There’s something wrong with UK plc, according to the Bank of England’s chief economist Andy Haldane. No, he hasn’t unearthed some sinister conspiracy in the beating heart of the City. Rather, the influential central banker has taken aim at corporate governance (gasp), saying the primacy of shareholders encourages risk and discourages investment.
In a speech delivered in Edinburgh in May but only just published, Haldane argued that changes in the characteristics of investors have led to a harmful rise in that most dreaded of maladies, short-termism. Institutional investors have come to control the lion’s share of UK equities at the expense of individuals, while among the institutions hedge funds and asset managers have trampled all over pension funds and insurance firms.
The result? Shares now change hands every six months on average, rather than every six years as they did back in 1945, while ever-rising dividends – now equivalent to 60% of internal cash flow compared to 10% in 1970 – are eating into investment spending. Apparently this is a bad thing…
‘The stakes – for companies, the economy and wider society – could scarcely be higher,’ Haldane warned.
Shareholder primacy used to rein bosses in from overly risky behaviour, Haldane went on, but the diversified portfolios of modern investors means they are less exposed to risk in any given firm, making them ‘unlikely to discipline risk-taking by management’. And we all know what happens then (here’s looking at you, financial sector).
Aside from taking aim at executive compensation, Haldane suggests we take a leaf out of the French, German or Japanese books. ‘A majority of Japanese, German and French company executives put employee job security above shareholder dividends. For UK and US companies, a strong majority place the balance the other way around,’ he said.
Involving other stakeholders (like creditors or employees, as they do in Germany) in management decisions or rewarding longer-term shareholders with more voting rights (as they’ve started doing in France) could help bring about this cultural change.
But do we really want that? France and Japan aren’t exactly shining examples of economic health. It may well be that without a little more risk, or even the boom and bust that creates, the alternative is stagnation.
Risk is as much about what can be gained as what can be lost. Without investors and bankers willing to take a chance, many innovative companies would never have been born. Without volatility or the ability of shareholders to reward profitable companies, an economy filled with self-serving, bureaucratic firms could struggle to keep up with a changing world.
Obviously too much risk is a bad thing, but whether the UK and US or Japan and Europe have the right balance is far from clear.
Beyond that, it’s debatable whether Britain is actually underinvesting. Certain industries would benefit from more, it’s true (telecoms and other infrastructure firms come to mind), but the UK’s comparative advantage is in areas like the creative industries and finance, which aren’t going to need the same kind of capital investment as, say, consumer electronics. That could be a case of chicken and egg, but either way Britain’s not doing too badly out of it.
Neither Haldane nor the Bank of England have the authority to do anything about Britain’s corporate governance laws, but they can spark a debate. The government may decide that short-termism is hitting productivity and something needs to be done. Just don’t expect shareholders to be happy about it if it does.