Does the UK have an industrial policy? Such a question is likely to become more acute as the UK seeks to forge new priorities to compete in the post-Brexit world. An answer can be teased out of the recent £8bn hostile takeover bid for GKN, UK’s third largest engineering conglomerate specialising in automotive and aerospace components, by Melrose, a UK-based private equity-like investment company.
Pressurised for quick returns
A key aspect of an effective industrial policy is to require companies to focus on the long-term development of skills, innovation, products and services. Government policies need to be geared towards nurturing such aspects. However, such assumptions are at odds with the UK’s shareholder-centric model of corporate governance which exerts pressures for quick returns.
The average duration shareholding in major companies has declined from around five years in the mid-1960s to around seven and a half months in 2007. At banks, it was around three months in 2008. Others suspect that the shareholding duration in large companies may well now have declined to around a month.
Whichever way you look at it, shareholders who pursue short-term gains function more like speculators than owners with long-term interest in companies. Institutional investors are part of the malaise. A parliamentary inquiry into the 2007-8 banking crash noted that institutional investors “were scarcely alert to the risks to their investments prior to the crash, but were mesmerised by the short-term returns ... ”.
The manufacturing industry requires long lead times and resources for research, development and skilling labour. It is hit hard by shareholder pressures for quick returns. A 2013 government-backed report on the future of manufacturing said:
“The existing corporate governance framework operating in the UK, which generally favours shareholders, acts negatively on innovation, with particularly unfavourable impact on manufacturing… the current legal framework in the UK is a deterrent to (manufacturing) firms’ undertaking complementary investments in knowledge-based technologies and firm-specific human capital, given that both generate returns over an extended period… there seems to be strong endorsement of the need to move towards less shareholder protection/liquid capital markets and more employee protection”.
No UK government has shown willingness to reform the shareholder-centric model of corporate governance. Such an environment emboldens speculators and makes it difficult for management to develop long-term strategies, even if they want to.
Melrose’s hostile takeover
The above provides the context for understanding the GKN takeover. In January 2018, its directors rejected a hostile bid by Melrose. But shareholders scenting large gains had to be appeased. In February 2018, GKN promised to sell parts of the business and cut costs/jobs to boost shareholder returns by £2.5bn over the next three years. The GKN pension trustees were not happy as the pension schemes had deficits of £1.5bn and Melrose had not promised to eliminate it. Melrose has a reputation for asset-stripping and cutting costs (read jobs) to boost shareholder returns. In the light of that, Airbus, a major GKN customer warned that it would be "practically impossible" to give new business to GKN if it was bought by Melrose.
Melrose’s persistence encouraged speculators to build a stake in the company and force the issue, with the full knowledge that the eventual takeover price will have to exceed the market price of shares and therefore they will make a killing. On 29 March 2018, contrary to the advice from GKN directors, shareholders exercising 52.43 per cent of the voting rights, which included institutional investors such as Aviva and Legal & General Investment Management, accepted the bid.
GKN has total assets of £8.9bn and its shareholders have provided about £2.6bn (or 29 per cent) to finance that. But they exercised 100 per cent of the controlling rights. Suppliers, customers and employees have a long-term interest in the success of GKN, but had no say in the takeover decision.
Tackling short-termism in industrial policy
The £8bn paid by Melrose to acquire control of GKN will go straight to the pockets of shareholders. None of it facilitates additional investment in the company. Shareholders secured a 40 per cent premium on what the shares were worth in January 2018. Melrose directors are expected to share £285m in bonuses from the deal. Accountants, lawyers and banks advising the warring camps are expected to collect over £240m in fees. Melrose will not eliminate the £1.5bn pension scheme deficit, but has promised to provide an additional £1bn over the next five years.
In principle, the government can counterbalance short-termism and veto the takeover, but has shown little sign of doing that. So what awaits GKN? If Melrose’s past practices are any guide, GKN will be loaded with debt to enable its new shareholders to extract higher returns. The need to service debt will reduce the resources for investment. Some parts of the GKN will be sold off and jobs will be lost to further reduce the UK’s pool of skilled labour. Melrose has indicated that it might hang on to GKN for five years, but that is insufficient for long-term planning, research and product innovation in the engineering sector.
The GKN story is another episode in short-termism that dominates the UK. Government can provide foundations for long-term industrial policy by ensuring that speculators cannot hijack companies. They can require investors to hold shares for a period of twelve months before they can vote. Stakeholders with a long-term interest in companies (such as employees, customers, etc.) should be empowered to vote on governance of corporations. Rather than a simple majority, company law should require the approval of 75 per cent of eligible stakeholders for major decisions, such as mergers and takeovers.
The above is not a panacea for the deep-seated problems of the UK industry, but nevertheless is a necessary step for focusing attention on the long term.
Prem Sikka is Professor of Accounting and Finance, University of Sheffield.
Image by Captain Roger Fenton.