Political Affiliation Shapes U.S. Boards

Political Affiliation Shapes U.S. Boards

Are corporate boards as polarized politically as the general population? That’s one of the questions we asked ourselves as we conducted a survey of directors of public and private companies headquartered in the United States.

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We and our research partners found that Republicans are more highly represented on boards than in the general population: they were 50% Republicans, 24% Democrats, and 26% Independents, while the American public, according to Gallup, is 28% Republicans, 31% Democrats, and 39% Independents. But affiliation doesn’t guarantee enthusiasm, as this sample of survey comments reveals: “On sabbatical from the Democratic party”; “Republican, unless they keep acting like goofballs”; and “Independent (especially this year!).”

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As with the general public, we found differences among demographic groups. Female directors are much more evenly split between the two main political parties. By comparison, male directors are more than twice as likely to identify as Republicans than Democrats. Our limited sample sizes suggest that African American/Black and Asian/Pacific Islander directors are more likely to be Democrats than their white (not Hispanic) counterparts, and single directors are more likely to be Democrats than their married counterparts. We did not find any notable differences by age group or education.

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We also found that industry matters. Boards of companies operating in the consumer discretionary industry have a disproportionately high representation of Democrats, while boards operating in the industrials and energy and utilities industries skew more Republican. The proportion of Democrat and Republican directors does not substantially differ between public and private firms.

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We found that directors of all political stripes care a lot about the economy and cybersecurity, and that Republican and Democrat directors are aligned in their concerns about political instability and healthcare costs, even though they may have conflicting views on how these costs should be contained. Alongside these commonalities, we also found some notable partisan differences. Democrats are less pessimistic about the economy: 10% of Democrats expect a global economic slowdown in the next three years, compared to 18% of Republicans. Democrats care more about economic justice, environmental sustainability, and equal rights for women. Republicans care more about corporate tax rates, the national budget deficit, and regulation. The ideological divisions we’re seeing in the political arena have permeated the boardroom. The disparities in the perceived importance of these issues could affect how directors prioritize and choose to address risks to the company.

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Directors are also consistent in their views of the key challenges to achieving their companies’ strategic objectives: attracting and retaining top talent, the regulatory environment, and domestic competitive threats top the list for directors from both parties.

Our limited sample suggests that both groups agree that board leadership should serve as champions of board diversity, but they differ on the policies they advocate to increase board diversity. Republicans generally favor developing a pipeline of diverse candidates through director advocacy and mentorship, while Democrats are more likely to favor requiring that every director slate include diverse candidates, or that boards implement targets for diverse membership. Democrats are also more strongly in favor of boardroom quotas for diversity, and Republicans are strongly against disclosure requirements on steps taken to seat diverse director candidates.

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We found differences in how Republican and Democrat directors view the performance of their boards. Both Republicans and Democrats say the most effective board committee is audit/finance. However, Republican directors are more likely to identify the compensation committee as the least effective committee. Interestingly, Republican directors think the compensation level of the CEO of their company is “too high.” Directors of both political views rate their boards similarly on processes, dynamics, and effectiveness as a whole, but differ on the question of compensation.

Democrat and Republican directors diverge on the skills they think are most important for board service today. Republicans prioritize industry knowledge, financial and audit expertise, and international expertise more than their Democrat counterparts. Meanwhile, Democrats place greater importance on technology expertise and risk management. It’s important to note that the representation of Democrats on risk committees is disproportionately high. These differences can manifest themselves when boards identify and select candidates for open board seats or when evaluating other directors.

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We also looked at how Democrat and Republican directors diverge on their self-evaluations. More Republicans consider themselves to be very good at negotiation, while more Democrats consider themselves to be very good at building teams. Overall, directors from both sides are bringing diverse strengths to the table.

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Why does all this matter? Boardrooms are not insulated from the widening rifts in political ideologies in the United States. Democrat and Republican directors differ in their economic outlooks, evaluations of the most pressing political issues, approaches to increasing board diversity, and even in their assessments of their own skills and strengths. Political affiliation is another form of board diversity–one that is rarely discussed, but could have profound implications on how corporate boards function and set priorities. Having directors with a range of political philosophies can invigorate board discussions and ensure that a wide array of issues and solutions reach the boardroom. Maintaining a diversity of political perspectives is an important consideration to ensure that boards are equipped to anticipate and tackle the multitude of challenges that confront companies today.

 

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Boards are stuffed with long-serving directors, UK members with 9+ no longer classified as independent

UK code of practice that stipulates that if a director has served more than nine years on a board they are no longer classified as independent.

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Google’s parent Alphabet and Warren Buffett’s Berkshire Hathaway head a list of more than 800 US companies that could come under pressure to refresh their boards, under new guidelines being floated among shareholders.

ISS, the influential corporate governance adviser, is considering targeting companies where boards are stuffed with long-serving directors or where there have been no new members for years.

In its latest annual survey ISS is asking clients their opinions of boards that have failed to appoint a new director in five years, where the average tenure of directors exceeds 10 or 15 years, or where more than 75 per cent of directors have served 10 years or longer. Its findings could form the basis for changes in its investor voting guidelines.

A Financial Times analysis of data from ISS Analytics, the company’s research arm, reveals that more than one in four of the 2,900 US boards closely tracked by ISS would fail on at least one of the mooted measures, including nearly 200 companies that have an average director tenure greater than 15 years.

Alphabet and Berkshire are the largest companies to fail on two, but the list of double-offenders also includes retailer Bed Bath & Beyond and Intercontinental Exchange, owner of the New York Stock Exchange.

On Berkshire’s board, Bill Gates, at 11 years, is one of the company’s freshest appointments, while four others have served more than 20 years. At Alphabet, five directors have served more than 15 years, including Google founders Larry Page and Sergey Brin.

Questioning the effectiveness of “male, stale, frail” boards reflects growing investor interest in improving director diversity, with shareholders increasingly demanding a portion of new directors as well as a formal board refreshment process.

Potential sanctions ISS could consider include voting against the chair of the board’s nomination committee or against long-tenured directors. If a consensus emerges, it could still be several years before voting guidelines are changed.

“The issue with board refreshment practices is not that one or two directors have been on the board for a longer period, but that the board doesn’t refresh periodically enough to add new blood,” said Marc Goldstein, head of ISS’s policy steering committee. “If there’s a mixture, that’s of less concern.”

The absence of a formal corporate governance code in the US, unlike in most markets, has been cited by investors as the reason American directors tend to be older, longer serving and less likely to be women than in many other countries.

The voting guidelines from ISS and Glass Lewis, its rival advisory service, are the nearest the US comes to a code of best practice, and they hold considerable sway because public pension funds and institutional investors follow their recommendations.

The Big Read

US board composition: male, stale and frail?

An FT analysis of directors at 5,000 companies in 30 markets

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At Alphabet and Berkshire, more than three-quarters of the directors have served more than 10 years, and the average tenure is greater than 12 years. Both have, however, appointed directors in the past five years, unlike 100 other companies in ISS’s data set. Alphabet and Berkshire declined to comment.

Paula Loop, leader of PwC’s governance insights centre, said senior directors can bring tremendous value, having a “complete picture” of a company. “But you also want new people. They’ll ask new questions, things that might be obvious, that no one else would ask, and it brings out good debate,” she said. “If the majority of your board is long tenure, I think you’re missing out on important insights.”

Corporate governance codes in most markets assume that long-tenured directors are less independent after years of working with a company and its management. Their removal also offers an opportunity to increase board diversity in age, gender, race and skill sets needed today such as cyber security, Mr Goldstein said.

The findings come shortly after an FT analysis that showed the diversity of US boards lagged behind Europe’s in regards to age, tenure and gender. In Britain, for example, there is a UK code of practice that stipulates that if a director has served more than nine years on a board they are no longer classified as independent.

http://www.ft.com/cms/s/0/0a1cd838-63e1-11e6-a08a-c7ac04ef00aa.html?siteedition=intl#axzz4I2QuA9vW

High CEO Pay = Lower Stock Returns

High CEO Pay = Lower Stock Returns

boardmember alberto balatti ceo compensation

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“Companies that awarded their Chief Executive Officers (CEOs) higher equity incentives had below-median returns.” This is how MSCI started a report on CEO compensation.
The idea of awarding CEOs equity in the companies they oversee was originally pitched as a way to align the interests of corporate executives with those of shareholders. If the stock fared well, shareholders would benefit and CEOs would be rewarded for driving up the stock price. Yet this has not been the case for many companies.
“If the total summary pay figures were effective in incentivizing superior future performance, we would expect to see a strong correlation between higher pay figures and 10-year TSRs (total shareholder returns). However, we found very little statistical evidence to support this; in fact, we found a small but consistently negative relationship, a possible indicator that superior performance may have been linked to lower rather than higher pay awards,” wrote Ric Marshall and Linda-Eling Lee of MSCI’s ESG (environmental, social and governance) research team.
During the period of 2005 through 2014, shareholders of companies with the lowest CEO pay realized 39% greater total returns than shareholders of companies with the highest CEO pay. Put another way, investing $1.00 in the companies whose CEO compensation ranked in the bottom 20% would have grown into $3.67. Investing the same $1.00 in the highest CEO-paying quintile of companies would have only turned your investment into just under $2.65. When Marshall and Lee analyzed companies by their sector allocation, the same inverse relationship appeared: higher CEO pay meant lower shareholder returns.
Given this, it would seem logical that shareholders would use “Say on Pay” votes to express their displeasure. The exact opposite has occurred, with approval rates exceeding 90% for many companies. Setting aside issues about the proportion of shareholders either not voting their shares or simply going along with the board of directors’ recommendations, there is a hurdle to figuring out exactly how much the CEOs are getting paid. An investor looking at a proxy filing (SEC filing DEF 14A) has to combine data from several different tables to calculate the CEO’s compensation.
Even compiling the data mandated to be disclosed isn’t enough to grasp the full picture. Marshall and Lee point to the lack of cumulative realized pay—what the CEOs actual take home from stock and option grants—in SEC filings. They also point out that shareholders don’t know how much compensation CEOs have realized over the course of their tenure or how the cumulative compensation compares to stock performance.
Making matters worse is that the compensation committees often base CEO compensation on what other companies are paying their executives. It’s akin to what’s happened in the world of sports, where salaries have soared as athletes use their peers’ compensation to negotiate better deals. These contracts are often announced by the media with no analysis about how much extra ticket sales, television viewership or merchandise sales the high-priced player will bring. Texas Rangers fans have found this out with Prince Fielder, who is due $96 million through the 2020 season according to CBS Sports. The first baseman is incurring his second injury-shortened season in three years and questions are now being legitimately being raised about how well he’ll play when he returns in 2017.
Ironically, the same day MSCI released its report, The Wall Street Journal published an article discussing how companies are trying to woo individual investors to vote. Railroad operator CSX (CSX) is going as far as to plant a tree for every shareholder who votes. The reason? According to the article, individual investors overwhelmingly side with the company’s management and can be a helpful swing vote in close corporate elections.
Companies should not count on our support. We shareholders are owners. It’s up to us to look out for financial interests, which can mean disagreeing with the board of directors’ proxy recommendations as well as voting against Say on Pay proposals.

http://www.econmatters.com/2016/08/high-ceo-pay-lower-stock-returns.html

BREXIT wrap up and actions

BREXIT wrap up and actions

maltaway brexit

After a heated political campaign, voters in the United Kingdom decided by a slim margin, on June 23, to exit the European Union, leading to a change in government. Now that a new prime minister has taken over, the next big question looms: How will the UK and EU negotiate their split?

I have spent almost 20 years researching, teaching, writing about, and advising companies and governments on how to negotiate when things seem impossible. In this article I offer an analysis of the negotiation landscape facing UK and EU negotiators, along with advice on how they might navigate the process more effectively. For the record, I have not (at the time of this writing) been asked by either side to advise on the negotiations.

I structure the analysis in much the same way as I would approach any complex deal where I was asked to lead (or advise on) the negotiations. I examine important elements of the process, the key interests and issues to be negotiated, the leverage each side has, some of the barriers to reaching a deal, potential outcomes, and strategic options on both sides of the table.

You can learn more about the history and factors leading up to the British referendum here and here.

CHAPTER ONE

What Is the Brexit Process?

The clock only starts when Article 50 is formally invoked by the UK.

It’s important to remember that the British referendum is not legally binding: The UK government must initiate “Brexit” by invoking Article 50 of the Treaty on European Union. There seems to be an emerging consensus that Members of Parliament will respect the wishes of voters if called to vote on the matter, despite the fact that most MPs were against leaving the EU. Moreover, Theresa May, the new UK prime minister, has made it clear that “Brexit means Brexit,” and that she intends to oversee the process.

Once Article 50 is invoked, the EU and the UK have two years in which to negotiate a withdrawal agreement and the UK’s future relationship with the EU. Any agreement being accepted by the EU requires the assent of a “qualified majority,” which means that 72% of the member states, representing at least 65% of the population of the EU, must vote in favor of the agreement.

If an agreement is reached, the treaties that currently govern the relationship between the EU and the UK (as a member state) will expire. If no agreement is reached, the treaties will automatically expire two years from when Article 50 was invoked.

Because the clock only starts when Article 50 is formally invoked by the UK, there has been some wrangling over when it should occur. There is an option of extending negotiations beyond the two-year time limit, but it requires the consent of all countries in the EU.

Two other points of process are worth mentioning. The first is that many parties within the EU are involved, and because a member state has never exited before, the internal process on the EU’s side of the table is itself being negotiated. The key groups are the European Council, the European Parliament, and the European Commission. (See here to learn more about these three institutions, and here for more information on the role they are expected to play in the negotiations.)

The second issue is more crucial. If the agreement reached between the EU and the UK is broad enough in scope to be considered a “mixed agreement” — which it certainly will be if the parties negotiate not only trade but also security and foreign policy issues — then the agreement will need to be ratified by the parliament of every member state, which means every EU country would have a veto. From a negotiation perspective, this not only increases the amount of time needed to reach a comprehensive agreement but also lessens the likelihood of a deal.

CHAPTER TWO

What Are the Major Issues?

The EU is based on the idea of a single market, characterized by four freedoms. They are the free movement, across borders, of goods, services, capital, and people.
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Protestors demonstrating against Britain’s proposed membership of the European Economic Community, January 22, 1972. The UK joined the EEC the following year.

Let’s start with some context. The European Union is based on the idea of a single market, characterized by four freedoms. They are the free movement, across borders, of goods, services, capital, and people.

There are three consequences of this arrangement that are of particular relevance to Brexit negotiators: free trade between EU member states (think “tariff free”); businesses in the member states being subject to EU regulations; and citizens of any member state being able to move to another member state to live or work there. All of these were important factors leading up to the Brexit vote, and they are central to the negotiations that will take place between the UK and the EU.

Trade and immigration. Two of the most important issues are trade and immigration. It is worth considering them together because doing so helps to highlight a key conflict in the negotiations. Simply put, the UK wants to keep the trade relationship with EU members as it is today (free trade) but significantly change the rules surrounding the free movement of people between the EU and the UK. Roughly half of the immigrants to the UK come from the EU, and polls conducted in the run-up to the referendum suggest that over 50% of those who supported Brexit considered immigration their biggest concern.

David Davis, who was appointed Secretary of State for Exiting the European Union by PM May, believes both of these goals are achievable: “The ideal outcome (and in my view the most likely, after a lot of wrangling) is continued tariff-free access. Once the European nations realize that we are not going to budge on control of our borders, they will want to talk, in their own interest.”

Unfortunately, this is not at all how the EU sees it. Donald Tusk, president of the European Council, has made clear that for the UK to have access to the single market “requires acceptance of all four EU freedoms — including freedom of movement. There can be no single market à la carte.” Other EU leaders have made similar pronouncements. How much wiggle room there is, and what kinds of concessions might be made on trade and immigration, remains to be seen (and negotiated).

Money paid to the EU. The UK pays more into the EU budget than it gets back in rebates and other payments to sectors of the UK economy. Leave campaigners and supporters argued that the money saved through Brexit could be used elsewhere (e.g., to enhance the UK’s National Health Service). Here, we see the same conflict: From the EU perspective, if the UK wishes to have continued access to the single market, it will be required to pay dues.

There is clear precedent for this stance. Norway, which is not a member of the EU, pays into the EU budget in order to have access to the single market. The precise amount that the UK would pay will have to be negotiated.

Regulations. Leave supporters complained about onerous regulations imposed by the EU, including environmental standards, product safety rules, and minimum working conditions for employees. Although Brexit would put an end to EU-imposed regulations, there are two important factors to keep in mind. First, many (perhaps most) regulations will continue because they or similar ones are important for the UK, even if the EU is not imposing them. The UK will not, for example, abolish all product safety or environmental regulations after Brexit. Second, the EU could continue to impose certain regulations after Brexit in exchange for the UK’s access to the single market. Again, this is consistent with the Norway precedent, although UK negotiators will want to avoid regulatory influence from the EU.

Free movement of people. Much of the Leave campaign’s rhetoric was aimed at stemming the tide of immigrants from Europe, but barriers to free movement of people would hurt both sides in the negotiation. Millions of UK citizens live and work in Europe, and even the loudest proponents of Brexit want them to retain their rights. Former mayor of London Boris Johnson, a leading voice in the Leave camp who now has been appointed foreign secretary, promised as much in anopinion piece he wrote following the referendum: “British people will still be able to go and work in the EU; to live; to travel; to study; to buy homes and to settle down. As the German equivalent of the CBI — the BDI — has very sensibly reminded us, there will continue to be free trade, and access to the single market….The only change — and it will not come in any great rush — is that the UK will extricate itself from the EU’s extraordinary and opaque system of legislation.”

The desire to address the anxiety of the British people is understandable. What is difficult to understand is how the foreign secretary intends to secure the rights of British citizens to free movement without offering reciprocal rights to citizens of other EU member states (or, for that matter, without offering any concessions at all).

Financial services. A particular concern for the UK in these negotiations is the fate of London’s financial services sector. It plays an outsize role in the broader EU financial industry, where it has a trade surplus of almost £20 billion with the rest of Europe. (The threat to this important sector of the UK economy is explained in some detail here and here.) How far the UK is willing to go (or be lobbied to go) to protect the sector — or, put differently, how much the EU is able to extract in exchange for concessions to City — is an open question.

CHAPTER THREE

What Leverage Does the EU Have?

Because the EU needs to deter future exits, threats to walk away even from economically attractive deals become credible.
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Euro stars on the glass doors of the main portal to the Palais de l’Europe, the European Parliament in Strasbourg.

There are four important sources of leverage for the EU.

The economics of trade. Leave supporters have made the argument that the UK will be negotiating from a position of strength because the EU exports more to the UK (around £290 billion) than the UK exports to the EU (around £220 billion).

The argument is a flawed assessment of the actual state of economic leverage. The key is to look beyond absolute numbers and consider the percentage of total exports they represent for each party. While the UK exports a lower nominal amount to the EU, these exports represent about 44% of total UK exports. In contrast, exports to the UK are only about 10% of total EU exports. By this measure, a “no deal” (or a deal that hurts trade, to be more precise) is much worse for the UK than it is for the EU.

This doesn’t mean that a good deal is impossible for the UK to achieve, but it does mean that putting too much weight on this political talking point would be unwise for negotiators.

The need to deter future exits. If the only players in this story were the UK and a firmly united EU, the UK would have more room to demand concessions. But the EU is not monolithic. One of the biggest concerns of EU negotiators will be the risk of setting a costly precedent. This deal will be closely watched by nationalist parties in other countries. If the UK is able to negotiate terms that give it a better deal than it had when it was a member state, that could encourage additional exits, which could jeopardize the union’s very existence.

As a consequence, there may be several agreements that the EU is tempted to accept on purely economic grounds (preferring them to “no deal”) but that are off the table because they could incentivize other defections from the EU. Because the EU needs to deter future exits, threats to walk away even from economically attractive deals become credible. This gives the UK leverage, albeit at the cost of making “no deal” more likely. As Martin Schulz, president of the European Parliament, has stated, “There is no intention to ensure that the UK receives a bad deal, but it is clear that there can be no better deal with the EU than EU membership. The EU moreover must look out for its members’ interests and uphold its founding principles. The single market, for example, entails four freedoms (capital, goods, services, persons) and not three, or three and a half.”

Too many veto players. As mentioned previously, any final deal will require agreement from a qualified majority of EU member states, or unanimity in the event of a mixed agreement. This potentially gives veto power to many small coalitions of member states — or to every individual state if there is a mixed agreement. It narrows the zone of possible agreement but also allows the EU to credibly say that the UK will have to make significant concessions to bring enough EU votes on board.

The psychology of precedents. Although it’s a smaller factor than those listed above, the psychology of deal making is currently working against the UK. All of the precedents in place — Norway, Switzerland, and even Canada — instantiate the European claim that there can be no “sweetheart deal,” and that it is not possible to get access to the European market without serious conditions and contributions.

CHAPTER FOUR

What Leverage Does the UK Have?

A number of the most influential countries in the EU are the ones that are most dependent on trade with the UK.
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British businessman and politician Oliver Smedley (1911–1989) leaving to demonstrate in Rome as part of his Keep Britain Out campaign to oppose British membership of the EEC, 1967.

UK negotiators also have at least four sources of leverage, although I do not wish to imply that this means both sides have equal leverage (as I discuss below).

Economic impact on the EU. Albeit less than what the UK stands to lose, the EU would lose financially in the event of a deal that is bad for trade (e.g., high tariffs). While this might not be sufficient leverage on its own, it does help to chip away at the problem for the UK.

Influence over key players. It is important to note that EU-level data masksconsiderable heterogeneity that exists across EU nations with regards to the balance of trade with the UK. Notably, a number of the most influential countries in the EU (such as Germany) are the ones that are most dependent on trade with the UK.

How these relationships are managed and how they can be used to influence the Brexit negotiations with the EU will be crucial considerations for the UK. I disagree with those who think the UK’s leverage vis-à-vis Germany is all that matters, and that this one trade deficit ensures a good UK-EU deal — but it certainly will play a role in the negotiations.

Security concerns. If the only issues on the table are trade and immigration, the EU arguably is in a strong position. But if the UK can make a strong case that a bad deal with the EU would threaten cooperation on other matters (e.g., security), that could help tip the scales. Such a threat ought not to be credible: In my view, two centuries of UK history show that every time the British have moved further away from Europe, they eventually have regretted the decision — and have had to return when things unraveled on the continent.

Everyone loses when the UK and EU drift apart on matters of security. And yet there are reasons that Europeans should take the threat to strategic cooperation seriously. The recent referendum shows a strong isolationist attitude in the UK, and the EU might want to consider the degree to which relationships might deteriorate if the eventual deal is perceived as one-sided (or punitive) by the British people.

Timing of invoking Article 50. The number of European leaders who are urging the UK to invoke Article 50 without delay is long and comprehensive, including European heads of state, the EU president, the European Commission president, and the European Parliament president. Meanwhile, the UK governments seem to be in no rush to pull the trigger, not least because there appears to be no negotiation strategy currently in place.

Only the UK can invoke Article 50. When everyone wants something that only you can provide, you have leverage. This raises the possibility of the UK agreeing to invoke Article 50 sooner in exchange for concessions. Given the order of events (Article 50 will be invoked before substantive negotiations get under way), any concessions demanded from the EU likely would have to focus on the process of eventual negotiations (timetables, sequencing, etc.) or on an agreement on principles that would frame the negotiation. This does not mean that the UK should invoke Article 50 before it’s prepared, but it does suggest that there may be some scope for a trade.

There are risks to using this point of leverage, however. If the EU decides to punish delays (or threats of delays) to the process, things could escalate and get ugly. The EU has the option of invoking Article 7 of the Treaty on European Union, which would take away the UK’s voting rights in the EU on the premise that the UK has committed a “serious and persistent breach” (or is at “clear risk of a serious breach”) of EU values, as specified in Article 2. Arguably, the values listed in Article 2 would not be breached simply because the UK is dragging its feet on Article 50, but such is the nature of escalation: Both sides could get into a death spiral of unhealthy and unreasonable tit-for-tat.

CHAPTER FIVE

A Key Barrier: False Promises

The EU might come to the conclusion that since any deal is going to fall short of the extreme promises made in the UK, it is not worth giving any special concessions at all. The UK government will have to find a way to sell a lesser deal, or end up with no deal at all.

From a leverage perspective, one factor cuts both ways. The Leave campaigners, in their enthusiasm for Brexit, seem to have promised more than they can plausibly deliver. And, in many cases, they appear to have done so with little regard for facts, data, or statistics. To name a few examples, the amount of money going to the EU was overstated; the ability to limit contributions to the EU following Brexit was exaggerated; the impact of immigrants on the economy wasmisstated; the ability to control immigration after a deal was inflated; and how much the National Health Service would benefit from a Brexit windfall was so inaccurate that the promise was walked back literally the day after the Brexit vote.

Almost none of what was promised is actually possible — especially given the EU’s leverage and other constraints — which means the UK government will have to find a way to sell a lesser deal, or end up with no deal at all. But remember: Constraints can be a source of leverage. UK negotiators might be able to credibly say that they can’t possibly go back to their supporters with significantly less than what they promised on the eve of the referendum. In other words, the EU will need to make more concessions to avoid no deal.

But the situation is a double-edged sword: The EU might come to the conclusion that since any deal is going to fall short of the extreme promises made in the UK, it is not worth giving any special concessions at all.

CHAPTER SIX

Two Looming Strategic Issues for the UK

Could the different parts of the UK (England, Wales, Scotland, and Northern Ireland) each negotiate a different relationship with the EU? And will the UK leave the EU customs union?
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Map of England in the ninth century from A Short History of the English People, by John Richard Green, published by Macmillan and Co., 1911.

The problem of Scotland. While a majority of all voters in the United Kingdom voted to leave the EU, a majority of voters in Scotland voted to remain. This is a problem for the government in England, which lives under a constant latent threat that Scotland might vote to leave the UK. A referendum in 2014 resulted in a majority of Scottish voters choosing to stay within the UK, but a second referendum is now being openly discussed.

While Scotland cannot legally veto UK’s exit from the EU, it can exercise leverage over PM May, who is faced with the delicate task of trying to keep the UK together. When it comes to Brexit negotiations, Nicola Sturgeon, first minister of Scotland, has made clear that she wants to ensure “Scotland is playing a very full part…including having the ability to put forward options for Scotland that would respect how Scotland voted.” To this end, she has suggested the possibility that the different parts of the UK (England, Wales, Scotland, and Northern Ireland) might each negotiate a different relationship with the EU.

The leaders of Wales, Northern Ireland, and Scotland recently have called for each of their devolved parliaments to be allowed to vote on any Brexit agreement. Even if nothing comes of this legally, the threat of a break-up over Brexit creates a problem for UK negotiators and further limits the set of deals that everyone can live with. Managing these relationships ought to be a first order of business for the UK.

Whether to leave the EU customs union. In order for the UK to negotiate its own trade deals with non-EU countries, it has to leave the EU customs union, which requires all members to accept the same rules when it comes to trading goods (though not services) with outsiders. (Learn more about the difference between a customs union and a free trade area here.)

Although it might seem obvious that Brexit would entail leaving the customs union, the two do not go hand in hand. Turkey, for example, is part of the EU customs union without being part of the EU. Leaving the customs union would make it harder and more costly for the UK to export goods to the EU, especially for goods that are made partially outside the UK.

Another problem is that leaving the customs union would raise serious concerns in some parts of the UK that already are against Brexit — most notably Northern Ireland, which would have to erect a customs barriers on the border with Ireland, something few would like to see. The issue will need to be decided soon, and iscurrently being debated. Some Leave supporters seem confident that the freedom to negotiate trade deals is worth the costs, while others are less convinced.

It remains to be seen how well the UK can actually negotiate non-EU trade deals. On the one hand, it will be able to negotiate without the constraints imposed by the demands of other EU countries; on the other hand, the UK’s economy is much smaller than the EU’s, so it has less to offer (meaning less leverage) in these negotiations.

CHAPTER SEVEN

What Are the Possible Outcomes?

The possibilities are many, from the Norway model to a unique UK deal to the chance that Brexit might not happen at all.
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May 1, 1975: Government documents about to be published for the British Common Market Referendum vote on June 5.

There’s an infinite number of potential outcomes in a negotiation like this one, but it’s useful to keep in mind a few salient possibilities.

No deal = WTO rules. If no agreement is reached within two years and the EU treaties expire, the default is that the UK and EU would trade according to World Trade Organization rules. Notably, these rules cover only trade, not the many other issues the two sides need to negotiate. The problem (i.e., cost) of the WTO outcome is that trade barriers, such as tariffs, would emerge where none existed before, hurting all sides, but especially the UK.

The Norway model. There already is a model in place for European countries that do not wish to join the EU but want access to the single market. Norway accesses the market through the European Economic Area. In exchange, Norway agrees to many conditions, including the free movement of people, most EU regulations, and financial contributions to the EU.

In other words, using the Norway model would mean the UK would accept roughly the same conditions as those prior to Brexit but with an additional cost: losing a vote in the EU halls of power.

The Norway model does allow for a bit of wiggle room to opt out of certain EU policies. The question would be how much wiggle room the UK would be allowed.

Other national models. Other models to follow include those used by Switzerlandand Canada. Switzerland, instead of negotiating a treaty with the EU, has negotiated separate relationships with each member state (using over 100 bilateral treaties cobbled together over decades). The Swiss are also subject to some EU policies and contribute to the EU, but not to the same degree as Norway. Canada has an even more remote relationship with the EU. It includes trade agreements, and while it allows for certain carve-outs and exceptions, it comes with its own constraints.

Neither of these models are great for the UK, and both would take longer to structure and implement than a Norway-style deal, but negotiators would be wise to look at these options carefully. They may find precedents they can point to that allow them to legitimize some of the concessions they need.

A unique UK deal. A one-of-a-kind deal is what the UK government will push for, but it would be foolhardy to think that any UK deal will ignore precedents or allow London to get all of what it wants without significant concessions in other areas.

A partial deal. Any extension to the negotiations beyond the two-year time period will require unanimous consent from the 27 EU nations remaining. Because divisions and disagreements regarding how things are shaping up are likely to emerge during the two years, the possibility that one or more countries would cite domestic pressure to vote against an extension — or use the threat of a veto to demand excessive concessions — should not be ignored. The UK and EU negotiators would be wise to wrap up whatever portions of a broader agreement they can before having things go to a vote on extending talks. Although there are costs to negotiating a deal piecemeal (e.g., trading across issues is difficult), in this case it would be wise to think carefully about whether and how to partition the full set of issues into those that are crucial to finalize before the risk of deadline pressure and those that should remain open until there is a full, final agreement.

Not following through on Brexit after all. Currently this option is not on the table — but once you consider each side’s leverage and how difficult it will be to achieve a “good” deal (especially for the UK), negotiators might want to keep this option alive (albeit unspoken) as they assess their bargaining power and craft their strategy.

CHAPTER EIGHT

Who Has the Greater Leverage?

A “no deal” scenario is still possible.

Analytically speaking, this is a trick question. On the one hand, when you look at the alternatives to reaching a deal, it seems that the EU has significantly more leverage than the UK because it is bigger economically and because it can credibly threaten to veto any deal that would make the exit option attractive to other member states.

The real problem, however, is that when you think about the interests and constraints of both sides, it becomes hard to envision any deal that all parties can accept — unless UK negotiators are able to go back to their constituents and sell a deal that falls well short of what was initially promised. This has a few implications:

  • A “no deal” scenario is very possible.
  • If a deal is going to happen, it will require tremendous creativity as well as sensitivity to the needs of the other side. Both sides will have to make as many concessions as they possibly can. The UK will have to ask for what it wants in ways that allow the EU to make concessions without setting dangerous precedents. The EU will have to make symbolic concessions that allow UK negotiators to sell the deal internally to a potentially disappointed audience. A unique UK deal is possible, but it is unlikely to meet the aspirations of Leave voters.
  • Given the fact that a “no deal” is possible and that a deal might disappoint UK voters anyway, might there not be a path toward reversing Brexit? There may come a time when the only outcome that allows all parties to declare victory entails no Brexit. EU negotiators obviously would be happy. PM May could say she tried but would not accept the EU’s likely terms (or the dismantling of the UK). Leave campaigners in the government could resign in protest — or gain in popularity for opposing the outcome.

CHAPTER NINE

In Conclusion

Smart negotiators know that the goal is not to “win” but to achieve their objectives.

In writing this analysis, I have tried my best not to take sides, nor to make unnecessary predictions. This is in part because there are limitations to doing a truly comprehensive or definitive analysis in a situation where all of the facts are not in the public domain. It is also because there are many paths forward and the outcome will be determined by how each side plays the hand it has been dealt.

The worst mistake either side could make right now is to take aggressive unilateral steps to improve its bargaining position without taking into accounthow this might cause the other side to escalate further. While EU leaders have seemingly ruled out any talks, however informal, before Article 50 is invoked, I find it hard to believe that back-channel conversations are not under way. (And if they are not, they should be.) Even if no substantive aspects of the negotiation are discussed, these conversations are opportunities to shape expectations, coordinate on process, build rapport, and create trust before deal making shifts to the media spotlight. These early moves could pay huge dividends when substantive deal making gets started — or reveal the need to revisit currently unpopular options (e.g., reversing Brexit).

As I write about in Negotiating the Impossible, if there is one lesson we can learn from some of the worst conflicts and deadlocks in history, it is that even seemingly impossible situations can be handled well if negotiators stay cool, prepare systematically, strategize with an eye on all relevant factors, have empathy for the needs and constraints of the other side, and understand that the goal is not to “win” but to achieve their objectives.