Investors, Governance and Culture, Part II
This is being published from the New York Fed by a guest writer as part of Reforming Culture and Behavior in the Financial Services Industry: Expanding the Dialogue. The views of the author are his own and are offered by the New York Fed to contribute to discussions on this topic.
“Expanding the dialogue” on culture and behaviour to investors is a welcome and timely development. I am delighted to participate in the discussion.
Culture and behaviour is a topic familiar to many in the investment community. Largely similar issues arise in respect of culture in other businesses. And investors routinely consider “societal” issues such as the environment and climate change.
Why should investors care about culture? Little convincing is required. Long-term investors already dedicate substantial commitment to their own in-house culture in discharging fiduciary responsibilities to their asset owner clients, not least as a source of competitive advantage. A business without resilient culture is unlikely to flourish in the long term. Anything less than a complementary focus on culture in their investee companies would seem inadequate and inconsistent.
Moreover, banks are special. In the aftermath of the GFC (Global Financial Crisis), there is an unsurprisingly increased societal interest in a financial system that is not only resilient in the sense of its reduced vulnerability to short-term instability, but which is also supportive of the real economy on a sustainable long-term basis. Given their exceptional social externalities, culture has special relevance to major financial institutions.
So why have investors overlooked culture until now? The prime responsibility for embedding and maintaining a culture programme is necessarily for the board and executive of the company. The responsibilities of asset owners and fund managers are, by contrast, more varied, typically less clear-cut and commonly include the option of selling stock.
Further, there is the difficulty of recognising and measuring the cultural health of an entity. Hard financial metrics are more familiar and more easily digested (save after an event of mishap or failure which gives rise to a penalty). Add to that an agency gap, which impedes effective communication between fund manager and a board.
Even where cultural issues have been identified, the wide dispersal of holdings limits the capability of most fund managers, independently of others, to exert meaningful influence. And, finally, a degree of presumption or expectation that the reach of financial regulators extends to cultural issues/deficiencies may lead to an abdication of responsibility on the part of investors.
Despite the weight of these factors, investors have the interest, responsibility and ability to exert constructive influence on culture in their investee entities. Equity capital is a scarce resource. Its providers are entitled to be more demanding as to its use.
What’s to be done? At the October 20 conference, I hope we can explore the most productive ways for investors to exercise greater stewardship in financial services. This concept has three dimensions. The first is communication. Asset owners should tell the boards of their investee companies their objectives for sustained performance over the longer term. Second, where asset owners are outsourcing part of their fund management, the selection process and award of mandates should focus on managers whose operating model and capability is closely aligned with asset owner objectives. Third, the ability of even larger asset owners or fund managers to engage appropriately effectively with a board will be enhanced where this can be done through collaboration with other holders. Ways of doing this should be developed proactively.
Culture is central to all of these approaches. Investors value their own cultures and see a clear relevance to performance. What’s good for the goose is good for the gander.