At the Association of Investment Companies conference, the UK’s minister for the City, Lord Myners, launched a fierce attack on institutional shareholders for not having engaged closely enough with the companies they own. He said they had acted like “absentee landlords” and that their representative body, the Institutional Shareholders’ Committee, has “sunk beneath the surface just when it is needed most.” By implication, this hands-off approach had contributed to the financial crisis by allowing companies to get away with behaviour that stricter corporate governance would have prevented.
In a response to the speech, the Financial Times’ “Lombard” column pointed out two important aspects of institutional fund managers: one, they can sell their shares whenever they want (unless the fund in question is an index tracker), and, two, their primary concern is the performance of their funds. And performance is likely to suffer as a result of the sort of engagement “that involved hanging on and denouncing the chief executive’s strategy even as he drove the company into the ground”.
The column also pointed out that it needn’t be like this. The model is broken because increasingly fragmented ownership means that individual investors have no sense of responsibility for a company’s eventual outcome. It is a model that encourages investors to “disengage when the going gets tough”. Lombard advocates a new model of constructive engagement that would bind them more closely to long-term active management of companies. At the moment, such a model is at the concept stage – not even a work in progress.
At a time when questions are being raised about the validity of the private equity model, it’s interesting that it provides at least two of the ingredients allegedly missing from its public market equivalent – one, alignment of interest between a company’s management and shareholders, and, two, long-term ownership. The problem in getting across this message across is that, between 2005 and 2007, the competing highly leveraged, mega-buyout model took centre stage – and that model is clearly broken.
Cleaning up the mess generated by the excessive use of cheap debt will, both within and outside the private equity industry, take a hell of a long time. It may take equally long to convince sceptics that private equity has always had – and continues to have – a compelling model of ownership that brings benefits to a wide range of stakeholders. Protestations that this is the real private equity model might prove fruitless. After all, as the saying goes: perception is reality. Of course, this doesn’t mean it’s not worth trying.