The Governance of Mutuality (CBR project)

Overview

Aims and objectives

This project reviewed the role played in the economy by organisations under mutual ownership and control (‘mutuals’) by considering the relationship between property rights and governance structures in alternative forms of business organisation. The essence of mutuality can be seen in terms of a particular structure of governance, ownership and objects. A building society’s governance structure reflects the long-term commitment of its members and their expectation, in return, of continuity of supply. The organisation is owned by its members who transact directly with it to receive particular benefits in return for their contributions. Hence in the traditional building society, the members transact with the society as both lenders and borrowers. The objects or purposes of the society channel its activities to a much greater extent than is the case with most commercial companies, whose object clauses normally leave them free to pursue a wider range of activities. The following inter-related issues arise:

1. What are the corporate governance issues involved in the comparison between mutual organisations and other, commercial forms of economic organisation (in particular the public, listed company)?
2. What has been the impact of changing legal interpretations of members’ property rights within building societies and other mutual organisations?
3. How do the objects clauses of building societies and similar bodies operate in practice to channel and/or constrain their activities?

Methods

To address these questions, a 3-fold approach was taken:

• Firstly, a historical analysis of the evolution of property rights in UK building societies was conducted. This focused on the importance of the legal framework
• Secondly, there was a review of legal and economic literature on ownership and corporate governance in the context of the comparison between mutuals (and building societies in particular) and commercial companies
• Thirdly, there was an analysis of the literature relating to the operation of mutuals in other European countries and in the USA.

Findings

Economic theory suggests the mutual form is likely to be efficient where there is homogeneity of interests among customers, and inefficient where there is divergence of interests. The traditional, pre-1986 building society form contained within it several institutional features which were designed to reduce the degree of heterogeneity of interests. These included the limitation of corporate objects under building societies legislation; the practice of one-member, one vote; and the persistence of highly complex rules for winding up a society or transferring its business. These had the effect of ‘locking up’ the surplus from the organisation’s activities, so precluding predatory strategies for gaining access to it on the part of a particular generation of members.

Since 1986, by contrast, a number of institutional changes have led to greater heterogeneity of interests among building society members. By providing a procedure for demutualisation, the 1986 Act made it possible to unlock the residual. A form of hostile takeover bid, mounted via a ‘proxy fight’ for internal control of a society, also became possible. Safeguards against opportunistic behaviour apparently put in place by the 1986 Act proved ineffective when tested in the courts. The result of the 1986 Act was to create an institutional hybrid in place of the traditional building society model.

A review of the empirical evidence suggests that investor-owned companies make higher returns for investors and undertake riskier business ventures than mutuals do. At the same time, both theory and evidence indicate that the mutual form is appropriate, in principle, for dealing with long-term, incomplete contracts of the kind required by personal borrowers seeking a low-risk loan for the purposes of house purchase and savers seeking a low-risk form of saving. Because mutuals do not have to pay dividends and deliver consistent income growth to external investors (shareholders), then, all other things being equal, their costs of capital will (other things being equal) be lower than those of investor-owned companies.

In so far as there are high agency costs in mutuals because of the limited threat of hostile takeovers and restricted external financial pressures (although this may be disputed), there is a need for internal governance mechanisms which can respond to the issue of board accountability. Evidence from other countries suggests models which be drawn on. These involve 3 elements:

1. federal structures of governance, designed to combine local autonomy with collective risk sharing and cost saving;
2. direct, 2-way information flows between members and management
3. electoral college systems which reward active (organisational) participation of members, as opposed to passive (purely financial) participation.

The present regulatory structure for building societies in the UK creates a real risk of the wholesale transformation of societies and other mutuals into investor-owned companies. The current hybrid model is inherently unstable. This development, which was neither intended nor foreseen at the time of the Building Societies Act 1986, would imply loss of an efficient form for delivery of long-term financial and other services to individuals and households who are not in a position to put up risk capital as part of financial investment provision.

Progress

In the autumn of 2002 further funding was obtained from Mutuo to extend the study by carrying out a survey of attitutdes towards mutual organisations, by comparison with banks and plcs, and to undertake case studies. This work was completed in the spring of 2003. Analysis of the data collected from the survey shows that the absence of external shareholder ownership is a major factor in inducing customers to repose high levels of trust in building societies. The work was presented to the annual conference of the cooperative movement in Manchester in May 2003 and to the major party political conferences in the autumn of that year.

In June 2004 Simon Deakin presented findings from the project in a lecture given to the Royal Society of Edinburgh, as part of the ESRC’s Social Science Week, entitled ‘The simultaneous fall and rise of mutuality’.

Project leaders

• Jacqueline Cook
• Simon Deakin
• David Nash (Cardiff Business School)
• Jonathan Michie (Birkbeck College)
• Alan Hughes

Project status

Completed