Owners used to be stewards of their company’s future, but this idea has faded in modern publicly-listed companies. Mark Goyder asks how dispersed share-ownership might affect corporate efforts to be responsible
Last month an old oak tree fell down in the field at the back of our house. There was a lot of work and some expense involved in putting things right.
But it did not really feel like an option to say: “We own the land; we are free to do what we like. We can just leave it.” There were consequences – for the sheep, the visual impact for our neighbours, the walkers. Our instinct when we first saw the tree was: “We are the land owners: it is our responsibility to clear up this mess.”
My own instincts have their roots in the attitudes of our ancestors. For me ownership means stewardship. And these instincts are also consistent with the origins of the word ownership (see below).
But does this historic view of ownership as stewardship still apply in the age of global capital flows, instant trading and complex derivatives?
Stewardship means a sense of responsibility for that which you own and handle every day. It implies that the business should be around for generations, and that the owner is responsible for handing it on to the next generation in better shape than he or she inherited it.
The measure of success that goes naturally with stewardship is going to be a measure of long-term health – of shareholder value, certainly, but shareholder value grown organically from nurturing the relationships of the business. The goodwill and intangible value embedded in the reputation and relationships and retained know-how of the business would explain why an acquirer would pay more than the book value of the assets.
With the separation of ownership from control in the listed company, stewardship does not disappear, but it does erode. In US markets particularly, the chief executive is judged by shareholders on his or her dependability in “hitting the numbers” – or meeting quarterly earnings targets.
There is little room for sentimentality about where the company has come from or whether it will still be around in its current form for the next generation. If the accumulated goodwill from the past feeds today’s numbers, fine; if it still feeds tomorrow’s, better still; but if the business is not performing, then change it or sell it to someone who will make it perform. The change in attitude is revealed in terms like “unlocking shareholder value”. The chief executive is less nurturer of the soil, more cranker of the earnings handle.
So is ownership as stewardship a sentimental concept that is rooted in our past, and rendered obsolete by the death of distance and the impersonal operation of global capital markets? Does the idea of ownership obligations actually get in the way of the efficient allocation of capital in global markets, and hold managers back from making the right decisions for the business? Are concerns about sustainability best met through trying to hang on to the idea that owners have obligations, or will sustainability only be achieved through the imposition of external rules on businesses?
These are vital questions. Before we can understand the prospects for a greater business commitment to sustainable development, we need to understand what is happening to ownership.
The slicing of ownership
Imagine the Adam family, running the family fruit farm in rural England early in the 20th century. Ownership is simple and undivided. The farmer is both steward of the company that runs the farm and also owner of the business. Over his lifetime, the business grows. It diversifies into apple juice production and cider making. A company is formed – let’s call it Adam’s Apples. Two daughters and one son are each shareholders. None of them feels suited to run the company. They bring in an external manager and outside funding.
The business thrives. In the third generation there are several hundred employees and not three but 15 family shareholders and outside investors. Some of the family shareholders want a chance to sell their shares. No-one in the next generation is thought right to be the next chief executive or chairman. The decision is made to sell the business to a major drinks company.
By this stage ownership has been sliced like an onion. At some point over those two generations, there has been not only the much discussed separation of ownership and control but also the separation of ownership and stewardship. The external investors may feel some emotion about the business. But they do not have the same emotional stake as the original owners.
The early managers – who represented both ownership and control – were on paper accountable to themselves. But in flesh and blood they felt accountable to the next generation.
The second-generation managers were hired professionals, but still felt accountable to a major owner, a small, although not always united, group of family members whom they would meet regularly to give an account of their stewardship. They were eyeball-to-eyeball with the people who would fire them if they made a mess of things.
By the third generation, divisional managers are accountable to group managers who are in turn accountable to a board and chairman elected by a body of shareholders. The thread that connects them all now is performance against the expectations of the board and shareholders. The managers who happen to be responsible for those orchards are no longer seeing the apple blossom they knew as children. Nor do they expect to pass the business on to their children. The face-to-face element of ownership is eroding.
Who picks up the obligations?
So who picks up the obligations that were in earlier generations integral to ownership? Everyone and no-one. The board of Adam’s Apples has to acknowledge responsibility for its impacts. But, to them, financial performance comes first. The primary pressure from the intermediaries who manage savings on behalf of the owners is to deliver results.
The chief executive in charge will be focused on delivering financial and quality targets. He will be worrying about labour costs and whether England is the right place to grow the apples; or whether it may be better to transfer the operations elsewhere in the world and sell the English orchards for lucrative property development.
The group chief executive may even be having arguments with some of his investors – a man like Robert Tchenguiz, for example, who recently criticised UK retailer Sainsbury’s for not selling off some of its property assets, saying: “Sometimes I wish companies would stop thinking about doing the right thing for the company and start thinking about the right thing for the shareholders.”
So now the ownership wheel has gone full circle, but, as it has revolved, strips of the original concept have been shredded away like rubber from an overworked tyre. There are people who own the shares in the company and who claim to own the company, but feel no commitment to its continuity or responsibility for its impacts.
Managers may feel some sense of responsibility for the next generation, but that accountability is not made vivid by living individuals who stare them in the face. It is a more abstract concept. Assets are there to be sweated, not stewarded.
The slicing of ownership has monetised relationships: it has decoupled ownership from responsibility and the growth of regulation and stakeholder activism is compensating for this divergence. Resistance to the slicing of ownership takes various forms – among them continued family ownership, mutuals, social enterprises and employee ownership.1
Then there have been the owners who have been willing to open up investment to outsiders but without ceding control. They use control enhancing mechanisms (CEMs) that allow them to wield enough power, through voting rights, to control the future direction of the company.
For example, Novo Nordisk has divided its share capital. The A-shares, owned by the Novo Nordisk Foundation, convey effective voting control; the B-shares economic interest. The foundation’s stated aim is: “To provide a stable basis for the commercial and research activities of Novo Nordisk and support scientific, humanitarian and social purposes.”
In the Danish company AP Møller – Mærsk, the controlling family hold A-shares that have two votes each while non-voting B-shares are held by the public. The latter make up 50 per cent of the company’s capital.
In Sweden non-voting shares are widely used to maintain control in the hands of families who, either directly or through their trusts, typically own less than 10 per cent of company shares but more than 25 per cent of voting tights. In Germany, no single shareholder in carmaker Volkswagen can exercise more than 20 per cent of the voting rights. In anticipation of the day when the government of Lower-Saxony obeys a European judge’s ruling and abolishes the “Volkswagen law”, the Porsche family has now increased its ownership stake to 31 per cent.
Opponents of block shareholdings argue that, just as political power corrupts, so concentrated economic power can corrode business judgement and put the minority shareholders in an unfair position. For example, once a single shareholder becomes as dominant as the Porsche family are within Volkswagen, minority shareholders feel powerless to challenge actions that may put the interests of the family before those of the company and the shareholders as a whole.
The EU recently commissioned a report to study whether CEMs undermine the creation of shareholder value. The report and its commissioning arose out of a fierce debate within Europe between advocates of “one share, one vote” – also known as the “proportionality principle”, where each share in a company carries the same voting rights – and defenders of block holdings and other CEMs.
The study found no conclusive evidence that companies that have dual share structures, or other CEMs, damage shareholder value. Shareholder activists continue to disagree. They argue that there is a tension between “one share, one vote” and the desire for concentrated and unassailable holdings that give stability to a company’s future planning. Yet this tension is nothing compared to some of the tensions to come in the capital markets of the US and the UK where one shareholder, one vote has prevailed.
Ownership and short termism
The debate about ownership is connected with, but not the same as, the debate about timescale. A family business will probably, though not inevitably, have the needs of future generations at the forefront of its directors’ minds. The portraits on the boardroom wall, the family relationships round the table, all communicate a deep sense of the business being not just about more than one quarter, but about the next generation.
Shareholder value need not necessarily mean short-term shareholder value. Depending on the industry and the objectives, the pursuit of short-term value may well be less rational than the steady building of relationships, reputation and long-term value. It is just that in the new age of dispersed ownership, the portraits of the founders have been replaced by the display showing the current share price. The auction is always on and there are often pressures to crystallise the value now.
Accounting practice is moving towards the idea of “mark to market”. Every asset must be valued at its current market value. If you value the apple orchards in this way, you start to see them as real estate, and visions of making a killing through house building and property development may flood into the mind.
Pension funds will hand over their beneficiaries’ savings to fund managers. Fund managers will be benchmarked against each other on their performance. They may not be judged quarterly but they will certainly be measured quarterly. The fund manager will say: “Never mind the next generation, I won’t keep the business unless my fund performs over the next two to three years.”
The fund manager will, in turn, put faith in CEOs who think the same way. When GE shocked everyone by missing its promised earnings targets for the first time in over a decade, the explanation was that the way the company had traditionally made the target was by carefully timing sales of assets to realise the promised amount of income. This time with a falling property market the calculations had gone wrong.
I spoke recently to a GE veteran. He explained to me that in GE Jack Welch had always told his managers that in order to be around to deliver the long term they had to deliver the earnings in the short term. This was essential to retaining the confidence of investors.
So the ability to “smooth” earnings and hide your reserves in a store cupboard unseen by auditors becomes the fund manager’s way of judging competence. It flies in the face of economic rationality and everything that accounting regulators are trying to achieve. But in an era where ownership is no longer face-to-face, and there are no recognised and agreed indicators for linking today’s engineering and innovation to tomorrow’s financial results, “hitting the numbers” has become the modern manager’s equivalent of filling the storehouse at the end of the harvest. It has a spurious simplicity about it.
What are the implication of this for ownership and sustainability? Ownership is the relationship that conveys accountability. When ownership was linked to place, performance and sustainability were more likely to go together. Imagine achieving a profitable result in a way that devastated the landscape to which the owners of the business woke up every day. In the largest concerns, ownership of shares no longer implies stewardship of the enterprise.
So where is ownership going? Is it inevitable that it will become more dispersed, and thereby decoupled from a sense of responsibility for future generations? Or is it towards a different future, in which ownership of shares in a company no longer conveys with it that same sense of responsibility? And if the owners will not hold a company to account, who will?
It may help to think of the issue in terms of two scenarios for the future. Let us call them “trading” and “ stewardship”.
The trading scenario
In this version of the future, life becomes ever more transactional. Derivatives trading continues to explode. Financial flows become an ever-larger multiple of national wealth. Hedge funds flourish. The power of “event-driven” hedge funds increases and operates across global boundaries, encouraged by the competition of financial centres to be a welcoming destination for “hot” speculative money. More and more money is to be made by shorting the shares of a company where there is weakness.
A growing number of individual investors think and act like day traders. Companies live or die by their share price: a company which fails to unlock shareholder value in, say, its property holdings finds itself under assault. The power of the traditional investment institution erodes, a process accelerated by the slow decline of the long tail of defined benefit pensions schemes. The length of time a share is held continues to decline.
The institutional investor finds it easier to sell and take their profits on a rising price as the hedge funds move in. The existing body of its shareholders no longer determine the fate of the company; the criterion for the decision is no longer the long-term health of the company. Even when there is no bid on the table, institutional investors, working more and more on “mark to market” principles want companies to be more efficient shareholder value machines.
Under this scenario, the European block shareholders fight a losing battle. Family ownership, mutual ownership and employee ownership survive as islands of continuity in a sea of formulaic owners.
The stewardship scenario
In this version of the future, the advance of globalisation also means the concentration of funds into the hands of professional asset managers who have the time and right incentives to do their ownership job well. While in the west the amount of money in defined benefit pension schemes declines, the expanding wall of savings from the emerging economies adds to the funds under professional management. The demand grows for the same expertise to be applied to the funds being managed on behalf of individual savers including those with defined contribution schemes. This trend is helped by the decision of governments and designers of schemes to set up “default options” that channel the most passive savers money to large centrally-managed funds.
Ideally, investment institutions have the resources and the expertise and the motivation to steward the enterprises under their ownership and insist, through the application of rigorous risk criteria and widely agreed codes, on high standards of behaviour and a focus on the wider impacts of a business.
Sovereign wealth funds, with their emphasis on holding significant but less than controlling stakes in business everywhere symbolise this new world of concentrated ownership (see below). Their time horizons are potentially intergenerational. They leave management with the confidence to manage, but insisting that they do so in ways that display stewardship of the commons on which all benefit.
Family ownership survives; mutual and employee ownership continues to thrive. Stimulated by exemplars like Grameen Bank, the Bangladesh microfinance institution, social enterprise emerges as a viable ownership model that is better placed to combine economic discipline with sustainability. Private equity matures and accepts the responsibility to internalise sustainability considerations into the companies it owns.
Concentration of ownership of companies enables all those concerned to uphold responsible investment with the vehicles that they need to secure the continued sense of stewardship of companies. Investor dialogue increasingly integrates sustainability into the ownership conversation; and markets factor sustainability risk into the price.
Ownership is important – leadership is crucial
It is impossible to tell which scenario is nearer the truth. In the decades to come will we see ownership as stewardship? That implies it has obligations.
Or are we seeing the culmination of an inexorable trend under which ownership is seen increasingly as a tradable title – a claim on a commodity – that can be rented out where convenient, without corresponding obligations?
It is inevitable that regulation will play a bigger part in filling the stewardship vacuum. Indeed many business leaders are now asking for regulation to make it easier for them to deliver what society needs.2
Leaders and boards also inherit part of the mantle of stewardship from the absentee owner. The best leaders do not meekly do the bidding of their owners, whatever form that ownership takes. They insist on using their judgement, while ultimately being held accountable for the results of their decisions. Most professional investors will respect the chief executive who says no to them. “Back me or sack me” is a powerful challenge to any owner.
Jeff Swartz of Timberland tells the story of having to face the banks during the clothing brand’s liquidity crisis of 1995. Swartz remembers being told by one banker: “None of this hugging trees and painting fences. It stops.”
Swartz replied: “One of us gets to run this company … You have a choice to make. It’s me or somebody else, and if it’s me, I’m telling you, we’re going to continue to do this”3
Mark Goyder is founder director of Tomorrow’s Company. “Tomorrow’s Owners” will be published in autumn 2008.
www.tomorrowscompany.com
1. See “Employee Ownership Tomorrow’s Company” – Tomorrow’s Company (2001)
2. See “Tomorrow’s Global Company” pp 20-23 – Tomorrow’s Company (2007)
3. “The Purpose of Profit”, Jeff Swartz, Tomorrow’s company Annual Lecture 2005 p23
Defining ownership
According to the Shorter Oxford Dictionary the verb “to own” comes from the Old English word “agan” and originally meant one of two things – either (first) “ to make a thing one’s own; to seize, win, gain; to adopt as one’s own”, or (second sense) “to have or hold as one’s own, or to have as one’s function or business”. The term “to own” was scarcely used until the 17th century and the dictionary tells us that up to that point the usual word to describe the second sense was “owe”.
The origins of the Anglo Saxon word own (from which the word ownership later emerged) are, therefore the same as the word to “owe”.
To own something once meant to acknowledge it as both your property and your responsibility. This may be partly explained by the common ownership of much land in England before the enclosures. The duties that went with ownership were divided. The tenants of common land would make a common decision on when to sow or harvest or graze the land. After the enclosures the boundaries were established and each tenant had to make their own decisions. Before the enclosures the tenants did not own the land as their property but did have some claims upon it and acknowledge some of the obligations to it. After the enclosures tenants still had obligations and so did owners.
The wisdom of Dow
Ownership is not a unitary concept. As the American writer Dow Votaw pointed out over 40 years ago, property consists of a bundle of rights to possess, use, dispose of, exclude others, and manage and control.
He goes on: “The corporate concept divides this bundle of rights into several pieces. The stockholder gets the right to receive some of the fruits of the use of property, a fractional residual right in corporate property, and a very limited right of control. The rights to possess, use, and control the property go to the managers of the corporation.”
“Modern Corporations”, Dow Votaw, Prentice Hall 1965, pp96-97 quoted in “Ownership and Control”, Margaret Blair, Brookings 1995 p224
Sovereign wealth funds
There is, ironically, a new investment phenomenon that reinforces a longer-term focus. As the global pendulum swings eastwards, over $2 trillion of reserves are now being invested, mostly on behalf of the energy-rich countries through sovereign wealth funds.
SWFs are not new. The Kuwait Investment Office has quietly held 3 per cent in BP for decades. But they are attracting more attention, particularly in the US where a phobia has built up that SWFs are an extension of diplomacy or economic war rather than a rational response to the need to find a return on the investment of national reserves.
There is, so far, little evidence that SWFs are motivated by anything more than a desire to achieve an efficient and diversified return on capital, but this could change and in principle we could see a position where major mining companies were owned by Chinese or Gulf sovereign wealth funds. What is clear is that the investments of SWFs so far have been measured in decades, a time horizon that should allow a strong interest in sustainability.
Responsible investors
The third response to the slicing of ownership has been the responsible investment movement. This has recognised the growing length of the chain that links the original investors and the companies in which their money has been invested, and then injected fresh accountability into that chain. It is now powerfully symbolised by the UN Principles for Responsible Investment, which represents some $14 trillion funds under management.
Behind this effort is the concept of the universal investor – the idea that large funds have a stake in every major company and as such a stake in the well being of the economy, society and environment around them.