Bowing to shareholder pressure can be costly

There is a fascinating piece in the latest issue of The Atlantic magazine called ‘Stop spoiling the shareholders’.

Contrary to conventional wisdom, it found companies that had a very accommodating approach to shareholders’ concerns have a poor track record in delivering long-term shareholder value.

In fact, companies that have a culture of putting shareholder value at the top of its priorities have limited upside potential. Or, as the piece states quite bluntly, “big banks that emphasise return to shareholders above all else have been shown to be menaces to society.”

Certainly there is a good argument to be made that caving in to shareholder pressure played a key role in the demise of the Irish financial sector. At AIB’s 2001 AGM, restive shareholders rounded on the bank’s management team. Their grievance was not that AIB was taking too many risks with their money — rather it was that bank was being far too conservative.

The then chief executive of Anglo Irish Bank, Seanie Fitzpatrick, was cited as the lead to follow. Anglo was generating hundreds of millions in profits through its bankrolling of the surging property market. Its share price was on a steep upward curve.

Following that fateful AGM, AIB, which was then the biggest bank in the State and which had been conservatively managed for most of its history, embraced risk-taking with abandon. It became heavily exposed to the property market. The bank is now nationalised having soaked up roughly €24bn of taxpayers’ money to cover losses shipped since the property market crashed in 2008.

Bank of Ireland was also badly damaged by its exposure to the property crash although, overall, it has fared much better than AIB. It is only 15% State-owned and it looks like it will be the first of the covered banks to return to private ownership and profitability.

The banks were not the only companies to chase topline growth in an effort to appease shareholders, but the consequences were much more damaging than elsewhere in corporate Ireland. The thriving bonus culture was pegged to short-term and ultimately unsustainable lending and other profit targets.

Now AIB’s main shareholder is the Government. Bank of Ireland has a number of large institutional shareholders, including Wilbur Ross, as well as the Government.

The CEOs of the main domestic banks were before the Oireachtas Finance Committee over the past week. Shareholder pressure is having a huge bearing on the resolution of both banks’ mortgage arrears problems.

AIB is ultimately owned by the taxpayer, which means that it will come under much more political pressure to write down mortgage debt. However, it also has to preserve capital and return to profitability. It will be a careful balancing act.

Perhaps reflecting its much lesser dependence on the State, Bank of Ireland has ruled out debt forgiveness.

In the longer term, both of these banks will have to operate in an environment that will be very different from the one which existed in the lead-up to the financial crisis. There will be a more intrusive regulatory environment with the advent of EU banking union, and much higher capital requirements as part of the Basel III framework.

But, over time, and as the memory of the financial crisis recedes, the pressure will mount on all financial institutions to take greater risks to boost returns.

That is why it is crucial to create a culture that rewards sustainable growth pegged to much more medium-term performance targets. Short-term targets that are very much in favour with shareholders can have disastrous consequences.