Rising profits and executive pay at a time of stagnant wages have eroded trust in big business but schemes rely on profitable companies, Natasha Browne hears
- Wealth inequality, low productivity and low investment are major challenges facing the UK economy
- Shareholder demand for dividends is driving short-termism
- Fund managers must do more to improve corporate governance
Company profits are fundamental to pension schemes on two levels: allowing firms that schemes invest in to pay dividends and as the backbone of the sponsor covenant. But in an era when the word profit has become synonymous with greed, the business world faces a major task in restoring public trust in company boards and chief executives.
Speaking at the National Association of Pension Funds (NAPF) Investment Conference in Edinburgh last week, experts debated this issue. The Institute of Directors (IOD) director general Simon Walker emphasised the importance of profits. He also highlighted the role fund managers can play in lobbying for good corporate governance.
He said: "Profit has to be a cornerstone of our economy and economic growth. But it can't be profit at any cost and any price to the community, to the customer, and to society as a whole.
"We're going into a general election where all the major political parties are committed to constraining public spending and taxing proceeds of companies' profitability is going to be more important than ever.
"Profit is really going to matter because that's where all the money that pays for health, education, and everything else the government ends up providing, actually comes from."
President of the Scottish Council for Development and Industry (SCDI) Lady Susan Rice agreed that the concept of profit-seeking had been dirtied by human behaviour. But she warned against overloading corporates with rules and codes that risked drawing attention away from the root issue of responsibility. There was, however, a worrying problem of short-termism among investors, she argued.
Rice said: "If you look at how profit is defined, it's about gaining usefulness and yet it carries this connotation which relates to a sense of ‘they've got something and I don't'.
"We need to keep in mind that the explosion in remuneration to top executives in our biggest companies over the years really kicked off at the time when transparency and public display of those packages started.
"You have a lot of highly competitive people running businesses and it's in their nature to be competitive and then all of a sudden they see what someone else is getting."
Frances O'Grady, general secretary of the Trades Union Congress (TUC), wanted to see ordinary workers more involved in the governance of the businesses they worked for. After all, they were the main wealth-makers, despite getting the thinnest share of the profits, she said.
"Institutional investors tend to spread their bets. That kind of intimate relationship between shareholders and the success of the company has been broken and so I think corporate governance needs reform and I'm keen that working people should have a role in that conversation as much as other shareholders," she said.
O'Grady (pictured) pointed out that Britain was wrestling with an environment of low investment and low productivity. But her greater concern was rising inequality and its effect on the economy. If ordinary workers receive a lower share of the profits, they have less money to spend, she said.
"Many economists now agree that it was that growing inequality that was a key factor leading to the crash and we're already seeing worrying signs now because wages and living standards haven't recovered to the extent that George Osborne would like us to believe," O'Grady said.
Walker disagreed with her on inequality, arguing that the situation was far worse in the 1970s when Britain was an "economic basket case". He attributed today's inequality to the effects of globalisation, but conceded that low investment and poor productivity were real challenges.
Walker said: "Profits are necessary to pay dividends to pension funds and to the pensioners of this country, and indeed of other countries. And that's why boards need to be far more aggressive in the way they actively pursue the executive management of companies. And fund managers are particularly important in that."
Demand for huge profits
But Rice argued that shareholders' preoccupation with quarterly performance was causing problems. She said investors often wanted to see quarterly profit rises in order to boost returns, which encourages businesses to make short-term profitable decisions that could be costly in the long run.
"Those of us in businesses, those of us who are managing funds and investments, have an obligation to take that longer-term view and to say it's about more than this quarter's profits. I think we as people have to address this issue," Rice said.
Walker took a different view. He told delegates he applauded when AstraZeneca rejected rival pharmaceutical firm Pfizer's advances. Had the deal gone through, shareholders stood to gain significantly in the short term. But Walker said: "That is good corporate governance and it shows in my view that the system is working. It actually shows that decisions are being made on a long-term view in the interests of the people who ultimately benefit from the company.
"But I think fund managers have a big role to play. They're not playing it properly at the moment. They're not nearly as activist as they ought to be."
The IOD chief warned against getting too hung up the idea that "wicked executives" had their hands in the till. But he added: "There's not nearly enough focus on whether their judgement is right. Is it appropriately cautious and long term? Have these dominant chief executives been questioned, been probed, adequately by non-execs on the board and by the ultimate owners of the company? I think that's not happening enough and it ought to be."
Rice was clear that too much government intervention and regulation could be distracting and lead to unintended consequences. She added: "One of the things that is sometimes missing when shareholders are making sure we're following all these codes is responsibility.
"You say ‘we're doing all these things, it must be right'. Actually every company has to have people in the company who are taking responsibility for the decisions over what that companies does, and that there is accountability or the compliance that is also required."
The Pensions and Lifetime Savings Association (PLSA) has announced it will shrink its board by more than one-third as part of a governance overhaul to make it "agile and more appropriate".
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