Making the 
City work 



Fabian Tract 528 

Making the City work 

Introduction 1 

1. Why financial markets are useful 3 
2. Is the City too international? 9 
3. Does the City starve industry of finance? 13 
4. Short-termism 17 
5. The example of Japan 23 
6. Takeovers 25 
7. Some alternatives 29 
David Goodhart is a Bonn Correspondent of the Financial Times. 

Charles Grant was Assistant Editor of Euromoney and currently writes on the City 
for the Economist . 

This pamphlet like all publications of the Fabian Society represents not the collective 
view of the Society but only the views of the individuals who prepared it. The 
responsibility of the Society is limited to approving the publications it issues as 
worthy for consideration within the labour movement. ·er I( 

Ot:<. -'" -<;i'

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Cover design: Brian Nugent 

July 1988 \.-\ Ct 

1ft~':\~

ISBN 0 7163 0528 3 

&v;; 0 ~ 

ISSN 0307 7523 

Printed by The College Hill Press Limited (TU), London & Worthing 
Published by the Fabian Society, 11 Dartmouth Street, London SW1H 9BN 



Introduction 


In the late 1980s, the once arcane business ofthe City ofLondon 
has swept into the public domain. First, Big Bang in October 
1986 blew away the restrictive practices of the London Stock 
Exchange. Then spiralling City salaries, a wave of giant 
takeovers and complaints from British industry about 'shorttermism' 
turned the spotlight on one square mile of central 
London. The scandals ofGuinness and insider trading drew the 
workings of financial markets from their ghettoes on the City 
pages into the news headlines. Even the Sun responded to the 
surge in private share ownership by creating a City section. 
The stockmarket crash in October 1987 failed to still popular 
interest in the City. 

These new editorial priorities cannot be 
dismissed as propaganda for the Casino 
Society, since they also reflect the growing 
importance of the financial services 
industry. The City houses a host of 
markets and institutions. Some are 
familiar and domestic: the insurance 
industry and the clearing banks. Some 
are little known and international: the 
Euromarkets, the futures markets and 
the currency markets. Others have been 
trying to transform themselves from 
sleepy cartels into modem international 
markets: the stockmarket and the commodity 
markets. The City's many markets 
not only influence the rest of the 
economy, they also constitute an important 
industry in their own right. 

Britain has possessed a sophisticatedfinancial industry for hundreds of years. 
But over the last 15 years, financial services 
has become Britain's fastest 
growing industry, employing about 
800,000 people and earning £9 billion a 
year for the overseas current account. 
When the common market in financial 
services is ushered in by the European 
Community in 1992, further growth can 
be expected as British firms exploit their 
competitive advantages.

Yet despite this apparent success 
story, people &utside the City-many of 
them not on the left-frequently criticise 
its role in the British economy. Most 
of these critics accept the need for 

properly-regulated markets in other 
industries, yet eagerly join in ritual 
denunciations of wheeler-dealing City 
gents and sometimes threaten crude 
interventionism. However, the nationalisation 
of the banks or the closure of the 
Euromarkets would entail heavypolitical and economic costs without 
resolving the real problems of the financial 
system. 

Often these criticisms are based more 
on prejudice than fact. For example, investment 
in the British stockmarket is 
supposed not to benefit industry, while 
investment in overseas stockmarkets is 
seen as direct support for our industrial 
competitors. And the accusation that 
the City conspires to promote high interest 
rates and a strong pound, at the 
expense of industry, no longer stands 
up. Nor can the argument that the Cityfails to provide enough capital to industry 
be sustained. 

However, there are causes for great 
concern about the City, its relationship 
with the economy, and its role in 
Britain's political agenda. This pamphlet 
touches on some of them. 

Public interest 

The City's investment institutions 
should come under closer scrutiny not 
only because of their influence on 

------------------------Fabian Tract 528 • 1 


industry, but also because they control 
the public's savings. Many politicians 
still view capital and labou!' as 
diametrically opposed forces. But these 
two categories now often converge on 
the same individuals, thanks to the 
growth of collective savings vehicles 
which now own three quarters of 
British shares. Most of the money tied 
up in pension funds and insurance companies 
is the savings of lower and 
middle-income groups. The ownership 
of the means of production has never 
been more widely spread over the population, 
yet control has become narrowly 
concentrated in institutional hands. 

Parts of the British financial system 
have long been bloated. The invasion of 
foreign firms around the time of Big 
Bang provided an extra bubble of 
wealth, which the crash popped. A 
more fundamental and permanent 
cause of the City's wealth has been the 
systematic over-pricing, over decades, of 
many financial products aimed at consumers 
and companies. The City's own 
beloved market theories should be 
turned against it to root out the waste. 
The competition-enhancing reforms of 
Big Bang should be extended into the 
remaining cartelised corners of the old 
City, such as the fixed fees for merchant 
banks underwriting new share issues. 

To keep themselves in work, swarms 
of money managers, brokers, analysts 
and traders juggle and rejuggle the portfolios 
of pension funds, insurance companies 
and unit·trusts. This 'churning' 
is wasteful, since most money managers 
underperform the market and they pass 
on their dealing costs, ultimately, to 
savers. Churning also makes the markets 
more volatile, and it can discourage 
institutions from making a long-term 
commitment to companies.

One reason the City has grown so fat 
is that financial services are notoriously 
difficult to value. Just as ordinary individuals 
have been easily bamboozled 
into buying expensive life assurance 
policies without noticing the large commissions 
they have to pay, so-even 
after Big Bang-finance directors continue 
to pay too much, for example for 

takeover advice or for products 
designed to reduce risk such as futures 
and options. The answer is more. competition 
coupled with better regulation; 
they are not mutually exclusive. 

· Financial consumerism is not of interest 
only to the rich. Many financially inexperienced 
people from middle and 
lower-income groups are receiving comparatively 
large sums to invest, from 
redundancy packages, maturing life 
insurance policies or the sale of 
inherited parents' homes. Their interest 
in new ways of saving extends beyond 
collective vehicles-to shares (aboutnine million people own them), to portable 
pensions, and to a variety of 
interest-bearing bank accounts. They 
must be protected from the countless 
abuses of consumer finance-from the 
overpricing of unit trusts, to the murkyand secretive charges levied by· the high 
street banks, to the scandalous rates of 
interest charged by credit card 
companies. 

Political debate 

Over the past few years, as competitive 
international markets have become its 
driving force, the City has shed much of 
its school-tie clubbiness. Once, peer-
pressure made financiers play the game. 
Now, in much larger, impersonal firms 
where people do not know each other, 
the new regulatory framework established 
by the Financial Services Act is 
supposed to impose discipline. The important 
debate about the changing 
nature of the financial industry and its 
regulation has been subject to little 
discussion outside the City. Yet given the 
importance of investment to the 
economy, not to mention the huge 
expansion of personal savings, developments 
in the City should not be left to 
insiders. 

Much dislike of the City stems from an 
excessive respect for the supposedly uncontrollable 
power of financial markets. 
The trends to deregulation and internationalisation 
have certainly weakened 
the ability of any government to 

2 • Fabian Tract 528 -------------------------



resist this power. But one which 
understands financial markets, does not 
preach inflationary policies and is 
prepared to stick to its guns need not 
be mesmerised-as the Chancellor of 
the Exchequer, Nigel Lawson, has 
shown. The problem for a Labour 
government is that if it tried to stand up 
to markets or to confront City opinion, 
its credibility would be weakened by a 
dearth of serious policy.

What isneeded are practical proposals 
to reform the City's many short


comings. But critics must stop tilting at 
a largely imaginary City and accept its 
economic importance. The Labour Party 
could establish a credibility-enhancing 
role for itself as a well-informed watchdog 
for this vital industry. Its failure to 
take many of these issues seriously,· 
while millions of voters have been 
expressing more than a passing interest 
in financial markets, has contributed to 
the overall feeling that Labour is out of 
touch. 

1. Why financial markets are 
useful 
Many believe the City wicked and parasitical: wealth created 
through finance is supposed not to be real wealth. The truth, 
however, is that a pound earned through selling someone a 
service such as an insurance policy isjust as real as one earned 
by selling that person a car. A successful economy needs banks 
to finance investment and institutions to manage savings just 
as much as it needs, say, hairdressers and telephone sterilisers. 

Capital markets serve a number of 
useful purposes. They widen choice for 
people wishing to save, by allowing 
them to diversify and to switch their 
investments. They provide companies 
with cheaper sources of finance than 
bank loans. Even new markets such as 
futures and options can be beneficial, 
provided they are properly understood 
and controlled: they enable companies 
and investors to insure themelves 
against foreign exchange, interest rate 
and stockmarket volatility. 

Stockmarkets provide a means of 
evaluating the worth-and the 
performance-of companies. There is 
probably no better means-the October 
1987 crash and crazy lurches in the 
market notwithstanding. For the priceof one company relative to another is a 

good indicator of its performance, 
whatever the absolute level of the 
stockmarket. A falling share price 
relative to the rest of the market is 
usually an indication that something is 
wrong and that managers should perform 
better. 

In Britain and America, a weak share 
price may trigger a takeover. In Japan 
and Continental Europe (of which more 
later), the stockmarket plays a smaller 
role and the banks a larger role in 
checking management performance.
Nevertheless in these countries too, the 
stockmarket remains a means of 
evaluating the relative success of companies. 
In communist states, bureaucrats 
fulfill this checking function. They 
are less well placed than stockmarkets 
to do so. For share prices effectively 

-------------------------Fabian Tract 528 • 3 


gather, process and reflect much more 
information relevant to a company's 
prospects than a group of bureaucrats 
can ever hope to do. 

Stockmflrkets can often provide a 
good-though not an infallible-means 
of allocating capital. 

New capital comes either in the form 
of debt (bank loans or bonds), on which 
the borrower pays a rate of interest, and 
which must be repaid after a certain 
number of years; or in the form of 
equity (shares). An investor with equity 
in a company has a share in its ownership; 
receiving dividends but never 
being paid back. 

Companies can tap stockmarkets by 
selling shares either when they float 
themselves on an exchange (a new 
issue), or when they return to the 
market at a later stage for more capital 
(a rights issue). In 1987 companies 
raised £14.5 billion on the London stock 
exchange. Institutions put money into 
companies whose relatively high share 
price reflects the collective wisdom of 
the market that that company is likely 
to prosper. Unimpressive companies 
find it hard or impossible to issue shares 
on the stockmarket. 

A big problem with stockmarkets is 
that share prices can be subject to fads 
and fashions. But short-term fluctuations 
do not affect most of us. The pension 
funds and insurance companies 
which invest some of our savings in 
shares are not seriously harmed by the 
stockmarket yoyoing. What matters for 
the value of our savings is how the 
market moves over decades. Over that 
timespan, today's 5 per cent rise and 
yesterday's 5 per cent fall are irrelevant. 
In the long term, fundamental values 
assert themselves over speculativebubbles. 

The crash of October 1987 was a correction 
to a speculative over-valuation 
of the market. We should not be over-
concerned about stockmarket crashes. 
In neither Britain nor America has the 
October crash made a significant impact 
on the real economy. 

Nevertheless, price gyrations may 

harm the small investor and damage 

business confidence. The Government 
could consider using a state body to 
intervene on the stockmarket to smooth 
out some speculative excesses. The 
Bank of England already does that on 
the foreign exchange markets, and 
effectively underpinned the whole 
equity market after the October crash, 
when it guaranteed that it would buyshares from the BP privatisation issue 
at a set price. In Japan, the Ministry of 
Finance asks the big four securities 
houses to intervene when it wants to 
brake a fall. In France, the Caisse des 
Depots (a state-owned bank and 
manager of government funds) has at 
times supported the stockmarket. The 
British Government does not possess the 
resources to stop the market falling if 
fundamentals are pushing it down; but 
there might be occasions when it would 
want to iron out fluctuations and give 
the speculators a bloody nose. 

Efficient markets 

The economist Burton Malkiel recentlyreviewed the huge body of academic 
literature on whether stockmarkets are 
efficient-ie, whether prices accurately 
reflect all available information. He concluded: 
"Pricing irregularities may well 
exist and even persist for periods of 
time, and markets can at times be 
dominated by fads and fashions. Eventually, 
however, any excesses in market 
valuations will be corrected". 

This 'efficient market theory' predicts 
not only that stockmarkets are efficient, 
but also that they follow a 'random 
walk' pattern. That is, no individual can 
ever succeed in predicting the way the 
market is going to move, because that 
will depend on information that has not 
yet become available. As soon as fresh 
information appears, the market 
instantly takes it into account, and 
prices adjust accordingly. Given that one 
individual can never know as much 
about a company as the combined 
knowledge of everyone else in the 
market, he or she will only be able to 
out-guess the market with the benefit 

4 • Fabian Tract 528 -------------------------



of inside information. 

Researchers have found various 
exceptions to efficient market theory, 
which show that stockmarket prices are 
sometimes driven more by speculationand psychology than rational expectations. 
But assuming that in the long 
term, markets are normally efficient, 
this theory implies that some sectors of 
the City are less than useful. Efficient 
market theory implies that a chimpanzee 
throwing darts is as likely to pick a 
winning stock as a highly-paid analyst 
or fund manager. An analyst may 
believe his knowledge of a companyallows him to see that it is undervalued; 
but provided that knowledge is based 
on publicly-available information, someone 
else will have spotted the anomaly 
too; the prices will have already 
moved up before the analyst makes his 
recommendation. 

Broad support for this theory comes 
from the statistics that show that in 
America and in Britain, about 80 per 
cent'of fund managers perform worse 
than the market average. One might 
expect at least 50 per cent of them to 
provide advice that beats the market. 
But fund managers do not, because of 
the expenses they incur buying and selling 
shares and the fees they charge their 
clients. 

And consider the performance of 
British money-managers in 1987. In the 
first half, most funds got out of gilts and 
property, which turned out to be the 
year's best performers. In the summer 
they stampeded into equities, so that by 
October, the average pension fund had 
85 per cent of its money in equities. 
And all the year they cut back their 
exposure to Japan, although it turned 
out to be the best performing of the 
major markets. The performance 
measurement services have worked out 

that if the funds had stuck with the 
assets they had at the start of the year,
they would have made a return of 7 per 
cent. But the median actual return was 
between 2 and 3 per cent. 

So most pension funds would do no 
worse by employing a chimpanzee. It is 
not surprising that the fastest-growing 

sort of fund management now is 'indexation', 
which involves investing in all the 
leading stocks and then sitting tight". 
Indexation guarantees that a portfolio 
will perform no worse than the market 
overall. In America, more than 10 per 
cent of total pension fund assets of $1.7 
trillion is already index-linked (ie, tracks 
the stockmarket indices). 

Thus much of the analyst and fund 
management industry could be regarded 
as superfluous. But people who lack 
financial expertise do need advice on 
the risks involved in different sorts of 
investment. Furthermore, a few brilliant 
company analysts and money managers 
do out-perform the market, because 
they think of original ideas. And 
even if one individual can seldom 
get ahead of the market, the system as 
a whole needs analysts. It is only 
because analysts and fund managers 
compete to spot price anomalies ahead 
of their peers that stockmarkets are 
usually quite efficient. However, many 
of the City's less-respected analysts 
could be thinned out without impairing 
market efficiency-and the need to trim 
costs has already forced many stockbrokers 
to do this. 

Many market-makers can also be 
regarded as parasites. They are traders 
who hold books of securities and deal 
with~make markets to!._other market-
makers or the public. A salesman or 
trader who sells a bond to an insurance 
company is adding value, and providing 
a service that the investor requires. But 
if traders Shuffle bonds or shares 
amongst themselves, no wealth is 
created, and the traders become a cost 
to the community. 

But for financial markets to work 
efficiently, some market-makers are 
needed. They provide liquidity, which 
means that they enable other people to 
sell their securities. Liquid markets 
allow a company to grow through retained 
earnings without its shareholders 
clamouring to get their money back 
directly from the company-therebythreatening to brake its growth. 
Liquidity generally makes prices more 
efficient, and it encourages small in


-------------------------Fabian Tract 528 • 5 


vestors to participate, since they will be 
confident of not getting stuck with 
what they buy. Liquid markets cheapen 
the cost of capital, since investors are 
prepared to accept a lower return in 
exchange for liquidity. But an excess of 
market-making firms is more of a 
burden than a benefit. After Big Bang 
about 25 firms made markets in ICI 
stock. The price would have been just 
as efficient with half that number. 

International markets 

Some view the international side of the 
City as parasitical. For example, John 
Plender wrote in the Financial Times 
on 15 June 1987: "[The City] is growing 
faster than most [industries] 
because it thrives on many of the instabilities 
that are contributing to low 
growth in the world economy. The City 
is taking a percentage of the huge 
capital flows that stem from trade imbalances 
and from financial volatility. It 
is thriving much as a drug companythrives in an epidemic". 

This is true for the foreign currency 
markets. If the world could agree on a 
stable exchange-rate system, many currency 
dealers would be laid off, and 
companies would not have to spend so 
much on currency futures and options. 
But most City activity is not dependent 
on the speculative short-term flows that 
we would all be better off without. The 
City fulfills a need in the world economy 
as a place where providers of capital can 
be brought together with its users, 
where companies can rely on finding a 
pool of financial expertise, and where 
markets that have been driven out of 
other centres by an excess of regulation 
can flourish. 

Over the last 25 years, the Euro-
markets have provided the City with its 
fastest-growing, most efficient and 
generally most honest sector. They are 
called Euromarkets because they are 
based on Eurocurrencies (a Euro-
currency is any money held outside its 
home market-a dollar in a London 
bank account is a Eurodollar). These 

markets grew up in London because it 
was free of the taxes and regulations 
which smothered them elsewhere. For 
example a Swiss tax on securities 
trading pushed Eurobonds to London, 
while America's reserve requirements 
made it cheaper for American banks to 
make their international loans in London 
than New York. 

Britain's new regime of financial 
regulation is stricter than anything in 
force anywhere else in Europe. But now 
that these international businesses have 
come to Britain, they are unlikely to be 
pushed out by the new regulation, since 
the City's concentration of financial 
talent isa powerful magnet. Most of the 
people who work in these international 
markets are not parasites. Eurobond 
salesmen, international merger experts, 
managers of funds for foreign clients 
and arrangers of export finance for less 
developed countries all thrive in the 
City-and by charging fees to foreigners 
contribute to Britain's invisible exports. 

Nor can the City's domestic side be 
branded as mainly parasitical: insurance 
brokers, managers of unit trusts, venture 
capitalists, building society clerks, 
computer operators of systems for settling 
share transactions, and bankers 
who vet loan applications are not 'thriving 
on an epidemic'. They are providing 
services which are essential in anymodern economy. 

The City's contribution to 
the economy 

Over the past 15 years, the biggest contributors 
to economic growth in Britain 
have been oil and finance. But while oil 
has had little impact on employment,
financial and business services have 
provided the largest source of new jobs. 
Despite the crash of 1987, finance's contribution 
to the economy is unlikely to 
wane. For in the long run, as more of the 
world economy becomes developed, the 
demand for international financial services 
based in London-such as insurance, 
money management and borrowing 
through loans and bond issues-is 

6 • Fabian Tract 528 -------------------------



likely to increase. 

In 1976, banking, finance, insurance, 
business serv1ces and leasing togetheraccounted for 10.7 per cent of GDP. 
Manufacturing then accounted for 29.6 
per cent. By 1986, output of the financial 
sector had grown to 15.8 per cent 
of total GDP. Over the same period, 
manufacturing slumped to 24.3 per 
cent. 

The employment figures tell the same 
story. According to the EmploymentGazette, jobs in 'banking, finance and insurance' 
grew from 1.7 million in June 
1981 to 2.3 million in June 1987 (compared 
to 5.1 million people then working 
in manufacturing). But the Gazette 
sneakily dresses up the figures to 
exaggerate the importance of finance. 
For further on, it provides a breakdown 
of the sector 'banking, finance and 
insurance'. That sector in December 
1986-then totalling 2.16 million-turns 
out to consist of banking and finance, 
527,000; insurance, 229,000; property, 
225,000; and 'business services', 
1,185,000. 

'Business services' appears to be a 
dustbin into which the statisticians have 
thrown anything that does not fit easily 
into another pigeon hole. They include 
public relations, auctioneers, the law, 
accountants, architects, computer services, 
market research, advertising, 
office design, surveyors and employment 
agencies; and dozens of other 
obscure categories which have little to 
do with finance, such as telephone 

sterilisers, non-medical bacteriologists, 
inventors and private detectives. So a 
better employment figure for financial 
services, ie, people who really work in 
banking, finance and insurance, would 
be about 760,000. 

The financial boom's indirect impact 
on jobs has been considerable. Th mentionjust 
some industries beginning with 

C: construction, computing, consultancies, 
car firms, carpet-makers and 
clothing factories have all gained. 
Although the boom has exacerbated disparities 
in regional growth rates, not 
only London and the South East have 
gained. There are plenty of insurance 
brokers, unit trust salesmen, bank clerks 
and building society cashiers in the rest 
of Britain. Money management is Edinburgh's 
fastest growing industry, 
employing 12,000 directly. The official 
figures do not provide a regional breakdown 
on a more detailed basis than 
'banking, finance and insurance'. But of 
that broad and rather misleading category, 
London and the South East 
employed 1,083,000 in December 1986, 
and the rest of the country-by a 
statistical fluke-1,083,000. 

The financial sector's contribution to 
the balance of payments is becoming 
indispensable. In 1986, Britain's deficit 
on visible trade grew to £8.5 billion. Fortunate, 
then, that financial services 
earned a net surplus of £9.4 billion. Net 
earnings from Britain's insurance industry 
grew from £810 million in 1976 to 
£4.28 billion in 1986. Banking provides 

Table 1 
City of London's foreign earnings, 1965-1986 (£ millions) 

1965 1968 1976 1979 1985 1986 

Insurance 81 198 810 1,074 2,909 4,260 
Banking (net) 
Commodity trading 
Brokerage 
Investment trusts 
82 
80-90 
30-35 
67 
57 
55 
35 
118 
309 
215 
47 
-96 
284 
331 
58 
1,311 
611 
547 
183 
2,296 
572 
645 
188 
Pension funds 5 14 46 587 638 
Unit trusts 2 11 23 113 175 
Leasing 
Securities dealers 
4 66 
318 
50 
552 

TOTAL 250-290 419 1,524 1,724 6,645 9,375 

Source: Central Statistical Office 

--------------------------Fabian Tract 528 • 7 


the next biggest slice of overseas earnings: 
its net contribution rose from £118 
million to £2.3 billion in 1986. Thble 1 
reproduces the 'City' table front the 
Government's Pink Book (which contains 
the official figures on earnings 
from invisible exports). 

This table amalgamates two groupings 
of balance of payments statistics in the 
Pink Book: 

• 
financial services -fee income 
earned from foreigners by British 
banks (including foreign banks in Britain), 
commodity brokers, stockbrokers, 
insurance underwriters, etc. 

• 
interests, profits and dividends (IPD) 
-the earnings on Britain's overseas· 
assets (such as interest paid to British 
banks and earnings from investments 
overseas) minus the outflows on its 
overseas liabilities (such as interest 
and dividend paid from Britain to 
other countries). 
These two components of the City's 
invisible earnings have grown at similar 
rates. The biggest factor behind the 
surge in IPD has been the huge outflow 
of portfolio investment since Mrs 
Thatcher withdrew foreign exchangecontrols in 1979. From 1979 to 1986, 
gross overseas portfolio investment 
went up from £12.3 billion to £145.7 
billion (while gross foreign portfolio 
investment in Britain grew from £10.4 
billion to £42.9 billion). That outflow 
boosted gross portfolio income from 
£540 million in 1979 to £5.7 billion in 
1986. 

Large chunks of the City's overseas 
earnings such as those from the Euro-
bond Markets go unrecorded. The City's 
invisible earnings are probably several 
billion pounds higher than the Pink 
Book suggests. 

Brain drain 

The financial sector has grown so fast, 
particularly in the securities markets, 
that City firms have suffered from 
shortages of skilled labour. The result 
has been spiralling wages and a brain 

drain on the rest of the economy. Ten 
years ago, the brightest graduates went 
into the civil service and the media. 
Today they choose investment banking 
and management consultancy. So it is 
not surprising that throughout the 
1980s, complaints have grown that the 
City siphons off a disproportionate 
share of human resources. 

But does the brain drain matter? For 
if financial services create wealth, 
surely Britain needs its cleverest people 
to work in finance and keep it ahead of 
the rest of the world. It does matter, 
because banking already has more than 
enough good people to stay competitive, 
while manufacturing industry suffers 
from a lack of talent. 

Surprisingly, even some of the free 
market enthusiasts of the London 
Business School have expressed alarm 
that about 60 per cent of their.students 
go into finance and management consultancy, 
and only 40 per cent into 
manufacturing.

That is unremarkable, given that 
manufacturing seems to be unable to 
match finance in offering high salaries 
or great responsibility at an early stage.
Some American investment banks have 
paid £25,000 starting salaries to 
graduates, because while markets were 
growing rapidly, they were held back by 
shortages of good people. 

There is little that a government can 
do to correct this imbalance in a free 
economy-except wait for the inevitable 
correction. Market forces are already 
cooling the sizzling salaries, particularly 
in the bond and share markets which 
had paid the most. Turnover has fallen 
since mid-1987, forcing firms to trim 
costs by cutting recruitment and pay. 
Wages will not fall far, however, in the 
many areas of finance that are international. 
This is because New York firms 
pay the most, so that if a London firm 
pays its bond traders less than the going 
rate, they are liable to cross the Atlantic. 
But recruitment has fallen sharplyand will fall further. More graduates will 
have to go and make things; the fewer 
who go into the City will still be paid a 
lot. 

8 • Fabian Tract 528 -------------------------



2. Is the City too international? 
One of the most powerful myths about the City is that its 
international bias damages the real economy. Each post-war 
generation chooses its own version. In the fifties and sixties, 
the City was accused of keeping sterling artificially high, at 
the expense of the competitiveness of British industry. In the 
sixties and seventies, it was said, the foreign exchange markets 
unpatriotically speculated against the Labour Government, 
landing us with sterling crisis after sterling crisis. And during 
the Thatcher era, the big investment institutions have 
channelled capital overseas which should have gone into British 
industry. 

The first version of this critique was 
true. Until the mid-1970s, the City 
wanted a high exchange rate for sterling. 
The Bank of England's lobbying for 
a strong pound contributed to Harold 
Wilson's reluctance to devalue before 
1967. British banks opposed devaluation 
partly because they feared it would provoke 
an outflow of 'sterling balances' 
(money that foreign governments had 
deposited in London). British banks profited 
from this business and knew that 
a weak currency would push foreign 
governments to withdraw their money 
or switch out of sterling. Many of the 
runs on the pound in the 1960s and 
1970s were aggravated by this money 
leaving the country.

These sterling balances are no longersignificant. Sterling has mercifully 
ceased to be a leading reserve currency. 
Now it is short-term speculators-
including the world's largest banks-
who drive currency crises. 

The City no longer has a strong rationale 
for preferring a high pound. 
Most of its foreign business is priced in 
dollars not sterling. If Lloyd's insures an 
aeroplane belonging to Pan-Am, the 
airline will pay its premium in dollars. 
About three-quarters of Lloyd's income 
is in dollars. The underwriting fees and 
trading spreads which clients pay to 
Eurobond firms are mainly in dollars. 

Foreign institutions which ask London 
firms to manage their money seldom 
pay the management fee in pounds. 
Thus a weak pound has little effect on 
the City's international business. 

A cousin of the high-sterling critique 
of the City is the high-interest rate 
bogey. The City's supposed lust for a 
vigorous pound is one reason given for 
its supposed enthusiasm for high interest 
rates. This rang truer in the past than 
today. The banks used to do particularly 
well out of high interest rates, since they 
paid nothing on current account 
deposits from the public. Thus if the 
rates they charged their customers rose, 
the banks' profitable 'spread!.._the gap 
between the cost of funds and the rate 
of interest received-grew larger. 

But over the past 20 years, the proportion 
of banks' funds on which they have 
paid nothing has shrunk. Banks have 
borrowed larger quantities of money in 
the wholesale money markets-where 
they must pay interest-than from the 
public. Furthermore, competition from 
the building societies and foreign banks 
has forced them to pay the public interest 
on some sorts of deposit. So high 
interest rates have ceased to be a free 
lunch for the banks. 

Other groups in the City-particularlyfirms trading bonds and shares 
-prefer falling -interest rates. Take an 

------------------------Fabian Tract 528 • 9 


investment bank holding a large trading 
position of Eurobonds, which pay a 
fixed rate of interest of say 10 per cent. 
If interest rates decline, the value of 
these bonds will rise. More indirectly, 
equity markets also gain from falling 
and low interest rates: lower rates imply 
higher company profits, bigger dividends 
and better economic growth. So 
share prices rise. 

Investment banks did very well from 
falling interest rates during the period 
1982 to 1987. Those were the years 
when the world's bond and share 
markets ef\ioyed an almost uninterrupted 
rise in value. The underlying 
cause of this 'bull' phase was the taming 
of inflation, which had two results. 
First, people wanted to put their wealth 
into financial assets such as bonds and 
shares, rather than into, say, property 
and gold, since securities are a good 
investment when inflation looks too low 
to erode their yield. 

Second, lower inflation dragged down 
interest rates. Because people with 
money to lend believed inflation was 
beaten, they were prepared to lend at 
lower rates of interest than they would 
have earlier. The continuous fall in 
interest rates-American long-term 
bond yields fell from 15 per cent in 1982 
to 7 per cent in 1987-helped propel 
stock and bond prices upwards. The rising 
value of bonds and shares fuelled 
the profits of securities firms. Even the 
dimmest of traders can make money in 
a bull market, simply by holding on to 
securities. Surging profits allowed 
salaries of over $100,000 to become 
commonplace in London and New York. 

Thus investment banks dislike increasing 
interest rates, and their influence 
in the modern City is certainly 
no weaker than the clearing banks. 
However, the City does retain a bias 
against inflation. If it believed that 
government policies were inflationary, 
it would favour a tightening of short-
term interest rates, as a means of reining 
in the money supply. Investors 
would demand higher bond yields at the 
long end to compensate them for inflation 
eroding the value of their invest


ment. And the City would oppose a 
steep slide in sterling since that would 
fuel inflation. But provided that inflation 
is not a worry, the City as a whole 
has no particular preference for high 
interest rates. 

Unpatriotic markets 

The foreign currency markets have 
attracted considerable odium since the 
world's system of fixed exchange rates 
fell apart in the early 1970s. A free 
market in currencies appears to deprive 
sovereign governments of the power to 
manage their economies in the way they 
want: if a British government tried to 
reflate, speculators would sell sterling. 

There is no question that the markets 
do restrict governments' freedom. But 
it is worth remembering that markets 
will not push sterling up or down unless 
fundamentals such as the balance of 
payments or differing rates of interest 
and inflation-or expectations of 
changes in those fundamentals-are tilting 
it in that direction anyway. If the 
British government reflated, the trade 
deficit would almost certainly worsen, 
and laws of supply and demand would 
push sterling down. So the speculatorswould be quite logical to bet on a fall 
in the pound. But although speculators 
exacerbate currency crises rather than 
create them, because they follow herd 
instincts they often make currencies 
overshoot further than the fundamentals 
justify. 

One solution would be a return to old-
fashioned foreign-exchange controls. 
From 1939 to 1979, anyone wanting to 
invest overseas had to bid for a limited 
pool o,f foreign currency. The scarcity of 
the available investment currencies 
meant that their price-which fluctuated 
according to supply and demand 
-was always at a premium to the 
normal exchange rate. Thus if an insurance 
company wanted to buy American 
shares, it had to pay a 'dollar premium' 
of perhaps 20 per cent. 

The point of these exchange controls 
was to discourage investment overseas 

10 • Fabian Tract 528 ------------------------



and thereby support sterling. But the 
evolution and internationalisation of the 
world's capital markets since 1979 
means that exchange controls would 
now achieve even less than they did 
when they were in force. As Harold 
Wilson well knows, exchange controls 
failed to prevent sterling crises. 

One difficulty is practical. The force 
of 800 bureaucrats in the Bank of England 
who monitored the controls was 
disbanded in 1979. A replacement force 
could not be trained instantly. And if, 
before a general election, a government 
committed to exchange controls seemed 
possible, there would be a run on the 
pound as people tried to get their money 
out. Such a currency crisis would not 
win a party advocating exchange controls 
many votes. 

The development of new techniquessuch as swaps, futures and options 
would also make it virtually impossible 
to enforce controls. These techniques 
make it easy for the crafty to buy and 
sell currencies without anyone else 
knowing the purpose of the transaction 
and who is behind it. A return to currency 
controls would provide a boon to 
a whole industry of lawyers, accountants 
and crooks who specialise in their 
evasion. This industry is now underemployed, 
since most European countries 
have largely abandoned their controls 
over the last decade. 

Controls could stop British residents 
from selling sterling. But that is not 
enough to protect the pound in an era 
of international capital markets. 
Foreigners now hold over £50 billion 
worth of gilts (British Government 
bonds), Eurosterling bonds, British 
shares and property. Because this has 
grown so large during the 1980s, controls 
would give little succour to the 
pound if people outside Britain wanted 
to sell it. 

Could the Government ban foreignersfrom selling sterling assets held in the 
United Kingdom? 1b effectively expropriate 
foreign investors would be 
counter-productive. Foreign governments 
would probably reply by seizing 
British assets in their countries. And 

since we have more foreign assets than 
any other country bar Japan, we would 
end up net losers. As for sterling assets 
held by foreigners outside the United 
Kingdom-including thousands of sterling 
bank accounts-the British government 
is powerless to prevent their sale. 

Any attempt to ban or control the 
trading of sterling in London would 
simply push the business to rival financial 
centres like New York and Thkyo. 
And it would harm the City's standing 
as a centre for foreign banks to locate. 
Controls could also damage industry. It 
would not help the efficiency, profitability 
or ability to compete internationally 
of a firm like Pilkington, if it were 
discouraged from, say, investing in a 
new glass factory in France or buyinga specialised glass producer in America. 
Many of Britain's most successful large 
companies-for example BP, ICI and 
Glaxo-are those which have become 
truly international. 

So if exchange controls are now a 
museum piece in the armoury of 
finance ministers, what, ifanything, can 
a British government do againstgyrating currency markets? One way 
forward would be to join a fixed 
exchange-rate mechanism, such as 
the European Monetary System which 
in principle could be extended 
to cover most of the world's 
developed economies. A commitment by 
governments to exchange-rate stabilitywould weaken the power of speculators, 
lead to lower interest rates, and provideindustrialists with a stable environment 
within which they could make investment 
decisions. 

But an international system of linked 
currencies is only feasible if governments 
are prepared to co-ordinate their 
economic policies to reduce global imbalances, 
such as America's trade 
deficit. A fixed exchange rate system 
would require member countries to 
avoid macroeconomic policies markedl¥ 
different from those of other members. 

Such a system would rwt prevent a 
British government from introducingspecifically socialist economic 
policies-for example public works, a 

-------------------------Fabian Tract 528 • 11 


wealth tax, industrial investment 
and workers' control-within a givenmacroeconomic framework. 

Capital exports 

When the Conservative Government 
abolished exchange controls in 1979, 
British money surged overseas. Britain's 
net external assets grew from £12 billion 
in 1979 to £162 billion in 1986, second 
only to Japan's £179 billion. British pension 
funds increased their overseas 
assets from an average of 5 per cent to 
15 per cent of their total investments. 
Thisreflected more than a change in the 
law: North Sea oil gave Britain a current 
account surplus which had to be 
balanced by capital outflows. Many see 
this outflow as harmful and relate it to 
chronic underinvestment in British 
industry. 

This view, however, is based on a misconception 
of what happens when an 
institution such as an insurance company 
builds up a portfolio of foreignsecurities. It normally buys already 
existing bonds and shares. The consequence 
is not to create new jobs 
abroad, but merely to push up prices in 
say, the New York stockmarket or the 
Japanese government bond market 
(other things being equal, the cost of 
capital in these target markets will be 
fractionally lower than it would otherwise 
have been). 

The capital outflow does not harm 

employment at home. For if the pension 
funds were banned from investingabroad they would simply put more 
money than they already do into British 
property, shares and gilts. That would 
raise the prices of these commodities 
but not necessarily create new jobs (on~ 
ly the small-albeit growing-proportion 
of total investment that goes into new 
bond and share issues could be said to 
finance job creation). Underinvestment 
in British industry has many causes (see 
page 19)-but does not stem from a 
shortage of capital. 

Indeed, the capital outflow has probably 
helped industry, through its effect 
on the exchange rate. From 1979 to 
1981, when the high value of the pound 
damaged industry so severely (remember 
the demise of the MG car?), capital 
exports stopped it going even higher. 
But the capital outflow has since 
slowed, and been overtaken by the 
growing income on our overseas assets. 
This has nicely balanced the oil industry's 
declining contribution to the 
balance of payments. 

Thus an attempt to stop institutions 
from investing overseas would not be 
worth the effort. It would needlessly 
antagonise City opinion, when there are 
plenty of other issues (read on) on 
which it is worth picking a fight. Let 
fund managers put billions overseas; but 
chivy them to put millions into new 
enterprise in Britain. The former does 
not preclude the latter. 

12 • Fabian Tract 528 ------------------------



3. Does the City starve industry 
of finance? 
The City has been accused of failing to meet the needs of 
industry and not just by those on the left. Attention has 
focussed on the supposed reluctance of British banks-unlike 
those in France, Germany and Japan-to provide their 
industrial clients with long-term finance. 

The Wilson Committee's report on this alleged failing 
concluded in 1979 that a 'finance gap' did not exist for most 
sorts of company. Wilson found that the banks had got better 
at lending for longer periods. Since the Wilson report, the 
clearing banks have continued to improve their record on longterm 
lending, partly thanks to competition from foreign banks 
which have been eager to lend over several years. 

But the City's record of industrial financing 
still leaves much to be desired. 
There is still little lending for more than 
five or seven years, except against the 
security of property. Banks generally 
limit their relationship with companies 
to the narrow provision of money, and 
are weak on advice and helping companies 
when they fall into difficulties. 
Companies in the regions are liable to 
suffer from the increasing concentration 
of financial expertise around London. 
And many small firms still find it 
impossible to raise the money they 
need. 

Small is difficult 

Wilson's one criticism of the City was 
that it failed to provide enough money 
for small companies. This spurred the 
Conservative Government to encourage 
several new channels for small company 
finance. Sources of money now include: 

• 
the Loan Guarantee Scheme, set up 
in 1981, partly guarantees loans that 
banks would normally consider too 
risky. The LGS has proved popular, 
and allowed 16,000 small businesses 
to borrow £530 million between 1981 
and 1986; 

• 
Britain's rapidly growing venture 
capital industry. The number of independent 
funds which specialise in 
lending to start-up or young companies 
has increased tenfold since 
1979, to more than 100. The total 
pool of venture capital either invested 
or ready for investment, is about 
£4.5 billion; 
• 
the Business Expansion Scheme, set 
up in 1983, which gives taxincentives 
to individuals who invest in small 
businesses. In the four years ending 
March 1987, 883 companies raised 
£502 million by the BES; 
• 
local enterprise boards (such as the 
Greater London Enterprise Board)
which lend to small firms; and more 
than 250 local enterprise authorities 
that offer advice and put small 
companies in touch with venture 
capitalists. 
The result is that small companies are 
better off in the late 1980s than the late 
1970s. But the improvements do not gofar enough. A 1986 report by the 
National Economic Development Office 
concluded that there remained a shor


------------------------Fabian Tract 528 • 13 


tage of equity finance for start-ups, and 
for firms needing equity of £100,000 or 
less. The Unlisted Securities Market and 
the Third Market Uunior stockmarkets 
for smaller companies which want to 
avoid the extravagance and complications 
of listing on the big London stock 
exchange) generally provide sums of £1 
million or more. Venture capital funds 
typically invest sums of £150,000 to £1 
million. And although share issues 
through the BES can provide sums of 
less than £100,000, 82 per cent of BES 
money has been raised in amounts of 
over £100,000. 

Investors in Industry is one of the best 
providers of small amounts of equity. 
About 2,500 of 3i's 5,000 outstanding investments 
(both loans and equity) are 
in sums of less than £100,000. The Loan 
Guarantee Scheme also reaches the 
smaller end of the spectrum, but it cannot 
provide equity. Small firms need 
access to equity, since it is more 
flexible-dividend payment is voluntary-
and often cheaper than debt. 

Many small businessmen, particularly 
in high-technology manufacturing 
industries, find that venture capital 
companies and the BES are ill-suited to 
their needs. American venture capitalists 
have a better record on providing 
advice to the firms they invest in. 
British venture capitalists often take 
a hands-off approach. Furthermore, 
about half of British venture capitalfunds refuse to invest in start-ups, insisting 
on companies with a proven track 
record. 

The BES has encouraged investment 
in the wrong sorts of businesses. It has 
allowed investors to earn tax breaks on 
putting money into shops, restaurants 
and wine bars-and, since the 1988 
Budget, residential property. Because 
there are so many virtually riskless 
investments available, the limited pool 
of money that is attracted to the BES 
avoids apparently riskier targets such as 
manufacturing firms in the regions. In 
1985-6, only 23 per cent of BES investment 
went into manufacturing, and only 
16 per cent went into firms in the 
Midlands and the North. 

Although the BES has provided the 
first stage of equity finance for many 
companies, the smallest firms find it 
punitively expensive. Costs are fixed, so 
that a company raising £50,000 may 
have to pay the same £10,000 arrangement 
fee as a company taking £100,000. 
Whatever the type of finance, smaller 
companies suffer from fixed costs-for 
lawyers, accountants, advisers and so 
on-irrespective of the amount raised. 
A company raising venture capitalusually pays set fees of £20,000 to 
£25,000, whether the investment is for 
£100,000 or £500,000. 

There is plenty of anecdotal evidence 
that the City often fails small companies, 
particularly those in high-technology 
industries. Thke two problems of 
the mid-1980s. First, the Cambridge firm 
Camputers, which made one of the first 
and best microcomputers, the Lynx. The 
company had management problems 
and ran into difficulties when IBM 
launched its micro. In 1984 Barclays 
Bank pulled the plug and the company 
was wound up, although no one disputed 
the quality of the Lynx machine. 
Camputers' technological expertise was 
dispersed and wasted. Second, Dragon, 
which was Wales's attempt at a microcomputer 
company. Dragon was backed 
by Prutech, the venture capital arm of 
Prudential, and by the Welsh Development 
Agency. Again, the product was 
good but the management inadequate. 
Both backers pulled out and the company 
folded. 

For small firms such as these, advice 
on marketing, management systems, 
financial control and product development 
would often be more useful than 
capital. But most·British bankers lack 
sufficient experience, knowledge and 
contacts. The Department of Trade and 
Industry's proposal in 1988 to subsidise 
management consultancy for some 
small firms is a small step in the rightdirection. 

No to nationalisation 

Given some of the failings of the current 

14 • Fabian Tract 528 ------------------------



system, nationalisation of the clearing 
banks remains an appealing battle-cry. 
However, state ownership is opposed by 
the bank unions, and _it would demotivate 
many of the best senior managers. 
The recent French experience suggeststhat nationalisation can harm the longterm 
interests of banks. For example, 
Banque Paribas's strategic expansion into 
foreign markets was held up because 
civil servants took so long vetting its 
management's strategy. In terms of 
efficiency, there is little reason to 
believe that civil servants and Labour 
politicians could run the clearers better 
than their existing managements. 

As for ensuring that the banks act in 
the national interest, and that they 
follow the wishes of a democratically 
elected government, the means already 
exist. Because of the special position of 
banks in the economy, the Bank of England 
tacitly agrees to bail out any large 
bank that fails. In return, banks have to 
submit themselves to the regulation and 
the tutelage of the Bank of England. In 
the mid-1980s, the Bank twisted the 
arms of the unwilling clearers to make 
fresh loans to Third-World debtors (it 
could have told them to lend less in the 
first place, but it lacked the foresight to 
do so). And in 1987 the Bank was instrumental 
in removing the chief executive 
of Morgan Grenfell, the merchant bank 
caught up in the Guinness affair. The 
Government could use the Bank's 
regulatory powers to insist, for example, 
that all lending to an unpleasant regime 
should cease. And it retains the right 
to appoint a new Governor. 

Given the Bank of England's powers, 
there should be little cause for concern 
if some of our leading banks or merchant 
banks were to be bought byforeigners. IfLloyds Bank were owned 
by Citicorp, it would still have to behave 
as a public-spirited corporate citizen-
for example by contributing to a rescue 
package for a bank or industrial com-
pany-or its licence would not be renewed. 
British financial firms have pur


foreign firms ifLondon is to be regarded 
as an international financial centre. And 
some of the sleepier British firms could 
benefit from being bought by the 
technologically more advanced 
foreigners. 

But is not nationalisation needed to 
direct credit towards the small and high-
technology companies that do suffer 
from a finance gap? The clearers are 
quite efficient at lending short-and 
medium-term to most sizes of company. 
Given the difficulties of changing corporate 
cultures that have developed 
over decades, if the state attempted to 
convert the clearers into long-term 
banks, the prospects of success would 
be slim while much that is good could 
be damaged. Better to plug the gap with 
other institutions. 

Yes to new institutions 

To fill the holes left by existing banks 
and venture capitalists, a British Investment 
Bank is needed. In their 1987 
Fabian pamphlet (An Investment Bank 
for the UK), Charles Williams and 
Dennis Turner argued the case for a Bffi 
based on an expanded and restructured 
Investors in Industry. The advantageof building on 3i is that it already contains 
a fund of industrial expertise. And 
it has the right sort of culture: its staff 
feel that because of its stable ownership 
structure, 3i can take a more long-term 
view than most banks. 

Investors in Industry resembles the 
state investment banks that exist in 
most European countries-with a few 
exceptions. 3i is a fraction of their size, 
it makes equity investments and 
it does not make subsidised credits. 
To protect 3i 's morale and culture, its 
size and scope should be increased 
organically, and with great caution. 

British industrial firms of all sizes 
could gain from access to institutions 
such as Credit National in France, the 
State Investment Bank in Sweden and 

sued strategies of expansion through Kreditanstalt fur Wiederaufbau (KfW) 
overseas purchases, so it would be in West Germany. These long-term 
churlish to deny reciprocal rights to banks support weighty research depart


-------------------------Fabian Tract 528 • 15 


ments, and have built up industrial 
expertise which can be used to help 
client companies. They do not lend to 
lame ducks, but concentrate their 
resources on new industries. And they 
tend to lend on the basis of a company's 
cashflow. This allows the banks to take 
a long-term perspective, since they are 
not too worried about the level of debt 
so long as the interest can be serviced. 
British banks, by contrast, usually assess 
companies on an accounting basis, 
which means they work out if the 
break-up value of a company can repay 
its debt. 

A key characteristic of most national 
investment banks is their ability to provide 
subsidised credit. There is plenty 
of evidence that the cost of credit is one 
factor holding back investment. InWest 
Germany, KfW carried out a survey of 
all its clients, and discovered that only 
20 per cent of them would have carried 
out their investment in the way they did 
without KfW's subsidies on long-term, 
fixed-rate loans. 

Distorting markets through subsidies 
is not intellectually fashionable in the 
late 1980s. But the BIB should subsidise 
credits for certain industries, where it 
decides that the national interest requires 
a boosting of investment. An undistorted 
market has clearly failed to 
provide Britain with a position in vital 
and growing parts of the electronics 
industry, such as semi-conductors. The 
BES, after all, provides a state subsidy 
to rich investors in small firms; whyshould the state not indulge entrepreneurs? 
Itis essential, however, that 
lending decisions should be taken on uncompromisingly 
commercial criteria. 

A BIB should prime investment in 
Britain's regions. Most venture capitaland BES investment is targeted towards 
companies in the South East. Investors 
in Industry already has a regional network 
of 27 offices, so would be an ideal 
vehicle on which to build a BIB. 

More resources should be pumped into 
regional initiatives to regenerate industry. 
There are currently only two 
regional development agencies-for 
Scotland and Wales-and more are 
needed. They should be modelled on the 
highly successful Scottish Development 
Agency, which takes a hands-on, longterm 
view of industrial finance. 
Regional agencies should be prepared to 
participate in setting up new firms, and 

if necessary find people who have particular 
skills that a venture needs. For 
example, it cannot be assumed that a 
genius who invents surgical lasers will 
handle the firm's finances brilliantly. 

Smallish firms in the regions could use 
local bonds to raise the sort of long-term 
finance that neither local branches of 
banks, with their short-term view, nor 
the City, which is too far away, could 
provide. People from say, Manchester, 
could be clued up about a local firm and 
its prospects, and prepared to buy its 
bonds. A partial guarantee from the 
local enterprise board would give the investor 
some security (a complete 
guarantee would take away the point of 
the scheme, since the bonds would then 
be simply liabilities of the local 
authority). Such bonds would often be 
held to maturity, but could be traded 
through a local stockbroker or even 
newspaper advertisements. 

The traditional complaint about the 
City has been that it does not provide 
enough industrial finance at the right 
price. Sometimes this criticism carries 
weight. But a more fundamental and 
surreptitious failing concerns the relationship 
between the providers of 
capital-whether banks or institutional 
investors-and the managers of industry, 
after the financing commitment has 
been made. The City has infected British 
industry with its culture of shorttermism, 
and it is to this that we now 
turn. 

' 

16 • Fabian Tract 528 ------------------------



4. Short-termism 
'Short-termism' has proved the most persistent criticism ofthe 
City during the 1980s. Not only socialists and industrialists, 
but also many stockbrokers and merchant bankers have claimed 
that the City's emphasis on short-term returns has harmed 
industrial investment. The most ardent defenders ofthe status 
quo tend to be the free-market professors in the business 
schools. 

The critics claim that the City harms 
industry in two specific ways: through 
the short-term time horizons of fund 
managers; and through the stockmarket's 
inability to take a long-term 
view of company prospects. In their 
simplest forms, neither criticism stands 
up to analysis. But in more subtle ways, 
both contain elements of the truth, 
which is that City firms often Jack sufficient 
commitment to the companies 
they finance. 

The short-termist critique of the Cityhas arisen from the apparent link between 
two marked characteristics of the 
British economy. First, Britain has a 
poor record on investment, research and 
development and training. Second, 
Britain ef\ioys (or suffers from, depending 
on your perspective) a more highly 
developed capital market than anyother country bar America. Aspects of 
this 'sophistication' include: 

• 
a relatively important role for the 
stockmarket in the provision of longterm 
funds, and a small role for the 
banks; 
• 
a high concentration of share ownership 
in the hands of a small number 
of institutional investors. The people 
who manage this money are subjected 
to stringent and short-term 
performance measurements, so 
therefore tend to trade institutional 
shareholdings for a quick gain, rather 
than treat them as long-term investments;. 
• 
the absence of stable bank shareholdings 
in industry, with the consequence 
that the majority of most 
companies' shares can be traded 
freely on the stockmarket; that 
allows one company to launch a 
hostile bid for another by buying its 
shares in the market; 

• 
the existence of specialist institutions, 
known as investment banks or 
merchant banks, which encourageand profit from takeovers. 
These characteristics distinguish the 
British and American financial systems 
from those of Continental Europe and 
Japan. The differences should not be 
overdone: the Japanese stockmarket 
overtook America's to become the 
world's biggest (in terms of market 
capitalisation) during 1987, while financial 
practice in France, Germany and 
Japan creeps closer every year to the 
Anglo-Saxon model. But for the time being, 
the two systems remain distinct. 

Is the juxtaposition in Britain of a poor 
investment record and a market-orientated 
financial system coincidental or 
causal? The link seems self-evident to 
many industrialists, who have been 
prompted by the takeover boom of the 
mid-1980s-in 1987 there were £15 
billion of public mergers and acquisitions-
to rail against the City's supposed 
short-termism. 

Fund management 
short-termism 

The first short-termist critique of the 

------------------------Fabian Tract 528 • 17 


City claims that the diminishing time 
horizons of money managers has a 
harmful impact on industry. Pension 
fund trustees increasingly farm out the 
money they control-British pension 
funds total about £220 billion-to 
money management firms such as merchant 
banks. The trustees of a pensionfund may review the performance of 
their money manager every three 
months. A firm stained with several 
poor three-monthly periods is likely to 
get the sack. Thus staff at money-
management firms-whose pay is often 
linked to their own performance-are 
under pressure to beat the market, 
which encourages them to buy and sell 
shares frequentJy_.!churning'. They 
eagerly seize on analysts' tips and their 
own whims to buy undervalued shares, 
and-assuming the shares rise-may sell 
them for a quick profit a month or two 
later. 

According to research published by 
the Bank of England, the average pension 
fund turned over 25 per cent of its 
portfolio in 1981, and 41 per cent in 
1986. Turnover of unit trusts-an industry 
now worth £40 billion-in the same 
period grew from 85 per cent to 116 per 
cent. This growth came before the much 
cheaper dealing costs that Big Bang 
offered, and was largely inspired by the 
increasing competitiveness of the 
money management industry. 

But it does not necessarily follow that 
industrial companies will have to pursue 
the short-term perspective of the 
fund managers. For whether he or she 
is looking for a profit over three months 
or thre.e years, the fund manager will 
want to buy a share that appears to be 
undervalued. Suppose that Beecham 
announces an investment in a new drug 
on which no returns are expected for 
seven years. The share price should rise 
immediately, so long as investors hear 
about and believe in the investment. 
The Beecham share price rises because 
it 'discounts' (ie, takes into account) the 
earnings expected in future years. It 
does not matter if a fund manager sells 
out a couple of months later. For if too 
many institutions sold, the share price 

would again become undervalued (relative 
to similar companies), and sharp-
nosed money managers would step in to 
buy the shares. Thus the short-term 
perspective of the money manager, and 
an increased volume of share trading, 
make the market more efficient. 

In a takeover situation, however, the 
fund manager's time perspective can 
prove harmful. Ifthe bidding company 
offers existing shareholders a price 
much higher than the existing share 
price, it may be hard for a fund managerworried about his three-monthly performance 
to forego a quick capital gain. 
Even if the fund manager believes that 
the company's existing management is 
competent, and engaged in a strategy 
that will produce a strong share pricefor the next five years, it is difficult to 
refuse a predator who is offering a considerably 
higher price for a 'company 
than the market had previously thought 
justified. 

Many pension fund trustees, facing a 
statutory obligation to obtain as high a 
return as possible, impose a similar 
obligation on their firm of money 
managers. That makes it hard to refuse 
a bid made by a company determined 
to pay 'too much', ie, one driven by the 
egotistical ambitions of its managers 
(should it not be made compulsory for 
a firm bidding for a much larger one to 
ask its shareholders' permission?).

But many institutional investors, 
especially the insurance companies, do 
behave responsibly during hostile takeovers. 
They listen to presentations by 
both sides, and generally have a bias in 
favour of the existing management. 
Research published by the Bank of 
England in 1987 suggests that most large 
institutions are not tempted by the 
chance of a short-term gain in a takeover 
situation. But the Bank noted that 
some smaller pension funds and unit 
trust companies were not so responsible. 

Stockmarket short-termism 

The second and related short-termist 
critique of the City is that the stock


18 • Fabian Tract 528 ------------------------



market's myopia discourages companies 
from investing. 

The idea goes as follows. The stock-
market often fails to appreciate the 
long-term benefits that an investment 
may bring a company. So if an investment 
reduces a company's profits in the 
short-term, the share price falls, and the 
company becomes vulnerable to takeover-
in which case managers would 
lose their jobs. Managers therefore 
adopt the cautious policy of eschewing 
any investment likely to reduce earnings 
per share. 

There is a large corpus of academic 
studies of share prices which contradicts 
this thesis, and suggests that 
stockmarkets are efficient in the informational 
sense. That is, they accurately 
reflect the information that is publicly 
available about economic conditions 
and about companies' prospects. So if 
GEC announces a new product, its share 
price willimmediately move up or down 
depending on the market's view (determined 
largely by analysts) of the 
product. ... 

The academic work goes further, and 
claims that current share prices accurately 
discount future earnings prospects. 
That is, the market attaches about 
the right weight to prospective future 
dividends, compared to current dividends. 
The implication of this research 
is that the market does not misunderstand 
companies when they make longterm 
investments that do not produce 
immediate dividends. 

Imperfect efficiency 

But despite this dominant academic 
view-which has been questioned by 
economists who are less enamoured of 
free markets-a significant minority of 
industrialists believes that financial 
markets are short-termist. That matters, 
since beliefs influence behaviour. The 
1987 report by the Confederation of 
British Industry on City-industry relations 
was largely a whitewash-hardlysurprising since its taskforce was drawn 
from the banking and business estab


lishment-but inducted much revealing 
detail. 

The CBI accepted that there was a 
problem of underinvestment in capitalequipment, research and development 
and training. But it pointed out, quite 
correctly, that there may be many 
causes of underinvestment other than 
the short-termism of financial markets. 
Itconcluded: ''The most important constraints 
inhibiting companies from taking 
strategic investment decisions in the 
long-term interest of the company and 
its shareholders appeared to be the high 
cost of capital and/or fears of an inadequate 
return. Short-term pressuresfrom financial markets and investors are 
much less important, with a majority of 
companies not regarding them as a significant 
constraint on their ability to 
take strategic investment decisions". 

But the detailed returns from a questionnaire 
the CBI sent out to 200 mainly 
manufacturing companies produced a 
different slant. The chief executives-
most of whom worked for firms 
with turnovers of over £100 million-
were asked what factors constrained 
their companies from taking investment 
decisions in their long-term interest. Of 
the 109 who replied, 12 per cent cited 
fear of a takeover as significant or of 
major significance; 23 per cent mentioned 
pressure from financial institutions 
or analysts; 41 per cent answered 
a weakness in their share price. So a 
substantial minority of chief executives 
believes that financial markets, in one 
form or another, do constrain their 
ability to invest. 

These chief executives reckon short


termism is worsening. When asked in 

what ways they had changed their 

criteria for evaluating an investment 

since the late 1970s, 50 replied " higher 

rate of return/shorter payback", 42 said 

"no change" and 11 went for " lower 

rate of return/longer payback". Why 

had those with shortening investment 

horizons changed their ways of 

evaluating an investment? They men


tioned an adverse economic environ


ment, high real interest rates and finan


cial market pressures in roughly equal 

-------------------------Fabian Tract 528 • 19 


proportions. 

Information flows freely 

The CBI, like the business schools, 
believes that the system itself is faultless: 
stockmarkets are essentially efficient, 
they do not over-emphasise the 
short-term earnings of companies, and 
if there is a problem-they have to concede 
that occasionally, some of the time, 
the market does not do justice to some 
companies-it can be overcome by making 
the market even more efficient. 
Industrialists should spend more time 
explaining their plans to analysts and 
institutional investors. Ifonly information 
flowed more freely, all would be 
fine. 

It is common sense that if a firm 
explains itself well, the market is more 
likely to get its share price right. The 
CBI report rightly proposed that companies 
should reveal how much they 
spend on R&D in their annual report 
and accounts. Why not also make them 
report the ratio of their capital spending 
to their depreciation of capital, so 
that analysts know whether capital 
stock is being replaced? And why not 
spending on training? 

There is some evidence that if companies 
communicate well with analysts 
and investors, the market can take a 
long-term view. One recent study of 324 
American companies by the Securities 
and Exchange Commission concluded 
that when firms spend more on R&D, 
their share price normally rises. And 
when British drugs companies 
announce plans to invest in new products, 
the market generally respondspositively. However, pharmaceutical 
companies have been an unusuallypopular sector in Britain in the late 
1980s; electronics companies have not 
always met the same response. 

Analysts play a key role in the Anglo-
Saxon financial system. Investors lack 
the expertise to judge the worth of say, 
a new telephone exchange planned byPlessey. They depend on stockbrokers' 
analysts to have the technical know


ledge to take an informed view of the 
impact of an investment on a company's 
prospects. 

The problem is that the quality of 
many analysts is less than their pivotal 
role in the system requires. Many are inexperienced 
and know little about the 
industries they cover. Analysts are supposed 
to be taught complex formulae for 
predicting the value of company shares 
several years ahead. But in practice 
most of them use rules of thumb for 
forecasting share values and earnings 
per share for this year and next year, 
and ignore the longer-term outlook. 

Analysts can argue that if they often 
fail to carry out fundamental and 
detailed research on companies, it is 
because their clients do not want that 
service. Money managers worried about 
their quarterly performance expect 
analysts to provide stock tips; and will 
feed more business to a firm of stockbrokers 
that provides a steady stream of 
successful 'buy' recommendations. The 
more respected analysts shift prices up 
or down with their tips, and encourage 
institutions to churn their portfolios. 

The more complex the 'industry', the 
more difficult it is for analysts to 
mediate successfully between companies 
and investors. That may be one 
reason why much of the anecdotal 
evidence for short-termism comes from 
high-technology industries such as 
electronics. 

• 
The share price of Oxford Instruments, 
for example, dropped 10 per 
cent in June 1987 after it announced 
that annual profits were up 6.7 per 
cent to £19.7 million. The market 
reacted to sluggish sales of superconducting 
magnets, which provide 
half the firm's earnings. Investors 
appeared to ignore that Oxford 
Instruments was laying the base for 
diversification into new product lines 
and took no notice of the contemporaneous 
announcement of a £10 
million contract to supply IBM with 
a new sort of super-conducting atom-
smasher, which was positive news for 
the firm's long-term prospects. 
20 • Fabian Tract 528 ------------------------



• 
Not only electronics firms claim they 
suffer from short-termism. In 
America, Levi-Strauss went privatein 1985, abandoning having its shares 
quoted publicly because it did not 
like having to make decisions in 
response to Wall Street pressures. For 
example in 1984 it had to sack 15 per 
cent of its workforce to satisfy the 
markets. Since going private, Levi-
Strauss has flourished; the companyhas restructured itself and put a new 
emphasis on marketing. The firm 
claims that the stockmarket would 
not have given its new strategyenough time to work. 
Fundamental flaws 

Faced with such tales, defendants of the 
system claim all that is needed is managers 
better-skilled at 'investor relations', 
and analysts and investors better-
trained to understand the insides of 
companies. 

But more efficient flows of information 
may not be enough to make 
markets work efficiently. The Anglo-
Saxon system contains inherent problems. 
Thke a company in a high-technology 
industry. If it reveals enough 
detail about a new project for the 
analysts to understand its significance, 
a competitor could get to hear and then 
copy it. This dilemma is worsened in 
Britain by the dispersal of ownership 
and effective control among dozens of 
institutional investors. In Japan, a company 
could easily inform the one or two 
banks which control it about a new and 
secret project, confident that news 
would not leak out. If ICL devoted the 
time and the effort to explaining a new 
computer to all its major shareholders 
.in private, rivals would soon hear. Yet 
if ICL denies its shareholders sufficient 
detail, they may not understand the 
investment well enough to treat any 
consequent short-term fall in profits 
sympathetically. 

This may explain why the British 
stockmarket sometimes fails to appreciate 
firms which invest in new pro


ducts. Investors are particularly reluctant 
to back a product that has not been 
proven in the market. Thus in 1984, 
when Racal announced that it was moving 
into the cellular telephone business 
through a subsidiary named Vodaphone, 
the stockmarket took a gloomy view of 
its prospects. But when earphones 
boomed, Racal's decision turned out to 
have been correct and profitable. Subsequently 
the stockmarket still failed to 
appreciate the worth of Vodaphone, and 
so Racal's share price remained relatively 
weak. Therefore in April 1988, 
Racal announced that it would float off 
a portion of Vodaphone, since the valuation 
the market would have to put on 
that-about £2 billion-would force it to 
upgrade Racal's own valuation. So it did: 
Racal's share price shot up 50 per cent. 

A recent report for the Cabinet Office 
secretariat by John Fairclough, seconded 
from IBM UK, concluded that (forthe period 1985-6) the British electronics 
industry spent too little on R&D 
to remain competitive internationally. 
But the problem with the British electronics 
industry is not simply that the 
stockmarket dislikes spending on R&D. 
Indeed analysts have on occasion 
marked down Amstrad for spending so 
little, since that endangers its long-term 
prospects. 

It is rare for specific investment 
decisions to be abandoned for fear of 
the market reaction. But the stockmarket's 
short-termism has blightedBritain's electronics industry in a more 
subtle way. The market does not like a 
company which seems to be adventurous. 
Thke Plessey and STC, both of 
which spend similar amounts on R&D. 
Analysts now love STC, just as they used 
to love GEC, because it has become a 
cautious company run with tight financial 
discipline. They do not like Plessey, 
partly because of doubts about its top 
management, but partly because it has 
grand ambitions. The City marked it 
down when it bought Ferranti's semiconductor 
business. Such a business is 
anathema to stockmarket opinion: it is 
capital-intensive, cyclical and extremelycompetitive. There is an assumption 

-------------------------Fabian Tract 528 • 21 


that if the big Japanese and American 
firms are competing in a market, British 
companies are bound to Jose. The 
market prefers electrical companies that 
milk a few profitable niches and 
guarantee stable earnings for the next 
few years. Japanese bankers lending 
money are often less over-cautious in 
their view of a company's prospects 
than the British stockmarket. 

The stockmarket's short-termism towards 
some sorts of company-which increases 
their exposure to takeover-has 
fostered a climate of caution among 
many British managers. These industrialists 
often appear to Jack the 
ambition to build up worldwide market 
share-in contrast to their counterparts 
in Germany and Japan who are free 
from worry about a falling share price 
and the risk of takeover. There is often 
a conflict between short-term profitability 
and growth of market share, 
which in British companies is usually 
resolved in favour of the former. 

The British electronics industry is 
more profitable, but slower-growing 
than that in most other western countries. 
In 1986, British output of information 
technology goods was just 6.5 per 
cent of GDP, compared to 12.5 per cent 
in Japan and 20 per cent in America. 
Thorn-EM! had global ambitions when 
it bought Inmos, but now it has sold or 

is selling its high-technology units, and 
is returning to the easier life of retailing 
electrical goods. British electronics 
firms have largely abandoned the production 
and development of microchips. 
In most of the principal segments of the 
electronics industry-telecommunications, 
computers, components and consumer 
goods-Britain Jacks a world class 
firm . Only in defence electronics is 
Britain a match for the rest of the world. 

Both the 'fund management shorttermism' 
and the 'stockmarket shorttermism' 
arguments often Jack substance, 
at least in their simplest and 
most mechanistic forms. But because of 
its impact on takeovers, the short-term 
perspective of much City opinion can 
discourage managers from taking the 
long view. And the fact that many 
industrialists believe there is a problem 
of short-termism influences their investment 
performance. In high-technology 
industries, the stockmarket's fear of 
bold strategies can discourage companies 
from pursuing the sorts of longterm 
plans that Japanese firms take for 
granted. In such industries-and in any 
industry, should a company hit hard 
times-companies would benefit from 
firm and committed shareholders. The 
Anglo-Saxon financial system militates 
against such commitment. 

22 • Fabian Tract 528 ------------------------



5. The example of Japan 
The theory of efficient markets supposes that so long as 
information flows freely from companies to investors, there can 
be no short-termism. But Professor Colin Mayer, of the City 
Business School, has sought to demonstrate that the structure 
of the British and American systems-with the stockmarket 
separating the institutional owners of industry from its 
managers-provides an insurmountable barrier to the necessary 
flows of information. 

Mayer claims that the providers of funds 
in the Anglo-Saxon system are not committed 
to the users of funds, because 
they do not know enough about the 
companies they own. He also believes 
that both the competitive nature of the 
Anglo-Saxon financial system and the 
prevalence of hostile takeovers worsens 
the two-way lack of commitment between 
institutional investors and banks 
on the one side, and corporate managements 
on the other. 

Mayer's key word is commitment. He 
points to Japan, where each company 
has a close relationship with one bank, 
known as its main bank. The bank will 
make long-term loans to the company 
and will probably own an equity stake. 
The law limits that stake to 5 per cent, 
but in practice the long-term loans act 
like an equity shareholding: they are 
seldom called in, and it is understood 
that the providers of the long-term loans 
should have some say in the company's 
management. In Britain it is the big institutions 
which ultimately control most 
large companies, but in Japan it is the 
banks. 

The important difference between the 
two countries is that Japanese banks are 
much closer to their companies than are 
British insurance companies and pension 
funds. Because the banks are in a 
good position to understand companies' 
strategies, and assess their managements, 
they are often prepared to make 
a commitment to support companies.
Thus they may be sympathetic to a firm 

that wants to invest in a new productthat will depress earnings in the short 
term. And if a company hits a rough 
period, Japanese banks may provide the 
sort of help that their British counterparts 
would seldom dream of providing-such as market intelligence, advice on 
restructuring, the secondment of management, 
the rescheduling of debts and 
subsidised loans. 

The gain for Japan is that its companies 
are frequently bold enough to 
take a long-term view on the development 
of new markets and new products. 
And it is extremely rare for the banks 
to allow large firms to go bust. Yet the 
result has not been a nation of lame-
duck industries. When Japanese banks 
restructure companies, they use their 
influence to make them slimmer and 
more productive. The banks reckon it is 
worth the effort, for in the long-run a 
revived company should feed its bank 
much profitable business. 

There lies the rub. In Japan there is 
a commitment of bank to company and 
company to bank. In Britain these 
relationships are much weaker and the 
banks compete much harder to win 
business from companies. Large British 
companies take advantage of this and 
generally auction a bond issue, a trade 
credit or a cash management system to 
the cheapest bidder-even if they use a 
regular house bank to clear their cheques. 
Many British firms will regularly 
switch business among half-a-dozen 
banks. 

-------------------------Fabian Tract 528 • 23 


British banks therefore cannot be 
blamed for failing to support their companies 
through thick and thin. Suppose 
a British bank pumped hundreds of 
millions of pounds and hundreds of 
hours of management time into a failing 
electronics company. Suppose, then, 
that the commitment proved farsighted, 
and the firm returned to profitability. 
In Britain, the company would 
probably say thanks very much and give 
its next syndicated loan to a rival bank 
which offered a cheaper price. Bank-
industry relations in Japan are less 
fickle, because the financial system is 
less competitive. 

Mayer points out that institutional 
investors in Britain, just as much as 
banks, are guilty of a lack of 
commitment. 

They discourage managers from thinking 
long term. Suppose that a manager 
devotes much time and effort to an 
expansionary strategy that should pay 
off five years hence. Whether or not the 
share price suffers in the short term-
that is not the issue for Mayer-the 
manager's plans may be scuppered by 
a takeover. Ifa predator offers a price 
significantly above the market price, it 
is in the institutional investor's interest 
to sell. At arm's length from the company 
it owns, the institution feels little 
loyalty to the manager whose plans it 
may not have understood. The manager 
will probably lose his job after the takeover-
receiving little or no reward for 
his efforts. So why bother? 

Different culture 

It would, however, be impractical to 
transplant the Japanese model wholesale 
into Britain. Japanese financial 
practice has evolved gradually amidst a 
very different culture-one in which, 
for example, ideas of consensus make 
the concept of a hostile takeover almost 
unimaginable. 

Two caveats about the Japanese and 

German systems are worth noting. First, 

the concentration of power in these 
countries is in the hands of bankers. 
Second, the Japanese model is changing. 
Over the last ten years, the slowing 
of growth in Japan has led to less investment, 
and bank lending to industry has 
therefore declined. Many industrial 
companies are now much freer than 
they were from banks' influence. 

Nevertheless, Mayer's analysis has 
relevance for Britain. It reminds us that 
more competition in financial markets 
is not always necessarily good. Before 
further liberalisation governments 
should consider the likely costs as well 
as the benefits. 

Beyond this there are three lessons to 
be drawn from Mayer's work. First, 
banks should get stuck into the companies 
they lend to. They should train 
industrial experts who can provide practical 
advice to client companies. 
Japanese management has probably 
been little better than British management; 
but its industry has performedbetter thanks to the high quality advice 
of its bankers, particularly those from 
the long-term banks. As David Walker 
said shortly before he left the Bank of 
England, bankers should not see their 
relationship with a company as limited 
to a loan contract. They should be well 
informed about a client, and be ready 
to apply gradually increasing pressure 
in the event of under-performance. 
They should not just wait until the 
breach of the loan agreement allows the 
bank to demand repayment or threaten 
the receiver. 

Second, companies too should change 
their behaviour and be encouraged to 
use one or two house banks, even 
though the result may be fractionally 
more expensive than if they auctioned 
all their financial business. 

Third, the Government should champion 
any scheme that encourages the 
big institutions to stick with their holdings 
and get closer to the companiesthey own. We look at some ideas 
designed to achieve this in chapter 7. 

24 • Fabian Tract 528 ------------------------



6. Takeovers 
Thkeovers are not wholly malign. So long as the providers of 
finance fail to discipline weak managements, takeovers will 
continue to play a necessary role. But an overwhelming 
dependence on takeovers is not the most efficient means of 
rooting out bad managers. To adapt an old cliche that has often 
been flung at the left, a takeover culture leads to an exaggerated 
concern with the redistribution of existing assets rather than 
the creation of new ones. 

However much takeovers may benefit 
the shareholders of some individual 
companies, their impact on the national 
economy has, overall, been negative.
They have produced an over-concentration 
of capital, while the performanceof merged firms is often worse than that 
of their original constituents. Takeovers 
may harm the interests of employees,
while they have encouraged managers 
to think of next year's dividend rather 
than long-term growth. 

Over-concentration 

Itis impossible to prove that high spending 
on takeovers is a cause of low new 
investment, since it is not known how 
companies would behave in an acquisition-
free economy. Similarly, it is difficult 
to prove that the high concentration 
of manufacturing output in the 
largest 100 firms (around 40 per cent) 
is a result of a permissive takeover 
system-but it seems a reasonable 
supposition. 

That is the conclusion of the standard 
work on Concentration in Modern 
Industry by L Hannah and J A Kay.
They write: " It is not an accident that 
Britain, which combines a highlydeveloped securities market with 
negligible legal restrictions on mergers,
has achieved increases in and levels of 
concentation which are the highest 
among developed countries" (Macmillan, 
1977). Such over-concentration 

has almost certainly contributed to 
British industry's lack of dynamism. The 
important role of small-and medium-
sized firms is better appreciated now 
than it was in the 1960s-when the 
Labour Government worked hard to 
promote mergers in the belief that big 
was best. 

Performance 

Academics have found several ways of 
measuring the performance of merged 
companies, such as profits, efficiency, 
growth, investment and share price. But 
none of these techniques has yet been 
able to prove that mergers benefit the 
economy as a whole. Some of the benefits 
for shareholders, such as economies 
of scale, elimination of duplicate functions, 
and increased market share, are 
more easily quantifiable than the costs, 
so one would expect them to be reflected 
in share price studies. 

Franks and Harris examined the 
share-price performances of 2,000 
acquisitions from 1955 to 1985. They 
concluded that share prices of the 
acquiring companies performed comparably 
to the market as a whole, during 
the two years following the merger. 
But acquirors' share prices performed 
worse than they had done before the 
merger. In contrast the shareholders of 
companies that were bought experienced 
clear share price gains (Shareholder 
wealth effect of corporate 

------------------------Fabian Tract 528 • 25 


takeovers: the UK experience, 19551985, 
LBS working paper, Nov. 1986). 

What is good for some groups of shareholders 
is not always good for the rest 
of the economy. An appendix to Lord 
Young's Department for Enterprise 
document Merger Policy (March 1988) 
recalls a 1978 Green Paper which compared 
profitability before and after 
merger. It concluded that in half the 
cases examined, the mergers had an 
unfavourable or neutral effect on the 
profitability of the companies concerned. 
Drawing on nine pieces of 
subsequent research, the document 
said: "Evidence on post-merger performance 
that has emerged since the 
Green Paper supports the earlier findings 
of disappointing or inconclusive 
performance". Astonishingly, the main 
argument of Merger Policy is that takeovers 
are of great benefit to the 
economy and that the free market 
should not be tampered with except on 
grounds of competition. 

Companies like Grand Metropolitan 
and Reed International, which grew by 
acquisition in the early 1970s, had to be 
partially deconstructed and reconstructed 
in the mid-1980s when it 
became clear that the first stage of combination 
had failed. 

Anti-growth management 

The takeover culture has fostered a particular 
style of industrial management. 
The investment institutions have tended 
to reward those companies which function 
in their own image. In their prime, 
companies like Slater Walker, Hanson 
Trust or GEC could do no wrong in the 
eyes of fund managers, partly because 
they seemed to view their acquisitions 
as an investor might regard a bundle of 
under-valued securities. 

Because investors view acquisitivegrowth as cheaper and less risky than 
organic growth, companies which excel 
at it have often enjoyed a higher share 
rating than organic plodders. Many of 
these conglomerates made huge profitsfrom rationalising Britain's creaking 

industrial base in the 1970s and 1980s. 
The fund managers naturally rewarded 
them with rocketing share prices, which 
in turn recharged their takeover 
ambitions. 

Thus, bull markets and takeover 
waves feed off each other. When the 
market is nea~; a peak, the shares of 
acquisitive companies with investor 
followings are at their most over-valued. 
That is when it seems cheapest and 
easiest for the managements of these 
companies to pay for fresh acquisitions 
by issuing new, over-rated shares-
rather than using cash. Not surprisingly, 
research shows a higher return to 
shareholders from cash bids than paper 
bids; those bidding with paper are easily 
tempted into paying too much. 

Much of the rationalisation accomlished 
by a Hanson or a GEC was necessary 
and welcome. But too many of 
Britain's most successful companies 
have been rationalisation-rather than 
growth-driven. They are what the 
Centre for Business Strategy at the London 
Business School has categorised 
financial controllers. These stockmarket 
darlings such as BTR, Hanson, GEC 
and most of the 'mini-conglomerates' 
typically have a small central headquarters, 
which allows subsidiaries a 
high degree of strategic autonomy but 
exerts tight control on investment and 
financial targets. 

The LBS found that financial-control 
companies tend to be low investors, to 
be risk averse, and to retreat into high-
margin niches. Managers are encouraged 
to seek high profits with strategiesdesigned to minimise the use of capital; 
this does little to promote long-term,
capital-intensive projects and encourages 
short-term milking. Hence financial 
controllers tend to pass-up new opportunities 
because of the risks involved. 
Both GEC and Ferranti had an early 
lead in the MOS-technology segment of 
the gate-arrays market (custom-built 
microchips), but both turned down the 
chance in invest in it, and the market 
is now dominated by LSI Logic.

The system also takes its toll on non-
acquisitive managements through 

26 • Fabian Tract 528 ------------------------



diverting time and money into anti-
takeover defences, or even defensive 
acquisitions or excessive indebtedness. 

Employees 

Even acquisitions which are of unequivocal 
benefit to shareholders may 
damage employees. Thke the case of a 
56 year-old production manager who 
had worked at Ever Ready for more 
than 25 years. In 1981 Hanson Trust 
bought Ever Ready, reducing the management 
layers from nine to three and 
cutting staff by 60 per cent. The production 
manager lost his job, but eventually 
found another with British Thlecom, 
though on a smaller salary and with 
reduced pension rights. After spending 
most of the next four years in a state of 
depression he died at the age of 60. 

This sad history illustrates a pointmade by Andrei Schleifer and Lawrence 
Summers in their paper, Hostile take-
O'IJerS as f.rreaches oftrust (LSE Financial 
Markets Group, Dec. 1986). They argue 
that employees enter into a large range 
of implicit understandings and contracts 
with their companies, on the basis of a 
long-term relationship. The employee 
accepts relatively low wages in return 
for the expectation of job security. He 
invests heavily in acquiring specific 
skills which he knows he cannot transfer 
elsewhere. He also believes that if he 
loses energy and ability as he 
approaches retirement, he will be 
moved into an easierjob rather than be 
sacked. 

Schleifer and Summers argue that by 
a hostile takeover, a predator can dash 
these expectations at a stroke, and the 
employee may have few means of redress 
because he failed to contract 
explicitly for such rights. Thus the 
advantages of a stable relationship between 
employee and manager may be 
destroyed by the lack of a long-term 
commitment on the part of shareholders. 
While efficiency is normally 
desirable-and surplus layers of management 
are not-takeovers which effectively 
shift wealth (in its broadest 

sense) from staff to shareholders do not 
necessarily promote productivity. De-
motivated staff work less hard. 

Evidently, if companies were better 
managed in the first place, they would 
not need to suffer the sudden shock of 
demanning. But this ideal is more likely 
to be realised through shareholders providing 
tougher and consistent monitoring 
of managements (see below), than 
by the current combination of non-
interventionism and corporate trauma. 

The bias to acquisition 

The nature of our financial system often 
encourages large firms to grow by acquisition 
rather than organically. Why build 
a new sausage factory if you cannot be 
certain the extra demand will still be 
there on completion, when you can buy 
one with an existing market share and 
er\ioy the benefits of rationalisation? 

But apart from this favourable 
cultural climate, there are other, more 
specific biases towards acquisitivegrowth in Britain. Hoards of City institutions 
prosper by encouraging the takeover 
business-merchant banks, stockbrokers, 
accountants, lawyers and 
public relations firms. The City's cut 
from takeovers in 1986 was estimated 
at over £800 million-boosted no doubt 
by over-pricing. Th take the example of 
one leading merchant bank, two thirds 
of Morgan Grenfell's profit of £51 million 
in the first half of 1986 came from advice 
on mergers and acquisitions. 

Commercial banks also find this activity 
nourishing. In an age of securitisation-
the replacement of traditional 
lending by the issuance of tradable 
securities-banks are desperate for profitable 
lending opportunities. They have 
thrown money at companies in supportof leveraged acquisitions, where the 
predator finances his bid largely with 
borrowed money. Although they are still 
much rarer in Britain than in America, 
debt-backed bids are growing increasingly 
popular, especially as a means of 
allowing small companies to buy much 
larger ones. Often the intention of such 

-------------------------Fabian Tract 528 • 27 


bids is to break up the target companyinto several bits, and then sell them off 
to get the cash to repay the debt. 

The arrival of arbitrageurs from New 
York since the mid-1980s is another factor 
which has helped swing the balance 
in favour of hostile bids. Ivan Boesky 
was an ''arb' ~someone who buys a 
stake in a company in the hope another 
party will subsequently launch a bid 
and buy them out at a premium. Arbs 
encourage takeovers, because once a 
few move in, psychological pressure 
puts the target company 'into play'. The 
knowledge that large blocks of stock are 
held by footlose shareholders is likely to 
prod a would-be bidder into action. 

Thus Pearson (which owns the Financial 
Times and Penguin) suffered when 
Carlo De Benedetti took 5 per cent; the 
Italian entrepreneur did not hold for 
long and flogged his stake to Rupert 
Murdoch, enabling the Australian to 
build up a 20 per cent-plus holding by 
early 1988. Arbs are beloved of free-
market theorists: by buying undervalued 
assets they make stockmarket 
prices more efficient, they pressure 
managements to pull their socks up, and 
they provoke value-adding takeovers. 

Britain's archaic accounting system 
gives takeovers another fillip. Some bidders 
openly admit that benign accounting 
rules are a motive for an acquisition-
for example FKI when it took over 
the much larger engineering group Babcock 
in 1987. The rules of acquisition 
accounting allow firms to make provisions 
against putative " reorganisation" 
costs, which, if subsequentlyfound to be unnecessary, can be fed 
back into the profit and loss account in 
future years, giving the illusion of 
impressive growth. 

There is nothing to stop predators 
undervaluing acquired assets, which 
maximises the goodwill (the difference 
between the market value of a company 
and the value of its physical assets). 
Goodwill can be written off againstcapital in one go and so does not hurt 
profits. In subsequent years profits rise 
impressively, since companies can make 
a lower depreciation charge against the 

falling value of their assets than they 
should. And they may take huge one-off 
profits on the sale of an asset which had 
been undervalued. 

While these pressures for takeovers 
continue, the Government has largely 
reduced its role in the market. 
The DTI's 1988 policy document 
on takeovers reaffirmed the so-called 
Tebbit guidelines of 1984. The then 
Secretary of State, Norman Tebbit, 
shifted merger policy in a more liberal 
direction. He said that the DTI would 
refer takeovers to the Monopolies and 
Mergers Commission primarily, though 
not exclusively, on competition grounds. 

Previously, it was quite common for 
non-competitive issues to count as the 
public interest and therefore as grounds 
for referral. For example, the MMC 
blocked the Hongkong and .Shanghai 
Bank's 1982 bid for Royal Bank of 
Scotland on grounds of regional interest. 
The 1988 document says that issues 
such as employment, regional development, 
spending on R&D and foreignownership do not merit (except in 
exceptional cases) government intervention. 
The Tebbit rules are particularly 
kind to conglomerate bidders, such 
as Hanson, which by definition tend not 
to have a prohibitively large market 
share in any one industry and so can 
never be stopped on grounds of 
competition. 

The current rules are more laissezfaire 
than they seem, because even 
evidently anti-competitive bids are 
waved through when a special interest 
can lean on government. Thus the MMC 
approved British Airways' bid for British 
Caledonian in late 1987. Fortunately, 
after the MMC had approved the merger, 
the European Commission intervened 
andforced BritishAirwaystounloadsome 
of its European routes. By the 1990s, the 
Commission will take an increasingly 
interventionist role in European Community 
mergers and competition policy. 
That is probably no bad thing, since the 
Commission-reflecting the views of 
other member states-is unafflicted bythe free-market bias of the British 
authorities. 

28 • Fabian Tract 528 ------------------------



7. Some alternatives 
A recognition ofthe visible and invisible costs of our capricious 
system of takeovers is surprisingly widespread. But if the 
practice is to be restrained, other means of disciplining and 
motivating managements are needed. Attitudes need to be 
nudged along two distinct but related paths: owners-the 
institutions-must behave more like managers, while managers 
(and employees) must behave more like owners. 

The simplest way to reduce over-
dependence on takeovers would be to 
reverse the burden of proof. A bidding 
company should justify to the 
authorities not, as at present, that the 
bid does not harm the public interest; 
but that it positively promoted it. Other 
desirable reforms would include the 
abolition of rigged accounting rules, the 
provision for employees of a right to be 
consulted, and a rule that predatorsshould pay their target's costs during a 
hostile bid. 

Despite the complexities involved, it 
should be possible to decide whether a 
takeover is in the public interest. A 
reformed authority-for simplicity'ssake the Monopolies and Mergers Commission 
merged into the Office of Fair 
Trading-would consider approving a 
bid if it offered the prospect of highinvestment and growth; the development 
of new products, markets and 
exports; and ofjob preservation or creation. 
Given that some companies over-
invest or invest in the wrong things, and 
suffer from over-manning, it is likely 
that the OFT would sometimes accept 
cuts in the workforce and in investment. 
But it would veto bids that appeared to 
be angled only at short-term rationalisation. 
Bidders would have to make commitments 
to the OFT, which, if broken, 
would warrant severe punishments. 

Owners as managers 

The growing institutional ownership of 
industry has not produced the stable 

support for companies that might have 
been expected. The increasingly competitive 
investment strategies of the 
big institutions has made the individual 
shareholder, by comparison, seem 
a paragon of long-termism. Yet, 
as David Tucker, a former director 
of the M&G unit trust group, has 
said: "The institutional investor is 
much better-equipped to play a proprietorial 
role than the private shareholder, 
and the risk that companies will 
become exposed to a tyranny of government 
by a few institutions is surely outweighed 
by the advantages of experience 
and resource beyond the scope of 
the largely disorganised private shareholder''. 


And despite the performance pressure 
of recent years, there remains an 
honourable tradition of institutions as 
stakeholders, rather than mere rentiers. 
There are some shareholders who 
accept the obligations as well as the 
privileges of the corporate relationship-
supplying funds for growth, defending 
companies against opportunistic takeovers 
and ensuring the appointment of 
boards of suitable quality. 

There have been a handful of cases 
when a few major shareholders have 
become interventionist, and acted to 
change a company's management without 
changing its ownership. In 1982 
Prudential helped install Francis Thmbs 
in the troubled engineering group, 
Turner & Newell; he subsequently 
refocussed it and turned it round, 
rewarding Prudential's effort. 

Many institutions evade the issue and 

------------------------Fabian Tract 528 • 29 


ay that they are not equipped to act as 
management consultants. But that is not 
good enough. An experienced fund 
manager has an overview of corporatebehaviour and a nose for what make 
a company strong or weak that is at 
least as good as the average management 
consultant. 

The problem is that there are currently 
few incentives, and plenty of disincentives, 
for the big investors to 
become interventionist. Why waste time 
and money trying to tackle weak managements, 
when a bid will do it for you? 

But in the future, a combination of 
fewer takeovers and widespread indexation 
of funds ought to give fund 
managers the time to get more involved. 
Some could win the approval of their 
clients through proving themselves 
effective interveners, rather than ineffective 
spotters of undervalued 

ecurities. The fund managers themselves 
would not have to sit on boards: 
they should seek out and appoint non-
executive directors to act as their 
agents. The objection to such interventionism 
is the so-called 'free-rider' problem. 
Big institutions which do devote 
time to troubled companies complainthat they bear th co t when all shareholders-
ome of them competitors-
e(\joy a o t-free benefit. 

The state could mitigate this problem. 
A mall pro-rata tax could be levied on 
in titution , to finance an Industrial 
Management In titute. This would act 
as a forum for in titutional trategie , 
and provide a pool of experienced nonexe 
utiv directors and company do tors. 
If the institutions object d to th 
tax, th tate could fund the venture. 
Th IMI could b run jomtly by repr 


ntativ of the Bank of England, th 
IITI and the in tltutions, with th up-
port of a full-tim r ar h taff. 

The IMI could draw up and monitor 
a od of orporat conduct This could 
ov r, for example, the minimum numr 
f non ut1v d tors that om 
pan1 should appomt And the code 
r uld in! 1St on fuller d1 lo ur of spen 
dmg on R&D, trammg and n w pr uct 

dt•velopm nt. 

One objection to the idea of an IMI is 
that if it was to be effective in working 
out a plan to reform a weak company, 
it would need access to inside information. 
But it i already common for in titutions 
to accept restrictions on d aling 
when they are taken into company confidences; 
the same would apply to tho 
institutions that became involved 
through the IMI. The principle i cl ar: 
for alltheir different priorities and timescales, 
and their greater comp titiveness, 
financial in titution (or at I ast 
their customers) have a mutual interest 
in effective company monitoring. This 
mutual interest ought to find a collective 
institutional expre ion. 

Consider the case of leepily-managed 
Distillers. The large institutions claim 
that for years they wer individuaJJy 
seeking to force the Distillers board to 
change its ways. Ifthey had had a m ans 
of pressing their complaints collectivelythe ghastly affair of Guinn 's takeover 
would have been unnecessary. 

Pension funds 

Pen ion fund trustees also need nudging. 
Companie appoint them to oversee 
the management of their pension fund 
ass ts, which now account for about 35 
per cent of the British tockmarket. 
Some tru tee have been guilty of hypocri 
y. On the one hand they d mand 
high r performance from fund managers-
implicitly encouraging th m to 
accept opportuni tic bid ; while on the 
other hand, wearing their corporatehats, they complain that fund managers 
are taking too hort-term a vi w of their 

of 

30 • Fabo n Trect 528 -----------------------



should also look closely at the virtues 
of indexation (see page 5). Or they 
should lay down clearer guidelines on 
asset allocation (such as the proportion 
of a fund allocated between bonds and 
equities). That could help prevent a 
repeat of the fund managers' lemming-
like rush into equities through the first 
nine months of 1987, which contributed 
to the October crash. And trustees could 
save money by paying fund managers on 
a fixed-fee basis. At present most fund 
management companies charge a percentage 
of funds under management, 
which allows them to ef\ioy the rewards 
of a rising market however poor their 
relative performance. 

Two things hold trustees back from intervening 
in a bolder fashion. First, theydo not have enough time for these issues 
and are thus easily intimidated by the 
jargon of fund management specialists. 
Considering how important pension 
funds have become as profit centressome 
have built up such huge surplusesthat corporate managements have 
declared 'pension fund holidays' during 
which they cease to make contributions 
-this amounts to a short-sighted mis-
allocation of management resources. 

Secondly, legal restrictions on trustees 

have encouraged this short-sightedness. 

Even David Walker, then of the Bank of 

England, regarded as 'plausible' the 

view that: ''Trust law is no longer able 

to cope with strains placed upon it by 

the weight and importance of the 

modern pension fund, and new pen


sions legislation may be required ... to 

set out more clearly where the respon


sibilities of trustees lie''. 

The law's narrow interpretation of the 

financial interests of current and future 

pensioners makes an artificial distinc


tion between the individual as employee 

and as pensioner. For example, it could 

be in the interests of the individual 

beneficiary to forgo a slightly higher 

return on invested funds-especially if 

these are substantially in surplus-in 

return for well-paid, secure, current 

employment.

Trade union trustees have been par


ticularly cowed by the notorious 

Megarry judgement, which ruled that 
the National Union of Mineworkers 
trustees of the Coal Board pension fund 
could not block investments in foreigncountries or non-coal energy firms. 
Judge Megarry appeared to say that anyfettering of investment managers' discretion 
was wrong, and that the only investment 
criteria that trustees could lay 
down was the narrow one of financial 
returns. 

A new Pensions Act could provide a 
clearer and wider definition of the 
financial interest of beneficiaries, 
without exposing funds to excessive 
risk. Such an act could also lay down the 
rights and responsibilities of trustees, 
and a minimum number of employee 
representatives among the trustees. 
And it should prevent an acquiror from 
manipulating a fat pension-fund surplus 
at a company it buys-for example by 
adding it to its own pension fund, or by 
taking a holiday from making further 
contributions. 

Managers and employees 
as owners 


In Britain there is an excessive bias 

towards public company status. Stock-

markets do provide a reasonable means 

of evaluating companies and of allocat


ing capital, and a public quote is sen


sible for most large firms. But by suc


cumbing to the cult of the stockmarket, 

many firms incur needless flotation 

expenses and then afterwards have to 

divert an inordinate amount of manage


ment time to investor relations. 

A return to Victorian family owner


ship is not the answer. But a progressive 

Government should use tax incentives 

to promote a variety of alternatives to 

the joint-stock company. Such incen


tives could encourage managers to keep

off the stockmarket, or, for those in 

public companies, to take their busi


nesses private in a management buy


out. Better still, the Government should 

promote Employee Share Ownership 

Plans. 

There are plenty of historical cases of 

-------------------------Fabian Tract 528 • 31 


finns that have chosen to insulate 
themselves from the vicissitudes of the 
stockmarket. The International Leisure 
Group, for example, decided in 1987 to 
go private in a £150 million management 
buy-out. ILG claimed that its diversification 
into the airline business involved 
risks that were not appropriate to a 
quoted company. Similarly, Air Call, the 
radio paging group went private in 1986 
because it expected that investment in 
a new product range would depress profits 
for several years ahead. And Tullis 
Russell, a Scottish family finn which 
exports paper and has annual sales of 
£80 million has chosen to stay private.
The finn spent £13 million on a new 
machine which makes high-quality gloss 
paper. It took Tullis Russell three years 
to learn how to use the machine 
efficiently, but the investment has 
subsequently proved lucrative. David 
Erdal, the chainnan, reckons that if his 
finn had been public, the stockmarket 
would not have been prepared to wait 
for the machine to work well, and a 
takeover would have ensued. 

Tullis Russell is now (in 1988) planning 
to launch an Employee Share Ownership 
Plan. ESOPs have proved popular 
in America, where about seven million 
employees work under them. They 
typically involve the setting up of a 
trust, which, with borrowed money,
buys shares from existing shareholders 
(or new shares from the company) and 
distributes them free to workers over a 
period of years. Thus some shares are 
held directly by workers, and others are 
held on the workers' behalf by the trust. 
The company makes regular payments 
to the trust, which uses this money to 
repay the loan. When workers retire 
they can sell their shares back to the 
trust. American companies are encouraged 
to set up ESOPs by a number of tax 
incentives; for example payments to the 
trust are tax-deductable, which makes 
an ESOP a cheaper way of raising fresh 
capital than a straightforward equityissue. 

There have so far been less than a 
dozen ESOP schemes in Britain, because 
British law does not recognise the con


cept and confers no tax benefits. This 
means that complicated and expensive 
legal structures, involving two separate 
trusts, have to be set up to produce the 
effect of a quasi-ESOP. And families are 
discouraged from selling their shares to 
an ESOP because they face stiff capital 
gains tax, which rose in the 1988 Budget 
from 30 to 40 per cent. Yet they are 
-encouraged to sell out to a larger finn, 
since if they are paid with new shares 
the capital gains tax can be rolled over. 
Legislation is needed, first, to allow 
companies' payments to an ESOP trust 
to be tax-deductable, and second, to 
excuse family owners from capital gains 
tax if they sell their shares to an ESOP. 

Unlike co-operatives, companies with 
ESOPs are joint-stock companies and 
can therefore raise capital in a nonnal 
way. Financial institutions are therefore 
readier to deal with them than with coops. 
Because of the inflexibility of their 
ownership structure, co-ops can be 
unsuitable for many larger and middle-
sized companies in competitive markets. 
ESOPs can work well in most sorts of 
company. They can combine a conventional 
management structure-allowing 
some nonnal shareholders-with many 
of the advantages of a co-op. 

Companies can tailor ESOPs to allow 
any degree of worker ownership (ie, 10 
per cent or 100 per cent), and any 
degree of worker control (workers may 
elect some of the trustees, while the 
trust may elect some of the company's 
directors). They give workers a stake in 
their company's growing worth. Studies 
of America's 7,000 ESOPs show that so 
long as managers learn to be more communicative 
io the worker-shareholders, 
ESOPs stimulate both the motivation of 
employees and the efficiency of the 
company. 

ESOPs also protect managers from 
institutional owners who may be 
tempted to sell to a bidder in return for 
a quick gain. ESOPs shorten and 
strengthen the bonds between owners 
and managers-which is what Britain's 
current financial system, with its 
obsessive pursuit of short-term dealinggains, has failed to achieve. 

32 • Fabian Tract 528 ------------------------



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Making the City work 

There is now greater interest than ever in the City of London following the BigBang, the explosion in salaries, a seemingly never-ending wave of giant takeovers, 
scandals such as Guinness and Barlow Clowes and the October 1987 stockmarket 
crash. 

In this pamphlet, David Goodhart and Charles Grant look at the role played in 
the British economy by financial markets. They set out the arguments in favour 
of using markets to make investment decisions and also review the performance 
of Britain's financial institutions. 

The authors highlight the growing importance of financial services both for 
employment and earnings. And they rebut the accusation that the City's 
international bias damages the real economy in Britain. Ruling out a return to 
exchange controls, Goodhart and Grant suggest that the outflow of capital since 
1979 may actually have helped British industry. 

Critics of the City are on firmer ground, according to Goodhart and Grant, when 
they accuse investment managers of 'short-termism'. Despite the strength of 
academic arguments in favour of the existing stockmarket-based system of 
industrial finance, the authors find evidence that British industry has not been 
well-served by the City-especially in takeover battles. A closer relationship 
between industry and the providers of finance is needed as is found in Japan. 

Among their proposals to overc')rne the divide between industry and the City 
are the following:

• 
an Industrial Management Institute to encourage investment institutions to pool 
their information about companies and co-ordinate policies to improve 
management;
• 
new pensions legislation, to protect pension fund surpluses from corporate 
raiders, and to enable trustees to insist that their fund managers behave 
responsibly during takeovers; 
• 
a reduction of the systematic bias which favours takeovers: the rules of 
acquisition accounting, and official policy on mergers need rewriting; 
• 
legislation to make it easier to establish Employee Share Ownership Plans. 
Fabian Society 

The Fabian Society exists to further socialist education and research. Its members 
are thoughtful socialists who wish to discuss the essential questions of democratic 
socialism and relate them to practical plans for building socialism in a changing 
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