I am grateful to the energetic strategic thinker Paul Barnett for highlighting that management guru Peter Drucker’s famous quote is actually much more interesting in its full version:

“What gets measured gets managed — even when it’s pointless to measure and manage it, and even if it harms the purpose of the organization to do so.” 

Yet we measure and measure, whether or not it is a helpful thing to measure, and we tie pay to these measurements. No wonder a sense of fairness rarely seems to arise from this misguided process.

Bob Emiliani of the Lally School of Management and Technology, mounts an entertaining attack on the whole concept of what gets measured. He claims to prove that it is a falsehood because business is always more complex than any simple promise indicates. He highlights the tendency of executives — from senior management to junior staff — to game any system they are presented with. Certainly, shareholders consistently worry that a focus on specific financial performance measures drives negative behaviours; the current row about share buybacks being driven by earnings targets and executive share options being just the latest public manifestation of this ongoing concern.

And it is not just shareholders that worry about the possible unintended consequences and perverse incentives embedded in the performance metrics of executive pay. One FTSE 100 chair of my acquaintance tells the story of a frustrating meeting with a fund manager who was insisting on the inclusion of an EPS target in executive pay. There was no coherent answer given when the chair pointed out that an EPS target made no sense because any EPS result could always be manufactured by tweaking investment or marketing spend, in effect harming future performance for the sake of near-term numbers. The history of recent business seems littered with companies that have indeed underinvested in their future — perhaps in part because executives were encouraged to over-deliver earnings in the near-term. 

It’s odd that this myth of the value of measures and measurement persists with such vigour. During the Vietnam war, US Secretary of Defense Robert McNamara demonstrated that using things that were measurable to judge success was a mistake. He ensured that available metrics were captured — metrics such as the enemy body count — and was happy to find these demonstrate ongoing success. What those metrics did not capture was the impending US defeat. Assessments that might have revealed the extent of US military failure were much less readily captured, and so the potentially useful information was ignored. Yet 50 years on the business world does not seem to have learned from what is known as the McNamara fallacy.

For some, merely setting targets drives short-termism. Harvard’s Robert Merton as long ago as 1936 (and claiming to build on the foundations of a remarkably diverse group of thinkers including Machiavelli, Adam Smith and Engels) argued that the measurement of performance automatically means the measured succumbs to “the imperious immediacy of interests” — in the less florid language of our own days, short-termism. He found that the “paramount concern with the foreseen immediate consequences excludes consideration of further or other consequences”. He went further: “strong concern with the satisfaction of the immediate interest is a psychological generator of emotional bias, with consequent lopsidedness or failure to engage in the required calculations”. In other words, target-setting blinds us even to our own best interests.

As indicated in Resentments and Rents, it is not enough just to talk about problems, we also need to consider what sorts of performance metric we should be applying to executive pay. This discussion is an attempt to respond to that challenge. Thus far, I have highlighted the dangers of narrow financial measures but I haven’t offered positive solutions.

Merton’s challenge is a substantial one: he doesn’t just raise the risk of gaming of targets but says we even trick ourselves and fall into a form of voluntary enslavement to any given performance metric. If this is right, and it certainly is easy to recognise the risks, we need to escape from the false precision of target-setting and need to assess performance in a much more rich sense. This is what happens in the rest of business, but oddly not at the top of organisations. 

So our challenge is to uncover the McNamara fallacy in business — so that we no longer use metrics just because they are available but apply intelligent judgement such that we assess what is actually worthwhile.

Given that the job of the CEO is to drive the long-term success of the business, not simply to make the numbers next week, measuring a richer set of measures of the health of the organisation has some attraction. This may require assessments of the extent to which stakeholder relationships have been built, business culture has been advanced, new businesses or products developed or fostered. This needs to be not an excuse for paying up in spite of weak current performance — jam today for the CEO on the promise of jam tomorrow or in some years for the shareholders and other stakeholders in the business would not be fair. But remuneration committees need to be bolder in their approach to the challenge of assessing performance and agreeing executive pay. And shareholders need to be more flexible.

The solution lies in judgement. Merton is right that any performance metric embeds some degree of perverse incentive, some pressure towards short-termism. Indeed, it could be argued that the major attraction of TSR (total shareholder return) as a performance metric is because it introduces the fewest possible perverse incentives, provided it is measured over a long enough time horizon. To avoid, or at least limit, these perverse incentives we need remuneration committees to apply judgement and to assess whether the targets have been delivered without having given rise to negative consequences. This will mean that remuneration committees need to move away from what another investor representative has called the standard board approach to their CEO:

Brilliant, brilliant, brilliant, fired

Even the best CEO is not brilliant, and is unlikely to deserve 100% of their available incentive. So we need a richer and more honest discussion of performance. This does require a brave step, and it requires trust. Trust by executives of remuneration committees, that they will genuinely display fair judgement to deliver an appropriate level of reward, and trust by remuneration committees that their appropriate judgements will win approval from shareholders. We need to acknowledge that the process of shareholders looking over the shoulders of remuneration committees is not yet driving the right behaviours. It is not helping reinforce appropriate business-specific judgement by remuneration committees but instead seems to be herding them into the safety of a few approved metrics and structures. This has happened because we shareholders tend to lack trust in the judgements of remuneration committees.

So our underlying challenge is to build trust: trust between remuneration committees and senior executives; and trust between shareholders and remuneration committees. Only in this way can we unlock the tyranny of the McNamara fallacy. 

McKinsey Quarterly recently published a paper which may open a window on how this might be done. Talking about pay structures in companies more generally, it highlighted declining trust in those systems, and discussed ways in which trust may be reawakened. Their answer is to generate clear and apparent procedural fairness in pay systems: not only fairness of treatment but also the expectation of fairness of treatment. The article suggests three key steps to make pay more procedurally fair:

1. transparently link employees’ goals to business priorities and maintain a strong element of flexibility
2. invest in the coaching skills of managers to help them become better arbiters of day-to-day fairness
3. reward standout performance for some roles, while also managing converging performance for others

Considering these same themes in the context of senior executive pay may help us to unlock the spirit of fairness, and so build the necessary trust between the parties. Certainly #2 above may require more active dialogue between remuneration committees and management about the underlying drivers of long-term business success. This would be no bad thing in itself, and may be necessary in order for us to see pay linked to a rich sense of long-term prosperity rather than the narrowness of the current performance metrics that we typically employ. 

Drucker also said “because knowledge work cannot be measured the way manual work can, one cannot tell a knowledge worker in a few simple words whether he is doing the right job and how well he is doing it”. Not only can we not say it in a few simple words, we shouldn’t try to measure it in a few simple numbers.

We in business forget this at our peril.

 

I explored some of the ideas in this post further in: Money is not the answer

The growth myth

The pursuit of happiness

People matter, but not like that

Funds facilitate unfair pay

Meritocracy’s unfair

The false promise of what gets measured gets managed, Bob Emiliani, Management Decision 38(9) [Nov 2000]

The Unanticipated Consequences of Purposive Social Action, Robert Merton, American Sociological Review, Vol 1, No 6 (Dec 1936)

Dysfunctional Consequences of Performance Measurements, VF Ridgway, Administrative Science Quarterly 1(2) [Sep 1956]

The fairness factor in performance measurement, Bryan Hancock, Elizabeth Hioe, and Bill Schaninger, McKinsey Quarterly, April 2018

Further to the discussions at the recent ICGN conference, responsible tax also featured at the current PLSA (Pensions and Lifetime Savings Association, the former NAPF) conference in Edinburgh. Delegates were asked their reaction to aggressive tax planning by companies.

Far fewer than 10% of delegates answered that any tax minimisation within the law was in shareholders’ interests. Nearly half were most concerned about the potential reputational risks to the company, and around a third expressed concern that aggressive tax planning actually harmed the company directly by undermining state investment in its local infrastructure and society. Rather fewer worried about future tightening of regulation. These results are still more striking and powerful than those from the ICGN conference because there were many more participants in the PLSA session and they were much less self-selecting.

One other message clearly heard at the conference was the importance of stories about ESG and stewardship as being hugely important for engaging savers in their pensions investments, and in making the mysteries of finance closer to real life. This is a message I have emphasised for some time, not least in my FT article.

A well-attended session at the RSA tonight to launch Blueprint for Better Business‘s paper on Fairness in Business.

It’s an excellent, challenging paper, building on earlier discussions. It sets out how “acting unfairly undermines the very basis of trust in market relationships on which all profitable activity depends”. It provides challenges and provocations rather than easy answers, and is all the stronger for it.

There was an open discussion between Charles Wookey of Blueprint, philosopher Baroness Onora O’Neill, Liverpool Councillor Jane Corbett and Justin King, former Sainsbury CEO. These are a few outputs (my quotes are approximately accurate but can easily be checked against YouTube):

Charles Wookey: “Fairness is one of the keys to unlock the system change” that business needs, from growth for its own sake to promoting human wellbeing. He suggests fairness should not be seen in the abstract but should be a frame of mind, enabling businesses to seek to act fairly in relation to each of their stakeholders. “Even if it is not possible to be fair to all, it should be possible for business to avoid acting manifestly unfair towards anyone.”

Justin King was dismissive of algorithms, saying “The decisions business takes now that have the biggest delta are those that are the furthest away from numbers, when the numbers can’t take them for you.” That’s why, he says, purpose is important — though he shies away from the uncertainties of fairness. He also emphasised our own influence as consumers. He notes the time-horizon of a family business like Mars, where 75-year investments are made — on that time-horizon “you must by definition think about these issues”.

Onora O’Neill said plainly: “Trustworthiness is the important thing, not trust.” She noted that companies are complicated so it is wrong to suggest that even a corner shop has a single purpose — all have a “plurality of purposes”, not just focusing on the bottom line or maximising profit. Limited liability is a major benefit for companies and brings responsibility. And on fairness specifically she noted Rawls’ book Justice as Fairness. Fairness is crucial because it cannot be reduced to a claimable right.

There’s a huge irony in talking about fairness and executive pay. 

The irony is that perceived unfairness is one of the drivers for the upwards ratchet in pay. That is, some CEOs feel hard done by, and some remuneration committees worry that their CEOs will feel hard done by, and so feel obliged to match the pay of others. This is not good, but it is human.

So deeply inculcated in humans is the sense of fairness that while it is hard to believe that increments on significant incentive pay can create a greater incentive to perform — most doubt that a CEO will genuinely work harder if paid £4 million rather than £3 million — there is nonetheless scope for rewards to operate as a disincentive. If others that the individual perceives to be peers are all paid £4 million then the CEO will feel hard done by, tough though that is for a thoughtful independent third party to believe. The sorts of people who become CEOs of public companies are by their nature more than marginally competitive.

But this sense of feeling hard done by is pure perception. In their excellent paper The Pay of Corporate Executives and Financial Professionals as Evidence of Rents in Top 1% Incomes, Josh Bivens and Lawrence Mishel of the US’s left-leaning Economic Policy Institute provide significant evidence that there is rent-seeking in executive pay. This is strongly suggestive that the roles would still be attractive if executives generally received lower levels of compensation — so that CEOs would work as hard if they were paid £3 million rather than £4 million. It is not that the quantum is necessary, it is just that it is expected because others get that level of pay — so that £3 million will be ‘enough’ only if others also receive similar amounts. But £2 million would also be ‘enough’, as long as others received similar amounts.

These days the peers that CEOs measure themselves against in this way are international. Bivens and Mishel acknowledge the negative influence that US pay structures and levels are having on the rest of the world. Yet just this week the latest statistics from shareholder advocacy group As You Sow on the votes of major US mutual fund groups reveal the extent to which many institutional investors bless the surprising structures and pay levels typical in the US. Even among the pay schemes enjoyed by what As You Sow deems the 100 most overpaid US executives, Northern Trust backed them all in 2018, Fidelity opposed just 7%, BlackRock 11% and Vanguard 14%:

These numbers are at least a toughening of positions on previous years’ stances — all of these investment houses, and 20 in total, had opposition levels in single figure percentage points in As You Sow’s 2017 report when the campaigner challenged: ‘Are fund managers asleep at the wheel?’.

Yet even a very basic set of standards with regards to executive pay leads to remarkably different voting results. A few years back I set out some basic requirements on performance linkage for my investment institution, meaning that US schemes would be opposed if any one of these triggers was breached: supposed ‘long-term’ rewards are released within 3 years of award; more than 25% of awards are time-based only and not performance-linked; and rewards paid out if they applied a total shareholder return (TSR) metric that allowed a payout for underperformance, that is if TSR was below median of the peers. This doesn’t amount to more of an insistence than that there should be at least some limited degree of genuine long-term performancing of US awards (not least given the quantum that is standard in that country), but even just applying these very simple requirements led to my employer opposing 74% of all remuneration resolutions in North America in the last full year I was responsible for those decisions.

The negative influence of US pay practices and quantum is shown very clearly by statistics from UK campaigner the High Pay Centre. This chart is from their August 2018 High Pay Centre/CIPD FTSE 100 executive pay survey report:

Those sectors where CEO single figure pay is above £4 million are those where there is a clear international market for talent. Pay has been pulled upwards in those sectors where UK companies face global competition.

It’s also worth noting as an aside that the High Pay Centre numbers show that median UK CEO pay has stayed roughly level from 2011, when it was £3.90 million, to 2017, when it was £3.87 million. It does not appear that executive pay is becoming more of a problem, at least in the UK, even if the attention focused on the issue, and on the generosity of specific outliers, continues to become more intense.

But there is a clear problem. These charts from my excellent colleagues at governance data shop Aktis tell a remarkable story*:

This close compression of pay at US banks — in effect they all seem to pay the same amount — strongly suggests that their directors believe that there is a going rate for the job. In short, compensation committees seem to have come to the bizarre conclusion that it is more important to pay at the same level as their peers than it is to pay according to the executives’ performance. This demonstrates the benchmarking ratchet in visible practice. Encouragingly, there is no such compression seen in the European figures; performance seems to be more of a driver of pay in the region (as well as overall quantum being lower).

Nassim Nicholas Taleb has argued (see his 2018 book Skin in the Game or Inequality and Skin in the Game) that it is this mindset that is felt to be unfairness (he uses the term inequality, but in two forms): people feel it to be unfair that time-serving should itself be rewarded. Taleb argues that no one objects to inequality that is deserved; that genuine entrepreneurs are seen to deserve wealth because their success comes from risk-taking and creativity. But merely participating in business life does not deserve huge reward — the inequality that arises from this is resented rent-seeking, he says. This just shows why fairness is a better term to use — the entrepreneur’s rewards are largely perceived as fair (unresented inequality), while the time-server’s similar sizeable rewards are seen as unfair (resented inequality).

So much for restating the problem: it’s unfair, and it isn’t working well. In many ways, things do not seem to have moved on much from nearly 20 years ago when my article Not badly paid but paid badly identified taxes, timeframes and trust as three key drivers of executive pay dysfunction. 

But we need solutions not just restatements of the problem. Here are some initial suggestions:

• Let’s use the lens of fairness, not be shy of it. That’s why the Investment Association’s use of the term fairness in relation to executive pensions (Investors to Target Pension Perks and Poor Diversity in 2019 AGM Season) is so welcome — and the associated plan to press for changes when management enjoy different rates for their pensions than the rest of staff. Let’s do this more. One obvious candidate is the blithe assumption that seems to be made that asserting CEO salary increases can readily be justified where they are of the order of pay increases throughout the organisation; given the multipliers from incentives that the CEO enjoys the comparison is weak and doesn’t feel like fairness.
• But the lens of fairness should not allow us to fall into the ‘price of the job’ trap. As Taleb rightly points out, it is this mindset that particularly fuels concerns about unfairness. Genuinely deserved riches can be a matter to be celebrated, but undeserved riches are not. This requires 2 things: 1. remuneration committees need to escape the benchmarking trap, and 2. they need to ensure the clarity of a link to performance is clear. As the US banks appear to have failed to do, they need to ensure that pay is driven by performance, not by the level of pay at peer organisations.
• Instead of the oft-mentioned worker representatives on boards or on remuneration committees, the accountability to the workforce regarding executive pay could come very directly in the form of an annual remuneration committee presentation to workers representatives. This would be of the remuneration report, i.e. the decisions in the year and proposals for the year to come. I am not sure there needs to be a vote by workers, as the UK’s Labour Party appears currently to be considering; the force of having to explain decisions and the implication of needing clearly to understand the broader context for the workforce could have a remarkable, salutary effect for many remuneration committees.
• Disclosures of pay ratios between the reward of CEOs and the average employee — flawed as they are for purposes of comparison between companies, even within a sector — should assist this salutary lesson and help encourage some sort of lid being placed on pay increases for top management. A comparison of such ratios year on year at a single company could be a powerful tool.
• If the overall numbers are too high, and are not necessary except that others pay it, we face a difficult collective action challenge. We need to change the norm, and in part recognising what are the limits to acceptability must be part of that; investors need to play a stronger part in bringing the acceptable norms closer into the boundaries of normality and rationality. For me, a reduction in quantum is the main attraction of restricted stock based schemes, which have been the subject of ongoing debate in the UK and remain opposed by many investors. That opposition is based on the argument that such schemes are seen reduce the linkage to performance, so perhaps my backing for them is ironic given what I have said (not least the inclusion of such schemes in my simple 3 tests for poor structure in the US). But in part the answer — particularly the inconsistency with the US — is to do with quantum. I would argue that is a trade that we have to be willing to make in order to address the perceptions of unfairness such as those Taleb identifies. But if the performancing at the front end of restricted stock schemes, through the annual bonus system, is delivered effectively we may in fact get a better linkage to what better reflects genuine performance and drives better behaviours through organisations than we now get from the forward-looking performance metrics embedded currently in long-term schemes. I will return to the question of what sort of performance we should be thinking about linking to for those bonus payments shortly in a forthcoming post.

Fairness is for management often a driver of the upwards ratchet in pay. The rest of us should not succumb to this perspective, but rather should use fairness as a lens to focus in on how the appropriateness of pay can be demonstrated. Pay structures that reward time-serving will never seem fair, but reward for performance (if at a reasonable level) can. Expecting remuneration committees to be able to explain how they have done that is a minimum expectation, and being able to do so to stakeholders as well as shareholders may provide additional challenge that helps them towards delivering in practice. And calling out any failures to deliver fairness — and calling them out on a level playing field globally — is the least that we can fairly expect from institutional investors.

 

* the full Aktis data is discussed in this Yahoo! finance article: New study argues US bank CEOs make too much money

 

The Pay of Corporate Executives and Financial Professionals as Evidence of Rents in Top 1% Incomes, Josh Bivens and Lawrence Mishel, Journal of Economic Perspectives, 27 (2013)

The following briefly captures the responsible tax discussion at the recent ICGN conference in Amsterdam, a topic to which I will return more fully in later blogs. In large part this was an encouraging discussion, though there were clearly significant gaps in practical implementation.

Inevitably perhaps in a self-selecting group, investors were clear the issue matters: 89% say responsible tax is a consideration in investment decisions, and fully 95% say corporate philanthropy is not enough, that responsible companies must focus first on paying a fair level of taxes. Further, 87% believed that country-by-country tax reporting should be required of all companies — though the discussion in the room suggested that the practical experience of this was not always as valuable as the theory.

Yet, even among this enlightened group only 47% say that they definitely take responsible tax concerns into account when structuring their own investments. And while one Dutch pension scheme reported that it has stopped stocklending because it could no longer defend the dividend tax arbitrage implicit in this process any more, its representative noted that most of his peers are unaware that this is even an issue in stocklending.

It is clear that there is much work to do before fair tax is delivered in practice, and it becomes an issue that we address as well as just expecting them to.

See also: Fair tax reflections from investors II

We are social creatures, and our attitudes and approaches are framed by the world around us. If we believe that world to be fair, we are likely to behave more fairly. The general and growing belief that the world is inequitable must therefore have a debilitating impact on many people’s approach to life.

In a series of experiments in quiet alleyways, Dutch scientists demonstrated just how susceptible we are to behaving in a way that we believe others are behaving. Sadly, we are easily persuaded to behave less well than we otherwise might.

Published in a study called The spreading of disorder the scientists reported on experiments in the small northern Netherlands city of Groningen — probably better known for its 400-year old university than for it being the Dutch host of the annual International Cycling Film Festival. 

Groningen is not a particularly dirty or unruly city, but the experiments explored the extent to which people can be influenced into worse behaviour by their environment. They are more likely to litter if the alleyway they are in has untidied rubbish and intact graffiti — 69% littering in the presence of mess, against 33% when the alleyway is tidy. The academics report that Groningen police do not enforce littering rules so they suggest that fear of getting caught is not the driver, rather that social norms are, and in a similar test found that 58% littered in a car park where a call to tidy away shopping trolleys had been clearly breached, while only 30% did where all shopping trolleys had been put away properly. 

Audible cues had a similar impact — the noise of fireworks being set off in breach of a national pre-New Year ban was sufficient to stimulate 80% littering rather than the 52% in a more obedient silent control situation. Furthermore, people appear to be more likely to trespass in breach of a clear sign instruction if they can see that another sign has already been ignored (82% vs 29%). 

The most striking of all studies are those where the academics created a temptation to steal: a stamped, addressed envelope with a visible €5 note in it was left not fully pushed into a postbox. Where the postbox was covered in graffiti, 27% of passers-by stole the envelope; where there was no graffiti but the ground was littered, 25% of passers-by succumbed to temptation to steal. Both results are significantly worse than the 13% level of theft in the clean and tidy control situation.

We are much more likely to misbehave if we believe that is the norm of those around us. We are much more likely to behave well when we understand that others do. We are social beasts.

And our actions are framed by the world around us not just in Dutch alleyways. For example, if people believe they have been cheated, they are more likely to cheat: one study found that those who received little or nothing in a dictator game (explained in Ultimatums and dictatorship: fairness shines through), or simply believe themselves to have been cheated in the game, are much more likely to cheat when reporting the results of a subsequent coin tossing game to gain an undeserved payoff. 

Another experiment is perhaps still more startling. Volunteers given expensive designer sunglasses are more likely to cheat in a self-marked maths quiz if they believe the glasses to be fakes. Those scoring well in the test earned up to $10; all were told that they were trusted to mark their own work, but the papers were later recovered and cheating identified. While 30% of those who believed they had been given genuine sunglasses cheated, fully 71% wearing supposed fakes did. Furthermore, those wearing fakes are significantly more likely to believe that others lie and act unethically; the wearers of fake glasses have their view of the world and of society significantly tinted for the worse. Given the prevalence of fake goods, this is a remarkable result — a sign that we risk the erosion of much through people’s desire for cheap substitutes to costly goods. Cheating the expensive designers may mean we lose more than we imagine we gain.

Social norms can be found on a much larger scale too. Researchers studied the honesty of people from 23 different countries, again through the medium of a self-reported test, this one involving a higher dice roll earned a greater reward. While none showed much evidence of blatant lying, there was clear evidence of some cheating through the statistically unlikely results that were reported. And these levels of (minor) cheating were greatest in those countries perceived to have the highest levels of corruption and rule violation, and lowest in countries where there is felt to be less corruption and unfairness. The researchers concluded that the results “show that weak institutions and cultural legacies that generate rule violations not only have direct adverse economic consequences but might also impair individual intrinsic honesty that is crucial for the smooth functioning of society”.

So the general belief that there is significant unfairness in the world must have a negative impact on the way that we treat each other and the fairness that we display in our lives. And no wonder that there is righteous anger when we see people avoiding taxes who are well able to pay. In contrast, if we wish to see fairness we must show fairness so that others feel it is the norm expected of us all.

One other lesson of the Dutch alleyway study is that I can no longer feel selfless when picking up rubbish on the streets around my house — I actually have a self-interest in so doing. Perhaps we also need to consider what are the metaphorical dirty alleyways of our world, and find ways to clean those up too. Surely finding some way to empower people to tidy the filth and rubbish from the world of social media would be a positive — and what a gift to us all if it no longer was an acceptable social norm to resort readily to anger online.

 

The studies discussed in this blogpost are:

The Spreading of Disorder, Kees Keizer, Siegwart Lindenberg and Linda Steg, Science 322 (2008)

Fairness and Cheating, Daniel Houser, Stefan Vetter, Joachim Winter, European Economic Review, Vol 56 (8) (2012)

The Counterfeit Self: The Deceptive Costs of Faking It, Francesca Gino, Michael Norton, Dan Ariely, Psychological Science 21(5) (2010)

Intrinsic Honesty and the Prevalence of Rule Violations across Societies, Simon Gaechter and Jonathan Schulz, Nature 531 (2016)

I was reminded in a chat this week of the Credo published by US pharma and consumer company Johnson & Johnson, and in particular its all-important final sentence: “When we operate according to these principles, the stockholders [shareholders] should realize a fair return.” The word ‘fair’ appears 4 times, once in each of the short paragraphs.

What does this focus on fairness, on a fair return, look like? Of what is it the outcome? 

The Credo was created by Robert Wood Johnson, a member of the founding family and J&J’s chair from 1932 to 1963. It was written in 1943, just before Johnson & Johnson became a publicly traded company; J&J claims it as a bedrock of how the business still runs 75 years on: “Our Credo is more than just a moral compass. We believe it’s a recipe for business success.”

What is that recipe? Simply, that its customers come first, that suppliers have a right to a fair profit, that employees need to be respected and given scope to prosper, and that local communities matter; and that J&J needs to be a good corporate citizen (including expecting to “bear our fair share of taxes”). Only once all that is delivered do the shareholders gain any consideration: “Our final responsibility is to our stockholders.” It is clear that shareholders’ fair return is an outcome of running the business well and delivering value for all the other stakeholders, it is not an end in itself.

And the consequence of this focus away from shareholder value maximisation and towards business success through delivering value to customers, suppliers, employees and the broader community? Value creation for shareholders too, with an impressive share price chart and still more impressive progressive dividend record dating back to the early 1970s.

So, long before the current debate on corporate purpose, and even long before the nonsense suggestions that US businesses are obliged to focus only on narrow shareholder value maximisation (both discussed in Accountable Capitalism, my article in October’s Governance), here was a US company going to the market with the explicit statement that shareholders do not come first, rather all other interests in the business do. And one that has amply demonstrated that the outcome of seeing shareholder value creation as an outcome not an aim is prolonged business success.

Some inevitably will criticise J&J and suggest that the Credo is mere words that deliver no substance. And of course, as a US healthcare business it faces multiple lawsuits regarding its products, a number of which it has lost. But my experience was that representatives of the company, both staff and independent board members, did talk about it differently from the way one hears from many US businesses. In particular, there was a pride in the company’s record of voluntary recalls of its products ahead of being obliged to by regulators or any certain evidence of problems — perhaps a putting into practice of the ‘first responsibility’ being to customers. It was never quite clear that problems were always avoided in the first place, but it was clear in discussions that this was a company with something of a different mindset.

I believe its Credo has something to do with that. Others might prosper by thinking in a similar way.

An excellent Private Sector Opinion document from the IFC, a meta-analysis of the research revealing the business benefits of diversity on boards and among management teams.

It was an honour to provide the Foreword for this document:

“The ongoing discussion about diversity—and, more broadly, about the importance of environmental, social, and governance performance—plays to a growing sense that the business world should be less distant from the population as a whole and that there is a growing need to be energized by a sense of fairness. A business world that more fully reflects its community and customers is more likely to be seen as fair and trusted.”

It’s a question of scale. Like Gulliver in Lilliput, it is almost impossible for large organisations to conceive of the impact that they may have on small ones. Sometimes that impact can be devastating.

This thoughtful, mournful article reveals that we are all potential giants in the Internet world, sometimes able to damage without being aware of it.

The article discusses the demise of what was said to be the greatest burger joint in America. It is more than worthy of the investment of time in reading it. While the editorial note that now heads the page adds a further set of factors regarding the demise of Stanich’s, the core theme and tone of the story focuses elsewhere and holds some interesting truths.

The article discusses the impact that all those clickbait lists that all internet users love can have — and the tendency that the readers of such lists often have to use them as checklists while ignoring what may be just around the corner.

It talks about individuals who serve local communities and do not want any more than that. It highlights though that the scale of modern media reach is such, and our checklist culture is such, that it is hard for the really good community businesses not to be impacted when their greatness is recognised.

It is impossible not to sympathise with the ceviche chef Jose Luis de Cossio who stopped serving ceviche when a selection as best restaurant made it impossible to serve his community. I personally love ceviche (as so much that comes from Peru), but some of my favourite restaurants have been those just around the corner from home.

We see the same harm from checklist behaviours in the damage that the weight of tourists have on some of our most beautiful places. Barcelona, Venice and Dobrovnik to name but three fantastic cities now struggle to manage the numbers wanting to visit. I’m not suggesting that it was all better when few could afford to travel — and I personally fully intend in due course to make it to the one of these three that has not been marked off my personal checklist. But it is amazing how narrow-minded we are; I am told that the National Trust now limits its core maintenance activities to 100 metres from its car parks because in a bizarre version of the pareto principle 90% of visitors do not walk further than 80 metres. We simply do not look beyond the near at hand or the obvious.

And in the Internet world the near at hand and obvious is frequently provided by clickbait lists rather than the evidence of our own senses. Our willingness to seek out for ourselves is too often supplanted by the ready reckoners provided by others.

In one of my favourite ever Letters from America the great Alistair Cooke began by saying there was something that he ought to talk about and something he must talk about (the delightful Workers, Arise! Shout ‘Fore!’ from December 1974). This blog is written in the same spirit. Having happened across the article on Stanich’s it has worried away at me and required me to share it. While not directly on fairness, it nevertheless seems relevant to some of the ways forward regarding our economic system, and the challenges that we currently face. 

I suspect that localism and appropriate scale will turn out to be part of the answer of having an economic system that works for all. In order to foster the success of local business, the Stanich’s story reminds us that localism is challenging in an internet world — just as the web offers an outlet for small manufacturers and artisans, internet success will challenge production levels and quality standards. Perhaps the challenges of scale was ever with us, but with global reach within easy reach, we may find Gulliver crushing more Lilliputians than he sustains.

 

Web address for the story of Stanich’s:

https://www.thrillist.com/eat/portland/stanichs-closed-will-it-reopen-burger-quest

A fair approach to climate change policy

A former colleague asked me a few months ago about the Just Transition on Climate Change. We chatted about fairness and justice and its implications. In the end, their investment institution did not sign up to the investor statement in this respect. And that put them in perhaps a minority among ESG-minded investment institutions, for when the Investor Statement to Support a Just Transition on Climate Change was launched in the outskirts of the Katowice climate change summit, the latest COP or conference of the parties to the UN Framework Convention on Climate Change, it was signed by 116 investment institutions with some $5.46 trillion assets under management.

The concept of a Just Transition in effect means taking into account social issues in the approach to climate change. In the increasing way of these things, the investor statement is no more than a signal and in effect commits the investment institutions to nothing in particular. Rather, they assert that they will integrate just transition concepts into one or more of their investment approach, capital allocation, company engagement activities, public policy campaigns or transparency. We shall see whether it will indeed change behaviour.

The Just Transition idea originates with the organised labour community: in 2013 the International Labour Conference adopted a set of conclusions seeking to ensure that labour issues are embedded in any move towards a more sustainable economy. As paragraph 4 reads:

“A just transition for all towards an environmentally sustainable economy … needs to be well managed and contribute to the goals of decent work for all, social inclusion and the eradication of poverty.”

Nick Robins and others at the excellent Grantham Research Institute on Climate Change and the Environment deserve particular credit for bringing this issue to the fore in investor thinking. But perhaps the activities of the gilets jaunes in Paris and across France have made the need for fairness and justice in climate change policy more apparent to all.

The catalyst for the street protests by campaigners without any formal leadership and self-identifying by wearing the high-vis vests that all French drivers must carry was an increase in fuel duties. But the disquiet that they were so vigorously expressing seemed rather more broad-reaching. Not least, the sharply retrogressive tax changes that President Macron had implemented — and is now rapidly withdrawing. 

Once again it is fairness that needs to be applied. Of course, the Paris Agreement already captures climate change fairness of one form: by insisting on different CO2 reduction trajectories for developed and developing economies it understands that the current levels of atmospheric CO2 are largely the results of past industrialisation by developed economies and recognise that it would be unjust — and politically impossible — to bar developing economies from economic development by applying constraints equally.

In some ways the concept of the just transition is a smaller scale reflection of the same concept of fairness: the burden of the fundamental economic changes that carbon constraints will wreak need to be borne by those with the greatest means to pay, rather than those with least flexibility and resources. At present, because carbon taxes largely fall equally across the income distribution, their effect is in practice regressive and so they appear unfair — an impact made more immediate given that many of those hit most hard by the economic dislocations caused by a carbon transition will be among the less well-off.

In part the response to this challenge will need to be hypothecation of tax revenues. I suspect this is an issue I will return to in future blogs, but hypothecation is the explicit allocation of tax revenues to spending in a particular way. Governments, and particularly treasury departments, don’t like hypothecation because it reduces their freedom of action and constrains them to certain forms of spending. Our politicians would much rather have ongoing budgetary flexibility, a large pot of unconstrained money from which to allocate to what they deem the political necessities of the time.

But this is precisely the point: hypothecation introduces a little more tension into government’s relationship with the people and so ensures a fuller sense of accountability. Hypothecation of taxes to spending commitments can help maintain the licence to levy tax. A hypothecation of green tax revenues to explicitly progressive tax relief could help mitigate unfairness that these taxes impose. Even if it did not entirely remove opposition to such taxes it could significantly draw its sting.

It increasingly looks like whatever emerges from Katowice will not be a strong agreement, limited by a bizarre coalition of the unwilling, Kuwait, Russia, Saudi Arabia and the US, who refuse to acknowledge the implications of the recent IPCC report encouraging a 1.5 degree rather than a 2 degree world (and rather than the 4.5 degree world that our current trajectory seems set to take us to). These four countries share little apart from wealth built on economic fossil fuel dependence. They may succeed in delaying concrete responses to climate change, the effect of which will be an increase in the eventual cost, and imposing a greater burden on those least able to bear it — because the physical impacts of climate change thus far seem to fall disproportionately on the poorest countries and the poorest communities. 

That isn’t just, and it isn’t fair.