Changing investment law for inclusive capitalism

The resignation of Sacha Romanovitch as Chief Executive of Grant Thornton – and the campaign waged against her by some of her partners – was a good reminder that inclusive capitalism won’t just happen because right minded people want it. If the press reports are to be believed, a significant minority of her colleagues could not tolerate her proposals for profit sharing, reforming the audit market, or paying attention to issues such as mental health in the workplace. Nor are Grant Thornton partners unique: my conversations with partners in other leading audit firms suggest she would have had just as much difficulty whichever firm she was at.  

In other words, we need more than persuasion if we are going to make capitalism and growth genuinely inclusive. One part of the mix may be change to investment law.   

This has potential because, in the end, inclusive capitalism is in the interest of most shareholders and most of those saving for a pension – the ultimate owners of most public companies. Reform has only to unblock the influence of this interest. 

To be clear, inclusive capitalism is not in the interests of all shareholders (think Grant Thornton partners). But crucially, most public companies are not owned by a handful of plutocrats: 44% of working age adults are currently saving for non-state pensions and much of their money is invested in the equity market; we are not talking about the 1%. Indeed, small savers of this type will own a majority of some companies – not directly of course, but through pension funds or other collective investment vehicles.   

There are three ways that inclusive capitalism can benefit this group. Firstly, it can increase the profits of the companies that practice it, although to be honest the evidence on this is not conclusive – it depends on the sector.  Certainly, Amazon has not been held back by its approach to warehouse staff pay. In any case, to the extent that this proposition is true, asset managers are already beginning to apply pressure on company directors to be more inclusive (including at Amazon, where investors have recently insisted on wage increases) and to adopt the long-term focus which tends to encourage this.  

Secondly, if most companies adopt inclusive strategies, then, so the argument goes, this will be good for the economy and society as a whole, and in ways that will boost the financial performance of most companies over the long term. This will then boost portfolio values. This is more of a challenge to the standard management model than the first point: as things stand, company directors are only incentivised to maximise their own company profits – there is no role for portfolio values or the collective goods on which these may at least partly depend.  

But do portfolio values depend on collective goods? It is difficult to prove this conclusively, but there are reasons for thinking it. For example, demand tends to be higher in a more equal, i.e. more inclusive, economy. Also, in a more inclusive economy, there is less need for tax funded redistribution, and therefore tax rates can be lower for a given standard of public services. In an inclusive economy there are likely to be higher levels of trust, and this has been shown to have a positive economic impact, partly by making some regulation unnecessary, but more generally by increasing people’s willingness to co-operate. More dramatically, the low levels of trust caused by economic exclusion can lead to sharp and sometimes economically damaging political change, as we saw with the Brexit vote. Somewhat similarly, a paper presented to the March meeting of the APPG on Inclusive Growth showed that taking into account certain system-level risks would improve returns. On a more positive note, a more inclusive economy will be associated with a stronger and, above all, more flexible skill base, and there is widespread agreement that this is good for both growth and profits.   

In addition to increasing portfolio value, inclusivity also has an effect on shareholders as citizens and workers: through its impact on the economy and tax rates as just described, but also through labour market norms and the energy with which business co-operates with government on, for example, skills investment. The size of these impacts will be different for different shareholders – but that doesn’t mean they should be ignored. Rather it suggests that shareholders themselves should decide how, if at all, the directors of the companies they own should take account of the public good. The alternative, of course, is more use of regulation and fiscal incentives, but these can only secure a marriage of convenience between society and business rather than the genuine partnership that is often needed.   

Hence the changes to investment law proposed in a new working paper from the Centre for Understanding Sustainable Prosperity. These would encourage pension fund trustees and asset managers to put more pressure on company managers to act in savers’ interests in ways they do not at the moment. The paper argues that the current failure is because of company director incentives, that these incentives could be changed by asset managers and pension fund trustees but are not because of their incentives, and that therefore these latter incentives should be changed.  

It then argues that this can be best achieved by making explicit that asset managers’ and pension fund trustees’ duty of care to the savers they represent includes a duty to advance the long-term financial success of investee companies and where appropriate, and, after consultation, the public good and other ethical objectives the savers may have (the public good including sustainability as well as inclusivity). It should also be made explicit that doing either of these things requires intermediaries to engage actively with both savers and companies, including exercising voting rights on incentive schemes. These changes would create the possibility of litigation by activist investors if the duties were neglected: one of the most powerful incentives in the industry. 

If you would like to see a copy of the draft paper please email Charles.seaford@worldfuturecouncil.org