Time-tested ways of holding business to account are crumbling

THE TERM “public company” to denote a group with shares listed on a stockmarket suggests that society at large has an interest in how they are run. Fair enough: one does not need to own shares in Royal Dutch Shell or Facebook to care what their bosses are up to. Comparisons between the market value of multinationals and countries’ GDP are wide of the mark, but their recurrence reflects a legitimate anxiety about the clout of business. Whether as employers, investments, polluters or purveyors of bestselling products, firms need monitoring just as governments do.

But how are firms scrutinised, exactly? In the old days a company would issue quarterly results, publish an annual report, and engage in continual, close discussions with a select group of shareholders, financial analysts and bankers. Once a year a domineering chairman might face the public at the annual general meeting. Today the relationship has flipped: companies and their bosses cannot escape a raging firestorm of public debate about their purpose and morality. Yet, at the same time, the quality of the scrutiny they receive in the financial sphere has declined.

Chief executives are now exposed to all that the digital, connected world can throw at them. Social media provide a torrent of feedback from customers, ranging from the quality of sausages to customers’ stance on Chinese intellectual-property laws. Companies’ supply chains, whether mines in the Congo or sewing factories in Bangladesh, are watched and documented by activists, who ask difficult questions about pollution and labour conditions that many firms once chose to ignore.

In an age of populism, politicians have become keener on grilling bosses in public—on December 11th Sundar Pichai, the head of Google, got the full treatment, with a three-hour roasting from Congress, including the question of why President Donald Trump’s image appears when you type “idiot” into the search engine. At some firms “woke” workforces stand ready to walk out the moment that managers offend their sensibilities, in a faint echo of the trade unionists who once bossed the bosses for higher wages.

Yet even as these theatrical forms of scrutiny have soared, the other kind—methodical, detailed, financial and often dry—is declining. This is harder to spot than the grandstanding, but is no less important. People who depend on share prices rising or falling are among the best at holding firms to account. They ask the questions that chief executives find most awkward to answer. The work required to do that can be achingly dry: the best financial analysis is rigorous to the point of rigor mortis. But some information that seeps out serves a wider purpose. An investor might demand that a company’s management detail how its underfunded pension pot will impact results in the third quarter, for example. “There’s an underfunded pension pot?” a crowd of retirees might then ask.

This kind of analysis has been in decline for several reasons. In America an ever-tighter mesh of regulations about what the bosses of listed firms can say about their financial performance, means that many prefer to say as little as possible, communicating instead through written documents and pre-prepared scripts.

And the chief question-askers are not investors themselves but analysts at brokerages looking to sell companies’ shares to putative investors (known as “sell-side” analysts). Most bosses keep specialised staff to talk to these hardened industry experts. Unfortunately, the number of analysts has tumbled. The dotcom bust revealed that they could be prone to conflicts of interest; the financial crisis exposed how little money they brought in. Changes in regulation in Europe, aimed at making the market for research more transparent, have upended the latter’s business model. Spending on research at investment banks has more than halved since 2008, to $3bn, according to Frost Consulting.

The biggest firms still get lots of attention, for now. But firms in the FTSE 250 index of mid-sized British companies, have seen coverage dwindle to seven analysts each, down by over a fifth in a decade, according to FactSet, a data provider. Some small companies have no analysts following them at all, or have started to pay for research firms to cover them, creating a glaring conflict of interest.

A lot of analysis now takes place in the private sphere. Many of the best analysts of yesteryear work for funds that invest in companies (thus becoming “buy-side” analysts). The insights they generate there are private. If they find a hole in a firm’s accounts, instead of telling the world in order to generate trading commissions for their bank, a buy-sider often shuts up and discreetly sells their shares. A rising share of companies, meanwhile, are staying private, including “unicorns” (privately held tech firms worth over $1bn), and industrial companies owned by private equity funds. The number of listed companies in the euro zone and America is down by 30% since 2001. Private firms have few obligations to report their finances and none to be grilled by outsiders about it.

Silent mode

One possibility is that technology might create sophisticated new ways of understanding big companies, whether public or private. Computers could short-circuit the company’s management and monitor the business directly. Think of satellite images of iPhone factories in China, or real-time monitoring of digital customers’ buying habits. But data-crunching power and raw information are expensive and thus only available to big investors.

As the volume of financial analysis falls and a rising share of what remains occurs in private, there is a cost. In order for industries and product markets to work well, sophisticated information needs to be publicly available, so that competitors know if their rivals’ profits have slumped or investment is rising. While the modern firm is constantly interrogated about its conduct and ethics, it is increasingly able to keep its performance under wraps. That makes companies look responsive but in the long run could mean the economy works less well for everyone.