For years it was simply assumed that people took financial reporting seriously. The model was simple. Finance directors and their teams produced information to enable investors to understand what was happening inside the company. There was a constant effort to improve the information, to tell the outside world what was happening, to fulfil the responsibilities of corporate governance. That model of investor relations still holds sway.
The only problem is that the landscape has changed. All that stuff about stewardship and governance might have gone out the window without anyone noticing. The problem is that the investors have changed, but the model has not adjusted to take account of it.
Once upon a time, the bulk of investors in a large and serious company were institutional. They invested in companies because the money to be invested was other people’s pensions and savings. They were in there for the long term: their decisions were considered. Their need for solid governance from the companies in which they invested was obvious. Widows and orphans might starve without it. Stewardship was a term for serious discussion.
But over the past few years, quietly and without much publicity, the world has turned upside down. The old rule was that about 80 percent of shareholdings in the FTSE-100, for example, were controlled by institutional investors. It was comfortable and solid. Companies could depend on this. The big pension funds might not ask too many questions, but they were in there for the long term. A company that explained itself well and provided a steady stream of earnings could prosper while the 20 percent of short-term shareholders who had but a passing interest in the company could be quietly ignored.
Today it is a different story, as Christopher Hogg, chairman of the Financial Reporting Council, highlighted to a gathering of corporate governance folk in May.
As he pointed out, international investors now own a much larger proportion of UK equities than in the past, while the asset management business is increasingly based on intensely competitive short-termism. Most crucially and dangerously of all, the percentage of the ownership of UK equities by what he describes as “long-only” investors – pension funds and insurance companies for example – is now down to 25 percent.
This trend means, as Hogg calls it, an “uncoupling” of time horizons. I should explain what this means. The institutional investors were in there for the long haul and could see the point of proper engagement in their role as owners.
The whole edifice of corporate governance and stewardship is built on this notion. The assumption is that better information creates confidence and better access to capital – a virtuous circle. But if the market has tilted to a majority being only in it for the short term, all the information assumptions, for example, change. Short-term investors tend to work off mathematical modelling. The figures are still essential, but all that investor relations and corporate governance stuff is wasted, or at best, superfluous. It may be that we are moving towards an investment world where increasingly automated decisions are at the heart of share trading.
If this is so, the work of the finance director becomes ever more confusing. On the one hand, more work is done to show the benefits of good governance, stewardship and quality information. Recent research from the Institute of Chartered Accountants of Scotland, for example, shows that companies with greater levels of intellectual capital disclosure have a lower cost of capital. And a host of evidence across a broad governance front shows similar results.
On the other hand, it may well be that intellectual is now the wrong word to use
about investor strategies.
Robert Bruce is a leading commentator on accountancy issues
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