Institutional Investors & Corporate Governance for sustainability - - PowerPoint PPT Presentation

Oxford University 18th May 2012

Institutional Investors & Corporate Governance for sustainability

Dr Raj Thamotheram

What I really appreciated about today

Creative/challenging/sophisticated Inter‐discplinary Examined most parts of the investment chain ESG conidered in an integrated manner Interaction of real world academics with reflective practitioners

And what would I love to see more of next time

More focus on the hidden gorillas in the ecosystem – investment consultants, analysts, financial media Make use of the points of intellectual flux – behavioural finance More practitioners, including mainstream More challenging of “BAU” assumptions Focus on what’s really critical (vs what creates papers to publish) Think communication to the public Action reseach – organisational transformation/management of change /immunity to change

11 fatalities 17 injuries Latest BP cost estimate $40 billion 30% share price drop 1‐year suspension of dividends

“The Dominant Narrative” – the BP example

"It's very dangerous to join up dots that may not be appropriate to join up" Tony Hayward “I left BP a long time ago, four years” Lord Browne “an Act of God” Rick Perry, Governor of Texas

Warning signs prior to the disaster

Source: Yahoofinance.com

“ “

Up until April 19 (the day before the Deepwater Horizon explosion), his [BP’s] performance was excellent.

An investor close to BP quoted by The Financial Times, July 25th 2010

Texas Refinery Accident Texas Refinery Accident Alaska Oil Spill Azerbaijan Gas leak Violations Of Clean Water Act Penalties From the OSHA Gulf of Mexico Oil spill Thunder Horse Accident Charges for Manipulation Of gas market Grangemouth 2000

How much attention did “sell‐side” pay to safety?

Before the oil spill, 6 occurrences every 100 pages = the vast majority of reports do not talk about these risks at all.

Behavioral finance expert: “analysts are biased”

 Unicredit: analysts claim that BP has a good operational momentum because

• f its

“first‐mover advantage in cost cutting” (17 December 2009)

5 = buy or strong buy recommendations 4 = add, overweight, outperform and accumulate 3 = hold, perform, neutral 2 = reduce, underweight and underperform 1 = sell or strong sell Source: SHEFRIN Hersh, CERVELLATI Enrico Maria, “BP’s failure to debias: underscoring the importance of behavioral corporate finance”, 21st February 2011

Are asset owners & “buy‐side” much better?

Sadly, no! Only 60% of capital voted at BP’s 2010 AGM 57% of votes in favour of chair of safety committee! (Only leaving in 2012!) Even proxy voting agencies recommended abstain (ISS) or vote against (Glass Lewis)

Source: BP plc, ISS ProxyExchange

Another Narrative

In the end it all comes down to….

We are all co‐creators of a dysfunctional system Investors are very important enablers (aka “shareholder value maximisation”) The stakeholders of investors are enablers of investors (Russian dolls) We can therefore consciously aim to create a better system

Another Narrative

Since neither worldview can be proven, let’s choose the latter

So what went wrong?

Narrow Conception of risk Shareholder value fundamentalism Weak concern for negative externalities Regulatory capture Leadership & Governance failures Organisational Learning disabilities Ineffective regulation Focus on riskier and dirtier O&G Outdated approach To safety Weak safety culture M&A and Outsourcing/SCM

Saviour CEO

SYSTEM O&G SECTOR BP

Fukushima

Driver Evidence? Lack of concern for negative externalities Full costs for dismantling plants, managing nuclear waste and damage in case of accident not “in the price” Narrow conception of risk Probabilistic thinking about a really severe earthquake excluded possibility of it + failure to consider consequences of earthquake AND tsunami + failure to consider how one accident could impact whole nuclear industry Regulatory capture “Tepco’s cosy links to watchdogs” (FT) + Lack of support from government for the Japanese nuclear industry regulator since nuclear was a non-negotiable matter of national energy independence Organisational learning disabilities Lack of learning from earlier near misses Leadership & governance failures Weak standards of governance (non independent board member) Shareholder value fundamentalism Focus on meeting investors’ expectations leading to a weak safety culture in practice

Source: THAMOTHERM Raj, LE FLOC’H Maxime, “Nuclear meltdowns are bad for returns”, FTfm talking head, Financial Times, 2nd May 2011 with additional research by Kazutaka Kuroda

News Corporation

Driver Evidence? Lack of concern for negative externalities Over-dominant role of politically motivated media barons ignored in most countries & over long-term Weak ethical standards taken as a given Narrow conception of risk Cameron himself recognised risk from overly close lobbying relationships Sector was widely viewed as low ESG risk Regulatory capture NewsCorp promised end of Ofcom “as we know it” Organisational learning disabilities Repeated warning signs ignored Leadership & governance failures Over-dominant Chairmen, lack of independent directors, class B, Shareholder value fundamentalism Repeated examples of most investors and most analysts discounting ethical concerns & weak corporate governance

Global Financial Crisis

Drivers Questions Lack of concern for negative externalities Why didn’t regulators/investors worry more about mortgage market “growth”? Capital adequacy? Narrow conception of risk Are current risk models ‘fit for purpose’ ?

• crossed derivatives linking financial firms
• quant VaR models which aren’t suited to high impact, low probability events

Regulatory capture Why did regulators accept claims that banks had diversified risk through derivatives? Why are regulators/politicians so vulnerable to attempts at regulatory arbitrage? Organisational learning disabilities What happened to the lessons learned from Enron/Dotcom & 2008 crash? What can we learn from repeated trading debacles at UBS about risk management culture? Leadership & governance failures What does it say about the leadership/governance culture that it tolerates

• utsized remuneration package WHILST banks are still being bailed out?

Shareholder value fundamentalism Why do most asset owners maintain benchmark exposure to a sector which has weak performance, has so much hidden risk & which operates so irresponsibly?

Investors: our 10 deadly mistakes

Mistake Still true? Passively/actively encouraged banks to pursue suspect / risky products & strategies Passively/actively encouraged banks to over‐leverage on debt Judged future performance solely on past performance Approved pay designs which incentivised dangerous risk taking and “too big to fail” growth Failed to get sell side/credit rating agencies to analyse bank’s corporate governance and didn’t resource/listen to independents who did do such analysis Didn’t ensure boards were experienced enough and independent enough Relied on the (inadequate) risk models that banks used (VaR) and didn’t invest in risk management models which they needed Did not appreciate the systemic risks presented by the shadow banking system Maintained excessive exposure to a high‐risk sector because of cap weighted indices. Allowed banking lobby to set public policy agendas and capture regulators/politicians

But “Black Swans” are the visible tips of the iceberg

“[…] the destruction of shareholder value through legal means is pervasive, perhaps even a routine way of doing business. Indeed we assert that the amount of value destroyed by companies striving to hit earning targets exceeds the value lost in these high‐profile fraud cases.”

Source: GRAHAM John, HARVEY Campbell & RAJGOPAL Shiva, “Value destruction and financial reporting decisions”, Financial Analysts Journal, Vol 62 No 6, 2006

Investors also enable wealth‐destruction below the waterline

Dealing with our “Inner Jack Welch” – academics too!

“As long as the music is playing, you’ve got to get up and dance. We’re still dancing” Chuck Prince

Minor tweaks or fundamental changes?

The practical agenda

• 2. Better reporting
• 1. Better metrics
• 3. Better supply chain management
• 4. More respect for employees
• 5. Better leadership
• 6. Better regulation

The strategic agenda

• 2. CEOs enabled & held accountable for being authentic leaders
• 1. More diversity in corporate purpose
• 3. Boards are guardians of long‐term sustainable wealth creation
• 4. Courageous, ethical government and smarter regulation
• 5. Investing as if the long‐term matters
• 6. “Citizen investors” drive this agenda – transparency taps public pressure

Sensible investing: 7 questions for self‐assessment

• 2. Are our high level strategic choices re products/services made as much on the

basis of the world that’s emerging as the world as it is today?

• 1. Are we well prepared, intellectually, to meet our clients needs in tomorrow's world?
• 3. Is our business as “fit for purpose” as it needs to be? Have we reviewed our
• rganisational design to ensure good alignment with strategy?
• 4. Does our governance/leadership framework maximise our chances of delivering

against our objectives?

• 5. Have we defined the battles we are committed to winning? Are we collaborating

enough with other players to get system change?

• 6. Are we sure we are doing what we say we are doing “on the tin”?
• 7. Is our organisation able to do deep learning and implement this lessons?

If things can’t continue, then they will stop

On track for 6 degrees warming: International Energy Authority Already using 1.5 planets Income inequality levels at 1930s levels, youth unemployment is very high: a hungry man is an angry man Growing influence of ultra‐nationalist, anti‐globalisation right‐wing parties Democracy under threat in many countries “State capitalism” becoming the preferred option

What does this mean for me, a MSc/DPhil/PhD student?

It’s time for more « Positive Deviants » in the academic community to Just Do it!

• No hiding place especially for diversified long‐term asset owners OR the next

generation

• We have known what we should be doing for some time & we have the technology
• Long history of people doing the right thing despite their context

Thank you, and please think how you can support this work!

www.sustainablefinancialmarkets.net www.preventablesurprises.com rthamotheram@gmail.com Network for Sustainable Financial Markets