UK firms harmed by bonus culture – report

A CULTURE of short-termism and high bonuses in the City is damaging UK businesses, a hard-hitting report commissioned by the government has found.

The study by Professor John Kay for Business Secretary Vince Cable concluded that the financial sector is too heavily geared on instant rewards for traders and not towards making long-term investments.

The report was welcomed by many business organisations, but British Chambers of Commerce raised concerns that it might fuel a “witch-hunt” in the City over bonuses and pay.

Prof Kay, a former member of the Scottish Government’s Council of Economic Advisers, hit out at bonuses based on short-term performance and called for a “much-needed shift” in the culture of the UK’s equity markets. His report was commissioned amid growing concerns over the size of bonuses available to traders and leading executives.

Anger over bonuses has
recently seen rebellions among shareholders, with protests over former Barclays chief executive Bob Diamond’s £2.7 million
reward in April.

In May, William Hill’s chief executive, Ralph Topping, faced a shareholder rebellion over his £1.2 million bonus, and Aviva’s chief executive, Andrew Moss, has also been criticised for his pay-out.

Prof Kay’s report, which was commissioned to examine the impact of UK equity markets on the long-term performance of companies, was welcomed by investor bodies.

He advocated wide-ranging reform, including paying executives’ long-term incentives in shares that do not vest until after they have left the company, and scrapping requirements for companies to report every three months.

Prof Kay said: “A lack of trust and poorly aligned incentives have helped create a culture of short-termism in our financial markets. This is undermining their role of supporting innovative, sustainable long-term business performance.”

This trend encouraged “bad long-term decisions” and the
report found evidence of “hyper­active behaviour” from executives who were driven by big takeover and merger deals, rather than improving their own businesses.

It even questioned why
executives needed to be paid bonuses in the first place, saying they were relatively unusual until the 1980s.

It said: “Many people doing responsible and demanding jobs – Cabinet ministers, judges, surgeons, research scientists – do not receive bonuses and would be insulted by the suggestion that the prospect of
bonuses would encourage them toperform their duties more
conscientiously.”

Speaking on a visit to Edinburgh yesterday, Mr Cable said the report confirmed there was a problem in the equity markets.

He said: “I commissioned the Kay Report because it did seem to me there was a very deep-rooted problem in that we do find it more difficult than our competitor countries to finance good long-term investments, because that’s what you need if you’re financing manufacturing or infrastructure, you need long-term investment.

“An awful lot of very clever people spend an awful lot of time focusing on trading
activity. It can be useful, but the
emphasis in the economy has to shift towards long-term
decision-making.”

He added: “The kind of thing that John Kay has been talking about, like moving away from the requirement to have quarterly reporting so that companies are fixed on a longer time limit; that’s the kind of cultural change that we want to try and encourage.”

Mr Cable added that most recommendations were directed at the industry, like “investment management and all the people involved in that supply chain”.

“He wants to create forums, which I think the government can initiate, to get the industry together to try to think about how we can get on to a
more long-term framework of thinking.”

Alan MacDougall, managing director of shareholder body Pirc, said the review painted a picture of an investment chain that is not working properly.

He said: “In almost every link in the chain there is a bias in favour of activity, regardless of whether this can be proven to be in the interests of either issuers or savers.

“Intermediaries seem to be the only group which unquestionably gains, but the lack of clarity about whose interests they actually serve has corroded trust in the system as a whole.”

The reports findings will heap more pressure on boards over executive pay, following the “shareholder spring”.

And there are fears that the reforms outlined could spell more redundancies in the City.

The report said the financial sector needed to focus on producing returns for investors and savers, and called for “investor forums” to be set up to foster closer engagement.

Companies should also update the market in a way that is easier for investors to understand, the report added.

John Longworth, the director-general of the British Chambers of Commerce, agreed that short-termism could act “as a brake on parts of the wider economy” by limiting the availability of capital for growing companies.

But he added that a “witch- hunt” must be avoided, because the City remains of crucial importance to the economy.

However, Matthew Fell, CBI director for competitive markets, said the report was right to focus on tackling the culture of short-termism.