People matter, but not like that

Taking the workforce seriously and treating people fairly and well is not served by mechanical approaches that hide as much reality as they purportedly reveal. Yet too often those proposing radical reform see the need to squeeze things that are by their nature hard to measure uncomfortably into a single box of a spreadsheet. That risks failing to do justice to the issues involved.

Their aim is an admirable desire to ensure a focus on fairness to stakeholders — in this case workers — and to drive long-term business success. Yet the approach is surely wrong-headed. Things absolutely need to change, but it would be best to focus on the areas where change can best be delivered and where it will have the greatest effect.

Two recent reports suggest specifically that investments in people be added to corporate balance sheets. One is in the US, Leo Strine’s Toward Fair and Sustainable Capitalism (see The Limited Responsibility Company), and the second in the UK, part of the British Academy’s Future of the Corporation work. This blog seeks to unpack these proposals, to the extent that they are clear, and test whether there is a better route to achieve their aims.

Strine is most explicit. One of his headline calls is: “Change accounting rules to treat investments in human capital like other long-term investments and require companies to disclose more information in narrative form about their human capital investments.” The second portion of this is unarguable, particularly in a US context where companies report little — mostly because they claim to feel constrained by litigation risks to disclose only what they are required by regulation to disclose. But the first portion is rather more debatable. In case there is any doubt about the proposal, the unnatural revolutionary later makes his meaning explicitly clear: 

“instruct the Financial Accounting Standards Board to revise generally accepted accounting principles to treat investments in human capital as capital expenditures like investments in plants, property, and equipment”

His intent is that investments in human capital should be capitalised on corporate balance sheets.

The Future of the Corporation’s proposal is less explicit — indeed a cynic might say that the bulk of its Principles for Purposeful Business is opaque and too high level to be meaningful — but appears to head in the same direction. It states that: “Measurement should recognise investment by companies in their workers, societies and natural assets both within and outside the firm.” The confusion of what is actually being proposed is shown by its call both for a “greater consensus … and standardisation of available information” and that “the board of a company should determine the firm-specific metrics against which fulfilment of purposes … can be evaluated”. How measures can be standardised and at the same time bespoke and company-specific is a mystery to me at least.

The intent of the Principles for Purposeful Business is made less opaque in one of its underlying papers, How to Measure Performance in a Purposeful Company? This states: 

“from a purpose driven, non-financial management perspective, investments into training of employees is viewed as an investment into building social and human capital for the company and its employees. This investment would be expected to yield positive operational results and should therefore be capitalized.”

Again, the intent seems to be that investments in human capital should be capitalised on corporate balance sheets.

There are practical challenges around this — not least the question of whether such capitalised employee assets should be amortised or subject to periodic impairment assessments. Those who follow accounting debates will know that this is a highly controversial area where there is much doubt about the effectiveness of the impairment process — but also a recognition that amortisation does not really reflect the economic reality of many capitalised assets, which often endure rather than deteriorating in value on a straight line basis over an arbitrary period. If we did capitalise it as an asset, would the value of training simply be amortised, or would it be written off when significant numbers of the trained individuals departed the business or a business process changed? 

There’s the old adage about half of the spend on advertising being wasted but that it is impossible to know which half. Investing in a business’s people surely suffers from a similar challenge, with the added complication that it is impossible to know how much of the half of spending that hits home will in practice remain in the company to its own business benefit. This makes both impairment and amortisation models hugely challenging. But none of the proposals I have seen suggesting that these be balance sheet assets have started to consider the most basic practical challenges around their proposal.

There is also a philosophical challenge — to whom does the value of training belong? It is surely hard to state that the value of everything in staff members’ heads belongs to their employers. The old saw of the majority of some companies’ value going down in the lift at the end of the day is a truism, so saying that training is a capital asset for the corporation is surely philosophically difficult. Regular readers will not be surprised to find that I do not wholly agree with Milton Friedman’s take on human capital, as set out in What is human capital? on the ever-excellent Aeon. This argues that the concept was invented as an argument in the Cold War, turning each individual into a mini-capitalist hawking their personal assets around businesses. The long-term consequence of this approach appears to have been divesting in people rather than the opposite — but the philosophical point that a person’s brain cannot belong to a corporation surely has some weight. 

Friedman’s argument that it is for individuals to invest in themselves and that corporate spending on staff training is worthless is clearly wrong. But seeing training and employee relations as generating an asset purely for the corporation must also be wrong — it must be about generating productivity within the business and about employee retention. It is certainly hard to keep good staff if the message to them is that they do not matter to the organisation. 

The academic literature on intangibles, which for many include aspects of employee skills and experience, focuses most often on the challenges with inclusion in accounts that arise from difficulties of measurement and objectivity. But as IAS 38 on intangibles clearly recognises, separability from the operating business is key — how can intangibles be calculated as separate assets when they only exist within the business processes? This is why many investors (and preparers of accounts) are frustrated by the current rules requiring the breakdown of goodwill into some separately calculated intangible assets — which exist only for accounting purposes because they cannot in practice be severed from the business as an operating business. That intimacy with ongoing value creation is precisely why these contributors to corporate value matter so, but that does not mean they need to be turned into balance sheet assets. Putting a false single value on something core to the ongoing business is more likely to mislead rather than inform (see What gets measured gets managed, unfortunately).

At their hearts, these proposals to capitalise employee expenditure are attempts to deliver greater fairness between spending on staff and spending on capital assets, and attempts to avoid disincentivising investment in people, which has led in part to less productivity in business. What might be a better approach to deliver on this intent?

Many will find it hard to disagree with the conclusions of the Brookings Task Force on Intangibles, as quoted in a 2019 FRC discussion paper on the issue:

“After some internal debate and extensive interviews with individuals preparing financial statements, users, auditors, standard setters, and regulators, the task force has concluded that the debate about capitalization versus expensing of R&D focuses on the wrong problem. What investors want, and need, is information about the value of internally developed intangibles and the other factors that drive the value creation process in firms.’’ 

This is also the conclusion of the IIRC (International Integrated Reporting Council). While its model talks about six capitals, one of which is human capital, it doesn’t argue that these need to be capitalised assets on balance sheets. Rather, first it notes that each of its six capitals are simply reminders for companies to ensure that their understanding of value creation fairly respects all relevant stakeholders, and that companies are not expected always simply to report on each of the capitals separately but should consider how they are best reflected in the company’s business model. As an aside, it would be great if more (some!) integrated reporting companies respected this call to think independently. But more relevantly, the IIRC model is that the capitals should be disclosed in the narrative reporting, using KPIs and hard metrics of performance and what has been delivered over the reporting period, but not altering the financial reports themselves.

This is the general model of the IIRC — that the reporting on key issues should be in the narrative section of reporting and not influence the financials. This seems wrong in some areas, such as climate change, where the financial implications of carbon constraints will need to be fully integrated into the balance sheet and income reporting by companies — as Nick Anderson of the IASB has recently acknowledged. But the approach does seem right for human capital issues. 

At its heart, what matters is not what is on the balance sheet, but that management should not be disincentivised from appropriately and fairly investing in the long-term of their business, including in the skills of their people. That’s why a recent study by Nesta is for me so depressing. The Invisible Drag on UK R&D demonstrates just how short-termist are the measures applied by the bulk of UK corporations (and there is no reason to assume that the UK is any worse than other markets, so this criticism is likely to apply to most public companies):

NESTA LTIP incentives

In particular, the chart shows just how low a rating most companies place on employee issues. It appears that just one company across all the UK listed businesses studied uses a health and safety measure, and only three use other employee measures in assessing executive performance. Even when they are used, their proportion within the overall incentive structure is so low as to be largely irrelevant. And unfortunately the three-year time horizon typical of LTIPs and their total shareholder return (TSR) measures is not sufficient to compensate for this as any underinvestment in staff skills is unlikely to become reflected in share prices over such a time period, whereas the cashflow benefit from the underinvestment will be felt immediately. The statistics for bonuses are no better: employee measures represent only 4.1% of the non-financial performance metrics, with a further 12% using health and safety measures; again, even where these metrics are used the portion of the overall incentive that they represent is paltry. 

It is perhaps no wonder that the UK has a productivity problem if no senior management has any incentive to invest actively in their people — indeed they appear to have active disincentives from doing so. Let’s address that problem fairly and squarely rather than reshaping corporate balance sheets as an indirect — and highly dubious — route towards the same direction.


I explored some of the ideas in this post further in: Better ways of showing how people matter


Toward Fair and Sustainable Capitalism, Leo Strine, Harvard John M. Olin Center for Law, Economics, and Business Discussion Paper No. 1018, September 2019

Principles for Purposeful Business, British Academy Future of the Corporation project, 2019

How to Measure Performance in a Purposeful Company? Analysing the Status Quo, British Academy Future of the Corporation Working Paper 3, JC Strehle, K Soonawalla, M Metzner (2019)

What is human capital? Aeon, 2017

Unseen Wealth, Report of the Brookings Task Force on Intangibles, Ed Margaret Blair and Steven Wallman, October 2000

Business Reporting of Intangibles: Realistic proposals, FRC discussion paper, February 2019

IFRS Standards and climate-related disclosures, Nick Anderson, IASB, November 2019

The Invisible Drag on UK R&D: How corporate incentives within the FTSE 350 inhibit innovation, NESTA, 2019

The limited responsibility company, or the tale of the unnatural revolutionary

“If companies do not focus on making sustainable profits by selling useful products and services, and treat their workforce well, our economy will not work fairly for everyone.”

Companies are at risk of losing their connections to the real world. It is some 200 years since the creation of the first limited liability companies in something close to the form that we now know them. The risk now is that some businesses are seeking to be limited responsibility companies.

This is the unwritten thesis between the lines of a radical set of proposals from a remarkably conservative source. Leo Strine does not strike one as a natural revolutionary. Most recently chief justice of the Delaware Supreme Court, he has spent more than 20 years as a judge in that state’s courts — the most important for corporate law because diminutive Delaware made its corporate framework attractive enough that over half of the US’s publicly traded companies are incorporated there. Strine has consistently been a careful jurist who has maintained the status quo more often than move the law forwards. For example, he has consistently reinforced the ‘business judgment rule’ which essentially frees US company directors from challenge to the bulk of their decision-making.

And yet now, Strine is questioning US business’s collective judgment — as the quote that heads this post indicates. Indeed, he is proposing something that for US culture at least amounts to little less than a revolution. This is in a paper published in his last month in office before his recent retirement, for the consistently challenging John Olin Center for Law, Economics and Business at Harvard. In it, Strine puts forward “A Comprehensive Proposal to Help American Workers, Restore Fair Gainsharing between Employees and Shareholders…” and several other things besides. 

The paper is called Toward Fair and Sustainable Capitalism. Naturally, I like the title.

strine pic

Strine puts forward what he claims to be no less than a new model for capitalism. For this, he adopts the acronym EESG, adding ‘employees’ to the start of the usual ‘environmental, social and governance’. Let’s set aside the issue that employees are central to most people’s understanding of what the ‘social’ in ESG means — perhaps the fact that this is not understood by so smart and thoughtful a commentator as Strine indicates just how much change is needed to US corporate culture. Setting that misunderstanding aside, the proposals are more than worthy of careful consideration.

It is a broad-based manifesto, only some of which I will seek to address this time around. Strine’s proposals include:

  • requiring operating companies to give appropriate consideration to and make fair disclosure of their policies regarding EESG issues;
  • giving workers more leverage by requiring large companies to have board level committees charged with ensuring fair treatment of employees, enabling works’ councils, and reforming labour laws to facilitate wider union membership and bargaining for fair wages and working conditions;
  • changing accounting rules to treat investments in human capital like other long-term investments and require more disclosure of human capital investment;
  • that if a company provides quarterly earnings guidance, it must also provide a broader context considering longer-term factors such as EESG;
  • requiring institutional investors also to have due regard to EESG, and explain how their policies and practices deliver on this requirement;
  • closing loopholes on disclosure of company ownership so that activists must disclose their economic positions in companies promptly and honestly;
  • reforming the corporate voting system in a number of ways that Strine suggests are supportive of sustainable business practices and long-term investment; these include transforming the vote on pay from up-to-annual to every four years, making it harder to submit shareholder proposals, and requiring the disclosure of the economic interests in the company of any investor making a shareholder proposal or soliciting proxies;
  • improving the tax system to encourage longer-term investment and discourage speculation — not least by extending the holding period for capital gains taxation, ensuring carried interest is taxed at the same rate as other income and establishing a financial transactions tax — with the resulting proceeds being used to green US infrastructure and tackle climate change; and
  • reforming corporate political spending and forced arbitration, to level the playing field for workers, consumers, and ordinary investors.

So is Strine right? First, it is fair to say that Strine reserves some strident criticism for institutional investors as well as urging them to put EESG at the core of their work (clearly, he has seen no evidence that they do so already). I will perhaps return to this criticism of investors in a later blog. Second, it is important to note that Strine’s criticism of capitalism is focused exclusively on the US, and it is fair to say that capitalism in the US is very much an outlier, particularly in the area of Strine’s greatest focus, the treatment of employees (workforce may be a better term given that one of the issues with the current version of US capitalism is that some companies carefully structure themselves and their contractual relationships so that the bulk of their workers are not in fact employees). 

The US is an outlier. Much of what Strine proposes in relation to EESG looks very much like the standards expected of UK companies through the modern interpretation of directors’ duties under s172 of the Companies Act. In particular, the Corporate Governance Code now insists that boards in some way ensure that the voice of the workforce is heard at board level, offering ways in which this may be done including by having worker representatives on the board itself, or having a designated non-executive director with the specific role of liaising with staff. Clearly much of this — not least worker representatives on boards — is already in place in much of Europe, and some UK voices are pressing hard for this particular solution to be taken forwards here. Strine’s proposals would only amount to a partial catching up with these approaches.

In part, the US hesitancy over taking account of stakeholder interests in a way similar to that called for in s172 reflects the ongoing misunderstanding that US law insists that corporate boards must focus on shareholder interests alone. This is not actually what US law requires. And US companies make much less disclosure than others on ESG (or EESG) matters, fearing greater exposure to legal action than necessary if they report more than the Securities and Exchange Commission (SEC) strictly requires of them.

In theory, the major US companies have now asserted their belief that stakeholders matter. Through August’s Statement on the purpose of a corporation, 181 US corporate leaders asserted that other stakeholders are as important as shareholders to their businesses. Yet this statement from the Business Roundtable has not been followed by any substantive changes in business approach. Indeed, it has become apparent that those same corporate leaders continue to pursue business as usual; for example it was within days of the issuance of the statement that Amazon (led by signatory Jeff Bezos) decided that its newly acquired Wholefoods should move to withdraw healthcare coverage from hundreds of part-time workers. So much for providing workers with important benefits and for stakeholders more generally (see also Demanding Supply).

Amazon is not alone. Apple, probably the most lauded company of recent years, has prospered by outsourcing its manufacturing, denying much of the responsibility for the lives of those in its supply chain by putting its business at contractual arm’s length from ongoing allegations of mistreatment of workers by, among others, Hon Hai Precision Industry (usually known as Foxconn). Uber has in effect outsourced its whole driver workforce, seemingly absolving it of all responsibility for their earnings or welfare. A couple of years ago I had the privilege of sitting on the panel alongside an anonymised Tesla worker who risked his job by making allegations that the company was irresponsibly risking the health and safety of its workforce in a rush to meet accelerating production targets.

This corporate denial of responsibility to those who create their products and provide their services has to be recognised as wholly irresponsible. 

With the development of such limited responsibility companies, no wonder there is a sense that the corporate world has become disconnected from society. In a very deliberate way, too many companies have sought to be so, cutting the ties that earth them. The company, an invention of law which is really just a nexus of relationships with actors in the real world, is in some cases at risk of morphing into a pure fiction drifting free of all reality. 

Perhaps it is therefore no wonder that the unnatural revolutionary Strine feels the need to rework US capitalism to put workers back at its centre. His proposals offer an interesting step towards reinjecting responsibility into US business, reconnecting companies with the factors that make them part of the real world — most importantly by reconnecting them much more fully with their workforce. His is a lengthy set of prescriptions, but it may be a long journey back from the world of the limited responsibility company.


Toward Fair and Sustainable Capitalism

Accountable Capitalism, Governance

Statement on the purpose of a corporation, Business Roundtable

Solidarity: fairness and the workforce

“Cooperatively calling for a fair workplace reflects a basic human desire to care for others in a mutually supportive way.”

I’m not sure that Google would be high on my personal list of employers showing the way forward for workers’ relations, but there is a recent Aeon article that is well worth a read from the perspective of fairness and industrial relations.

Aeon is one of my favourite venues for accessible academic thinking, and I’m pleased to be a supporter. This brief article is written by Carl Rhodes, deputy dean of the business school at the University of Technology Sydney.

Find the article here Solidarity is not dead: how workers can force progressive change.

“The pursuit of workplace fairness is not just a matter for the individuals who have been mistreated, maligned or manhandled. Justice is not just justice for me. It forms the heart of a community. What that community is collectively prepared to accept as fair and unfair defines its moral character.”

Demanding supply

There has been much talk in both British and US business of late about stakeholders. A couple of years ago UK politicians and commentators appeared to rediscover section 172 of the Companies Act 2006, which codified the pre-existing law on directors’ duties. Section 172 makes clear that prosperity in business can only be delivered by taking into account the interests of stakeholders (including, specifically, employees, suppliers, customers, local communities and the environment). Companies are now responding to a new call in the Corporate Governance Code to report on how they have done this in practice. More recently, the US’s Business Roundtable (BRT) in August purported to redefine the purpose of the corporation by asserting the need to consider the interests of customers, employees, suppliers and communities as well as shareholders. 

I’ve explained elsewhere that the modern US assumption that shareholder interests always come first is a misreading of the legal precedents, so this restatement seems unnecessary. It’s also worth noting that the negative response to the BRT statement from the major US investors was based more on a disbelief that any of the 181 corporate signatories actually meant it than on a belief that stakeholder interests are unimportant. The actions since its publication of many of the companies whose leaders signed the statement have not demonstrated any shift in their approach to the treatment of stakeholders: none has demonstrated greater fairness of late.

For these key stakeholder relationships all need to be mediated by fairness — indeed the BRT statement specifically mentions fairness, at least in relation to employees and suppliers. Yet, all of these stakeholders are at various times mistreated and not dealt with fairly — if this were not the case there would be no need for the US corporate elite to restate something that amounts to no more than motherhood and apple pie. 

Of all the unfairnesses, perhaps the most consistently unfair is the way that large companies treat their suppliers. The power imbalances in most supply chain relationships were brought home very clearly to a friend of mine early in his business career when his triumph over a successful negotiation, knocking down a supplier’s prices significantly, turned to rather different emotions a few months later when the supplier went bust. This, and the challenge and cost of replacing that supplier, apparently amounted to a highly chastening experience. 

Most choose to sweep it under the carpet, but the unfairness of these differential power relationships is made plain by those handful of companies that are transparent about their economic treatment of suppliers. The result is economic madness as well as supplier unfairness. A typically excellent recent report from the Financial Reporting Lab highlighting best practice disclosures on the sources and uses of cash includes a small section on supply chain financing. It is mostly obliged to lean on invented examples as there is precious little best practice in reporting on such financing. The report does, however, include some disclosures from AstraZeneca which allow us to have some insight into the economic irrationality that underlies how big companies treat their suppliers.

AstraZeneca reveals in its Annual Report (p34 and p177) a relatively recently established supply chain financing programme, whereby suppliers are able to be paid earlier than their contracted due date through payments from financiers Taulia and Greensill Capital. AstraZeneca then pays Greensill on the contractual date. The suppliers in effect pay an interest rate for the privilege of being paid earlier than they might be. As at the year-end December 2018, 2548 suppliers were enrolled and the trade payables associated with the programme amounted to $166 million (the newness of this programme is clear from the fact that this balance has risen from $64 million in the prior year, and $0 previously).

A more mature such programme is operated by Vodafone. It has 3500 suppliers enrolled, and the balance of supplier invoices in the programme at year end March 2019 was £2.5 billion (this seems to be near steady-state as the prior year balance was £2.3 billion). The company explains this as follows: “Our suppliers have the opportunity to take up early invoice payments on a completely voluntary basis, where payment can be taken in advance of agreed terms at much lower rates than they are likely to receive under traditional factoring or borrowing arrangements” (quote from p63 of the latest Annual Report, other information p161). 

It is that ‘at much lower rates than under traditional borrowing arrangements’ that reveals the unfairness of this approach for our economy as well as for the individual suppliers. Having had discussions with the financial institution that provides this financing, the model is clear: it is an arbitrage between the cost of debt of Vodafone (very low) and that of its suppliers (higher, by a lesser or greater margin). In effect, suppliers are allowed to piggy back on Vodafone’s credit rating and so borrow money more cheaply than they might otherwise be able to.

For many finance teams, this reflects a way they seek to demonstrate their effectiveness: they try to manage down the company’s working capital, minimising the amount of money tied up in the business. Among other actions, they work to extend supplier terms, and measure success by paying as close to the final deadline as possible. Nirvana in this mindset is negative working capital — being paid by consumers or customers for goods before having to pay suppliers for the inputs. Some finance teams wear this like a badge of honour.

It’s economic nonsense though. As the Vodafone case shows (and note that I have no reason to believe that Vodafone or AstraZeneca are any worse than other companies, it’s just that we have some visibility on what they do), this is a deliberate shifting of the borrowing burden onto those with a higher cost of capital. Before anyone suggests that money is essentially free for consumers, do remember that at least 4% of consumer spending is on (expensive) credit. Even on relatively modest assumptions, the economic drag from just this visible portion of Vodafone’s approach to paying its suppliers runs into the tens of millions of pounds.

Companies act as though this money that they use to run their business, the money that is in effect borrowed from customers and from suppliers, is free. But the cost drag is clear: a higher cost of debt is built in to the prices companies pay their suppliers. So not only is the differential power relationship between companies and suppliers leading to unfairness, it also represents a drag on the economy. If the larger companies provided the financing, and did not seek to minimise their working capital, the overall cost of debt in the system would be reduced, leading to greater economic efficiency and greater fairness to all participants.

We need to find a fairer approach.


Accountable Capitalism, Governance, October 2018

Statement on the purpose of a corporation, Business Roundtable, August 2019

CII Responds to Business Roundtable Statement on Corporate Purpose, Council of Institutional Investors, August 2019

Disclosures on the sources and uses of cash, Financial Reporting Lab, September 2019

Lessons from Argentina, and Copperfield

As Argentina’s economic problems worsen, with capital controls reintroduced and the value of its debt fallen back to around 40c on the $, I have been reflecting again on a recent trip there. It is a wonderful country, with beautiful countryside and delightful people. My memories are clouded though by the economic lessons that are impossible not to see around you. It was unfairness visible.

I was there on the day in August of the primary elections when current President Mauricio Macri was trounced by his populist rival Alberto Fernandez. These votes didn’t mean anything in themselves other than foreshadowing the real thing, due at the end of this month. There had been huge and angry demonstrations leading up to the election date, and the streets were filled with political billboards. During the day itself, the streets seemed quiet and the main impact I felt personally was the ban on alcohol sales until 9pm on the day of any vote.

The waiter who brought me that 9pm beer was thus particularly welcome, but he was also particularly glum. The exit polls were already showing victory by 40% by Fernandez, which he regarded as a disaster. Others were more positive: I am told supporters of Fernandez flooded some streets in Buenos Aires in noisy celebration, though I didn’t witness that.

The currency markets, however, agreed with my waiter: the peso fell almost at once by 25%, and share prices by 35% (in non-peso terms, shares halved in value), putting further pressure on an economy already facing steep recession through Macri’s tough austerity programme. Unemployment is high, and inflation is creeping upwards despite administrative controls — in spite of those controls, it is running at over 50% a year.

I have never before travelled in an economy falling apart in front of my eyes. Cuba was non-functional but still people coped; everyone seemed to have some small scam going, mainly revolving around getting hard cash from the tourist market. The number of people who ought to have more productive lives who were operating as tour guides was hugely depressing. In a similar vein, I vividly remember the shelves of a supermarket in Soviet Russia holding only distinctly blue-tinged milk, and nothing else; and yet the people seemed to expect nothing better and survived. Both were messes in their own ways, but in their own ways they were steady state situations. Argentina was different.

I had only before studied the theory of shoe leather costs — the daily grinding additional burdens that arise in an economy weighed down by high inflation. But in Argentina there was no escape from seeing its reality. There were long daily queues at cashpoints to take out the meagre amount permitted for withdrawal each day — P2000, at a fee of P350-450 per transaction (those administrative measures to limit inflation are pretty blunt). The blackboards showing prices which changed rapidly, or the multiple labels on menus to reflect the fact that last week’s prices no longer reflect economic reality; or the side-stepping of both with lengthy negotiations about what price is appropriate and can be afforded on both sides. Silent queues of protest outside the offices of the failing municipal utilities. In a country of high unemployment and little opportunity, time is cheap and so gets wasted in various mundane frustrating ways. Soviet Russia used to formalise this by requiring shoppers to queue up three times to make a single purchase, should there have been anything other than blue milk to buy. This was in part a make-work scheme and in part a make-slow scheme. But Argentina demonstrated that formality is not needed and queuing can become a way of life. Mostly those queues and protests were quiet and dignified but the underlying anger was not hard to sense, and it was not hard to imagine more of those quiet protests at some point boiling over into something more — the point at which unfairness can no longer be tolerated.

One of the most poignant sights of a proud economy that is failing came at the border with Brazil — the mutual bridge proudly painted with each nation’s colours to halfway, the green and gold of Brazil glowing with a recent coat and the blue and white of Argentina cracked and peeling. The saddest sight was the bags and bags of onions seized at the border. Smuggling even this mundane a product was lucrative enough to justify the risk of being caught and all that might entail. 

But Argentina’s problem is more fundamental and mundane even than onions: with 10% unemployment and a third living in poverty life is impossible for many, but even the average middle class wage of around P30000 a month is no longer proving possible to live on. As inflation has outstripped wage rises, everything has become too expensive, so even the middle class is struggling and barely coping. Perhaps the queues at the bank would be still longer if people had more money available to them to spend. Discussing the situation reminded me of Wilkins Micawber in Charles Dickens’ David Copperfield (freshly and dazzingly brought to our screens by the magical Armando Iannucci). He states the problem with precision:

“Annual income twenty pounds, annual expenditure nineteen nineteen and six, result happiness. Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery.”

Micawber, like too many Argentines, is always the wrong side of that equation. The tragedy of Micawber is that while his sunniness in the face of what ought to be misery allows him to believe that something will turn up to unlock him from the inability to afford to live, we the readers believe that it never will (though Dickens is ever a benevolent author). That we have whole economies now operating on the false promise that something will turn up is our current tragedy — it is unfair that we seem to be lying to such people, who do not have the benefit of salvation at the hands of a kindly writer.

And sadly we cannot assume that this phenomenon is restricted to emerging economies. How else can we explain the ever-increasing personal debt levels, the use of equity in housing and rising credit card balances, that are a feature across major developed economies? While interest rates are low, significant portions of the world are now operating on the never never. While it temporarily keeps individuals’ heads above water, overall it will not make us more prosperous. Indeed, it might seem that there are pockets of troubled economies hidden within the wider, supposedly prosperous developed economies: that’s what our inequalities and unfairnesses have brought us to.

consumer credit data UK

Take the latest Bank of England figures on consumer borrowing (above). There has been no overall repayment of consumer debt since 2012, and while the monthly growth in debt has reduced marginally in recent months it still has a run-rate of around £1 billion a month, and now totals over £200 billion (this is in addition to mortgage borrowing, which also continues to grow, at around $4 billion a month, and totals some £1.4 trillion). That £1 billion a month, £12 billion a year, is a significant portion of the overall level of household expenditure in the UK, which runs at around £300 billion annually. Mr Micawber’s hopes make up around 4% of personal spending. The inequalities and unfairnesses that we all face mean that we are collectively hoping that something will turn up. False and unfair aspirations are likely to end in tears.

To return to Argentina, and the lessons that we might learn from it, I can do no better than quote from the conclusions to a recent (US) National Bureau of Economic Research working paper on Latin American populism: 

“Populists implement redistributive policies that violate the basic laws of economics, and in particular budget constraints. Most populist experiments go through five distinct phases that span from euphoria to collapse. Historically, the vast majority of populist episodes end up with declines in national income. When everything is over, incomes of the poor and middle class tend to be lower than when the experiment was launched. I argue that many of the characteristics of traditional Latin American populism are present in more recent manifestations from around the globe.”


On Latin American Populism, and its Echoes Around the World, by Sebastian Edwards, NBER Working Paper No. 26333, October 2019

Funds facilitate unfair pay

Institutional investors wave through pay practices that are unfair — to themselves as well as to others. Even the best barely manage to arrive half-way towards fairness. Funds thus fail to have fairness at the heart of what they do.

These are the conclusions of a fascinating recent presentation by Steve O’Byrne and his Shareholder Value Advisors, still available as part of an on-demand webinar (at least at the time of writing). 

It’s worth noting of course that Steve has developed a particular definition of fairness, and his own detailed statistical analysis of whether companies deliver it — and also whether investors respond appropriately. But the mere fact that he considers fairness is clearly welcome, and his analysis at the least confirms that there is a problem (as if further confirmation were needed). It’s worth also noting that he focuses purely on the US, where that problem is arguably greatest, and his main focus with regards to investors is their voting on so-called ‘say-on-pay’ resolutions, the normally annual non-binding votes to approve company pay practices.

Steve’s definition of unfairness is essentially one of excess rents — ie payouts that are undeserved, essentially because they provide rewards for performance that is no better than the industry standard. By this definition, these are unearned payments and so should not form part of any individual’s earnings. To the extent that investors are supporting payments that amount to unearned rents they are harming their own returns and signing off on skewed economics.

He has developed what he believes to be the perfect structure for a fair pay scheme, which derives awards based on TSR and the level of vesting based on returns greater than the industry. Whether everyone would deem the outcomes of these calculations ‘fair’ may be in some doubt, as the starting point is ‘market pay’, ie it assumes that generally pervading pay levels for top US executives are appropriate, in effect baking in current levels of unfairness. Nonetheless, the model does appear to deliver some greater relative fairness between executives and between companies, and it is a useful thought experiment stepping towards a broader fairness that reflects economic rationality. Steve is good enough to recognise that there is another form of ‘perfect’ pay structure to have been proposed for corporations: the Dynamic CEO Compensation model developed by excellent UK academic Alex Edmans. Both this, and Steve’s own version of perfection, have some striking similarities with the proposals for lifetime restricted stock compensation that a number of investors (notably Norges Bank and Hermes) have been trying to promote.

While there are dangers in a focus on TSR — this must always be an output of decision-making and there are dangers in bringing it into the foreground through making it a metric — over the long term it should be a reasonably fair measure. It is usually regarded by investors as the least gamable of performance measures. It is potentially subject to gaming, yes, but less so than other metrics and with fewer perverse incentives built into it. 

In some ways, it appears that investors are doing a good job: Steve identifies a high correlation between votes against US say-on-pay resolutions and the amount by which CEO pay exceeds fair levels in terms of company size, industry and relative TSR. However, he notes “extraordinarily high pay premiums are needed to get a majority ‘no’ vote” so majority opposition is only brought about by truly egregious cases. His other yardsticks on fairness include whether the CEO is paid more than 2.5x the median of the other 4 disclosed highest earners at the company and assessing pay against relative returns on invested capital. Both seem sensible measures of some aspects of fairness, though it is impossible to know if the calibration set is the right one.

However, despite this limited positive, two of Steve’s overall conclusions are pretty damning:

  • only 3 of 213 funds are halfway to what he would say is fully informed and fair say-on-pay voting (kudos to Irish Life, Calvert and to Wells Fargo, which leads the pack with a calculated 56% vote quality); and
  • three quarters of funds vote with a lower quality than the overall average, which itself is sadly below 40% of perfectly fair levels according to the calculations.

And his chart on the fair voting performance of the largest fund managers is unimpressive:

Fair pair voting

BlackRock is the only one of these for which he provides broken out data, and the 28% average according to Steve’s calculation is dragged down in particular by his analysis that the firm votes against only 7% of those situations where the CEO’s pay premium above a fair level is more than 100%.

It must be clear that this is an idiosyncratic analysis, and a particular and personal perspective on fairness. No doubt through other lenses the performance of the investment industry would appear better. But the clients of the industry, who can only dream of the rewards received by top CEOs — and would welcome small portions of the pay inflation that they have enjoyed — could certainly be forgiven for asking if this is fair. It is further evidence that too many investors continue to be content to allow the persistence of much unfairness, in effect facilitating it.

Bowling together

It feels wrong on a day of Ashes cricket to be writing of bowling in the American sense of the word, but sadly this title is a reference to ten-pin bowling not that of the wonderful Broad and absent Anderson, and the whole squad (and yes, some of the Australians are quite good at it too).

It is nearly 20 years since Harvard Professor Robert Putnam punished his seminal work Bowling Alone. This highlighted the significant decline in social capital in the US between 1965 and 1995, coinciding with a marked increase in inequality (unfairness, as this blog prefers). No longer were US citizens bowling in leagues, they were bowling more, but bowling alone. The fall in membership of almost every other social organisation — the social and community links that constitute what is meant by social capital — mirrored the decline that he used to give his work its title. 

At the time of the book’s publication, people from many other countries talked about these trends as a peculiarly US phenomenon. Most now accept that these same effects — declines in social capital and increases in inequality — are near-universal. We are all more isolated, and unfairness has increased.

I understand that Putnam is preparing a 20th anniversary edition of the book, which will include some reflections on the Internet and its impacts. Not all of these are bad and isolating in Putnam’s view; indeed, he sees some signs of new communities being created through the web, as well as the negatives of occasional egotistical narcissism. 

He is also preparing a new work, as yet unnamed as far as I know, considering not just the 30 years from the mid-1960s but comparing data from around 1900 through towards the current day. I had the fortune to hear Putnam talk about this work earlier this week at a Tortoise gathering dedicated to him. He considers again factors of social capital and inequality, and also political partisanship and cultural individualism, using a remarkable number of datapoints across each of these areas. Again and again these datapoints reveal  the same pattern, with a remarkable degree of consistency. 

The simple message is that political partisanship peaked in the 1950s, social capital around 1960 and cultural individualism (using the simple test — at least simple with the benefit of the remarkable datapools and analysis of Google Ngrams — of the frequency of ‘we’ compared with that of ‘I’ in all publications) in about 1970. The decline from these points is well known, indeed it was the core of Bowling Alone and much of what has been published in this area since (though Putnam uncovers further declines beyond his original 1995 end-point). Over the same period, inequality has risen at a remarkable rate.

The most notable thing about Putnam’s data though is what comes before 1960: it turns out that this was a peak in all the datasets, and that each factor had been increasing steadily from around 1890 (or, in the case of inequality, decreasing). We are in many cases at or around the levels last seen in 1890 (in some cases we have fallen below them); the period leading to this point was known as the gilded era in the US and was the peak of robber baron capitalism and all the unfairness that came with it.

Some may be surprised to hear that Putnam is sure that rising inequality is not the cause of the other declines. Rather, his data shows that increases in inequality are a lagging indicator of the other trends that he identifies. Thus, if we are to answer our current challenges of fairness we need to consider ways of addressing the other declines.

Putnam is eager to talk about these. He notes that the gilded age ended through social and political choice, and perhaps the fear of civil unrest (not least in the economic depression known as the Panic of 1893 — though the depression lasted until 1897). The US’s gilded age ended with the so-called Progressive Era and more generalised reforms.

The lessons that Putnam draws from that era, and what he believes lies behind the turning point in the data he identifies are:

  • genuine grassroots mobilisation is required
  • problems should be solved locally and boldly (allowing a thousand flowers to bloom), and effective solutions then shared nationally [and if culturally appropriate perhaps internationally]
  • bridges (across class, race and organisation etc) are essential
  • charismatic national leaders are only important after the grassroots process has begun

He gives the example of US public schools, which did not exist until the progressive era. In a handful of towns and cities across the midwest communities came together to ensure that every child should have around 4 years of free secondary education. This revolutionary step proved a great success and was then adopted nationally. Among other things, this supply-side revolution pump-primed the US economy by ensuring a relatively well-educated workforce — which played a key role in the economic success of the American century that followed.

There is work to be done.

Gaping chasms

The excellent Institute for Fiscal Studies has just released some exemplary work on those in the top 1% of incomes. This provides more evidence to reinforce the themes of my last blog, Gaping holes in fairness. It sparks further thought.

The IFS notes the tax advantage enjoyed by many of those with the highest incomes. Of those enjoying the top 1% of incomes, 18% of income is from partnerships, 11% from dividends and nearly 4% from self-employment. All these are taxed at lower levels than employment income. Most of these proportions are still more extreme for those in the top 0.1% of income category: 23% of their income is from partnerships, and 13% from dividends. It seems nothing other than fair that we should seek to equalise the taxation on the various forms of income, not least to dissuade structuring and avoidance (including delays in paying taxation by holding income in personal service companies and subsequently releasing it in dividends), as touched on in Simplifying tax is fairness.

But the most striking element of the IFS work is the evidence of the chasms that there now are, and the perceptive framing that we face because of it. This chart is telling:

IFS chasm 1

As the IFS says, this highlights “just how different the top 1% are from even the merely quite well-off”. The median income of all taxpayers is £22,000. Those at the 90th percentile enjoy more than double that, £59,000. But the 99th percentile kicks in at £162,000, nearly three times the level of those at the 90th percentile, and more than 7 times those at median, and therefore:

“If you are at the 90th percentile, you may well feel more like the person at the median (21.6 million adults below you in the distribution) than the person at the 99th percentile (just 4.9 million people above you).”

As the study notes, the disparities above the 99th percentile are even more extreme (the bar charts in Panel B). Remember always that these are disparities based on income tax returns, and that wealth disparities are likely to be still greater.

If anything, the regional disparities are even more striking. Half of those in the top 1% of income taxpayers now live in just 65 parliamentary constituencies, down from 78 in 2000. 30 constituencies have more than 2% of their adult population in the top 1% of income taxpayers; 17 of these 30 are in London and all but two, the IFS reports, are in the South East. Eyeballing their map suggests one of these constituencies is Aberdeen (the data is all 2014-5 tax year so predates the latest oil downturn), and the other is St Albans — which most would, I think, classify as being in the South East, though for these purposes it is placed in the East of England. In total, around 58% of all the top income taxpayers live in London and the South East, and a further 10% are in the East of England.

The skewing of the highest of incomes towards London is so extreme that the IFS points out that a London-based man aged 45-54 would be in the top 1% of income taxpayers nationally with an income of £162,000, but would need a further £560,000 in income to be among the top 1% of those of the same age, gender and location.

No wonder people’s perceptions are skewed, in just the same way as top executives’ pay expectations are framed by those of their peers. People’s thoughts are anchored by what they see around them and struggle to understand what they do not see, especially when the disparities are so great. I vividly remember the regular occasions when Justin King, then Sainsbury CEO, explained to investment analysts that they live in ‘an absolute bubble’ and that sharper pricing of everyday shopping was necessary for it to be affordable by the general population. The pricing of more expensive competitors was, he said often, ‘la-la land’ (this was long before the film of that name so did not conjure images of people dancing on top of cars).

The chasms are gaping. And our bridges aren’t working. The BBC’s recent documentary How to Break into the Elite served to demonstrate how tough that challenge is, even using the most frequently commended route of education. The programme quotes research by the London School of Economics that found a working class graduate with a first class degree was less likely to land an elite job than a middle class graduate with a 2:2, and even if they succeeded in doing so, they would earn 16% less than a middle class equivalent.

We need to shrink the chasms, we need to improve the bridges. That is only fair.


The characteristics and incomes of the top 1%, Robert Joyce, Thomas Pope, Barra Roantree, IFS Briefing Note BN254, Institute for Fiscal Studies

Gaping holes in fairness

Our businesses are missing out on putting all their best talent to use. Gaping pay gaps are evidence of failures fully to appreciate and recognise the skills and abilities of the whole workforce. They are also unfair.

Since 1975, UK employers have been barred from paying men and women differently for the same work. That was when the Equal Pay Act 1970 came into force, partly in response to the Ford machinists strike remembered to modern audiences by the 2010 film and subsequent musical Made in Dagenham, and partly as a requirement for then-imminent membership of the European Community, as was.

The 1970 Act has now been replaced by the Equality Act 2010, which brings together the anti-discrimination standards from a range of legislation, meaning that there should now be equal treatment across all ‘protected characteristics’, including age, disability, gender, ethnicity, religion and sexual orientation. There will be ongoing disputes around equal pay — and particularly around what forms of work should be deemed equal and so should fairly receive the same pay. But more disheartening is the story revealed by the gender pay gap reporting now made mandatory under a 2016 amendment to the Act. Despite this being the longest-standing area of equalities legislation, the reporting reveals that 78% of companies still pay men more than women. 

These reflections were brought on by a discussion hosted by Tortoise, a vigorous new media operation committed to slow news. This ‘ThinkIn’ covered pay gaps generally and why they are so intractable. The discussion ranged across all forms of pay gap, not only gender but also ethnicity, disability and socio-economic. All are unfair, but the latter was felt by most in the room to be the most intractable and least discussed.

The statistics on socio-economic issues are indeed disturbing. As it happened, later the same day the Education Policy Institute released its latest annual report on education in England. This revealed the extent of the ongoing gap in school attainment experienced by disadvantaged kids compared with their peers. The EPI defines as ‘disadvantaged’ children who were eligible for free school meals at any time in the prior 6 years, and by the time they reach the end of secondary school these pupils are more than 18 months behind their better off peers (and in many UK regions it is much worse than this). The persistently disadvantaged — those eligible for free school meals for at least 80% of their schooling — are nearly a full 2 years behind.

EPI disadvantage now

According to the EPI, this 18-month or 2-year gap represents the accumulation of disadvantage over what is only a few years of life, starting in pregnancy and pre-school as well as reflecting the educational experience. When companies do not act to counterbalance these disadvantages they can only unfairly persist. The extent to which our society is failing to address this persistent unfairness is shown by the EPI’s historic data on the disadvantage gap. Though it has closed somewhat in the last decade, that progress has stalled most recently. The EPI estimates that on the trend of the latest 5 years it will take fully 560 years for the disadvantage gap to be closed. One doubts if our children have that long.

EPI disadvantage history

In a similar way, the second year’s disclosures of their gender pay gaps by UK companies also emphasise just how long unfairnesses persist if they are not addressed very directly. They imply that companies need to be working much harder to ensure that they are properly inclusive of all the talent available to them. Many companies attempt to explain their reported pay gaps by the fact that they have more men in senior positions, or more men in traditionally higher paid roles. But the key question is how to unlock and overturn this differentiation. Merely restating it shows little intent to do so. The simple fact is that such companies are not treating their employees with fairness. There are inherent biases which drive differential recruitment and differential promotion. Only when those differences are actively considered and pressed against will they be addressed.

The gap is now one of fair promotion not equal pay. Companies are in practice failing to make opportunities fairly available to all and thereby missing out on unlocking the talents of their whole workforce.

The gender pay gap is associated with childbirth and the decisions related to the care of children. Disproportionately still it is women who take on a higher burden of the childcare and work more locally and more part time. Promotion is slower for those working part time (though it needn’t be), and pay tends to be lower for those who are less willing to travel for it. Of course, not all individuals and couples reach the same decisions but the simple fact is that still at present women are more likely to take this sort of step back. This drives this particularly striking chart (based on Danish data but likely to be largely universal):

NBER child earnings

Companies can and should play a greater role in this, to retain all their most talented staff. There was much discussion at the Tortoise event of encouraging paternity leave, and equal choices by new fathers and new mothers — the comments both from a personal perspective (“demand more from your partner”) and from a corporate, with one participant revealing that their company, after a year of offering full paternity leave rights, only recently had their first individual taking them up, and then only after specific encouragement. In large part, the move to greater fairness and smaller pay gaps will require a changing of norms.

Some of those norms need to be around the willingness of hiring managers to recruit for difference and promote for difference. Another business leader at the Tortoise gathering noted that she had spent a year saying in talks around the business that she was expecting to be appointing more female heads of country operations, to no avail. It was only when she told recruiting managers that she would scrutinise each employment decision that a greater mix of appointments was made — though this was still only 10% female. Accountability matters, and challenge is needed to change norms.

Businesses need to work to remind all managers that employing people who are similar to oneself is not a model for greatest effectiveness, and that diversity is a good thing in itself for the effectiveness of teams. Just as the best boards are diverse, and the best chairs know that a large part of their role is to work the alchemy of drawing the best from a diverse group rather than hearing similar minded individuals reinforce each other, so the best teams and whole workforces are diverse. Evolution teaches us that extinction happens when species become specialised and too brittle to adapt to new changes and pressures. We know that such pressures are being placed on the global environment; that same challenge, together with the pressure of technological competition, are ratcheting up the difficult environment of the corporate world. Those that are robust and nimble enough may be able to adapt to these challenges, but one thing they are likely to need is diversity to aid their flexibility and adaptability. Fair employment approaches, and pay, are needed.


Education in England: Annual Report 2019, Education Policy Institute

Children and Gender Inequality: Evidence from Denmark, Henrik Kleven, Camille Landais, Jakob Egholt Søgaard, NBER Working Paper 24219