20 Apr

Relational Research Responds to Green Paper on Corporate Governance Reform

28.5 blog image

Response to Green Paper on Corporate Governance Reform published by Department for Business, Energy & Industrial Strategy on 29th November 2016.

Jonathan Rushworth and Dr Michael Schluter

Introduction.

The Government is to be commended for bringing into public debate issues of concern over the practice of certain companies which fall short of standards expected in the corporate world. Companies have the benefit of limited liability for shareholders (no liability for the debts and other obligations beyond their investment in the company) and beneficial tax and other treatment and, in return, a certain responsibility to stakeholders and society generally is expected. For companies operating in the private sector (whether listed or non-listed) the standard of behaviour should be overseen by shareholders who jointly have the ownership and controlling interest in companies.

However, encouragement is needed by legislation, regulation and code in particular to provide the framework within which companies should operate.

This generally works well where companies recognise the boundaries and their responsibility to all stakeholders who rely on the company for their livelihood and wellbeing but there are times when society at large (prompted by politicians, business leaders, academics and opinion formers) challenges the legitimacy of the corporate world where unacceptable, sometimes egregious, practices are allowed to flourish.

Many shareholders regard their investment purely as a tradable commodity and, by delegating full authority to the directors to operate the business, have little interest in the underlying business of the company, with its impact on employees, suppliers, customers and wider society, beyond their own financial return. Indeed, shareholders tend to exert little or no control over the behaviour of the directors, nor do they hold directors to account for their actions. Individual capital providers (those investing in companies through pension funds or personal investments) often have no say and their investments are in any event held through intermediaries, for instance nominee accounts or investment funds. The publication of the Green Paper is a necessary recognition that certain aspects of corporate behaviour need to be addressed.

Indeed, many of the proposals for consultation in the Green Paper reflect ideas suggested by ourselves and others that there is an urgent need for a change of emphasis in the purpose of the corporate world from the relentless focus and demand on short-term and ever increasing financial return for shareholders in listed companies, in the form of dividend payments and share price increase, often achieved through share buy backs, towards an approach which recognises and values the benefits of positive, nurtured and mature relationships with stakeholders and their interests. This reflects the value of the company’s social and relational, and not just financial, capital in which companies display commitment to their stakeholder community.

The stakeholders are, as the Green Paper suggests, employees, suppliers, customers and the local community, but we suggest that they should include others who work with or have an interest in the success of the company, for instance financial lenders to the company (banks and holders of tradable debt) and regulators (as representatives of Government and public interest).

There should also be recognition of the responsibility of the company in its relationship not only to the local community but also to society at large.

It should be noted that current legislation recognises this responsibility to a limited extent (in particular in s172 Companies Act 2006) but City Codes in the form of the UK Corporate Governance Code and the Stewardship Code do not address relationships with stakeholders other than shareholders. Third party stakeholders are of course affected by company decisions and operations with little or no direct influence or recourse.

Many companies strive to achieve ethical standards and have active CSR projects but these do not go to the heart of how they relate to employees, suppliers, customers and others who rely on the business for their jobs or livelihood.  Para 2.4 of the Green Paper recognises that many companies are aware of the economic benefits of understanding and maintaining healthy relationships with interested groups such as employees, the local community, customers and suppliers. The paragraph acknowledges that more needs to be done to develop an appropriate model to develop this approach. The paper reflects that the requirements of s172 Companies Act 2006 need to be properly understood and applied. This relates directly to the requirement for the directors to have regard to various stakeholder interests and for the strategic report to provide shareholders with information that will enable them to assess how the directors have performed their duties under s172.

Companies whose interests are aligned with those of its stakeholders and which operate as a community of interests, are likely to be more competitive, sustainable, profitable and overall more successful as well as attracting loyalty from employees, suppliers and customers.

Properly paid employees with promotion prospects who are incentivised (through cash bonuses and share schemes), who are respected and their ideas and concerns listened to, will tend to be loyal to the company, more productive and less likely to leave or be absent from work through illness. Similarly, suppliers who are paid within a short time-frame and on the contractually due date, as well as being supported by the company, are more likely to give loyal commitment and service than if they are treated at arm’s length and with late payment with its damage to cash flow and the threat, for instance, of demands for more payments to display goods and early termination if price reductions are not forthcoming. Customers who are treated with concern and whose complaints are properly, promptly and personally handled will show loyalty and support for the business.

Further, individuals who are shareholders and consider their concerns and interests are listened to and respected as investors, who have prompt access to directors and senior managers and are able to gain an understanding of the business and its plans are more likely to feel a part of the company, show loyalty and take a longer-term view of their shareholding. They will also be in a position of knowledge and understanding to hold the directors to account if the company falls short of standards expected of a properly and responsibly run company. Incentives could be provided to encourage long-term investing (for instance, additional shares after 2 years).

Companies could consider ways to engage more closely with shareholders and other stakeholders on a regular basis. Companies could hold quarterly meetings with shareholders, possibly in different parts of the country and at convenient times of day, encourage attendance, and invite not only shareholders but employees and perhaps some suppliers and customers. There could be break-out groups for shareholders to meet individual directors to discuss different aspects of the business. Face-to-face meetings with directors would lead to greater openness, understanding and trust. Those investors in the company who are the main capital providers would be encouraged to hold shares directly in the company and to attend meetings with the company and other stakeholders.

The Government should encourage, through legislative or regulatory means supported by society as consumers and investors, a change in corporate culture to meet the expectation of employees, investors, suppliers, customers, regulators in the context of the responsibility of the corporate world to the society in which it operates and from which it benefits. Companies which already adopt this approach will be recognised and encouraged and will lead others by example. The debate prompted by the suggestions in the Green Paper provides an ideal opportunity to start to reframe and refocus UK corporate culture in a distinctive and exciting way, making the most of our enterprise, talents and resources, so that all will benefit and the litany of criticism of the corporate world will start to evaporate as faith and confidence is restored. There will be recognition of a more inclusive, responsible, constructive and successful form of capitalism.

A description of some of the problems with aspects of corporate behaviour, an analysis of the underlying causes (going back to company structures developed in Victorian times) and suggested ways to address the issues can be found in Transforming Capitalism from Within by Jonathan Rushworth and Michael Schluter at http://relationalthinking.net/relational-research/

These comments now address the particular chapters and questions in the Green Paper.

Executive pay.

The Green Paper reflects concerns over the increase in executive remuneration over the past 18 years, as mentioned by the Prime Minister. This has caused concern not only as to the amounts in absolute terms (which can have an adverse effect on the company, as less money is available for investing in the business) but more particularly on the impact on other employees in their companies. What does it say, for instance, to a low paid person on the supermarket checkout desk, who works long hours and has a stressful job dealing with customers, that the senior executives in the company are paid maybe 1000 times more than they are? Do they feel that their value and worth to the company is properly recognised? What does it tell them about how their job is regarded by the company? At the very least it does not promote a sense of corporate and shared endeavour.

The senior executives take considerable responsibility (but generally with no financial risk) in their roles and promoting the success of the business but there may be doubt as to whether such generous terms (often paid when the business is not particularly successful) are needed to attract high calibre leaders. The rewards of running a large company successfully are measured not only in financial terms but in their satisfaction and reputation as entrepreneurs and business leaders in achieving success in leading a prosperous company nationally or internationally.

We regard the question of what seems like ever-increasing pay differentials as illustrating a breakdown in the relational understanding and dialogue between those in senior management positions who operate the company on behalf of the shareholders, and the shareholders who have collective ownership rights. In addition to their rights to vote on the company’s pay policy, the shareholders appoint and reappoint directors, who have delegated authority and power to operate the company, and under the provisions of the Companies Act the shareholders have the right to pass a resolution (by simple majority) to remove directors from office. Yet remuneration committees frequently do not seem to have a satisfactory dialogue with shareholders to establish what an acceptable level of remuneration should be and this is reflected in the significant number of AGM’s each year when shareholders voice concern over the scale of remuneration packages.

Question 1: Do shareholders need stronger powers to improve their ability to hold directors to account on executive pay and performance?

We would suggest, as proposed in option (v) of part A (Shareholder voting and other rights), that the Corporate Governance Code be amended so that remuneration committees scrutinise more closely pay levels within the company (from the highest to the lowest), listen to and take into account the views of a range of shareholders, institutional and individual, as well as a range of employees and possibly other stakeholders. In some companies remuneration levels cause an annual battle with significant voting against pay packages at AGM’s. Directors should strive to avoid this as it reflects badly on the company and its image and does not show a consistent approach to the way in which the business is managed. Other ways to give shareholders a greater say in voting on remuneration levels, as suggested in the options proposed, should be considered but only in a way which is practical, given the long-term nature of some pay packages. In addition, there should be clear reporting annually on the nature, scope and details of executive remuneration, its justification and a summary of discussions between the remuneration committee and shareholders.

Question 2: Does more need to be done to encourage institutional and retail investors to make full use of their existing and any new voting powers on pay?

Consistent with the relational approach outlined above, we believe that all shareholders should be encouraged to engage with the company in discussions not only on executive pay but on other aspects of the company’s operation and its relationships and engagement with stakeholders. Clearly the directors are appointed to make decisions on the operation of the company but there should be closer engagement with other stakeholders. Greater disclosure on fund managers’ voting practice is to be encouraged. A shareholder committee could be appointed to discuss remuneration levels and amounts with the board remuneration committee. Individual shareholders should be encouraged as long-term investors (perhaps by tax relief) and their voting encouraged either directly or through their nominee holding arrangements. A greater acknowledgment by companies of individuals who are significant shareholders and access to the directors, perhaps through a liaison committee with the company, would encourage greater interest, loyalty and responsibility by those shareholders. They could, for instance, be named in the annual report and accounts and invited to regular lunches with directors (with employees and other stakeholders).

Question 3: Do steps need to be taken to improve the effectiveness of remuneration committees, and their advisers, in particular to encourage them to engage more effectively with shareholder and employee views before developing pay policies? Do you support any of the options set out in the Green Paper? Are there other options you want to suggest?

As suggested above, there should close liaison between remuneration committees and shareholders, institutional and individual, as well as with employees and possibly other stakeholders. This could be reflected as a requirement of the Corporate Governance Code. The Code could reflect a requirement that the remuneration committee should have a measure of independence from the board of directors of the company. They could report each year how they have approached their role and summarise the consultation they have undertaken and why they consider their recommendation to the board as to the level of remuneration for executives is reasonable and proper and in the interests of the company, not just in terms of a comparison with other companies of similar size in the sector but also in the context of all remuneration levels within the company.

Question 4: Should a new pay ratio reporting requirement be introduced? If so, what form of reporting would be most useful? How can misleading interpretations and inappropriate comparisons (for example, between companies in different sectors) be avoided? Would other measures be more effective?

The issue of pay differentials and the impact they can have on a company workforce and in the mind of the public is considered earlier in these comments. Remuneration levels make headline news and cause shareholders to vote against resolutions at AGM’s, although rarely with sufficient numbers to prevent a resolution being passed (by simple resolution). To encourage directors and remuneration committees to come to reasonable views on pay levels throughout a company (or group of companies) it would be helpful for different levels of pay to be disclosed, alongside the report of the remuneration committee as suggested above. This would follow the practice of a number of companies, so that the number of employees within different payment bands would be disclosed, from the lowest to the highest paid. The report would explain the appropriateness of the differential for the business of the company and the sector in which it operates. The company would explain its policy and approach to remuneration at all levels and why, for instance, limited or no increases are given at some levels but increases are proposed at other levels. If the company outsources a significant amount of its business or has self-employed workers, consideration should be given to equivalent disclosures for the third-party contractor and self-employed workers, to encourage transparency.

These disclosures would ensure that companies have considered remuneration levels carefully throughout the business and require them to justify their approach. It would also enable comparison to be made between businesses in the same and similar sectors. The requirement for disclosure should be such that a consistent approach is encouraged by all companies which comply.

Question 5: Should the existing requirements to disclose targets that trigger annual bonus payment be strengthened?

A relational approach reflecting openness and dialogue between stakeholders suggests full disclosure but we believe that grounds of genuine sensitivity or confidentiality should be respected.

Question 6: How could long-term incentive plans be better aligned with the long-term interests of quoted companies and shareholders?

We consider that the interests of the company and its shareholders would be best served by incentive share (or cash bonus) schemes being established for all levels of the company’s employees. Simple long-term non-contributory schemes could be devised for all employees in the form of exercisable options or the issue of shares assuming various targets are met. Such targets would include investment in and expansion of the business by organic growth. Tax relief would be given if options are exercised or shares awarded if they are held for a set period of time.

Strengthening the employee, customer and wider stakeholder voice.

Question 7: How can the way in which the interests of employees, customers and wider stakeholders are taken into account at board level in large UK companies be strengthened?

The Green Paper acknowledges that many companies recognise the benefits of engagement with stakeholder interests in their business activities and that economic benefits are derived from bringing external perspectives to bear and in properly understanding and maintaining healthy relationships with interested groups. As explained above, we suggest that engagement with stakeholders, having a continuing dialogue with them to understand their interests and values, listening to their views, treating them with respect, seeking a common goal and recognising issues over the running for their business and their contribution to the success of the company (whether they are employees, suppliers, customers, the local community, lenders or regulators) is essential for the operation of a successful and productive company. In other words, this engagement and recognition goes much beyond just an economic and financial goal.

Further, we consider that companies cannot have effective risk management unless stakeholder relationships have been understood, analysed and properly managed. This applies not only to external relationships with suppliers, customers, shareholders and regulators, but also with regard to relationships with employees, internal audit and partnerships and relationships with other group companies in groups which have holding companies and subsidiaries. The risks may be generated by the actions of external parties, inadequate engagement by the company’s own management team, or a weak relationship between senior management and those holding the client or other stakeholder relationship. In every case, sound relationship management practice will reduce the risks faced by the company.

The Green Paper recognises the need to find new ways for boards to connect with a wider range of interested stakeholder groups, beyond the shareholder base, whilst acknowledging that many companies have constructive practices in this regard.

The concern, as raised in the Green Paper, is that in many cases the intention and meaning of s 172 Companies Act 2006 is not properly understood and applied. There has been debate over the meaning of the words “have regard to” and the level of consideration that should be given to the interests of the stakeholders specified and, indeed, the scope of stakeholders, for instance where the wording refers to “and others”. Although s 414 requires the strategic report to provide shareholders with information that will enable them to assess how the directors have performed their duties under s172, there is a question as to how companies are complying with this requirement beyond the required disclosure on the specific matters mentioned in the section, for instance with regard to environmental and employee matters, as summarised in Appendix B of the Green Paper.

The Green Paper suggests how companies could be encouraged in their decision-making and operations to give more prominence to the interests of all stakeholders, so as build confidence that the provisions of s172 are properly understood and applied. We now comment on these suggestions and make a proposal for an agency with statutory authority to oversee and give guidance on best corporate governance practice.

Option (i) suggests that one or more stakeholder advisory panels could be formed for consultation with the directors on specific topics (for instance directors’ remuneration) or items relevant to those stakeholders, for instance relationships with suppliers. Such panels would need to be properly constituted and operated and given due respect and regard to their views by the board. The scope of their remit and responsibility would have to be established and there would need to be an understanding that individual representatives do not promote their own interests but the stakeholder group as a whole which they represent.

There would be questions as to how members of the panel would be appointed, for how long and how they take views for the stakeholder groups represented. An employee representative group, for instance, could be elected for different levels of seniority of employees for a set term (would the trade unions be involved?). Representatives of suppliers and customers might be harder to find and elect on any continuing basis as the members of both groups might be likely to change regularly. This would of course depend on the nature of the business. Suppliers to a company may compete with each other and therefore forming a cohesive group to represent might be difficult. Some stakeholder groups would be more likely to be cohesive and able to choose and influence a representative, while others would be unrelated individuals. Connected stakeholders would be more easily represented that disparate ones.

The relationship between the board and stakeholder panels would have to be such that the consultation process was not seen as just another formulaic, mechanistic process. This would be supported by a reporting requirement on the activity of the panels, their procedures and process for liaising with the board and how the board takes their views in account on relationship and company matters more generally. The panel and the board would need to keep under review the relationship and dynamics of different stakeholder groups and ensure that all relevant stakeholders are represented.

Option (ii) suggests that existing non-executive directors are designated to ensure that the voices of key interested groups, especially that of employees, are heard at board level.

We see merit in this suggestion in that it would bring a representative voice for the main stakeholders with an interest in the business directly into the board room. However, non-executive directors are not intended to be engaged in detailed operational matters and they only devote part of their time to the non-executive role. The practical aspects of engaging with stakeholders and understanding and promoting their interests in a balanced but effective way, with the time which would be expected to carry this out effectively, seem to be more in the remit of an executive director. A detailed knowledge and understanding of the business and how stakeholders engage with and contribute to the success of the business would be required to carry out the relationship role.

To give this responsibility to an executive director would recognise the significance of stakeholder interests in corporate decision-making and planning at the board level and throughout the business. Creating a post of Stakeholder Relationship Director would send a clear message to the corporate world and society in general that companies will move to a more stakeholder-inclusive approach and away from a narrow finance driven shareholder focus. Such a director would therefore have similar status at board level as, say, the finance director. As with option (i) the stakeholder representative director and the board would need to keep under review the existence and dynamics of stakeholder groups and relationships and those whose interests are represented.

Although certain non-executive directors may have the interest, personality, character and time to understand and represent the interests of stakeholders at board meetings, this is unlikely to be as effective as a director employed by the company with a full-time role to work with the other directors and employees to understand, measure the strength of and promote the interests of those stakeholders who have a close financial and wider interest in working with the company. The appointment of a director with responsibility for stakeholder relationships would avoid an election or other choice for a stakeholder representative panel as described above. Further, the director should have a degree of longevity in the post, whereas panel members may change more rapidly and would in any case devote less time and have less knowledge of current developments in the company.

Option (iii) suggests that individual stakeholder representatives would be appointed to company boards.

For the reasons set out in the Green Paper, we think there are difficulties with the idea that particular stakeholder groups would have a representative on the board. Difficulties over choice and changes in the represented group, as well as the conflict and balance of interests, could undermine what is intended to be achieved.

Option (iv) suggests strengthening reporting requirements related to stakeholder engagement.

This is a key suggestion as the reporting requirements could help to explain what is expected of directors in having regard to the various stakeholder interests mentioned in s 172. As the Green Paper states, there are already some detailed reporting requirements but this could be developed further to widen the range of interests which should be considered and addressed.

There are many examples of disclosures which could be required, in addition to or expanding current requirements. The company could be required to disclose its policy towards stakeholder recognition and relationships, the directors’ approach to measuring the quality of these relationships, how it has engaged with the various groups of stakeholders and how their legitimate interests are met on the basis that this is in the best interests of the company and its shareholders. This we suggest goes further than the ideas proposed in paragraph 2.33 (which are in themselves very positive), as they would require disclosure not only that different stakeholder interests have been given consideration, but demonstrate the approach and action taken by the company to understand and measure the strength and quality of the relationship, the results of such exercise and how it can be developed for the benefit of both parties to a particular relationship and stakeholders generally. In other words, it is not sufficient to report that there is a framework for engagement and measurement in place but the disclosure would have to show that it has been applied in practice and the actions taken as a result. The suggestions in paragraph 2.33 would add to and complement the disclosures about the relationships, their strength and how they can be improved.

Clarity of, and justification for, the remuneration packages of senior executives would be required to be disclosed and a summary of the process which led them to be recommended to shareholders. This would set the scene for their being put to shareholder vote. Disclosure could be required as to how the company engages with the interests of employees beyond current disclosure requirements, for instance how much weekend and overtime work is required, confirmation that share purchase schemes for all employees funded by the company are provided, the minimum pay scales and disclosure in bands of remuneration for all employees and details of any discussion forum with different seniority levels of employees.

With regard to supplier disclosures could be made, for instance, of evidence of building close and understanding relationships, for instance with payment on time or earlier (with no more than a 30-day payment period), help with IT and no penalties or requirement for additional payments for displaying goods. Disclosure would be required of incentives to encourage long-term holdings of shares by investors and engagement with individual as well as institutional shareholders. Clarity would be needed of tax paid and rates in countries where the company’s and group profits are earned, with full disclosure of any schemes or mitigating factors for lower taxes being paid.

If detailed guidance is given as to the disclosure requirements on a variety of aspects affecting companies’ operations, examples of which are given above, this would enable there to be greater scrutiny of their approach to stakeholder groups and their regard to the society in which they operate and from which they benefit. It would also be possible to compare the attitude and performance of companies in the same or similar sectors or across sectors, recognising that businesses may need to approach stakeholder engagement and support in different ways depending on the nature of the business and which stakeholders have a significant interest. Shareholders, analysts and the wider public would then be able to judge the level of responsibility of companies and their legitimacy in the context of their role and responsibility in society. The disclosure exercise would help to set a new standard for acceptable business practice and to help to redefine the identity of the corporate world with values of fairness, inclusiveness and transparency. Companies which meet the standards of acceptable business practice, of which there will be many, will be recognised and encouraged, by attracting goodwill, investors and customers or clients, and this will lead others by example to improve their practices.

In summary, we consider that all listed companies (and non-listed companies of a certain size measured by number of employees or shareholders) should appoint an executive director with responsibility to engage, where practicable, with all relevant stakeholders who work with or for the company or otherwise rely on the company for their livelihood or wellbeing (as well as the local community and society more widely). The director would measure the strength and quality of such relationships, in the context of the business of the company and its responsibility to society, and work with the directors and management more widely to understand and improve the quality of the relationships, as well as ensuring that their interests are taken fully into account in decision-making in the company’s operations, not only at board level but throughout the company (and any group companies) and its management. The director would be responsible to ensure that detailed reporting requirements as to the company’s policy with regard to these relationships and how the company has taken their interests into account (as summarised above) are complied with.

The board as a whole will share the responsibility of the appointed director to take the interests of the relevant stakeholders into account in the company’s decision-making and operations as well as in its general approach to its business. In this way, we would expect that a change in culture will take place over time with a recognition of the value of positive and constructive relationships with stakeholders which will lead to a more inclusive, stable and successful model for the company’s operations and responsibility. The directors, employees, shareholders and all others dealing with the company will see the benefit of this to the company, and employees, suppliers, customers and others who are more likely to wish to be employed by, or otherwise engage with, the company.

An analysis of the meaning of relationships and how they can be measured, improved and reported on can be found in The Relational Lens by John Ashcroft, Roy Childs, Alison Myers and Michael Schluter (published by Cambridge University Press 2017).

Question 8: Which type of company do you think should be the focus for any steps to strengthen the stakeholder voice? Should there be an employee number or other size threshold?

Although we consider that all operating companies should adopt an approach which values engagement with stakeholders and puts their interests at the heart of the company and its operations, the suggestion for a director to have responsibility for this and the reporting requirement may be appropriate for companies of a certain size. The threshold could be the number of shareholders (the greater the number the greater the likelihood of shareholders taking less interest and having less say in the operations of the company). Other tests might be applied, for instance turnover and number of employees.

Question 9: How should reform be taken forward? Should a legislative, code-based or voluntary approach be used to drive change?

The framework for additional reporting requirements outlined above could be included in a revised s 414 Companies Act 2006. The additions could presumably be introduced as secondary legislation by statutory instrument, as other changes were recently made to s414 by this means. It may not be appropriate or necessary to legislate for the requirement for a director with responsibility for stakeholder engagement. The Companies Act, for instance, does not include any requirement for listed companies to have a finance director. Perhaps the new role could be set out in an amendment to the UK Corporate Governance Code, which would of course need the support of the FRC. Listed companies would then be subject to the requirement on a “comply or explain” basis. There would therefore be scrutiny to see which companies adopt the new structure and which do not. Pressure through publicity would be put on those which did not and the reasons they give for not doing so.

Corporate governance in large privately-held businesses.

Question 10: What is your view of the case for strengthening the corporate governance framework for the UK’s largest, privately-held businesses?

It is reasonable and proper that all companies should adopt and follow the highest standards of corporate governance. However, many private companies are small and there are issues of scale and cost for such companies in particular as to the level of formal requirements, whether they are through legislation or regulation, which it is reasonable for smaller companies to adopt. We consider that even the smallest companies should adopt through their constitution or by directors’ resolution a responsibility to operate in the interest of all stakeholders, recognising that there is value for the success of the company in doing so. A broader more detailed code could be developed in conjunction with the FRC as a framework to guide larger private companies in matters of governance (for instance remuneration and audit committees). A scale of detailed codes could be developed which would apply to private and public companies depending on size, measured by turnover or number of employees or shareholders. The full Code requirements would apply to listed companies (whether full or AIM listings).

Question 11: If you think that the corporate governance framework should be strengthened for the largest privately-held businesses, which businesses should be in scope?

This question is answered under Question 10 above.

Question 12: If you think that strengthening is needed how should this be achieved? Should legislation be used or would a voluntary approach be preferable?

In order to guide directors of all but the smallest companies as to the meaning of directors’ duties in s172, legislation (by statutory instrument) could adopt some of the disclosure requirements as outlined above by adding to the requirements of s414. Code requirements, as outlined above, could address other issues.

Question 13: Should non-financial reporting requirements in the future be applied on the basis of a size threshold rather than based on the legal form of a business?

As mentioned above, all companies should operate with the highest corporate governance requirements in the interests of all stakeholders. The argument for greater disclosure required for listed companies is that they have the greater “relationship distance” from shareholders, and often a short-term horizon with little engagement between directors and shareholders. The disclosures enable not only shareholders to see how the company matches up to expected standards of corporate behaviour, but also other stakeholders, for instance employees, and society more widely, including analysts and the press. This allows for significant scrutiny of the actions of the directors and opportunities to hold them to account.

As for other companies, there needs to be a balance between encouraging smaller companies to adhere to the necessary requirements and over-burdening them with disclosure requirements. However, it should be possible to introduce requirements of different levels for different sizes of company based on number of shareholders, employees and turnover. There may be little benefit in trying to achieve a consistent threshold for all situations, as circumstances and the reason for the reporting requirements vary.

Other issues.

Question 14: Is the corporate governance framework in the UK providing the right combination of high standards and low burdens? Apart from the issues addressed specifically in the Green Paper can you suggest any other improvements to the framework?

In addition to the suggestions above which involve internal company practices, we suggest that a statutory agency be established with responsibility to monitor the corporate governance standards of listed and large unlisted companies. It would be an independent body which would assist companies to understand their responsibility to stakeholders including society at large and would advise on the measuring and reporting of the quality of stakeholder relationships and on other aspects of corporate governance and reporting.

South Africa King IV Code.

We consider that, as part of the consultation exercise, there would be merit in considering the Report on Corporate Governance for South Africa which was published by the Institute of Directors in Southern Africa on 1st November 2016, incorporating the King IV Code on Corporate Governance. It takes a different approach in a number of respects to the UK Code. It includes extensive narrative explaining the background to and reasons for the latest version of the Code, following earlier versions, developed under the chairmanship of Professor Mervyn King. Corporate governance is considered as the exercise of ethical and effective leadership by the governing body towards achievement of the following governance outcomes:  an ethical culture, good performance, effective control and legitimacy.

It sees the governing body’s primary governance role and responsibilities as steering the organisation and setting its strategic direction, approval of policy and planning to effect the strategy and direction, ensuring accountability by, for instance, reporting and disclosure, and it oversees and monitors implementation, execution and management. Its underpinning philosophy of sustainable development includes integrated thinking (connectivity and interdependence), the company as an integral part of society, corporate citizen status and stakeholder inclusivity.

The 17 principles of the Code reflect requirements, amongst others, in respect of: ethical and effective leadership by the governing body; an ethical culture; the need to be a responsible corporate citizen; appreciation of the inseparable elements of value creation (core purpose, risks and opportunities, strategy, business model, performance and sustainable development); the quality of reporting; composition of the board (executive and non-executive); evaluation of its performance; committee appointments; opportunities and risk; technology and information governance; remuneration policy;  and investment responsibilities of institutional investors. The requirement for compliance with the Code is on a “apply and explain” basis, in contrast to the “comply or explain” basis of the UK Code.

Stakeholder-inclusive approach.

There is a particular emphasis on the stakeholder-inclusive approach which recognises that there is an interdependent relationship between the organisation and its stakeholders. Its ability to create value for itself depends on its ability to create value for others. Pursuant to this approach the governing body takes account of the legitimate and reasonable needs, interests and expectations of all material stakeholders in the execution of its duties, in the best interests of the organisation over time. Instead of prioritising the interests of the providers of financial capital, the governing body gives parity to all sources of value creation, including social and relationship capital as embodied by stakeholders.

The concept involves the balancing of interests over time by prioritising and trading off interests in some cases, in the best interests of the organisation over the longer term. The stakeholder-inclusive approach means that the best interests of the company are not necessarily always equated to the best interests of shareholders, so shareholders do not have a predetermined precedence over other stakeholders. It is an inclusive, stakeholder- centric approach in contrast to a shareholder-centric approach.

Paragraph 16 of the South Africa Code.

The stakeholder-inclusive approach is reflected in Principle 16 of the Code requiring the governing body to adopt the approach that balances the needs, interests and expectations of material stakeholders in the best interests of the organisation over time. There is a requirement for the governing body to take responsibility for the governance of stakeholder relationships by setting the direction for how they should be approached and conducted. The body would oversee stakeholder relationship management which results in management of stakeholder risk as an integral part of organisational-wide risk management, mechanisms for engagement and communication with stakeholders and also measurement of the quality of material stakeholder relationships and appropriate responses to the outcomes.

Although there are disclosure requirements including an overview of arrangements for governing and managing stakeholder relationships, actions to monitor the effectiveness of stakeholder management and how outcomes were addressed, they do not extend to disclosure of the results of the measurement of the quality of material stakeholder relationships.

Conclusions with respect to King IV.

Although the stakeholder-inclusive approach of the South African Code may not be considered appropriate in detail for the UK, the recognition of the value of stakeholder engagement and relationships is aligned to the overall approach to this aspect contained in the Green Paper.  It is suggested that a detailed analysis of the South African Code and its background and operation could yield value as part of the consultation exercise addressed by the Green Paper.


Jonathan Rushworth is a retired solicitor, whose legal career was at a major City of London law firm. He was a partner in the firm with a broad ranging company and finance practice. In addition to pursuing charity and history interests since retiring from legal practice, he has worked with Michael Schluter and others on the analysis and practical approach to put relationships and the interests of others at the heart of society rather than a focus on the rights and interests of the individual with a narrow materialistic approach. He co-authored with Michael Schluter ‘Transforming Capitalism from Within’ (2011).

Dr Michael Schluter trained as an economist before working as a research fellow with the International Food Policy Research Institute, and as an economics consultant with the World Bank in East Africa. Michael has launched many charities whose work includes international peace-building (Concordis International), alternative finance (Allia) and social policy (Credit Action). He is co-author of The R Factor (1993), The Relational Manager (2009), Transforming Capitalism from Within (2011, with Jonathan Rushworth) and The Relational Lens (2016). He is an experienced speaker who has addressed audiences all over the world, and was awarded a CBE in the Queen’s new year honours in 2009.

Relational Research Ltd, Future Business Centre, King’s Hedges Road, Cambridge CB4 2HY.

15th February 2017

17 Feb

Measuring Relationships: a route to competitive advantage and reduced risk

Mervyn King

This article originally appeared as a blog on the International Integrated Reporting Council website. It is reposted with permission from the International integrated Reporting Council.

Corporate failures and scandals often have deep relational roots. So too does success, for the essence of any business is to invite people into relationship as investors, customers, employees or suppliers and to make such relationships more valuable. Yet, as the authors of The Relational Lens recently published by Cambridge University Press point out, these relationships are too often like dark matter – the fabric of the universe that passes unseen.

As a global leader on corporate governance and reporting I have advocated since 1994 that in its decision making process a board needs to take account of the legitimate and reasonable needs, interests and expectations (NIE’s) of its primary stakeholders.

Either management must have an ongoing communication with stakeholders or a Corporate Stakeholder Relationship Officer (CSRO) should do so. The CSRO informs management of the stakeholders’ NIE’s and does a written report to the board on the quality of the relationships.  At every board meeting there should be an agenda item “Stakeholder relationships.”  This will result in the board having an oversight which is informed in regard to managements’ proposals on strategy.

The Salz Review into Barclays, the National Commission on the BP Deepwater Horizon Oil Spill, the Inquiry into the death of Victoria Climbie (a major UK public service failure), or indeed the reviews into almost any corporate failure show that weaknesses in relationships between the company and its stakeholders are readily identified after things have gone wrong. But would Volkswagen or Deutsche Bank have landed in their current situations if their internal and external stakeholder relationships had been better founded and managed?  Could the many corporate disasters, of which Enron, Lehmans, Cendant, Worldcom, HealthSouth, Tyco, Qwest Communications, Toshiba, BP and Arthur Andersen are just some of a long litany, have been avoided by a more systematic management of stakeholder relationships?

Restoring confidence in corporate, political and other institutions will require more than clever PR. It requires systematic measurement and reporting on the quality of relationships with all major stakeholders so that companies can take specific steps to address the key issues seriously.

Andy Haldane, Chief Economist at the Bank of England puts it this way in his comments on The Relational Lens: “There is widening acceptance that organizations – large and small, public and private, commercial and charitable – may be failing to meet the needs of their societal stakeholders. This has, in some cases, caused a rupturing of trust, a loss of social licence. This book … equips companies with the tools to begin the slow process of rebuilding trust, relationship by relationship.”

In corporate reporting on social and relational capital, companies have too often resorted simply to recording their CSR spend. With integrated thinking and embedding sustainability issues into a company’s business strategy CSR has become yesterday’s thinking.

The lack of available quantitative measures is perhaps the main reason why the boards of companies, as well as executives and managers, invest so little monetary, temporal and other resources into understanding, managing and measuring relationships with their stakeholders.

A way forward is shown by the new book by John Ashcroft and his colleagues, based on over 20 years of measuring relationships within and between organizations across the public and private sectors, as well as in different parts of the world. They demonstrate persuasively that all relationships operate in 5 domains – communication, time, information, power and purpose. Using these 5 domains will aid the CSRO in carrying out their mandate.

This approach identifies whether the conditions for effective relationships are being put in place and identifying perceptions gaps around the effectiveness of such measures. Looking at the preconditions for relationships serves as a way to assess a leading indicator of risk, focuses on the relational building blocks of such outcomes as trust, accountability or loyalty, identifies the factors that can be managed and changed, as well as enabling more constructive and effective dialogue about the issues identified.

All that makes this book timely, especially for the corporate world.

Here is the framework, here are the tools and the case studies to enable companies to give stakeholder relationships the kind of detailed and systematic attention which will bring an informed understanding to a board about a company’s social capital, and help bridge the divide between financial and social capitals.

‘The Relational Lens: Understanding, Managing and Measuring Stakeholder Relationships’ was published by Cambridge University Press in October 2016. A video of the launch can be found at Relational Analytics.

Author: Professor Mervyn King SC, Chairman, International Integrated Reporting Council

Photo: Mervyn King by Sveriges Kommunikatörer on Flickr.

11 Nov

The Relationship of Relationships to Productivity

productivity

Connecting the Dots

Economist Paul Mills gave a remarkable speech at the annual conference of the Relational Thinking Network in Cambridge at the end of September. He examined a range of subjects, offering “relational solutions” to global financial instability.

It was fascinating to see the connections made between seemingly unrelated matters, showing that our current economic model is geared towards proliferating and exacerbating the pains of ordinary people suffering at the hands of an inherently flawed and unjust economic system.

In his talk, Paul connected the dots on a range of topics – the housing market, household debt, wage stagnation, income inequality, structural flaws in the banking model, corporate structure, the implication (and responsibility of) limited liability, taxation, the intergenerational crisis, and so on. Against each of the key areas, some relationally grounded solutions were briefly explored. Several days later, the implications of all that are still sinking in.

The most surprising fact however, lay tucked away in a one of the presentation slides:

“the declining rate of productivity growth”

Productivity Growth

Why is this significant? Because growth in productivity can be regarded as one essential factor which could help to dig us out of the current global economic doldrums.

I later learned I wasn’t the only one to have picked up on it. While discussing the day’s events over a drink at the pub, several of us mentioned our surprise at the notion of declining productivity growth which we all assumed was at an all-time high, given the age of technological proliferation in which we are living.

I had asked Paul about this during the coffee break and he explained that “most of the low hanging fruit” of technological innovation had already been “picked”, and that what lay next on the technological horizon was costlier progress in areas such as energy and transport – requiring far greater infrastructural investments.

My Experiences

This is where I got to thinking and to connecting what Paul had said to my personal experiences as a business consultant working in the relational field, and helping organisations to achieve growth in the three domains of culture, profit and social impact.

My experience has been that individual and team performance is underpinned by engagement and motivation. We know from numerous polls (Gallup, KPMG, Deloitte etc.) that workplace engagement is roughly stagnant around 35-40%. That means ~60% of the average workforce are either actively dis-engaged or only passively engaged – with immense and perhaps obvious implications for individual productivity and company performance. My experience (and the research bears this out) has also been that engaged people represent more productive (as well as happier) people. My experience has also been that good relationships lie at the very heart of well-functioning teams and thus are critical to engagement and productivity. This is the common thread of all facets of the Relational movement, that relationships underpin healthier, happier, more productive people and societies.

In other words, we may be overlooking our greatest opportunity for growth in productivity. Instead of looking to technology alone to fuel growth in productivity, is it time we reversed the equation and looked to relationships to fuel productivity and technological growth?

Consider the invention of smartphones. No doubt, these are an outstanding technological innovation with immensely positive implications for growth in productivity. Yet, that growth in productivity, can (and has) been turned on its head when the use of that technology overtakes its intended optimum: overuse of a smartphone can cause chronic back and neck pain, especially in the cervical spine due to the lengths of time we hold it in positions which are un-ergonomic. Lengthy exposure to the electro-magnetic fields that it emits are considered by many to be harmful to health and can deplete energy. One only has to do a quick Google search to learn about the detrimental impact of smartphone overuse on face-to-face relationships, even marriages. Smartphone overuse has also been linked to sleep deprivation, depression, anxiety and several other disorders. Thus, our relationship to technology can not only serve to increase our productivity, but it can also threaten and undermine our productivity!

My point is this. The next phase of growth in productivity should come from deeper engagement with ourselves and our contexts; with our friends, class mates, families, colleagues and the strangers we have the opportunity of meeting.

The Relational Lens

Thankfully the relational model offers a clear pathway for doing this through the Relational Health Audit – a tool designed to assess the health of key business relationships and for developing those relationships to increase engagement and productivity. The 5 dimensions or pillars of successful relationships are:

  1. Directness – the nature and style of communication
  2. Continuity – the degree to which a relationship shares a common thread of past, present and future
  3. Commonality – the degree to which a relationship shares common goals
  4. Parity – the balance of power in a relationship
  5. Multiplexity – the variance in the contexts within which you know or have known someone

The tool measures the perception of relationships in respect of the above dimensions and the difference in perception is where the gold dust lies. As Rob Loe pointed out during his talk on the Relational Schools project at the Cambridge conference: “perception is reality”. Thus, understanding and comparing individual perceptions of a relationship provides the essential first step to understanding its strength. The differences in perception provide the areas of focus for exploration and they in turn give rise to the powerful interventions which can be applied to improve a relationship.

So while we continue to navigate the treacherous waters of global financial instability, we can start to make strides in a positive direction by expanding our relational lens to increase engagement, productivity and the raft of other associated benefits in the workplace. Perhaps a return to solid relationships will be our greatest weapon in the battle to return to long term financial and social stability.

Nashak Billimoria
Founder, BeUnlimited
http://www.be-unlimited.org/

07 Jul

Inventing the Individual – Book review

Individualism - People

Individualism and the near global preoccupation with the self and the interests of the self is increasingly becoming the norm everywhere.

This norm is an abnormality. It is destroying the foundations of what makes life meaningful, and long lasting human relations and fulfilment possible. From time immemorial humanity has been characterized by the idea of community and commonality. This ancient norm is perhaps wired into our human genes, and correctly defines a key aspect of what truly makes us human. The rise of the solitary individual, and ‘the lonely crowd’, is a paradox that has been the focus of many studies. The English poet John Donne immortalized the powerful message that:

No man is an island,
Entire of itself,
Every man is a piece of the continent,
A part of the main …
If a clod be washed away by the sea,
Europe is the less.

Any man’s death diminishes me,
Because I am involved in mankind,
And therefore never send to know for whom the bell tolls;
It tolls for thee.

Larry Siedentop’s book, Inventing the Individual – the Origins of Western Liberalism, demonstrates that Individualism has not always been an essential part of the Anglo-American/European ethos or of non-Western, non-European societies either. It is a new invention which arose at a certain point in the history of these societies. This development was however, progressive, eventually preferring an “association of individuals rather than an association of families” (p129).

Central to Siedentop’s argument is the pivotal role played by the medieval Church. He pays special attention to the rise of monasticism and the teachings of the Church fathers and intellectuals, such as Bonaventure, Thomas Aquinas, Dons Scotus, William of Occam and Augustine, among others. He discusses, for example, the role played by Augustine who in his Confessions (an extended prayer) focuses on “the inwardness of the individual … a sphere of dialogue, of conversation with God” (p104). By Augustine privileging prayer and grace, thus “Inventing the Individual – in the sense of acknowledging the equality of humans in the face of their maker…” (p105), Siedentop argues, he laid the foundation for “ … the demolition of ancient rationalism. The patriarchal family, the aristocratic society underlying the polis, the cosmos as a hierarchy of ends and purposes: all these became suspect and vulnerable without its support” (p104).

The European renaissance and reformation created the context for a further development and understanding of these ideas. Christian belief in the special place of prayer and grace, in the equality of souls and in moral equality before God are then seen to be the mother of Western Liberalism, together with its radical notions of human liberty, equality and fraternity.

The new secularism, and the future of these ideas cut off and without reference to their original Christian cradle and context, poses a present and real danger. The runaway contemporary naked individualism, the glaring inequalities and lack of respect one for the other, the diminishing freedoms everywhere – these are perhaps a sign of this danger. So, too, is the unconscionable greed, excessive love of money and power, at the expense of loving and empowering human relations. Siedentop very powerfully reminds us of this. To his fellow Westerners he concludes “If we in the West do not understand the moral depth of our own tradition, how can we hope to shape the conversation of mankind?” (p363).

Review of Larry Siedentop, Inventing the Individual – The Origins of Western Liberalism (Penguin, 2015).
Dr Aloo Mojola Visiting Professor in Translation Studies, Philosophy and Biblical Studies at St Paul’s  University, Limuru, Kenya.

RTN is neutral politically, and is not a religious organisation. On this website we publish articles and opinion pieces that align with our values (link to values statement on the website) but the author’s views are his own.

23 Jun

Orlando: How our Ideology is Killing us

Donald_Trump_and_Hillary_Clinton_during_United_States_presidential_election_2016 2

By Robert Hall – 

He who knows only his own side of the case knows little of that.
John Stuart Mill

Orlando now joins San Bernardino, Paris, Fort Hood and many others. Attempts to understand these atrocities focus on the ideology and theology of the killers – issues around ISIS, radical Islam, and hate crimes. But those issues beg a bigger question. How have our own ideology and theology immobilized our ability to respond? We lament that the enemy does not change their ideology while we steadfastly hold on to ours, leaving us unable to act. In light of that old adage, “It’s not what happens to you, but what you do about it” – we are failing.

It is our country’s own ideological divide that makes many of today’s headlines. Presidential candidate Donald Trump accuses President Obama of stupidity, indifference or “something else.” Obama goes on a tirade denouncing Trump’s statement about Muslims. Trump retorts that Obama is angrier at him than at the Orlando shooter. Our gravest risk is not that terrorism will destroy us but that it will provoke us to destroy ourselves.

We keep asking: When are we going to wake up and take action about – fill-in-the-blank. For some the blank is filled in by stricter gun laws, limits on immigration, more effective mental health programs, or more aggressive police or military action. But as a nation we are immobilized by the depth of our disagreement. Our response is heightened worry, but not heightened action.

Our inability to agree on a holistic, strategic response means that we eventually become a part of the problem – but at least it is a part we can do something about. We have met the enemy and it is not just guns, bad guys, ineffectual military efforts or dysfunctional mental health system. The enemy is also us and our broken relationships that prevent constructive engagement and thus constructive solutions on behalf of future innocent victims. The first one or two incidents – shame on the perpetrator. The last ten, shame on them AND on us and our disabled relationships.

We may not be able to control “them” but what to do about “us”? That should be a different story but it requires leadership.

It is time for leaders and followers to stop asking: How do I convert others to think like me? The more constructive question is: What about your ideology or theology would you be willing to repurpose in order to reach a shared solution that would save lives and save our Union? What would you be willing to concede, not by forfeiting your personal beliefs, but in support of a shared higher-purpose solution for the country.

Until leaders and followers humble ourselves regarding our own imperfect beliefs, we will remain stuck. Let me suggest three keys for thinking more relationally about ideology.

Recognize broken relationships as our greatest long-term risk.
No matter how you disdain violence, loss of innocent lives, and any opposition you consider the enemy – ISIS, gun lobby, religious extremism, immigration policies – we are stuck unless we come together enough to craft solutions.

Years ago General Peter Pace, then Chairman of the Joint Chiefs of Staff commented on the sectarian violence in the midst of the Iraq war:

“If the Iraqi people as a whole decided today that, in my words now, they love their children more than they hate their neighbors…this could come to a quick conclusion.”

If we could decide we love those future people who will be gunned down and blown up more than we hate our fellow citizen’s solutions, that would be the starting point.

Place relationships at the center of ideology and theology. The preamble to the U.S. constitution begins with these words: “We the People of the United States, in Order to form a more perfect Union…”. Our Constitution – the supreme law of the land – seeks union. As a nation of individuals with diverse backgrounds, beliefs, and needs – the founding hope was union and relationship as the best means to serve and benefit from our diversity.

Theologically, we all have beliefs, be they faith-based or secular. I am a Christian and since that is the largest group in this country, let’s start there. In Matthew 22 Christ was asked what is the greatest commandment. His answer was relationship: Love your God with all your heart mind and soul and love your neighbor as yourself. Then he added: All the law and all prophets hang on these. The Bible is the supreme law of Christianity and Christ described the law as a means to a higher purpose – relationship.

To disagree is human. To deploy our differences as weapons trained on each other is self-destructive. Making productive relationships our highest priority is crucial to creating broader, more holistic strategic solutions.

Sacrifice for the purpose of relationship. Sacrifice is the acid test of commitment. If productive relationships represent higher purpose, we must be willing to sacrifice some of our favored ideology if we are to reach common ground with those who have their own favored ideology. Remember John F. Kennedy’s famous question: “Ask not what your country can do for you, but ask what you can do for your country.” Said differently, ask not what you can get others to do for your belief, ask what you can do to “sacrifice” for shared belief that increases safety for all. Assault rifles, immigration policy, more invasive law enforcement — it is a fool’s errand to ask others to sacrifice what they hold sacred if we are unwilling to also. The arrogance of our self-righteousness is daunting – I am righteous and of God and thou art an evil idiot. It is the ideology we disdain in our enemies and it must cheer the hearts of those who would kill us to see its disabling effect on us.

Our enemy’s beliefs and connected actions threaten our safety and our way of life. Our failure to connect our beliefs to the higher purpose of constructive relationships blocks our attempts to respond with holistic, strategic action. It is time to Relationship-up!

This was originally published on 17/06/2016 by the Huffington Post and has been re-published here with the author’s permission.

09 Jun

Relationships and Mental Health

Daughter and father

The Mental Health Foundation have released an excellent report, which you can read here, which sets out further evidence that investing in relationships is at least as important to our health and wellbeing as not smoking. Their argument, like that of Relational Thinking Network, is that  both as a society and as individuals we need urgently to prioritise relationships and tackle the barriers to forming them.

The importance of relationships for health

Looking at a range of evidence, the authors show that people who are more socially connected to family, friends, or their community are happier, physically healthier and live longer than people who are less well connected.

Indeed, a review of 148 studies concluded that:

the influence of social relationships on the risk of death are comparable with well-established risk factors for mortality such as smoking and alcohol consumption and exceed the influence of other risk factors such as physical inactivity and obesity.

They make reference to a longitudinal Harvard study, that began in 1938 and published in the 2012 book ‘Triumphs of Experience’, that found that that relationships are the most important factors for health and happiness.

Factors causing relationship problems

The report discusses a number of inter-related factors that negatively affect relationships. For example:

  • Moving away from one’s hometown, family and friends can have a very real impact on our relationships. Moving means having to adapt to a new physical and social environment. Studies suggest that one of the biggest challenges facing individuals when they move is building relationships and connecting with others.
  • Social media and other online technologies have many positives. However, the report notes that almost half of internet uses in the UK reported that the internet had not increased their contact with friends or family who had moved away.

Indeed, while they have increase our sense of belonging, online relationships cannot replace our offline relationships.

The neurochemical response that occurs during face-to-face interactions contributes to our sense of connection, understanding and ultimately wellbeing. In other words, face-to-face communication still matters.

  • Bullying can have a negative effect on people’s health. Conversely a positive experience at school, particularly with teachers, can “act as a buffer and help protect young people during this difficult time.” This is something that Relational Schools has been researching on.
  • Loneliness and isolation are a significant issue for older people. See an earlier blog post we wrote about this here.

Actions to be taken

The report ends by calling, as the Relational Thinking Network has done, for “a sea change in thinking”. We need to not only recognise the importance of relationships, (which we instinctively do), but that we take an active approach in the way we build and maintain relationships, and to tackle the barriers that prevents strong relationships from being built.

 

28 Apr

The rise of the machines: the risks of robots in financial markets

rise of the machines

Introduction

The title of this article is borrowed, in part, from the third instalment of the Terminator movie franchise, released in 2003. The movie tells the story of a robot that returns to the year 2018 from a post-apocalyptic world with intent to destroy humanity’s ability to stand in the way of a future ruled by hostile machines by taking control of world’s computer systems. Far fetched? Perhaps, but there are some interesting similarities to that storyline with what researchers and market watchers are starting to observe looking at the gyrations taking place across the world’s financial markets over the past few years.

‘Flash’ Crashes

In May 2010, all the key US market indices experienced a massive collapse and then a swing to recovery, close to previous levels, in little more than half an hour. All this happened in the early hours of the morning before the trading floor was even open. The Dow Jones in particular experienced a loss of 1000 points in just a few minutes, equating to trillions of dollars in value. In 2013, a similar crash was experienced on the Singapore exchange that lost nearly US$7 billion in market capitalisation over 3 days. More recently in August 2015, another flash crash took place in the US with another 1000+ point drop precipitated by sell-offs in China and index drops in Europe prior to the opening on trade in the US. Major stock markets are not the only ones affected. At the start of 2016, Bloomberg reported on the flash crash of a 10% drop in the value of the South African Rand in the matter of minutes of one morning.

There is a lot of speculation as to the causes behind these changes from highly publicised examples of individual rogue traders all the way through to the panic-induced retail investor. As debates have evolved and research has discovered, there is an increasingly common denominator starting to emerge. A CNBC report from January 2016 recognises the US trading regulator CFTC’s (Commodity Futures Trading Commission) findings that “One of the key connections is the rapid placement and withdrawal of trading orders that lies at the core of high frequency trading (HTF)…this activity was at least significantly responsible for order imbalances in the derivatives market, which in turn affected the stock market.”

The Rise of the Machines

So where are the evil robots? The same CNBC report goes onto point out: “These crashes are caused by institutional trading from exchange traded funds (ETFs) and HFT. They are not caused by mums and dads trading because mums and dads simply do not act in such a coordinated fashion in such a short timeframe. Mums and dads also do not have the leverage to shift markets in this way within 30 minutes or an hour. That power lies in the hands of large-scale derivative traders.”

Large scale derivative trading is an increasingly automated process. Traders, ultimately human decision-makers, develop and instruct automated systems to make decisions on their behalf in times, places and frequencies that would not be humanly possible. Powerful institutions equipped with the capital, skills, information and infrastructure seek and extract return across global capital markets. As has been identified, the losers in this war are the retail investor and those institutions that are unable to compete with the sophistication and speed that these powerful robots have at their disposal.

It is not the robots that are evil, it’s the set of rules and algorithms that determine their behaviour to buy or sell that are the real problem. These rules do not apply discretion beyond what they are coded to do. Scarily, they are able learn by these rules and market movements to serve their masters for effectively and efficiently in future. Unsurprisingly, it’s the masters of the machines that stand accountable.

A relational view on robotic trading

The world’s financial markets are a clear example how relationships between nations, regions, industries and asset classes can impact each other through complex interconnections. Robotic trading is a mechanical attempt to identify these connections and derive an information advantage in a market to deliver financial return by trading assets based on rule-based assumptions. Essentially, this mechanical process looks to transform the observed dynamics of a relationship into a tradable transaction for gain for those who command it.

The unsettling reality is that investigators and researchers still do not know to what extent robotrading affects the world’s markets because of the pervasiveness of systems and the herding effect that they induce when it comes to other institutional investors trying to follow the lead of their more sophisticated peers. What is clear though, is that there are casualties in the process. Mums and dads do not have the speed and information to make decisions like robots do, but there still remain many millions of families across the world that invest their savings into markets to pay for school fees, retirement and rainy days. Attempting to make sense of market information so skewed by machines can be a fearful and potentially fruitless pursuit.

Colin Habberton is CEO of PayProp Capital in Stellenbosch in South Africa. Before that he was CEO of the GivenGain Foundation South Africa (GGFSA).

14 Apr

‘Big government’ anti-relational? Not when it comes to income inequality!

Goldfish income inequality for RTN website

Over the last decade, research on well-being has increased exponentially. While the main focus of economists is on the relationship between well-being and GDP per capita, they are becoming increasingly aware of the role of income inequality. This is an important topic for relational thinking as well, since income inequality is closely related to social cohesion and trust within a society. While relational research often focuses on interpersonal relationships directly, the structure and organization of societies and their economies can be a major source of stress. The impact of poverty is widely understood, yet income inequality can put relationships under a similar kind of pressure. Much is still unknown about how inequality affects well-being and what can be done about it. This blog aims to give a first glance at ongoing research on the matter, from a relational perspective.

When discussing income inequality, we should first ask ourselves what do we mean, and why is it worth to be studied? A classic approach is to look at absolute income differences within a country. Yet, as humans are social beings whose well-being depends on interaction and comparison with others, it is relative income inequality that social scientists should be most concerned about. A commonly used measure is the Gini-coefficient, a complex mathematical function that unfortunately tends to overestimate inequality between incomes in the middle of the distribution. Due to the nonlinear nature of income inequality, a better alternative is to look at the % of national income that is earned by the richest 10% of the population of a country. For European countries this number ranges from about 24% in Denmark, up to more than 40% in the UK. This means that on average one third of all income in a country goes to 10% of the population, leaving two thirds to the remaining 90% . This may not sound very alarming. Yet a similar pattern can be seen within the 90% group. In the end, high inequality means that a relatively large group is left with relatively little income. Several researchers have argued that the current level of inequality causes polarization of societies, as different income groups tend to become isolated from one another through consumption patterns, education, and even residential areas. When inequality is furthermore perceived as a sign of unfairness, it can pose a serious threat to social cohesion and mutual trust, even further deteriorating relationships.

Closer investigation of the matter shows that while perceptions of inequality are important, countries with higher levels of income inequality have lower average life satisfaction irrespective of cultural differences. This is especially true for countries with relatively high standards of living, and the relationship is causal. The question is then what causes income inequality, and can it be influenced without major distortions to the functioning of the economy. Ideally, productivity should determine one’s income. Productivity can however not be directly observed, while differences between supply and demand of labor may lead to unequal bargaining positions. Thus, market structure and government institutions have a major impact on the distribution of income. More formally, these are called the degree of economic freedom of a country. As an indicator, economic freedom is usually divided into five sub-indices, being size of government (consisting of government expenditures and fiscal policy), the quality of the legal system, sound money, free trade, and the degree of regulation of capital, labor, and credit markets. Of these sub-indices, tax policies and low regulation have a strong and very significant impact on income inequality. As suggested by Piketty (2014), a country’s tax structure has an important signal function regarding what kind of earning system and income distribution are acceptable to a society. In addition, government regulation of an economy strengthens the bargaining position of the weak and poor and offers them protection against abuse of power. In addition to its potential direct positive impact, this leads to more equal outcomes, strengthening both work and family relationships.

What does this mean for relational thinking? While a lot of things can be left to the responsibility of local communities, sound macroeconomic structures are essential to contain income inequality, strengthening these communities and supporting healthy relationships. Thus, how paradoxical it may sound, ‘big government’ is not always such a bad idea!

Bjorn Lous is a second-year PhD-student at Tilburg University, studying the relationship between economic freedom, income inequality and life satisfaction.

24 Mar

The Toughest Testing Ground – Relational Risk and Peace

Peace

War zones and regions of inter-community tension and civic unrest are, almost by definition, high in Relational Risk. But how does Relational Risk help us not only understand instability but also find solutions in places like Ireland?

Watch below to see Pádraig Ó Tuama speak powerfully on relationships and peace. Pádraig is the Corrymeela Community leader and brings interests in poetry, language, theology and conflict to his work. You can find out more about Pádraig here.

Image: Peace (By Tessi on Flickr)

17 Mar

Debating India

Debating India

The Following is a review, written by Prabhu Guptara, of Debating India, by Bhikhu Parekh, (Oxford University Press, 2015, ISBN:  0-19-806045-9).

Relational themes are touched by most of the twelve essays in this outstanding book by a distinguished scholar who is now Emeritus Professor of Political Science at the University of Westminster as well as Emeritus Professor at the University of Hull, a Member of the House of Lords, and one of the Relational Thinking Network’s own Patrons.

However, three of the essays focus exclusively on relational themes.

First, Parekh’s imaginary debate between Osama bin Laden and Gandhi, conducted through correspondence:  The initial letter by bin Laden is couched in terms of an appeal to Gandhi to support bin Laden’s cause, putting forward the case for bin Laden’s approach to Islamic Jihad.  Interestingly, bin Laden comes across as someone who is neither mad nor murderous – nor an irrational person “devoid of decency and good sense, with whom no dialogue is possible”.  Gandhi responds fully and frankly.  Osama bin Laden’s retort is again responded to by Gandhi.

Though there are only two letters here from each of them, the upshot is to persuade readers that genuine dialogue is possible even between such diametrically opposed parties and traditions of thought, if each party practices, in the dialogue, what we in the Relational Thinking movement call “parity” – that is, if each appreciates what they accept as valid in the other point of view, and responds honestly.  Gandhi, for instance, accepts bin Laden’s critique of the contemporary West, but unhesitatingly puts forward the view that bin Laden attacks European imperialism “not because you are against imperialism but because (European imperialism) ended Muslim imperialism, and you attack Americans because they are preventing you from reviving (Muslim imperialism).   An imperialist yourself, your attacks on the imperialist designs of others sound hollow and hypocritical and convince no one”.  Moreover, Gandhi’s offers to bin Laden the seminal thought that he has “no patience, no plan of social and religious regeneration, no desire to deal with the deeper causes of (Muslim) social decay”.

Parekh concludes the imagined correspondence between the two by observing that it “is easy to imagine…how their dialogue would proceed.  Deep and irresoluble differences between them would remain in several areas.  (However, dialogue) with the likes of bin Laden is both possible and necessary…. (Such dialogue) can do much to improve mutual understanding, resolve some differences, build trust, and detoxicate the intellectual and political climate so necessary for the ordinary political processes to operate”.

Parekh’s point is relevant not just to the tensions and violence between Islamic militants and the West, but also to the internecine struggles between fanatical Islamists and ordinary Muslims, as well as between fanatical Hindutvans and normal Hindus in India.

Whether, at the end of the day, dialogue with people such as bin Laden will result in any reduction of violence on their part is not clear. I wonder whether Gandhi’s two attempts at dialogue with Hitler failed because Hitler lacked Indian traditions of debate?  Or would such attempts at dialogue have succeeded if they had been undertaken much earlier in Hitler’s career?  Perhaps “dialogue” alone is too thin for such purposes, as it succeeds in providing, at best, what we Relationists call “directness”; and that needs to be enriched by increased “commonality” and “multiplexity” – a process that was enabled by systematic and wide-ranging research, in the Newick Park Initiative (http://www.jubilee-centre.org/history-newick-park-initiative-jeremy-ive) which is what succeeded in defusing at least some of the potential violence surrounding the end of apartheid in South Africa.

Second, Parekh’s essay “Friendship in classical Indian thought”:  he points out that the conditions in which friendships can arise and flourish “do not obtain in all societies, and hence friendship is not a universal phenomenon”.  So the essay asks whether “Indian thinkers identified a form of relationship broadly analogous to that of friendship as we generally understand it” and, if so, “how they analysed its nature and structure, and what value they placed on it”.

He picks, for particular examination, the two great epics, the Mahabharata and the Ramayana. Taking his orientation from the contrast between anthropocentric/ theocentric views of the world dominant in the West, and the cosmocentric view of most Indian thinkers, he writes: “For (Indians), the natural world was an internally articulated and ordered whole whose constituents were all its ‘co-tenants’ enjoying the right to exist and avail themselves of its resources.  Human beings therefore had a duty of friendliness and goodwill towards each other as well as other orders of being” – meaning flora and fauna.

The question that arises is how this philosophy of universal goodwill produced something as oppressive and inhuman as the caste system and, even today, does not see the contradiction between universal goodwill and casteism.  Not only that, this philosophy of universal goodwill seems to have taken little interest in even attempting to seek any explanation for the rise of the contradiction, or for the existence of that contradiction for centuries.

Is it possible that ‘universal goodwill’ functions, then, as a comforter, which distracts from recognition of the reality of the ‘universal ill-will’ that is maintained by the caste system?

In any case, Parekh concludes that, for classical Indian thought, friendship “is one of the noblest of human relationships offering joy, love, security, and all else that makes human life rich and full”; that while Indian traditions are “rich in … detailed exploration of the different forms and dilemmas of friendship…it is poorly theorized” by Indian traditions; that Indian traditions do not “give as much importance to the bonding of heads as to that of hearts; that, in Indian thought, “friendship does not seem to play the kind of epistemological role that it does in some other traditions”; and that it is surprising that “there has so far been no systematic study” of Indian traditions regarding friendship.

That is indeed surprising, since my own childhood experiences of friendships in India contrast so much with friendships that I see among my children in the West.  For example, Indian friendships are in the nature of an emotional contract which cannot gradually slacken and starve, but can only be broken with a rather sharp gesture accompanied by verbal statement to that effect.  At least in Punjabi, there is even a word (“kutti”) for the breaking of a friendship.

Third, the essay on “Ambedkar and the Pursuit of Fraternity”:  Ambedkar is best known as the Father of the Indian Constitution, through which he tried to institutionalise the pursuit of equality and fraternity in India. The Huguenot ideals of “liberty, equality, and fraternity” (later kidnapped by the French Revolution) are well known throughout the world, and it is worthwhile reflecting briefly on the similarities and differences between these notions and some of those that are essential to Relational Thinking.

“Liberty” does not loom large in the Relational Thinking vocabulary, primarily because in the Relationist view, liberty needs to be balanced by responsibility, and contemporary culture overemphasises liberty; by contrast, we Relationists probably under-emphasise liberty in our effort to bring responsibility back into some semblance of balance.

Incidentally, the notion of liberty by itself did not mean much to Ambedkar either. In his view, “liberty” needed to be grasped as two different entities: “political independence” (e.g. from the British, which is what Gandhi and the rest of the Indian elite were obsessed with); and “social liberation” (from caste-based oppression, from which the vast majority of India’s population still suffer) which was Ambedkar’s focus.

From those brief remarks on “liberty”, let me move on to “equality” – which is a legal notion, to do with one’s relative status in the eyes of the law.  That contrasts with the Relational concept of “parity”, which is an inter-personal dynamic, to do with each party’s use of power to enable the best win-win environment for both parties.

Further, if we move on to the notion of “fraternity”, could it not be argued that that is rather like “good relationship”?  Well, “fraternity” is an inspiring vision or goal which remains rather abstract, unless fleshed out by detailed thinking covering many areas of life, society, economics and politics – of the kind that is provided by Relational Thinking.

Now, to the gist of Ambedkar’s work towards these goals or values, which Parekh puts well:

Unlike classical Indian thinkers, Ambedkar did ask why Hindus never protested against or even felt embarrassed by the practice of untouchability.  In his view, it was primarily because of their commitment to the doctrine of karma with its concomitant belief that one’s situation in this life is due to one’s sins or virtues in previous lives.

Such beliefs are also why India lacks what Ambedkar called a “public conscience” or “public spirit”.

So much is this the case that “Hindu society” cannot exist, because there can be no “society” in the absence of shared sympathies: “In India people are treated with contempt, yet it does not sicken an Indian with disgust, rouse his sense of justice and fair play, … his humanity does not rise in protest at what is going on around him” as Ambedkar himself put it or, as Parekh puts it: “Being entrenched within a way of thinking that reduce(s) human beings to their membership of particular castes, Hindus could not see untouchables as human beings like them, let alone as fellow members of a shared community.  Not surprisingly, they rarely took interest in, let alone campaigned against their degrading and inhuman status”.

For Ambedkar, eradication of untouchability “involved nothing less than a social revolution, a radical restructuring of the very foundations of Hindu society….(through) relentless struggle, an uncompromising, determined, organized … movement by untouchables with a view to acquiring political power, the key to all social progress”.

Since Ambedkar failed to achieve this, and failed even to create a political party of any longevity, he focused on “using the institutions of the state to create an egalitarian and casteless society”.  Ambedkar knew that this was not going to be easy, “because of a deep tension at the very heart of the Indian polity”.  The Constitution, framed principally by Ambedkar, committed India to the great ideals of liberty, equality and fraternity, but these are largely absent in its daily life.  As a result, state and society pull in opposite directions.

That contradiction could only be resolved, in Ambedkar’s view, by “the state dominating and systematically shaping society in the desired direction.  Since the objectives of the state are alien to Indian society, they could only be realized if the state was led by a determined Westernized elite.  If the state became a hostage to society as was the case for centuries in premodern India, or was led by men and women with no commitment to these objectives as in colonial India, Ambedkar saw no hope for the country”.   Parekh expresses no clear view regarding whether Narendra Modi’s election as Prime Minister portends the capture of the state by a party with no commitment to the values of the Indian Constitution – and therefore whether the Indian State is at present hostage to traditional Indian society.  Perhaps the manuscript of the book was sent to the press well before the shape of the actions of the current government became clear.

To return to Ambedkar’s strategy: the question raised by it is whether fraternity can ever be an institutional objective, let alone an institutional achievement.  He saw, of course, that fraternity was impossible without equality, and so he lowered his sights to using the Constitution and related legislative mechanisms to achieve at least political equality, without which social equality and fraternity have no hope of emerging.

The question Parekh does not ask is:  why did Ambedkar fail to rouse the majority of the country to exert themselves to achieve the self-evidently beneficial goals of fraternity and equality?  Could it be that emotional appeals successfully inspire those who are emotionally-inclined so that they are prepared to make enormous sacrifices?  However, for those who are inclined to be less emotional, such appeals to overarching goals need to be supplemented with a comprehensive programme consisting nevertheless of actions of varying shapes and sizes to suit people in different circumstances (a programme such as is developed by the Relational Thinking movement)?

In any case, as Parekh points out “the idea of fraternity is neglected in much of modern, especially liberal, political theory”.  He lays out and assesses Ambedkar’s signal contributions to that, as well as his enormous contributions to the making of modern India.

I wish I had the time and space to explore here the rest of essays in this collection, which are on other fascinating themes such as the choice of the National Symbols of India, the debates between Gandhi and Tagore, Einstein on Gandhi’s non-violence, Gandhi and inter-religious dialogue, the unfortunate narrowing of the perception of Gandhi’s philosophy to non-violence, the question of India’s National Philosophy, and reflections on the successes and failures of democratic politics in India.  Each of these has relational resonances.  I’m sure the Relational Thinking Network would welcome wider discussion and debate not only about the matters I have raised in this review, but also about other matters in Lord Parekh’s richly multifaceted book.

Prabhu Guptara is an executive member of the board of Relational Analytics.