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The Kay Review: Five years on

“The epic story of Ulysses tying himself to the mast to resist the call of the sirens demonstrates the length of the history of attempts to construct devices and institutions to combat our instinctive short-termism.”

In July 2012, Professor John Kay framed the problem of short-termism by citing the Odyssey. Five years on from the publication of the Kay Review of UK Equity Markets and Long-Term Decision Making, how much progress have institutions made in resisting the siren song?

The simple answer is certainly “not enough.” The overarching conclusion of the Kay Review was that short-termism is a problem in UK equity markets caused primarily by the decline in trust and a misalignment of incentives.

At a company level, there remains a reluctance to commit long-term capital to foster innovation and growth. Now this could be partly to do with the current environment given the fragile nature of some parts of the economy. But among some senior management teams there is still the mindset of not wishing to invest only for their successors to reap the rewards.

Part of the problem – as identified by Kay – are the pressures that arise from the excessively frequent reporting of financial and investment performance, including quarterly reporting by companies. If the focus is on meeting next quarter’s targets, there may be little thought given to long-term strategy. Similarly within asset management, there is a focus on short-term gains rather than long-term returns.

Kay believed part of the solution would be to improve the quality of engagement by investors with companies. This is an area where there has been some progress with the formation of the Investor Forum, which began operating in 2015. The forum’s role is to promote the concept of stewardship in the investment industry and to encourage dialogue between shareholders and companies. It’s too early to tell whether the organisation will lead to real changes in behavior, but it has already done some decent work in promoting engagement between companies and investors.

The other main development has been the Law Commission’s investigation of fiduciary duty, social responsibility and the scope that institutional investors have to take account of it. The commission’s report is a good bit of work, but for the most part, it hasn’t yet been taken on board by institutions.

And that, so far, is the main achievement of the Kay Review. Our clients do appear to be more interested in the concept of stewardship. It may be anecdotal evidence, but it’s now vanishingly rare for many investors to seek offerings without a discussion of environmental, social and governance issues and stewardship playing at least some part in their considerations. And investors are asking increasingly smart questions on these issues.

That’s a step forward. We’ve also seen faint signs of improvement in remuneration. There is, for instance, evidence that executive pay in corporate Britain is no longer rising faster than pay across the general population. And some companies have used their new pay policies to reduce executive compensation. More should be done though to ensure that managers’ interests are aligned with those of long-term shareholders.

Five years on from the Kay Review, then, material progress has been relatively scant. We shouldn’t underplay the significance of the change in tone across the corporate sector. That should gradually lead to a better situation. But so far, not enough company CEOs and investment managers have been lashed to the mast of long-termism. As far as genuine alignment of interests goes, we still have an odyssey ahead of us.

Important Information

A version of this article originally appeared in Investment Week magazine on July 31, 2017.

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