This article is the latest in a series passing between Paul Lee of Aberdeen Asset Management and myself, which explore our views of, and some nuances on, the role of governance and stewardship in asset management. Notwithstanding the differences expressed in these articles, the centrality and perhaps criticality of these roles is not in dispute. Previous articles may be found here
Paul’s latest response expresses a narrow view of stewardship as protection of the interests of shareholders, and continues with: This action to protect shareholder interests, which we call stewardship or engagement, contributes to business success and long-term economic prosperity, to the benefit of all stakeholders, not just the shareholders. Unfortunately, experience with shareholder activism shows that this benign outcome does not necessarily have to follow. The exploitation of other stakeholders in pursuit of shareholder interests has been widely documented. Indeed, the promotion of shareholder interests may explicitly act to the detriment of the company itself – extractive, ‘disgorgement’ strategies, operating through share buy-backs or dividend distributions, rarely promote the long-term wellbeing of the company.
It is worth noting that these shareholders typically have not contributed to the company’s finances as they have bought these shares in a market from some previous shareholder. In this sense, it is clear that other stakeholders are far more important to the financing of the business operations of the company. The absence of such a connection gives substance to the question: why should management engage with shareholders at all? The answer to which lies in the few rights which are reserved to shareholders, such as the appointment of directors.
If we express the purpose of governance and stewardship as being promotion of the long-term well-being of the company, then shareholder interests are protected in time and extent, and the interests of shareholders, other stakeholders, and particularly management and the board of directors coincide.
Paul tells me that I was mistaken to assert, in my earlier article, that we own the money in our bank accounts. If I am, then I am in very good company: to quote the NY Federal Reserve Bank: bank deposits are claims on the assets of banks and Federal Reserve notes (such as dollar bills) are technically claims on the assets of the Federal Reserve System, to which I will add: claims that are denominated and payable in money. Paul’s description of the banking system as a process of deposit re-cycling is accurate in a practical or flow of funds sense but it would fail to distinguish between a bank and a peer-to-peer lender. Through the credit process, banks create money. The liabilities of a bank are money, though not circulating currency. Of course, the asset which I possess and own after making a deposit is the bank liability. Did the depositors of Northern Rock really run because they thought that it would renege on its obligations, as Paul proposes? I think that they ran because they thought that Northern Rock would be unable to repay them, with consequential losses in wealth and convenience for them.
The substantive difference between Paul and myself reduces to whether or not shareholders ‘own’ the company. My position is clear; all that shareholders own are shares. The argument that shareholders are the residual claimant is true but not an indicator of ownership. The residual claimants, the youngest generation, to the use of common land in a tragedy of the commons setting have (or should have) interest-protecting rights, and it is possible that these extend to transferability of their interest, but even that is not complete and unconditional ownership. In fact, it is only in liquidation, the end of the company, that shareholders substantiate this residual claim.
Even a sole controlling shareholder cannot, in the presence of debt, be validly described as ‘owning’ the firm – a result made obvious by Black and Scholes. It is an equally incorrect description when the ‘ownership’ argument is framed in terms of shareholders as the residual bearers of risk.
It may have been a shocking juxtaposition, but a company, a juridical person, can no more be ‘owned’ than can a natural person; in the latter case, the reasoning is a question of morality, but in the former, it is a matter of law and economics.
The problem at heart is a question of the purpose of the corporation. During Sunday morning’s Radio 4 programme, Broadcasting House, in a section ostensibly concerned with Tata Steel’s problems, we heard Ben Southwood, the head of research at the Adam Smith Institute, state that “we build companies up to sell them” and Frances Coppola, who had been introduced as knowledgeable of City views by virtue of having worked there, did not demur. This is short-termism to the core; a blinkered financial system view. In fact, we build companies up to produce the goods and services that we need and want more efficiently.
Fascinating though these issues may be, they are largely incidental to the practical governance and stewardship problems that fund managers will face: how they should utilise the limited rights they do possess in support of a company’s pursuit of its objectives and how they should communicate the realised value-added to their investor clients.
