Investor pressures can be damaging

FTSE 100 - THE LARGEST COMPANIES

Some dimensions.

Most developed market economies have a Stock Market index for their largest companies. In the UK it is the FTSE 100, in the US, the S&P 500. They are bellwether indicators of the health of the economy, as well as spelling out its particular strengths and weaknesses. For example, the UK FTSE 100 has heavy representation by financial and general services companies, but very few high-technology enterprises.
The figures below are for 2002, when the FTSE 100 was at a low point. In a word, the FTSE 100 is huge:

In 2002, the average number of employees per company in the FTSE 100 and the largest American companies in the S&P 500 was 44,000.
In mid-March, 2005, the combined value of the FTSE top 5 companies was £527 billon.

FTSE 100 companies are subject to the most intensive investment analysis money can buy. Except for 'players' in the City and some entrepreneurs, their leaders are the most highly paid in the country. Surely the combined effects of stock market disciplines and inspired leadership must have created a powerhouse of innovation, efficiency and performance?
Let's see.

'Financialisation'

To start we return to the research published in early 2006 by professor Karel Williams and colleagues from the University of Manchester.
They describe massive changes in the nature of giant companies' corporate strategies that have occurred over the last 20 years.
Intense pressures from the capital markets have caused companies to focus mainly on how to satisfy investors. In turn, this has changed the character of corporate strategy, which has become, in essence, the production of numbers for the markets, supported by a 'narrative' that supports the numbers.
More important than this, the primary role of the corporate office is now to support top managers in their transactions with the financial markets, which are now estimated to take up about one third of CEOs' time.
This finding is supported by much corroborative research and evidence.
Corporate offices of many FTSE 100 companies have therefore become mirror images of the financial markets. The effect of this and the pressures for narrow corporate governance have been to distance boards from the businesses and organisations they are supposed to lead. This leaves corporate managers with a limited range of 'levers' that they can use to improve the business. A short tenure CEO is most likely to resort to transactional means to improve performance and impress the financial markets - thus the massive dependence on corporate restructuring and mergers and acquisitions - neither of which have been demonstrated to have the desired long-term effects.
Has this created a high-performance engine that can power the economy?
Judge for yourself.

FTSE 100 Performance

Annualised Percentage Increases 1983 to 2002

Most data drawn from: Financialisation and Strategy, Froud et al, Routledge, 2006.

Analysis.

• The rate of sales and profit growth in both FTSE 100 and S&P 500 is not significantly greater than the underlying economic growth rate. Thus despite the attentions of the full weight of the City and very expensive top managers, the biggest companies have averagely grown at or below the rates of the underlying economies.
• In UK companies, the rate of dividend growth far exceeds the rate of underlying growth in profits. This has supported share prices, (and directors' pay), but is probably one driver of a generally low rate of investment in Research and Development (R&D) and capital expenditure.
• In 2005, the top 750 'British' R&D-intensive companies spent £17 billion (240 of these 750 were foreign-owned and overall reduced their UK R&D spending).
• The minister in charge of technology announced "UK companies ranked 'intensive' for R&D have surged by more than 75% in the past 4 years". This contrasts strangely with the revelation in the same report that R&D spend had reduced by 0.5% in 2005, continuing a consistent long-term downward trend.
• By comparison, FTSE 100 companies spent £39 billion on mergers and acquisitions in 2003 - and £306 billion in 2000. It is very well known that M&A destroys far more value than it creates. So 'buy, not create', seems to be the order of the day.
• The 'spread' of FTSE 100 companies across industrial sectors is hardly that of a high-tech economy:

  Sector	Number of Companies
  Banking and Financial Services	24
  Media and Entertainment	14
  Utilities	11
  Food, Drink, Tobacco	12
  Retailing	10
  Mining and Resources	8
  General services	4
  Transport and Distribution	1
  Telecomms. Services	4
  Pharmaceuticals	4
  Aerospace, Engineering, Materials	5

  Of this listing, only the last two, making up 9% of the FTSE 100, could be regarded as genuine creators of science and technology-based products.

There seems to be a definite bias towards financial companies and companies that have secure markets or are in industries where one can measure the tangible assets. Clearly, the lead for a science-led economy is not going to come from here. The latest industry to be acquired by a foreign country is steelmaking, in the form of Corus plc, ex British Steel, acquired by Tata Iron and Steel, a key component in India's national industrial development. Whilst jobs may be preserved in the short term, it is likely that many will be lost eventually and another tranche of knowledge and expertise lost to the UK.
Oh, and as manufacturing and technology account for a large part of UK exports, the decline of British companies in these sectors means that the burgeoning Balance of Payments deficit is likely to be permanent.

The driving force? Short-term, risk-averse investment.

Research into the values and practices of UK investors led by Prof. Andrew Tylecote of the University of Sheffield concluded that the UK stock market had a world-leading aversion to long-term investment in technology. +
The UK is strong in just two sectors of advanced technology - Aerospace and Pharmaceuticals. Pharmaceuticals is described by the researchers as a special case, where the need for R&D is understood on an industry-wide scale and risks are reduced by patent protection and having governmental and quasi-governmental bodies as customers.

The two UK players in aerospace, BAe Systems and Rolls Royce, are protected by a UK government 'golden share' that makes them difficult to acquire, although BAe Systems is known to have unsuccessfully hawked itself around US companies looking for a 'merger' partner.
Thus UK investors will support high levels of R&D in Pharmaceuticals, because the industry can be understood without having a close relationship with individual companies; and in the cases of BAe and Rolls Royce, because they find it difficult to stop them.

In all other high-investment, high technology sectors, the UK is markedly under-represented by big companies. These include:

• IT hardware
• Electronic and electrical equipment
• Semi-conductors
• Office, accounting and computing equipment
• Radio, TV and telecommunications equipment
• Chemicals - a rapidly declining sector in the UK
• Metal manufacturing
• Automotive
• Industrial Gases and Cryogenics
• Computer software, except for standard software.
• And for good measure, Investment Banking, Ports and Airports, international Consulting - and probably to come, Stock Exchanges and metals.

This list might be described as the sinews of a modern high-technology economy.

Where are we going?

There seem to be too many threads that indicate that, despite the talents and capacity for hard work of a generally well-educated workforce and apparently good news about the British economy - together with frequent trumpetings of schadenfreude from Treasury sources - all is not as well as it could be at the top end of British industry.

We have an uneasy feeling that Britain may be sliding ever so gently towards a high-employment, low wage, low added-value, and lowish-knowledge economy - with the creation of most of the fundamental technologies that underpin modern industry is carried out elsewhere. This is not the kind of economy that will continue to support the excellent academic and research facilities that we currently possess - nor will it retain many of the people with the highest innovative skills. We hope that we may be wrong, but feel that we are not.
Readers can make up their own minds.....