The British disease of business short termism is entrenched and takes many forms: the UK suffers from low levels of investment in capital and R&D, with companies hoarding cash and buying back shares; there are too many value-destroying acquisitions and restructures, arising from optimism-bias and boardroom hyperactivity; and equities are held for shorter and shorter periods, by disparate global investors more interested in daily trading and quarterly results than long-term stewardship. So in a recent Fabian report Robert Tinker and I argued that ‘long-termism’ should be one of two key objectives for economic policy under the next government (2014).
You don’t need to be on the left to agree that short-termism is a problem; or to recognise that other European market economies have both different corporate governance arrangements and more long-termist business cultures. Proposals for reform of governance relationships therefore deserve a hearing from across the political spectrum: increasing the breadth of reporting requirements; giving workers representation on boards or remuneration committees; or introducing continental-style supervisory board arrangements.
But there is another argument for change: the second economic objective proposed in the Fabian report is for an incoming government to tackle inequality. And corporate governance reform is an essential component in any response to the new inequality: the rise of the ‘one per cent’. For under New Labour, income and wealth at the top soared away, even while the party was successful in preventing the gap widening between the poor and the affluent middle classes. Thomas Piketty shows that it was the same across the advanced economies in his widely praised study Capital in the 21st Century (2014). He demonstrates that the widening gap between the top one per cent and the rest is an embedded feature of today’s capitalism, unless policy makers intervene.
The first part of the argument is remarkably simple: Piketty shows that, while returns on capital are higher than GDP growth, in coming decades the owners of capital will gain a greater share of each nation’s economic output. This is particularly true in an era of low economic growth. The second component of the ‘one per cent’ story concerns the earnings of people at the top of companies: since the 1970s there has been a shift in power within firms, caused by the decline of collective bargaining and increased incentives for executives to take more, as a consequence of lower top rates of tax.
Corporate governance must take a share of the responsibility. While once you might have thought of executive board members as salaried officials, their remuneration has increasingly been tied to returns for investors; and hence has risen by far more than economic growth or typical earnings. There was also the ratchet effect of remuneration committees, each vying to pay executives above average, accelerated by the unintended consequences of increased reporting transparency. All this was driven by an apparently rational response to the ‘principle-agent’ problem: if the owners could not directly supervise the executives, then the incentives of the two groups should be aligned. But it was a sticking-plaster solution, masking wider governance problems and it super-charged the cult of short-termist ‘shareholder value’.
The rise of the ‘one per cent’ has far-reaching implications for public policy. It demands a major institutional response, one not motivated out of envy but because this is the only way that we can hope even to stabilise inequality at today’s high levels. There are three practical avenues for reform, which look radical only when you ignore the practice of other advanced economies. The UK must take action on ownership, taxation and corporate governance.
First, ownership. If the tendency is for capital to grow faster than wages, then who owns capital really matters. The left therefore needs a new politics of asset ownership. Much more should be done to promote a wide range of corporate ownership models, including help for firms to become employee-owned businesses, either in whole or in part. For example, there could be tax incentives for businesses that placed a 10 per cent stake of their firm in a trust for the workforce. Future governments must also broaden the personal ownership of investment assets, with policies like pension autoenrolment (or perhaps compulsion) and the pound-for-pound matching of modest savings.
More radically, the government should also become a strategic long-term investor on behalf of us all. The nation should take small minority stakes in companies whose success has depended on public sector intellectual property. And the Treasury could also establish a UK sovereign wealth fund, capitalised with some of the proceeds of the sale of the nationalised banks. (From the perspective of net public debt, it doesn’t matter whether you use the money to repay debt or invest in liquid assets.) The main purpose would be to ensure that we all benefit collectively from the asset markets. But think about the implications for business stewardship too: here would be one minority shareholder taking an ultra long-term perspective. Companies committed to investment could expect to prosper, augmenting the view already taken by enlightened public sector pension funds, including the new National Employment Savings Trust.
Second, tax. If we are to widen the ownership of assets, distribute the returns on capital broadly across society and ameliorate dangerous asset bubbles, then our tax system needs radical reform. Tax reliefs should be designed to broaden not deepen asset ownership, so 54 Beyond Shareholder Value pension tax relief should be redirected to low and middle earners. We should stop taxing gifts and unearned income less than earnings, by gradually merging national insurance into income tax and by treating receipt of gifts and bequests as taxable income. A proper system of property taxation would share wealth and suppress house price inflation. And a higher marginal rate on payroll taxes for the highestpaid workers would stop top executives being quite so focused on extracting rewards from their firms, at the expense of workers and owners (Piketty et al, 2011).
Third, corporate governance. This is the critical piece in the jigsaw for regulating the distribution of rewards between the executive class and the workforce; and for reducing the extent to which owners put immediate profit over their long-term interests. We need a new governance model that ensures owners take their responsibilities for stewardship seriously and executives concentrate on the long-term interests of the firm. The current policy agenda – requiring long-term executive incentive plans and better stewardship along the investment value chain – is just not enough. It is a ‘transactional’ response to a problem of relationships, networks and culture. So it is time to experiment with an alternative, along the lines of continental supervisory boards. The creation of mediating structures between individual shareholders and the executive team would be the institutional manifestation of current efforts to promote ‘voice’ rather than ‘exit’ in relations between firms and their owners. The detail of a new supervisory structure could be tailored to the UK context: there are many models on offer so we don’t need to blindly copy Germany.
Alongside structura l change, more transparency is essential. Reporting should include information on the relationship between the pay of executives and typical employees (as recently proposed by the European Commission) and on conditions in domestic and global supply chains. How this is presented is all-important. Boardroom pay transparency was initially counter-productive, because executives used the information to bid-up their own rewards. But other reporting requirements could have the opposite effect.
Publishing pay ratios might work, but how about going a step further, and requiring boards to report the annual pay rise and bonus for each tier of employees in their organisation? Boards should be required to explain whenever growth in rewards for the top outstripped those for the middle and bottom, extending the principles in recently introduced requirements. This might nudge executive mind-sets, so pay expectations at the top became (a little more) tethered to the experiences of those below, not just to corporate peers. Transparency is not a panacea, but I’m optimistic enough about human nature to think that a requirement for executives to say publicly why they deserve a bigger rise than their shopfloor workers might have an effect: after all, executives don’t like public embarrassment and recognise the link between staff morale and long-term corporate success.
The pressure of this openness on pay would undoubtedly be amplified by a true stakeholder approach to corporate governance, including substantial employee representation (ideally alongside some element of collective employee share-ownership). David Coats’ recent study for the Smith Institute explored options for employee participation in great detail (2013). He showed that employees on boards could be important for establishing a broader, fairer Beyond Shareholder Value 55 decision-making process, but only in the context of other workplace reforms. (It is also worth considering how other stakeholders could be represented, not least customers and suppliers. Here an exploratory, voluntary approach might work best, with firms invited to test different approaches.)
Employee represent at ion and pay transparency is, however, intended to be a lot more than a short-term, zero-sum initiative to rebalance corporate power. Alongside a supervisory structure, the point is to create more collaborative, long-term behaviours among all stakeholders, with mutual respect and benefit, to achieve more equality and shared interests over time. This insight has always been at the heart of egalitarian arguments for corporate governance reform. In the 1952 New Fabian Essays Tony Crosland proposed workers on boards not just as a tool to redistribute resources but to transform social relations. It was an example of what he termed a ‘socio-psychological’ measure, designed to eradicate class enmity and create ‘a sense of common interest and equal status’.
In the 1950s, the 1970s and the 1990s the left considered corporate governance reform and drew back. The arguments for long-termism, mutual respect and common interest never quite won the day. This time it can be different, because all these good arguments sit alongside the rise of the ‘one per cent’ and what that means for the whole economy. Without institutional reforms to channel the direction and distribution of corporate success, Britain’s future prosperity is at stake.
Andrew Harrop is General Secretary of the Fabian Society. This essay originally appeared in the TUC report ‘Beyond Shareholder Value: The reasons and choices for corporate governance reform’, published in July 2014.