Short-Termism in UK Equity Markets
Sarah Jane Leake | Bloomberg Law
The Kay Review of UK Equity Markets and Long-Term Decision Making – Department for Business, Innovation & Skills Call for Evidence, 15 September 2011; The Kay Review of UK Equity Markets and Long-Term Decision Making – Speech by Professor Kay, 15 September 2011
Earlier this year,1 the Secretary of State for the Department of Business, Innovation & Skills (BIS) – the Rt Hon Dr Vince Cable MP – announced the launch of an independent review, chaired by Professor John Kay, into the “the mechanisms of corporate control and accountability provided by UK equity markets and their impact on the long term competitive performance of UK businesses.”2 Colloquially, the Review is known as the Kay Review.
On 15 September, Professor Kay officially launched the Review, in the form of a call for evidence, which builds on BIS’ terms of reference published some three months ago. In a speech given before the National Association of Pension Funds on the same day, Professor Kay expanded on the broader philosophy and objectives of the Review.
Purpose & Objectives
The Kay Review arose out of BIS’ consultation on improving long-termism in corporate Britain, launched last autumn, which looked at broader governance issues including takeovers and executive pay.3 Feedback indicated that short-termism is indeed a problem now seemingly inherent in UK equity markets. “The perception of a problem,” opines Professor Kay, “is in itself a problem; especially if that perception is maintained by people in the investment community.” Investigative action and, where necessary, remedial relief in this sphere is therefore now one of BIS’ top priorities in order to secure a successful departure from the governance failures of recent years.
Providing an important link between the activities of publicly traded companies and returns to underlying beneficiaries, equity markets represent a critical source of jobs, growth and stability. In the wake of the financial crisis, the Government seeks to acquire a better understanding of the extent to which equity markets enhance company performance – by facilitating investment and supporting better corporate governance – and enable investors to achieve the best possible returns.
Professor Kay has been asked to review corporate behaviour along the whole investment chain – company boards, pension funds, advisers, fund managers, and the ultimate beneficiaries, and the relationships between them – in order to assess how well equity markets are achieving their dual purpose. In particular, he will be looking at their incentives, motivations and timescales with a view to establishing how these affect long-term performance.
For the purposes of the Review, asset managers are considered the most important type of intermediary. The pivotal role they play creates scope to stimulate better decision-making by companies and investors alike; they are perfectly placed to oversee the activities of businesses and match investment opportunities to individual investors’ needs in a more sophisticated fashion. While the growth in intermediation may increase professionalism, it also has the potential to increase costs incurred by investors and multiply conflicts of interest between intermediaries on the one hand and companies and investors on the other. Weighing up the benefits and pitfalls of intermediation in today’s markets, Professor Kay will, in particular, focus on whether the costs of increased intermediation justify the benefits.
The Review will principally concern companies traded on UK markets with significant operations in the UK – including AIM, PLUS and the London Stock Exchange Main Market. Companies with listings in the UK that are, in other respects, not UK businesses (e.g., mining companies based in the former Soviet Union) and companies operating in the UK but listed elsewhere (e.g., Kraft Inc.) will not be subject to review.
In particular, the Kay Review will examine the following issues:
- The extent to which the timescales used by companies and asset managers match beneficiaries’ interests and expectations. Professor Kay will assess, amongst other things, the relationship between reporting timescales and those used for internal planning and appraisals.
- How to make sure that shareholders and their agents give sufficient emphasis to the underlying strengths of the companies in which they invest. Evidence is especially welcome on the degree to which trading in equity markets is driven by analysis of underlying corporate performance and, in particular, short-term market trends.
- Whether boards are sufficiently encouraged to focus on long-term growth and development. In particular, Professor Kay will examine whether changes in reporting obligations in recent years have influenced the timescales of managers and boards and, if so, whether such changes have helped or hindered long-term decision-making. He will also test his hypothesis that publicly traded companies are overly focused on short-term fluctuations in their share prices to the detriment of long-term profitability.
- The extent to which existing law and regulation encourage boards to focus on long-term development. The Review will look at whether current policy places too much focus on cost-cutting, in consequence limiting firms’ ability to engage in long-term investment. Suggestions are also welcome on ways in which the Government could step-in to help foster longer-term business growth.
- Whether existing law and regulation sufficiently encourage institutional investors and fund managers to set long-term objectives and promote effective collective engagement. In particular, Professor Kay will examine whether the regulatory requirements to which asset managers are subject encourage excessive emphasis on benchmarking and short-term performance metrics.
- The degree to which the current legal duties and responsibilities of asset owners and fund managers, as well as the fee and pay structures inherent in the investment chain, promote long-term development. In the current climate, there is a faster turnover of asset managers. Professor Kay queries whether this makes it harder for asset managers to adopt a longer-term view of the companies in which they invest. Further, the Review will look at the way in which individual asset managers are assessed and rewarded, and what impact this has on their incentives as well as those of their clients.
- Whether the activities of fund managers, clients and their advisers, and the companies in which they invest, and the relationships between them, are sufficiently transparent. Stakeholders are asked to comment on whether existing disclosure rules are excessive or inadequate and also whether the overall costs of intermediation are proportionate to the value of services provided.
- The quality of engagement between institutional investors and fund managers and UK quoted companies. In particular, Professor Kay will examine whether steps taken to facilitate engagement (e.g., the introduction of the Stewardship Code last year) have been effective and whether further intervention is desirable and/or necessary.
- The impact of internationalisation on UK share ownership on the quality of company-shareholder engagement.
- Trends in international investment and in the international regulatory framework and their impact on UK equity markets. In the wake of the financial crisis, financial services regulation across the globe is being revised and strengthened with unprecedented vigour. Professor Kay is keen to understand how UK asset managers expect regulatory change to affect engagement with the companies in which they invest.
Comments are welcome on the issues outlined above until 18 November 2011. Stakeholders are urged to submit evidence-based feedback, such as statistical data or descriptions of their own experiences, rather than expressions of opinion.
Professor Kay anticipates being in a position to provide BIS with an interim report in February next year, which will outline his preliminary findings and recommendations. A final report will be published in July 2012.
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