Select Committee on Treasury Written Evidence


Memorandum submitted by the Share Centre

SUMMARY

  Key to The Share Centre's ethos is the power of ordinary share holders to hold bodies in which they have invested to account. We believe that active share holders make a fundamental contribution to encouraging corporate governance, and it is in the long term interest of the UK to foster an environment to this end. This paper therefore encourages the Treasury Select Committee to examine the long term impact of private equity on shareholder democracy.

  Businesses need to be held accountable for the employment, goods and services they provide, the pensions, benefits and taxes they pay, the regulations they observe and the innovation they drive. Their power to shape society by these means must be held widely accountable to prevent a schism between wealth creation and wealth distribution. This accountability is delivered through share ownership.

  Ownership brings responsibility. As responsible society is therefore a share-owning society. To foster and encourage share ownership we recommend:

    —  Giving private equity firms an incentive for going public, so that ordinary people can participate.

    —  Seeking international agreement on maintaining a high percentage of public ownership.

    —  Abolishing stamp duty on share purchases in the public secondary market.

    —  Creating a level fiscal playing field for shareholder debt. The cost of financing acquisitions should be an allowable expense for public companies.

  The Share Centre is well placed to speak on the economic advantages of firms being publicly listed as opposed to being privately owned—one of the Treasury Select Committee's stated priorities for examination. We believe passionately in encouraging ordinary people to participate in the ownership and direction of the businesses that shape the communities in which they operate.

PRIVATE EQUITY

  Private Equity has drawn much media comment over the past two to three months as a result of the sheer scale of its activities. Over the past five years the world's largest private equity firms have raised $551 billion (£276 billion), and London shares the lead with New York in private equity activity. The current private equity take-over of Alliance Boots plc may be the first of a FTSE 100 firm, but it follows a substantial flow of British business. Meanwhile at least four further FTSE 100 businesses are understood to be under review for exit from the public market.

Who are the Private Equity firms?

  The largest players are Carlyle, Kohlberg Kravis Roberts, Goldman Sachs Principal Investment, Blackstone, Texas Pacific, Permira and Apex. They are unlike the conglomerates of old (Hanson, BTR, etc) in that they are not themselves quoted vehicles; although Blackstone has stated its intention to float in the near future. Their funds for equity purchase are raised directly from very large, mainly institutional, investors. The private equity firm may supplement them from its own resources, then leverage the equity available with debt in order to assemble finance for a bid. Significant—some would say excessive—fees will be levied on this investment, which will then be monitored closely to ensure that business objectives are being met.

What are the key motivations?

  Clearly profit is the overarching motivation and with the scale of investment exceeding the GDP of many countries it is easy to see how the returns can be very substantial. So it is reasonable to ask how a private equity firm can find such a source of enrichment that is not available through public ownership?

    —  Risk

    Part of the answer lies in a more clinical approach to risk assessment. The stockmarkets' assessment of risk is based on myriads of analysts using conventional risk measurement techniques. These then have to be publicised, then matched against the risk profiles of public market investors. However with a wide range of derivative-based instruments available, the appetite for risk for that part of their activity which is allocated for cash markets is not extensive.

    Private equity investors are therefore able to "gear up" with leverage to an extent significantly greater than in the public market; if a listed company were to follow that route, its valuation may well fall due to insufficient demand for that level of risk.

    —  Tax

    The tax treatment of private equity is a subject which few accountants are prepared to discuss (FT, 26/4/2007). However their principle advantage is in being able to offset interest charges (on shareholder debt) against pre-tax profit in order to substitute dividend tax (at 32.5%) and corporate tax (at 28%) for increased capital value (taxed at 10% or less). The Private Equity firms are therefore washing out the high-tax obligations of the domestic economy with the low-tax environment of the global economy; while many would regard this as tax avoidance it is, in fact, a very common form of arbitrage for international institutions. As the president of the Chartered Institute of Taxation says, "there is a tendency for a private-equity owned company to have a lower tax burden"". Probably somewhat of an understatement.

    —  Business Perspective

    It has been claimed that private equity challenges employment, and this is a major source of union unrest over their activities. However their business model requires continued business success, and this cannot be achieved simply by cost-cutting and asset-stripping. It is therefore important to look at the private equity business perspective on a global basis. The key challenge to domestic economies is the ability to re-locate and out-source without the glare of these decisions being scrutinised by the public markets. Private Equity ownership therefore presents a growing contingent liability for governments wishing to retain influence over the wealth-creating sector of their economies.

    —  Transparency

    The lack of transparency is, of course, a major boost to private equity ambitions. Issues of business strategy, taxation and corporate governance can all be handled more robustly within a cloak of secrecy. However although this is a major ongoing concern over their operations it is collusion between the directors of target businesses and private equity managers which should cause particular concern, since such collaboration cannot be regarded as anything other than a conflict of interest. It is to be hoped that the Companies Act of 2006 will result in a strong check on such activities, but the part addressing conflicts of interest is not scheduled for implementation until October 2008.

Why does Ownership matter?

  There is, however, a dimension which is often overlooked in the debate over private equity: it is the long-term impact of removing businesses from accountability to the community in which they operate. These businesses are, after all, essential to the wealth creation which fuels the welfare state and the conscience of the community towards the world at large. If ownership is disassociated from this accountability, the schism between wealth creation and wealth distribution will become ever more evident: the rich become richer, and the poor, poorer.

  Business also shapes the society which people live in to a substantial extent, by:

    —  providing employment

    —  paying pensions and benefits

    —  observing regulations and codes of conduct

    —  providing structure and discipline, in the widest sense

    —  tax-gathering

    —  competing and innovating

    —  and, of course, by supplying goods and services.

  The mutual appreciation of businesses for people, and people for business, is vital for economic productivity, maintaining a healthy trade balance, financing the public sector, and retention of skills within the UK. That mutual appreciation is best served by maintaining people's participation in the businesses they work for and use either directly or through their pension funds and other investments. Cash is not an acceptable substitute for this long-term participation, either as deposits or by borrowing.

  Most people would accept that ownership brings responsibility: this is particularly evident in property, where rented accommodation does not attract the same degree of occupier care and attention as with home ownership. So it is with business: ownership by the people, albeit indirectly, brings a sense of responsibility. A responsible society is therefore a share-owning society.

What can be done to re-dress the balance?

  Several measures could be taken to enable publicly-owned businesses to compete on more level terms with those in private equity within the United Kingdom:

    —  Give private equity firms an incentive for going public, so that ordinary people can participate (currently the definition of a private equity company is limited to 99 shareholders).

    —  Seek international agreement on maintaining a high percentage of public ownership.

    —  Abolish stamp duty on shares to breathe liquidity—and therefore improved valuations—into the secondary market. This will also substantially benefit pension funds and make it easier for smaller businesses to raise capital.

    —  Introduce a level fiscal playing field for shareholder debt, as regards treatment of interest payments.

IN CONCLUSION

  It is worth bearing in mind that the human quest for leveraging open a chink of opportunity in order to extract value is boundless. Civilisation determines that this worthwhile characteristic is kept in check for the benefit of all, and the balance of government and business makes this possible. The phenomenon of private equity seeks to break out of this check by moving its sphere of action to a level where government is weak: the global business environment. It is therefore necessary to tread with caution so that the national economy offers the same benefits to the equity owner in both spheres, but retains influence over good corporate governance through public ownership.

May 2007





 
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