is extremely US-centric in its analysis, to the exclusion of the experience in other share-owning democracies. For example, suggesting that investors should have the right to approve remuneration reports is a sensible recommendation, yet the authors do not discuss the experience in the UK where such a provision has been in place for some five years.
The second is that the book starts with a model - that of the New Capitalist, a shorthand for individual investor activity - and appears intent on forcing every bit of data into this model. While it is relatively uncontroversial to suggest that individual investors could, and probably should, exert more influence on their pension funds and asset managers, the authors over-attribute changes in corporate activity to the role of individual investors. They argue that the arrest of Enron CEO Jeffrey Skilling in 2004 "... can be read as a gritty symbol of how the new citizen owners of corporations are calling an end to old ways of business". Although public outrage against Enron played some part, a range of other factors were at work, including the amount of money lost by large investors, the significant press coverage and the adversarial nature of the US legal system.
The third problem is that the authors over-emphasise the importance of voting, to the exclusion of the broader relationship between investors and companies, and the influence that the dialogue between these parties can have on corporate behaviour. While shareholders can vote against management, this is not the only or even the most effective way in which investors can exert influence. It is also interesting that the authors put so much emphasis on proxy voting advice services, but do not discuss whether such services will perpetuate the disconnect between ownership and investment where investment managers simply follow the recommendations of proxy voting advisers.
Finally, the analysis is incomplete. The authors propose that investment managers should not be rewarded simply for gathering assets but also for the performance that they generate. What they fail to do is to evaluate the experience of asset managers that have been rewarded on this basis - as many hedge funds are - in terms of investment performance or corporate governance outcomes.
In conclusion, I don't believe the book really contributes much to the corporate governance debate; it is dated, lacks analytical rigour and its messages have been communicated more clearly and more sharply by other authors. Readers interested in a critique of US corporations would be better served reading Bob Monks' writing on the subject. This book is definitely one to leave on the booksellers' shelves.
The New Capitalists: how citizen investors are reshaping the corporate agenda, Stephen Davis, Jon Lukomnik, David Pitt-Watson, Harvard Business School Press, $29.95, ISBN: 1-42210-101-0.
Rory Sullivan is head of investor responsibility at Insight Investment, the asset management arm of HBOS, and is co-editor, with Craig Mackenzie, of Responsible Investment (Greenleaf, 2006)