FLAWS IN THE UK’S financial markets have been exposed in a 40,000-word review by leading British business economist, professor John Kay. The review, entitled UK equity markets and long-term decision making, was established in order to consider how well equity markets are achieving their core purpose of enhancing the performance of UK companies and enabling investors to benefit in returns from equity investment.
A key theme in the review is that all types of investor, sophisticated or not, should have what Kay describes as “well-founded trust” in the markets.
It comes as no surprise, after such talk of trust, that Kay has recognised the need for strong relationships within the market, with one of his key recommendations being that companies should consult their major long-term investors over significant board appointments.
These appointments are intended to allow companies and their investors to assess the long-term effects of their actions, and focus on long-term performance – including practices such as holding company shares until after the executive has retired from the business. Kay also suggested setting up a forum for investors to engage with UK companies as well as each other.
According to Kay, analysts’ tendency to focus purely on the contents of the next company statement has led to a disconnect between the statements and companies’ underlying performance.
“The exercise need have little, if any, connection to the underlying competitive capabilities of the business,” says Kay, in a view also expressed by executives interviewed during the review process.
“But we believe it is important that the UK should not move any further in this damaging direction.”
The relationship between companies and shareholders would be more effective if shareholders took part in the selection of chairmen and/or non-executive directors, the review finds, and adds that this could be a means to open up broader discussions between the parties.
Robert Hodgkinson, executive director at the ICAEW, agrees that businesses should start to consider the long term: “Equity markets have a vital part to play in ensuring we have well-run companies providing sustainable returns for investors.”
No quarter given
However, the review, described by business secretary Vince Cable as “insightful” and “powerful”, was not founded solely on the idea of improving the relationships between businesses and investors, or even encouraging wider outlooks on the future of businesses, although both ideas featured heavily in the 111-page document.
Kay went into depth when discussing the importance of maintaining focus on improving UK companies and concentrating on the road ahead, which is likely to be his reason for recommending an end to the requirement that listed businesses must provide a quarterly financial report.
Quarterly reports are dreaded by the listed companies obliged to produce them, as they are incredibly time-consuming. In the report, Kay suggested that their time could be better spent looking at ways to increase growth, and CBI director for competitive markets Matthew Fell concurs.
“Removing the requirements for quarterly reporting and short-term earning updates will take away the unnecessary distractions, and help boards and investors focus on the long term,” explains Fell.
Not everyone agrees wholesale with professor Kay’s review. Martin Gilbert, chief executive at Aberdeen Asset Management, brands the review as “a pretty sensible report”, but adds: “Getting rid of bonuses would mean less flexibility over pay and we might have to lay more people off in a downturn.”
Whether Kay’s expansive suggestions will become compulsory changes for UK businesses is not yet clear. However, it appears that the majority would be willing to embrace these new rules, and focus fully on the long-term journey of their company.
THE KAY REVIEW’S FINDINGS
• Companies should consult their major long-term investors over significant board appointments.
• Ending the requirement for listed businesses to produce a quarterly financial report.
• Company executive pay should be designed to focus on long-term performance, and company shares should be held until after the executive has retired from the business.
• Setting up a forum in which major investors can engage with UK companies and each other.
• A government review of the scale of merger activity in the UK.
• EU and UK regulators should apply a “fiduciary” legal obligation to anyone who manages other peoples’ money or provides investment advice.
• Asset managers should make a full disclosure of all their costs, including transaction costs and performance fees.
• Independent review of the way in which large investors process financial data, measure financial risk and make investment decisions.
• Fund managers’ pay should similarly
be designed to reflect long-term performance.
• The government should explore the most cost-effective means for individual investors to hold shares directly on an electronic register.