The latest headlines to hit the Royal Bank of Scotland are shocking. Allegations that businesses, many successful, were preyed upon and asset stripped to bolster the profits of RBS. You would have thought that post the sub-prime bailout with tax payers money and the subsequent interest rate and forex rigging scandals that the banking sector would have cleaned itself up but apparently not.
The banking sector is in no way unique. We read with depressing regularity about: corporate corruption; human rights, labour-market and customer exploitation; tax avoidance; and rent seeking. We need no further evidence – despite the best efforts of well-resourced corporate affairs departments – to conclude that our current economic crisis and the resultant social implications are linked to the dysfunction of big business and the capital markets.
I believe that the problems we face stem from the free-market capitalism introduced by Margaret Thatcher’s Government. The global banking sector was enticed to set up shop in London with the promise of a non-interventionist government with ‘light touch regulation.’ Over the next 30 years’ successive Westminster Governments embraced laissez faire capitalism with gusto. Big government and nationalised industries were replaced with deregulation and privatisation. By the start of the 21st century the veneer was beginning to peel off. By 2005, the World Bank was recognising that economic policies were failing and that inequality and systemic poverty was on the rise.
Most of us will have heard the story that Thatcher carried in her handbag a copy of The Wealth of Nations by Adam Smith. What is perhaps less well known is that the capitalism set in motion by her government was a gross distortion of his beliefs. Smith, economist and thought leader of the Scottish Enlightenment, believed that liberalism was about personal (not corporate) freedom. It required a government strong enough to deal with threats to liberty and with a duty to intervene to assist the less fortunate. He believed that the more fortunate should pay taxes. He believed that the law should serve the common good and not special interests. Most importantly, he believed in equality and fairness, that ‘no society can surely be flourishing and happy of which the far greater part of the members are poor and miserable.’
This is not the system that we have. The system we have is one where it is possible for healthy businesses to be squashed by larger corporates. If Smith got anything wrong it was his belief that everyone possessed an innate conscience and was capable of empathy.
Michael Marin, Canadian law professor and Gates Cambridge Scholar in his paper Disembedding Corporate Governance: The Crisis of Shareholder Primacy in the UK and Canada sets out in detail the role that the corporate governance of laissez faire capitalism had in the global financial crash. A crash that had a crushing inevitability about it. A crash that was predicted by the American economist, Hyman Minsky, twenty years before it happened.
At the heart of the problem is the fact that a company and its directors are legally required to put the interests of shareholders above all other stakeholders. Directors’ interests are neatly aligned with shareholders through share option weighted compensation packages. In addition, regulation is ‘light touch’ and often advisory. If you add to this a deep reticence by the courts to intervene you, not surprisingly, end up with a system that is broken.
Shareholder primacy, together with inadequate regulation, is as pervasive as it is regressive. It dictates every key performance indicator, every bonus target and indeed every decision taken at every board meeting. It sets the entire culture of an organisation and fuels behaviours such as short-term profiteering, excessive risk-taking, bonus bonanzas and stakeholder exploitation. The mission of a company becomes about maximising shareholder returns – often at any cost.
The world is slowly waking up to the reality that the economy needs to be reconceived. That it needs to be based on the principles of inclusive and sustainable economic growth. In 2015, the World Economic Forum recognised that there no longer needed to be a trade-off between economic growth, competitiveness and social inclusion. The OECD Ministerial Council Meeting in 2016 took a similar view by talking about ‘turning trade into engines for inclusive growth’ and the adoption of new business models guaranteeing a positive creative disruption.
But our governance system is not geared this way. A fact experienced by Bart Houlahan, a US businessman who helped grow the basketball apparel company, AND1, to become the number two brand in the US behind Nike. AND1 was run differently from its competitors – employees were looked after, workers in China paid the living wage and 10% of profits were given to charities focussed on urban education. But AND1 became too successful and following a ‘brutal gross-margin battle with Nike’ it was put up for sale. The directors were duty bound to ensure maximum value for shareholders was obtained. Within weeks of the sale, the company’s commitment to employees, the community and the environment had been stripped away.
Houlahan knew the rules better than most being a former investment banker and it was this knowledge of the system that helped him become a disruptive innovator in the world of corporate governance. He co-founded the not-for-profit B Lab which sets standards and certification for companies that wished to maximise societal value. B Corps are companies that have met these standards and changed their constitution to rank all stakeholders equally.
There are now B Corps in 50 countries with global revenues totalling $28 billion. Recognised brands have come on board including the clothing company Patagonia; the on-line market place Etsy; the funding platform Kickstarter; and the ethical bank Triodos.
The movement is being embraced by institutional investors desperately seeking secure low-risk investments that provide sustainable returns. Ironically many of the traditional ‘defensive stocks’ of the past having become too high risk due to their relentless pursuit of shareholder value. J P Morgan has estimated that the impact investment market will grow to between $400 billion – $1 trillion by 2020.
B Corps are out-performing their competitors and were more resilient during the global recession. Fast Company attributed ‘The B Corp movement [as] one of the ‘20 Moments that Mattered’ over the last 20 years.’ Fortune Magazine reported that ‘B like a B Corp’ is one of the 5 Business Trends to Master in 2016.
In Scotland, we have perhaps the best opportunity to reconceive our economy to support those businesses that contribute to inclusive and sustainable economic growth. The Scottish Government has chosen a progressive path where inequality must be addressed, ensuring there are opportunities for all. We should embrace initiatives such as Business for Scotland’s Scotianomics, as together we have all the answers.