Covid-19 and corporate resilience

29 June 2020

The pandemic is highlighting the deep flaws in the UK’s corporate governance system. Will this prompt listed companies to rethink their priorities?

Rachel Kay

Public companies, as institutions which dominate the organisation of labour and production, are fundamental in determining how power and wealth is distributed in our society. Just as the COVID19 pandemic has laid bare the many structural failings and injustices of the UK’s socio-economic system – from the insecurity embedded in our labour market, to the insufficiencies of our social safety net – it has also brought increased public scrutiny into how corporations operate and whose interests they serve.

The economic shutdown brought about by COVID19 has dealt a huge blow to the majority of listed companies in the UK. At the same time, there has been wider economic hardship for workers and families across the UK, with an alarmingly rapid rise in claims for Universal Credit and people accessing foodbanks. As keyworkers risk their health and their lives to keep society functioning, there is not only an economic pressure on large companies to preserve resources at a time of uncertainty, but also a moral pressure on business leaders to demonstrate that they too are willing to make sacrifices in the best interest of society at large.

Public companies have responded to the financial strain in a variety of different ways. Some have taken no action at all. Others have responded by implementing pay cuts for executives and senior staff, although the majority of companies have made cuts only to salaries, which tends to make up only a small proportion of total executive remuneration. A large number have also cancelled or suspended dividends for shareholders.

A further measure taken by several listed companies is to make use of the UK government’s ‘Coronavirus Job Retention Scheme’ whereby the state foots the bill for 80 per cent of workers’ wages. This scheme is a necessary measure to protect jobs and incomes, and the state is absolutely right to prioritise the economic security of workers. However, it should be noted that the Job Retention Scheme is also a substantial subsidy to businesses: in effect, it is a form of state bailout for businesses. Worryingly, some major UK firms have made use of public money to put their workers on furlough, but have left shareholder and executive rewards untouched. One example of this is the betting company GVC, whose CEO and CFO have recently been rewarded with shares worth over £4m, whilst 14,000 staff have been furloughed. This is essentially a repeat of the 2008 financial crisis, when banks continued to pay huge bonuses whilst being bailed out by the government.

The use of public money by some of the UK’s largest companies also raises deeper questions about their recent histories with respect to wealth distribution and the systemic forces that are behind this. Could these companies have put their substantial profits to better use in past years, in order to be more prepared for crises such as this one?

In recent decades, public companies have channelled increasingly large amounts of wealth into shareholder rewards and executive remuneration. Many have prioritised the maximisation of shareholder profits to the extent that they have continued to maintain dividend payments even when the company is underperforming. Whilst some dividends are paid into pension funds, payments to shareholders disproportionately benefit a wealthy minority. And even in the case of pension funds, wealth is very unequally distributed, with some 46% of pension wealth owned by the richest 10% of households.

This doctrine of ‘shareholder primacy’ inevitably means that there is less money available for employees. Since 2014, returns to shareholders grew seven times faster than wages for the median worker. Shareholder primacy also incentivises short-termism, giving companies fewer resources to re-invest. This limits their ability to increase production capacity or to ensure sustainability, with long-term investment in action to protect the environment taking a back seat. And – crucially at present – prioritising the payment of dividends means that companies are less able to keep funds in reserve to deal with future economic shocks.

The same can be said of paying executives and other top earners millions of pounds each year. Whilst excessive CEO pay receives by far the most media attention, most CEO awards are small compared to the total employee costs, and would not make a significant difference to the pay of low and middle earners if they were to be redistributed. However, executives and senior staff below the CEO frequently receive huge sums too, and these earners collectively represent a significant cost to the company. For example, in 2019, 751 RBS staff (around 1 per cent of their total workforce) were paid £327 million.

Public companies have not always directed wealth primarily towards shareholders and executives. Since the 1970s there have been a number of important developments which have dramatically changed how corporations function. These have included legal changes to the UK’s corporate governance system, such as the alignment of executive interests with those of shareholders, as well as broader economic shifts such as the financialisation of global markets and the weakening of organised labour. These developments have helped to transform the corporation from an entity primarily focussed on increasing production into a system of wealth extraction underpinned by financial logic.

Of course, no company could have predicted the exact scenario playing out today amidst the pandemic. However, it is fair to say that the way in which most companies operate is not geared towards sustainability or resilience. Recent research by the High Pay Centre found that the FTSE 350 companies making use of the government furlough scheme had made £42 billion in net profits over the past five years (notably, this is equivalent to the Office for Budget Responsibility’s estimated total cost of the furlough scheme). Over the same period of time, these companies spent £26 billion on dividends. This raises the question of whether these companies would have needed to make use of the furlough scheme to the extent that they have – or even at all – had they taken a more long-term approach to their finances.

This short-termism should have been more widely recognised by company boards as a serious risk. Scientists have repeatedly warned of the possibility of a global pandemic, and due to the climate crisis, other major environmental shocks are also highly likely in the near future. COVID19 is now drawing attention to the factors that make some companies far more resilient than others.

The importance of environmental, social and governance (ESG) concerns for investors has also been growing over recent years. The health crisis seems only to have strengthened this momentum, especially as ESG indices have overall performed better than their broad-market equivalents during the economic downturn. It has been widely noted by those in the field that prior to COVID19, the ‘S’ in ESG had been relatively neglected, with concerns around climate change and excessive executive pay (the ‘E’ and ‘G’) tending to dominate. Now, however, the pandemic is starkly highlighting the importance of companies treating their workforces well. The evidence (as well as common sense) suggests that companies which have good labour relations and safeguard employee’s physical and mental health are more likely to perform well over the long-term.

COVID19 is also making it impossible to ignore the fact that many of the workers who are most crucial to society are grossly under-valued. It seems likely that beyond COVID19, the fairness of pay distribution within companies, as well as companies’ treatment of workers more broadly, will continue to come under greater scrutiny by investors as well as by the general public.

It could be assumed that this concern with the ‘S’ in ESG will eclipse environmental concerns, but this may not be the case. Many investors see parallels between the COVID19 crisis and potential crises resulting from climate change, and overall resilience will likely be more highly valued by investors from now on. Consensus is also building around the idea that governments and businesses must institute a ‘green recovery’ from COVID19. The consumer goods company Unilever has been an early mover on this by pledging to invest $1 billion in environmental projects and by promising to sell off brands that do not meet its sustainability standards.

Corporations tend to present a narrative of themselves as independent of the state and operating in accordance with market forces. Conversely, this crisis – as with the financial crisis of 2008 – has made clear the existential reliance of the corporation upon the state. Beyond this, the corporation relies deeply on its employees and on the natural world in which it resides. This interconnectedness is something that companies have not recognised enough, but which the pandemic is clearly highlighting.

The fact that several listed companies are currently making recourse to public money sits very uncomfortably with the recent history of huge payments to shareholders and executives, and the prioritisation of these payments over commitments to workers, wider society, and the environment. This is the inevitable outcome of a corporate governance system that is designed to funnel wealth into the hands of a very few, to incentivise the pursuit of short-term financial gain, and to exclude employees from the corporate decision-making process.

Whilst individual companies are likely to respond to scrutiny from investors and the public in the aftermath of COVID19, public policy measures are also deeply necessary if we are to address the harmful incentives and power imbalances that are built into the UK’s corporate governance system. Governance structures and executive pay incentives must be drastically altered in order to end shareholder primacy and to ensure that companies genuinely act in the interest of all stakeholders. Exactly how to do this has long been the subject of debate in the policy and academic spheres. However, one policy that stands out as a much overdue measure is to directly involve UK workers in the governance of companies. This could be done by giving workers representation on company boards, or by setting up works councils which have power of veto. Such models of ‘co-determination’ are the norm across much of Europe, and due to these existing precedents, it would be relatively straightforward to design and implement a British model. This would ensure that employee voices carry weight with regard to strategic decisions, many of which will directly affect them. This is a positive development in its own right, but further to this, evidence also suggests that democratising the workplace gives companies greater resilience in times of crisis.

It has become commonplace of late to hear reference to a time when the COVID19 crisis will be behind us, ‘when things are back to normal’. However, it is unlikely that a return to ‘normal’ will be a long-term possibility, if indeed it happens at all. The interrelated phenomena of climate change, ecological breakdown and overpopulation mean that catastrophes and crises will become the norm. These events are very likely to exacerbate existing inequalities, as COVID19 has done across the world. With this uncertain future, it is more important than ever that corporations are both prepared for economic shocks and are committed to act in the public interest. They must recognise that they are intrinsically dependent upon the state, the citizenry and the planet. In return, it is their duty to contribute to building a fairer and more sustainable society. If they cannot do this, we will all be worse off as a result.