Thursday 6 February 2014

Stewardship: the natural evolution of fiduciary duty?


In the wake of the recent financial crisis and the subsequent Kay Review into long-term decision making in capital markets, the Law Commission in the UK has been charged with performing a root and branch review of fiduciary law. This is a huge opportunity to inspect the essential plumbing of our modern democratic capitalist system.

Getting there from here       

The long-running debate over fiduciary duty reminds me of the familiar joke about asking for directions from a less than helpful local: “if I was going there I wouldn't start from here.” Those of us who look at fiduciary law through the lens of business ethics may wish we could uninvent it and simply start afresh. To do so we need the collective moral imagination to conceive anew the nature of the fiduciary relationship; not in a way that dilutes or diffuses accountability but instead clarifies and strengthens it. It is to view the fiduciary relationship as just that, marked by mutual trust and respect.

The notion of a fiduciary can be greatly enriched if we reassert our shared humanity into real-life economic relations. As we do, the relationship between ‘self’ and ‘other’ is free to evolve into something we might usefully call ‘stewardship’. It is a phenotype of the fiduciary genotype. A steward inherits the same essential traits of a fiduciary: service to others. But unlike its forebear a steward can be trusted to do so. The real task for the lawyers is to figure out how the legal framework can facilitate the development of trusting relationships, rather than simply seeking to enforce them. I suggest the ascent of man-as-fiduciary towards man-as-steward proceeds through five evolutionary generations.

1 - Fiduciary Duty: to serve the interests of an other

Grounded in the principal-agent view of contracts in financial economics...

  • Interests are ‘given’ and delegated by the principal to an agent with requisite skills and specialist knowledge.
  • In its narrowest terms, the ‘interest’ is in private property – an asset over which a legitimate property right exists.
  • The interests served by the fiduciary are the ‘self-interests’ of the principal only.
  • Agents are similarly motivated by self-interests and are inherently self-serving and opportunistic.
  • The agent-as-fiduciary must be incentivised, including by force of law, to serve the self-interests of the principal.
  • These mechanisms are sub-optimal; they impose agency costs on contracting.

According to the basic economic model, the principal is an isolated individual, save for his entrusted agent. No other relationships are necessary to the standard agency model. Using his specialist knowledge or skills, with some degree of discretion, the agent-as-fiduciary is expected to act prudently and in the best interests of the principal; exercising the sole virtue of undivided loyalty with respect to his self-interests.

Of course this is simplified picture of real human relationships: both parties are in reality situated in a wider social setting. And even those who would defend a narrow concept of fiduciary duty concede that fiduciaries must at least respect the legal and social norms of civilised behaviour. This is to admit that principals and their agents stand in relationship with not just one but a range of others. It is the case that the fiduciary relationship imposes special obligations on fiduciaries. But contracting takes place in a wider social milieu in which others may also assert certain claims or rights. In some cases, these rights might be secured by a corresponding duty of care on fiduciaries to take reasonable steps to avoid inflicting harms on third-parties (the common law tort of negligence). Participation in civilised society attaches at least some minimum duties beyond those explicitly expressed in private, legally enforceable contracts. Both principal and agent are economic and moral agents.

As my local MP, Jesse Norman, recently remarked in the Daily Telegraph, making profits has never been the sole duty of companies, or the fiduciaries that run them. Indeed, if companies' only responsibility were to maximise shareholder returns in the name of financial wealth creation, society should happily allow them to avoid tax and shift environmental costs on to someone else to the maximum extent permitted by law. But it doesn't and for good reason. As social institutions business cannot afford to ignore the norms, expectations and indeed values of wider society. Arguably it never has.

2 - Enlightenment: the interests of the self are tied to those of others

Thus, the principal as a nexus of relationships...

  • Self-interests are given but contingent on those of others.
  • Human behaviour and conduct is governed by institutions, formal and informal.
  • Property is a ‘bundle of rights’ which includes control surrendered to a fiduciary.
  • Rights and duties imply mutually respected reciprocal obligations.
  • Contracts may be explicit and implicit.

The simplifying axioms of economic rationality and behaviour have never been seriously advanced as a full and accurate portrayal of the human condition. Neither are the assumptions made for the purposes of economic analysis intended to faithfully describe the richness of human experience, character or motivation. And neither are they normative. The self-interests of rational economic actors are 'enlightened' only by the acknowledgement that humans do not live isolated existences. Our actions and decisions usually affect others; and the behaviour of others usually affect us. We cannot so easily isolate the interests of ‘self’ from those of ‘other’. Moreover, just as self-interest should not be confused with greed, neither should enlightened self-interest be viewed as a form of altruism.

The duty of the enlightened fiduciary is to still to serve the self-interests of a single principal, though now aware that his actions may have consequences for others too. To the extent that those consequences may be detrimental to the interests of the principal, either now or in the distant future, they must be taken into account by the fiduciary in the exercise of his responsibilities. Nevertheless, it is stretching the point somewhat to suggest that either actor has somehow become 'socially responsible'. The principal is still motivated by the interests of 'self'; and the enlightened fiduciary is still bound by the duties of prudence and loyalty to serve those interests alone. And as long as human behaviour is governed by the assumptions of agency theory he must be suitably incentivised to do so. Trust remains at a premium.

And so does legitimacy. Now ‘enlightened’ to the wider interests, claims, and duties of countless others the principal is obliged to instruct his fiduciary to ‘take account’ of them. On receiving such an instruction, a loyal fiduciary must nevertheless seek to preserve the self-interests of the one he serves. The interest of the principal must come first whenever a conflict arises: at least until he is expressly instructed otherwise. At best he can try to balance the principal’s interests in the long run with those of others who might be affected by his actions. If they are really to count at all, the interests, claims, rights, etc. of others matter only in a ‘tie-break’ between two alternative courses of action. If the interests of the ‘self’ and ‘other’ can be mutually advanced that is a real bonus.

And so the enlightened fiduciary’s job has just got a lot harder. In the pursuit of the principal’s best interests he is to try to balance or reconcile the interests of others with his principal duty towards the best interests of the principal. The enlightened fiduciary is now accountable to one - and all.
     

3 - Stewardship Theory: serving a common interest

Towards a revised ‘model of man’...

  • A richer view of human nature and motivation.
  • A steward makes the interests of the ‘other’ his own – psychological interest alignment.
  • A focus on the content of human relationships: trust and respect.
  • A common interest implies a shared goal.

Once the simplifying assumptions of agency theory are relaxed, a less pessimistic and perhaps more realistic view of human motivation is allowed in. It is one informed as much by psychology and sociology as economics and legal theory. According to stewardship theory, a steward is someone who receives greater satisfaction (or ‘utility’) from serving the interests of the principal than by simply serving his own. Indeed, a steward is a trustworthy agent precisely because he has made the interest of an ‘other’ his own. The principal and his agent, once in a stewardship relationship, in fact share a common interest. But, one might ask, an interest in what exactly?

This insight from stewardship theory goes further than the ‘enlightened’ realisation that we can’t entirely isolate the interests of ‘self’ and ‘other’. Real people – not autonomous ‘agents’ – are motivated by the things they believe in or 'value' as important, fulfilling or meaning-making in their lives. Stewardship shifts the emphasis from external mechanisms of control and enforcement to the personal motivation of an ‘agent’ and the intrinsic rewards he receives from performing his duties. The task of the principal is to inspire a genuine commitment to the sort of shared goal that can satisfy the ‘higher needs’ of a steward.

4 - The Stewardship Chain: recasting both principal and agent

Mutuality of interests allows accountability to flow in two directions...

  • Extending the principal-agent relationship upwards and downwards
  • Corporate stewards as public fiduciaries
  • Who is the principal at the end of the chain? 
  • The steward-steward relationship
  • Discovering our shared values

Apart from recognising the possibility of a genuinely aligned interest in a mutually agreed goal, stewardship theory permits an extension of this relation from two to multiple actors along a 'stewardship chain'. Each pair of actors along its length may form a steward-steward relationship whenever they share a common interest. This of course means a stewardship chain can in theory only be completed if these interests are held in common along its entire length. But where does the chain of delegated responsibilities end and accountability terminate?

Firstly, looking downwards, the chain ends with the ultimate beneficiary owner, for example individual savers in a pension vehicle governed by trust law. As stewards, the company's management have a 'downstream' duty to serve their interests. But looking upwards it is easy to envisage the terminal ‘principal’ as the public at large or ‘society’. Viewed as a ‘public fiduciary’ a corporation must therefore also act in the 'public interest'. In their role as stewards, corporate management therefore have both upward ‘social responsibilities' to serve the public good and downward responsibilities to serve the interests of its owners.

So, although the notion of a stewardship chain may not diffuse accountability as widely as the ‘stakeholder theory’ of enlightened self-interest, a potential conflict of interest nevertheless remains. Moreover, the stewardship chain breaks down completely if interests are not properly aligned along its length and truly held in common. If this happens, we are rapidly returned to a bleak principal-agent world of mutual distrust, shirking and opportunism. Clearly, company management is still in a tight spot.

One way to resolve their dilemma is to see the chain not so much in linear terms with two dangling ends but rather as a loop. The two loose ends need to be tied together through the formation of a stewardship relationship between the owner-beneficiaries and the public at large. Like the companies they own, investors may be conceived as public fiduciaries subject to an implicit social contract or covenant. True stewardship demands the reconciliation of private self-interest with civic virtue, only possible through processes of engagement and moral deliberation in which the interests and values savers share as citizens can be revealed and discovered. The ultimate owners of capital are in fact persons-in-community not autonomous economic agents. Societies and the global community frequently form institutions that express a commonly held interest in certain social 'goods', reflecting broad agreement on the values they share. Why should the same not be true of the dominant social institution of democratic capitalism: the publicly-owned corporation?
      

 5 - Ethical Stewardship: Rediscovering Purpose

From common interests to a shared purpose...

  • A common purpose reflects shared values.
  • Shared values are discovered through dialogue. 
  • Accountability is responsiveness to societal values.
  • A closer integration of ‘ownership and control’.

By inserting the ‘public interest’ into the stewardship chain one can make the normative claim that that both the corporate steward and its owners should both serve the public interest and respect the norms, values, and expectations of society at large. Yet this ‘ethical stewardship’ does not fall into the trap set by ‘enlightened self-interest’and into which stakeholder theory and its various approaches have fallen. That way is marked ‘multi-fiduciary’ and is indeed a paradox. While enlightened self-interest is a welcome riposte to the cruder and narrower interpretations of fiduciary duty, ethical stewardship is in fact closer in many respects to the Friedmanite account of corporate responsibilities.

Ethical stewardship, then, adds to a commitment to service and genuine accountability a strong sense of purpose. Purpose is a motivator. It is how human beings derive a sense of identity, fulfillment and meaning in their lives. The formal purpose of an organisation may have been originally defined by its founders and former owners or through a process of engagement with its current owners. It embodies its values as well as a sense of mission or direction. A shared purpose builds commitment to a common endeavour: it adds tensile strength to the stewardship relation.

Little wonder that companies have rediscovered their interest in the question posed by Charles Handy: “what’s a business for?” It is a question that the Corporation 2020 organisation in the US has set out to answer with welcome clarity. And it is one answered in its own way by the B-Corp movement. It is to define the ‘ultimate ends’ of any business enterprise.

Clarity of purpose also establishes clear lines of accountability between those that ‘own’ the purpose and those charged with fulfilling it. Strictly, purpose should be jointly owned. The shareholding owners must 'own' the purposes to which their capital is being deployed. Ideally, the board should be custodians and defenders of the corporate purpose, upholding and protecting it on behalf of its owners. Above all, the corporate purpose must secure the crucial common interest of end investors and the public at large.

There are any number of candidates for a common purpose and the values or ‘goods’ it represents. Stewardship conceives wealth or value creation in broad terms. Individual companies will express it in their own way, with particular reference to the profitable delivery of specific products and services. Profitability is evidence of the wealth created by business through freely functioning markets. A company cannot attract the capital it needs to fulfill its purpose if it is unable to deliver the financial returns required by its providers.

But stewardship also advances a positive ethic of value creation and contribution to wider society, including but not limited to the material and financial. Ethical stewardship doesn't rule out the perfectly legitimate contribution business makes solely through privately accrued financial wealth. But this isn't wealth creation in the broader sense if its financial contribution is outweighed by wealth destroyed elsewhere: for example, through the social cost of environmental damage or unsafe working conditions.
    

Conclusion: The Role of Citizen Savers

The stewardship relationship between corporations and society-at-large is founded on shared values reflected in a clearly articulated business purpose. Corporate purpose establishes legitimacy and trust with the wider public only if it is accompanied by real accountability for its contribution to the public good. In that regard, the advent of ‘integrated’ financial and sustainability reporting is an important new mechanism for ensuring transparency and developing social trust. It means companies must demonstrate that they are serious about being responsive to the needs and expectations of society within and beyond the marketplace.

The crucial stewardship relation is that which must be forged between saver and society. There is no interface between them as such. Rather, one is the simple aggregation of the other. The best interests of the investment beneficiaries therefore can and must be reconciled with the public interest. Savers-as-citizens surely share an interest in some conception of a common good. And they inevitably share the values of the society in which they in a very real sense belong. The corporate purpose simply codifies that reality and articulates a shared commitment to make a positive contribution to society. It is a clear recognition that ‘value creation’ in human terms inevitably has both an economic and moral dimension.

The real challenge for those lawyers revisiting the notion of fiduciary duty is to create a safe environment in which the ultimate owners of companies may pursue their financial self-interest by making investments in corporations with a clear and legitimate purpose. The challenge for corporations is to be genuinely accountable to them alone, and not to try and be all things to all men.