The government’s proposed Corporate Governance reforms have the opportunity of being one vehicle for the transformation of the UK economy to one that ensures that the benefits of economic growth accrue to the many rather than the few. This is the main point that we make in our recently released paper in response to the government’s Green Paper.
The UK economy is structured systematically to favour returns to owners of capital at the expense of returns to employment. Company law forces Directors to favour the interests of shareholders above all other stakeholders. This results in Boards acting as conduits through which wealth is not necessarily created but can simply be transferred to shareholders from other stakeholders leading to progressive impoverishment of the UK economy. In addition, the tax system also favours returns on capital over wages earnt through employment. In such a system, it is to be expected that owners of capital will become progressively wealthier while those who depend on employment (ie. most people) will become progressively poorer.
These systemic flaws are amplified in the implementation. Short-term stock price performance is used as a flawed proxy for shareholder value. As a result, stock prices are used as the primary metric to judge corporate performance and to set the levels of executive pay. Yet, in a financialized economy such as that in the UK, stock prices largely reflect short-term performance and activity in the financial markets rather than providing a good compass as to the long-term health of the economy. The evidence is overwhelming that such a focus on stock price performance embeds short-termism, damages the economy and even acts against the long-term interests of shareholders themselves. That is why Jack Welch, the legendary former CEO at GE, called maximizing shareholder value ‘the dumbest idea in the world.’
The inevitable result is a vicious spiral of increasing inequality and long-term economic decline. As wages are squeezed and jobs eliminated, profits increase, stock prices may rise and, as a result, senior executives get paid even more. Increasing inequality is thus built into the system. Long-term economic damage is further increased as the focus on short-term stock price performance pushes senior executives to prioritise actions such as earnings management, large scale stock re-purchase schemes, and even setting their companies up for takeover, over investment in the growth of their businesses. The result: publicly quoted companies invest half the amount invested by comparable private companies in the growth of their business.
In our paper we provide specific recommendations as to how the proposed corporate governance reforms provide an opportunity to re-vitalise the UK economy and make the benefits of growth more inclusive. It remains to be seen whether, notwithstanding the rhetoric, the government has the appetite to drive such change. The Green Paper does not provide much encouragement. Its main characteristic is a decided lack of ambition.
Please join us with input into the debate in our online forum.
Dr Joe Zammit-Lucia FRSA is an entrepreneur, investor and trustee of Radix.