We are entering an era of investor activism. There are at least three broad shifts that will compel investors to enter the market as more than merely consumers.
First, the failure of free markets to live up to claims made on their behalf. Milton Friedman and his mentor Freidrich Hayek told us that the market was free and fully rational. It turned out to be neither. The debacles of Russia and Argentina showed the folly of the first claim. Long tails and speculative bubbles put paid to the second.
Second, the growing realisation that central control cannot keep the City in check. Freidman and Hayek were right about this. Regulation, the product of a few bounded rationalities, can never out-perform the multiple mind of the market.
This second point is relevant to the current political situation. As the fall-out from the sub-prime affair continues, we are bound to get more and more calls for regulation. This is not necessarily a bad thing. Some regulation can be beneficial. But we would be kidding ourselves if we believed that regulation was the final answer.
The City is the very crucible of innovation. The men and women there, incentivised to create, will always be one step ahead of the regulators. As Michael Lewis describes in his book Liar’s Poker, mortgages were first packaged up and sold as bonds by a trader at Salomon Brothers, looking to steal a march on his rivals. It was a minor innovation that became a way of doing business. An army of independent watchdogs could not have stopped it.
The third reason for the rise in investor activism I pointed out yesterday. It is the catalogue of mismanagement attributable to that once-storied British institution, the joint stock company.
What does the rise of investor activism mean for companies?
In his recent RSA lecture, marking the launch of our project Tomorrow’s Investor, David Pitt-Watson heralded the arrival of the new regime.
Companies, however, can be excused if they are not so sanguine. They need to distinguish between engaged activist investors, who may tell them uncomfortable truths they don't want to hear but have the long-term interests of the company at heart, and 'drive-by activists', who may whisper seductive tales of optimising shareholder value but whose real interest is in extracting cash from the company now, even if that leaves it debilitated and unable to cope with tough times in the future.
Investor activism can also be tricky ethically. Hugh Fearnley-Whittingstall’s attempt to improve the lives of Tesco chickens, for example, splits people down the middle. We discussed this at the Tomorrow’s Investor deliberative forum; about half the participants supported the “rights” of chickens, half the “right” to cheap food. There are no easy answers on ethical questions.
One way to get around - or at least ameliorate - this issue is to have broad participation from across the population. Then, hopefully, companies will behave in the interest of the many, rather than the few.
This more general citizen activism is what we are currently investigating in our Tomorrow’s Investor project. Check out the web page for more details.