Hack:
Sustainable Companies, Excellent Governance, Responsible Investors, New Stakeholder Value Measure Needed

For the last thirty years the concept of Shareholder Value Maximisation has ruled much of corporate governance in the Anglo-Saxon world, leading to significant levels of short-termism in both executive and investor behaviour; one example is the failure of General Motors, which required $57.6B US government support. (Chang, 2011).

There has been much criticism of the “Shareholder value maximisation” approaches of Anglo-American corporations (Chang, 2011), which has lead to a range of adverse behaviours, such as short-termism, excessive project risk taking (Lin-Hi and Blumberg, 2011 and Hubbard, 2009) and questionable executive remuneration practices (Pryce, Kakabadse and Lloyd 2011) which resulted in the destruction of shareholder value..

Anglo-Saxon corporations, both in the banking sector and in many other sectors, are locked into bonus schemes for executives of up to 300% of base salary, subject to achievement of “stretching targets” (Costello, 2012), whilst at the same time pensions for other staff are being reduced (Costello, 2012). However, the governance of UK remuneration committees is very weak with the majority of the membership being composed of “insiders” (Clark, 2012).

We have had the 2008 Sub-Prime Mortgage Securitisation created Credit Crunch which was partly caused by inappropriate and failed approaches to Risk and Compliance management, short-term profit maximisation (Zuckerman, 2009) and also by a strong belief that powerful computer systems would protect our organisations (Curtis, 2011).

Current stock market indices provide a single view on the valuation of a corporation, based on the current traded price of the relevant equity and the number of shares issued. Little evidence is available to provide any indication to investors how well the corporation is managed for the long term; many do not care, due to the short time that they intend to hold the investment. There is a lack of diversity in available indicators to help executives and investors identify how organisations are managed for either sort-term or long term perspectives.

Too many people attempt to solve a complex problem with a simple minimisation or maximisation of the chosen single solution parameter. For example, if product prices are tightly controlled by the market, the simple solution to margin management and growth is to minimise costs. However, this can then lead to a “dive to the bottom” in terms of quality, ultimately leading to loss of customers and sales, damage to the workforce and the local community.

The world is very complex and interlinked, it is, therefore, not appropriate to follow a maximisation or minimisation approach to a single problem. Instead, an approach of optimisation is required. Indeed, much of what has and is happening results from following the principle of maximising whatever parameter of management is considered fashionable or good, (see Archilochus’ aphorism of the tortoise who knows just one big idea as compared to the fox who knows many things (Rodrik, 2011)).

The UN Principles of Responsible Investment states

“As institutional investors, we have a duty to act in the best long-term interests of our beneficiaries. In this fiduciary role, we believe that environmental, social, and corporate governance (ESG) issues can affect the performance of investment portfolios (to varying degrees across companies, sectors, regions, asset classes and through time). We also recognise that applying these Principles may better align investors with broader objectives of society” (UNPRI 2005).

In order to identify the breadth of the optimisation rquired a brief review of business, governance and informatics literature spanning the last twenty years suggests that there is a wide range of areas where investor and executive behaviours have lead to initial sort-term gains but which have, over the longer term lead to significant destruction of both shareholder and stakeholder value (Zinkin, 2010). This can either occur by executive actions or is facilitated by lack of understanding of the related risks and failure to effectively implement appropriate risk management policies, a failure in compliance with authorised policies.

Short term gains of a few days and a few tens of millions of dollars finally cost BP, on current assessments $25B and thousands of people their livelihoods (Lin-Hi & Blumberg, 2011) and (Macalister, 2012).

Technology and other complexity and risk and programme  management issues (Project Governance) resulted in the B787 and the A380 aircraft being ready for customers several years late with consequential costs on a wide range of stakeholders (Airlines, passengers and airports).

The Standish Group have consistently demonstrated since 1994, through their bi-annual Chaos Reports, that only about 30% of projects involving information technology are fully successful (on-time, to budget and delivering the contracted functionality), and that approximately 20% fail to deliver (Standish Group 1994, 1995, 1999, 2005, 2009) . The remainder, their “Challenged” projects, are over budget, late and deliver only a small part of the contracted functionality. Whilst this is debated by some authors and practitioners, the fact of large numbers of high value IT projects is incontrovertible. Their analysis of the caused of failure strongly suggest significant failures in Project Governance, often including failure to comply with existing, authorised policies. The costs associated with IT failures of governance is estimated as being between $50B and $200B worldwide per year in an industry which is equivalent to some 3% to 6%  of world GDP ($2T to $3T).

The governance of operational systems is also highly deficient. Analyses of the problems of the failure of operational systems to deliver the required functionality leads to high levels of End User computing with very high levels of organisational risk (Panko, 2008, Panko & Port 2012 and Deloitte, 2010). Over 95% of all spreadsheets contain one or more significant errors, yet they are used in many organisations in large interconnected data analysis systems for operational purposes and decision making (Cluster seven, 2011). Most end user systems are un-maintainable, leading to re-creation of the spreadsheets at a later date. This represents a high level of wasted corporate and stakeholder value.

Remuneration and bonus systems for executives are high in the public consciousness and clearly do not have the intended consequences of driving strong governance and alignment of management and shareholder value. They are rarely constructed to consider the wider issue of improving stakeholder value. The failure of Lehman Brothers clearly demonstrates that even the highly developed use of long vesting share bonuses did not protect the company from overly risky behaviour and failure to comply with existing policies. The UK debate on bonuses for achieving the agreed targets, rather than exceeding the targets is a further indicator of the problems in the governance of businesses for long term stakeholder generation.

Many companies state that their value is based on the quality, knowledge and experience of their staff. Yet, little of this is explicitly recognised in any standard measure of the shareholder or stakeholder of an organisation. In addition, Anglo-American companies are prone to cutting staff costs, as a general principle, using outsourcing, off-shore outsourcing and staff reductions in times of temporary economic downturn. In contrast organisations in other cultural environments, with government, staff and union support,  use temporary short time working to retain the knowledge capital and skills of their workforce, thus benefiting both the company and also the local community.

Existing measures of the value of companies generally revolve around market capitalisation (number of shares issued multiplied by stock market price. This is a highly volatile valuation primarily driven by short term issues and investor horizons. Up to 50% of all share trading across all exchanges are held for short periods of time. At the extreme end, High Frequency Traders may only hold the equities for a period of a few seconds or less, whereas pension funds may have investment horizons measured in years.

Existing Sustainability indices operate by factoring the market capitalisation by some form of sustainable governance factor, however, this maintains the volatility of valuation, giving little indication of the long-term value of a company to responsible investors. Many of the factors included in sustainability indices are related to the existence of, rather than compliance with, governance policies and procedures, which are often not complied with in order to meet short term benefits and equity price targets ( BP Deepwater Horizon being a significant example (Lin-Hi and Blumberg 2011)).

There is, therefore, a need for a new way of valuing an organisation that takes account of a wider range of governance and stakeholder factors that provides a more stable indication of the value of a company over the long haul.