The government’s proposals will do little to check fat-cattery or improve corporate governance

Fat-cats have no shame and shareholders have no long-term commitment to any company. New measures won’t work.

The government’s proposals for reforming corporate governance and executive pay are hopelessly inadequate. Pay ratios highlighting differences in CEO and average salaries are already reported in the media, with the names of directors filling their own pockets paraded for the public, and this has failed to curb executive pay. The fat-cats have hardly shown any remorse.
The government’s new idea is that listed companies should publish pay ratios and ask the Investment Association (not Companies House) to keep a register of instances where 20% or more of shareholders have voted against executive pay. This does not amount to a meaningful reform of corporate governance and will fail.

I want to highlight two issues. Firstly, the government’s proposals apply to around 900 quoted companies only and most large companies will be exempt. Around 7,200 companies meet the Companies Act 2006 definition of a large company. They employ about 10.5 million people and have a turnover of about £2 trillion. Companies such as Sir Philip Green’s Arcadia Group (26,000 employees), John Lewis Partnership (86,700 employees), New Look Retailers (15,000 employees), Matalan (14,000 employees), Virgin Atlantic (8,500 employees) and hundreds of other large companies are beyond the scope of the government proposals. If the pay ratios and ‘naming and shaming’ are supposed to check fat-cattery and secure decent rewards for employees then why are hundreds of large companies exempt?

The second problem with the government’s proposals is the misguided faith that shareholders will somehow act in the broader interests of society. Through power and politics, shareholders have acquired rights to control companies but they are neither the owners nor the major investors in large companies. At banks, shareholders provide less than 10% of total capital.

In the UK case of Short v. Treasury Commissioners [1948] 1 KB 116 122, the judges said that “shareholders are not, in the eyes of the law, part owners of the undertaking. The undertaking is something different from the totality of the shareholding”. The case of Gramophone & Typewriter Ltd v Stanley [1908] 2 KB 89 stated that “The directors are not servants to obey directions given by the shareholders as individual; they are not agents appointed by and bound to serve the shareholders as their principals”. There is a pressing need to redefine the nature of a corporation and its relationship with all stakeholders, but the government does not do that.

The shareholder centric model of corporate governance can’t address poor practices because shareholders have no long-term commitment to any company. They are mainly interested in short-term returns. The Bank of England’s Executive Director noted that by 2007 the average shareholding duration in UK companies had declined to around 7½ months. For banks it was about 3 months in 2008. The informed opinion is that the shareholding duration may now be around one month. In the era of automated share trading wheelers and dealers hold shares for just 22 seconds. Today shareholders are more dispersed than ever before and cannot easily act in concert. Some 54% of the shareholders of quoted companies are foreign and the major reason for their investment is high returns rather than any concern with curbing fat-cattery. The government has provided no evidence to show that these speculators are capable of invigilating companies for the common good.

The government exhorts institutional investors to police corporate executives, but institutional investors themselves are corporations. Their executives are subject to short-term performance evaluations and exert pressure on other companies for quick returns. A Bank of England official also reported that in 1970 UK companies paid out about £10 out of each £100 of profits in dividends, but by 2015 the amount was between £60 and £70, often accompanied by a squeeze on labour and investment. The Parliamentary Banking Standards Commission inquiry into the 2007-08 crash concluded that institutional investors were “scarcely alert to the risks to their investments prior to the crash, but were mesmerised by the short-term returns and let down those whose money they were supposed to be safeguarding”.

Under pressure from shareholders, the stock market, in which the government shows so much faith, has become a vehicle for cash extraction rather than investment. The Bank of England’s chief economist noted that “Among UK companies, share buybacks have consistently exceeded share issuance over the past decade, albeit to a lesser degree more recently ….  In other words, over the past decade the equity market no longer appears to have been a source of net new financing to the UK corporate sector”.

The government’s proposals will do little to check fat-cattery or improve corporate governance. The faith in shareholders to invigilate companies is misguided. Democratisation of corporations is the key to good governance, but it does not figure in the Tory policies.

Prem Sikka is Emeritus Professor of Accounting at the University of Essex. He was an adviser to the Work and Pensions Committee for its investigation into BHS and related matters.

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