In almost every respect, the Kay Review of UK Equity Markets and Long-Term Decision Making is an exemplary piece of work. Professorial in the best sense, John Kay’s analysis of where and how the City of London went wrong is elegant (not a usual epithet to apply to a business report), eloquent and subtle. A journalist as well as professor who writes an essential weekly column in the FT, Kay has a telling eye for the concrete example, illustrating his history of the City’s failure to nurture UK corporate success with salutary vignettes from ICI, GEC and BP as well as the banks. Anyone seeking a master-class on what equity markets are for – ‘to operate and sustain high-performing companies and to earn good returns for savers without undue risk’ – and how they should work can do no better than start here.
What’s more, Kay’s recommendations – all designed to wrest primacy (and profits) back from advisers and intermediaries to benefit savers and corporations – have been greeted with deafening lack of push-back. The most anyone can find to say against them is that they are doing what he recommends already. No one has dared to say that Kay is wrong.
Why then do I say ‘in almost every respect’? One troubling aspect is precisely this unnatural lack of criticism. It is too quiet, Carruthers. It is striking that the people who are now apparently unanimously in favour of the long-termist, trust- and relationship-based arrangements that Kay advances have in practice delivered the exact opposite. All these things applied before Big Bang in 1986. Since then, ‘my word is my bond’ has been replaced with ‘caveat emptor’, relationships with transactions, and finance has become the end rather than the means.
As Tony Hilton pointed out in the Standard, these relationships were held in place by the market structure – chains of independent ‘single capacity’ stockbrokers, corporate financiers, market-makers, stock lenders, fund managers, underwriters and custodians each focusing on one activity and acting either for clients or themselves, but not both. The competition for custom that took place at every stage of the chain kept them honest by exerting a strong incentive to provide good service.
All that was swept away by Big Bang, which ushered in the financial conglomerate one-stop-shop and began the shift to finance as an end in itself, ‘with deals done not because they had economic rationale but because they made money for bankers and costs, both direct and indirect, that impose a colossal and unnecessary burden on that real economy’. Kay, in my view rightly, makes much of structure and incentives being a better path to desired outcomes than regulation of behaviour; but will – can – his new-old world of trust and fiduciary come about without corresponding back-to-the-future structural change?
There’s a somewhat similar issue at the level of management. In Kay’s vision, the benefit that committed investors can bring to a company is improved governance through active engagement and encouragement of long-term decision-making. But it wasn’t just Big Bang that changed in the 1980s. So did the underlying theory of corporate governance, and with it the very definition of company success. Henceforth success was to be measured narrowly in terms of shareholder value, and governance became a matter of aligning the (self) interests of agents (managers) and principals (shareholders).
We know where this disastrous doctrine would lead – the enrichment of managers and intermediaries and the impoverishment of all the other stakeholders, including and especially the company itself, as witnessed by the implosion of the banks in 2008. The stock market has failed both its primary purposes, and for the same reason – as Kay earlier pointed out in his sharp book on Obliquity, shareholder value isn’t something that can be addressed directly, or at least not for long. It is rather the by-product of building an organisation with distinctive skills and resources that can consistently offer customers attractive goods and services that they want to buy. As Kay succinctly remarks, directors owe a fiduciary duty to the company, not its share price.
The trouble is, though, that the whole weight of official theory, as well as market structure, is now on the other side. It is enshrined in governance codes, in 30 years of business school teaching and consultancy practice, in the assumptions of most managers, and not least in the entrenched views of the Treasury. Without attacking shareholder value head on, Kay does put heavy emphasis on stewardship for both managers and fund managers. But financialisation now runs very deep; and it is global, with particularly deep roots on Wall Street, with which the City is intimately bound. So two more questions: even if the City wants to foster long-term corporate success, has it any idea how to? And can London institute radical change when Wall Street shows not the slightest inclination of doing so?
In the end, of course, it all boils down to a crude issue that Kay doesn’t address: power. For proof of the enormous strength of vested interests, look no further than the failure of governments to cut the banks down to size despite near unanimous support from electors and commentariat alike. Kay is right that ‘the task of recreating an equity investment chain that meets the needs of users and that is based on trust, respect, confidence and cooperation, will be long and difficult’. He is also right that it is as important for the future health of the economy as a functioning NHS is to the health of the people. But however sensible his recommendations, they are unlikely to come to pass without a substantial thump of government welly.