Just before conference I caught some largely unreported news on a Private Member’s Bill, put to the Commons by Steve Baker MP, founder of the Cobden Centre, and one of the Conservative 2010 intake.
My usual response to scant coverage of a Conservative backbencher’s bills would be thankful, but in this case, the bill highlights something that has received astonishingly little attention: reforming the personal liability of directors. We’ve rested on the important points of how to discharge shares in effectively state-owned institutions, and how to increase lending to struggling businesses. On these issues Stephen Williams and Vince Cable have been great. But it’s not enough.
The organisation of financial services is not just academic. The detail is technical, but the perception of unfairness when gains are private and losses are public is real. I’m not the only activist to have had heard these sentiments in meetings and on doorsteps. While it’s easy to become distracted into argument with those who argue that financial services are inherently evil or could do with permanent nationalisation, they occupy the debate because no alternatives are presented. Public outrage is justified.
Liberal responses are required, and we should be interested in some of the appealing points raised in Baker’s bill. He wishes to see a reinstitution of a system of director responsibility: making the people who take decisions personally liable for losses through personal bonds. There’s often a great deal of risk involved in investment, but unlike the owners of a business, directors of investment banks are fairly unlikely to be financially devastated by unwise decisions. This is a system that the UK’s major banks emerged under, which existed in some cases well into the latter half of the 20th century. It is perhaps our best deterrent against the moral hazard of decision-makers without personal responsibility.
We are at our best when we protect people from unaccountable power, whether in overbearing government or businesses whose capitalism does not extend to losing money. We should reject corporatist relationships with big business, and not pretend that government can perform all regulation. People should value the work of most of the financial sector in facilitating lending, investment and valuable speculation. So long as they feel wronged, that won’t happen, and we’ll be left with a poisonous political atmosphere.
A Lib Dem proposal of this nature would never be identical to Baker’s bill. We instinctively favour more regulation than Conservatives, but self-regulation can do a lot of that job when financial failure carries genuinely punitive disincentives. We would be left with a more reliable and trustworthy banking sector, and in the event of losses, shareholders and the public could at least be spared the injustice of seeing those poor decision-makers in a comfortable state. Ironically Mr. Baker’s own party are unlikely to support him, for reasons Stephen Tall’s analysis of party donations makes relatively clear. Liberals should be placed perfectly to capture the public imagination, and find the political edge that the ‘Sage of Twickenham’ had in 2008.
Mike Bird is the newly appointed Co-Chair of Liberal Reform, who held their launch event on Saturday evening in Gateshead.
* Mike Bird is the Chair of Liberal Reform
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11 Comments
Almost completely agree Mike.
The issue of limited liability for large financial firms and their directors is a very interesting one. You used to require an Act of Parliament in the 19th century to get limited liability and Gladstone was very averse to granting it for these reasons (I dont think we should return to those days its just an interesting point to note).
On the point of shareholders rather than just directors as you talk about:
If you own shares in a massive bank and have no intention at all to pay any attention to which non-execs are elected on to the board, how much bonuses are being paid, which regulatory structure the bank picks etc…which tbh I assume nearly all shareholders in banks act this way (not least because a lot of them are held for very small amounts of time.
Then why shouldn’t you be liable for at least some of the debts that are incurred if that big bank goes bankrupt, innocent non-rich individuals lose out and yet you get to walk free only losing your share value when you did nothing to stop it.
All the gain and very little risk, it would be nice to introduce a bit more risk into owning banks so that people self regulate to a degree, theres very little incentive to now.
Of course one way to engender director responsibility is not to bail out the companies they direct when they run out of money…
Good to see a thought provoking piece from Liberal Reform.
However, I would not support this approach. It seeks to further regulate the ‘status quo’ whereas the Lib Dem view – most notably from Vince Cable – has been that the banks should be split. This could achieve a separation between ‘good’ lending (even if it loses money) and speculation.
Yes, Graeme, and now banks are being restructured so that an investment arm going to the wall doesn’t take ordinary people’s savings with it, that’s a much more realistic option than it was a couple of years ago.
Looks like a good idea to me.
There is a big opportunity for Liberals to take the sides of the risk-takers, those who genuinely stike their livelihood and usually their house in order to create wealth. I have no problem with such people reaping the rewards. This looks like a step towards redressing that balance.
Making auditors more accountable to shareholders would help, too.
Fascinating historical note by Joseph, BTW.
Interesting idea.
Like you say, there’d be less need for self regulation in some areas if directors accepted some of the risk from their decisions.
Can you get into a bit more detail on how it would work?
I don’t currently know what “Personal Bonds” are, how they would relate to the success of the company and how they would affect the director.
You are talking about scrapping the idea of a limited liability company. There is some merit in that idea as an end goal, but since this would turn the entire world of business upside down, the resulting economic chaos as every company reorganises to manage risk would probably wreck what little economic stability we’ve managed to gain.
So, without disputing the interesting nature of your end goal here, you’re going to have to think of a way to do it slowly and smoothly before we can really discuss this.
Perhaps instead of the general spectre of “all forms of financial failure”, you could come up with something based on specific, avoidable behaviours?
Also, be wary of expecting “self-regulation” to work out neatly: this would cause businesses to become far more fiscally conservative and risk-averse, and hence cause mass redundancies. You’re not going to get away with that unless the economy can pick up the slack and prevent this from turning into mass unemployment.
Completely wrong I’m afraid Mike. There certainly is a lot to be said for making senior managers have more of a stake in the results of the decisions they take but that has already happened by making 60% of there pay be in shares ,, vesting over a number of years.
There is by the way no evidence that this will make any difference – Lehman’s and Bear Stearns both had very high level of employee ownership and it made not a jot of difference to their appetite for risk.
The danger of personal bonds is that there is no upside to them so they would simply incentivise low risk behaviour. Why lend to SMe’s for example when you can end to high rated corporates or governments ?
Simon – the bonuses being in shares means the value of their bonuses can decline. But that’s hardly a loss, is it? There’s not meant to be an upside to posting personal bonds – it’s meant to disincentivise high-risk behaviour. If you subscribe to the economics that Baker does, and to some extent I do, then that easy credit causes malinvestment.
And actually, as for there not being evidence…
http://knowledge.wharton.upenn.edu/papers/232.pdf (“We show that the optimal exposure to risk of the limited liability firm is always larger than under full liability.”) or,
http://economics.ouls.ox.ac.uk/14265/1/paper453.pdf (“Risk-neutral individuals take more risky decisions when they have limited liability.”)
I don’t have the education to understand the mathematics, but the conclusions are pretty clear, backing Smith and Friedman’s conception of the personal risk deferred by limited liability. You’re probably right about lending to SMEs – but Baker addresses it in his FAQs: “One should bear in mind that many of the ‘profits’ reported in recent decades were merely returns to excess risk-taking, which were then more than offset by subsequent losses when those risks turned sour.”
@Andrew
You raise a good point about limited liability, and the truth is that it needs more thought. However, as I mentioned to Simon, the general point is that investment practices become more conservative and restrained. I think it’s right that we thoroughly debate whether the flux of financial crisis is worth the employment it provides (at times)
@William
It’s an interesting idea but it’s generally being looked into in the case of banks that are essentially nationalised. When that’s the case, the failure has already occurred, and it’s really too late for a scheme like this, which is preventative rather than reactive.