Paul Myners Executive chairman, Gartmore plc and companion of the IM
'All too often companies do not know why institutions are choosing to invest in them, what their expectations are in terms of returns and growth. In return, companies need to explain more clearly what their plans are for long-term investment, both capital and revenue, and their reasonable expectations of the likely impact this will have on long-term results and corporate cashflow'.
Innovation is vital if British companies are to compete successfully in the global economy, creating jobs and bringing greater prosperity in the process. As William Coyne, senior vice president of 3M in charge of research and development, noted in this year's Innovation Lecture, 'Innovation is the key to growth because it delights our customers'. To innovate requires continuous investment: not only in the research and development of new products and services, but also in new processes and human skills.
Yet how often do we still hear the cry, 'City short-termism is undermining UK industry'. All too often it is alleged that financial markets are to blame for the UK's lack of investment. It is claimed that because of their excessive demands for dividends, institutional investors discourage management from undertaking the long-term investment necessary to promote future health and competitiveness.
It sounds all too plausible - but is it true? I believe not. Many of you will have seen the report, Developing a Winning Partnership, first published in February 1995 and relaunched in a revised edition last month.
The report is the result of a working party made up of figures from industry and the City, sponsored by the Department of Trade and Industry and established under my chairmanship. It examines the relationship between companies and their institutional investors and, more importantly, how that relationship can be improved to their mutual advantage.
Short-termism is said to be endemic in British society: public finances are run on an annual accounting basis; the broader economic environment in which industry and commerce operate is heavily influenced by political considerations which in turn are driven by the demands of the electoral cycle; and our recent history of high and volatile inflation, high interest rates and the uncertainty of demand as a result of frequent changes in policies has led to an understandable reluctance to commit funds for investment.
Corporate managers and institutional investors are demanding higher and more immediate returns to satisfy the risk premium. As a consequence a climate of mistrust between companies and their institutional investors developed, with each suspicious of the other's motives. Whether or not City short-termism exists, and I believe that all too often the phrase is used as a convenient scapegoat for broader failings in economic and corporate management, this mistrust and suspicion has had a deeply damaging effect on the UK's competitive position over the past 50 years. The terms of reference of my working party implicitly recognised this problem in that we sought 'to suggest practical ways in which the relationship between UK industry and institutional shareholders can be improved as a stimulus for long-term investment and development'.
Unlike the Cadbury committee and the Greenbury study group we do not prescribe codes of practice. Rather, as a result of detailed consultation with a wide range of individuals, companies and institutions, our report establishes models of behaviour for companies, institutional investors and boards of pension fund trustees. These models are based on the elements of best practice that presently exist. This led to criticism from some quarters. At the time that the report was published some said it contained nothing new, that it was 'motherhood and apple-pie'.
But this is to miss the point altogether. Time and again we were surprised at just how few players, both companies and institutions, actually managed to match best practice, which in some instances is little more than common courtesy.
The models show the need for greater and more open communication. We do not deny that there are inherent tensions in the relationship between companies and investors - given their differing objectives it would be surprising if there were not. But all too often companies do not know why institutions are choosing to invest in them, what their expectations are in terms of returns and growth. In return, companies need to explain more clearly what their plans are for long-term investment, both capital and revenue, and their reasonable expectations of the likely impact this will have on long-term results and corporate cashflow. Of course, we are not arguing that companies discuss commercially sensitive matters, nor that institutional investors should seek to abuse the privileges of one-to-one meetings, but with both parties clear about the other's expectations it is possible to change the whole tenor of the relationship for the better.
This has broader implications, including highlighting the need for far more extensive training. We were horrified at the lack of awareness of how the financial markets work among quite senior corporate management.
At the same time much could and still needs to be done by institutions to improve the broader industry knowledge of their fund managers and to develop an awareness of the general uncertainties of corporate life.
The need for training extends to the trustees of pension funds. No doubt we would all like to see the performance of our particular fund in the upper quartile every year. But if all trustees set this as a specific goal 75% are going to be disappointed. Yet these targets are frequently set, without any reference to the needs of the fund itself, and only a vague understanding of what it is they are trying to achieve. In turn these unrealistic targets place pressures on the fund manager to behave in ways that emphasise shorter-term performance over the longer-term needs of the fund.
By adopting the models set out in the report we believe that the climate for innovation and long-term investment and growth in this country can be greatly improved, and the mistrust and suspicion that has scarred these vital relationships removed. A recent workshop confirmed that the models remain at the forefront of best practice in this area and we are greatly encouraged that the Hundred Group of finance directors, among others, has decided to adopt the report as part of its core policy. We all have a role to play in this - it is, after all, in all our best interests.