In the decade since the financial crisis public confidence in business and the market economy in general has taken a hit. Weak investment, corporate scandals and high executive pay have all contributed to the problem.
There is a clear need for policies that reform corporate governance and boost business investment. However, the proposals of the three main parties fall some way short of what is required.
The Conservatives have flip-flopped on their approach to business in recent years: cutting taxes then raising them; proposing workers on boards then reversing the decision; appearing to promote a free-wheeling ‘Singapore’ model based on deregulation, only to propose significant increases in the minimum wage. The lack of coherence to the Conservative proposals suggests a failure to diagnose the problems that lurk in the UK economic model and a lack of clear direction.
Labour has discarded most elements of its past social-democratic accommodation with the market, blaming ‘profit’ for environmental failures ranging from carbon emissions to the depletion of fish stocks. Its proposals represent an anti-market radicalism that would see a third of board seats reserved for workers and 10% of all large companies’ shares sequestered in an ‘inclusive ownership fund (IOF)’.
In particular, it is unclear that worker-directors are an effective way to tackle corporate short-termism. Instead there is a risk that they exacerbate producer capture and fail to align corporate behaviour with social goals. Meanwhile, the IOF is an idea that will not benefit workers in the long run, gives them little control and is best seen as a corporate tax increase. The IOF would do significant damage to investment at a time when UK investment performance is already weak, and deteriorating due to Brexit.
The Liberal Democrats offer a range of soft stakeholder ideas ranging from workers on boards to clearer statements of corporate ‘purpose’, which don’t really address the core problems of short-termism. However, they also propose an ambitious range of industrial and technology policies to move companies up the value chain.
The big hole in the policy debate is around any effort to reform equity markets to enable sufficient corporate control for shareholders who are engaged for the long term. Such moves would be more likely to be successful than most proposals on offer, since the interests of employees, shareholders and wider society are much more closely aligned in the long term.
In the wake of a decade of anaemic economic growth since the financial crisis the market economy has rarely been more unpopular. Between 2007 and 2017, responses to the British Social Attitudes survey indicate that the public became markedly more sceptical about business[_]
This loss of trust has been driven by several developments. High executive pay and perceived neglect of the environment and wider community are factors. There have also been a string of high-profile examples of corporate malfeasance including controversies involving BHS and Carillion, and the collapse of household names like Thomas Cook.Rising public scepticism has been compounded by sky-high executive pay in some companies that appears unjustified by performance. The High Pay Centre found that, between 2000 and 2013, the pay packages of FTSE 350 executives increased by over 1100% but the performance of their companies, measured by earnings per share, rose by a weighted average of only 179%.
Underlying all these problems is a longer-running failure of UK businesses to invest. The UK has the lowest level of non-government investment in the G7. This is despite near zero real interest rates since the crash making it historically cheap to borrow. Sclerotic business investment is a key part of the slump in productivity growth that has caused wage growth to stall since the financial crisis. This chronic problem is in part down to structural failures with corporate governance and equity markets that discourage investors from backing companies with a more long-term, strategic outlook.
Together, these problems risk damaging the economy and undermining political support for wealth creation through the market economy.
These problems have spurred new thinking, both in the UK and elsewhere, about the way businesses operate and how the problems can be addressed. Ideas range from putting more workers on company boards to getting companies to focus on their ‘purpose’ rather than short-term profit maximisation. The 2019 party manifestos, which reflect some of these ideas, therefore mark a critical moment in the debate about how the market economy should be governed.
The main parties are far more divided on business issues than in recent decades. The Conservatives’ traditional suspicion of overt government intervention contrasts with the Liberal Democrats pursuit of an activist industrial policy and even more so with Labour’s proposals for a massive extension of state power into the economy.
Jeremy Corbyn’s Labour appears to have jettisoned most elements of Labour’s past social-democratic accommodation with the market. The manifesto argues, for instance, that the market economy and ‘profit’ lie behind environmental failures from carbon emissions to the depletion of fish stocks.
To temper the market, Labour advocates a much bigger role for the state and greater intrusion into the ownership, management and control of private businesses. An Inclusive Ownership Fund would hand 10% of the equity of large companies to their workers. Meanwhile Labour plans to tackle short-termism by reserving one-third of board membership for ‘worker-directors’, with the aim of increasing employee ‘voice’ and tackling high executive pay. Trade unions’ power would be strengthened through a repeal of industrial relations laws that hamper union activities while encouraging sectoral wage bargaining. The overall flavour of Labour’s approach is one of anti-market radicalism.
Labour’s position, while flawed, is at least intellectually coherent. By contrast, the Conservatives appear to lack any clear narrative about the problems or solutions to the crisis of confidence in business. There has been a marked shift away from the 2017 manifesto’s emphasis of mandating worker representation on boards. On the other hand, the Conservatives have scrapped plans to cut the rate of corporation tax and pledged a further rise in the minimum wage. Given Boris Johnson’s previous flirtation with a post-Brexit ‘Singapore’ approach to deregulation, it is unclear whether a Conservative government would pursue more state intervention, or revert towards the party’s traditional free market orientation.
The Liberal Democrats alone demonstrate more continuity in their policy stance with an ambitious slate of industrial and technology policies to move UK companies up the value chain and comparatively soft ‘stakeholder’ reforms to corporate governance . The latter combines a mixture of ideas: encouraging statements of corporate ‘purpose’, putting workers on boards, and regulation to strengthen corporate duties of care to the environment.
There are real challenges facing corporate governance that need to be addressed if the UK is to improve investment and address the other problems that have shaken public faith. However, the extreme positions of the two main parties miss that opportunity.
There is a widespread consensus that many UK companies are too short-termist and fail to invest enough, which is damaging productivity growth. A leading explanation for this failure is a corporate governance regime which prioritises maximising short-term shareholder value and profitability ahead of other objectives, notably those activities which contribute to longer-term but more uncertain payoffs, such as workforce training and R&D.
To combat this, all three parties have at times considered measures to introduce more ‘stakeholder’ elements to corporate governance. These aim to get managers to consider the wider, long-term interests of all of the company’s stakeholders rather than appeasing short-termist shareholders – most obviously by giving employees a direct role in the governance of companies by putting them on boards. Both Labour and the Liberal Democrats are pushing these proposals in 2019. The Liberal Democrats also hope that forcing companies to define their purpose more clearly will help to ensure they take account of wider social interests by shifting management’s focus beyond shareholder value maximisation.
The Conservatives dropped the stakeholder elements from their program under pressure from employers following the 2017 election. Instead the May government made a number of changes to the corporate governance legal framework designed to tackle short-termism.
However, it is questionable whether moves to foster employee participation on boards will fundamentally change managers’ behaviour and orientate them towards the longer-term. There is at least as much risk of introducing short-term producer interest that hampers effective decision making, particularly when industries are experiencing rapid technological change. Meanwhile it seems unlikely that clearer statements of corporate purpose will be strong enough to override deeply entrenched interests, at least without supporting measures.
The core challenge, rather, is to reform equity markets and ownership of listed companies, in order to ensure that there is sufficient corporate control for shareholders who are engaged for the long term. Such moves are more likely to be successful since the interests of employees, shareholders and wider society are much more closely aligned in the long term.
This is where we see a critical policy gap in all of the parties’ proposals. Specifically, none of the parties are considering removing rules that discourage large ‘block-holdings’ of committed shareholders. This is an area in which the UK is an outlier globally, and many researchers have made the link between the dispersion of corporate control and poor outcomes. Fostering block-holdings would likely create a virtuous circle of shareholder commitment and control that will ultimately improve outcomes ranging from investment and staff training, to environmental outcomes and fair pay.
INCLUSIVE OWNERSHIP FUND
Alongside proposing to reform corporate governance in a stakeholder direction, Labour wants to broaden the ownership base of UK businesses through their ‘inclusive ownership fund’ (IOF). Applying only to companies with more than 250 employees, ONS figures show that this would affect over 7,500 UK businesses employing almost two million people. Labour says the aim of the IOF is threefold: to financially benefit employees; increase workers’ ‘voice’ in company affairs; and improve productivity.
Although billed as a device to ‘give workers a stake in the companies they work for’, it is unclear what this would really amount to. Employees would be unable to sell their interest in the IOF and would receive a maximum £500 of dividends a year, with the rest – some 90% of the dividends according to some analyses - going to the Treasury. It is also unclear how the move would increase worker ‘voice’ in the running of companies, given that their supposed owners cannot sell their holdings and Labour is already proposing putting workers on company boards to achieve this aim.
While the £500 extra income for employees might sound attractive, it is unlikely that they will ultimately see much direct financial benefit from the measure. Rather it is likely that over time large company employees would find their regular pay drifting down relative to what would be on offer in equivalent roles for companies that aren’t subject to the IOF rules.
Probably the biggest impact of the IOF would therefore be its damaging impact on businesses and investment. With most of the cash bound for the Treasury, rather than employees, analysis by law firm Clifford Chance indicates that IOFs would cost UK investors £125bn in lost capital with at least £31bn siphoned off from pension funds, hitting the incomes of retirees. Its impact would be similar to hoisting the rate of corporation tax on UK businesses to a crippling 33%, the highest in the developed world, according to the Institute for Fiscal Studies.
As such, the IOF is unlikely to boost productivity either because it would encourage productivity-sapping distortions to companies’ behaviour as they attempted to avoid the IOF rules. For example, firms would be incentivised to reduce UK headcounts so as to stay below the size threshold. Another way around it would be to choose to operate as UK branches of foreign companies and to rely more on debt rather than share capital. Major international businesses unable to do this could seek to relocate overseas, costing the UK in jobs and tax revenues. Overall, in discouraging foreign investment, the IOF would be a bad idea at the best of times, but is particularly unwise at a time when the prospect of a hard or no-deal Brexit is already shackling investment and economic growth.
Both Labour’s obsession with ownership and the Conservatives’ inattention to the many failings of the current corporate governance regime risk prolonging the productivity crisis. A forward-looking business and competitiveness policy would look to reforms to corporate governance and equity markets to give long-term-oriented shareholders more opportunities to engage with managers. It would also try to provide political certainty over trade, investment, taxes and regulation to enable firms to plan for the long-term. These themes are largely absent from the election debate.