Summary and implications
The Department for Business Innovation & Skills (BIS) has issued a consultation paper, titled “A long-term focus for corporate Britain”, on the perceived existence of short-termism and market failures in the UK equity markets.
Vince Cable states in the foreword that he wishes to examine whether the system in which UK companies and their shareholders interact promotes long-term growth or undermines it. The tenor of the paper suggests that further legislative or regulatory reform in this respect may be expected during the life of this Government. Given the potential consequences, we believe that it is important that everyone involved in “corporate Britain” should contribute to the debate.
The deadline for responses is 14 January 2011 and if you wish to discuss any of the issues raised and/or have your views represented in our response, please speak to your usual Nabarro contact or either of the authors of this briefing.
The specific areas covered by the call for evidence are: the board of directors; shareholders and their role in equity markets; directors’ remuneration; and takeovers.
The Board of directors
The paper notes that the Companies Act 2006, which put directors’ duties onto a statutory footing for the first time, calls on directors to consider the long-term consequences of their decisions in the context of promoting the success of the company for the benefit of shareholders as a whole. The first question on which evidence is sought is on the face of it a simple one:
- Do UK boards of public companies have a long-term focus – if not why not?
However, the many issues this question raises are often contradictory. Should directors always act in shareholders’ best interests or in those of other stakeholders? Should directors prioritise the interests of long-term shareholders over other shareholders, regardless of the make-up of the shareholder base?
In addition, the consultation seeks to consider whether the long-term focus of boards would be improved if the relationship between boards and shareholders were improved. One suggestion is a change to company law which would require beneficial ownership of shares to be disclosed generally, not just at the company’s instigation.
Shareholders and their role in equity markets
The paper notes the changing face of share ownership in the UK, in particular the increased participation of overseas institutions and sovereign wealth funds and asks:
- What are the implications of the changing nature of UK share ownership for corporate governance and equity markets?
- Is short-termism in equity markets a problem and, if so, how should it be addressed?
- What action, if any, should be taken to encourage a long-term focus in UK equity investment decisions? What are the benefits and costs of possible actions to encourage longer holding periods?
The Government appears to take it as a given that increased engagement by shareholders is a good thing and the focus of investors on short-term returns is a bad thing. We expect this area of the consultation to generate some of the most interesting responses, given the wide-ranging and often conflicting interests of different market participants.
The specific questions posed by the consultation are:
- What are the most effective forms of engagement?
- Is there sufficient dialogue within investment firms between managers with different functions (i.e. corporate governance and investment teams)?
- How important is voting as a form of engagement? What are the benefits and costs of institutional shareholders and fund managers disclosing publicly how they have voted?
- Are there agency problems in the investment chain and, if so, how should they be addressed?
- What would be the benefits and costs of more transparency in the role of fund managers, their mandates and their pay?
The issues behind these questions go to the core of how the investment community currently operates. Greater interaction with companies will require greater resources, which will increase costs for the average investor. If investment managers are to focus on a longer-term horizon, investors will correspondingly need to adjust their focus away from the annual performance of the funds under management. Whilst this may encourage longer-term investment decisions, it would result in it being harder for investors to detect any problems or performance issues at an early stage.
In the wake of the financial crisis, much commentary has been devoted to the increase over the last decade in the remuneration of FTSE 100 directors, both in gross terms and as a multiple of average employee earnings. In recognition of this, the Government is seeking evidence on whether additional measures to assist scrutiny and accountability are required:
- What are the main reasons for the increase in directors’ remuneration?
- What would be the effect of widening the membership of the remuneration committee?
- Are shareholders effective in holding companies to account over pay? Are there further areas of pay, e.g. golden parachutes, it would be beneficial to subject to shareholder approval?
- What would be the impact of greater transparency of directors’ pay in respect of linkage between pay and meeting corporate objectives, performance criteria for annual bonus schemes and the relationship between directors’ pay and employees’ pay?
It is true that the remuneration of FTSE 100 directors who, by definition, ought to be at the top end of the talent pool, has been increasing through bonuses and incentives vesting. However, research from the IoD indicates that this phenomenon is not necessarily as prevalent amongst directors of companies outside the FTSE 100.
The ink had barely dried on the Takeover Panel’s review of the regulation of takeover bids, which was published on 21 October, when the Government published this consultation, which looks further at the broader issues relating to the economic case, and corporate law framework, for takeovers. The consultation asks:
- Do boards understand the long-term implications of takeovers, and communicate the long-term implications of bids effectively?
- Should the shareholders of an acquiring company in all cases be invited to vote on takeover bids, and what would be the benefits and costs of this?
Despite agreeing with the Takeover Panel’s conclusion that some measures are required to rebalance market practice which is weighted in favour of the offeror, the Government has chosen to reopen the question of whether shareholders of an offeror company should always be invited to vote on takeover bids. The majority of the responses to the Takeover Panel consultation on this question were negative.
Curiously, the paper discusses the merits and economic effects of takeovers, before stating that the Government would like to consider whether “on balance, the economic framework for takeovers is likely to improve the long-term competitiveness of UK companies”. However, the paper fails to directly address the issue in the context of takeovers.