Professor John Kay is one of Britain’s leading economists. His work is centred on the relationships between economics, finance and business. A review of his 2012 report in The Economist opened: “the stock market exists to provide companies with equity capital and to give savers a stake in economic growth. Over time that simple truth has been forgotten”.
In the report, he summarised certain characteristics of short-termism, the search for immediate profit at the expense of long-term security, as being:
“a tendency to under-investment, whether in physical assets or in intangibles such as product development, employee skills and reputation with customers and hyperactive behaviour by executives whose corporate strategy focuses on restructuring, financial re-engineering or mergers and acquisitions at the expense of developing the fundamental operational capabilities of the business”.
British business must invest and develop its capacity for innovation, its brands and reputations and the skills of its workforce.
There was wide agreement amongst those who submitted evidence to the Review that equity markets today were not as effective as they should be in supporting these purposes and that consensus is growing with the recent takeover of GKN.
McKinsey‘s 2017 study compared companies that take a long-term view and those that do not and fonund that the long-termers perform better metrics such as employment growth and shareholder return. Its findings were that companies on the long-term end of the spectrum dramatically outperform those classified as short term. And it offers a basis for extrapolating the economy-wide costs of short-termism as measured by GDP and job creation lost.
Stuart Dunbar, a partner in Baillie-Gifford (investment management), pointed out in the Financial Times (April 2018): “The short-termism foisted on company management by the majority of investors is well-known and has been addressed among others by the Kay Review . . . much of the industry has allowed itself to become entangled in a destructive and complex spider’s web of short-term index-relative risks and phoney quantitative sophistication that measures just about everything except that which matters most: the fundamental long-term prospects for the companies in which we invest on behalf of our clients.
Professor Prem Sikka’s 2018 overview of the UK’s shareholder-centric model of corporate governance – which exerts pressures for quick returns – notes that the average duration of shareholding in major companies has declined from around five years in the mid-1960s to around seven and a half months in 2007.
Accountant John Ficenec (2015) called for the bold changes necessary to encourage saving and investment that will support the long term success of the UK economy. He commented that Margaret Thatcher’s dream of creating a nation of private investors which would hold management to account had become a nightmare “Instead of UK households owning stakes in our companies they have been sold off to foreign owners. The UK utility companies have been steadily sold to buyers such as Hong Kong businessmen Li Ka-shing, and Australian investment bank Macquarie”. Transport services are also predominantly now in foreign ownership
FT View (April, 2018) notes that, in the aftermath of the sale of UK industrial group GKN, the City of London – “one share, one vote” culture – is once again being questioned.
Management protections – defensive measures used in American and European countries – are considered:
- Tenured voting is a stock-voting structure by which investors receive additional votes the longer they hold shares in a company unlike the “one share, one vote” system which can be exploited by activist investors whose short-term interests often run counter to those of long-term investors.
- “Poison pills” can allow existing shareholders to buy extra shares to dilute the acquirer’s and make the venture costlier,
- A ‘white knight’ – an alternative acquirer of which the board approves — may be sought.
- In the Netherlands, with “stichtings”, foundations that separate ownership from control enable Dutch companies to block takeovers
- Double voting systems reward long-term shareholding, making extra voting rights automatic for long-term investors in listed companies unless shareholders vote to opt out. US and Sweden have long had double voting systems. In France and Italy, following legislative changes implemented in 2014, a number of companies have introduced double voting rights.
In the executive summary of his final report (page 13), Professor Kay’s recommendations included:
- Setting up a forum for major investors to engage with UK companies and each other (now in force)
- A government review of the scale of merger activity in the UK
- Companies consulting their major long-term investors over major board appointments
- Asset managers making full disclosure of all their costs, including transaction costs and performance fees
- Ending the requirement for listed companies to produce quarterly financial reports
- Designing company executive pay to focus on long-term performance, including company shares to be held until after the executive has retired from the business
- Designing fund managers’ pay to reflect long-term performance.
The shareholder-centric model of corporate governance – as Professor Sikka points out – “emboldens speculators and makes it difficult for management to develop long-term strategies”.
Will the next UK government reform it?