Behavioural finance is a well-established and respected philosophy for improving investment decision-making by combatting ‘groupthink’ among decision makers. It is a view summed up in Warren Buffett’s well-known quote: “Be greedy when others are fearful and fearful when others are greedy.”
“Anecdotal evidence from Sweden suggests directors feel more empowered when shareholders are actively involved in their selection.”
Simon Wong
If more balanced investment decisions create better outcomes, so more balanced company decision making should create better outcomes for shareholders. What can investors learn from behavioural finance to improve their stewardship efforts? Should investors be noisy when others are fearful and fearful when others are silent?
According to Goldman Sachs Asset Management managing director Paul Craven: “One of the most dangerous things you can do in a group is agree for the sake of it. A decision making group that allows disagreement is really important.”
Yet, a growing body of evidence suggests group-think is rife among many corporate boards, born largely of the nominations process that encourages agreement with the chairmen who drive the process. As John Maynard Keynes famously said: “It is better to fail conventionally than succeed unconventionally.” Research by Cass Sunstein, a leading American legal scholar, shows that putting groups of people together who share similar views leads to those groups becoming more extreme. His research shows democrat-only panels reach more liberal decisions while republican-only panels reach more conservative ones.
“This has obvious applications in the makeup of remuneration committees,” says Pensions and Investments Research Consultants (PIRC) head of communications Tom Powdrill. “They predominantly consist of directors and ex-directors who are used to high pay and are naturally better at defending high pay. That would explain why they make decisions that are inexplicable to shareholders and the public.”
Failure to challenge key leadership figures has been widely blamed for the excessive pay handed out by Royal Bank of Scotland to its chairman, Sir Philip Hampton, and chief executive, Stephen Hester.
This underscores the importance of diversity on boards to combat the group-think problem, and the important role shareholders can play in creating the right environment for debate. According to Governance for Owners partner Simon Wong: “Anecdotal evidence from Sweden suggests directors feel more empowered when shareholders are actively involved in their selection, such as through representation on a nomination committee.” McKinsey & Company’s Women Matter report found companies where women are most strongly represented at board or top management level perform best. McKinsey analysed the financial performance of the top 89 European listed companies with a market cap over €150m with the highest level of gender diversity in top management posts against the average for their sector. They found that, beyond doubt, these companies outperform their sector in terms of return on equity, operating results and stock price growth.
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