 Well, good afternoon everybody, thank you for coming along to a PCL seminar this afternoon. I'm delighted to introduce Dr Roger Barker. Roger is Director of Corporate Governing professional standards at the Institute of Directives, where his responsibilities include corporate governance, board effectiveness, risk management, company wall and corporate social responsibility. As well as his IOD position is also Senior Advisor to the Board of Equidad, the European Federation of Directors Associations. He's also Chairman of the EECADY Education Committee. He sits on advisory boards at a number of organisations, including the Institute of Chartered Accountants. And he's a visiting lecturer at a number of institutions, including Seed Business School at Oxford, East Second Paris, UCL and the Ministry of Defense. Dr Barker's offer, the couple of books influential books in Corporate Governance, Corporate Governance Competition and Political Parties, Explaining Corporate Governance Change in Europe, was published by OUP in 2010. Roger's also the co-author with Dr Mevel Bain, of the IOD's main guide to the role of the board, the effective board building individual and board success. In his past life, Dr Barker was an investment banker in London and Zurich. He's also a doctorate. He has a PhD in Corporate Governance from Oxford. And he's also previously been a lecturer at Merthyn College. And I only recently found out he's also a Cambridge alumnus as well, a former Corpus Christi person. I didn't know prior to inviting Roger to this event that he actually had a Cambridge note as well as an Oxford history which he was delighted to hear about. He also has degrees from Southampton and Cardiff as well. Roger's here to speak about one of the most topical issues in certainly corporate governance and in commercial and financial law in practice more generally, which is financial market short-termism and corporate short-termism. Hence the title of Roger's talk this afternoon, short-termism in UK public companies, implications, evidence and policy options. So without further ado, I will ask the full role of Roger. Thank you very much Mark. Thank you. I didn't realise I was that old actually as you were going through that list of other things. I mean, you know, I'm only a young chap still. Yes, it was great to see you here today to talk about this topic. And you're probably thinking, what on earth has a marshmallow got to do with the issue of short-termism? Well, you may have heard of this experiment which took place at Stanford University in the late 60s, early 70s, where kids were given the opportunity to delay their gratification in terms of eating marshmallows and then be given additional marshmallows or to just, you know, go for it, immediately gratify their desires and eat the marshmallow. And in a way, what was interesting actually about this particular experiment was that those kids that were able to delay their gratification in subsequent years actually had much more successful outcomes in terms of their careers, in terms of their relationships, in terms of their earning power. So it seemed that there was a relationship, some kind of relationship at the individual level between your ability to take a long-term view and delay gratification of needs and desires and success. And that really, I think, is analogous to the debate that we are going to talk about today which relates to the possible short-termism, or otherwise, of UK public companies, UK companies quoted on stock markets. Is there something about that kind of organisational model which inherently pushes companies towards a short-termism which in some way could be detrimental to their long-term success and to the success actually of the UK economy as a whole? I mean, this is not a new argument. I mean, it really goes back to Max Weber, if there are any budding sociologists out there who actually try to explain economic performance in terms of the ability to delay gratification. So it's a very long-standing argument and it continues to be controversial and what I want to do today is just really to take you through some of the evidence. Some of the evidence I'm going to present is academics or academic studies. Some is more anecdotal evidence, a couple of case studies and survey evidence. I mean, I wish that I could provide the definitive answer to this whole topic in the course of the next hour, but I can't. What I'm going to present to you is to some extent a partial snapshot and ultimately I think you have to make your own mind up as to whether short-termism genuinely is a problem in UK public companies, whether something needs to be done about it, whether it has serious implications for the UK economy or not. So let me just start by asking, why should short-termism in UK public companies matter? Well, in theory, if you're short-term oriented and you are really wanting to extract the maximum of return, that you're really wanting to make your assets wet, get the greatest short-term return out of your company, that is going to have implications for the way you operate your company. You are possibly not going to be very inclined to invest in a lot of research and development, which is something which could only pay off in the very long term, very uncertain. You may be very skeptical and cautious about investing in new products, entering new markets or developing or applying new technologies. You may be also very cautious about recruiting new staff. Why add to your overhead when that could have very negative implications? It also, I think, can affect the attitudes that your staff have for you as an organisation. In the so-called varieties of capitalism literature associated with Hall and Soskis, there's a lot of talk about how, when companies are prepared to take a long-term perspective, the staff, the human capital of companies, is much more inclined to invest in specific skills which are relevant only to that specific company. Because they're willing to do that, that ultimately potentially can enhance the productivity and the success of the company. So, the overall argument as to why short-termism matters is that it can lead to this range, potentially, of adverse behaviour on behalf of organisations which ultimately is going to stand in the way of economic success of the company and of the economy. Now, what evidence actually is out there to suggest that short-termism is actually a problem? You know, maybe it isn't a problem. Well, let me start here just with a survey that the IOD undertook a few years back. We surveyed a number of different groups, we surveyed our own members that are somewhat oriented towards the directors of smaller companies, unlisted companies. We surveyed some business leaders who were board members of major listed companies, intellect members were academics, TUC representatives were people from the trade unions. And we asked them, do you believe that short-termism is a problem in the UK economy with our companies in the UK economy? And as you can see there, there was some spread of views. But surprisingly, actually, most of these stakeholder groups did think that it was either a major issue or a significant issue. So there was a perception from these different groups of stakeholders that it is something that was worthy of concern. I mean, another type of statistic which is often adduced in respect of this debate, and this is something which was presented in the K review, a report published by Professor John K a couple of years ago when he examined the issue of short-termism in equity markets, was the fact that the UK in particular seems to spend amongst its private sector companies a relatively small amount relative to other countries on research and development, particularly compared to countries like Germany and Japan. So again, this is the sort of statistic which has been adduced to suggest, well, is there something about the nature of UK public companies which makes them averse to investing in long-term research and development activity. Another report which looked at this topic which was produced by Sir George Cox a couple of years ago, Sir George Cox is a former director general of the IOD. He gave this particular example of how the UK has a tendency to be very good, actually, in basic scientific research, particularly at the university level, but then is relatively poor in developing that research into commercially applicable and successful outcomes. And the example which he gave in this report was that of a new material called graphene which has been developed at Manchester University about 10 years ago, which won them the Nobel Prize and appears to have a tremendous range of potential applications. It's a very flexible, thin, high-conductivity material which has all sorts of potential applications in mobile phones, solar cells, and a range of other applications. And what he quoted in his report were the number of patents that had been filed in respect of graphene from different countries and different types of organisation. And it was very striking how, for example, Chinese companies appeared, really, to see the potential of this new material and had filed literally thousands of patents, whereas UK companies, the country where this material had been developed, UK companies, only 54 patents. Samsung alone had filed more patents than the UK as a whole. So, again, for Sir George Cox, this added to the impression that somehow the UK, because of the short-term orientation of its public companies, was somehow reluctant to invest in this sort of long-term research and development activity. Let me provide you here with some studies, more academic studies, which have been conducted on this topic. I won't go into them in a huge amount of detail. The first one, King, is actually Mervyn King, the former Governor of the Bank of England, who, earlier on in his career, did a lot of research into this topic and concluded from his research that the sort of discount rates which were being used by UK corporate entities in order to assess investment decisions was incredibly high, which to him was indicative of a pretty short-term perspective in terms of investment activity. There have been various other surveys which have been undertaken by professional services firms, which have asked managers the sort of questions like, if it was a choice between investing in a project which was going to generate a lot of value or alternatively not investing in those projects, but using earnings to smooth the earnings profile of your company so that your shorter-term earnings look more favourable, which of those would you choose? The sort of results which have come out of these surveys is that yes, corporate managers do seem very willing to actually favour this sort of short-term earning-smoothing type activity, even if it's going to be at the expense of long-term value creation. And final study there, Andy Houdang is currently the chief economist at the Bank of England. He's done a lot of research on this, and when he looked at the valuation of the UK and US equity markets, the sort of implicit discount rates which he calculated from the valuations of those markets to him also implied that there was a short-term perspective on behalf of investors in terms of valuing equity markets. Now I will, there's just one study which I think is of particular note, which was published about a year and a half, a couple of years ago, which I think by John Asker and his co-authors, which I think is a particularly interesting study because it's very well-designed and it's trying to actually look at the investment behaviour of public companies versus private companies. And it's quite a sophisticated piece of work because it tries to very much compare like with like. So it looks at companies that are equivalent in terms of their sector operation, their size. The only difference between them is that one is listed and one is a privately held company. And it looks at thousands of companies across the US in these terms and finds that private companies, relative to their peers in the listed sector, appear to invest, have much higher rates of investment. And this is particularly the case actually where investment opportunities arise, that private companies are much faster to actually to respond to these investment opportunities by increasing investment. And this finds this to be a particular issue in comparison with public companies that have very sensitive share prices relative to earnings news in the stock market. So for him, the conclusion of this is that there is something about being a listed company with your shares quoted on the stock market, with your shares actually fluctuating in response to changes in short-term changes in investor sentiments, that really places short-term pressures on you and that makes you, for example, much less likely to invest in long-term uncertain benefits. Now, let me now just move away from the academic studies to just a bit of a case study here. And that's a very recent problem that we've had in the UK with Tesco, our biggest supermarket. I mean, this monolithic entity, which I think has at its peak had about a third of the UK food retailing market, was embroiled last summer in an accounting scandal. It turned out that actually it had overstated its earnings by about 260 million pounds in the first half of last year. And effectively what it had done is it had shifted revenues from the future into that accounting period in order to flatter its earnings picture. And that, you know, there's been a lot of controversy over this. The CEO of a company resigned, although he actually, it actually came to light a few weeks after a new CEO had taken over, but there's been a lot of turmoil at the company. And what seems to have happened is that Tesco appears to have had some pretty bad relationships with its suppliers. And there have been various commercial relationships in place between Tesco and its suppliers. Tesco appears to have been in a position, like other food retailers, to exert a lot of pressure on its suppliers, to move backwards and forwards the revenues that arise from its commercial relationships with suppliers. The new CEO of Tesco has said, look, this was a disaster. It's not going to happen again. We were under a lot of pressure. You know, we're facing a lot of competitive pressure from discounters like Aldi and Lidl, who are really coming into the market and challenging our position. And that what seems to have happened is that managers in Tesco felt under pressure from investors, from financial markets, to come up with the goods, to keep their earnings at a high level. And as a result of that, they succumbed to the temptation of trying to manage their earnings stream and boost their earnings in the short term. Even if that ultimately is not something which can be sustained over the long term. So this appears to be a case of where market pressure is really affecting management behaviour. There are various other points, shall we say, circumstantial evidence, which I just want to very briefly point out to you. Which, although perhaps not direct evidence of short termism, do give one pause for thought and do demand an explanation. And the first thing that I would point to is that we are currently living in a world where large corporations have huge cash piles. And for some reason, even though we're living in a world of record low interest rates and there's been unprecedented monetary stimulus, in the global economy, corporates are not investing. They're sitting on huge piles of cash. Why is that happening? Well, there are various explanations for that. I mean, there are explanations in terms of taxation. You know, a lot of US companies have big piles of cash outside the US, which they don't want to bring back into the US because they'll be penalised by the Internal Revenue Service. But personally, I'm not hugely convinced by that argument. I mean, there was an amnesty about 10 years ago which allowed a lot of US companies to bring back their cash piles. And what did they do with the money? Were they tended to spend it on share buybacks rather than actually invest it? And this actually brings me to the next point. It is actually amazing the level of share buybacks which are going on amongst large companies at the current time. And it's especially amazing actually when you think that it wasn't that long ago when buying back your shares was illegal. And I think even as late as 1998 in Germany it wasn't allowed to buy back your own shares. But yet now share buybacks have conquered the world and it's the mantra almost of any self-respecting management, particularly in the US but also in the UK or any activist shareholder, buy back your shares. But what is that actually achieving? There are good, I think problems with a lot of these things is that there are of course good reasons to buy back your shares. You know, if you haven't got any compelling investment opportunities rather than waste the money, by all means return the money to shareholders. But have management really run out of ideas? I mean, are they really unable to identify the sort of business opportunities and possibilities for value generation to the extent that these cash piles and these sharebacks imply? It to me it's a very unsettling type of activity. Another statistic I would point you to or work that I would point you to is the work which has been undertaken by the OECD who have actually found that public equity markets on a global basis over the last decade or so have not actually raised any net capital for companies. So the capital which has been raised in the form of IPOs and secondary equity issuants has been more than matched by share buybacks and other types of activity which actually reduced the amount of equity in circulation. So what is it meant to be the big advantage of the public company vis-a-vis the private company is that it's a vehicle which is better placed to raise capital. And that is what stock markets ultimately are primarily there to do, to provide a vehicle for capital raising which can be then applied in the economy to generate growth, innovation and so on. But equity markets don't appear to be doing that. And that, to me, is a worrying sign. Why are equity markets not actually fulfilling their true purpose? Why are equity markets just being used as a kind of vehicle of secondary trading to kind of recycle funds from companies back to shareholders back to companies, of course, with all manner of financial intermediary sitting in between these flows and taking their cut of the funds? Another piece of circumstantial evidence which worries me is actually the behaviour of US technology companies which have been listing on the US equity market in recent years. Companies like Facebook, Google, Amazon and so on. And you probably observe that they have been adopting very sharehold, minority shareholder, unfriendly type governance structures. They've effectively been designing a governance structure which insulates either the founders or the management from financial market pressure either by issuing non-voting shares or having multiple share classes. And the rationale for these mechanisms, the rationale which is put forward by Jack Ma or Jeff Bezos or whoever it might be is we can't run a technology company if we are subject to the constant buffeting and short-term demands of financial markets. We need stability in order to make the long-term investments which are going to turn us into a successful technology company. And so they come to the market with these structures and institutional investors have complained and sort of griped about it, but ultimately these are the amazing companies of our age and they've still invested. And something similar was, a similar type of point was made recently just within the last couple of weeks where it was reported that a lot of late stage US technology companies were actually not listing on stock markets. They were preferring to actually remain closely held companies because on the one hand there appears to be ample sources of financing available to them from venture capitalists and the like. And much better to stay private if they can get that sort of funding than expose yourself to financial markets by becoming public. Of course it's a risky thing for investors because these companies are not going through the same due diligence that they would go through, for example, by the ACC if they were listing. But again, to me this is a worrying sign that a lot of the really entrepreneurial dynamic companies out there see the public equity markets as something which isn't actually going to be helpful for their developments. So a source of concern. And here is the man himself, Jack Ma, who actually made what I thought was quite an amazing statement just prior to the flotation of Alibaba in New York last year, the world's largest ever IPO. Blatantly said, look, we put customers first, employees second and shareholders third. We are running this company, we're not running this company for shareholders. Which is a, if you think about it, an amazing thing to say, just immediately prior to launching an IPO. But he, that was what he believed. And something like Jeff Bezos, I think would say exactly the same thing. Now, what are the causes of short-termism? If you accept my argument that there is short-termism in public companies, and I don't want to suggest that I've presented a definitive proof of that, but I think that there are strands of evidence out there which give one cause for concern. What are the, if you buy that argument, what are the potential causes of short-termism? Well, certainly the survey that we did did point the finger at a shareholder pressure. So it's very much an issue for public stock market quoted companies. And I think really the argument here is that, is in two parts. The first part is that financial markets on which listed companies are trading are themselves pretty short-term in terms of their fluctuations and in terms of their sentiment. I mean, I've put there that 70% of stock market turnover is by traders rather than longer-term investors. The average holding period of an equity investor in the UK pretty short of about eight months has come down hugely over the last couple of decades. But so financial markets are relatively volatile. But on the other hand, one could equally say, well, just because financial markets are short-termists and are relatively volatile, that doesn't necessarily mean that companies themselves have to be short-termists. There has to actually be a transmission mechanism from the short-termism of financial markets to company behaviour. And I think that the transmission mechanisms which are generally put forward are first of all the type of executive pay arrangements that exist in major UK companies, but also US companies, which are often designed to align the interests of senior management and the CEO with shareholders. They're kind of a response to the principal agent problem in corporate governments. So they are trying to get managers thinking and behaving like investors, like shareholders. A second transmission mechanism is the threat of hostile takeover, which I would suggest is very specific to the UK, because the UK is quite distinctive in having a very open market for corporate control in contrast to continental Europe or the United States, where poison pills are very prevalent. So the threat of hostile takeover, your share price goes down too far, suddenly you become vulnerable to a takeover from another organisation that potentially can put pressure on you to think short-term. And then a growing source of short-termism, I would argue, are active as shareholders that are becoming incredibly important in the United States. Less importance elsewhere in the UK, for example, and beyond, although it's interesting to see what's happening currently in Japan, where activist shareholders are trying for the first time to put pressure on certain Japanese companies, like Sony, for example, and others. But certainly in the United States, there's a huge amount of money within hedge funds, which is out there pursuing an event-driven activist strategy. And typically the demands of these hedge funds are break up the company, buy back your own shares, undertake a takeover, or all allow us to sit on the board so that we can actually push that through ourselves. It's very much event-driven. And of course, these hedge funds are not homogeneous. They have many different strategies. Some are more long-term than others. But in a lot of cases, it is about, I would argue, it is about getting that pop in the share price through this kind of strategy, which then enables you then to sell out at a profit. So it's quite a straightforward strategy. The difficulty, I suppose, with these transmission mechanisms is that one can actually see them all in a positive light, rather than a negative light. The threat of hostile takeover, it could be seen as a source of discipline for companies rather than the source of short-termism. Activity shareholders could be seen as, again, a source of discipline to shake up companies to make them do the right thing, to think about not their own personal interests, but the interests of shareholders. So that is, I think, that's where the debate is so difficult, just depending on how you see actually the influence of these type of actors and these mechanisms, either in a positive light or as a force for short-termism. Now, I'm just briefly going to run through some potential policy options, which, if one thought short-termism public companies was a problem, the sort of things that one could consider. Some, I think, are more credible than others, but I just wanted to give you a range of options to inform your thinking. I mean, perhaps the most benign and light-touch way of trying to deal with this is through the introduction of the stewardship code, which has been introduced by the Financial Reporting Council here in the UK, which is really a way to cajole and persuade institutional investors to take a longer-term approach to their investments, to be good stewards, to not just be traders of shares, buying and selling, but to be there as longer-term government actors. And that's a related initiative, something called the Investor Forum, which is something which arose from the K-Review, which is trying to also coordinate institutional investors to get them to work together, actually, to exert a more positive influence over companies over the longer term. I have to say my own view of that is I don't see much evidence that that has fundamentally changed investor behaviour. A lot of fund managers and asset owners have signed up to the stewardship code in principle. Has it actually changed behaviour? I'm not so sure. I was just yesterday had a meeting with the head of governance at Standard Life, one of the big UK institutional investors, and he is very pessimistic about the impact that that has had. You could try to nudge, incentivise, or cajole institutional investors to behave in a more long-term manner in terms of their investment philosophy, by, for example, using the tax system. You could, for example, imagine a more favourable rate of capital gains tax for people who hold shares for a longer period of time. The problem with that, of course, is that the majority of people who own UK equities nowadays are based outside the UK. They're not UK investors. A lot of the institutions have their own pretty favourable tax arrangements anyway. So I'm not sure how that is going to have a big impact. Ensure that long-term shareholders only vote on takeovers. So something which I understand is going to go into the Labour Party's manifesto just ahead of the general election is a proposal that if you have joined the shareholder register during the course of a takeover bit, you won't actually get a vote on the takeover. So this is an effort to say, well, it's only longer-term shareholders who will actually have the say in a takeover. This was something that was a very controversial issue in Kraft's takeover of Cadbury a few years ago when the board of Cadbury, Sir Roger Carlaw, Chairman of Cadbury said, look, ultimately the people who were making the final decision here are just a bunch of hedge funds who bought in during the course of the takeover process. Encourage another policy approach. Encourage separate classes of shares with different voting rights. My view is that there's nothing intellectually wrong with that. I personally don't have a great adherence to the kind of one-share, one-vote mantra, but one has to recognise that institutional investors in the UK are completely against different classes of shares. They see that as unfair. They want to have the maximum flexibility and the maximum power. So I think the problem that any company has is getting investors to accept that. And at the end of the day, what investors, what companies tend to care about is are they going to be able to raise the funds that they need from the market? And if there is this huge barrier in the way, that is something which deters them. Encourage companies to grant preferential dividends or enhance voting rights to longer-term shareholders. Well, we just had an interesting case study of this, actually, within the last few weeks, when the Italian government tried to make it... or put forward a proposal to make it easier for companies to actually allow shareholders who were longer-term shareholders, longer than two years, to have a greater voting power in the company. The result was a whole group of institutional investors wrote a letter to the Italian government and the Italian Prime Minister, Mattia Renzi, literally after a couple of days, did a U-turn and said, we don't want to put anything in the way of foreign investment into Italy, so we're not going to do this. The French have done this since 2012. Something along these lines has been in place. But it's not popular with institutional investors. I'm just going to step over that. Implement a Tobin tax. I mean, if you feel that financial markets are too volatile, too focused on trading, rather than ownership, why not introduce some kind of tax on the trading of shares? This is something that a number of countries in the European Union, led by France, still want to do. But it's something which the UK, in particular, is very much against. Luxembourg, as well, because they see as a threat to the financial market activity that takes place in their respective countries. So whether that is something that will come to pass is difficult to say, although, of course, we've had stamp duty in the UK for about a century, which is effectively a Tobin tax, a financial transaction tax. That doesn't appear to have affected our financial markets too much. Another proposal abolished short-term reporting, abolished quarterly reporting of companies. The argument there, which was made in the K review, is that if companies are reporting on a very short-term basis, that encourages a short-term as mentality, both amongst investors and the companies themselves. That proposal is actually being acted on. In fact, in November of last year, across the EU, it no longer became mandatory to report on a quarterly basis. It is now up to the company to decide did they want to report on a quarterly basis. A few UK companies have already decided that they're no longer going to report on a quarterly basis. National Grid, United Utilities, for example, they both announced that. Other companies I would have thought are likely to follow. To me, that is a sensible approach. Allow the company itself to decide does it want to report on a quarterly basis? Is that what is relevant for its particular business model and its investor base? Encourage longer-term remuneration arrangements for executives and non-executives. I think that's a huge issue, a very top, horny, highly political issue. We're just going now this week into the reporting season for the major banks. We had HSBC reporting yesterday, and pay is going to be very, very controversial. Of course, the big part of most executive remuneration at the current time is not their basic salary or their bonus. It's actually their long-term and so-called long-term incentive plans, L-TIPS, which is generally a package of variable pay which executives receive when they achieve certain performance goals. Problem I have with them at the moment is that typically this performance horizon is three years, which doesn't sound to me like a very long-term performance horizon, despite the fact that they're called long-term incentive plans. It's hardly long-term. So, I think what we need to do is actually make them more genuinely long-term. And the other thing, where much they're criticised, is that they tend to actually focus performance on things like earnings per share grow and total shareholder return, which fluctuate on a short-term basis. A lot of people would like to see performance criteria which are much more tied to the long-term strategy of the organisation. But, of course, these are foreign issues. If there were easy answers to these issues, then they would have been undertaken already. We could, of course, allow poison pills, as is undertaken in the US. That is something which would be, I think, anathema here in the UK. Really, the whole framework of takeover regulation in the UK has been developed to really ensure that minority shareholders get a fair deal. Poison pills are seen as something, I think, which entrenches management and entrenches boards. But I suppose, you know, with these other topics, there are two ways of looking at poison pills. Either they're something which entrenches management and boards, or they're something which allow you to take a long-term business approach. And which side of that argument you come down on? Well, it's not clear who is actually right. And then a final point I would make here is that one could actually get the government involved in determining takeovers and extend the current public interest test for takeovers. I mean, there are certain areas where the government is currently entitled to intervene in a takeover situation and potentially block the takeover. That could be extended. That's something that we at the IOD are not to like the idea of, because we can easily see that the whole takeover process can become highly politicised. You know, you can imagine a situation where a particular group of affected stakeholders from a takeover starts to lobby hard in the media and with government, and then that then leads to decisions about takeovers being taken on political grounds. But it's certainly one way in which one could address the issue. So that's, those I think are a range of policy options which one could use to address this issue of short-termism. But for me, I think, you know, the whole problem would probably go away and would probably be solved if we had more investors like Mr Buffett here who proclaims that his favourite polling period is forever. You know, if we had patient capital, if we had investors that were prepared to sit it out for the long term and conveyed that to boards and to management, that probably would be the ideal solution. So really what I'm saying is somehow can we get to a situation where we have the best of the worlds of a private company with a long term, potentially long term horizon and a public company where there is this great potential to raise capital for future growth? That to me is the challenge of this debate. Can we blend together these two worlds in the best possible way? Thank you very much.