Returns, Reputation or Both? What to do when the regulator calls

Short-term profit maximisation for shareholders, or longer-term value optimisation for stakeholders? Returns, reputation, or both? In a recent Amrop article, ‘Cash or Continuity?’ we revisited assumptions of ‘shareholder primacy’ and the link with fiduciary duty. We found that sustainable performance is increasingly important not only for organisations, but for all stakeholders. Here we take a closer look at the Australian context.

In the past years, some of the world’s most famous multinationals have been hit by reputational crises - VW, Siemens, Wells Fargo, Facebook - to name just a few. Now in Australia, a Royal Commission Report is causing upheaval in the financial industry. Even ASIC, the regulator, has met criticism for failing to effectively enforce the law.

The “returns versus reputation” debate to which these events give rise is rooted in a conflict of interest between stakeholder and shareholder value. In other words, the emphasis placed by top executives and boards on optimising stock ownership at all costs, at all times. Unethical behaviour may result from this emphasis, versus a broader perspective, one which adopts a stakeholder, or even stewardship, approach.

 

There is a Core Dilemma

How should boards react to a reputational crisis such as the one faced today by AMP and other major Australian banks? The discussion boils down to two perspectives: short-term profit maximisation for shareholders, versus longer-term value optimisation for the organisation (where block holding shareholders and crucial stakeholders, such as employees, play an important role). Surely, many argue, any top executive should above all else enrich the owners of the company? Isn’t this what fiduciary duty should be all about? 

The answer, we argue, is No if this duty only concerns short term stockholders and their serving executives. Moreover, the misguided behaviour within AMP (and other financial services providers) outlined in the Royal Commission Report has taken the scalps of the CEO, the Chair, and half of the directors on the board, as well as the general council of AMP. Do other financial institutions face a similar fate?

 

The Throne of shareholder supremacy Is Wobbling

Over forty years the concept of ‘fiduciary duty’ by executives and boards has fallen prey to a series of misinterpretations, to the point that it is now widely taken to mean ‘shareholder primacy’. The idea that shareholders should ultimately dictate the functioning of a company creates a robust platform for short-term shareholder activism. It is also facing some serious counter-arguments.

Three flaws in the shareholder primacy argument:

  1. Ignoring key stakeholders can create an existential threat. Without an engaged, proficient workforce, or loyal customer base, a company will underperform - also financially. And acting in a socially or environmentally responsible way is an increasingly important factor in how people choose where to work or what to buy.
  2. Shareholders are not a single ‘entity’. Different shareholders have different motivations and time perspectives for investing.
  3. Many shareholders are essentially risk-takers. They are providing capital to enhance the short-term [quarterly or annual] financial performance of the organisation, and their own portfolios. Top executives allegedly need to serve these risk-takers at all costs. But risk-taking does not need to be at the expense of sustainable performance.

It’s Time to Re-Frame ‘Fiduciary Duty’

Executives are not ‘agents’ of shareholders, whose job is to ‘serve’ their interests as the organisation’s ‘owners’. Their duty should be seen as loyalty to the organisation and its sustainable or long-term value. And that duty needs to extend beyond organisational walls: to customers, employees, lenders and other critical stakeholders. Without clients there is no return, and without dedicated professionals, no quality products or services. If shareholders could be seen as first among equals, they are certainly not the only major player a responsible organisation needs to consider.

Have your sights on Trust and Reputation: ESG

If potential suitors must demonstrate care for the long-term interests of organisations, so too must target organisations. Research indicates that a majority of investors (up to 82% in one study) now use ESG data because it is financially material to investment performance. Many do so due to growing client demand or formal mandates. Even Larry Fink, the CEO of BlackRock – one of the biggest global investment funds with $6.3 trillion assets under management – recently advised CEOs to act more responsibly. So it is increasingly acknowledged that modern businesses are part of a broader societal framework. Profit at any cost will no longer secure a “license to operate” or genuine legitimacy. The Australian financial industry is fast (and painfully) finding this out. 

In Conclusion

The time has come to uncouple ‘fiduciary duty’ from ‘shareholder primacy’ and reinstate its true definition: loyalty and care to the organisation, restoring trust and reputation to the core of its business. And intangibles such as responsible ethical behaviour, sound investments and proper governance, measured by ESG criteria, are increasingly part of loyalty and care. For organisations, executives and investors.

Going forward, boards and executives will need to carefully weigh up and balance the interests of share- and stakeholders (beyond organisational walls) when considering sources of capital, or their response to tempting short-term windfalls. The question boils down to instant gratification (short-term shareholder profitability) versus the longer-term creation of organisational value, where stakeholders’ interests are taken seriously, and the ‘no-harm’ adage prevails. The Australian public and investors are rightfully outraged at the unethical behaviour of boards, executives and managers, as well as that of financial services stockbrokers.

Leading Questions

  1. Do you trust your banker, financial advisor, or the boards of these organisations? Are your own board and top executives role models?
  2. What kind of an organisation does your board envision? At what moral level should it operate?
  3. How important are non-financial objectives in your organisation? What value do individual board members attribute to sustainability, and ESG criteria? To what extent are ESG criteria embedded in corporate reporting?