10 December 2019

The 10% share policy that would decimate corporate Britain

By Peter Young

Imagine you run a successful, expanding British business. You have 249 employees and are about to hire your 250th. But if you do so, 10% of your company’s shares will be confiscated by the state.  Do you hire the 250th employee? I strongly suspect that most people would think very hard about doing so.

This would be just one of the consequences of Labour’s extraordinary policy for 10% of the shares in all UK companies with more than 250 employees to be transferred to an ‘inclusive ownership fund’. These IOFs, although nominally under the control of employee representatives, would be in fact a vehicle for de facto nationalisation of the shares. While a maximum of £500 per year in dividends would go to the employees of the companies, 90% would be paid to the state. Moreover the IOF wouldn’t have meaningful ownership of the shares in that it couldn’t sell them, nor could employees sell their interest in the IOF.

Then there’s the sheer cost of the policy. Law firm Clifford Chance estimates a hit to investors in the region of £340 billion of lost capital, with at least £31 billion of that being born by pension funds, and therefore ultimately by pensioners themselves. Clifford Chance suggests that the negative effect on pensions – an average long-term decline of 2% in pension fund valuations – would even negate the £500/year benefit for most employees.

Of all Labour’s policies, this would have the most catastrophic effect on the economy.  Confiscating 10% of large companies, £340 billion of assets, would destroy investor confidence in Britain and lead to capital flight and a collapse in the value of the pound.

Why would investors wait to see if the Corbyn Government would confiscate any more of their assets? Another way of looking at the effect is that combined with Labour’s intended increase in corporation tax to 26%, this would take taxes on corporate profits to 33.4%, the highest level in the developed world.

Moreover, the way the policy is structured would drive companies out of Britain, with all the knock-on effects on jobs that would entail.

Under John McDonnell’s proposals, shareholders from a UK-headquartered multinational group would have 10% of all their assets taken away, whereas foreign-headquartered multinationals would only have 10% of the value of their UK subsidiaries confiscated. Thus UK-based companies would have a big incentive to move their headquarters and as many operations as possible overseas.

Foreign companies would have a similar incentive to move as many of their activities as possible to other countries and also to shift profitability to other countries with a few as possible of dividends being generated by UK subsidiaries. There would also be, as the Institute for Fiscal Studies has noted, an incentive for foreign companies to operate in the UK through branches which, unlike subsidiaries, do not issue shares or pay dividends to head office. They would also have a strong incentive to extract profits from the UK through interest, royalty, or service payments as opposed to dividends.

Clearly some activities have to remain in the UK to be effective. For example, a dealership selling cars to customers at multiple locations couldn’t just move to another country. However, other activities could be moved, manufacturing ones in particular. Cars don’t need to be made in Britain, for example. They can be made in another country that doesn’t confiscate 10% of shareholder assets then be imported into Britain.

Not only would companies not expand beyond 249 employees, (as Clifford Chance notes “the decision for a medium-sized company to hire its 250th employee would have to be taken with great care….at a stroke, the shareholders would lose 10% of their value”) but other companies would actually shrink their workforce.  Companies with some 300 employees would likely seek to reduce employee numbers below 250.

Moreover investment into the UK would likely largely dry up as it would have to earn a return that was at least 10% higher than that available in other countries. From being the leading country in Europe for foreign direct investment, and the third most significant in the world behind the US and China, Britain would become a foreign investment desert.

This would all have a huge effect on employment. Hundreds of thousands of jobs would be lost, with the impact becoming much worse over time as the lack of investment throttled the expansion of economic activity. The large businesses with over 250 employees which will be hobbled by the policy account for 40% of employment and 10.7 million employees. Of those, 4 million employees are in companies with between 240 and 499 employees. A good number of these can be expected to contract employment or shift it overseas, in order to come below the 250 cap. Businesses with between 50 and 249 employees, which would hold off expanding, account for 13% of employment and 3.4 million employees. Of those, 2.1 million are in companies with between 200 and 249 employees.

SMEs are the primary engine of job creation in the UK and have created two and a half times as many jobs as large businesses over the last five years, with net job creation of 1.7 million as opposed to 650,000 by large businesses. The IOF policy would put the brakes on that job creation at a stroke.

Destroying jobs and investor confidence are just some of the pernicious effects of this ludicrous policy.

For one thing, it puts shareholders in companies that are leveraged with large amounts of shareholder debt at a major advantage and thus provides an incentive for companies to abandon equity and shift to shareholder debt models. Take two companies with identical enterprise value, one unleveraged but the other with 70% of its value in shareholder debt. In the first case the shareholders would lose 10% of the value of their shares, in the second case only 3%.

Corporate restructurings and mergers would become much more difficult, as would share buybacks and new capital raising.  As the IOF could not fall below a 10% share, then any investors who raised new capital would have to be diluted by 10%, making such capital raising very unattractive. Moreover, many joint ventures, which rely on both parties having a 50% share and blocking power, would become unviable.

And what’s the longer term plan? The policy appears to be based on the Meidner Plan, a scheme promoted by two Swedish trade union economists in the 1970s which involved worker control being gradually extended to full ownership of all businesses. While Labour are now claiming that only 10% of shares would be confiscated, that could easily be changed in future to involve majority state ownership.

As Clifford Chance Partner Dan Neidle says, “the fear of many would be that….this proposal… is being done for something much more ambitious, much more radical and much longer term”.

This policy could be the Trojan Horse for Corbyn and McDonnell to seize state ownership over yet more of the economy. The only problem is by the time they reach that goal, there won’t be much of an economy left to seize.

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Peter Young is former Head of Research at the Adam Smith Institute