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Social responsibility and finance - on the precipice

Date: 27 Nov 2011
Author: Mallen Baker

Jack Welch

Social responsibility and the business model

When the credit crisis first broke, there seemed a real chance that some pretty fundamental questions would be asked - not just of the banking sector but of business more widely.

Former sharks for the principle such as retired GE boss Jack Welch came forward and said that maximum shareholder return was a pretty dumb main purpose for business. After all, it is a logical impossibility for all companies to achieve "above average returns", but that was what they were stating as their aim. French president Sarkozy and former British prime minister Blair held a summit that looked at such questions.

And the drive for 'above average returns' was a key driver for short-termist thinking.

As was the common device of tying CEO bonuses to stock price. Factors that affected stock price in the short term were not always those that benefited the health of the business long term. Although it was a tool that was meant to align the interests of the shareholders and the executive management, it actually created perverse incentives that fed the impossible spiral.

And lots of people knew that it was impossible, that it couldn't last. But then the logic of the potential short term gains led them to ignore this information. As former Citigroup head Chuck Prince said: "So long as the music plays, you have to keep dancing". Because if you stopped before the music, you would be out on your ear for failing to deliver.

In the event, Chuck Prince was out on his ear anyway once the music abruptly stopped. By then, he had been paid enough to survive that outcome pretty well.

But the focus on business models, and incentives, and all those things that had led to the crisis became replaced by a focus on individual executives who could be blamed and sacked. And plenty of those bankers remaining began to regain their confidence that all they had to do was tough it out through the storm and business as usual beckoned on the other side. Bankers bonuses stayed high, and became the focus for criticism - again, at the expense of the real issue.

So the question is how bad do things have to get before we can see the real issue clearly? And that is that social responsibility needs to be built into the business model of financial institutions. Those banks that fulfil an important social function cannot be allowed to operate on the principle that they exist to provide maximum returns to shareholders. They may be able to provide a fair return to shareholders - and if that comes with lower levels of risk, there may be plenty that will gladly accept that deal.

According to Peston, European banks will need to find an estimated 810bn euros next year to repay loans (British banks own 110bn euros of that). Something is going to have to give.

If the crisis is inevitable, we need to grasp the opportunity it provides. If our response to government default, banking meltdowns and system failure is to blame a few bankers we will deserve everything we get.


[This feature was originally produced as a themed article linked to Ethical Corporation's Finance Summit]

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If the crisis is inevitable, we need to grasp the opportunity it provides. If our response to government default, banking meltdowns and system failure is to blame a few bankers we will deserve everything we get.

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