Sunday, 15 December 2013

Plebgate and why Good Governance is about Trust

It has been some time since I wrote a blog on this site. This is because I can see problems but so seldom do I see their solutions and, after a while, I despair of just writing about failure. Nonetheless, I think the issue of trust is so important that it deserves an airing.

Forgive me for quoting background liberally from Wikipedia but I can't set out the critical facts any better;

The "Plebgate" scandal in the United Kingdom concerns an altercation between Conservative MP Andrew Mitchell, the former Government Chief Whip, and the police, which took place in September 2012. It gained notoriety initially for his alleged conduct and again, two months later when, subsequent to his resignation, CCTV and other evidence was revealed which appeared to call into question some of the evidence against him.
Leaked police logs, later backed up by eyewitness evidence, had suggested that Mitchell swore at police officers on duty at Downing Street and called them "plebs" (a pejorative word signifying someone of low social class) when they refused to open the main gate for him as he attempted to leave with his bicycle. Mitchell apologised but denied using the words claimed and in particular calling officers "plebs". However, finding his position untenable amid the media storm, he resigned from office.
The story returned to the headlines again in December 2012, when CCTV footage was released which threw into doubt the police version of events and it was revealed that an email purporting to be from a member of the public, which had backed up the accounts given in the police log, was actually sent by a serving police officer who had not been present.

The affair was revisited again in October 2013, after a report from the Independent Police Complaints Commission concluded three officers who met Mitchell at his constituency office, supposedly to clear the air, had given a false account of what was said while the findings of a subsequent investigation had been changed at the eleventh hour to recommend no disciplinary action be taken against them. This report prompted both Home Secretary Theresa May and Prime Minister David Cameron to criticise the conduct of the officers involved and bemoan the lack of disciplinary action.

The issues in this case are wide ranging and build on previous highly publicised instances of unreliable police evidence and subsequent cover up by senior officers. Why does it matter? Well, clearly, if a senior government minister can be brought down by an apparent conspiracy of lies then who is safe? But more important is the issue of trust. Our entire criminal justice system is built on believing what police say. If they not only lie but also engage in conspiracy and cover up then the whole edifice crumbles. Over twenty years ago I sat on a jury which was unable to reach a conclusion because one member would not trust the police version of events. I was horrified. If you don't believe the police evidence then where does that leave us? How can we convict the bad people in society?

I realise I am taking a step away, but the same principles arise in all aspects of society and including business organisations. So when local councils in the UK earn huge incomes from parking fines and fees but  claim they are engaged in improving traffic flow and not in income generation then that damages our entire democracy because we all know they are lying. When business leaders earn eye watering sums of money, often from failure, then that erodes the trust of their work colleagues who are less empowered to eat at the trough. The consequences matter: staff motivation is reduced and honesty suffers at all levels. Why not manipulate reported figures to boost bonuses if the bosses are helping themselves? Why not use company assets for personal use if the bosses also appropriate such assets? Why be the only one who is honest? Why not take the odd back-hander?

Indeed, remuneration committees and non-executive directors bear heavy responsibilities.

Saturday, 2 March 2013

Is Boris right to oppose an EU cap on bank bonuses?

My usual liberal instincts tell me that governments have no place in micro-managing markets: that what companies choose to pay their staff is no business of either politicians or bureaucrats in a democratic society. Such interference is the hallmark of tyrannies and, practically, has been shown not to work very well in the log run, leading to a misallocation of resources and economic activity. Even more to the point, in a world where the residence of individuals and companies can be changed virtually at the flick of a switch, it is a quixotic gesture. Either the individuals the regulations are aimed at will suddenly be employed offshore, or corporate structures will be devised that enable them to stay in situ but to be paid offshore, or the jobs will move to other people in other jurisdictions where the dirigistes hold no sway. As Boris Johnson has identified, the effect on the individuals' earnings is likely to be small but the damage to the business of the City of London, and to the EU economy, may be large.

On the other can see their point...the interferers, the micromanagers, the bureaucrats the very indirectly elected politicians. They say that such large bonuses encourage individuals to take huge risks with other people's money. When the individuals who may receive the bonuses work for very large banks then the 'other people's money' is the public purse because a big risk that goes wrong must be covered by government intervention to prevent the collapse of the banking system. So the risk takers may not even be risking their jobs. When these risks are so large as to threaten the economic system then, the dirigistes argue, government must act to contain these risks. One way of doing so is to limit the incentives to take risk. Further, they may argue, the normal mechanisms of shareholder oversight of these financial institutions has failed. It has done so for two reasons; either shareholdings are so thinly spread that none has the power to influence or the institutional shareholders themselves employ large bonus schemes and are therefore part of the problem.

But then...oh how I wish for a third hand...voluntary codes of conduct have been put in place in the City of London that restrict the way bonuses are paid, spreading them over several years to try to limit the incentive to boost short-term profits at the cost of taking big long-term risks. Why can't such methods be extended to more individuals and permanent working parties be established, on a voluntary basis, to find ways to limit incentives that encourage bad behaviours? Are we sure that such voluntary mechanisms don't work?

I think, on balance, we the public need more information before we could possibly make an informed decision. And that is a big issue with these and other EU proposals: the democratic deficit of EU institutions. These matters are not debated and publicised in the public domain. Regulation within the EU is something that is done to us rather than something we can feel we participate in. That is why, in the end, the liberal in me revolts at EU regulation and supports Boris's protest

Wednesday, 30 January 2013

Banking scandals, corporate memory and incentives

I have not blogged here for some time, which is not because I have tired of the subject. Many people would yawn at the mere thought of corporate governance but it holds a fascination just because it is actually not some arcane discipline beloved by crusty academics and dull accountants: it is about everyday life. It is about "why do people behave like that and what can be done?". My slowing blog writing arises from my failure in the realm of answers. I find I keep coming back to words like integrity rather than being able to suggest smart procedures that will solve our problems.

And what a host of problems we have. As an example, it is hard to open a newspaper without reading about legal actions by regulators and law enforcement authorities against banks in America, many of them British. There is the Libor scandal that encompasses many of them, accusations of helping drug lords to launder their ill gotten gains, accusations of helping countries evade UN and US imposed sanctions. In the UK there is the massive scandal of miss-sold loan protection insurance. You may want to click across and look at Forbes list of scandals...

I am not just picking on banks but they happen to provide such good examples. The question is, why do these things keep happening? What is it about the structure of these organizations or the incentives they offer (which is surely much the same thing) that makes it keep happening? It is not as though such behaviour is good for the these organizations. If you look at the size of some of the fines and settlements then you must conclude that their size swamps any gains. You may argue that there are lots of such scams that do not come to light but I am rather inclined to think that, eventually, most of them do and then again, there is the size of the penalties: HSBC, for example, recently settled for $1.9bn.

Then Daniel Finklestein, writing in the Times, discussed the private interests of public servants. In doing so he evoked the 'Mandy Rice Davis principle'.

It was June 30, 1963, and the second day of the trial of the osteopath Stephen Ward, charged with living off immoral earnings while Miss Rice-Davies was his tenant. The dancer was asked about her claim to have slept with Lord Astor.
Do you know, asked Ward’s defence lawyer, that Lord Astor has denied these allegations of yours? And Miss Rice-Davies gave her immortal reply: “He would, wouldn’t he.”
He would, wouldn’t he. The Rice-Davies principle. Much (most?) of what people say and do in politics and in life can be most readily understood by appreciating their incentives, by understanding what they have to gain or lose.
He went on to mention the work of economist James Buchanan in researching such incentives in the public realm.

Finally, to complete my parcel of evidence, came a private conversation with a friend that ranged over these banking scandals and touched on the work of a mutual friend, Arnold Kransdorff, who writes about corporate memory and the perils of losing those memories. My friend then observed that there is nobody left in any senior position in the City of London who remembers the pre-Big Bang world. And there you have it.....

In those old, forgotten days, incentives were lower (still high but not so high) and an individual's reputation for integrity mattered - if you were rumoured to be a bit shifty then you were shunned and struggled to do business with or work for a City firm. What has happened since 'Big Bang' is that the rewards for success have grown so dramatically that they have overwhelmed the role of integrity as a restraint and have made it far more worthwhile to take the risk of being caught doing wrong.

The answer...? It comes from the top. First of all, the top team must talk about values and set an example and must live the talk. Too often the prime wrongdoers are the guys at the top. When they are seen to take outrageous rewards then you can hardly expect the little guys not to try to feather their nests too. But assuming a good example is set from the top and that they talk about values, promote values and reward values then they must also punish wrongdoers - when they get away with it then that encourages others to cheat. Secondly, rewards and incentives must be reduced to reduce the incentive to cheat. It is hard to do, seems to go against liberal economic sense but in the long run these incentives are not sensible because they encourage behaviours that have a massive long-term cost when you all get caught. Some of this is discussed in a book, The Value of Talent (due to be updated next year).