Drones and non-drones

Over the years, social experiments have shown our willingness to help people in trouble diminishes dramatically when we are standing in a crowd.

According to research, we help an injured person on nearly every occasion, when we are alone. But the arrival of four bystanders cuts our interventions to 30% of the time. As crowds get larger, response times diminish further.

The theory runs that the presence of others diminishes our willingness to take individual responsibility for things. We become “social loafers”, expecting someone else to step in. We don’t want to look like a fool when nobody is doing anything. We want to conform. It takes a determined activist to do otherwise.

This behaviour has serious consequences in the corporate world, when chief executives are given too much rope. This is because, as economist Daniel Kahneman points out in his recent book Thinking Fast, and Slow, their minds operate in ways that are dangerous if others fail to intervene.

One, which Kahneman calls System One, operates on a day-to-day level, reacting automatically to events around us. It tends to take a sunny view of life, giving us the confidence to move forward. As we saw was the case during the credit boom.

The other mental process, System Two, analyses complex situations but fails to kick in when System One is ticking over without intervention.

System Two is averse to making a loss and wary of danger. Once engaged, it can be hard to switch off for a while, as we all found out after the credit crisis.

Chief executives take an optimistic view of life because they are driven to keep their businesses moving forward. Kahneman quotes a survey that shows US small businesses have a 35% survival rate after five years. In a separate poll, he notes, 81% of entrepreneurs put their chances of success at 70%. They were clearly failing to engage System Two. No doubt they did so, later.

Veteran corporate governance campaigner Bob Monks has just written a book called Citizens Disunited, concerning the abuse of power by US chief executives.

Over the years, he has witnessed the abject failure of crowds of institutional shareholders to restrain the optimism of chief executives. More often than not, the only people prepared to bring them to account were big investors with, say, 10% or more of the equity. Alternatively, they were the families who founded the business.

Either stood to suffer considerable financial or emotional damage or both, if things went wrong. Unlike their chief executives, they both engaged System Two.

Monks calls companies lacking input from big investors or founding families, drones. He has found that 269 companies in the S&P 500 index can claim this dubious status.

His data suggests drone chief executives, on aggregate, are paid more than non-drones. They are more likely to double up as chairmen. They suffer more regulatory infringements. They are more likely to avoid taxes, sack workers and freeze their pension plans. They are more likely to have played internal politics by rising up through the ranks. Their non-executive directors only have relatively small stakes in the business. They are more likely to be influenced by lobby groups. They are more likely to sit on each other’s boards. It goes on.

The evidence suggests drone chief executives are playing politics, rather than building a business. Rather than investing for the future, they are sitting on cash. And the stock market is starting to realise something has gone wrong. In the five years to July 2012, shares in S&P500 drones only rose 34% against a 42% rise for non-drones. Activist investors are on the rise.

Listed family companies are a decent proxy for non-drone corporations and you don’t need to look too hard to find success.

Research carried out by March Group of Spain has found listed family companies in Europe generated an annualized return of 13.6% over the decade to 2010, against 8.6% from non-family companies.

Oddo Asset Management of France has published similar data. Tokio Marine Asset Management of Japan has discovered that listed family companies in the Topix index have outperformed over 20 years.

Families are not perfect. The business dealings of certain oligarchs from the former Soviet Union are less than edifying. Family businesses in the West can have a range of systemic failings, including a lack of entrepreneurial zeal.

Most of the time, however, families do well because they care more about their businesses than their pay packets. And research by March Group has also discovered businesses perform best of all, where families hire third-party chief executives to run them, thus meshing together System One and System Two in a way mere drones can never hope to emulate.