The former Bank of England economist on governance
In recent polling, YouGov asked the public how much, if at all, they trust the finance industry to look after their money. Nearly 70 per cent answered “not much” or “not at all”. Only 2 per cent replied “a great deal”.
Confidence in the financial system has drained away. But capitalism is the most powerful force for prosperity ever invented.
So how can we restore trust after the behaviour by the so-called Masters of the Universe – the greed, recklessness, and irrationality – when finance became a world dominated by skewed incentives, optimism bias, short-termism, the herding of the crowd, the power of social norms and loss aversion.
Free market capitalism can only work effectively if it enjoys public trust. That trust is only maintained if the finance industry – the symbol of capitalism – shows it is founded on integrity. But in recent times, banking has profited in a moral vacuum.
Takeovers rarely add value, yet shareholders very rarely vote down management proposals
In the wake of the 2008 crisis, there has been endless analysis of the economics behind the crash. But this has largely ignored one fundamental aspect: the role of human behaviour and culture in causing the crisis. How banks, businesses and economies behave is determined by human nature, with all its irrational quirks, as much as it is by structure and regulation.
With public trust at such a low, a more responsible, ethical and trustworthy financial industry is vital. And this can only be achieved through a change in culture.
A daunting challenge.
Tougher at the top?
The first place to tackle this culture is at the top. Leadership matters in finance as much as in any other area of life, to shape the boundaries of acceptable behaviour.
Such cultural boundaries can provide an important bulwark against some of the extremes that we have seen. Accordingly, the rules of corporate governance can be used to strengthen a culture of responsibility, and shape incentives.
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Evidence and anecdote suggest that the cult of personality and the composition of boards leave little opportunity for challenge. Takeovers rarely add value, yet shareholders very rarely vote down management proposals. Meanwhile the board have a monopoly over information and rarely have to work to justify their decisions.
In other areas of life, this problem is addressed by a public protagonist, who on behalf of society challenges proposals and tests arguments. In the House of Commons we have an official opposition to challenge government, with a leader paid a cabinet minister’s salary and given a research budget. Professional or employment tribunals provide a voice for each side of the argument. In criminal law, public prosecutors make the case and others try to undermine it.
As a stronger barrier to the more extreme behaviour, more acts of gross negligence should be treated as imprisonable offences
Given the recent crisis, the public should have a representative to improve corporate governance. A public protagonist could have the authority to convene special shareholder meetings on behalf of the public, and publicly test a course of action contemplated by the management.
The management would of course remain under their obligation to shareholders, but shareholders would now hear both sides of any argument. Faced with this challenge, and with their monopoly on the supply of information to shareholders broken, a culture of challenge would be strengthened and the senior executive would be forced to consider their options more carefully.
No more fear of failure
Along with a public protagonist, we need to see an end to the immunity which seems to surround the senior management of failed banks. The failure of big banks infects the whole economy. But no senior banker in the UK has been brought to trial for authorising the decisions which caused the credit crunch. Regulators’ investigations of the crash found that since no rules were broken, no action should be taken.
As a stronger barrier to the more extreme behaviour, more acts of gross negligence should be treated as imprisonable offences. Even the threat of prison as a result of some of the more egregious acts of greed would help change the culture of finance.
If a bank is forced to come to the government for a bailout, its board should be treated as having let it go bankrupt and face the consequences for directors of bankrupt companies
We also need non-executive directors to treat their positions less like a pension plan and more like a job. The task of being a non-executive director must be more onerous, with the number of directorships that one person can hold capped.
In other professions, those in a position of trust are held accountable for their actions. If doctors are found guilty of serious malpractice then they are struck off the medical register. Would anyone suggest that this system of punishing professional failure has resulted in the mass exodus of Britain’s best medical talent?
The boards of systemically important financial institutions are placed in a similar position of social responsibility. If we want them to behave like professionals they must be treated as such.
Accordingly, if a bank is forced to come to the government for a bailout, its board should be treated as having let it go bankrupt and face the consequences for directors of bankrupt companies.
Cultural change is an ambitious goal, but these policies, enforced together, would begin to imbue a new culture of challenge and fear of failure at the top of the banks.
Crucially, they would also send a strong message to the public that lessons have been learnt from the 2008 crisis, in a first step to restoring the public trust that the financial sector ultimately needs to be able to thrive.
Matthew Hancock, Conservative MP for West Suffolk, is a former economist with the Bank of England and former chief of staff for George Osborne. He studied PPE at Oxford University and has a masters in economics from Cambridge University. Earlier this month he published an analysis of how to reform Britain’s banks, Masters of Nothing.