Thomas Macaulay observed that “Free trade, one of the greatest blessings which a government can confer on a people, is in almost every country unpopular.”. There is plenty of evidence to support this assertion but the reason for public hostility is less clear. What is it that impacts public opinion about trade and why is it not better liked?

Diana Mutz, Professor of Political Science and Communications at the University of Pennsylvania, has spent a number of years researching these questions in the United States and, in Winners and Losers: The psychology of foreign trade, she summarises the results of her research, considers the evidence of other researchers, draws conclusions and reflects upon their implications. She says that her “central purpose … is to bridge a gap in our understanding of the causes and consequences of American attitudes toward international trade” (page 15).

The result is both fascinating and important. All those who believe in the merits of free trade and wish to see it widely pursued by democratic countries should read what Mutz has to say.

She begins with three basic propositions, each of which she successfully justifies. First, “for most Americans, globalization is something happening ‘out there’, away from their everyday lives” (page 2). Secondly, unsurprisingly, most Americans are largely unaware of the economic arguments for and against free trade. As Mutz puts it, “few wax poetic about the wonders of the invisible hand, the efficiency of market specialization, or even the lower cost of consumer goods” (page 3). Thirdly, despite their profound ignorance, people do nonetheless hold opinions about international trade, holding “alternative, lay theories about how international trade works” (page 3).

Many economists have asserted that these home-spun theories are based on the self-interest and Milton Friedman asserted that “Complete free trade is not politically feasible … because it is only in the general interest and in no-one’s special interest”. Mutz’s research, however, provides little support for this. Instead, she suggests that public opinion is based upon sociotropic factors or what, more bluntly, might be called unsophisticated nationalism.

Mutz observes that trade is often seen in terms of competition rather than cooperation and American attitudes to trade are determined to a considerable extent by whether or not it is expected that America will be the “winner”. Furthermore, many people perceive trade as a zero sum game in relation to job gains and losses and, when coupled with uncertainty as to whether America will be the “winner”, this perception can produce highly negative attitudes to it.

Mutz suggests that people’s reasoning in relation to trade is similar to their reasoning in relation to human relationships at a personal level: “People trust people who look more like them” (page 101) and people are influenced by things as basic as who they like and who they do not like. Hence, in a survey conducted by Mutz, those who, in answer to a request to name the US’s three largest trading partners forgot Canada were less likely to support international trade than those who remembered Canada, whilst those who forgot China were more likely to support trade than those who remembered it.

Unfortunately, all of the attitudes that lead to a negative view of trade receive regular reinforcement. Mutz’s survey of references to trade in major US newspapers between 2000 and 2018 indicates that the vast majority of such references viewed trade as competition rather than cooperation; her survey of references to job losses in major US newspapers over the same period indicates that trade is frequently blamed for losses, whilst automation is very rarely blamed despite most economists believing that this is the primary cause of US manufacturing job loss; the idea of trade being a zero sum game is reinforced by concepts such as “trade deficits” and even “fair trade” (which sound, to the uninitiated, as though a fixed sized pie is being unevenly divided); and news stories reporting the benefits of free trade generally support their narrative with graphs and other impersonal material whilst those opposing it show pictures of forlorn American workers who have lost their jobs, which naturally have a bigger emotional impact. More fundamentally, Mutz points to the simplicity of the claims made by those who oppose free trade (primarily relating to job losses) in comparison to the complexity of the arguments in favour of free trade.

Mutz provides copious evidence that, overall, supports her theories. However, the book is not without flaw. Some of the numerous graphs and charts are not well labelled and space limitations have resulted in Mutz cross referring to a significant amount of online material. Readers also need to be on their guard since a number of the graphs are not based to zero, which results in differences being exaggerated (the graphs on page 127 relating to racial differences being particularly egregious examples of this). Furthermore, some of the research results, whilst statistically significant, do not suggest huge differences among different categories of people and Mutz may on occasions be guilty of over-interpreting them.

Mutz is clearly highly pro trade and moderately to the left of centre in her political views. She does not disguise her distaste for some of those who take a different view and, unfortunately, this may have distorted some of her conclusions. For example, she appears to believe that those who are pro trade are more rational than those who oppose it but this does not seem consistent with her own evidence. Thus, she comments that “protectionist attitudes in the US are driven largely by non-economic, symbolic beliefs” (page 241) apparently forgetting that the same appears to be true of attitudes that favour free trade. She also appears reluctant to acknowledge that some non-economic arguments relating to trade may be rational and reasonable. For example, no matter how pro free trade one might be, it is hard to disagree that there are downsides in trading with countries governed by authoritarian regimes and thus the apparent implication in Mutz’s comments that logical and reasonable people should favour trade with China as much as they favour trade with Canada is surely misplaced.

Mutz recognises that her findings are limited to the USA and her evidence from Canada suggests that they may not apply elsewhere. Nonetheless, the findings present those who favour free trade with a challenge: what are we to do about this? Mutz makes a number of reasonable suggestions: efforts should be made to make people realise that most job losses are not caused by trade but by automation; we need to make efforts to enable people to understand trade in terms of cooperation and to realise that it is not a zero sum game; and we need to build on the finding that the vast majority of Americans believe that trade is good for relationships with other countries. However, these suggestions are vague and do not relate closely to all of the issues that Mutz identifies.

In particular, she fails to focus adequately on her recognition that many influences on people’s attitude to free trade “pale in comparison to the impact of prospective financial concern” (page 225). The more insecure that people feel, the more they “hunker down” and one suspects that negative attitudes to trade in the USA are to a significant extent a reflection of a loss of national self-confidence and feelings of insecurity. In The Wolf at the Door, Michael Graetz and Ian Shapiro suggest that addressing this is the most important domestic challenge faced by America and it may be that, if it were adequately addressed, support for free trade would materially increase.

That said, Diana Mutz has done a great service to those who favour free trade by clarifying the causes of opposition to it. It is now up to others to work out how best to apply the implications of her research in influencing both politicians and public opinion.

“Winners and Losers” by Diana C. Mutz was published in 2021 by Princeton University Press (ISBN 978-0-691-20302-7). 275pp plus notes and bibliography.

Richard Godden is a Lawyer and has been a Partner with Linklaters for over 25 years during which time he has advised on a wide range of transactions and issues in various parts of the world. 

Richard’s experience includes his time as Secretary at the UK Takeover Panel and a secondment to Linklaters’ Hong Kong office. He also served as Global Head of Client Sectors, responsible for Linklaters’ industry sector groups, and was a member of the Global Executive Committee.

Management as a Calling is aimed primarily at business students but it has far wider relevance.  Andrew Hoffman says that he wants “to personally challenge every business student, every business executive, and every business school professor to think about the system in which students are beginning their careers and to push back when it is steering them away from their calling” (page 18).

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Hoffman is the Professor of Sustainable Enterprise at the University of Michigan Ross School of Business. His basic thesis is simple: there is a crisis in capitalism of which the symptoms are income inequality and climate change; governments have a role to play in providing solutions to the relevant issues but the leading role has to be played by business since “if there are no solutions coming from business, there will be no solutions” (page 4); treating the sustainability challenges as mainstream business issues and fitting them into the market as it exists will not provide solutions; what is needed is not incremental change but a radical change of values and culture involving future business leaders being taught “to consider management as a calling – one that moves away from the simple pursuit of a career for private personal gain and toward a vocation that is based on a higher and more internally derived set of values about leading commerce and serving society” (page 5); and this requires that we should be turning “to religion and philosophy as a way to augment the market in making this shift” (page 116).

At times, the book loses its business focus and cannot seem to decide whether it is about business management or about the best way to build a political and societal consensus that permits the tackling of climate change. Nonetheless, Hoffman pursues his theme with evangelistic fervour, concluding with an alter call: “You, the next generation of business leaders, have been born into this reality, and you have no choice but to respond. You did not choose this reality but you must embrace it. The nobility of your lives will be determined by how you respond to the challenges you face” (page 138). This is an inspiring message but as a rule evangelists have weaknesses as well as strengths and Hoffman is no exception to the rule.

On the negative side, some of his attacks target Aunt Sallies. For example, he points to the growth in the Stock Market in recent years as evidence that share values are divorced from underlying economic reality and he dismisses Gross Domestic Product growth as a measure of wellbeing or even a reliable measure of economic success, but few would dispute these things and they do not assist in proving his case. On occasions he is also guilty of overstatement or misrepresentation. For example, his linking of the Wells Fargo, Volkswagen and Sackler scandals with Adam Smith’s “invisible hand” does grave injustice to the sophistication of Smith’s economics, let alone his moral philosophy. Conversely, when advocating change, Hoffman is on occasions guilty of dubious logic (the most egregious example of which is his twice stated assertion that “Our problems are manmade – therefore, they can be solved by man”, page 118). Furthermore, his discussion of issues relating to inequality is very brief and superficial. Indeed, no issue is covered in great detail, the book being only 138 pages long.

Hoffman’s vision of the future is both vague and, by his own admission, Utopian. He asserts that “perpetual growth is not possible and its continued pursuit is self destructive”, quoting with approval Naomi Klein’s statement that we have to “come face to face with the hard truth that the conveniences of modern consumer capitalism [are] steadily eroding the habitability of the planet” (page 33): he calls on us to be radical and attacks those who believe that the solution lies in technology, such as electric cars. However, his positive suggestions sound surprising incremental rather than revolutionary. They even include the use of electric cars and, despite quoting Naomi Klein’s challenge, he never discusses in detail what we have to give to up to deal with the problem that he perceives and how our living standards will change in consequence of this.

Having said that, there is much that is commendable and thought provoking in the book. Hoffman does not pretend that he has all the answers, recognises the fact that we do not currently have the infrastructure to be ecologically neutral and criticizes over simplistic debate; he notes that “social media outrage” increasingly drives social discourse and laments that the resulting behaviours and emotional perspectives “are not conducive to the kind of tempered, thorough, and compromise seeking discourse that democratic government needs in order to function well” (page 61); he recognises that part of the reason why the public ignores scientists is because there are some within the scientific community who hold the public in low regard and others “who subscribe to a view of scientism that elevates the natural scientists in relation to all other ways of knowing the world around us” (page 75); he is also cautious about the role of so-called “activist CEOs” and recognises the danger that theoretical accountability to everyone in practice means accountability no-one (i.e. the danger that the effect of weakening accountability to shareholders will be precisely the reverse of the effect that its proponents desire); and, most importantly, he calls for business thinking to encompass more than growing the bottom line without regard to the means or consequences of doing so.

Hoffman’s aim is not to set out a road map to Utopia or to some less desirable but at least sustainable future. Instead, he wants to add new dimensions to the business debate, change mindsets and provoke productive discussion, starting in the business schools. He aims, in this way, to generate new business models that “begin to coalesce around a composite model that brings the full scope of market transformation into greater clarity” (page 39).

Readers of Management as a Calling may well disagree with a number of Hoffman’s assertions, particularly one or two of the more left-leaning of these but few will doubt the need for business discourse to encompass fundamental values as well as ethics in a narrower sense. Unlike Socialism, Capitalism does not, or at least should not, claim to be an all embracing philosophical, social and economic system.  It needs to be supplemented by well thought through values. Despite its failings, Management as a Calling is a valuable reassertion of this point and an important call to both existing and future business leaders to think more broadly about what they are seeking to achieve. It is well worth reading.

“Management as a Calling – Leading Business Serving Society” by Andrew J. Hoffman, was published in 2021 by Stanford University Press (ISBN – 13:9781503614802). 138pp.

Richard Godden is a Lawyer and has been a Partner with Linklaters for over 25 years during which time he has advised on a wide range of transactions and issues in various parts of the world. 

Richard’s experience includes his time as Secretary at the UK Takeover Panel and a secondment to Linklaters’ Hong Kong office. He also served as Global Head of Client Sectors, responsible for Linklaters’ industry sector groups, and was a member of the Global Executive Committee.

The Centre for Enterprise, Markets and Ethics (CEME) is pleased to announce the publication of Lessons from Family Business: Perspectives from Faith by Steven Morris.

A PDF copy can be found here. Alternatively, a hardcopy can be purchased by contacting CEME’s offices via email at: office@theceme.org

Colin Mayer is a distinguished professor at the University of Oxford, former dean of the Said Business School and a Fellow of the British Academy . Throughout his career one of his fields of interests has been the business corporation and at present he is director of the Academy’s research programme into the Future of the Corporation.

However neither the title nor sub-title of the book do justice to its contents. The book is nothing if not ambitious. In examining the business corporation the claim is that “it will take you across history, around the world, through philosophy and biology to business, law and economics, and finance to arrive at an understanding of where we have gone wrong, why, how we can put it right and what specifically we need to do about it”.

The remarkable fact is that I believe he has achieved his aim. The book is wide in scope, has considerable depth and is not superficial. It is well written, interesting to read and draws on a lifetime of research into different aspects of the business organisation.

The book is first a sustained and vigorous attack on Milton Friedman’s claim that the sole social responsibility of business is to increase its profits, subject however to doing so in open and free competitive markets, without deception or fraud, while conforming to the basic rules of the society embodied in law and custom. For Mayer the public have lost trust in business precisely because business has followed Friedman’s advice and put the interests of shareholders above other stakeholders.

In its place he proposes a total reinvention of the corporation. Corporate law should be changed so that each company is required to state its ultimate purpose over and above  profit, redefine the responsibilities of directors to deliver these new objectives, develop new measures by which they can be judged and introduce incentives to deliver them.

In exploring the purpose of business Mayer distinguishes between ‘making good’ (such as manufacturing cars, or electrical products) and ‘doing good’ (treating employees well, cleaning up the environment, enhancing the well-bring of communities). The latter has a social public-service element which goes beyond the private interests of the firm’s customers and investors, and even beyond section 172 of the 2006 UK companies Act, which already imposes duties on directors to take into account the interests of stakeholders other than shareholders.  As examples of successful and enlightened corporations he mentions with approval “industrial foundations” companies such as Bertelsmann, Bosch, Carlsberg, Tata and John Lewis which are set up as foundations or trusts.

While I admire his ability to explore different dimensions of the business in one book, I have serious problems with his argument.

First, the pursuit of long term profitability is essential if a company wishes to prosper in the long term. Long term profit is a great discipline. This applies not just to publicly quoted companies; it applies equally to private companies, B-corps, partnerships, foundations and trusts. If companies of any kind make losses, capital will drain away and either they get taken over or go bust. This applies to all companies even those which are foundations and trusts. Not only that but long term profitability is a pre-condition of companies doing good: being able to reward employees well, help communities, develop new products and services for customers and invest to protect the natural environment. In this context it is important to distinguish between long term profitability and short term profitability.

The pursuit of short term profitability is bad business. Just recall the financial derivative products created by banks in the feverish boom years leading up to the 2008 crisis which ultimately led to some banks going bust and others being bailed out by governments. This was bad business.  British Home Stores was a classic example of short term profit maximization with inadequate investment in the business itself or the pension fund. Again short termism leading to bad business.

Pursuing long term profitability is not just a matter of management getting numbers right. Before they can do that it requires them to set out a vision which makes the firm “a great place to work”, ensures customers recognize value for money in what they buy, becomes known as an ethical organization by the way they conduct business and admired by shareholders for earning a superior long term return to capital.

A second problem with Mayer’s proposals is the sheer complexity of managing the diverse and frequently opposing interests of stakeholders. It is logically impossible to maximize in more than one dimension. If managers have to manage the interests of all stakeholders they need to be able to make meaningful tradeoffs between competing interests. Profit or change in long-term market value is a way of keeping score in the game of business. Michael Jensen and others have shown that in the long term prospective profit maximization and shareholder maximization amount to the same thing. The use by management of a balance scorecard is no better as it ultimately gives no objective way in which to weigh all of the elements in the scorecard to arrive at a single figure.

A third problem with Mayer’s argument is accountability. “Accountability to everyone means accountability to no one”. The author’s proposal is a revolutionary re-definition of property rights within a modern corporation to make it “trustworthy” but to whom is the board of this new “trustworthy” corporation responsible? And what are the rights of ownership over the funds invested in the business? Already in the US the number of publicly traded companies quoted on exchanges has roughly halved over the past 25 years. One reason is the increasing cost of regulation: another is the availability of private equity finance. If Mayer’s proposals were ever to be implemented they would constitute a major disincentive for companies to raise capital through the public markets and only accelerate the decline in stock market listings.

In Mayer’s proposal shareholders would become providers of capital to business rather than owners of the business. The general public have never had a great trust in business which is why ever since the Industrial Revolution governments have stepped in to control business through laws passed by parliament, regulation, mutualisation, nationalization and state ownership. Mayer’s proposals will downgrade the existing well defined ownership rights which exist in publicly traded companies and replace them with a form of ‘social’ decision making in which the leadership of the company is answerable to trustees but shielded from competition in the market place through take over bids. A sure way to create inefficiency.

In this respect these proposals are a far cry from an exercise in academic research, more a political statement. Far from having no objection to the existence of ‘trustworthy’ corporations as one of many different forms of corporate ownership, I welcome them. In terms of corporate structures let a hundred flowers bloom. If the author was making a case for the idea of ‘Industrial corporation’, fine. However he is doing more than that. He is making the case for eroding private property rights and restricting what companies can do, which is as much a political statement as one based on objective analysis.

“Prosperity: better business makes the greater good” by Colin Mayer was published in 2018 by Oxford University Press (ISBN: 978-0-1988240-08). 288pp.

Lord Griffiths is the Chairman of CEME. For more information please click here.

The Centre for Enterprise, Markets and Ethics (CEME) is pleased to announce the publication of Enterprise and Entrepreneurship: Doing Good Through The Local Church by Steven Morris.

The publication can be downloaded here. Alternatively, a paperback copy can be ordered by contacting CEME’s offices via email at: office@theceme.org

The Centre for Enterprise, Markets and Ethics (CEME) is pleased to announce the publication of Capital Markets for the Good of Society: A Christian Perspective by Lyndon Drake.

The publication can be downloaded here. Alternatively, paperback copies can be ordered by contacting CEME’s offices via email at: office@theceme.org

An event associated with this publication was held in November 2017 

About the Publication

Capital Markets for the Good of Society discusses the ethical foundations and societal benefits of capital markets from a Christian perspective, emphasizing their role in promoting human flourishing and economic fairness.

It makes the case that capital markets — despite their terrible public image — provide genuine and often overlooked benefits to society, particularly to the poor. Drake argues that public discourse is dominated by highly visible failures like the 2008 financial crisis, while the gradual, dispersed benefits of capital markets go largely unnoticed.

To assess social utility, Drake develops a framework grounded in Christian theology, using ancient Israel as a paradigm. Drawing heavily on the book of Deuteronomy and early Church thinkers like Basil of Caesarea and Clement of Alexandria, he identifies key principles: that economic structures should promote human flourishing and creativity, that justice includes a redemptive dimension (not merely punishment of wrongdoing), and that no person or group has an absolute right over capital — ownership is contingent and comes with obligations.

From these theological foundations, Drake distils four practical norms for evaluating capital markets: they should provide harmless credit for the poor, support personal economic freedom, ensure visibly fair pricing, and enable broad participation in material blessings — not just aggregate GDP growth.

He then applies these norms to specific market types — bonds, equities, commodities, currencies, money markets, and derivatives — arguing that each provides measurable social utility. Government bond markets fund public infrastructure and welfare; equity markets democratise investment access; commodity markets protect weaker participants through transparent pricing; currency markets enable vast wealth transfers to developing countries through remittances; and even derivatives, despite their complexity and risks, lower borrowing costs in ways that disproportionately benefit poorer borrowers.

Drake also addresses the real problems: harmful products like NINJA mortgages, market scandals, information asymmetry, excessive compensation, and overleveraged speculation. However, he concludes that these are reasons for better regulation and cultural reform within the industry, not for dismantling capital markets themselves. The deeper challenge, he argues, is that the benefits of capital markets are gradual and invisible while their failures are dramatic and headline-grabbing — making it easy for society to undervalue what these markets actually contribute.

About the Author

Dr. Lyndon Drake (PhD, Computer Science, York; MA, Theology, Oxon) is a research student at the University of Oxford, working on a biblical theology of capital. Until 2010, Lyndon was a Vice President at Barclays Capital, trading government bonds and interest-rate derivatives. He now chairs the Council for Business and Theology (part of the Business Coalition of the World Evangelical Alliance), and has served as pastor of a city centre church in New Zealand, as well as teaching the theology of work at seminaries and serving in regional church leadership.

This is an excerpt from the The Mais Lecture: Restoring Trust in the Banking System at Cass Business School, May 24th 2017. For the full text, please click here.

It is a great honour to be invited to deliver the Mais Lecture this year, the 38th occasion on which it has been given. It is also a particular personal pleasure.

I was appointed to the Chair in Banking and International Finance at The City University in 1976. The funds for the chair had been raised by a previous Lord Mayor, Lord Mais and so out of recognition for his contribution I felt it appropriate that we establish a lecture in his honour. Hence the Mais Lecture.

The first Mais lecture was given in 1978 by Sir Gordon Richardson, the then Governor of the Bank of England, who told me that it was the first time a Governor of the Bank of England had set out in detail the design and implementation of UK monetary policy. The event was a huge success and the text of the lecture was reproduced in full the following day in The Times newspaper. The lecture has subsequently been given by central bank governors, finance ministers, prime ministers, a French president, a journalist, a chief rabbi and a number of distinguished academic economists including Frederich von Hayek and Lord Robbins. This year I’m afraid you come down to earth!

The subject I have chosen for this lecture is restoring trust in the banking system and by the banking system I mean central banks, bank regulators and commercial banks. I should make it very clear that this lecture is my own personal view and not that of Goldman Sachs, though I acknowledge a great debt to my colleagues at the firm for their valuable insights.

Since the financial crisis began in 2007 the reputation of the City, and trust in the banking system, have never been more challenged. The UK Parliamentary Commission on Banking Standards described the crisis as “a collapse of trust on an industrial scale.” Paul Tucker, a deputy governor of the Bank of England has described (with hindsight) the associated failure of regulation as “shocking, astonishing…catastrophic” which “left the credibility of financial regulation in tatters!” A review of what went wrong in one major UK commercial bank concluded that trust in commercial banks had been “decimated” by the crisis.

The pre-crisis factors which led to this loss of trust have been well documented in books and research papers and commented on in plays, novels, films and the news media by academics, journalists, novelists, playwrights and filmmakers.

Since the crisis each of the countries involved has undertaken a sweeping review of its regulatory structures, resulting in the creation of new institutions (the PRA and FCA in the UK), new regulations (covering capital, liquidity, compensation, resolution planning, governance and conduct) and more comprehensive and intensive supervision (UK Senior Managers Regime). Internationally, countries have worked together through the G-20 Financial Stability Board to facilitate harmonization and cross border regulation.

Yet ten years later and after this immense effort, trust remains low. Only 20% of the UK population think banks are well-managed, down from 80% in the 1980’s. In a recent survey in Germany only 26% of the population expressed confidence in the banking system. The independence of central banks has been challenged in the US, the Eurozone, Japan and the UK. The view of the new regulatory structures by academics and commentators is ‘could do better’.

One respected commentator concluded a recent piece on the UK claiming “the haze of mistrust continues to hang over the whole City”, while in the US context another remarked that “the world has not come to terms with the crisis of 2008. Justice has not been seen to be done. Remedies to prevent a repeat have not been seen to be applied. Dodd-Frank has failed to instill confidence.”

If a modern advanced economy is to function effectively it needs a sophisticated financial system which is trusted by the public. They must believe that it benefits society as a whole, and not just bankers. They must believe that the services sold by banks are appropriate to their needs and competitively priced. They must have faith in the competence and integrity of bank leadership, and respect for banks’ corporate cultures. The financial system must be seen as making a contribution to society, not being an island within it.

Against this background I wish to explore three challenges which I believe must be met if trust is to be restored and maintained in the banking system.

Preserving Central Bank Independence

The first challenge we face is preserving the independence of central banks from political control.

This independence has only been recently won. The independence movement began in the late 1990s with the central banks of England (1997), Japan (1997) and then Sweden (1999), along with the ECB (1999). It was a response to the Great Inflation of the 1970’s and the accompanying stagflation of low growth and rising unemployment. Central bank independence cannot be taken for granted. We forget the 1970’s too easily. In 1974 inflation in the UK averaged a staggering 27%. For short-term political reasons, control of the money supply was neglected and replaced by control of the price of credit (the interest rate) and direct controls on credit allocation to certain sectors of the economy (such as real estate and housing).

The reason the independence of central banks is important is that they alone among all the economic institutions in our society have the ability to provide stable prices. Price stability is important because it is a foundation for an efficient functioning market economy and a pre-requisite for confidence, growth and prosperity. Stable prices enable market participants to have confidence in the value of the money they use for exchange, its future value as an asset and its dependability as a unit of account.

Stable prices in turn depend on central banks setting appropriate short term interest rates to control the money stock. Any politician making such a decision will at some point succumb to short term political pressures. That is the day-to-day reality of politics in a modern democracy. But it will inevitably mean a loss of focus by politicians on maintaining medium term price stability. Independent central banks are therefore uniquely the guardians of stable prices in a democracy.

Deflation can be as serious as inflation. After the financial crisis it was this independence, along with transparency and accountability, which enabled the major central banks to confront the threat of falling prices and enable the global economy to return to a path of recovery.

Despite this success, the value of central bank independence has recently been questioned.

The Bank of England is facing political criticism for its continued policy of Quantitative Easing. After nine years it is judged as counterproductive in stimulating investment, and a cause of growing inequality by helping those on the property ladder at the expense of those who cannot afford to buy their own home. If continued it is judged a threat to its independence.

In Germany a group of economists and entrepreneurs has challenged the legitimacy of the purchase of sovereign and corporate bonds by the Bundesbank, on behalf of the European Central Bank (ECB), on the ground that it crosses the line between monetary and fiscal policy and unduly burdens the ECB with troubled government debt.

In the US the vice-chairman of the Financial Services Committee of the House of Representatives (Patrick McHenry) in a letter to the chair of the Federal Reserve (Yellen) stated that it was unacceptable for the Fed to continue negotiating financial stability rules “among global bureaucrats in foreign lands, without transparency, accountability or the authority to do so.”

These could perhaps be dismissed as the views of politicians and commentators. More difficult to dismiss however are the considered judgments of former central bank governors who are respected academic economists such as Mervyn King and Otmar Issing and the views of the central banker’s bank, the Bank for International Settlements.

In its 2016 Annual Report the BIS stated that “the extraordinary burden placed on central banking since the crisis is generating strains. During the Great Moderation, markets and the public at large came to see central banks as all-powerful. Post-crisis, they have come to expect the central banks to manage the economy, restore full employment, ensure strong growth, preserve price stability and foolproof the financial system. But in fact this is a tall order on which the central bank alone cannot deliver. The extraordinary measures taken to stimulate the global economy have sometimes tested the boundaries of the institution. As a consequence risks to its reputation, perceived legitimacy and independence have been rising.”

Facing up to these risks poses difficult as well as controversial challenges.

The most fruitful starting point I believe is to recognize that the world in which we live is best characterized by Frank Knight’s concept of true uncertainty, or Mervyn King’s radical uncertainty, rather than a world of risk, in which the outcomes of alternative decisions can be measured in a probalistic sense. In a world of radical uncertainty we simply do not know what the future will hold. We do not know with any precision the connections between banks and financial markets. Similarly we have limited knowledge of the connections between the financial sector and the real sector of the economy. Forecasting is an inherently complex business with great limitations. Because we live in a world of true uncertainty, we then shroud our ignorance by resort to expressions such as animal spirits, irrational exuberance and hubris to explain economic behavior.

It is important to emphasize that it is because of the success of central banks that parliaments around the world have given them increasing mandates. In the UK the Bank of England’s responsibilities now cover price stability, financial stability, prudential regulation, fair and effective markets as well as cyber security, fin tech and Brexit as they affect the banking system.

However these increased mandates bring with them risks.

One risk derives from the central banks’ responsibilities for delivering financial stability. To start with there is a serious debate to define what it means. Presumably it includes preventing future asset price bubbles and financial crises. However a failure to prevent a future crisis (and as sure as night follows day there will be future crises) will be perceived as a failure in judgment and execution by the central bank, which could easily undermine confidence in its ability to achieve its monetary policy objective.

Another risk is that the central bank will be perceived as designing policies impacting the distribution of income and wealth and which should properly be the preserve of elected politicians. Simply because of the need to set interest rates central banks will have an impact on the distribution of income and wealth. Over the cycle rates will rise at times and fall at other times. However a general consensus has been established that such a result is acceptable in order to achieve price stability. However targeting financial stability with direct controls (such as loan to income ratios for residential mortgages) and indirect controls (such as setting the minimum capital required to make loans to certain sectors of the economy) will lead to winners and losers, so making central banks open to the criticism that the implementation of these policies should be taken by politicians rather than unelected officials.

A further risk arises from the fact that sometimes monetary policy has been used as a cover for what is in reality fiscal policy. One example of this was the proposal by the European Central Bank (ECB) to engage in outright monetary transactions (to do “whatever it takes”) by purchasing the government bonds of countries that have not pursued prudent fiscal policies in order to keep down their cost of borrowing. Such a policy is effectively a fiscal transfer from countries that have run their public finances well to those that have not and for some this was a clear violation of the no-bail out clause of the European Treaty. The independence of the ECB has been further questioned by its participation in the design of bail out programmes along with the IMF and the European Commission.

In the light of these risks to the reputation, legitimacy and independence facing central banks, the question arises “Have central banks been overburdened by the increased mandates they now have and has it created exaggerated expectations of what they can deliver?”

This is a serious and difficult question because while central banks must be independent of political control they cannot be totally isolated from political environment they operate.

For this to be addressed I believe there needs to be greater realism and public acknowledgement about what central banks can and cannot achieve. In this regard I am always inspired in reading Otmar Issing’s work by the emphasis he places on the need for humility on the part of central banks, simply because to reduce the behavior of a modern economy with a complex financial system operating in a global environment to a set of equations is exceedingly difficult if not possible. In addition it is important that there is clarity regarding the responsibilities of central banks and those of other economic policy makers. When the Financial Policy Committee was first set up the statement made by the then Chancellor of the Exchequer was that the Bank “will have the tools and the responsibility to look across the economy at the macro issues that may threaten economic and financial stability and take effective action in response.” This is a very broad remit indeed which in my judgment blurs the line between monetary policy, fiscal policy and structural policies and ultimately poses a risk to central bank independence.

As a result I believe there is a strong case for requiring the central bank to give priority to what only it can do; namely setting a medium term numerical target for inflation. This will come to be seen as the expected rate of inflation, and have credibility because of the central banks ability to control money supply growth. In the short term, in a world of radical uncertainty, there will be deviations in prices and output from their medium term path. Because of this central banks should have discretion over the period of adjustment in returning to the medium term target. And in all of this they should of course be held accountable for and transparent in their actions.

Regulation in a World of Radical Uncertainty

I now turn to the second aspect of restoring trust namely through ensuring that regulation can be effective in a world of radical uncertainty.

The years since the financial crisis have seen an immense increase in the extent, detail, complexity, cost and supervision of bank regulation. In the UK, the US, the EU, Japan and other G20 countries the pendulum of regulation has been allowed to swing as far as necessary so as to give the public a firm assurance that taxpayers would not have to pick up the bill for bank failures, in a future crisis.

After the last crisis regulators around the world effectively sat down with a clean sheet of paper and set about a root and branch reform of the system. A number of academic economists and commentators advocated the most radical structural change, namely ending the fractional reserve system of banking and requiring banks to hold 100% of their assets in liquid form. This proposal was originally put forward in 1933 in the US following the financial crisis of the early 1930’s. It was known as the Chicago Plan after its author Henry Simons who was a professor of economics at the University of Chicago and has subsequently been supported by some of the leading names in the economics profession including Frank Knight, Irving Fisher, Milton Friedman and James Tobin.

Their argument was that because money is a public good which is vital for the efficiency and stability of a market economy, it is important to separate the creation of money from the creation of private sector credit. Narrow banks would have their deposits matched by 100% liquid assets which would consist of deposits at the central bank and government securities. Providing the public have confidence in governments to fund future expenditures, there would never in future be a reason to have a run on banks. As Irving Fisher put it, “nationalize money but do not nationalize banking”.

However following the 2008 crisis this approach was considered a bridge too far. One reason was the disruption which such a huge change would entail as banks reorganized their activities into ‘narrow’ banks, backed only by approved liquid assets, and ‘wide’ banks which could perform activities such as corporate lending. In addition a rigid separation might well hinder beneficial innovation, including more flexible forms of borrowing or lending. Such a change would also transfer risks to non-bank financial intermediaries, with the prospect that the cost of capital of investing in real assets such as plant, machinery and houses would rise.

At the same time governments recognized that in extremis they have an ultimate responsibility to provide catastrophic insurance to support the financial system. Although a 100% reserve banking system would prevent a run on banks, if there was a shock to the economy resulting in a sharp and significant reduction in total spending, central banks and governments might still have to step in and rescue ‘wide’ banks, rather than let households and firms bear the cost of significant falls in asset prices, including those of houses.

One result of the pragmatic and piecemeal approach which governments and central banks have taken is that the banking system is far more robust today than it was in 2008. Retail depositors are ring-fenced from the complex risks undertaken by investment banks and the payments system is more stable. Banks are better capitalized, have limited leverage, and hold far more liquid assets than before. Investors are better informed about the potential risks of investing in banks. New compensation structures for bank executives reward longer-term performance and discourage short-term risk-taking, with increasing use of deferred stock awards and claw back provisions instead of cash bonuses. Resolution planning (special bankruptcy procedures) allows banks in financial difficulties to sort out their problems without disrupting their basic services to clients: in other words banks can fail but without systemic repercussions. Finally, the UK Senior Manager’s Regime holds specific senior individuals personally and directly accountable for their actions, with reckless mismanagement of a bank a criminal offence subject to a maximum of seven years in prison and a fine.

These are significant achievements which deserve to be recognized.

However despite these achievements the new regulatory structure has come in for significant criticisms.

One is the charge of complexity.

International prudential agreement among banks first started with the Basel Accord of 1988, a 30 page document. Basel II in 2004 was 347 pages. By 2010, Basel III reached 616 pages! In the US the Glass-Steagall Act of 1933 ran to 37 pages, whereas the Dodd-Frank Act of 2010 runs to 2,300 pages, not to mention the growing thousands of pages covering detailed supporting rules.

Bank capital requirements account for much of this paperwork. UK banks must hold a variety of different types of capital in proportion to their risk weighted assets including: common Tier 1 equity, additional Tier 1 equity including perpetual subordinated debt instruments, a capital conservation buffer, an additional equity buffer for internationally systemic banks, risk-specific equity, a PRA buffer and a time-varying counter cyclical capital buffer. Banks are also required to issue bail-in bonds which convert debt to equity upon certain trigger events. The measure of “risk weighted assets” which regulators use to calculate the ratios is subjective, complex to determine and can change significantly and quickly in a crisis. Banks are additionally subject to stress testing, which is highly subjective, but whose results will inform regulators in setting certain of these buffers. Equally complex calculations and reporting requirements apply to holdings of liquid assets, the structure of compensation and resolution and recovery planning.

A second criticism of the current regulatory system is the increased deadweight cost to society of the new regulation. In advanced countries regulatory bodies employ significant numbers of employees and consultants. In 1980 there was one regulator for every 11,000 people employed in the UK financial sector; by 2011 there was one regulator for every 300 people employed. This pattern is repeated in the regulatory reporting, compliance and internal audit departments of regulated firms. At my own bank we have one compliance officer for every 30 bank employees – which is not unusual for major banks. When added together the number of people engaged in regulation runs to several hundred thousand.

A further criticism of the increased regulation is that it undermines trust and moral responsibility. Under the present system the primary duty for risk managers is making sure that certain numerical targets are met. Does this undermine a sense of personal responsibility and ownership? Instead of bankers being held accountable for determining appropriate amounts of capital and liquidity which in reality are unique to the risks and nature of each business, detailed regulatory prescriptions can become a prop on which they can lean. John Kay has stated the problem succinctly “Regulation based on detailed prescriptive rules has undermined rather than enhanced ethical standards, by substituting compliance for values.”

A fourth and perhaps the most important of all of the criticisms of the present system is that it fails to address the challenges to bank regulation of an economy characterized by radical uncertainty. In a world of radical uncertainty it is not possible for regulators to determine the appropriate amount of capital or liquid assets that individual banks should hold. What might seem the right amount at one time can easily change to be inappropriate in a relatively short period of time. As a result banks should be made to think much more deeply about the way they deal with uncertainty in order to improve their management of risk.

The most comprehensive and innovative approach to reducing the complexity of current bank regulation is I believe that outlined by Mervyn King in his book, ‘The End of Alchemy’ and consists of a number of elements.

First a maximum leverage ratio, i.e. the ratio of total assets to total equity. Second a liquidity rule that ‘effective’ liquid assets should exceed effective liquid liabilities, (where effective liquid assets are holdings of bank reserves at the central bank and a collection of pre-selected short term securities which could be used, subject to a haircut agreed in advance, as collateral on which the central bank would advance funds to the bank in the event of a run on deposits: This is the central bank acting as Pawnbroker for All Seasons rather than as Lender of Last Resort (LOLR)). Third that the scheme should be implemented gradually over a period of ten to twenty years. Fourth, during the transition period existing prudential regulation and ring fencing restrictions imposed in recent regulation should be retained. Finally, the scheme should apply to all financial intermediaries, banks and shadow banks which issue unsecured debt with a maturity of less than one year (above a de minimus proportion of the balance sheet, which is an arbitrary figure and open to debate).

The benefits of this system are that it would drastically simplify regulation. Complexity would be replaced by two rules: a minimum leverage ratio and a liquidity requirement. It would dispose of detailed capital and liquidity rules and the challenge of defining what constitutes risk weighted assets. It would be introduced over a decade or two. It avoids banks having to make a choice of being either a narrow or wide bank and it enables competition among banks but at the same time limits private credit creation. Central banks would still have to make discretionary judgments over the leverage ratio and the assets which banks could hold as collateral and the haircuts which would be attached to them.

To sum up on regulation. The architecture of bank regulation which has been built up since the crisis has resulted in a better capitalized, more liquid, more long term focused and more resolvable banking system. This is no mean achievement. As a protection for tax payers facing a future financial crisis it is a distinct improvement on regulation pre-2007. However it suffers from excessive complexity and deadweight cost, and stresses managing risk to regulatory standards rather than intrinsic risk. For the longer term the challenge is to move to a system which reduces complexity and cost and is fit for purpose in a world of radical uncertainty. And so far and by far the most promising alternative is the proposal of Mervyn King.

Restoring Trust in Banks

Having considered the independence of central banks and the regulatory structure in which they operate I would now like to turn to the steps necessary to restore trust in commercial and investment banks.

First, the public must be convinced that the remorse expressed by banks regarding past failures is genuine and that they are sincere in wanting to reform.

One evidence of banks commitment is the time and resources they have devoted to strengthening their processes of control. Most if not all bank management of systemically important institutions have undertaken comprehensive reviews of their business, followed by reforms, which have then been fed back into training programmes. The compliance and internal audit functions have conducted meticulous reviews of failures in their own institutions and of the lessons which can be learnt from publicly reported failures in others.

The numerous and sizeable fines imposed on banks in recent years has regrettably only served to reinforce the perception of a lack of remorse. Some fines relate to legacy issues which go back many years. Others which relate to more recent violations in the Libor and FX markets and anti-money laundering only increase the challenge banks have in convincing the public of their commitment to change. Until however the public sees results from bank reforms – such as an extended period of time with few if any major regulatory problems, the public will remain sceptical.

Next in order to restore trust the public must be convinced that what banks do is of value to society and not just themselves and their shareholders. The social value of retail banks is readily understood by the public through ATM machines, debit and credit cards, cheque books, on-line banking, loans and mortgages. By contrast the social value of investment banks is not well understood. Their clients are not the general public. Their financial products and services are complex. The clients of investment banks are other banks, asset managers, large public and private companies, governments and public sector bodies but not the general public. Many of the products and services the investment banks provide, such as interest-rate derivatives, credit default swaps and structured finance are complex, involving private, innovative and highly specialized markets of which most people have no understanding at all. However, these banks are of value to society because they raise funding for companies and governments and allocate capital to its most productive uses either through lending directly or through the capital markets in which risk is competitively priced.

A third step in restoring trust in banks is that if banks are to be trusted they themselves must demonstrate that they are trustworthy institutions.

Trustworthiness has a number of elements. One is competence. Basic to competence are the skills, knowledge and experience of those working in banks to undertake the business. Along with competence, consistency in delivering a first class service is important. Competence and consistency together mean that banks can be considered reliable in the services they provide and the transactions they execute for clients. In providing these services they will incur certain obligations to clients, which they and their clients need to be clear about, and when necessary fully documented. Both individuals and the institutions for which they work must accept accountability for their performance.

For banks to be trusted, bank culture is important. We know that poor cultures have resulted in large fines.

James Heskett, Professor Emeritus at Harvard Business School spent more than four decades, researching the relationship between business culture and business performance both in the field and through case studies. On the basis of his research he claims that an effective culture can explain as much as half of the difference in operating profit between companies in the same business sector. By an effective culture, he means one that unifies those who work in a bank in achieving its goals, whilst promoting a supportive work environment. The reason the relationship is not simple is that the strength of a culture by itself is not enough to guarantee improved performance. It must be accompanied by effective leadership, an openness to adapt to change and new ideas, continuous quality improvement and by benchmarking the company against the world’s best. When these are present a strong culture has maximum impact. An effective culture can be a source of competitive advantage because of higher job satisfaction, higher retention rates of staff, a reduction in hiring costs due to employee referrals, employee ownership, increased productivity and improved relationships with customers.

Culture is important for reasons other than performance. A good corporate culture is a good in itself. The culture of any business is an expression of the purpose of the organization. A business is a community of people who need to feel that what they do day after day serves a greater purpose. People come to work not just to earn money. They want to believe that what they do matters, that it is valued by society and that the organization for which they work is a force for good in the world. People take pride in their work. They need to feel that the services they offer have a quality tag attached to them. They need to feel at home in the institution in which they work. They expect that throughout their career it will help them develop as persons. Effective cultures create great places in which to work. They want the bank for which they work to be regarded as more than a profitable money machine.

If an organization is to serve a greater purpose it is not enough simply to maximize profit within the law. Client’s interests must come first, relevant information must be disclosed, conflicts of interest must be managed and the commercial activities of the bank must be seen as contributing to society. Because of this, when discussing a piece of potential business, bankers must ask themselves key questions. Is this piece of business legal? Is it commercial? But also is it the right thing to do? Put differently, not only can we do this piece of business? But also, should we do this piece of business?

In the years leading to the crisis banks recognized the importance of culture in their organizations. All major banks, including those which failed and those which were subsequently rescued, already had comprehensive statements of business principles: “the highest personal standards of integrity at all levels”, “complying with the spirit and the letter of the laws and regulations,” “trusted-acting with the highest integrity to retain the trust of customers, external shareholders and colleagues”, “to be a great place for our customers to do business”, “we regard every day as a new chance to earn your trust. It demands hard work, integrity and transparency, but that’s what we do”.

These statements were held out as being the moral compass set by bank executives to guide them in making business decisions. They were the ideals banks set for themselves and the culture of their organizations. They were as far removed from a ‘cesspit’, “casino” or even ‘vampire squid’ as it was possible to be. As a result bank customers and the public came to expect certain standards of banks; competence, prudence, integrity, responsibility. One reason the public have become so disillusioned and angry is their perception that the moral compass they were led to believe guided senior management was in fact broken. Prudence, competence and integrity had given way to recklessness, greed and dishonesty.

Business principles are the standard to which a bank aspires. A culture is what happens in practice. It is the way a bank does business day by day. What the financial crisis exposed was a glaring divide in some banks between high ideals and daily practice. In the euphoria of the boom years, the principles and values which bank leadership publicly espoused, were not sufficiently robust to prevent bank management sailing too close to the wind and ultimately out of control. In the build-up to the crisis bad decisions and poor judgments resulted from bank cultures in which the pursuit of profit and personal reward became too dominant. Sadly we have seen more examples in recent years.

Building a culture, maintaining a culture and changing a culture are far from easy. All take time and need to be attended to each day in countless small decisions. There are no easy levers to pull but the decisions management must take day in day out, week in week out, month in month out, will in time serve to either strengthen a culture or undermine it.

One area which is important is recruitment, especially recruitment from other financial institutions and businesses. Competence, credibility, commitment, the ability to work in a team and the ambition to do well are important: but the ability to earn revenue should never be at the cost of the character of those hired. Criteria for promotion are similarly important. A person who is promoted because of the business he or she has built but who lacks integrity will diminish a culture. By integrity I mean being totally open and honest about business selection, the state of the books, valuation procedures, resolution of conflicts of interest, respect for compliance issues, commitment to developing people and concern to ensure that the values enshrined by the company are lived out day by day.

Along with recruitment and promotion another important area is compensation. If compensation is primarily based on earned revenue, regardless of the way executives behave, this will be the strongest possible signal to employees of the real values of the company. Compensation must take into account less tangible qualities, such as reinforcing the culture of the firm and the development of people. In the case of wrongdoing compensation must be impacted. Individuals must be reprimanded, and deductions made in their compensation with the most serious issues requiring the most difficult decision, namely dismissal. At the same time, good conduct judged by people being role models for the values of the institution and taking ownership for the development of those who report to them should also be rewarded.

In all areas training is important. It is key to ensuring that the values of the business are understood by everyone involved and the ways in which they are critical to its success. Training must not be sterile recitations of rules and regulations, but embody real life examples from which employees can draw, in thinking how to act in their day-to-day jobs.

Before we move on from the subject of culture we should recognize that the culture of an individual institution cannot be easily separated from the more general culture in which it is embedded. As traditional banking has become far more competitive and integrated with securities so it has brought with it a different culture emphasizing trading and risk taking. In the 1970’s Daniel Bell who was a professor of sociology at Harvard wrote about the cultural contradictions of capitalism, namely the change which has occurred from a bourgeois matter of fact world view based on rationalism, functionality and optimism to one of unfettered freedom, hedonism and boundless experimentation. Gordon Gekko celebrating the virtues of greed in the film Wall Street is about as far removed from the asceticism of Richard Baxter quoted in Max Weber’s The Protestant Ethic and the Spirit of Capitalism as one could imagine. A contrast which has only become more marked through the growth of social media and the technology revolution.

Culture and Leadership

In creating, sustaining and, if necessary, changing a culture the role of leadership is crucial. Leadership has the responsibility to articulate the values of a bank. Leadership is about setting out a vision and inspiring the staff. It is about defining the purpose of the business, the standards which are expected, and setting the right example. Leaders are the trustees of the values of a company. Leaders must establish the values, communicate the values, take ownership of the values and then — most crucially — live the values.

Perhaps the most important element of the culture of any financial institution is the tone from the top. People in an organization will judge how serious leadership is about its culture not by what leaders say but the decisions they take. Who in the business do they reward? And for what? Who do they promote? Would they remove senior executives whom they knew were damaging the business by behaving inappropriately? Most important of all, do they themselves practice what they preach? One of the founders of a US company quoted on the NYSE ServiceMaster, on whose board I sat for fifteen years, was known for his remark, “if you don’t live it, you don’t believe it.”

Leaders have a responsibility to ensure that the tone from the top reaches down to all levels of the organization especially the middle area which a former regulator described as the “permafrost” within an organization. A recent survey of over 28,000 individuals working in banks and building societies across the UK conducted by the Banking Standards Board found that only 65% of employees agreed with the statement that there was no conflict between their firms stated values and the way the firm did business.

Leadership within a bank exists at all levels so that it includes not just the CEO and senior management. This means that leaders at all levels throughout the organization must own the values, communicate the values and most important of all live out the values.

Crucial to the tone from the top is the role of the board. One of the key responsibilities of boards is their role as trustees of the culture of the organization. This involves supporting management in its efforts to build the right culture. It also involves when necessary challenging management. A banks culture is not easy to assess and many boards do not have a structured process for reviewing a firm’s culture in the way they do for risk, audit, governance, nominations and compensation. It is a current challenge many banks are grappling with. For banks the issue is how to recruit, promote and nurture first class, competent leadership which recognize the importance of character and values as essential to implementing business principles.

Performance and Character

In this lecture I have sought to argue that restoring trust in the banking system depends on maintaining the independence of central banks from political control with the overriding priority to maintain a low and stable rate of inflation; the importance of regulation for the banking sector but also ways it might be reformed to reduce complexity, cost and managing in order just to meet numerical targets; and within banks the need to set out the purpose of the institution, its business principles, the obligations which doing business entails and the role of leadership in establishing and maintaining an effective culture. Key to this is the personal responsibility of each individual working in the bank which is built ultimately on character and values.

In view of this let me conclude with a personal story. Some years ago I gave a lecture at Claremont College, California on “The Business of Values” to which Peter Drucker gave a response. He described my lecture as the case for business as ethics in action. He stressed that the values of a business are a commitment to action not preachments which are at best only good intentions. The most decisive, unambiguous and visible actions he suggested were those regarding people. Regardless of what the CEO may say in his speech at the annual meeting, what he does in rewarding, placing or punishing people are the values the whole organization sees and takes seriously. He then concluded with a personal story.

“Many, many years ago, at the very beginning of my working life, I had the good fortune to work for a short year for a man of rare integrity and great wisdom. I had tremendous respect for him; and so I was quite shocked when he did not promote an older colleague – let’s call him Tom – who had clearly done an outstanding job. I was so troubled that I took my courage in my hands and went and asked the boss why he had so pointedly passed over our department’s top performer. He looked at me with a smile and said “I know you are too young to have a son but I understand you have a younger brother.” Yes I did. “Would you”, he then asked, “want to have this younger brother work for two or three years under Tom and try to become like Tom? You are right” he continued, “Tom has the performance; but does he have the character?”

It is when an organization asks this question and takes it seriously that its values become action”.

Lord Griffiths is the Chairman of CEME. For more information please click here.

They often say ‘never to judge a book by its cover’, that initial external appearances can distort or even deceive the audience from the content that lies within. Well, the principle doesn’t apply here. Lynn Stout’s The Shareholder Value Myth attempts to achieve exactly what the title entails: a pure and straight forward critique of the belief that the ultimate purpose of business is to maximise shareholder value, which often dominates the field of business management.

Author Lynn Stout is Professor of Corporate & Business Law at the Cornell Law School where her main areas of research include corporate law, securities and derivatives regulation, economics, and organisational behaviour.  Stout argues that the Shareholder Value ideology is ultimately just an ideology, not a legal requirement or a ‘practical necessity of modern-day business life’ (p3). In this sense, Shareholder Value thinking is a mistake for most companies because it indirectly forces corporate managers and executives to ‘myopically’ focus on short-term earnings at the expense of long-term stability and performance. It also ‘discourages investment and innovation, harms employees, customers, and communities; and causes companies to indulge in reckless, sociopathic, and socially irresponsible behaviours’ (p10).

The book is written clearly and concisely, predominantly using direct rhetoric and short sentences. In terms of structure, the book is broadly divided in two comprising parts: Part 1 is a direct attempt in ‘Debunking the Shareholder Value Myth’ while Part 2 is mostly an investigative endeavour into who the ‘shareholders’ are and what they actually value. Each part is made up of five shorter Chapters so let’s take a closer look into some of the main points and arguments made throughout the book.

The first half can be seen as a systematic critique of the means and (even disastrous) consequences of ‘shareholder value thinking’. Corporate scandals such as the 2010 BP Oil Spill and cases of serious fraud in large companies such as Enron, HealthSouth and Worldcom throughout the 2000s are all cited as consequences of shareholder value thinking. Professor Stout makes a compelling case that the ‘narrow’ focus on share price alone can result in ruthless management behaviour. The drive for extreme cost-cutting in the hope of increasing short term profit doesn’t just hurt the employees and the company, but the shareholders themselves.

The book provides a brief historical account of how shareholder value thinking came to dominate teaching in business schools as well as becoming the norm within the private sector itself. If in the 1800s most privately held companies were of single ownership (or a tight shared ownership), by the 1990s publicly held companies have tens of thousands of shareholders. Stout rightly argues that this replacement of the ‘single’ ownership model with an executive Board to represent the vast number of shareholders causes the Board (as well as the senior management) to assume that all the shareholders want is ‘to make as much money as possible, as quickly as possible’. It rather quickly trickles down to the lowest common moral denominator, ignoring the fact that shareholders are real human beings with different investment timeframes, different priorities and different attitudes toward the well-being of others. In this sense Lynn Stout rightly argues that ‘recognising these differences reveals that the idea of a single objectively measurable “shareholder value” [i.e. solely based of share price] is not only quixotic, but intellectually incoherent’ (p60).

The second half of the book turns its attention toward the shareholders themselves: who are they? And what do they want to get out of their investment? These questions in turn give rise to a clear dichotomy within a company’s pool of shareholders: ‘short-term speculators versus long-term investors’. Again, Lynn Stout rightly points out that ‘long-term shareholders fear corporate myopia. Short-term investors embrace it – and many powerful shareholders today are short-term’ (p65). The conflict of interest generated by short vs. long-term investors indirectly forces a company’s management to take the default position and assume that every shareholder is a ‘platonic investor’ – i.e. an investor that only owns shares in company ‘X’ and the share price increase is all that they are interested in. Lynn Stout argues that in reality however, this ‘platonic investor’ does not exist. The overwhelming majority of investors today own more than just shares in company ‘X’, they are invested in the marketplace as a whole and want to protect the value of their other investments also. In this sense, the short-term focus generated by shareholder value thinking can actually work against the interests of the shareholders themselves.

The book as a whole presents a compelling critique of shareholder value thinking. Yet it’s strength is also its greatest weakness: it is just that, a critique –nothing more and nothing less. What are the solutions? The final pages of the book only tentatively touch on a possible way forward in arguing that what is needed is a more ‘complex and subtle understanding of what shareholders really want from corporations’ (p115). This all sounds great and very necessary but how do companies get there? Even if executives come to acknowledge the variations in their shareholder’s desires – is this a guarantee that the company’s approach to corporate governance will change?

I have written on this topic in the past  where I highlighted the importance of first establishing a concrete set of internal ethical values and practices. Only then does it become possible to accommodate the desires of a larger pool of shareholders and indeed, stakeholders.

A great deal remains to be written on this topic and The Shareholder Value Myth by Lynn Stout is an excellent addition to the growing body of literature that forces us to re-think the role and purpose of business in society.

A recommended read.

“The Shareholder Value Myth” was published in 2012 by Berrett-Koehler Publishers (ISBN 10: 1605098132). 134pp.

Andrei Rogobete is Associate Director of the Centre for Enterprise, Markets & Ethics. For more information about Andrei please click here.

The Centre for Enterprise, Markets and Ethics (CEME) is pleased to announce the publication of Ethics in Global Business: Building Moral Capitalism by Andrei Rogobete.

The publication can be downloaded here. Alternatively, hardcopies can be ordered by contacting CEME’s offices via email at: office@theceme.org

Colin Mayer is Professor of Management Studies at the Saïd Business School in Oxford. He believes that “the corporation is failing us” and that dramatic changes in the rights and obligations of those who control corporations are needed. Firm Commitment explains why and makes proposals for change.

Mayer uses the term “corporation” to refer to the kind of limited company that is commonly used by large businesses. He recognises the huge benefits that corporations have brought but he considers them to be seriously flawed. Indeed, he describes his book as “both a tribute to and a condemnation of this remarkable institution that has created more prosperity and misery than could have ever been imagined”. He perceives the main problem to be that corporations are seen as the creatures of their shareholders, rather than as independent entities, and this leads to the pursuit of shareholder value over the interests of stakeholders other than shareholders. In support of this, he cites numerous well-known corporate scandals.

The primary focus of his book is the UK and Mayer appears to believe the position here is worse than elsewhere. However, he is not starry eyed about any currently available option. Notably, he recognises that family and other tightly owned companies may have their own problems and scandals (citing Parmalat) and, in any event, family ownership “is not the resolution to the 21^st–century corporation’s problems”. He is also dismissive of the attempts that have been made in recent years to correct problems through regulation (which, he asserts, “promotes immoral conduct”) or through enhanced corporate governance (which, he suggests, may promote increased shareholder control to the further detriment of other stakeholders). He suggests that what we need is “to find mechanisms by which companies can demonstrate a greater degree of responsibility themselves without relying on others to do it for them”. Specifically, he suggests that “we need to establish the means by which corporations can demonstrate more commitment to their stakeholder community”.

Salvation is in what he calls “trust firms”, which would be like existing corporations subject to three adaptations: entrenched within their constitutions would be corporate values (which might reflect the values of their founders, public policy or other things); there would be trustee boards to act as custodians of these values; and the corporation would have “time dependent shares” whereby the voting rights of shareholders would depend upon the extent of their commitment to hold their shares for the longer term (e.g. a share which its holder is committed to hold for a further ten years would have ten times the voting rights of a share which the holder is only committed to hold for one more year).

Mayer does not want any compulsion to be applied in relation to this. He argues that diversity in corporate forms should be permitted. He does, however, suggest that there be tax incentives to encourage the use of trust firms.

There is a lot to applaud in this book. In particular, there is depressingly little evidence that increased regulation or the focus on corporate governance in recent years has materially improved the corporate world and, against this background, Mayer’s stress on the importance of “commitment” as opposed to “control” deserves serious consideration. It links with ideas derived from the work on “relational thinking” that has been undertaken in recent years by, amongst others, the Relationships Foundation and Tomorrow’s Company. Furthermore, the concept of a “trust firm” is an interesting one that could contribute to the development of a broader view of corporate purpose and responsibility.

Unfortunately, however, this is a flawed book. Perhaps Mayer has tried to cram too much into 250 pages. Whatever the reason, almost every page contains contentious statements or statements that require significant qualification. Although there are plenty of footnotes referring to past research, there are also many ex cathedra statements as well as many assertions and assumptions with which specialists will take issue. For example, some of the statements of law are, at best, partial and Mayer seems unaware that much of what he proposes can already be achieved through existing law (as, for example, the entrenchment of editorial independence within the constitution of The Economist Newspaper Ltd illustrates). He also accepts dubious interpretations of past events. In particular, his long description of the Cadbury takeover accepts the views of its former chairman, Sir Roger Carr, without examination. This is a pity because others involved in that takeover (including former Cadbury directors) have different views and consideration of these might have led to Mayer modifying some of his suggestions.

More seriously, Mayer’s analysis of the objective of corporations is unhelpful. He states that “shareholder value is an outcome not an objective” and even quotes former GE CEO Jack Welsh in support of his views. However, his argument only addresses the use of short term share prices as the test of shareholder value and his suggested alternative as a corporate objective is demonstrably inadequate. He asserts that a corporation’s “first and foremost objective is not to its shareholders, or to its stakeholders. It is to make, develop, and deliver things and to service people, communities, and nations”. It is unclear from where he derives this overarching normative assertion and, in any event, it is no more useful than saying that the objective of corporations is “to do things”! It does not help a corporation’s management to decide whether they should remain in heavy engineering or move to IT or whether to be a volume manufacturer or a niche player.

Finally, Mayer’s evident confidence that the trust firm does not suffer from serious flaws and is the solution to the myriad of issues that he has identified is not backed-up by careful analysis. He appears to recognise this since he says that his ideas need to be “subject to careful scrutiny”. They certainly do and, whilst they are undoubtedly worth such scrutiny, it may be seriously doubted whether they are the “cure all” that Mayer appears to believe.

That said, provided that the book is read critically, it is well worth reading.

“Firm Commitment” by Colin Mayer was first published in 2012 by Oxford University Press (ISBN-10: 0199669937).

Richard Godden is a Lawyer and has been a Partner with Linklaters for over 25 years during which time he has advised on a wide range of transactions and issues in various parts of the world. 

Richard’s experience includes his time as Secretary at the UK Takeover Panel and a secondment to Linklaters’ Hong Kong office. He also served as Global Head of Client Sectors, responsible for Linklaters’ industry sector groups, and was a member of the Global Executive Committee.