Published on February 23, 2014
Whose Risk Counts? And how academics could be a bigger part of the solution Dr Raj Thamotheram CEO, Preventable Surprises Visiting Fellow, Smith School, Oxford University Canterbury Christ Church University 19th February 2014
Pension members are getting a raw deal! • Dutch/Danish young person can expect a pension which is at least 50% higher than a British young person would get. (Tomorrow’s Investor Project, RSA) Thanks to Heather Hachigan
Not transparent & big questions about value for money
Economies are becoming more dysfunctional CFOs will trade off practically everything to protect the quarterly number More bubbles, more damaging Kay Review: investors are driving corporate short-termism McKinsey & Co and CPPIB: “short-termism is undermining the ability of companies to invest and grow, and those missed investment, in term have far-reaching consequences, including slower GDP growth, higher unemployment, and lower return on investment for savers.”
The Eco-Resources Crunch 7
The Great Disruption s “The hallmarks of tomorrow’s world will be scarcity – of land, oil, food and ‘air-space’ (for greenhouse gases)” US NIC, 2008 The ‘Perfect Storm’ (UK Government Chief Scientist, John Beddington, 2009) [Climate change risk] “should compel all elected leaders to take immediate action” Mayor Bloomberg, 2012
“Why the World Faces Climate Chaos”
Back to the Future = Exploding Inequality & Extremism “A hungry man is an angry man” Bob Marley http://www.guardian.co.uk/world/2013/apr/01/greece-golden-dawn-globalambitions (0:00 – 1:05)
The Key Question! WHY AREN’T WE RESPONDING? “the crisis is in implementation” Kofi Annan (2002)
How Are We Doing – Views From The Frontline Accenture http://www.guardian.co.uk/sustainable-business/video/ peter-lacy-business-strategy-sustainable-investmentsystemic-change?INTCMP=ILCNETTXT3486 (0:35 – 3:30) Unilever http://www.reversethefuture.org/discussions/47/resourceefficiency-shareholder-value/ (25:20 – 26:57) 12
Investors = 1° enablers of dysfunction behaviour Investors are more important than even regulators in shaping directors’ priorities. PwC, Annual Director Survey 2010 “[…] 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.” John GRAHAM, Campbell HARVEY & Shiva RAJGOPAL “Value destruction and financial reporting decisions”, Financial Analysts Journal, Vol 62 No 6, 2006 “Investors don’t care about Sustainability” Business Week, 9th Nov 2010 (Global Compact / Accenture survey)
Processes & Reporting Aren’t Delivering Outcomes! Thanks to Inflection Point Capital Management
Five (Financial Sector) Patient Categories Happy Imbeciles Suppor2ve Pessimists Denialists Market Eﬃciency Fundamentalists Sustainability Smooth Talkers
11 fatalities 17 injuries Latest BP cost estimate $40 billion 30% share price drop 1-year suspension of dividends
“The Dominant Narrative” – the BP version “an Act of God” Rick Perry, Governor of Texas “I left BP a long time ago, four years” Lord Browne "It's very dangerous to join up dots that may not be appropriate to join up" Tony Hayward
The dots we shouldn’t join up… Azerbaijan Gas leak Thunder Horse Accident Texas Refinery Accident “ Alaska Oil Spill Charges for Manipulation Of gas market Gulf of Mexico Oil spill Violations Of Clean Water Act Texas Refinery Accident Penalties From the OSHA Source: Yahoofinance.com Up until April 19 [ie the day before the Deepwater Horizon explosion], his [BP’s] performance was An investor close to BP quoted by The Financial Times, July excellent. 25th 2010 “ Grangemouth 2000
How much attention did “sell-side” pay to safety? Before the oil spill, 6 occurrences every 100 pages = the vast majority of reports do not talk about these risks at all.
“Analysts are biased” Analysts claim that BP has a good operational momentum because of its “firstmover advantage in cost cutting” 5 = buy or strong buy recommendations 4 = add, overweight, outperform and accumulate 3 = hold, perform, neutral 2 = reduce, underweight and underperform 1 = sell or strong sell Source: SHEFRIN Hersh, CERVELLATI Enrico Maria, “BP’s failure to debias: underscoring the importance of behavioral corporate finance”, 21st February 2011
Are asset owners & “buy-side” much better? Sadly, no! Only 60% of capital voted at BP’s 2010 AGM 57% of votes in favour of chair of safety committee! (Only leaving in 2012!) Even proxy voting agencies recommended abstain (ISS) or vote against (Glass Lewis) Source: BP plc, ISS ProxyExchange
Today’s ESG Doesn’t Address “Preventable Surprises” Narrow Conception of risk Weak concern for negative externalities Outdated approach To safety Focus on riskier and dirtier O&G SYSTEM O&G SECTOR Ineffective regulation Regulatory capture Shareholder value fundamentalism M&A and Outsourcing/SCM BP Saviour CEO Weak safety culture Organisational Learning disabilities Leadership & Governance failures
Screening vs Stewardship – the Balance is Wrong! What is it RI? Integration Stewardship Incorporate ESG analysis into investment decisions Investing Responsibly & Sustainably Monitor, Vote & Engage to promote LT success 24
Research Governance Corporate and Practice Failures Galore! 25 Copyright © 2011 Richard Leblanc. Copyright © Richard Leblanc. All rights reserved. All rights reserved.
An Overly Intermediated System Companies Deals Pensions Fees Mandate + contribu2ons Informa2on Pension Funds Sell-‐side Analysts Informa2on Fees Advise Investment Consultants Returns Investment Banks Brokering Informa2on Informa2on Mandate + fees Selec2on Investment Managers Fees
Momentum Investing is Out of Control! “The bulk of incremental financial activity is trading, and trading, while it may provide a little useful public information about market opinion, is largely a way to transfer wealth from those with inferior information and calculation ability to those with more. There is no enhancement of economic efficiency to speak of.” Robert Solow, the Nobel prize winner and an MIT Emeritus Professor Sunday Times, May 6, 2012
Majority of Investors Have No Reason To Care! Intrinsic investors Mechanical investors Traders Deep understanding of strategy/sector Mathematical formulae (incl index & closet index) Bet against market with regards to news More like to support management thru ST volatility Supporting or not supporting management isn't part of their reality Interested in earlier access to better news 20% of market 30% 35% 4-10 positions 100-150 positions 20 positions 28 Adapted from McKinsey & Co
Incremental Progress vs. Fundamental Change
What academics should avoid doing! • Frederic Mishkin, Professor, Columbia Business School http://www.youtube.com/watch? v=8lHvTKzfu8Q&feature=player_embedded#t=0s • Glenn Hubbard, Dean Columbia Business School http://www.youtube.com/watch?v=CaXNqGgIcg&feature=player_detailpage#t=6s
But Good Guys Can Also Mess Up!
Be Brave! (Jeremy Grantham) “Scientists are understandably protective of the dignity of science and are horrified by publicity and overstatement.”
Challenge Convention (Alice Stewart) “Pioneering woman scientist whose research into the dangers of x-rays and nuclear radiation shook the Establishment” (GUARDIAN OBITUARY) "We have already doubled the level of background radiation today. What is the effect on human genes? That is the really important question: it won't show up for two or three more generations.”
Approx. right vs precisely irrelevant! (Anat Admati) http://www.preventablesurprises.com/ Some take-aways: • Avoid paralysis by analysis • Be approximately right, not precisely irrelevant • Manage one’s own anxiety about peer criticism
“Bridge the Gap!” (Campbell Harvey) “Often academics don’t know the important problems facing industry” Survey methodology to bridge the gap Disguised the real question Big impact – earnings management isn't primarily by accounting but rather by cutting budgets 1900 Google cites (2006 paper)
Look where the keys were lost, not where there is light • Analysis of PRI Academic Network 66 papers from academics past two conferences (2011 and 2012) • 1 of the 66 papers focus on the ‘gatekeepers’ of information (sell side, credit ratings, investment consultants). • 15 of 66 address systemic problems (behavioural, cultural and institutional) • 7 of the 66 papers address public policy • What is getting attention? Doing well and doing good- that is, how integrating ESG can lead to better financial performance, using the same old models. • E=G>S • Fundamental investors > Index Investors • Stock picking/valuation > Stewardship Thanks to Heather Hachigan
Thank you for listening! “Homo Financialus”
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