Ken Henry ponders the state of capitalism – and agrees it's not pretty
Ken Henry's soliloquy on the state of capitalism provided one of the more philosophical moments in an at times testy appearance before the banking royal commission.
The counsel assisting, Rowena Orr, perhaps erred when she asked the National Australia Bank chairman a rather open-ended question as to whether the bank was too focused on shareholders at the expense of its customers.
Henry said the question went to the behavior of businesses and what motivated them; the things that boards held themselves accountable for the conduct of their businesses.
"It goes to the state of capitalism," he pronounced.
"The capitalist model is that businesses have no responsibility other than to maximize profits to shareholders," he said.
"A lot of people who have participated in this debate over the past 12 months have said that all that you should hold boards accountable for is that they are focused on the maximization of profits for shareholders.
"Now, of course, some people will say: 'but that does not mean that you can mistreat customers, because doing so might be the interests of … the short-term interests of shareholders, but not in the long-term interest of shareholders. '
"But even that approach sees customers as instruments in an instrumental fashion; that the customers are seen as the means by which shareholder profits are secured rather than the customer being the focus, what the business is actually all about. ''
He said some saw customers as the means to an end rather than as an end in itself.
Rather than positioning the business to maximize shareholder returns, subject to customer and regulatory tolerance, NAB's purpose today was to maximize the outcomes for customers, subject to financial viability. He described that a "profound distinction" and "a monumental shift."
The view of customers and shareholders as competing interests, where the sole responsibility of a business is to maximize shareholder returns, is a rather crude and antiquated one.
Most businesses now recognize – and the fact of the banking royal commission underscores it – that they need a social license to operate. Indeed, they have to deal decently and fairly with customers and suppliers, and comply with the law and regulations if they are to survive.
There is, however, a tinge of reality to it that Henry would have first-hand experience of.
There have been pushback from some institutional shareholders in recent years when companies have tried to include non-financial and / or subjective measures in their remuneration schemes.
Last year's "first strike" against Commonwealth Bank's remuneration report and its plan to give social metrics equal weighting with financial metrics within its variable remuneration assessments was referred to by Orr.
Some fund managers, with business models that provide incentives for prioritizing their own short-term performance, want a near-term alignment of shareholder and company interests; one focused on near-term shareholder returns.
NAB itself recently restructured its executive remuneration scheme, generating a mixed response from the market.
It has collapsed the short-term and long-term variable remuneration for its executives into a single reward, 40 per cent payable in cash at the end of the financial year and 60 per cent in shares that can not vest for four years.
The metrics that will shape and determine the size of the executives' reward pool and how it is distributed include the results for the customer and the risk and regulatory outcomes as well as financial metrics. Risk and compliance outcomes are the "gateways" that the bank has to clear before any performance-related incentives are awarded.
It will give the board far more discretion – and far more responsibility and accountability for the results.
'Enough is enough'
In tandem with the Banking Executives Accountability Regime, where individuals responsible for various key bank functions are identified and held accountable – and liable- for their compliance outcomes, the incentives granted ought to better reflect individual performance on both financial and non-financial issues.
The nature of the remuneration structures the banks are trying to put into place in the context of the royal commission's airing of their dirty linen and the resistance to the inclusion of non-financial metrics, says that Henry's moodings about the state of capitalism are not quite as anachronistic as they might initially appear.
The proof of the pudding, of course, lies in the eating. Company executives tend to see variable pay as all upside with little downside. Despite what's been broadcast of their behaviors by the royal commission, bank executives have still tended to be granted the bulk of their incentives.
NAB chairman Dr Ken Henry tells the Royal Commssion the board should have told management "enough is enough".
If NAB is truly elevating customers, risk and compliance outcomes ahead of simple total shareholder returns, it's successes, or failures, ought to be measured as much by the rewards it does not hand out – to executives and to shareholders – as by those it does.
There's likely to be (and already is) a near-term cost to the shift in focus towards customers and compliance and away from a fixation with total shareholder returns.
If the banks and other major financial institutions that have been savaged at the royal commission do not make that shift, however, there might not be much of a longer term future for their executives, or shareholders.