Prem Sikka finds Hammond’s industrial strategy an empty wish list
The UK economy continues to suffer from low productivity, low investment, short-termism, light-touch regulation, a weakening of its industrial base and low wages accompanied by unprecedented fat-cattery at the top. This requires a radical overhaul of economy policy, state intervention and governance of companies. Rather than addressing deep-seated problems, the government’s White Paper ‘Industrial Strategy: Building a Britain fit for the future ’ is more of a wish list rather than a concerted effort to meet the challenges.
The expression ‘industrial strategy’ conjures up an image of a substantial manufacturing sector. Yet the government offers no means of securing it. This is because of its hatred of public investment. Historically, the UK economy has been built by a mixture of private investment and direct state intervention. All too often, the private sector has shown little appetite for long-term risks and the state had to build airlines, telecommunications, engineering, biotechnology, nuclear and computer industries. It also reinvigorated railways, water, gas, electricity, shipbuilding and many others. The same will be necessary again not only to renew infrastructure but also to invest in new technologies, green industries, artificial intelligence and much more.
Don’t Leave it to Shareholders
A focus on the long-term is a key ingredient for any industrial renaissance, but is neglected by the government’s White Paper. The UK’s shareholder-centric model of corporate governance has been dogged by short-termism as shareholders push for quick returns. Shareholders provide a small fraction of total capital, at banks it is less than 10%, but enjoy 100% of the controlling rights. They have hollowed-out companies. Andrew Haldane, the Bank of England’s chief economist has noted 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. He added that “Among UK companies, share buybacks have consistently exceeded share issuance over the past decade”. Short-termism has incubated economic failures.
The European Commission’s analysis of the 2007-2008 banking crash concluded that “the majority of shareholders are passive and are often only focused on short-term profits”. In 2013, UK’s Banking Standards Commission concluded that “shareholders failed to control risk-taking in banks, and indeed were criticising some for excessive conservatism” . It urged the government to “consult on a proposal to amend Section 172 of the Companies Act 2006 to remove shareholder primacy in respect of banks, requiring directors of banks to ensure the financial safety and soundness of the company ahead of the interests of its members” . There have been no reforms.
Diluting shareholder control is a key requirement for rejuvenation of the economy. One possibility is to introduce a minimum qualifying period (e.g. twelve or six months) for shareholding before any shareholder can vote. This would prevent speculators from exerting pressure on directors to indulge in share buybacks, payment of excessive dividends and divestment programmes.
Stakeholders on Boards
The above alone won’t change the internal culture of corporations. This necessarily means changing the composition of company boards and give rights and powers to those with a long-term interest, including employees, in the wellbeing of companies. The Conservative government has made some cosmetic noises. The latest draft of the revised Code of Corporate Governance, published by the Financial Reporting Council with government backing, rules out direct employee representation on company boards. Instead, it offers three possibilities: assign a non-executive director to represent employees; create an employee advisory council or nominate a director from the workforce. This tokenism cannot prioritise the long-term.
Within the European Union countries, there are two broad models of governance: the single-tier system combining executive and non-executive functions in one ‘unitary board’; and the two-tier system distinguishing between an ‘Executive Board’ and a ‘Supervisory Board’ which must oversee the executives and confirm the decisions of executives on major issues. The two-tier supervisory board system predominates in almost half of EU member states, such as Germany, Austria, the Czech Republic, Hungary and Slovakia. The supervisory board has representatives of employees and shareholders.
The single-tier system with places for employee representatives as non-executives is established in France (companies are allowed to choose either the two-tier or the unitary board), Norway, Sweden and many other states. Where there is a very high density of trade union membership, as in Sweden, employee representatives are usually trade union representatives appointed or elected by trade union members in a company. Elsewhere they are employees elected by the entire workforce often in separate sectional votes. In some companies, worker directors are appointed on a voluntary basis.
The unitary board system has serious drawbacks. Unless employees and other stakeholders occupy a substantial proportion of the board, they risk being marginalised and will almost always lose all votes. On such boards, there is no easy way of differentiating between those decisions that are essentially about day-to-day management and those that affect the longer term strategy or future of the company.
The two-tier system is commonly associated with Germany. This was formally adopted in 1976 and confirmed by the Expert Commission reports in 2006 and 2014 to have contributed to the maintenance of a national manufacturing base, high investment and value-added economy. In Germany, enterprises having more than 500 or 2000 employees are represented in the Supervisory Board, which is composed of employee representatives to one-third or to one-half respectively. For enterprises with more than 2000 employees, the Chairman of the Supervisory Board, who, for all practical purposes, is a representative of the shareholders, has the casting vote in the case of split resolutions.
The two-tier system emphasises the need for co-operation amongst stakeholders to generate and share wealth. It separates the executive and supervisory roles. The Executive Board makes day-to-day decisions within a strategic context established by the Supervisory Board. The Supervisory Board makes longer-term strategic decisions, notably the allocation of resources between dividends and investment, take-overs and mergers, divestment, executive remuneration packages and much more. Trade unions continue to pursue collective bargaining within the statutory framework.
The system permits the replacement of the current system for appointing supposedly independent non-executive directors, often friends of executives, with fairly elected representatives of all stakeholders, including shareholders. The membership of the Supervisory Board can be extended to include other stakeholders. For example, the names and addresses of customers at water, gas and electricity companies, as well banks can easily be identified. They can act as a constituency and elect directors to represent their concerns at Supervisory Boards.
Despite the banking crash, failures of the gig economy and scandals at BHS and Sports Direct, the UK is yet to have a serious discussion about reforming corporate governance to build a sustainable economy. The Conservatives are not keen on employee and consumer elected directors. Labour party and trade unions have been surprisingly absent from the debate. Perhaps, after the electoral performance in the 2017 election, Labour would be buoyed to call for radical reforms.
Prem Sikka is Professor of Accounting and Finance, University of Sheffield
& Emeritus Professor of Accounting, University of Essex