Corporate governance
At the moment, so the argument goes, too many companies pay out their profits in dividends rather than investing in the future. This hampers productivity and benefits nobody apart from the shareholders. Meanwhile, executive pay has outstripped average employee pay for years. Despite repeated initiatives, companies have failed to respond adequately to concerns about social justice and the aim is for the worker block vote to prod them into redressing the balance.
All political parties share the concern about lack of investment, lacklustre productivity and pay inequality. History suggests that after initial blustering, others could end up backing the concepts of the fund. Employee share plans were once opposed for being too radical. Then, years ago, a short-lived Lib-Lab pact introduced them. They were developed by the subsequent Conservative administration and have had cross-party support ever since. Ten years ago, the LibDems advocated raising personal allowances (the income threshold for paying tax). Unworkable, critics said. They were adopted in 2010 and now parties compete to see who can increase them the most. So the Inclusive Ownership Fund deserves to be taken seriously.
International investor protection
One reservation is that forcing large companies to pay into an external fund could be regarded as expropriation. That’s permitted legally if it can be said to be in the public interest. Otherwise it falls foul of the European Convention of Human Rights (yes, really). Article 1 of Protocol 1 of this convention says that acting in the public interest is the only reason for interfering with a person’s right to the “peaceful enjoyment” of their property. A dispute on these grounds could end up being settled in Strasbourg. And in case you’re wondering, Brexit won’t change that. The human rights convention has nothing to do with the EU.
Apart from this, law firm Clifford Chance says the UK has also signed more than 100 bilateral investment treaties with foreign states, including Singapore, Hong Kong, China and the United Arab Emirates (UAE). These prevent cross-border investments from being expropriated without adequate compensation unless the property dilution falls within the state’s legitimate regulatory powers. Brexit will trigger tortuous renegotiations of existing trade agreements that the UK currently has (via the EU) with Canada, Singapore, Vietnam and Japan, and these are also likely to include investor protection clauses. If the Inclusive Ownership Fund is deemed to conflict unreasonably with investors’ interests, that could also end up being resolved in foreign courts.
Unintended consequences
What this illustrates is what anyone involved in pay, and particularly employee share plans, will tell you: that apparently simple proposals can have complex and unexpected ramifications. The practical aspects need to be considered too.
Would the many really receive £500 from the fund? Growth companies often don’t pay dividends. Nor do many others. The amount per person will obviously be much lower for companies on low yields and for companies, such as retailers, that have a large workforce. Even for those that do receive the payouts, tax will probably be deducted, and chances are that over time companies will adjust other parts of their pay to offset the extra cost of the employee ‘dividends’.
What would be the impact on companies and investors? Around 7,000 publicly listed and private companies operating in the UK can expect to be caught by the fund. It could change their behaviour. To find the shares for the fund, they’d probably issue new shares – there’d be no cash cost, but existing shareholdings would be diluted. Borrowing more would reduce that dilution, so during the first 10 years of the fund, companies might cut their dividends and borrow to buy back shares. Companies that are already heavily indebted, such as private equity, would have an early advantage. Once the fund’s 10 per cent ceiling was reached, buybacks would become less likely because they’d unnecessarily increase the proportion of shares in the fund. To avoid this, some companies might relocate instead.
Arbitrary thresholds
Since the fund would apply to companies with 250 employees or more, some might lay off people or outsource work to get below the threshold. One with, say, 450 employees might split into two companies with 225 employees each and so avoid qualifying. A company with fewer than 250 employees might prefer not to expand to avoid having to set up a fund. That hardly encourages growth.
And that £500 limit per employee seems arbitrary as well. The intention is for surplus dividends accrued to the fund to be spent on public services as a ‘social dividend’ – a tax in other words in all but name. That’s unfortunate for foreign investors. Since their lost dividend would not officially be a tax, they might not be able to offset it against their local taxes.
The UK corporation tax rate is currently 19 per cent and only Hungary, Ireland and Lithuania have lower rates. Clifford Chance estimates that the fund would push up the effective UK corporation tax rate to 24 per cent. But that’s because it expects £9bn to be generated annually for public services, compared with £1bn for employees. The firm has estimated that the fund would cost investors in total £340bn of lost capital, of which about a tenth would be borne by pension funds. That would hit their members.
These figures have been challenged. They don’t include the benefit to companies from the expected productivity gains or the company growth generated by the investment in public services. The ‘tax’ figure assumes that global companies will pay dividends on their global profits, but that only UK employees will benefit. By contrast, others have estimated that the ‘tax” take will only be about £1bn – that would make the effective increase in corporation tax less than 1 per cent.
Fortunately there’s a safety valve. Perhaps because it expected difficulties, the Labour Party has said that it intends putting the proposal out for consultationso that when the legislation is eventually passed it would be “robust and widely supported”. That might take some time.
The wheel reinvented
The irony of all this is whatever the fund is trying to achieve could be done immediately – and more effectively – through arrangements that are either already in place or which worked in the past. Companies used to be encouraged to have profit-sharing schemes and they could easily be reintroduced. These lasted from 1979 to 2000 and were linked to a company’s financial performance; they came with tax breaks; and they had to apply to every employee. According to ICSA Proshare, the employee share ownership association, changing working practices mean that if everyone who contributes to a company’s success is to be included, profit-sharing would need to apply to the whole workforce – the distinction being that in the gig economy, workers are not necessarily employees. The schemes don’t need to be mandatory, but they could be nudged in that direction through corporate tax breaks.
To encourage productivity, there’s plenty of evidence to suggest that giving employees shares in their company would boost motivation and engagement far more effectively than the remote, pooled concept of the Inclusive Ownership Fund. Companies can already do this through the tax-advantaged Share Incentive Plan (SIP), and employees can save for more either through the SIP or through Save As You Earn (SAYE) options, which are almost risk-free. At the moment, participation rates in these plans are not as high as they could be, largely because many companies have failed to market them well to employees. Meanwhile, shares awarded to top executives account for most of their stated pay. To add bite, Proshare has suggested that these two should be linked: why not permit corporation tax deductions for executive plans only if their company has meaningful employee share ownership plans?
That leaves one last objective: to understand the views and concerns of employees, how about having a director from the workforce on the company board, or creating a workforce advisory panel, or something similar? The Investment Association is there already. It warned companies earlier this year to expect large investors to challenge them on what it terms any lack of “the employee voice”. Arguably, these warnings could do with more rigorous enforcement.
There are parallels between the Inclusive Ownership Fund and Brexit. For both, the devil lies in the detail. Both are apparently straightforward solutions that hide complicated, disruptive and potentially negative consequences, the irony being that both could achieve most, if not all, of their aims through simply adapting and enforcing existing structures. Both have sought to justify a disruptive transformation by confusing correlation with causation. Supporters of the fund assume that lack of investment is because of greedy shareholders. The real cause is the external culture of constant change. Investors are unlikely to fault company directors who see little point in shelling out for the long term when it will take them years to find out approximately where the goalposts will eventually end up.
