Public Limited Companies (Financial Regulation)

Part of the debate – in Westminster Hall at 4:22 pm on 13th March 2003.

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Photo of Mr Howard Flight Mr Howard Flight Shadow Chief Secretary to the Treasury 4:22 pm, 13th March 2003

I congratulate the Treasury Committee and its Chairman, Mr. McFall, on its report. I have read it in full and very little of it cannot be agreed with by a broad cross-section of hon. Members—and, indeed, of the nation as a whole. It was particularly important that the Committee recognised the changes and improvements that had been made to the accounting profession in the United Kingdom since the Maxwell scandal. The Committee also recognised that rules are not the answer—indeed, rules were very much the cause of the problems in the United States of America—and that principles are of acute importance.

The only territory where I express some dissent, and to which I have referred, is Sir David Tweedie's proposal about how to deal with the excessive use of share options in the US. There is no doubt that that occurred and was often quite ridiculous. Shares were given out like confetti. Students would suddenly find themselves worth $1 million because a high-tech company had boomed, and then it would disappear. Sir David Tweedie recommends in respect of all granting of options or shares at a discount to market value that that difference should be charged to the profit and loss account. That is undesirable as it will create great volatility in the profit and loss and a charge to it—in a cash sense, it is not a charge. When times are good in respect of options and discounts, there will be large charges, and when times are bad and options are out of the money, there will not be charges. That will provide a further complication in understanding accounts.

It has always been clear that shares at a discount dilute earnings per share, and as a shareholder I want to know what the earnings-per-share dilution is and what is the effect of the dilution of my equity. Just having a charge to the profit and loss will not tell me that. For starters, the most important thing is to require the fullest description of the earnings-per-share dilution impact in the notes to the accounts.

Secondly, Proshare is the main campaigner for widespread employee share schemes, which will be affected. As the Minister told the hon. Member for Dumbarton in a note, the only way around that will be for companies not to apply any discount to shares that they issue under widespread employee share schemes.

The big corporate problem is disappearing profitability. It is pretty likely, if companies are faced with this accounting problem, that the result will be a major contraction in broadly based employee share schemes. Indeed, that is precisely what Proshare found from its soundings of the FTSE 100 companies. It would be a mistake to think that this change to accounting standards, international and domestic, will not carry a very heavy price in terms of restricting, if not stopping, broadly based employee share schemes, and I think we all agree that their impact has been excellent. They improve productivity and bring communal effort to businesses. There are famous examples such as John Lewis, and measurements of company performance show that those with widespread employee share schemes have a significant impact: they outperform others by a factor of 40 per cent.

It would be a great economic loss to this country if the likely change in the accounting standard ended widely based employee share schemes, as I and many others, including Proshare and many Members of Parliament, fear will happen.

There was pretty widespread agreement with what was contained in the reports of the co-ordinating groups on accounting and auditing issues, and on 29 January, the Secretary of State for Trade and Industry announced a review of the regulatory structures for the accountancy profession. As others have said, the UK would undoubtedly benefit from a companies Bill to introduce the modern company law framework outlined in the company law review, and the sooner the better. It is a little disappointing that more progress has not been made in that respect.

The company law review contained two other important measures—the introduction of a mandatory operating and financial review to provide, in narrative form, an outline of the company's business strategy and the risks and opportunities inherent therein, and secondly, the removal of statutory provisions preventing auditors from limiting their liability, together with a proposal to establish an informal framework for liability capping.

Some hon. Members have suggested that the proposals to date do not go far enough. I think that they are measured and appropriate. If anything, the danger is going too far as a gut reaction to the problems that have occurred in the United States. No one wants to be complacent, but to date there have not been problems of the same magnitude on the accountancy front here.

The Select Committee report drew attention to the warnings that Sir Howard Davies, the head of the Financial Services Authority, has given about the impact of increasing European Union financial regulation, which appears not to have received the same consideration as was given to the Financial Services and Markets Act 2000, and which could be a major threat to what is left of the financial services industry in this country. The report particularly referred to the listing directive.

Let me now turn to Higgs. As others have pointed out, time has passed. Higgs represents the Government's response to further proposals on corporate governance. I felt that the hon. Members for Dumbarton and for Bexleyheath and Crayford (Mr. Beard) were somewhat unfair in attributing the reason for their criticisms of the CBI, the Institute of Directors and the overwhelming majority of chairmen purely to self-interest. I accept that what I have always called the great and the good of the 100 FTSE companies are too narrow a group of people and that they are often motivated to vote generous pay increases for each other. That is a perfectly fair point. I am concerned that Higgs may not necessarily address that.

The concerns that have been raised about Higgs are genuine, and the Government should listen to them before proceeding with implementation of the proposals. There have been three general complaints, which have largely been referred to by my hon. Friend Mr. Ruffley. First, the report is misguided, in that the proposals could make boards less rather than more effective and could undermine the position of the chairman by reintroducing the senior independent director, whose powers seem to run parallel with, and compete with, what many would consider the proper role of an independent chairman.

Secondly, there is a view that the proposals are too prescriptive and rule-based. Although they are supposed to be voluntary, there is a probability that they will be institutionalised in code and that trying to explain why a company has not followed them will be seen as a not particularly pukka or proper position. At the least, there will be a very strong, if not regulatory, pressure to fit into the code.

The third general criticism is the lack of time for consultation before implementation. I do not know whether it is true, but I have heard that the Government are giving consideration to extending the consultation. I hope that the Financial Secretary will be able to confirm that.

There have also been specific criticisms. The first, which I think is fairly valid, is that while such an overly prescriptive regime may not be a huge burden for very large companies, there is the question of those that are not FTSE 100 companies. The regime is too expensive and is not particularly suitable for them. Where do they stand? I should initially have declared an interest, incidentally, in that I am a non-executive director of a company. It has decided to follow Higgs, although it is manifestly inappropriate for what is actually a small company. The decision was based on exactly the type of mentality to which I have referred. A good case can be made for the argument that the success of smaller businesses depends on powerful leadership.

Warren Buffet speaks with two voices because in his companies he pays little regard to the rest of the board and thrives on being able to dominate a weak board. His perspective as an investor in other companies reflects what he says, but that is not so in his practice, nor is it the reason for his considerable success, which has been the robust, individual, all-powerful leadership of a business. It is strange that even large boards will be controlled by non-executive directors. As with the other proposals, their ability to know and understand a large company is perhaps not as great as many may think.