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Is the quoted model bust?

Created:

29 October 2008

Written by:

Alistair Blair

Banks have been up to naughty things and many were catastrophically bust before governments got it together to save them. The corporate governance of banks has been disastrous and has injured all of us. A new banking model will emerge over the next few months and years. Corporate governance outside the financial sector has been hardly more inspiring. This is not surprising: the rules and practices of corporate governance do not differentiate between banks and other types of companies.

Should our current difficulties and the manifest need to rewrite the rules of banking lead us on to question of the lynchpin of capitalism - the quoted company? A debate has got going in this area, to which my colleague Chris Dillow has been a significant contributor. Last month, in The Times (17 September), he argued that the crisis is "not so much a financial crisis as an ownership crisis… [what has failed is] a peculiar form of ownership that we have taken for granted for decades - stock market companies with dispersed shareholders". Chris went on to laud hedge funds. Although some have collapsed, the overall hedge fund model, he says - with tight control over investments by managers who are investing their own wealth alongside that of their clients - is a more effective method of restraining the natural impulses of "greed, hubris and stupidity" built into corporate managers, than the stock exchange model of dispersed ownership.

A couple of weeks ago, Luke Johnson got onto the same theme in The Financial Times (14 October). Mr Johnson, who has a lot of experience within boardrooms as well as without, described witheringly the dysfunctional chief executives, non-executives and institutional shareholders he has come across, and concluded that "public ownership is a failed model".

Mr Johnson speaks warmly of "family or employee ownership corporate governance", without suggesting how this model could be widely implemented. Chris Dillow appears to favour the hedge fund model as an alternative to dispersed ownership, although appearances may be deceptive. In short, both say the quoted model is broke without proposing a convincing alternative.

Nor does the think-tank Tomorrow's Company, which has just launched a 70-page report, 'Tomorrow's Owners'. This is available from tomorrowscompany.com; you can read the press release for free, but the full report unfortunately costs £35. The report researches the state of company ownership with admirable thoroughness, although it can't quite bring itself to write off the quoted model. Instead, it merely wishes that those who take stewardship seriously should be encouraged.

This column would claim to be a foremost critic of corporate governance as it has been carried out over the past 20 years. But it wouldn't write off the quoted company model, and not only because there is no sign of a meaningful alternative. The problem is that quoted ownership has been emasculated by rising prosperity, which has masked the institutionalised mendacity of institutional shareholders and has enabled managements to become far too powerful.

The quoted company model needs three obvious fixes. First, auditors must be removed from management thrall. The nomination of auditors (rather than merely their re-election) should be a matter for shareholders rather than management. This would require only a simple change to company law. This would make auditors accountable to their proper constituency: shareholders. This development would, I believe, help break up the cosy consensus that characterises the global accountancy industry by encouraging the launch of breakaway firms. If auditors won their appointments by championing shareholders and challenging managements, a new breed of accountant would emerge to fulfil these roles.

Secondly, and similarly, institutional shareholders must become properly accountable to their customers. Insurance companies, unit trusts and pension funds should be required to seek the views of their savers on key points of corporate governance, to publish the results and to publish how they voted their shares at company annual meetings. Thus they would not be compelled to follow the views of their customers in every case, but they would be accountable for the difference.

Thirdly, some means must be found to restrain the activities of hedge funds, and a means greater than the shrinkage they are now experiencing. I can propose nothing more here than that hedge funds must be required to make public their ownership positions and their trading results in just the same way as the law intended to be required of traditional shareholders, before contracts for difference and a multiplicity of other derivatives were dreamed up. Markets serve us all better when everyone knows what is going on. Daylight will restrain hedge funds.