Whose Risk Counts?

And how academics could be a bigger part of the solution

Dr Raj Thamotheram CEO, Preventable Surprises

Visiting Fellow, Smith School, Oxford University

Canterbury Christ Church University 19th February 2014

DIAGNOSIS

Pension members are getting a raw deal!

•  Dutch/Danish young person can expect a pension which is at least 50% higher than a British young person would get. (Tomorrow’s Investor Project, RSA)

Thanks to Heather Hachigan

Not transparent & big questions about value for money

Economies are becoming more dysfunctional

CFOs will trade off practically everything to protect the quarterly number

More bubbles, more damaging

Kay Review: investors are driving corporate short-termism

McKinsey & Co and CPPIB: “short-termism is undermining the ability of companies to invest and grow, and those missed investment, in term have far-reaching consequences, including slower GDP growth, higher unemployment, and lower return on investment for savers.”

7

The Eco-Resources Crunch

s

“The hallmarks of tomorrow’s world will be scarcity – of land, oil, food and ‘air-space’ (for greenhouse gases)”

US NIC, 2008

The Great Disruption

The ‘Perfect Storm’ (UK Government Chief Scientist, John Beddington, 2009)

[Climate change risk] “should compel all elected leaders to take immediate action”

Mayor Bloomberg, 2012

“Why the World Faces Climate Chaos”

Back to the Future = Exploding Inequality & Extremism

“A hungry man is an angry man” Bob Marley

http://www.guardian.co.uk/world/2013/apr/01/greece-golden-dawn-global-ambitions

(0:00 – 1:05)

WHY AREN’T WE RESPONDING?

“the crisis is in implementation” Kofi Annan (2002)

The Key Question!

Accenture http://www.guardian.co.uk/sustainable-business/video/peter-lacy-business-strategy-sustainable-investment-systemic-change?INTCMP=ILCNETTXT3486

(0:35 – 3:30)

Unilever http://www.reversethefuture.org/discussions/47/resource-efficiency-shareholder-value/

(25:20 – 26:57)

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How Are We Doing – Views From The Frontline

Investors = 1° enablers of dysfunction behaviour

“[…] the destruction of shareholder value through legal means is pervasive, perhaps even a routine way of doing business.

Indeed we assert that the amount of value destroyed by companies striving to hit earning targets exceeds the value

lost in these high-profile fraud cases.”

John GRAHAM, Campbell HARVEY & Shiva RAJGOPAL “Value destruction and financial reporting decisions”, Financial Analysts Journal, Vol 62 No 6, 2006

“Investors don’t care about Sustainability” Business Week, 9th Nov 2010

(Global Compact / Accenture survey)

Investors are more important than even regulators in shaping directors’ priorities.

PwC, Annual Director Survey 2010

Thanks to Inflection Point Capital Management

Processes & Reporting Aren’t Delivering Outcomes!

PROGNOSIS

Happy  Imbeciles    Suppor2ve  Pessimists      Denialists    Market  Efficiency  Fundamentalists  

Sustainability  Smooth  Talkers  

Five (Financial Sector) Patient Categories

11 fatalities 17 injuries

Latest BP cost estimate $40 billion 30% share price drop 1-year suspension of dividends

“The Dominant Narrative” – the BP version

"It's very dangerous to join up dots that may not be appropriate to join up" Tony Hayward

“I left BP a long time ago, four years” Lord Browne

“an Act of God” Rick Perry, Governor of Texas

The dots we shouldn’t join up…

Source: Yahoofinance.com “

“

Up until April 19 [ie the day before the Deepwater Horizon explosion], his [BP’s] performance was excellent. An investor close to BP quoted by The Financial Times, July

25th 2010

Texas Refinery Accident

Texas Refinery Accident

Alaska Oil

Spill

Azerbaijan Gas leak

Violations Of Clean Water Act

Penalties From the

OSHA

Gulf of Mexico Oil spill

Thunder Horse

Accident

Charges for Manipulation

Of gas market

Grangemouth 2000

How much attention did “sell-side” pay to safety?

Before the oil spill, 6 occurrences every 100 pages = the vast majority of reports do not talk about these risks at all.

“Analysts are biased”

Analysts claim that BP has a good operational momentum because of its “first-mover advantage in cost cutting”

5 = buy or strong buy recommendations 4 = add, overweight, outperform and accumulate 3 = hold, perform, neutral 2 = reduce, underweight and underperform 1 = sell or strong sell

Source: SHEFRIN Hersh, CERVELLATI Enrico Maria, “BP’s failure to debias: underscoring the importance of behavioral corporate finance”, 21st February 2011

Are asset owners & “buy-side” much better?

Sadly, no! Only 60% of capital voted at BP’s 2010 AGM 57% of votes in favour of chair of safety committee! (Only leaving in 2012!) Even proxy voting agencies recommended abstain (ISS) or vote against (Glass Lewis)

Source: BP plc, ISS ProxyExchange

Today’s ESG Doesn’t Address “Preventable Surprises”

Narrow Conception of risk

Shareholder value

fundamentalism

Weak concern for negative externalities

Regulatory capture

Leadership & Governance

failures Organisational Learning disabilities

Ineffective regulation

Focus on riskier

and dirtier O&G

Outdated approach To safety

Weak safety culture

M&A and Outsourcing/SCM

Saviour CEO

SYSTEM O&G SECTOR BP

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Screening vs Stewardship – the Balance is Wrong!

Integration

Incorporate ESG analysis into

investment decisions

Stewardship

Monitor, Vote & Engage to promote

LT success

Investing

Responsibly &

Sustainably

What is it RI?

   

Copyright © 2011 Richard Leblanc. All rights reserved.

Research and Practice 25

Copyright © Richard Leblanc. All rights reserved.

Corporate Governance Failures Galore!

Companies

Investment  Managers

Investment  Consultants

Pension  Funds

Pensions

Mandate  +  contribu2ons

Advise Fees

Mandate  +  fees

Returns

Selec2on

Informa2on

Informa2on Informa2on Fees

Brokering

Deals

Fees

Informa2on Investment  Banks

Sell-­‐side  Analysts

An Overly Intermediated System

Sunday Times, May 6, 2012

“The bulk of incremental financial activity is trading, and trading, while it may provide a little useful public information about market opinion, is largely a way to transfer wealth from those with inferior information and calculation ability to those with more. There is no enhancement of economic efficiency to speak of.” Robert Solow, the Nobel prize winner and an MIT Emeritus Professor

Momentum Investing is Out of Control!

Majority of Investors Have No Reason To Care!

Intrinsic investors Deep understanding of strategy/sector More like to support management thru ST volatility 20% of market 4-10 positions

Mechanical investors Mathematical formulae (incl index & closet index) Supporting or not supporting management isn't part of their reality 30% 100-150 positions

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Traders Bet against market with regards to news Interested in earlier access to better news

35% 20 positions

Adapted from McKinsey & Co

TREATMENT

Incremental Progress vs. Fundamental Change

•  Frederic Mishkin, Professor, Columbia Business School http://www.youtube.com/watch?v=8lHvTKzfu8Q&feature=player_embedded#t=0s

•  Glenn Hubbard, Dean Columbia Business School http://www.youtube.com/watch?v=CaXNqGgIc-g&feature=player_detailpage#t=6s

What academics should avoid doing!

But Good Guys Can Also Mess Up!

Be Brave! (Jeremy Grantham)

“Scientists are understandably protective of the dignity of science and are horrified by publicity and overstatement.”

Challenge Convention (Alice Stewart) “Pioneering woman scientist whose research into the dangers of x-rays and nuclear radiation shook the Establishment” (GUARDIAN OBITUARY) "We have already doubled the level of background radiation today. What is the effect on human genes? That is the really important question: it won't show up for two or three more generations.”

Approx. right vs precisely irrelevant! (Anat Admati)

http://www.preventablesurprises.com/ Some take-aways: •  Avoid paralysis by analysis

•  Be approximately right, not precisely irrelevant

•  Manage one’s own anxiety about peer criticism

“Bridge the Gap!” (Campbell Harvey)

“Often academics don’t know the important problems facing industry” Survey methodology to bridge the gap Disguised the real question Big impact – earnings management isn't primarily by accounting but rather by cutting budgets 1900 Google cites (2006 paper)

Look where the keys were lost, not where there is light

•  Analysis of PRI Academic Network 66 papers from academics past two conferences (2011 and 2012)

•  1 of the 66 papers focus on the ‘gatekeepers’ of information (sell side, credit ratings, investment consultants).

•  15 of 66 address systemic problems (behavioural, cultural and institutional)

•  7 of the 66 papers address public policy  •  What is getting attention? Doing well and doing good- that is, how integrating

ESG can lead to better financial performance, using the same old models.

•  E = G > S

•  Fundamental investors > Index Investors

•  Stock picking/valuation > Stewardship

Thanks to Heather Hachigan

Thank you for listening!

“Homo Financialus”