City culture of bonuses under attack

A report commissioned by Business Secretary Vince Cable said the financial sector was too heavily geared towards rewarding traders and middle men and not focusing enough on long-term investment and providing returns to shareholders.

Its author, London School of Economics professor John Kay, hit out at bonuses based on short-term performance and called for a “much needed shift in the 
culture of the UK’s equity markets”.

The report, which was set up to examine the impact of UK equity markets on the long-term performance of companies, was welcomed by investor bodies, although the British Chambers of Commerce warned against a “witch hunt” in the City.

Mr Kay advocated wide-ranging reform, including paying executives’ long-term incentives in shares that do not vest until after they have left the company, and scrapping requirements for companies to report every three months.

Professor Kay said: “A lack of trust and poorly aligned incentives have helped create a culture of short-termism in our financial markets. This is undermining their role of supporting innovative, sustainable long-term business performance.”

This trend encouraged “bad long-term decisions” and the report found evidence of “hyperactive behaviour” from executives who were driven by big takeover and merger deals rather than improving their own businesses.

It even questioned why executives need to be paid bonuses in the first place, saying that they were relatively unusual until the 1980s.

It said: “Many people doing responsible and demanding jobs – cabinet Ministers, judges, surgeons, research scientists – do not receive bonuses, and would be insulted by the suggestion that the prospect of bonuses would encourage them to perform their duties more conscientiously.”

Alan MacDougall, managing director of shareholder body Pirc, said the review painted a picture of an investment chain that is not working properly.

He said: “In almost every link in the chain there is a bias in favour of activity, regardless of whether this can be proven to be in the interests of either issuers or savers.

“Intermediaries seem to be the only group which unquestionably gains but the lack of clarity about whose interests they actually serve has also corroded trust in the system as a whole.”

The Business Secretary will later this year respond to the report, which he said was insightful and powerful and “describes vividly the flaws of the UK’s financial markets”.

Its findings will heap more pressure on boards over executive pay following the shareholder spring, which saw several rebellions amid allegations that pay had become out of kilter with performance.

And there are fears that the reforms outlined in the report could spell more redundancies in the City, which has already been 
hit by the crisis in the banking sector.

The report said the financial sector needed to focus on producing returns for investors and savers and called for “investor forums” to be set up to foster closer engagement.

Companies should also update the market in a way that is easier for investors to understand, the report added.

John Longworth, director general of the British Chambers of Commerce, agreed that short-termism could act “as a brake on parts of the wider economy” by limiting the availability of capital for growing companies. But he added that a “witch hunt” must be avoided because the City remains of crucial importance to the economy.