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Of carrots and sticks

Home / Hermes EOS Blog / Of carrots and sticks

Is it best to use the stick or a carrot?

The question has become a tired old cliché. Of course, we all know that while carrots might often be the best incentive to achieve a desired outcome sometimes you simply have to use the stick. If it was an exam question, a model answer would say that neither is right, that one has to take a holistic view and use both depending on all of the factors affecting the situation.

In the world of corporate governance and responsible investment, we are frequently guilty of using the stick too much. Most talk among investors is about corporate laggards, poor practice and the way we can signal our displeasure. Most engagement focuses on seeking improvements from companies that have been identified as underperformers. Most conversations with them concern shortcomings rather than acknowledge their improvements. Clearly this approach has an important place and it has led to important reforms.

However, should we not also be thinking about the benefits of carrots as well? How do sustained reforms occur? Is it by attacking the laggards or by encouraging those with best practice to become even better? Should we redefine our expected standards upwards? To improve markets we need to encourage companies to be aspirational. The best companies are doing this anyway, the next best will respond to our requests and together, with our help, will begin to drag the others behind them.  Those companies, which through enlightened self-interest, are on a journey of self-improvement will welcome the critical friendship that investors can provide. Investors meanwhile will learn a lot from the best companies and be more effective engagers as a result.

Of course, much of our work involves dialogue and other action with laggards to stimulate progress at the companies at which we have identified serious problems. However, we should also seek to identify, encourage and celebrate progress at companies and seek to spread understanding of their successes and how those were achieved for the benefit of the rest of our portfolios.

Just when I finished writing this piece, I received an email from the Carbon Disclosure Project. I will write to Wal-Mart to congratulate it on its inclusion in the CDP’s leadership index for the first time.

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Tim Goodman Tim Goodman is a director at Hermes EOS and sector lead for oil and gas. He is also responsible for Hermes EOS’ activities in North America. Previously, he worked in the insurance industry and held a number of senior operational management roles before acting as a company secretary in a UK-listed company. He is a member of the Institute of Chartered Secretaries and Administrators, having obtained the institute prize for the best overall performance when he qualified. Tim is a regular speaker on governance-related matters, a member of the US Council of Institutional Investors’ corporate governance advisory council and a former chair of the UK Quoted Companies Alliance corporate governance committee.
Read all articles by Tim Goodman

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