Finance, industry and the public.
It seems that we might be approaching a tipping point in our economic affairs. There is mounting evidence that the global financial system is running out of control, with huge amounts of money and power in the hands of unregulated speculators such as Hedge Funds. Equally, questions can be raised about the accountability of those who run the world's biggest companies, whose actions and rewards seem to be divorced from the lives and well-being of the ordinary person. Many leading politicians in Washington and London, who are supposed to be the guardians of the public interest, seem to have been 'recruited' by the financial/industrial system.
Last, but not least, more and more ordinary employees and citizens seem to be getting an increasingly raw deal. Research shows that the pressures and stresses of working life appear to be on the increase, exacerbated by a decline in job and financial security. Employment-related pensions are coming more and more under threat, leading many to wonder just what and who are big companies and the investment industry really there for. We are reminded almost daily of the scandalous behaviour of the banks and financial services industry in constantly ripping off its customers and offering tempting allurements to buy, buy and never mind the debt.
A case for change?
At the very least, there is a case for discussing whether there are better ways of harnessing the power of industry and finance to serve the good of all in our society and not just the interests of the elites who run them.
Some perspectives to think about.
In the introduction to our book, 'Having Their Cake' we said:
- There is such a thing as Society.
- The economy is an integral part of a society.
- The main goal of a society should be to strive to ensure the greatest well-being of all its members.
The performance of a society as a whole and each of its constituent parts, including the economy should therefore be judged by the degree to which it contributes to the overall well being of the greatest number of its members.
If any element - political, military, economic - is manifestly serving only the interests of a small part of society, or damaging its overall interests, then action should be taken to modify or regulate what it does so that its contribution to the whole can be positive.
To allow the self-interest of elite and exclusive groups to be separated from the interests of society will more likely than not create corruption and distortions in the effective use of resources for the benefit of society as a whole.
Equally, to argue that the interests of individuals are more important than those of the society of which they are a member is likely to result in behaviours by some which will seriously damage the overall interest.
It seems to us that the above propositions are not at all incompatible with a strong belief in capitalism.
Writer Charles Handy asks some very penetrating questions about the purpose of business.
Following the Enron and other scandals, he wrote: Corporate governance will now surely be taken more seriously by all concerned, and watchdogs appointed. But these will be plasters on an open sore. They will not cure the disease that lies at the core of the business culture.
We cannot escape the fundamental question, what is a business for? The answer once seemed clear, but no longer. The terms of business have changed. Ownership has been replaced by investment, and a company's assets are increasingly found in its people, not its buildings and machinery.
In the light of this transformation, we need to rethink our assumptions about the purpose of business. And as we do so, we need to ask whether there are things that (UK and American) business can learn from Europe, just as there have been valuable lessons that the Europeans have learned from the dynamism of the Americans.
Both sides of the Atlantic would agree that there is, first, a clear and important need to meet the needs of a company's theoretical owners: the shareholders. It would, however, be more accurate to call most of them investors, perhaps even gamblers. They have none of the pride or responsibility of ownership and are, if the truth be told, only there for the money.
......to turn shareholders' needs into a purpose is to be guilty of a logical confusion, to mistake a necessary condition for a sufficient one. We need to eat to live - food is a necessary condition for life. But if we lived mainly to eat, making food a sufficient or sole purpose of life, we would become gross.
The purpose of a business, in other words, is not to make a profit, full stop. It is to make a profit so that the business can do something more or better. That 'something' becomes the real justification for the business. Owners know this. Investors needn't care.
The pension investment group, Hermes, who are well-known for taking an enlightened approach to corporate governance, are quite clear about the purpose of investment and industry - in this they mirror the axioms in the Combined Code on Corporate Governance.
It is axiomatic that the Primary Goal of a UK-listed company is to be run in the long-term interests of its shareholders......Central to this goal is the need to create a financial surplus.
So, the prevailing view held by those who run our financial system is quite clear - it is axiomatic that the 'shareholder' is king.
But is it quite as simple? First, who is the 'shareholder'? It is quite clear that the investment industry is not - they are agents of the millions and millions of savers and pension fund members who currently are almost totally disenfranchised, having little say in how the investment industry deals with their money.
Second, if it becomes clear that massive companies and huge global investment banks are serving their own interests and not those of the public at large, where is the redress - what leverage do we, the public have to reform the system?
This is not a new conundrum, but it has not yet been satisfactorily resolved.
Here is what Lord Percy, President of the Board of Education said in 1944:
Here is the most urgent challenge to political invention ever offered to statesman or jurist. The human association which in fact produces and distributes wealth, the association of workmen, managers, technicians, and directors, is not an association recognised by law.
The association which the law does recognize - the association of shareholders, creditors and directors - is incapable of production or distribution and is not expected by the law to perform these functions. We have to give law to the real association and to withdraw meaningless privileges from the imaginary one.
Lions, donkeys and cannon fodder
What then, of the effects of the management/financial markets 'nexus' for employees at large, the 'lions' upon whom the future of the economy depends?
Observers of societal trends speak of widespread and growing public cynicism and distrust of leaders and institutions in public life. Banks, the Financial Services industry, top managers, journalists and politicians are regarded with a mixture of distrust and suspicion by the general public. Such scepticism may be healthy, for the fact is that it is absolutely and objectively right. Members of each of the above have been repeatedly caught out indulging in exploitation, deception, cheating, incompetence, fraud and misleading 'spin'.
So, what of the 'Fat Cats' in management and the City? It would be surprising if, given the publicity of the last years, but especially more recently, the public perception of our subjects in top management and the financial markets was any better than that of the other objects of suspicion.
What kinds of effects do the behaviours of top managers and through them, the markets, have on employees and the public interest?
Here are some.
Distorted Rewards and Huge differentials.
We have already seen that the total earnings of CEOs of the biggest companies are averagely more than 100 times those of the ordinary employee.
Readers will remember that top compensation packages contain:
- Annual salary plus annual bonus - in the range of £700,000 to More than £2,000,000.
- Long Term bonus plan, which can pay out up to 100% of base salary.
- Share Options with an initial value in the range of 4 to 10 times base pay.
- Contributions to a pension plan. In the case of FTSE 100 CEO's, we are speaking of funds of several million to fund pensions amounting to two thirds of final pay. (The company's contribution to the pension of Lord Browne, of BP, was £2.4m in 2001, the value accrued to pay his pension on retirement of £860,000 was reported to be £12.8 million). (Observer Business section, 18 May 2003).
- Then there are sundry perks, ranging from the standard car and chauffeur to the much more exotic, in the form of travel and accommodation, health and entertainment, much of which is difficult to access publicly.
For the enlightenment of employees who may have been made redundant or lost a job for other reasons, things are not all that bad either if a top executive should unfortunately happen to lose his or her job. In 2001, seven directors of FTSE companies received more than £1,000,000 as 'Golden Goodbyes'. The star turn was Ken Berry, the ex-CEO of EMI, whose terminal package amounted to £6,076,200.
If the public at large believe that top managers are 'fat cats' who line their baskets with money, it is just as well that most do not know what top operators in the investment and banking industries earn. We were recently treated to a portentous lecture from Mr Ed Balls, the City minister about keeping general pay rises below inflation, the day after it had been stated in the press that City bonuses for 2005 had topped £19 billion. Quite a lot of bonus to go around some 300,000 people. It might seem to the innocent observer that Mr Balls is indulging in breathtaking hypocrisy or is taking the Mickey!
For the average employee, all of this is from another planet and something altogether out-with their influence. They have to make do with a weekly wage or monthly salary and rapidly diminishing pension entitlements.
We are not going to enter the lists shouting how 'unfair' all of this is, but we would comment that such differentials do tend to cause a huge psychological gap to develop between the top earners and the bulk of employees. Perhaps top managers ought to be encouraged to explain to their colleagues - the employees that they lead - the exact details of the pay and perks they receive and account for what they have done to merit them. Perhaps investment bankers should be paid for the value created by the deals they advise on.
Increasingly 'absent' Bosses.
We have seen how top managers have to spend much time transacting and communicating with the financial markets and working with advisers who will help them to get their message across. We have seen that many managers can find themselves taking the knife to their own businesses or organizations in order to satisfy investors that they are being decisive.
We have also seen that top executive wealth is increasingly tied to the financial markets' measures of corporate performance, and less and less to any more qualitative assessment of how well they lead their organizations. Only very occasionally might today's top managers feel that they are accountable in any real way to the people that they are supposed to lead. Perhaps this tendency will cause top managers to be more often surprised by the behaviour and reactions of staff, as was Rod Eddington, CEO of British Airways, when the airline was nearly brought down by a walkout of check-in staff at Heathrow airport.
All of this is tending in many cases to distance top managers from the organisations they lead, without any noticeable increase in empowerment of middle managers to fill the leadership vacuum left by their superiors. All of this seems to be shaping the psychology and skill sets of top managers. Perforce, they need to focus on numbers and analytical presentation rather than the basic human skills of leading people. Thus it is, in our experience, and according to the Council for Excellence in Management, that many very successful top executives do not have the man-management skills that we, the authors, might have expected from a junior supervisor. (The Council are too polite to put it this way!)
As John Seddon of Vanguard Consulting so eloquently put it, "Most (top) managers sit in management 'factories' insulated from the real work of the organization and only dealing with abstract data. Leadership is about getting back in touch with the work".
Quite so, but right now, this is unlikely to generate £ millions in pay, so why should managers bother?
Employee Stress and Insecurity.
British workers put in more time, less productively, with less time off, than most of their European counterparts. They are supported by less capital equipment. At the same time, they generally enjoy less job security than in days gone by. Now, many are finding that their retirement benefits are being reduced by top managers under great pressure from investors to produce uniformly high returns to maintain 'shareholder value'.
It is reported by survey after survey that all of this is at last beginning to take a toll on a generally tolerant and hardworking workforce. Militancy is again on the increase, family life is said to be suffering and stress is increasing. And now, the risks of providing retirement benefits are being passed from companies to individuals.
Copious survey data indicate growing distrust and demotivation.
Trust in leaders.
In late 2003, the Cabinet Office strategy unit published a wide variety of statistics on its website. Here is some about trust in public institutions, which was expunged fairly rapidly!
- More than 50% of the population had a great deal of trust in family doctors (90%), school teachers, local police officers, BBC News journalists, and judges.
- More than 75% of the population had very little/ no trust at all in "Red-top journalists, estate agents, Labour and Conservative politicians and 'People Who Run Large Companies', which group were mistrusted by 80% of respondents and came 4th from bottom in a group of 20.
Source YouGov for the Daily Telegraph, March 2003
Workplace Employee Relations Survey.
This is one of the world's largest and oldest periodic surveys of employee relations. It is conducted by UK government and the survey group is over 21,000.
Here are some dimensions from the 2004 survey
There were significant deteriorations in employees' feelings about
- Influence over the job, with 49% feeling that they had not very much or little influence over how it was to be done
- Involvement in decision-making, with 63% feeling that they had little or no influence.
- Training, with about 50% of employees feeling that training was unsatisfactory
- Pay, with 65 % feeling that it was not satisfactory or fair
- 71% felt that their jobs made them feel tense a significant part of the time - 30% 'all or most of the time'
Managers versus employees' perceptions
47% of managers believed that workplace relationships were 'very good' - 19% of employees agreed.
46% of managers believed that relations were 'good' , 40% of employees agreed
6% of managers believed that relations were 'neither good nor bad', 26% of employees thought the same
3% of managers believed that relationships were 'poor', 15% of employees felt the same.
Economic and Social Research Council.
Women and Older Employees (over 50)
Women now make up 50% of the UK workforce and still growing - older employees are becoming a vital element as the population ages. Their opinions about work are therefore important. There has been a noticeable deterioration between 1992 and 2002.
Over 50's % were 'completely or fairly satisfied' about the following facets:
|Their supervisor/ manager||59||43|
|Using their abilities||60||41|
|Variety of work||60||41|
|Amount of work||51||26|
|Women: % satisfied with hours of work/pay|
|High level professionals||38||26|
|Lower level professionals||44||28|
|Higher administrative staff||58||35|
Managers: Research by Chartered Management Institute with University of Lancaster. 2006.
Sample of 1500 managers in the private sector.
"More than half suffered from insomnia, muscular tension, constant tiredness and trouble with personal relationships".
92% regularly worked over their contracted hours
41% regularly worked more than 60 hours a week.
40% found it difficult to concentrate
60% reported sickness and absence levels were rising in their workplace
Men were very reluctant to share their problems with their bosses - 29% said that they were willing to share 'serious problems' of stress or health, as opposed to 46% of women. The researchers commented that a majority of directors were 'unaware of or disinterested in' the problems.
CIPD - Employee Well-being and the Psychological Contract.
Prof David Guest from King's College London has conducted a survey into a variety of facets of workplace commitment since 1996. It is thus possible to track trends. Guest has in the past been critical of reports that employees' attitudes to work and their employers were worsening, but has now expressed concern at the rapid changes reported in employees' experience of work.
Several factors stand out from this survey:
- There is a marked gap growing between the public sector (except for central government) and the private sector. Guest et al comment on the fact that public sector employees report that the experience of 'providing a useful public service' provides positive motivation, whereas private sector employees report a decrease in satisfaction from their ability to give a good service.
The dimensions that show the greatest decline (usually from about 2000/2001) in the private sector are:
- Feelings of autonomy in deciding how to do work
- Overall work motivation
- Perception of fair pay (big drop) since 2002
- Trust in employers (big drop) since 2001
- Commitment to the organisation they work for
- Work satisfaction (big drop) since 2001
- Increased intention to quit (big increase since 2001)
Public sector employees report positive changes in all of these dimensions since 2000.
This does not seem to be a very positive scenario, containing as it does, in many British-owned companies at least, under-investment, declining benefits and overwork. It is hard to keep the word 'Exploitation' at bay.
To further illustrate the interconnections between industry, finance and government and the effects on us, the public at large, here is a history of what has happened to our most important long-term assets - our pensions.
Pension fund members account for a considerable portion of the real shareholders, the very people for whom the investment industry is supposed to be working. And when funds invest in the Stock Market, the companies who comprise the market and their top managers are also supposed to be working for the members of pension funds. Surely the creation of 'shareholder value' is essentially about creating wealth for pension holders and savers?
Why then, do so many of them seem to get such a raw deal?
A Short factual history of UK pensions.
- Originally, the Basic State Pension was linked with average earnings.
- In 1975, the Social Security pensions Act introduced a basic State pension and an additional pension (State Earnings Related Pension) related to an individual's earnings over a career. SERPS was implemented in 1978. The original ceiling for SERPS was 25% of average lifetime earnings. The intent was to ensure that all those who had performed paid work in their lifetimes would receive more than the basic state pension.
- From April 2000, the original SERPS formula of up to 25% of lifetime earnings was deemed to be too expensive, and has been reduced to a maximum of 20%.
- In the 1960's and 1970's governments encouraged company occupational pension schemes through tax breaks on contributions and dividends received from investments.
- During this period, many companies, believing that it was their duty to look after employees' long-term interests, made membership of their final salary occupational schemes compulsory.
- In 1980, the Basic State Pension link to earnings increases was replaced by a link to price inflation because of cost. This was, and is still seen by many as a regressive move.
- In 1988, the government introduced Personal Pensions - seen by many as bringing a desirable element of choice and flexibility into pension provision. At the same time, compulsory membership of occupational schemes was outlawed and personal pensions were heavily promoted by government and the pensions industry.
- The introduction of personal pensions resulted in the first of many orgies of deception and mis-selling by the Financial Services industry. It is estimated that the whole personal pension disaster cost some £15 billion in compensation and affected literally millions of people. It was also a seminal event in creating high levels of justifiable distrust in the financial industry that has subsequently been fed by scandal after scandal. Government can take its share of blame for failing to regulate the industry and educate the population.
- The whole farrago was exacerbated by the unwillingness of many private pension providers to compensate those they had misled - cases took years to resolve, and some companies were eventually fined for dragging their feet.
- As the long Stock Market boom took shape in the early 1990's, occupational schemes began to run up large surpluses - and companies responded by reducing their pension contributions, encouraged by government restrictions on large surpluses. Many companies ceased to make any contributions at all.
- The long boom period saw outbreaks of 'irrational exuberance' in Stock Markets and in the actions of companies. The net effects of the dot.com and technology booms and the huge increase in massively value-destroying M&A activity destroyed huge amounts of shareholders' wealth (estimated at over $25 trillion in the USA) and built the conditions for a disastrous financial markets crash. It can only be a matter of speculation as to what might have happened if companies had behaved more prudently and been allowed to amass higher pension fund surpluses to protect against the inevitable crash, and investors been more restrained and sane. We can also wonder what happened to Britain's vast North Sea oil wealth - surely a national asset, as the Norwegians have demonstrated by saving their surplus oil income for the long-term good of the public?
- Chancellor Brown introduced his already mentioned removal of relief from Advanced Corporation Tax relief for pension schemes in 1997. This move appears to have been less negative in its effects than some lobbyists would have us believe, but nevertheless reduced some pension schemes' income from dividend payments by 20%. (Dividend Payments form on average about 20% of a pension scheme's income).
- 2001/2 saw the Stock Markets go into reverse after a long boom. The crash wiped out pension fund surpluses and led in many cases to substantial deficits. This effect was exacerbated by the fact that many occupational schemes had taken lengthy contribution holidays, presumably using the money saved for purposes unrelated to general employee benefits.
It is estimated that companies saved over £20 billion in pension contributions withheld during the stock market boom years - of the same order of magnitude as Gordon Brown's tax raid - but not as well publicised!
- The State Pension age for women was increased from 60 to 65 in 2000.
- June 2001 - changes in accounting rules (introducing a new rule called FRS 17) meant that companies had to report pension deficits (or surpluses) in the year the deficit occurred, despite the fact that pension funds and their investment requirements should be seen over long periods.
- The net impact of the Stock Market crash, the sudden emergence of large deficits in under-funded schemes, Brown's tax actions, investor pressure for profits and dividends and changes in accounting rules led many companies to close their Defined Benefit pension funds to new members. (A Defined Benefit Scheme involves a company making a long-term commitment to provide a pension of a percentage of salary). Many companies have instituted Defined Contribution Schemes, (in which employees and the company contribute agreed sums, but no commitments are made as to the eventual pension outcome) instead. The key difference between Defined Benefit and Defined Contribution Schemes is that the investment and financial risks move almost entirely from the company to the employee. Thus many people are finding that in addition to the growing pressures and uncertainties of their working lives, they now have to face additional risks in their pension provisions.
- At a broad estimate, over 50% of companies providing Defined Benefit Schemes have closed them to new members. This must represent one of the greatest changes in companies' attitudes to employee welfare in living memory, and is almost entirely a private sector phenomenon. NB: most directors' pension provisions have not been reduced in line with those of employees in general.
- 2000 and onwards - 'discovery' that we are living longer and that this will have a marked effect on our pensions, costing much more to fund income for longer life-spans. One of our informants, an experienced pension manager, contends that the government actuaries were very slow in drawing attention to this most predictable of trends.
So we hope that you will see that the Pension Crisis is in part but not all Gordon Brown's fault, or simply a result of increasing life expectancy. Many actors have played on the pension stage, and in quite a few cases with little honour or distinction.
Working people in Britain are faced with an investment industry that is actively hostile to putting employees' interests before profits, dividends and bonuses, employers that dance to the tune of investors and are richly rewarded for so doing, a financial services industry that has manifestly lost the confidence of the bulk of people and deservedly so, and a government that is scratching its head about what to do, whilst denying responsibility for the disastrous results of advice that it provided to pension fund members. An impartial person might be tempted to ask about the purposes the financial and industrial systems if they enrich a minority and let down most of us.
Last, a view from the financial services industry regulator....
What follows are excerpts from the text of a speech made by Carol Sargeant of the Financial Services Agency at the Summit of the Financial Services Industry in Edinburgh, 7 May 2003.
'Dealing with consumers - the opportunities and the costs of getting it wrong'
Make a customer happy and she will tell two friends, make her angry and she will tell everyone she knows". One of the problems of course with a lot of retail financial products is that the consumer will not know for a long time whether they should be happy or angry. I want to talk to you today about your retail consumers and the opportunities and costs of getting this part of your business wrong.
.....Sadly, there are still many - too many - cases of misselling, misrepresentation and faulty products - that is, products that were never going to deliver what they promised from the beginning because of a design fault. The facts speak for themselves. £11.5bn of compensation will have been paid for pensions mis-selling, another £300mn for FSAVCs. Work on endowments continues and the compensation paid to consumers is around £600m and rising. And now we have splits and precipice bonds. Add to this the administrative costs of dealing with compensation - estimated at £2bn for pensions alone - and you are talking about a lot of money and literally millions of consumers affected with consequent damage to market confidence and of course damage to shareholder value. There may well be other unrecognised potential and actual risks lurking in your portfolios of retail products right now. What analysis and processes do you have in place to avoid these risks if possible, to spot them when they do arise, to manage and mitigate them?
..... Actions by both government and companies are requiring individual consumers to take on much greater responsibility for their current and in particular their future financial health.
How well equipped are consumers - your customers - to deal with the planning responsibilities and risk management issues - including volatility risk - that this will demand? Most human beings are notoriously poor at long-term planning. People in the UK are also relatively inexperienced and unsophisticated when it comes to matters financial. This is hardly surprising after two generations of mainly welfare state and employer provision. Many consumers have also still not fully adjusted to the implications of a low inflation environment and probably don't understand the liability side risks they are running any better than their savings and investment risks.
......It is hard to overestimate the extent of financial illiteracy amongst some consumers. Let me give you some illustrations from recent research. Many consumers have serious numeracy problems. Research by DFES has shown that one in four adults cannot calculate the change they should receive out of £2 after buying three items costing less than that. A significant number thought 10% of £300 was worth no more than £25. Some rather older research by the OFT showed that only 64% of consumers might be expected to draw the right conclusion when comparing 2 APRs and 23% of the sample could not explain what a percentage was.
A more recent survey by NOP for Invesco found that half of investors surveyed (and over two-thirds of the public at large) do not understand the difference between equities and bonds.
The FSA's own research and that of the independent Consumer Panel is also revealing. One quarter of pension and endowment policy holders did not realise that their money was invested in the stock market. 57% of consumers never or hardly ever read the personal finance page in their newspapers. Consumers find financial information difficult to understand and frequently fail to read or retain the information provided. 56% of consumers agree or strongly agree with the statement "I find it hard to understand financial leaflets". Even products designed to be simple confuse consumers - only 33% of consumers thought cash ISAs were straightforward for example.
How often and how much do your product designers, delivery channel experts and marketeers test whether consumers really understand the product being offered, its relevance to them and its risks? Do they, for example pay any attention to generic or firm specific complaints data? Do they really understand the underlying causes of past and present problems in the industry? Do they really understand consumers' needs? Our impression is that the consumer's capacity to understand the product being offered and its appropriateness for their own circumstances do not feature highly in product or market analysis or design. This is very evident from much of the promotional material, which often focuses on form rather than substance. In particular the risk reward trade off is too often either not explained at all or relegated to illegible footnotes. And once sold there is not enough monitoring of the continued efficacy of a product or indeed of any unintended or unexpected side effects. There is rarely any after sales information or service to consumers except where FSA has required it.
For the full text of the speech and further opinion, click to: Financial services industry malpractice - the FSA scolds the industry.