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Professor John Kay’s interim report seeks to encourage more responsible capitalism and challenge predatory activity
The rules and practices used to govern companies listed on the London stock market are in need of a radical overhaul to better equip the City for an increasingly complex and fast-moving modern world, according to a report commissioned by Vince Cable, the business secretary.
After scores of submissions and interviews with leading figures in the corporate and investment world, Prof John Kay said in his interim report to Cable that Britain’s equity markets need to re-connect with their core social purpose. “The long-term public goal for equity markets is in securing the public purpose of high performing companies and strong returns to savers through an effective asset management industry,” he said.
Kay has received strong lobbying on contentious issues such as short-selling, high-frequency computerised trading, foreign takeovers and diversity in the boardroom. He said the UK equity markets had been through radical changes that had brought a wave of overseas investors and companies seeking capital to London. In addition market patterns had changed, with high-frequency computerised trading accounting for more than half of all activity.
However, the issue that topped many investors’ list of concerns was executive bonuses. “The principal stated rationale for the changes in the structure of executive pay in the UK over the last three decades has been a desire to align the incentives of managers with the interests of shareholders. It does not appear that this objective has been successfully achieved,” added Kay. “Indeed, [shareholder groups] suggest that the design of executive remuneration schemes, far from being an issue which brings managers and shareholders closer together, is now a principal source of friction between them.”
Kay said some investor groups had told him that bonuses, even when deferred for three years, were ineffective, and often structured “asymmetrically” so that bosses benefited more from strong performance than they suffered from under-performance. He is determined to include aspects of executive pay within the scope of his review despite Cable having set up a separate report on this subject.
Another aspect of public company life that came in for strong criticism was quarterly reporting, which some business leaders told Kay had drawn investor focus away from engagement in long-term strategy. In particular, Kay cited the views of Sir Terry Leahy, the long-standing Tesco boss who stepped down last year.
Outlining a preferred model for shareholder engagement with executives, Kay said: “Terry Leahy, perhaps Britain’s most successful and respected manager of the last two decades, told us that he did not feel he had enjoyed such a relationship with analysts and fund managers â€¦ He further told us that the interaction had deteriorated rather than improved â€“ that analysts and fund managers had become more concerned with quarterly numbers and with earnings guidance, and less with the strategic direction of the business.”
Many other submissions to the Kay review echoed Leahy’s frustrations with quarterly reporting â€“ a requirement that is already under review at a European level.
On the subject of foreign takeovers, Sir Roger Carr, the former Cadbury’s chairman, made clear that directors at the confectionery group did not believe they had any choice but to recommend the 2010 takeover by its US rival Kraft. According to the report, Carr said this was the case even if “they considered that the long-term success of the company may best be achieved if it remained independent”.
Kay’s interim report points to a number of measures that might help bolster the role of long-term investors in public companies â€“ but also brought up a series of problems many of them may bring. Among the suggestions are tax breaks and enhanced voting rights for investors as well as greater contact with management, possibly through the establishment of a shareholder committee.
Cable himself has set great store by the Kay review and hopes that its implementation will form one of the central legacies of his time as business secretary.The report, as much as analysis as recommendations sets out the case for restraints on short selling and high-frequency trading, and proposes greater transparency on excessive asset management fees. is also proposedThe proposesIt also outlines various means to enable the rejection of takeover bids which may be in the interests of some investors but not the company itself. .and do not promote the success of the company including differential rights for shareholders, changes to the thresholds for shareholder approval, review of takeover bids by a public body, and greater discretion for directors to reject unsuitable bid.
The report Kay suggests there is a widespread view that “while it was once the case that shareholding was dominated by large UK institutions which were likely to have long-term stakes in both the acquirer and the company potentially to be acquired, and could therefore take a view of the merits of the transaction as a whole, this was no longer true. In some recent transactions a large proportion of shares in the target company had been owned by arbitrageurs whose only interest was in a rapid, profitable exit.”
At present UK company law does not currently provide enhanced rights for long-term shareholders, but such a change would represent a significant change. in custom and practice. One proposal, relate specifically to takeovers, would be to “disqualify voting by shareholders who had acquired shares after announcement of the bid. Arbitrageurs would therefore have a reduced influence on the outcome of the takeover. of the bid process.
The report also looks at measures to improve shareholder involvement in a company beyond simply trading shares. It asks “whether people or bodies who have an economic interest in a business, but who cannot be constructively involved with the management of that business by virtue of anonymity, remoteness or the nature of their interest should expect to enjoy similar rights vis-Ã -vis that business as others who are engaged shareholders in the business”.
Kay also re-examines the case for restructuring executive pay so that it rewards long term performance of the company rather than the immediate dividend performance. The ideas go beyond those set out by the government only a month ago designed to restrict levels of executive pay. It says the current design of executive pay schemes “encourages decisions, such as major acquisitions, which are likely to have large effects for good or ill in a relatively short time scale. Paradoxically, the effect of a ‘long term incentive plan’ may be to encourage risk taking with a short time horizon”.
It says “the design of executive remuneration schemes, far from being an issue which brings managers and shareholders closer together, is now a principal source of friction between them”.
On quarterly reporting, singled out by Kay for its distorting impact on company managers’ time horizons, the government is likely to be very supportive. Ministerial sources pointed out that the European Ccommission has recently proposed moving away from mandatory requirements on quoted companies to produce quarterly reports and interim management statements.