A Firm Partnership
A Firm Partnership
Executive Summary
Introduction
Labour has made reversing Britain’s economic malaise its central mission. Overcoming the toxic combination of stagnation and inequality that will be the next government’s inheritance requires two changes as a minimum: increasing business investment to generate broad-based productivity-driven growth; and equitably boosting real wages to improve living standards. The Party has set out a series of reforms — of the planning system, labour markets and public services, among others — through which they intend to achieve these outcomes. However, there is a fundamental piece of the puzzle missing whose absence will undermine Labour’s wider agenda: corporate governance reform.
Corporate governance is so important because it defines the rules — and therefore, decisively shapes the operation — of a fundamental entity of the economy: the corporation. In particular, how those rules are designed shapes both production (how corporations operate and innovate) and distribution (how corporate income is used, for example whether to increase wages, or distribute profits to shareholders). Perhaps most fundamentally the rules determine who matters within the company: whose interests and voice count. Corporate governance is a matter of power and purpose.
The UK is an outlier among richer economies in the extent to which the doctrine of shareholder primacy — the idea that the overriding priority of the corporation is maximising shareholder value — defines corporate governance. The effects of the shareholder-oriented corporation are clear: senior management is pressured to maximise short-term shareholder payouts, often through hollowing out reserves, taking on debt, or creative accounting manoeuvres, regardless of the long-term cost to the company; wealth is consequently extracted for shareholders while those who work to produce that wealth scrape by and are denied representation in the strategic decision-making of their workplace; and business investment — the lifeblood of a dynamic economy — stagnates.
The effects of the shareholder-oriented company contribute decisively to our investment-starved economy. Between 1995 and 1999, FTSE350 companies distributed an average of 34 per cent of their post-tax profit as dividends and buybacks; in the last five years, that has risen to 103 per cent. According to ONS UK National Accounts, during the second half of the 1970s, private non-financial corporations paid out 20p dividend payments for every £1 of gross fixed capital formation, a measure of investment. In the second half of the 2010s, this figure was 95p of dividends for every £1 of gross fixed capital formation.
Meanwhile, as corporate income has been used to handsomely reward shareholders, business investment remained consistently among the lowest levels in the OECD. The relative dearth of investment in turn is a crucial factor in Britain’s poor productivity performance; indeed, countries with more stakeholder-oriented firms typically have both higher rates of business investment and stronger productivity performance.
If Britain’s economic stagnation is entwined with the outcomes of a shareholder-oriented company model, so is inequality. Firstly, because returns to shareholders have increasingly outstripped employee compensation, it has worsened inequality between wage earners and asset-owners. Secondly, because executive management have seen their remuneration surge due to little checks or balances in existing governance frameworks, which has helped drive up income inequality.
Corporate governance is only one factor that helps explain Britain’s low-investment, high-inequality model. However, so long as the rules shaping the corporation, and hence the structure of decision-making power and purpose within it, pressure companies to distribute their income to shareholders instead of investing to increase their productivity capacity or better reward employees, then wider efforts to deliver broad-based growth will be running up a downhill escalator. Labour’s central missions are compromised from the start without corporate governance reform.
This essay lays out why reform of the fundamental unit of our economy is a precondition for economic renewal through a focus on two areas where corporate governance shapes (poor) economic outcomes in the UK: investment and inequality.
In her Mais Lecture, the Shadow Chancellor Rachel Reeves spoke of the need for a partnership between business and a “strategic state” to revive the UK’s economic fortunes. If this partnership is to succeed, business needs to change as much as Labour contends the state does, from the current short-termist, shareholder-oriented model to one that is inclusive in operation, a vehicle for shared prosperity and democratic by design. The stakes could not be higher. Change cannot rely on business as usual. As the coalition behind the Better Business Act demonstrates, there is a clear appetite from many businesses themselves for a cleaner, greener and fairer future for all. It is time for a firm partnership for economic renewal.
Shareholder Primacy and the “Hollow Firm”
Decision-making within companies is shaped, not by any fixed “natural” logic, but by politics and law. In the UK, the corporation — the institution that coordinates capital and labour for production — has been transformed by legal and policy changes over the last four decades, shifting the typical public company from a “retain-and-reinvest to downsize-and-distribute” approach. Behind this shift is the doctrine of shareholder primacy, the notion that shareholders count above all other corporate stakeholders and are the only group that should be represented in company governance. Shareholder primacy has pressured companies to move from retaining and investing corporate income to expand their productive capacity, to distributing more of their income to shareholders while shifting risk onto labour through holding down real wage growth, outsourcing, and squeezing working conditions. Notably, companies have increasingly distributed to shareholders not through higher earnings, but by hollowing out corporate reserves, or financial engineering of the fair value accounting regime.
The result has been what the political economist Adam Leaver and others have termed the “hollow firm”: fragile, unequal and less productive companies. This transformation of the firm has produced two notable effects: prioritising distribution to shareholders over investment; and rising inequality as returns disproportionately flow to investors and executive management over ordinary employees.
Distribution over investment
While, in theory, the idea of what benefits shareholders might encompass their long-term as well as their short-term interests, in practice the UK’s corporate governance promotes a form of “quarterly capitalism” where shareholders demand high returns on their investments now. Corporations respond to this pressure by paying out ever higher amounts to shareholders through dividends and more extensive share buybacks, leaving less money available to be reinvested in the company.
As Chart 1 demonstrates, a focus on prioritising shareholders has coincided with — and helped drive — a long-term decline in business investment as the percentage of corporate income distributed to shareholders has intensified. Among the 110 firms that have stayed in the FTSE350 since 1995, cash payouts to shareholders relative to post-tax profits has risen from 34 per cent in the late 1990s to 103 per cent over the last five years (2019-2023). Over the same period net capital expenditure relative to depreciation and amortisation has fallen from 150 per cent to 85 per cent.
[.fig][.fig-title]Figure 1: Less In, More Out: FTSE Firms are Investing Less and Paying Out More[.fig-title][.fig-subtitle]Shareholder payouts relative to post-tax profits vs net capital expenditure relative to depreciation & amortisation, 110 firms present in the FTSE350 throughout 1995-2024[.fig-subtitle][.fig]
[.notes]Source: Common Wealth analysis of LSEG Eikon.[.notes]
This is clearly not only the result of corporate rules and financial markets pressuring companies to “disgorge the cash” (the idea that, as the economist JW Mason notes, “shareholders do not simply want higher profits, but also want a higher proportion of those profits paid out in the form of dividends and buybacks”). For example, a lack of investment opportunities in an economy held back by austerity and weak demand has also helped to constrain business investment.
Nonetheless, the evidence suggests that there is a clear and common-sense link between the shift to rewarding shareholders as the primary goal of the corporation and the consequent rise in shareholder payouts and related decline in business investment. Chart 2 shows that the ratio of dividend payments to capital investment by private non-financial corporations hit a historic low in the late 1970s, and more than quadrupled over the subsequent four decades. (It is extremely unlikely that there was a commensurate shift in the investment financing mix from debt to equity to account for this.) This quadrupling was driven in part by the active reorientation of the firm toward maximising shareholder value. Reversing this trend will be fundamental to delivering the productivity-enhancing investment the British economy sorely needs. That, in turn, will require reversing shareholder primacy.
[.fig][.fig-title]Figure 2: Dividends Outpaced Investment from 1979 until the Pandemic[.fig-title][.fig-subtitle]Amount of dividend payments for every £1 of gross fixed capital formation among private non-financial corporations[.fig-subtitle][.fig]
[.notes]Source: Common Wealth analysis of ONS.[.notes]
Asset-owners over wage-earners
The focus on distribution has not just held back much-needed investment, it has also sharpened the divide between wage-earners and asset-owners, a critical amplifier of inequality.
As Chart 3 illustrates, the fortunes of wage-earners and asset-owners have sharply diverged as the corporation has been refashioned in the interests of shareholders and at the expense of ordinary workers. The analysis shows employee compensation (across all corporations, including the public sector) to dividend payments by private non-financial corporations, relative to their respective 1988 levels, the earliest year available. From 1988 to 2019, the eve of the pandemic, dividend payments by UK private non-financial companies grew 2.5x faster than employee compensation (including pension contributions) each year on average. During 2000-19 it grew 5.5x faster. If worker compensation and dividend payments had grown at an equal pace over 1988 to 2019 (i.e. at 1.9 per cent per year each, instead of the 4.2 per cent for dividends vs 1.6 per cent for pay that actually transpired), then hourly labour compensation would have been 8.9 per cent greater going into the pandemic. Only since the onset of the gas crisis of 2022 has pay fared better than dividends.
[.fig][.fig-title]Figure 3: Dividends Have Far Outpaced Stagnant Pay[.fig-title][.fig-subtitle]Economy-wide labour compensation vs PNFC dividend payments, CPI-adjusted, per hour worked, indexed 1988=100, 4-quarter trailing average[.fig-subtitle][.fig]
[.notes]Source: Common Wealth analysis of ONS.[.notes]
If share ownership was broadly and equally held, then rising returns to shareholders would matter less, at least from distributional concerns. However, despite the rhetoric of a “shareholder democracy”, that is emphatically not the reality. Share wealth is highly unequally distributed in the UK, with the wealthiest one per cent of households owning 39 per cent of all directly held share-based wealth, more than the poorest 90 per cent combined. Pension wealth, while giving millions of people a stake in corporate wealth, is also highly unequal, with the richest 20 per cent of UK households by income owning almost as much as the poorest 80 per cent combined. Furthermore, UK pension funds have, in recent years, invested far less in shares in British businesses: where almost one in three UK-quoted shares were owned by UK pension funds in 1990, by 2018 this was less than one in 25, a decline of over 90 per cent. All of this means that the beneficiaries of rising shareholder payouts are disproportionately international investors and wealthier households in the UK — while ordinary workers have suffered from stagnant real wages and rising insecurity.
In addition, executives as well as shareholders have been the beneficiaries of the present corporate governance regime. Board members and investors are responsible for setting executive pay, which has continued to spiral even as real wages have stagnated. Analysis from the High Pay Centre has shown that in 2022, the median FTSE 100 CEO was paid 118 times the median earnings of a UK full-time worker. Trends in executive pay only underscore the deepening divide between managers and asset-owners and workers when it comes to reaping the rewards of corporate profits.
Wealth over democracy
The harm of this extractive model is not just economic. It also runs counter to a fundamental principle of political life: that those affected by decisions should shape how they are made. This year, Keir Starmer announced a new “Take Back Control Act” to further devolution in the UK, yet amongst proposals for new powers for mayors, there has been no effort to bring democracy to our central economic institutions.
The UK is an outlier compared with countries in Europe this regard: 12 of the 27 EU countries have provisions for workers to be represented on company boards across most of the private sector, with a further six having those rights for a smaller selection of companies. Indeed, as Chart 4 shows, the UK comes third from bottom in the European Participation Index (EPI), a composite index from the European Trade Union Institute which summarises both formal rights and the extent of participation at three levels: in the board, at plant level and through collective bargaining, above only Latvia and Estonia. This poor ranking — associated with higher inequality, worse productivity, and lower investment — reflects the fact in the UK workers have no guaranteed representation in corporate governance, either at a board level (the executive) or the company membership/shareholder body (the legislature). A fundamental and deeply political unit of our economy is a zone of non-democracy: political rights are assigned based on wealth holding (shareowners) not democratic participation.
A more democratic model of corporate governance would recognise that shareholders are not the only ones with “skin in the game”. Workers are also affected by how companies choose to invest or distribute their earnings; indeed, they bear far more risk, with their livelihoods much more directly tied to their company, than a shareholder who often has highly diversified holdings. And, more broadly, we have suffered decades of corporations polluting and emitting in spite of the clear harms to communities and the planet because none of those affected have had a voice when those decisions were made. It is not right that we should insulate the corporation from the same democratic principles we apply to other areas of economic and political life, especially when the consequences of doing so have been so damaging.
[.fig]Figure 4: The UK is one of Europe's Worst Performers on the EPI[.fig]
[.notes]Source: European Participation Index.[.notes]
An Alternative: A Firm Partnership
An alternative vision of the company is possible. It is also necessary. Whoever forms the next government must rewire the corporation if it is to successfully address Britain’s malaise. Our upcoming programme of research, analysis and policy recommendations will support growing calls from within the labour movement, civil society and even within business itself, to change the UK’s corporate governance regime, giving companies clearer purpose, making their governance more participatory and making them more publicly accountable.
Purpose
Rather than focusing on benefits to shareholders, a reform to directors’ duties — as supported by the Better Business Act — would articulate a new purpose for the company. This would ensure decisions are made with multiple stakeholders in mind, promoting a more long-termist and less narrowly extractive outlook.
Participation
To support this new, multi-stakeholder governance model, other stakeholders should be able to participate directly in decision-making. As is the norm in many other European countries, and as has been called for by the Trades Union Congress among others, worker representation on company boards as well as expanding company membership to allow employees to vote at Annual General Meetings would bring greater democracy into the corporation.
Public accountability
Beyond workers, a wider set of stakeholders is affected by decisions companies make, especially when it comes to the future of the planet. For us, the public, to hold companies to account, we need reform to audit and accounting procedures to ensure proper transparency. And, if we are to address the climate crisis, policies such as windfall taxes that only influence decisions from the outside are not enough: we should embed climate safeguards into decision-making to ensure that companies cannot continue to externalise the harms of polluting and emitting.
Corporate governance reform is not a quick fix for the UK’s longstanding economic problems; the causes of the current malaise are multiple, and the solutions will also need to be multiple, encompassing planning reform, strengthening collective bargaining rights and greater public investment and public coordination of key industries. However, at present, Labour’s agenda is silent on this necessary piece of the puzzle. Only by acknowledging the need for reform can Labour articulate a vision for the economy that promises growth, equity and much-needed investment, especially in decarbonisation.
If reforming such a central economic institution seems impossible, Labour should draw inspiration from their forebears: every previous Labour government from Atlee to Blair has introduced reforms to company law. Taking up this inheritance is the right thing to do not only because it will improve our economic fortunes; it also makes good on the promise to empower local communities across the country to have more of a say over their political and economic lives.
Our future programme of work will explore these themes of business investment and inequality, as well as climate, to build an evidence base to advocate for reform. Over the course of this year, we will be working to support the growing coalition calling for an end to business as usual in order to reclaim the company as a vehicle of generative and inclusive enterprise.
