Thursday, 9 April 2015

My speech at Cranfield's Leadership Summit 2015: on Value and Governance

In March 2015 I was one of the speakers at Cranfield School of Management's annual Leadership Summit.  My subject was Value and Governance: I spoke about shareholder value, ownership problems, and activists.  Below I've put the text of the speech.  (Sorry, slides not available here.) 

I'd be interested to hear your thoughts on the subject.

(And for those of you asking why I included nothing on s.172 - I agree that it's very relevant, and indeed, I had it in the first draft. But I was over-running my 40 minutes so it never made the final cut.)




Presentation at Cranfield Leadership Summit, .  23 March 2015


Good afternoon everyone. 


When I started teaching at Cranfield, I used to walk into a class and say, “the Objective of a business is to create value for its shareholders”. And the Brits and Americans would just nod.  But all my German students used to sit there like this.   They didn’t contradict me – they were too polite.  But they didn’t believe it either – they understood a Stakeholder model instead.  And over the years I came to understand that there are different points of view. 


I still teach that Shareholder value is the main objective.  But these days I define Value very carefully.

So why am I illustrating this with a picture of Jack Welch, the CEO and Chairman of General Electric for 20 years?  Well, many people say that he was one of the founders of the shareholder value movement.  Every quarter, he managed to increase the earnings per share of GE.  And he was acclaimed as the ‘business leader of the century’. 

 In 2008 the financial world fell off a cliff. 

On 12th March 2009 Jack Welch went into print to say that “Shareholder Value is the Dumbest idea in the world”.

On 12th March 2009 I went into print too.  I wrote a letter to the FT, which started, “Jack Welch was wrong. Twice”.

They didn’t publish it,


But I do think he was wrong.  He was wrong because running a company for quarterly eps is not the same thing as creating shareholder value.

And he was wrong because Shareholder value is not actually a bad idea.





In this talk I’m going to cover two related questions – what is Value, and How should companies be governed.

And before you get any ideas, I’m unlikely fully to answer either of those!  But I will try to show you what is happening in these fields that might affect us all.


So, given that I’ve said Jack Welch wasn’t focused on it, what is Value?



Well, value is NOT share price.

Price is important, but it’s not the same as value,

In the 18th century, shares in the South Sea Company went from about £100 to almost £1000 per share – just before it went bust.  That’s not Value

In 2001 Time Warner bought AOL for a price of  $164bn.  It became known as the Biggest Mistake in Corporate History. That’s not Value.

Last year, Facebook bought WhatsApp for $19bn – I have no idea what they will get from that, but again, the $19bn was Price, not Value.

We focus on price because we can measure it.  Measuring Value is way more difficult





1. Increase growth in sales

2. Increase operating profit margin

3. Reduce cash tax rate

4. Reduce working capital as a % of sales

5. Reduce fixed assets as a % of sales

6. Reduce the cost of capital

7. Increase the period for which the business has a competitive advantage


 If you were to come to my class I’d work through this model.  It was developed by Alfred Rappaport, an American professor, and one of the academic gods of shareholder value.  He said that there are seven things that drive value.  I’ve summarised them into four. And to be honest, #6 isn’t that important for most businesses, which reduces it down to three.

You get value by moving the value drivers in the right direction.  You calculate value by estimating the value drivers.  It’s the fundamental behind every good analyst’s model, behind every proper valuation.

I want to highlight two parts of that slide.




Shareholder value is NOT about next quarter’s profits.  As originally construed – and indeed, the way we teach it at Cranfield! – it is about the long-term  Timescale is a fundamental part of the shareholder value equation.

And that means you need to make trade-offs.  Yes, I can increase this quarter’s profits.  But if that cost-cutting makes my best employees leave, it hits the long term.  Yes, I can get more sales.  But if it then hacks off my leading customers, that destroys value.  Or, yes I can reduce my tax down to zero – but if it makes people boycott drinking my coffee…

The best way to think of it is that SV is basically, Warren Buffett’s philosophy slammed into a formula – his Owner’s manual at Berkshire Hathaway focuses on Intrinsic Value over the long term. 


 So let me move on, to address the other bit that draws fire; the Shareholder bit.




The current debate, raging in the USA and lapping into the UK, is about Shareholder Primacy.  Broadly speaking, the idea of Shareholder Primacy is that the duty of management is to maximise returns for Shareholders.


But which shareholders?

There you have a nice little old lady, who is holding shares as her nest egg.

Or Bill Ackman, a hedge fund activist investor.

Or a financial institution, with the aim, perhaps, of slightly beating the index.

Or a day trader, who might hold your shares for a few minutes or a day….

Or a High Frequency Trader, who holds them for a microsecond.


They’re all shareholders.

How can you possibly run a business in such a way as to give priority to shareholders?  Which shareholders?  They all have different aims and timescales

That’s the problem with shareholder primacy.



Also relevant to this debate is the fact that the structure of markets has changed enormously.

This is the ownership of UK plc.  In 1992, when most of our corporate governance institutions started, it was held y pension fund and insurance companies.  Mostly based in the City of London, geographically close, and knowing each other.  If there was a governance problem with a company then a few people could meet up, and agree how to use their voting power to encourage it to behave

That works less well when most of the market is held overseas, by people who don’t know each other. 

And that matters even more when we realise that the trend is to push more and more onto the Shareholders to control the company.  The Stewardship Code demands active  investors – not activist investors, just concerned investors with the long-term interest of the business in mind – it requires them to vote intelligently on issues, and to have dialogue with the executives.  But most of these ‘owners’ don’t necessarily care.  And those who do are immensely resource-constrained, to the extent that even if companies want to see them, sometimes they can’t.


And as I suggested earlier, with day traders and now high frequency trading, holding periods are getting shorter.

These graphs are from a rather good speech by Andre Haldane of the Bank of England a few years ago.  He pointed out that

In 1940, the average holding period for US equity holdings was around 7 years.

By the time of the stock market crash in 1987, it had fallen to under 2 years.

By the turn of the century, it had fallen below one year.

By 2007, it was around 7 months.

And the UK, as you can see, is barely different. 

High frequency trading accounts for about 70% of volume in US equities, about half of that level in the UK.  Technically, these people are our shareholders – at a point in time – but would you want to run the company based on what they want?



In 2010 Cadbury failed to fight off the takeover bid by Kraft.

Roger Carr, the then –chairman of Cadbury, said that over the 19 weeks between the disclosure of Kraft's interest and Cadbury's final acceptance, 26% of Cadbury's shares were sold by long-term shareholders.  The eight largest buyers were hedge funds or other short-term traders. He said that Cadbury's board was then forced to accept Kraft's offer because of its fiduciary duty to shareholders.

Different shareholders.  And even the “long-term” ones didn’t stick with the company.



And of course, we assume that the people who hold the shares do actually want the share price to rise.  But not if you are holding derivatives which might pay out if it goes the other way.  Or if you have more to gain if an acquisition goes through, because you own even more shares in the over-priced target. 

Shareholders are very different, in their aims, timescales and positions.  Running a company for the current shareholder’s value is an almost impossible task. 

I think you need to be thinking about the hypothetical long-term holder of the company.  And that’s better for the business anyway.



Let me just summarise all of that

Value is Not to do with price, it’s about generating cash flow for a long time by improving profits and using the asset base more efficiently.

And because Value is not to do with share price, we should not be running businesses in line with the latest whims of the current investors in the company.



Which brings me to the second question I said I’d address – Corporate governance.

There is a huge amount of stuff flying around about how companies should be governed.  I’m going to limit my comments to discussing these four things.


·         Best practice – whether we have any idea what it actually is

·         Activist investors – which links back directly to the ‘Who is the Shareholder debate I discussed before.

·         Control Enhancement mechanisms, which are one way that companies are trying to dodge the activists – but not necessarily a good way.

·         And executive pay, which Always makes the headlines, and on which I’ve just finished serving on a High Pay Centre panel.


So, best practice?



 This not just a picture of George Clooney.  You can see the theme – it’s doctors.  And they are up there to illustrate a point of fundamental importance when we talk about corporate governance.  We speak of ‘best practice; in governance as if it exists.

Best practice exists in medicine.  We tried something and people died, so we tried something else. And the thing that kept most people alive became best practice… until we found something else that prove to be better so we changed our minds.

I’m afraid corporate governance is not like that.  In Governance, best practice means, hey, I’ve had this great idea – let’s try it.

So let me address the first of the three governance subjects – Activists.



Shareholder Activists are everywhere.  You can’t open a newspaper without reading something – good or bad – about what they are doing. 

Activists generally – not always, but generally – have a SHORT-TERM TIME HORIZON.  They buy a small percentage of a company, and take action to drive the price of the shares up – or return money to shareholders – in order to make a profit on their investment.

What they suggest might indeed be for the benefit of the company.  But their motive is not altruistic and, as I said, rarely long-term.



Here’s some research put out by the New York Stock Exchange.  It ends 2013.  The Economist suggests a leap in activity in 2014, to 344.

The light blue is activity in North America, the grey is the rest of us.  I think the two main reasons for the differences are cultural, and also very different governance and legal regimes.  But you can see, activism is growing.  And more in the UK than the rest of the world.



Just looking at the UK, this is from an academic paper published earlier this year.  It shows activism in the UK over a decade from 1998.  That last bar, where it goes lower, that’s a half year!  And it shows that generally the most the activists do is stir public debate – the blue bar – in the hope that that will do the trick.  But increasingly we see the green bar – putting proposals at EGMs (which of course means an EGM has to be called, with all the disruption that entails).  Or, the yellow bar, at AGMs.  And that new purple one, creeping in, is Litigation.  Doesn’t happen nearly as much in the UK as the US – different regimes - but it is interesting to note.

So let me give you an example of how this operates.


 I thought I’d illustrate the UK activist stuff with an illustration, so I chose this one, more or less at random.

Electra is a private equity investment company, listed in London.

The activist, Sherborne, is quite old – founded in 1976.  The CEO’s background is in funds and private equity; he has turnaround experience; and he did actually do a proper job as CEO of a real company for 6 years.  He seems to have quite a good record.

The proposal was that he and a colleague be appointed to Electra’s board, and an existing director be removed.  Then they would conduct  a strategic review’.  They set out in their circular some area where they thought Electra could be improved, but gave nothing concrete on how it might be done.



The proposal was rejected; over 60% voted against.

Electra reckoned that it cost £2-3 million to deal with it all.

  Then Electra did a strategic review!

This is the share price of Electra over the relevant period.  The dip is where the EGM proposal was rejected.

And the increase…

Sherborne is back last month with a new offer!  So, it can be difficult to escape their grasp – particularly as they don’t need to have enough funds to BUY the company; just enough shares to worry it.



So – does all of this activism work to Create value?

You’d think that’s the sort of question academics could answer, wouldn’t you?  Take a series of activist interventions, and examine them over time to see what happens, then draw conclusions?  .


Academics are in two camps about this.  It’s not that they haven’t done the work. There are lots of papers.  It’s just that the results you get appear to depend ever so slightly on the biases you bring to the table before you started


So I call it the Mythical debate, and I’ve illustrated it with two representative papers, from academics at the heart of the battle. 

On your left, Professor Lucien Bebchuk – a leading academic in corporate governance, convinced that the main enemy of good companies is their management.  He argues – indeed we’ll see in a minute he does more than argue – he argues that shareholders should be able to do what they like to companies in the name of creating value, and any defences put up by the board are just self-preservation and getting in the way.

On your right, Professor Lynn Stout, another leading academic in corporate governance. I think you can see her stance from the title of her book.  She says, ““Shareholder primacy” thinking causes corporate managers to focus myopically on short-term earnings reports at the expense of long-term performance; discourages investment and innovation; harms employees, customers, and communities; and causes companies to indulge in reckless, sociopathic, and socially irresponsible behaviours”

So, no academic consensus there!


It gets interesting with this next slide.   Lucien Bebchuk – he who believes that management teams need putting in their place – is based at Harvard, where he set up the Shareholder Rights Project.

Basically, it was taking his academic research into practice.

So Bebchuk set up the Shareholder Rights project.  Basically their message is:

Shareholder Good

Management Bad


And their research tends to prove this.

And what the Shareholder Rights Project does is lobbying.  If I just read it to you:

…”operated a clinic that assisted institutional investors into moving companies towards annual elections”

Let me put that into English.  In the USA a company can have a provision in its constitution for Staggered Boards, also known as Classified boards.  What this means, simply, is that  some or all directors have a fixed term – can be several years - and so can’t be voted off before then. 

It basically entrenches the management.

As a governance researcher I object to classified boards on principle.  But that’s not actually the issue here.  The issue is that Bebchuk and his team believe so strongly that this is bad that they went beyond the research, to lobby institutions to vote against classified boards, because his  research shows that they destroy.

Which led to this…


Did Harvard Violate US Federal Securities Law…

This is a working paper published at the back end of last year. 

It argues that Bebchuk and his colleagues  were somewhat misleading in the papers they produced and sent to the financial institutions to persuade them to vote against.  It says that they selectively included the evidence from papers which supported their view … and ignored all the papers that did not support their view.


Unfortunately, this type of bias might be against SEC rules – and one of the co-authors of this paper is an SEC commissioner.

I don’t know if what they did was illegal.  But I do know that it matters.

We mustn’t forget is that this has led to REAL CHANGES IN OVER 100 REAL COMPANIES.  It’s not just an academic debate



Of course, some companies are activist-proof.  Here are four.

Manchester United.  Malcolm Glazer and his family needed to float the company to refinance it, but didn’t want to lose control. So they issued A and B shares. A shares have one vote each.  The Glazers hold B shares, which have 10 votes each. That means the Glazers can always outvote anyone – they keep control.

Google – Google had A and B shares as well, with a similar structure empowering the three founders.  But Google was issuing A shares so quickly for its acquisitions that they were in danger of diluting themselves too much- so they invented C shares, which have no votes at all!  So Larry, Sergey and Eric have permanent control of that company.

Facebook.  Mark Zuckerberg owns around 20% of the company but controls about 60% of the votes – A shares and B shares.  (And somehow he has managed to insert a provision giving him the right to decide who runs the company when he dies! Which is really cool)

Alibaba – not a dual class, but the company’s constitution gives management control over who can be on the board.  Not shareholder, management.   (And, incidentally, gives management over management pay as well.)


Now you could argue that for the internet companies (not ManU) it makes good commercial sense for their founders to have protected ownership, because they have the interests of the business at heart, and you don’t want them to be overruled.

That’s okay, up to a point.

But things change.  The people who founded a company might not be the right people to run it 20 years on.  Tough. We have no choice.



 This is the New York Stock Exchange, where all of those companies are listed.

They listed there because the dual share structure is not allowed in many other places.  The London Stock exchange forbids it.  So do Hong Kong and Singapore. 


The situation is slightly different in Europe.  But it’s changing.  We might soon all have Loyalty Shares.

The idea is that we want long-term shareholders, so to encourage shareholders to be long term there will be a clause that says that if you’ve held the shares for X years you get something extra – more voting rights, or better dividends, or something.

You might have seen some discussion in the media about this last month, regarding France and Italy.

In France, Under the Florange law, passed last April, investors that have held stock in a listed French company for at least two years will automatically be granted double voting rights unless the company alters its constitution to opt out of this provision.  Few companies look like they are going to opt out of this.

So, these are ‘loyalty shares’.  Long term shareholders – which in France is generally the State, or the founding families – get double votes.  Indeed, some people have suggested – with reasonable evidence – that the sole purpose of the law was to entrench the French government as a shareholder so that it could prevent foreign takeovers!

Whether or not that’s true, the law will stop – or slow down- activists

But , at the expense of shareholder democracy.  That is a big downside.  The minority has no protection.

Similarly, last month there was a big debate in Italy where the Government made it easier for companies to create these loyalty shares with multiple voting rights, although they changed the law back again after protest from the large international investors.. 

The trouble is, there is no one best practice in corporate governance.  I can see benefits in having loyalty shares; I can see problems.  It’s like everything – what we perhaps want is a benevolent dictatorship, always doing the right thing for the circumstances!

But it doesn’t really matter what I want – these dual shares could well appear everywhere in Europe very soon. The new Shareholder Rights Directive  is currently under debate in the EU Parliament, one of the amendments being considered is to make these dual voting rights, or other perks such as enhanced dividends or tax advantages, mandatory in all EU countries.
And as with most governance practice, this is being done regardless of the fact that there is no evidence that it works.
Remember, Cadbury got sold to Kraft because the ‘long-term’ shareholders sold out to hedge funds. But what the heck, let’s do it anyway.

SLIDE             FAT CAT

Let me now turn to my final governance topic – executive pay.

My article on exec pay made the front cover of Cranfield’s journal, Management Focus, last year.  I’d like to tell you that that was because it was the best article.  But I think that the fundamental reason I was the cover article was that they thought the cat picture was really cute!

So let me tell you some of the problems with executive pay


·         There’s no link between pay and performance

·         Psych research suggests there is unlikely to be

·         Even if there were, it is very difficult to establish the right performance measures or targets and to measure them correctly


This is a graph from a piece of work commissioned by the High Pay Centre in their year-long examination of executive pay.  I’ve been sitting on a Panel at the High Pay Centre for the last year, helping commission and review a research project in the area of performance-related pay for executives.  It’s been very interesting.

Now, many of you will know The High Pay Centre – they do some very good work but they do have an agenda.  And it’s not in favour of paying a lot to CEOs!

But nonetheless, this analysis does show practically no link between pay and performance over a long period.  I was curious about some of the data, so I asked for an academic literature review to be commissioned, to see whether decades of research showed that same result.

And the lit review says that that “academics are undecided about the strength of the pay-performance link, but , evidence for significant correlation is relatively rare.”

(Which, incidentally, is a great shame, because the UK Corporate Governance Code spent over a decade insisting that pay should be substantially related to performance.  And it appears to have made not a jot or iota of difference.)



Let me move to the next point, the psychological research.

To simplify decades of motivation research into a couple of sentences – rewards can motivate for simple tasks with a clear and immediate outcome.  But they don’t motivate performance in complex, cognitive tasks. And they don’t motivate performance where there is not a direct line of sight between the action and the outcome.  Which is a pity, cos that’s kind-of what executives are all about.

And furthermore, the governance bods talk a lot about deferring pay.  Well, it has been shown pretty conclusively that executives attract a high time value to bonuses – is you were going to pay me £1000 now, you will have to pay me considerably more than £1000 in a year’s time for me to get the same utility out of it.  Far, far more than the risk-adjusted cost of capital.


Who here believes that a set of financial accounts absolutely and unconditionally reflects performance?

Of course it doesn’t.  But we take those numbers, those changes of a fraction of a penny in eps, and we award bonuses based on them.  Sometimes, it’s a bit of a nonsense.  The metrics we use are flawed. 

And gamed.

Yet we still use them.



And finally, another piece of work from the High Pay Centre.  This is a good read – they did a series of interviews with CEOs, investors, commentators, even one of our own professors here at Cranfield.  They were looking at how easy or difficult it is to measure performance – you know, what we reward – and how easy or difficult it is to attribute that to the executives.

Not surprisingly, the interviewees overwhelmingly pointed out that it’s really, really difficult to attribute any corporate success to the decisions or abilities of one executive, or to those of the relevant senior management team.

Yet that’s exactly what we try to do.
So that was a quick run through on Value and Governance.  I didn’t manage to draw any conclusions.  But then again, I warned you at the start that I wouldn’t be able to draw conclusions.  I hope that you found it interesting