Performing shareholder primacy

A few thoughts on the governance Panopticon

I really like this bit from comedian Pat Burtscher:

Isn't it weird how we made almost everything up and it still sucks? Isn't that crazy?
Like, you know they turn the stock market off every night and they turn it back on every morning.

And they're like: “We're in a bubble. It's gonna burst. It's bound to happen any day now”

Then leave it off. What are you doing turning it back on?

You idiots.

They're like: “The dollar's down, the economy's down.”

Why don't we just say it's not? How's that sound?

You can see the whole bit on Instagram. NB - I’ve edited the swearing in the original clip out of the excerpt above.

It’s obviously meant to be funny, and his angry/bewildered delivery works much better than the transcript, but like a lot of good comedy it hits on something real. In particular for me it links to a couple thoughts I keep returning to. The first is our tendency to be more comfortable dealing with abstraction rather than reality. The second related thought is the way humans act as if something is real and in doing so effectively make it real.

The first point I’ll come back to in a separate piece, but I’m very interested in the idea of ‘legibility’ articulated in James C Scott’s Seeing Like A State. In that case he was looking primarily at how authoritarian states seek to abstract reality (people, nature) in order to control it, and why that goes badly wrong. But he also made clear that the market mode of thinking does something similar - a practice that has exploded in the over 25 years since the book was first published. We can see it all the time in governance and stewardship - the urge to categorise and quantify in order to assess, even if it squeezes out meaning. But that is for a future post.

On the second point, one thing I’ve noticed when you work a lot with investors is that you can lose sight of where the action really takes place (this is an admission as a much as an observation). It’s interesting to think about, for example, returns to investors from shareholder engagement. To the extent that these can be measured, who are they attributable to? Investors might make suggestions (or demands) for change but it is companies that take action that affects returns.

The link between investor behaviour and returns is perhaps easiest to demonstrate when shareholder demands are clear and the company acts upon them. But much engagement in practice is far more diffuse, meaning it is harder to draw a causal link between investor demands, company actions and financial returns.

This is important currently given the claim that much engagement is politicisation of investment, so there is a pressing need to demonstrate there is a strong financial justification for activity. But it also matters because it gets at a larger confusion in thinking about the role of shareholders and their influence on investee companies.

On the one hand, shareholders have been the subject of regular criticism for being insufficiently engaged with, or poor stewards of companies. Yet on the other corporate decision-making is criticised for being too responsive to shareholder influence. Are they exerting too little influence or too much?¹

In reality, I think forceful and impactful engagement activity is relatively rare. Co-ordination amongst shareholders is hard (and getting harder). That means truly direction-shifting interventions either involve activist campaigns led by a single or small number of investors or require the stars to align to generate enough momentum amongst dispersed shareholders to push for the same demand.

Inevitably then companies’ experience of such events is relatively rare, and the same goes for the other threat to incumbent boards: the hostile takeover. In practice most boards most of the time are not at any serious risk.

Why then is there a perception that boards are overly attuned to shareholder interests? I think the reality is that boards themselves are the principal creators of shareholder primacy in practice. Consider the forced departure of CEOs - how often is this result of direct shareholder pressure through the use of voting rights, or the requisitioning of a meeting? Almost never. Boards almost always do the job themselves.

This is not to say that boards do this independently of shareholder views, in the same way that they don’t independently make strategic changes when activists or potential acquirers are on the prowl. But by and large shareholder primacy in practice is something that is enacted, or performed, by boards themselves.

In a way this shouldn’t be a surprise. A large part of the justification for the appointment of independent non-executives to boards was to address the perceived agency problem where the managers of public companies do not own them. They were in part intended to be shareholders’ eyes in the boardroom, to overcome the information asymmetry of shareholders being outsiders.²

One could see this as a governance version of the Panopticon, where boards feel under constant scrutiny even if operationally it is clearly impossible for shareholders to be effectively monitoring all companies all the time, ready to dispense discipline when need be.

Clearly some of the behaviour of boards is explained by self-interest. Directors can earn a lot more if they keep delivering for shareholders, and similarly this makes them less likely to become a target for either activists or acquirers. And shareholder primacy is backed in by all kinds of other things, be it analyst coverage, financial media or whatever. But it remains the case that boards are where the action is and where the constraints of shareholder primacy are performed.

The idea that boards are the primary reproducers of shareholder primacy is analogous to the way politicians constrain themselves by reference to bond markets. And, as with that example, the argument is not that constraints do not exist. Share price still determines cost of capital, takeovers and activist campaigns do exist and serve to discipline those not subject to them, dispersed shareholders sometimes do co-ordinate effectively. But boards likely have more freedom of movement much of the time than people often think, or even that they sometimes allow for themselves.

A few things flow from this. First, it does help untangle the question of whether shareholder engagement is relatively infrequent and/or unfocused or if boards are overly attuned to shareholders at the expense of other interests. It can be both. There’s an entire ecosystem in and around boards that assumes shareholder primacy, meaning it’s almost not a practice in itself but is instead more like a negative image formed in between all these components.

Second, this may help explain why efforts to strengthen shareholder powers and the disclosure of information to investors have not always delivered what was expected. Essentially, such efforts may have overweighted the role of investors in achieving outcomes, even when board decision-making is undertaken with investor interests front of mind.

Third, we can see how the curtailing of shareholder rights in the US will likely not result in any meaningful change in the ordering of interests in corporate decision-making by US firms, at least in the short term.³ This is what I’ve been trying to get at with the idea of ‘shareholder welfare’.

Taken together, this may have implications for future interventions intended to shape corporate governance and related fields. On the one hand the focus may shift back to the boardroom, as the site where the most impactful outcomes are determined. On the other, there may be less appetite to re-establish investor rights that have been taken away if the benefits are unclear.

1. Slightly relatedly, there was a great survey years ago when both the NAPF (what Pensions UK used to be called before it was the PLSA) and the IMA (what the Investment Association used to be called) asked their members whether pension funds put short-term pressure on asset managers. NAPF members said “NO!” IMA members said “errr……”

2. This fact about the history of why boards are now constructed the way they are is now buried under subsequent reforms. Policy expects shareholders to hold directors accountable for holding management accountable for acting in the interests of shareholders. And the Stewardship Code, at least in part, was designed to ensure that asset owners hold asset managers accountable for holding directors accountable for holding management accountable for acting in the interests of shareholders. In turn, reporting by asset owners enables beneficiaries to hold them accountable for…..

3. I would not rule out the possibility that, if this drift continues, over the long term boards do become less attuned to shareholder interests. In the US context I think this would likely mean they shift further towards oligarchy.