A book to be published shortly by two participants in the Network for Sustainable Financial Markets (NSFM) – Raj Thamotheram and Maxime Le Floc’h – compares the BP Gulf of Mexico spill and Fukushima nuclear events and highlights the important role that institutional investors could play with regards to these events. Their diagnosis includes systemic disorders of regulatory failure, organisational learning disabilities, an immature conception of risk, weak leadership and anemic concern for negative externalities. Their focus on industrial catastrophes is timely, given that leading experts – Nassim Taleb and Charles Perrow included – believe such events are becoming more frequent and more serious as a result of the growing complexity of operations and concentration of economic and other power within corporations today. But important as they are, such catastrophes are, arguably, only the visible tip of an iceberg of value destruction, with much of the damage being “under the water line”. Duke University economists who studied CFO decision-making in response to the pressure to deliver on the quarterly number concluded that: “[…] the destruction of shareholder value through legal means is pervasive, perhaps even a routine way of doing business. Indeed we assert that the amount of value destroyed by companies striving to hit earning targets exceeds the value lost in these high-profile fraud cases.” Even prominent critics of corporate behaviour have questioned whether shareholders are “part of the solution or part of the problem.” One way that shareholders contribute to value destruction is through narrow analytical frameworks and fundamentalist shareholder value assumptions. For example, it is well known within the industry that thereis a big gap between what happens in the mainstream research supply chain and what long-term investors, leave aside what responsible ones, really need. Leading behavioural finance specialists show that sell side analysts systematically missed the importance of safety culture in their analysis of BP. And other links in the investment chain have also shown themselves unable to make an adequate response. For example, 57% of investors expressed confidence with the chair of BP’s safety committee when major proxy voting agencies recommended either an abstention (ISS) or a vote against (Glass Lewis). The silver lining in BP’s case is that it is a company which nearly all large investors own, both mainstream funds and even specialist SRI funds. In addition, safety is a first generation ESG issue. There is no question of it being a “soft” or hard to manage issue. Analysts following BP have been repeatedly placed on alert as a result of the company’s poor safety track record and had been warned that mortality figures were no use as indicators of process safety. Put simply, all the usual excuses for not integrating ESG into mainstream analysis and governance processes did not, and do not, apply to BP. If stronger evidence were needed that all is not well, it is hard to imagine what that would be. This failure of investment research to take account of risks has been well documented. For example, academics reported that UK financial sectors analysts failed to even read the corporate governance sections of annual reports because “the governance of UK banking was generally trusted”. And IBM is reported to have concluded that sell side research, credit rating agencies and hedge funds are collectively responsible for destroying $459bn per year due to the inaccuracy of much of the analysis delivered.
The key investment industry challenge is not a technical one. It is simply a leadership issue relating to supply chain management. Interestingly, this leadership challenge is very similar to mainstreaming good safety practices down the contractor chain of high impact sectors. If investors want to see this happen at companies like BP and Tepco, shouldn’t they walk the talk in their own sphere of control and influence? So what do the authors propose as the treatment plan for this systemic disorder? They list 7 actions for “getting off the path that leads to preventable surprises.” The prescription: better metrics (“putting a greater emphasis on lead indicators”); improved internal and external reporting (“to make this information accessible to top management and investors”); better supply chain management (for “safety integration and oversight of contractors”); more attention to employees (“through ombudsman and whistle blowing systems”); and enlightened leadership (to “send a clear and consistent message from the top that safety matters”), which “inturn depends on better regulation” and “more transparency over companies’ political activities.” Underpinning it all is a commitment to better investing.
They argue that institutional investors need to become a bigger part of the solution by placing more “emphasis on safety and other material environmental, social and governance issues,” as well as “lengthening their investment horizon and acting as owners.” They acknowledge these are not new insights but observe that “common sense does not automatically translate into common practice”. The authors make a valuable point that is worth repeating: “The global financial crisis had already shown that lessons learned from the dot.com bubble and Enron were not put into practice to any great extent. It is important we do not ignore the lessons of the Gulf of Mexico and Fukushima.”
Link to NSFM