The second of this series on a new capitalism calls for a culture dedicated to long-term, ethical goals
Twenty years ago, Britain’s greatest industrial companies were ICI and GEC. A third, Rolls-Royce, secured from hostile takeover by a government golden share, had a board that was boringly committed to research and development and to investing in its business. ICI and GEC, under colossal pressure from footloose shareholders to deliver high short-term profits, tried to wheel and deal their way to success. Neither now exists. Rolls Royce, free from concerns about hourly movements in its share price, has gone on to be almost our last remaining great industrial company.
Britain, as the Kay review on the equity markets reported, has far too few Rolls-Royces. Instead the report identified a lengthening list of companies – Marks and Spencer, Royal Bank of Scotland, BP, GlaxoSmithKline, Lloyds and now BAE – which have made grave strategic errors, taken ethical short cuts or launched ill-judged takeovers, hoping to benefit their uncommitted tourist shareholders. Their competitors in other countries, with different ownership structures and incentives, have survived and prospered.
It is an unreported crisis of ownership that goes to the heart of our current ills. Over the last decade, a fifth of quoted companies have evaporated from the London Stock Exchange, the largest cull in our history. Virtually no new risk capital is sought from the stock market or being offered across the spectrum of companies. A share is now held for an average of seven months. Britain has no indigenous quoted company in the fields of car, chemical or building materials. They are all owned overseas, with design and research and development travelling abroad as well.
The stock market has descended into a casino, served by a vast industry of intermediaries – agents, trustees, investment managers, registrars and advisers of all sorts – who have grown fat from opaque fees. It has become a transmission mechanism for highly short-term expectations of profit driven into the boardroom. Directors’ pay has been linked to share price performance, offering them the prospect of stunning fortunes. As a result, R&D is consistently undervalued.
British companies are now hoarding some £800bn in cash, cash they would rather use buying back their own shares than committing to investment. We have allowed a madhouse to develop. An important reason why Britain is at the bottom of the league table for investment and innovation is the way our companies are owned or, rather, not owned.
It is a crisis of commitment. Too few shareholders are committed to the companies they allegedly “own”. They consider their shares either casino chips to be traded in the immediate future or as no more than a contract offering the opportunity of dividends in certain industries and countries; this requires no engagement in how those profits and dividends are generated. British law and corporate governance rules demand the narrowest interpretation of investors’ and directors’ duties: to maximise short-term profits while having minimal associated responsibilities.
The company is conceived as nothing more than a network of short-term contracts. Any shareholder – from a transient day trader to a long-term investor – has the same standing in law. American directors’ ability to defend their company from hostile takeover or German directors having to live – horrors – with trade union representatives on their supervisory boards are seen as obstacles to enterprise that Britain must not go near. But companies and wealth generation, as Professor Colin Mayer argues in his important forthcoming book Firm Commitment, are about co-creation, sharing risk and long-term trust relationships: Britain’s refusal to embrace these core truths is toxic. Companies were originally invented as legal structures to enable groups of investors to come together, committing to share risk around a shared goal and so make profit for themselves, but delivering wider economic and social benefits in the process. Incorporation was understood to be associated with obligations: a company had to declare its purpose before earning a licence to trade. There existed a mutual deal between society and company.
No game-changing improvement in British investment and innovation is possible without a return to engagement, stewardship and commitment. Limited liability should not be a charter to do what you like. It must be conditional on a core business purpose, along with the creation of trustees to guard it. Directors’ obligations should be legally redefined to deliver on this purpose. What’s more, every shareholder should be required to vote, with voting strength, as Mayer argues, increasing for the number of years the share is held.
To solve the problem that individual shareholders – even savings institutions – do not have sufficient muscle nor sufficient incentive to engage with managements, voting rights could be aggregated and given to new mutuals. These would support directors in delivering their corporate purpose, a proposal made by the Ownership Commission I chaired. Companies would become trust companies, with a stewardship code. The priority in takeovers would be the best future for the business, not the ambition to please the last hedge fund to take a short-term position.
Stakeholders should also have a voice in how the company is run. In Germany, a company’s bankers and its employee representatives have seats on the supervisory board. Why not copy success rather than continue with our failed system? The Kay review’s proposals to stop quarterly profit reporting, while a useful first step, do not address the core of the problem. The company has become a dysfunctional organisational construct that needs root-and-branch reform.
As part of the reform, Britain also needs more co-operatives, more employee-owned companies and more family-owned firms. It needs to be more attentive to which foreign companies own our assets and for what purpose. It is an ownership revolution to match the revolution in finance proposed last week. Together with an innovation revolution – see next week – the British economy could at last begin to deliver its promise.
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