[.green]1[.green] Shareholder Primacy: The Missing Piece of the Investment Puzzle

Business investment is shaped by demand and supply and their interaction, and a set of policy choices and events have weakened demand in recent years. Brexit has raised the cost of exporting, increased the friction and costs of EU imports, and elevated levels of uncertainty — all of which have undermined the case for businesses investing. Austerity reduced government spending, leading to lower domestic demand, which consequently depressed investment. In her Mais Lecture earlier this year, Chancellor Rachel Reeves cited both austerity and Brexit-related instability as factors in the UK’s economic underperformance, though given low levels of investment predate these events, they cannot in themselves be a sufficient explanation for what has been a decades-long trend.^[1]

At the same time, supply factors such as business concerns around the planning process, the cost of land, or other barriers have been highlighted as reasons businesses have held back on investment. So too has the concentrated nature of many sectors of the British economy, as, facing little competition, many dominant firms could choose to lower investment, restrict output and raise prices as the most profitable strategy.

The causes of the UK’s investment problem are multiple then, with all these factors likely playing some role, but this diagnosis remains incomplete. What is missing is the role corporate governance has played; as Common Wealth recently argued, the UK’s current corporate governance rules prioritise company shareholders to the exclusion of other stakeholders.^[2] This is not a natural or inevitable way of organising the company. It is the result of legal and policy changes since the 1980s to make shareholder primacy the dominant framework — in other words, that “shareholder profit is the ultimate purpose for all corporate activity and that corporate governance should be exclusively in the hands of shareholders, not other corporate stakeholders.”^[3]‍

As shareholders have become more powerful within corporate governance, so companies have reoriented their behaviour to maximise their interests, in part by “increasingly prioritising shareholder payments over other, more productive uses of corporate resources.”^[4] And increasingly, shareholder primacy has led to companies distributing to shareholders not through higher earnings, but by hollowing out corporate reserves or financial engineering of the fair value accounting regime.^[5]  

In the context of rising shareholder payments (through a combination of dividends and stock buybacks), companies have fewer funds available for productive investment or raising employee compensation. Figure 2 shows how, from 1979 until the pandemic, dividend payments outpaced investment, with the ratio of dividend payments to capital investment more than quadrupling over these four decades.

[.fig][.fig-title]Figure 2: Dividends Outpaced Investment from 1979 until the Pandemic[.fig-title][.fig-subtitle]Amount of dividend payments for every £1 of gross fixed capital formation among private non-financial corporations[.fig-subtitle][.fig]

[.notes]Source: Common Wealth analysis of ONS.[.notes]

Without rewriting the rules around corporate governance, Labour’s other pledges around tax, public investment, regulatory reform and economic stability are unlikely to orient business away from a focus on shareholder distribution toward increasing business investment.  As the rest of this briefing demonstrates, alternative solutions have in the past proved ineffective at moving the dial on investment, but there is good evidence that corporate governance reform can make the difference.

[.green]2[.green] Tax and Spend? Previous Efforts to Raise Business Investment

The tax system is one of the main levers used by previous governments to encourage business investment. However, as shown in Figure 3, there is not a clear link between business taxation and levels of investment and productivity. Relatively higher levels of revenue from corporation tax in the late 1990s and 2000s saw higher levels of business investment growth than in the 2010s where the levels of tax on business were lower.

[.fig][.fig-title]Figure 3: Corporation Tax Rates Do Not Have a Clear Effect on Business Investment[.fig-title][.fig-subtitle]Corporation tax and business rates revenue (% of GDP) vs other UK output per worker 1992-1993 to 2021-2022[.fig-subtitle][.fig]

[.notes]Source: Demos analysis of IFS and ONS.[.notes]

Meanwhile “full expensing” of capital — a generous tax deduction introduced in the Spring Budget of 2023 to encourage businesses to invest that Labour pledged to maintain in their manifesto — is also unlikely to have much effect. Analysis by Demos of the cost of permanent full expensing of companies investing in plant and machinery^[6] and the OBR’s projection of business investment across the forecast period,^[7] shows that net business investment is expected to increase by £10.5 billion between 2023/24  and 2028/29. At the same time, the cost of full expensing is due to be £29.6 billion. This means for every £1 of revenue forgone on full expensing, net business investment is predicted to increase by just 35p. Moreover, in only two of the five years covered by their period is the cost of full expensing lower than the net increase in business investment over the same period.

[.fig][.fig-title]Figure 4: Full Expensing Has Had Only a Modest Effect on Business Investment Despite Its Costs[.fig-title][.fig-subtitle]The revenue forgone of permanent full expensing of companies investing in plant and machinery and net change in business investment[.fig-subtitle][.fig]

[.notes]Source: Demos analysis of OBR and HMRC.[.notes]

This data does not mean that every £1 revenue forgone on full expensing creates 35p of business investment, as the tax incentive might account for some, all or none of that figure. On the downside, there is inevitably a deadweight cost to full expensing, meaning a reduction in net economic benefits resulting from an inefficient allocation of resources. On the upside, it may be that by offering tax incentives to invest in plant and machinery offsets other drags on potential business investment (e.g. perceptions of risk, internal hurdle rates for investment, interest rate volatility, etc.). Moreover, since official data concerns all business investment and not merely investment in plant and machinery, any net increase identified covers a wider pool of business investment than is likely to be directly affected by full expensing.  

Despite these uncertainties in describing the exact relationship between full expensing and rates of business investment, this analysis does indicate that full expensing has hardly provided a solution to the UK’s weak business investment performance. That the £29.6 billion price tag of full expensing so greatly outweighs the increases to business investment raises the question of whether the public would achieve greater value of money through the Exchequer directly investing £30 billion a year into the British economy through new infrastructure, which may have a higher multiplier effect.  A recent OBR paper on the benefits of public investment to UK economic output suggests that a one per cent of GDP increase in public investment could boost output growth by just under half a per cent after five years, and around 2.5 per cent in the long run (50 years).^[8]

Indeed, Labour has called for more public investment as a way of crowding in and increasing business investment.^[9] This reflects a growing consensus of the value of public investment as a lever for growth, but as recent research from IPPR has found,^[10] Labour’s manifesto pledges amounted to an overall reduction in public investment, as commitments in their Green Prosperity Plan are not enough to offset their planned cuts elsewhere. A more ambitious plan for public investment should certainly be part of Labour’s economic plans to grow the productive capacity and resilience of the economy as well as crowd in business investment from the private sector, but even if Labour was to significantly increase public investment, this would run into the issue of corporate governance: greater public investment cannot change the fundamental problem of shareholder primacy and the prioritisation of wealth extraction over productive investment. In other words, a more buoyant economy might increase corporate earnings, but would likely result in higher shareholder payments rather than a step-change in business investment.

While using the tax system or public investment might be incomplete or inefficient levers to change corporate behaviour, there is a strong base of evidence for the effect of corporate governance on business investment as a key missing piece of the puzzle to get Britain investing again. Specifically, we consider below the evidence that changes to increase participation in corporate governance as well as to make long-term purpose the focus of decision-making can affect business investment.

[.green]3[.green] Broader Participation

The UK is one of the lowest-ranked countries in Europe on the European Participation Index, a measure of the degree of democracy at work — including rights to participate in decision-making at board level.

[.fig]Figure 5: The UK Is One of the Worst Performers on the European Participation Index[.fig]

[.notes]European Participation Index.[.notes]

When it comes to decisions around investment, the evidence suggests that workers are stakeholders with a longer-term view of the company than shareholders. The latter typically have more diversified holdings, so are less dependent on the performance of a single company, whereas for workers their livelihoods are often entirely dependent on their employers. In Germany, where companies with over 2,000 employees outside the coal, iron and steel industries must have worker representation on supervisory boards, analysis has shown that levels of investment are higher in firms with co-determined governance.^[11]

Meanwhile, as shown in Figures 6 and 7, Common Wealth analysis has found that higher scores on the European Participation Index are correlated with higher levels of R&D investment and higher productivity overall.^[12]

[.fig]Figure 6: European Economies with Low Economic Participation Have Low Productivity Rates[.fig]

[.notes]Source: OECD. Note: Malta and Cyprus have been excluded due to lack of data.[.notes]

[.fig]Figure 7: Business Expenditure on R&D as a Percentage of GDP Is Correlated with Economic Participation across Europe[.fig]

[.notes]Source: OECD. Note: Bulgaria, Cyprus, Croatia, Malta and Romania have been excluded due to lack of data.[.notes]

The case for greater worker representation in company decision-making is strong on democratic grounds: employees should be empowered to have a say in decisions that affect them. But the evidence also suggests that it would have positive effects on business investment — likely because workers are long-term stakeholders in the company, and as such their interests are better aligned with productive investment that yields benefits over time rather than the distribution of cashflow to shareholders today.

[.green]4[.green] Long-term Purpose

There is also good evidence that purpose-led businesses — defined as those that give social and environmental commitments as great or greater value than profit maximisation in their governance — perform better on a range of indicators. Research from Demos found that purpose-led businesses were more likely have better decision-making, higher levels of employee satisfaction and greater value creation, leading to positive effects on investment and productivity.^[13]

[.fig]Table 1: Characteristics of Purpose Led Business in the Economy[.fig]

[.notes]Source: Demos.[.notes]

Demos analysed the effect on the UK economy if purpose-led businesses were the default form of business and found that this would lead to higher levels of capital investment, higher levels of spending on R&D, more people paid a living wage and overall higher levels of economic growth. Altogether, this would amount to a £149 billion per year boost to GDP and an increase of four percentage points in the UK’s investment to GDP ratio, bringing it into line with other large economies in the G7.

[.fig]Figure 8: Increase in Investment as a Percentage of GDP for UK Compared to Other G7 Countries[.fig]

[.notes]Source: World Bank and Demos analysis.[.notes]

Moreover, research by Social Enterprise UK found that social enterprises were more likely than other forms of business to invest in the UK economy.^[14] If the proportion of social enterprises and cooperatives in the UK economy were to increase from three per cent of GDP to twelve per cent of GDP (on par with countries such as France, Germany, Italy and Spain), business investment would increase by around £14 billion per year.

[.green]5[.green] Recommendations

The UK cannot afford to keep doing business as usual. Fixing the country’s economic malaise will require raising business investment, but the current corporate governance rules cut against Labour’s other planned reforms. If Labour leaves these rules in place, their ambition for boosting investment through a “strategic” partnership state coupled with changes to the planning system and the labour market will be weakened from the start.

The alternative is clear: a more participatory and purpose-led form of corporate governance can reverse the trend of ever-greater extraction of wealth from businesses to distribute to shareholders, raising investment and bringing greater democracy to one of our central economic institutions.  

The coalition of support for reform is broad, spanning progressive business, civil society and trade unions. Some of the core demands of this coalition include:

[.num-list][.num-list-num]1[.num-list-num][.num-list-text]Make purpose-led businesses the legal default in the UK through a reform to directors’ duties to articulate a new purpose for the company, as called for by the Better Business Act, a campaign for corporate governance reform with close to 3,000 businesses as part of its coalition.^[15] This reform would ensure decisions are made with multiple stakeholders in mind, promoting a more long-termist and less narrowly extractive outlook.[.num-list-text][.num-list]

[.num-list][.num-list-num]2[.num-list-num][.num-list-text]Commit to worker representation on company boards, as called for by the TUC.^[16][.num-list-text][.num-list]

[.num-list][.num-list-num]3[.num-list-num][.num-list-text]Expand company membership to allow employees to vote at Annual General Meetings to ensure both labour and capital investors in the corporation are represented.[.num-list-text][.num-list]

Making changes to the structure of business is clearly possible: every previous Labour government from Attlee to Blair has reformed company law.^[17] With the Companies Act turning twenty in 2026, the time is ripe for a new approach. Labour can draw inspiration from the purpose-led businesses already existing in the UK, which adopt a mission broader than returns to shareholders; as well as from abroad, given the UK is an outlier compared with countries in Europe in terms of levels of worker representation in company decision-making.^[18]

^‍Keir Starmer’s new government has made achieving higher growth its core mission. There Is no silver bullet for this, but changes to corporate governance must be part of the toolkit. This means taking up the Labour tradition of company reform, reorienting the corporation away from extraction and exclusion and towards participation and investment.