Publication Tomorrow’s Capital Markets: an invitation to work with Tomorrow’s Company to set new incentive structures for a sustainable world

by Luke Robinson _______4th June 2012

Executive Summary

We believe in the ability of capital markets to act in a way that promotes the long-term sustainability of companies. As they are structured today, this is not being fully realised.

Companies and equity markets are key partners.

Companies are the engines of wealth creation for societies. The equity capital markets were formed for the purposes of generating long-term capital for companies, and through the secondary markets, to provide liquidity for the original investors.

We are now in a different era. One where we are facing significant global, social and environmental challenges. Progressive companies recognise that creating long-term sustainable value depends on understanding the interdependency between financial, social and environmental factors. Companies also have the innovative capability and capacity to produce the solutions to many of the challenges facing the world.

There is a mismatch between the financial support the real economy needs and what the equity markets are delivering and the gap needs to be closed to harness the capability of everyone to achieve sustainable development.

Leveraging the financial self-interest of many in the system provides one of the keys to changing the system. Therefore this study has focussed on what changes to incentives are needed to ensure capital markets are better structured to incentivise sustainable business behaviour. Its primary focus is on the equity markets within an Anglo-American context and has involved both a systems level analysis together with a detailed examination of the incentives of the individual players within the system.

We have found a growing appreciation that success should be measured in ways other than just financial performance and that this is starting to flow into how incentives are structured. This momentum for change is welcome but in many cases the current incentives of those in the system still work against the long-term sustainability of companies.

There is a lack of alignment between incentives, the interests of beneficiaries and business strategy.

The criteria on which performance and hence reward is based are still too often founded on financial and market value based measures. In part this is a reflection of the lack of knowledge, understanding, common language and metrics about what drives sustainable performance. Discussions about sustainability often default to ESG, SRI, the ‘green agenda’ or are simplified to discussions about long-term versus the short-term horizons. And for outsiders, it is hard to obtain detailed information on how incentives are structured and designed – there is a lack of transparency. Financial incentives do not operate in isolation – neither are they the only incentives for those in the system. Reputation, personal success and security, organisational values and culture, regulation, fiscal policy and reporting models, all play their part.

There is a growing sense that the system has reached a pivotal point in its evolution and the time is right for change. Public outrage, shareholder activism and the scrutiny of regulators is growing. More importantly, many who have deep and long experience of working in the system believe change is needed.

Change needs to be created and owned by those in the system and those who are responsible for the system. Interventions need to be carefully judged, and require both a systemic and collaborative approach.

We set out an agenda for change and invite those in the system to work with us to develop this agenda and help translate it into practical actions to move the system towards achieving more sustainable outcomes to meet the needs of today and of future generations.