4 Government intervention
Short-termism in the market:
the Kraft experience
56. The Kraft takeover of Cadbury highlighted the
pivotal role played by institutional investors in large takeovers.
During this inquiry, both Unite the Union and Professor Bones,
from Henley Business School, argued that the Kraft takeover of
Cadbury was driven by investors who had no interest in the long-term
future of the company. As Jack Dromey, the Deputy Secretary General
of Unite put it, the future of Cadbury was decided by "hedge
funds in the form of boys wearing red braces who move in to make
a quick buck at the time of a British icon's vulnerability."[68]
57. In his written evidence, Professor Bones argued
that the basis of short-termism lay in the structure of share-ownership
with intermediating stakeholders, namely fund managers having
shorter term horizons than the individual shareholders whom the
fund managers represented:
This possible mis-alignment between the interests
of the ultimate stakeholders in whose long-term interests the
firm should be run, and those of the 'intermediating stakeholders',
who may hold shares on their behalf for shorter term motives may
result in a less than ideal outcome.
The obvious example of intermediating stakeholders
would be fund managers (whether principal traders, pension fund
managers or mutual funds). These intermediate stakeholders buy,
hold, and sell stocks not only for reasons of changes in their
underlying value, but also for shorter term motives—either
bonus arrangements or, more professionally, because they have
need for liquidity to finance other investments (or to cover other
needs for cash) […]. Long term stakeholders would of course
prefer to continue to hold the stock until its value rose again,
but they would be overruled by the short term interests of the
intermediating stakeholders.[69]
Professor Bones believed this to be a failure in
the market because there was every chance that "the price
agreed by those who will act on behalf of the ultimate owners
of the company (i.e., the individual investors, insurance policy
owners and pensioners/
prospective pensioners) will not represent by a long way that
which would be agreed in a perfectly informed market."[70]
58. Both Lord Mandelson and Ian Lucas MP, Parliamentary
Under-Secretary of State, Department for Business, Innovation
and Skills, indicated that the Government was already taking steps
to encourage fund managers to act with a longer term perspective
in mind.[71] Lord Mandelson
told us that he had initiated discussions with institutional shareholders
"about how their decisions and behaviour can be linked to
long-term interests and value of the companies in which they have
holdings".[72] Ian
Lucas also told us that concerns about short-termism were being
considered as part of a review undertaken by Sir David Walker[73]
which "raised important issues relating to the opportunities
for institutional investor engagement in the long-term interests
of UK companies.[74]
59. Furthermore, Ian Lucas highlighted the fact that
the Institutional Shareholders Committee was also developing a
new Code with the aim of providing good practice for institutional
investors when engaging with the UK-listed companies in which
they invest. [75]
That consultation is due to finish in mid-April with the
results published shortly afterwards.
60. The issue of 'short-termism' in takeovers has
recently been given far more prominence by Lord Mandelson. In
his speech to the Mansion House he expanded on this theme:
In recent years, the UK Government has carried out
a number of significant reforms to encourage the right kind of
long-termism among company directors not least the directors'
duties in the 2006 Companies Act. We need an equivalent long-termism
among company owners, especially institutional shareholders. These
company owners need to combine short term activism on company
strategy with long term commitments to the development of the
companies they own.[76]
61. In putting forward this view, Lord Mandelson
returned to the case of the Kraft takeover of Cadbury:
In the case of Cadbury and Kraft, it is hard to ignore
the fact that the fate of a company with a long history and many
tens of thousands of employees was decided by people who had not
owned the company a few weeks earlier, and probably had no intention
of owning it a few weeks later.[77]
62. We are deeply concerned by reports that the
takeover of Cadbury by Kraft was ultimately decided by institutional
investors motivated by short-term profits rather than those investors
who had the company's long-term interests at heart. As a template
for takeovers, this is not in the interest of UK companies or
the UK economy.
63. We welcome the Government's focus on the issue
of 'short-termism' in decision-making on the future ownership
of UK companies, and its efforts to engage with institutional
fund managers as part of the process. However, we are sceptical
about the extent to which informal engagement alone can instigate
any fundamental change in institutional shareholder behaviour,
in particular where there are financial incentives for fund managers
and others to act in the short term.
Possible areas for reform
64. In his speech to the Mansion House, Lord Mandelson
set out a number of options for reform of regulations governing
mergers and takeovers. These options included:
- Raising the voting threshold
for securing a change of ownership to two-thirds;
- Lowering the requirement of disclosure of share
ownership during a bid from 1% to 0.5% so companies can see who
is building stakes on the register;
- Giving bidders less time to "put up or shut
up" so that the phoney takeover war ends more quickly and
properly evidenced bids must be tabled;
- Requiring bidders to set out publicly how they
intend to finance their bids not just on day one, but over the
long term, and their plans for the acquired company, including
details of how they intend to make cost savings;
- Requiring greater transparency on advisors' fees
and incentives; and
- Requiring all companies making significant bids
in this country to put their plans to their own shareholders for
scrutiny.[78]
65. In its written submission, Unite added to that
list. It recommended:
- An extension of TUPE protections
to cover mergers and takeovers by share transfer; and
- The right for workers' representatives to negotiate
protection of investment, jobs and terms and conditions.
66. The Union also argued in favour of a reform of
shareholder rights to restrict voting rights to those shareholders
who had owned shares for at least a year at a time of any bid.[79]
Ian Lucas MP pointed out that companies are already empowered
to give preferential status to long-term shareholders under the
Companies Act 2006:
Many of the things that have been done in terms
of giving preferential status to long-term shareholders could
take place now in the UK under the Companies Act 2006, but the
situation is that companies decide not to introduce that form
of provision within their articles of association. The powers
are there already. The issue is not so much to do with whether
the legislative framework exists; it is more a matter of culture.
One of the interesting aspects of UK businesses is that we tend
to have a broader shareholder base than, say, companies in Germany.[80]
67. The CBI agreed broadly with Lord Mandelsons's
recommendations but made the point that raising the voting threshold
from 50.1% to two thirds of the shares might not by itself make
much difference if the bid was recommended and, if it was not,
the aggressor could fire the board, unless the rules for directors'
appointments were also changed.[81]
On the other side, representatives in the City have warned that
the Government should not intervene in the Code. One said:
If there was a politicisation of the code, it
would be a disaster. The fact we have a Code policed by practitioners
instead of civil servants is one of London's last remaining strengths
as a financial centre. The Code has proved itself time and again
to work very well, and the panel has been shown in the past to
be able to adapt to best practice.[82]
68. We also note that the Takeover Panel is conducting
a consultation on reform of its Takeover Code. That consultation
is due to close on 21 May 2010.[83]
69. We welcome the fact that the Government is
considering a review of the rules and legislation governing takeovers
in the United Kingdom. We also welcome the current consultation
by the Takeover Panel on its City Code on Takeovers and Mergers.
Such consideration of the underlying issues must not be seen as
protectionism against foreign takeovers but as seeking to ensure
that all takeover activity, whether entirely domestic or by foreign
companies, is conducted in the interests of the UK economy.
PUBLIC INTEREST TEST AND ADDITIONAL
CONDITIONS
70. Under the current legislation, the Secretary
of State for Business, Innovation and Skills may only intervene
in takeovers by foreign companies in very specific circumstances.
There are presently three public interest considerations specified
in the Enterprise Act 2002 as legitimate bases for Ministerial
intervention. These are:
- national security;
- media plurality, quality and standards; and
- the stability of the UK financial system.[84]
It is also possible for the Government to intervene
in mergers that fall under the EC Merger Regulation; generally
being those larger merger cases that affect trade in more than
one EC member state. European law currently specifies two grounds
on which public interest interventions are possible: public security
(equivalent to national security) and plurality and quality in
the media.[85]
71. Professor Bones argued for "far greater
specificity of the intentions of [the] potential acquirer regarding
strategic assets of national importance" and that the "commitments
the acquirer would be prepared to make in terms of identified
strategic assets" should also be considered.[86]
He also recommended that while Government intervention should
not be aimed to "stop the deal going through" there
would be benefits gained from it imposing conditions on an acquisition,
regarding the protection of strategic assets (skill bases and
centres of R&D).[87]
He pointed out that in strategically important sectors such as
energy, foreign owners were controlled through regulators such
as Ofgem, but by contrast, there was no equivalent regulation
covering manufacturing, in particular over what foreign owners
could or could not do with assets of strategic importance.[88]
72. Ian Lucas MP confirmed that a power to attach
conditions relating to the relocation of manufacturing and Research
and Development during any takeover would be "part of the
debate."[89] However,
in supplementary evidence he told us that broadening the intervention
criteria to include the national interest would require legislative
change:
Any proposed new consideration to be specified
in the Enterprise Act would need to be approved by a resolution
of each House of Parliament. In addition, if it was to be relied
upon also in European merger cases, it would need clearance by
the European Commission. They would have to be satisfied that
the consideration was legitimate and compatible with the objectives
of the European Treaty, in particular in relation to the free
movement of capital.[90]
73. Lord Mandelson remained unconvinced that providing
Government with the power to intervene in the public interest
was either necessary or desirable. He feared that:
in those circumstances a government's judgment
and intervention could be too exposed to political lobbying and
short-term populist pressures which are unable to make an assessment
of long-term growth and value that might come from the move. It
might give rise to capricious decision-making of one sort or another,
depending on the ministers and their official advisers, and it
can lead to a loss of transparency and a loss of predictability
which at the moment makes the current UK regime open to investors
from which, I just underline, we benefit a great deal.[91]
In his Mansion House speech, Lord Mandelson added
that "Britain benefits from inward investment and an open
market for corporate control internationally. A political test
for policing foreign ownership runs the risk of becoming protectionist
and protectionism is not in our interests."[92]
74. Any reform of takeovers in the United Kingdom
has to recognise that foreign direct investment is of great benefit
to the UK economy. We agree with the Secretary of State that an
extension of his powers to intervene would come with a risk that
the takeover process would be determined by political lobbying
rather than economic fundamentals. However, we believe that the
Government should consider how other countries act to protect
key national assets while at the same time retaining a liberal
investment climate. In particular, it should consider how aspects
of Research and Development which are in the United Kingdom's
national interest may be protected in the event of foreign ownership.
75. While we have not taken sufficient evidence
at this stage to enable us to come to a view on the merits or
otherwise of extending the powers of intervention by the Secretary
of State, we strongly believe that this issue should be considered
as part of the wider debate on takeover regulations.
Conclusion
76. The takeover of Cadbury by Kraft has highlighted
a number of important issues in respect of the way in which foreign
takeovers of UK companies are conducted. It has been the catalyst
for a wider debate, both in Government and in the City, about
how takeovers are conducted. In highlighting the Kraft takeover
of Cadbury, we have contributed to that debate which now needs
to continue, and with urgency. Time does not allow us to consider
the wider proposals for reform in detail but it is clear that
the Companies Act 2006 has not resolved these major issues in
corporate governance. We urge our successor Committee to consider
this Report as a starting point from which to conduct a detailed
inquiry into these important issues and into the role of shareholders
and managers of companies more generally. Recent experience of
the behaviour of boards and shareholders in situations ranging
from the fall of RBS to the Kraft acquisition of Cadbury indicate
that it is time to reconsider many aspects of corporate governance.
68 Q 39 Back
69
Ev 50 Back
70
Ev 50 Back
71
Q 69, Oral Evidence given by Rt Hon Lord Mandelson, First Secretary
of State, Pat McFadden MP, Minister of State, Department for Business,
Innovation and Skills; HC 299-i, 19 January 2010, Q 8 Back
72
Oral Evidence given by Rt Hon Lord Mandelson, First Secretary
of State, Pat McFadden MP, Minister of State, Department for Business,
Innovation and Skills; HC 299-i, 19 January 2010, Q 8 Back
73
The Terms of Reference of the Walker Review of Corporate Governance
of UK Banking Industry which was completed in November 2009 including
looking at the role of institutional shareholders in engaging
effectively with companies and monitoring of boards. Back
74
Q 69 Back
75
Q 82 Back
76
Lord Mandelson's Mansion House Speech, 1 March 2010; http://nds.coi.gov.uk/content/Detail.aspx?ReleaseID=411720&
NewsAreaID=2 Back
77
Lord Mandelson's Mansion House Speech, 1 March 2010 Back
78
Lord Mandelson's Mansion House Speech, 1 March 2010 Back
79
Ev 54 Back
80
Q 88 Back
81
The Times, Britain must decide whether to welcome allcomers,
3 March 2010 Back
82
The Financial Times, Prospect of stiffer rules for buying UK
groups, 25 February 2010 Back
83
http://www.thetakeoverpanel.org.uk/wp-content/uploads/2008/11/PCP201001.pdf Back
84
Ev 48 Back
85
Ev 48 Back
86
Q 7 Back
87
Q 12 Back
88
Q 16 Back
89
Q 89 Back
90
Ev 48 Back
91
Oral Evidence given by Rt Hon Lord Mandelson, First Secretary
of State, Pat McFadden MP, Minister of State, Department for Business,
Innovation and Skills; HC 299-i, 19 January 2010, Q 13 Back
92
Lord Mandelson, Mansion House Speech, 1 March 2010 Back
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