Taking the ‘I’ and ‘me’ out of investment
Civitas, 31 May 2011
Last Wednesday saw the Government release provisional business investment results for the first quarter of 2011. They indicate that, in general, investment is falling across the British economy with only manufacturing bucking this trend by increasing investment by 14.8% compared to a year ago. According to one commentator the results mark a record low. Yet while they paint a bleak picture of the British economy, the current remuneration of Britain’s top executives belies this impression.
Capital investment is a good indication of current business confidence. A business which expects to expand, or has a positive outlook for the future, is far more likely to invest than one who is unsure about their own, or the economy’s, health. Furthermore, investment, in itself, is often the driver of future economic growth. Thus, in both respects it is important. It is therefore worrying that the CIA World Factbook currently ranks the UK below Greece, Italy, Germany, France, Switzerland and Japan for business investment as a percentage of GDP.
Now, there is no direct link between the investment climate in Britain and much of the performance of the FTSE 100, indeed many FTSE companies are multinationals with little, if any, activity in Britain. This is particularly true of the mining companies listed in London, many of which have been enjoying windfall profits due to the current commodities boom. Nevertheless the fact that executive remuneration in the 100 largest British companies rose by 32% last year, while the FTSE 100 grew by only 9% does raise some interesting questions about corporate governance.
One question often discussed involves weighing up the relative merits of executives and shareholders, who should get the bigger piece of the pie? Recent results could indicate that shareholders are getting the bum deal. Other debates examine the incentive structures involved in executive pay. While accepting that high pay for many in the world’s largest and most successful companies is a necessary factor in continued success, some nevertheless question whether more pay should be linked to long, rather than short-term success. The problem with both questions, however, is that they view businesses in an atomised, individualistic manner.
A more pertinent question should be: Is a company’s profits being used to further the interests of the company or the individuals that work for it? For some this question could seem like a fallacious distinction: companies are the people that compose them: the workers and the shareholders. However, this ignores the fact that most businesses are more than the sum of their parts. In a perfect world, the interests of the employees, the shareholders and the firm (as a separate entity) would converge. In reality they do not, at least not all the time. The challenge is to weigh the competing interests up in a fair, and productive way.
In the short-term both employees and shareholders could benefit from downsizing and neglecting investment. Return on equity and remuneration could increase. The problem however is that such a strategy is short-termist, akin to making hay while the sun shines, but failing to save for a rainy day. It is not clear that UK corporates have been doing this, in actual fact earnings have been retained but not invested in recent years, perhaps as a corollary of an uncertain economic climate.
What can the Government do about this? Importantly it needs to encourage investment. The coalition reduced the main recovery rate for capital allowances from 20% to 18% and lowered the annual investment allowance from £100,000 to £25,000. This sends the wrong message to businesses, and counteracts the encouraging reduction in corporation tax. The Government could also do more to help companies invest through direct financial assistance, within the scope of EU state-aid rules.
The financial crisis and current economic climate means that all governments can no longer stand on the sidelines, safe in the knowledge that the market will produce beneficial results and national economic growth. The tension between employees, shareholders and the company is one area of possible market failure where there is scope for the Government to encourage long-term thinking and help produce wider economic benefits.