Tim Wates, Chairman, Wates Family Holdings
Blake Lee Harwood, Consultant
Matthew Gwyther, Management Today
Will Hutton, Executive Vice Chair, The Work Foundation
Adrian Beecroft, Senior Managing Partner, Apex Partners
Sir John Egan, Chairman, Severn Trent Water Company
Mark Goyder, Founder Director, Tomorrow’s Company
Rajesh Sennik, Private Equity and Corporate Strategy, Accenture
Colin Melvin, CEO, Hermes Equity Ownership Services
Richard Ufland, Corporate Partner, Lovells
Tomorrow’s Company’s report on 'Tomorrow’s Owners – Stewardship of Tomorrow’s Company' poses many questions which we’d like to tackle today. Do you agree that the success of a company depends upon stewardship? Do you agree at its description of the four roles of the shareholder – financier, member, scrutineer and steward? Do you agree that stewardship is ultimately a joint function that has to be exercised between the board and shareholders of a company? Do you agree that that rise of the ‘the casino economy,’ before the crash has changed the picture? Is the listed company model broken? Do we have something to learn from Europe, where block shareholdings, which give a clearer lead from a particular shareholder, are more common? Does national interest with regard to the holding of assets come into this debate?
Sir John Egan
The listing rules that we now have for the Stock Exchange were a great step forward. Stewardship has a governance framework in the UK, which is better than anywhere else in the world. This contrasts with the USA, where company boards are often made up of a number of the CEO’s cronies, all of whom agree with him or her. This enhances the dictatorial powers of the CEO, which may lead to change, but does not necessarily develop stewardship.
Company behaviour has improved enormously since the listing rules were introduced. The non executives are now in charge of pay and, if you are paying too much, the non-executive director in charge of remuneration has to defend the charges in front of shareholders. There is now an audit committee, which should remain impartial because the non executives have the power to change the auditor and to ensure the accounts are accurate.
In the past, many passive shareholders did not take any interest in companies. Ten years ago, I would phone Barclays Global Capital, and say ‘What do you think about something I’m going to do?’ They would reply, ‘Gosh, don’t bother us with that. We’ll sell the shares if we don’t like it.’ ‘But you’re one of our top five shareholders’ ‘So what?’ ‘This is your responsibility. I want to know which way you’re going to vote’ ‘Well, we’re not going to vote.’
Ownership on the stock market is good for many kinds of assets and companies, but not for all. I think about the privatisation of Jaguar, where we took it out onto the stock market. The stock market was an inappropriate place for a small maker of luxury cars; it should have been in private hands and protected from predators. There are some kinds of assets that are better suited to private, as opposed to public, ownership.
Stewardship is about the dynamic between the owners and the company. I accept that there is a muted kind of conversation between shareholders, or their agents, and the boards of companies; but this conversation is generally of poor quality and with regard to short term financial matters. When I worked as an investment manager, we would talk to companies about next quarter’s earnings, rather than the strategy for the next five to ten years, even while we were investing assets on behalf of pension funds which were themselves investing over a long period. The intermediation within the City is generally undertaken by those who are short-term in their outlook, incentivised to perform on a short term basis, and who then communicate this short-term view to the company; there is no stewardship in that sense.
I hope that one consequence of the current crisis will be a greater attention to the position of shareholder as owner and more support for companies in undertaking long-term investments, which then lead towards the proper representation of pension funds over the 20-to30-year period in which they are investing in companies.
I agree that UK plcs have gone a considerable way to making themselves more transparent to encourage dialogue with investors. It is difficult to see at the moment how they could go further, while still running their businesses.
Secondly, it is worth saying that, while we do have a major problem at the moment, over the last 70 to 80 years they have generated a lot of wealth for a lot of people. They will recover, although it is important to try to identify where things have gone wrong and avoid the same mistakes in the future, but I do not think it means there is something inherently wrong in the whole system.
Turning to the casino economy…the report points out that a number of the transactions that form part of the casino economy are quite healthy for the economy, although clearly there are some that are dangerous. Trying to recognise market abuse is part of the job of government and there is now more regulation on short selling, for example. We need to attack what creates market abuse, rather than decrying the whole thing.
Will, do you think ‘the casino economy’ is dead, and, if it is, should we be grateful for its demise?
This is a provocative question. This is a question about wealth generation and the complicated relationship between companies and their owners, with regard to how the former is financed. In talking about the crisis in his industry about six weeks ago, I was astonished by an off the record comment from an investment banker, who said, ‘the real economy is just not throwing up the deal flow.’ In one sentence, this says it all and it has been my problem with the stock market since I began working in it as a young institutional account executive and an investment analyst in the early 1970s.
Financial innovation contributes to wealth generation, but is not the locus of it. The prevalent perspective in the City is that the point of the real economy is to throw up the deal flow for us. This relationship has to be inverted. Obviously, this perspective has resulted in a major national and international crisis, which has created a brief window of time within which there is an opportunity to modify the way the City operates. The Americans want change; we should not halt this by continuing to conduct capitalism as we have been conducting it.
Ownership is at the heart of this issue. This asymmetric relationship remains skewed if owners do not take their cultural, legal, or regulatory stewardship obligations seriously; this is a problem in the UK. Additionally, many companies do not know who the mass of their shareholders are; only a minority are British-based in any case, and so, even if Hermes is not exceptional , companies will probably only speak with two-fifths of the ownership base. The other three-fifths are international, transactional, and not in the business of taking stewardship and ownership obligations seriously in the way that I understand them.
I think of ownership in terms of the European Enlightenment, of Adam Smith and of John Locke, for whom to own something was to want to nurture it, to grow it, to be committed to it, to want the best for it, and to understand the dense network of reciprocal obligations which you have to it. Rajesh, when you were involved in the Alliance Boots deal none of that was on the table and, to be provocative, in June 2007, I said to all my friends, ‘Sell. This is the moment when the markets are at their peak. This is a ludicrous deal’ and it is the quintessential exemplar of all that is wrong with our capital market structures and with our handling of the economy over the last few years.
It is difficult to know how business should be conducted. One idea is that companies should declare a purpose. Originally, when companies were founded, and this was the case right up until Delaware undermined it in the last decade of the nineteenth century, companies incorporated in the USA had to declare their purpose and, when shares came to be traded, owners had to buy into that purpose and hold directors to account for the delivery of that purpose. The object of this design was to deliver that purpose and to maximise profit in the execution of that purpose. Along with the inversion evident in the ‘the point of the real economy is to provide a deal flow’ remark , we have reached an impasse where the point of a company is to make money, regardless of its purpose. With regard to profit, I agree with Deng Xiaoping: ‘It is glorious to be rich’, it is glorious to make profit, and it is glorious to make supernormal profits.’ I am the high priest of making money and I would like to make more of it.
However, money-making should be done via the execution of a purpose. We have to use this window of opportunity, which will not last long, to rethink the foundations of company law, the institutions and the relationship between those who trade equity, those who own it, and the directors who try to generate wealth in the real economy.
In my experience, stewardship is at the core of PE funds’ businesses; this is because it drives the financials. When you look at the leveraged buyout model, what drives the majority of the internal rate of return (IRR) for a PE fund is the exit value. How are you going to maximise exit value? It’s about profits times the multiple – and the multiple is driven by whether a new buyer sees a future for the business. While doing our pre-deal work, we are asked by PE funds, ‘Tell us what we should be doing with this business for the next three to five years – not quarterly – but give me a three-to-five year plan for this business. Then, at a high level, give me what the new owners should be doing for this business once they have bought it.’ This is what we are seeing. There is a sustained reason for that. It has changed over the past few years; some firms are more enlightened than others, but that is my experience.
With regard to Alliance Boots, I cannot comment because they are a client. I would, however, point out that this is a seven-year deal at least, in contrast to many firms who fixate upon their quarterly earnings target. The retail sector is bleeding, but the Alliance Boots results have been positive up to now, when compared with the rest of the sector; Alliance Boots is in a great position and there is investment going on behind that business. My experience differs from the word on the street; fund management is still evolving, and not all are run in the way I have described, but, because of linkage to the financials, the strategy I have discussed is powerful and I am seeing many funds conducting business in this way.
Adrian, Will’s language – ‘nurture,’ ‘commitment,’ ‘wanting the best for it’ – is the language with which you would refer to your own children, is it not? Is he saying, by implication, that private equity does not have that relationship with the things it owns?
I thought he was giving a boost to the world of private equity! I would like to perform a thought experiment. Suppose there had always been private equity, and, then, that someone invented public equity. Now, let us compare them. You have a system of relationship between the owners and the business, where the owners are intimately involved and expect to have a three, five, seven-year time scale; they also know that growth over that period, along with the promise of future growth, will drive their return. Additionally, they are represented on the board and know exactly what is happening; they understand the business and the management.
In contrast, in the new model of public equity, the shareholders will meet the management twice a year for half an hour, during which the management will announce that they cannot tell the shareholders anything substantial as this would make them insider dealers. I shudder when you say that management is increasingly asking the institutional shareholder what it should do because that is power without knowledge.
When there are downs, as there always are in the ups and downs of business, the gut response of shareholders in publicly owned firms is to remove the management; as such, management knows that it has a three-year time horizon. With this in mind, the management under public company governance is incentivised to maximise profits this year, next year, and the year after that, and not to do anything for the long term that would at all upset current profits. In the private equity model, the management has a three, five, seven-year time horizon, and they know they will do well if they leave a company that is growing quicker, more efficient, and more profitable as a prospect for the future.
Finally, the new public company model will include non-executive directors, who do not have a stake in the business and do it as a part time job one or two days a year and are expected to understand the company and to control the business, when the largest companies, for instance, have operations in over 100 countries, with 50 different product lines. At least in the private equity model, there is a director on the board, who is a direct representative of the shareholders, and whose performance is tied up with the progression of his career and the accumulation of his personal wealth, all of which depend upon the company fulfilling the goals it has set for itself. Additionally, he will spend up to half of his time on any given company; presumably, he will be on the boards of one or two.
Emotionally, I totally engage with what Will says because it is exactly how we feel and behave as a private, family business. I am not saying that can work outside family businesses and indeed there are some family businesses that are run very badly. I can see how you would feel like that in private equity, but I cannot see how a pension fund could feel like that. In a public company, I believe it can be fatal to your career to take a medium or long term view, because the short term drive is so strong. It is slightly more difficult in private equity, although you can take a long term view. In family businesses, you can certainly take a long term view. The model of families owning businesses has been around for a very long time. The Egyptians who built the pyramids were family businesses.
I think Wates has had its ups and downs, no question. We now have a trimmed down ownership with three families and eight owners, which means we have a very tight ownership group. In my generation, there will be five owners in the business, which, considering it is a fourth generation family business, is quite a good achievement. A lot of that is to do with a strategy over the years of making sure you have the assets that enable you to buy out families that do not wish to engage. In my generation, we are thinking strategically about how we can get assets in place to continue doing that. I cannot think that all of my four children will want to go into the business. Maybe none of them will, so we have to have assets in the group so that we can buy them out and look after them fairly.
We have family principles, which are very personal, but they acknowledge that we have a big asset and you need to spend a bit of money on that. In the end, however, we are stewards for our generation and custodians of the business to the fifth generation.
Blake Lee Harwood
Stewardship is exactly the kind of word you get from the environmental movement. We are very aware of nurturing growth and protecting for the future. In a world with a changing climate and dwindling resources, where things are already much worse than any of you think is the case, because the science is getting worse by the day, what is the corporate response to that?
I am going to put in a word now for the placard-waver at the AGM. He gets a handful of shares and turns up and there is an awkward scuffle down at the front after the first 10 minutes, as the security guard escorts him out. I have been there and lost a couple of rather cheap suits as a result. It is, nonetheless a noble tradition.
How do you reconcile all the good things about capitalism with the need to respect things like environmental limits? They are terribly important.
Sir John Egan
I agree that these are very difficult for the listed company board to deal with in its time horizon.
Blake Lee Harwood
Although there are completely unacceptable forms of shareholder activism in pursuit of ethical objectives - and the animal liberation movement completely destroyed itself by resorting to violence - there are good examples as well. Faith groups in the US managed to get 20% of Exxon’s shareholders to vote in favour of that company devising a strategy for tackling climate change. They lost the vote, but 20% of Exxon is not bad. Exxon’s behaviour has been completely disgraceful and how does that reflect on the way we structure companies and the way their owners interrelate with the people who run them?
It seems to me very significant that, although John Egan said we had the best listed company governance in the world, everyone round this table including John has agreed that the listed company model as we operate it does not allow boards to take a long enough view to allow them to reflect the impact of climate change and other externalities into their decision-making.
Adrian, if you had one thing you could do to alter the capitalist system to make it better, what would you choose?
It is very tempting to say that nobody should be allowed to own less than 20% of a company. You then have five owners who really do care, so you have to do something about how tradable it is, because somehow you have to get these owners of 20% of the business to want to take an interest for five to 10 years.
Would anyone want to get rid of shorting, which has had a very bad press recently, because it seems to me that, with the very act of shorting, you are actively trying to undermine that company?
If you are shorting, you can be lent stock to sell and that is where the corruption about ownership reaches its climax. You lend your own equity for someone else to short sell, and who you know is going to do it collusively in order to get the gain. You diminish the value of what you retain to get a small fee for what you lend. It is unbelievable.
Sir John Egan
I have been on boards where we have looked at short selling and asked whether (our pension fund) should do this. We have said it is in our fiduciary duties to get the money from this. One of us mentioned transparency: that you should not do be allowed to do any of this in the dark. The Hart Scott Rodino legislation in the US said that, whatever you are doing as an investor in a company that has more than $100 million in sales, you have to explain what you are doing. If you are lending your stock to someone else or short selling it, you have to explain what you are doing and why you are doing it in advance of you doing it. That legislation only applies to buying in order to stop dawn raids to buy the company, but I think you should do everything to do with the company in the same transparent way.
Short selling, it is the only form of ownership whereby the people involved want the company to do badly. Private equity and public markets want the company to do well. There is a very strong temptation, if you do want that, to do something to promote it doing badly. I would be tempted to say no short selling. We do not want people owning companies who want them to do badly.
As a pension fund you lend stock and it can be used against your interests, because the people who will want the company to fail may be actively trying to achieve that. There are occasions when lent stock is used to do tax arbitrage around dividends in different countries around the world, but those are pretty dismal activities as well. The basic idea is quite right; you should at least know where it is going and what is going to be done with it, and often it is used contrary to the interests of the long term shareholder, yet that same shareholder is lending the stock to facilitate the shorting.
Will, let us talk about the German model, which you have written about a lot. Are you still as in favour of that as ever?
Yes, I think they have their financial market and capital structure right and their labour markets wrong. However, Germany remains formidable. It has thousands of small and middle sized companies, which are the backbone of the German economy. They are financed by families and long term investment banks, and it works. There are also cross shareholdings, which allow companies to take the view that the German car industry has taken, which has innovated its way through difficult times. The German car industry is in a better place, for example, than the American car industry at the moment.
I have always thought that the Germans need a bit of our labour market structures and we need more of their financing structures. When you look at the rise and fall of great countries, there is always an enormous vested interest in countries that get stuck by an elite that is doing very well out of the existing order; Spain in the eighteenth century, for example. How we can ever move the world of private equity, hedge funds, investment banks, lawyers, accountants and everything that sits behind it from what it is to where I think it needs to be? Getting its willing buy in and compliance is never going to happen.
I would like to build on what Adrian said. If you did that and had my declaration of purpose notion at the core of a company, I think you might get somewhere.
Thanks to Lovells LLP for hosting this event. 'Tomorrow’s Owners – Stewardship of Tomorrow’s Company' was published in October 2008 and is available from www.tomorrowscompany.com