I will argue that the recent McDonnell proposal on share ownership for workers does not achieve its objectives and is unfair to shareholders.
The BBC* reports the proposal as follows:
“Under Labour’s “inclusive ownership fund” proposal, Mr McDonnell said workers would be given a financial stake in their employers and more say over how companies are run.
Firms would have to put 1% of their shares into the fund every year up to a maximum of 10%.”
This is outside the usual run of taxation because it has the same effect as removal of assets from existing shareholders, since it is uncompensated. It is also unreasonable to describe it as an inclusive ownership fund since it mostly generates cash for the government. This is the case since there is a cap (£500 per employee) above which the dividends go to HMRC.
What Is The Proposal?
Every year, companies listed in the UK will have to put 1% of their equity in a misnamed “Inclusive Ownership Fund.” This will continue for ten years so we can expect that after that period, 10% of the equity of all such companies will be placed in a fund. The current situation today is that existing shareholders have a claim on the future cashflows of the company in proportion to their shareholding. I will explain below why this will affect shareholders immediately since shares are valued on a forward-looking basis.
Right now, all the shareholders together can expect to benefit from 100% of the companies’ cashflows. If the McDonnell proposal takes effect, they will only be in a position to expect the benefit of 90% of future cashflows, because there will be another 10% of new shares in issue.
It might be thought that the shares issued will not be new ones. This is not the case because the proposal is unfunded. There is no plan to compensate existing shareholders. As will become clear when I consider objections to my account below, many of the problems with the proposal flow from its uncompensated nature.
We may safely assume that the proposal does not include compensation even though this is not stated for three reasons. Firstly, McDonnell has a track record of proposing uncompensated asset seizures.** Secondly, I estimate that the costs to FTSE-100 firms alone will exceed £100bn. This is the case since there are 100 firms in the FTSE-100 of a similar size to Shell and the proposal applies to the much larger group of all companies listed in the UK. The UK Government does not have access to sums of that nature. Finally, it would be extraordinary to fail to mention such an aspect of the policy when discussing it since that would make it much less unjust.
It is important to note that one reason this is a problem is that the new shares will not be paid for. This is one defence against dilution — the issuing of new shares which is detrimental to existing shareholders — under normal circumstances. If a company issues new shares on the stock market, they are sold at market value. The company then owns that cash, and shareholders have a claim on it. Similarly, they have a claim on a share of anything the company does with that cash. Ideally, it will invest it in growing its existing business or starting new ones, and everyone is happy.
The McDonnell proposal does not involve any compensation. So it will just be a dilution of existing shareholders by 10%. Given the forward-looking valuation I will describe below, this means that all existing shareholders will see their share prices decline by 10% immediately. That is why this proposal amounts to an asset confiscation.
Simon Jack, the BBC’s Business Editor, summarises the effects of this disastrous policy as follows:
“workers will not be able to buy and sell the shares – so they won’t really “own” them in a traditional sense. They will be eligible to receive dividends on the shares up to a value of £500 per worker per year. The government gets the rest.
The Labour Party reckons this will raise about £2bn a year. It could end up much more. Let’s take just one company – bumper dividend-payer Shell. Ten percent of its £12bn annual dividend comes to £1.2bn.
If each of its 6,500 UK employees got £500 each (totalling £3.25m) that leaves £1.116bn for the government. That’s just from one company – every year. Wow.”
This clearly means that calling the proposal an Inclusive Ownership Fund is a misnomer since in the case of Shell, the total cost to the company of £1,119.25m would be divided between employees, who would get £3.25m or 0.29% of the cost and the government would get £1,116m, or 99.7%. So in fact the amounts going to employees are irrelevant.
Share valuation is based on fractional ownership of a company — this is why it is called a “share.” This means that if I own a share of a company, I am entitled to a small percentage of the value of that company. If the company has issued ten shares and I own one of them, I own 10% of the company and I can expect to benefit from 10% of it’s future cashflows. Note immediately that it is important to avoid what is known as “dilution.” This, as mentioned previously, is the issuing of large numbers of new uncompensated shares. That dilutes the claims of existing shareholders which is obviously unfair and so this area is highly regulated. It is not legal to dilute existing shareholders; McDonnell’s proposal is dilution on a massive scale. Again, as I mentioned above, this cannot be avoided by buying the shares on the open market unless funding is provided and there is no proposal to provide such funding.
Share valuation must also take account of the fact that shares are a claim on future cashflows. These must be therefore be considered on a Net Present Value (“NPV”) basis, to reflect the fact that money in the future is worth less than money today. This is because in a world of positive interest rates, it is slightly better to have money today than money in a year from now.
For example, imagine you have £90 today and interest rates are 10%. This means you could save the £90 for a year and at the end of a year, you would have £99. Turning this around, we can say that the value today of £99 to be received in a year from now is £90, if interest rates are 10%. We need to discount the values of all future payments by the amount of interest we would receive over the period between now and the time of the payment. So clearly, payments far in the future are worth much less today than payments closer to the present.
Discounting all the future cashflows like this gets you the NPV. A share of a company is worth the NPV of the expected future cashflows. It has to be, because if it moves out of line with that, the market will either buy it or sell it so it moves back in line.
The reason this is a serious problem is that it means proposals to take value away from shareholders in the future cost them money today, since that is how shares are priced.
Before considering some objections to my account, I will finally mention that the effects of this policy could easily avoided by companies if they simply delisted from London. Many large companies already have multiple listings in places other than London, such as New York or Frankfurt. It would be wise to avoid giving them a powerful reason to delist from London, especially give the strong commercial disincentives created by Brexit.
- The Conservatives are in power and Brexit is a disastrous economic policy. (This objection is aimed at showing that Labour is a better choice than the Conservatives on economic grounds.)
- 1.1.True, but irrelevant for two reasons. Firstly, the fact that the alternative is dire does not make this a good policy. Secondly, the Labour Party position is also Brexit plus this share appropriation proposal, which is worse.
- 1% a year for ten years is less than 10%
- 2.1.This is true but extremely minor as an adjusting factor. There is some benefit to not having this policy come in in full immediately, but since shares are valued on an NPV basis, it won’t help much.
- The shares could be sourced from the market and so this would be fine
- 3.1.That would in fact be fine, because it would mean buying the shares from existing shareholders rather than causing them to be issued and diluting existing shareholders. However, as noted above, this is not the proposal, since that proposal would require funding to be provided on an unrealistic scale.
- Some continental companies (e.g. Equinor/Statoil) already do this so it is fine
- 4.1.No, because the cost is already “in the price.” It is fine to sell people shares on the basis that they will only get 90% of the cashflows; it is not acceptable to change a situation in which they paid to own 100% of the cashflows into one where they own only 90% without compensation.
- You would only “lose cashflow” if the company you owned failed to grow by more than 1% a year
- 5.1.False. You lose 10% of whatever the cashflows turn out to be. Currently you own 100% of the cashflows with growth of X and afterwards you own 90% of cashflows with growth of X.
- This will be compensated for by reduction in salaries
- 6.1.False. Firstly, that would likely be contrary to employment law. Secondly, the employees are only getting 0.3% of the funds in the case of Shell, so even if they do compensate for that through reduced salaries, there is no compensation for the other 99.7%.
- The Labour Party claims that the policy only raises £2bn a year so it will be fine
- 7.1.The policy raises £1bn a year just from Shell, which is just one of 100 major companies that are members of the FTSE-100. So it looks as though this policy will raise more than £100bn a year. Either that, or the Labour Party does not understand its own policy, which is another reason to avoid implementing it.
- The cost of the proposal would only relate to UK activity and so would be less than the calculated amount of e.g. £1bn for Shell.
- 8.1.This is not stated and the London listed shares of Shell represent a claim on the value of all global activity of Shell and all of its cashflows. So such a proposal could not be implemented based on shares.
- This will not be so bad because companies can easily avoid it
- 9.1.True. They can delist in London. Why is that positive? Should we not construct policies with some intelligence?
- Shareholders have been stealing from the public purse so this is fine
- 10.1.This objection is at least honest in that it admits that this proposal is theft. It seeks to say that shareholders have unreasonably benefitted from the provision of public goods such as roads and an educated populace. It would therefore require a major economic research programme to back it together with a determinate ethical view. Neither are forthcoming.
I conclude that this is a bad policy. Since pension funds are major shareholders, it would have major negative financial implications for current and future pensioners as well.
** See PFI: The Real Problem with “Bringing the Contracts In-House” Will be the Bonds
— where the proposal is to cancel existing contracts without compensation current holders of bonds (which we know for the same reason as above, it is unaffordable). In addition, the proposal to renationalise water companies involves swapping equity for government bonds. Even if done on reasonable terms, that is a compulsory change of asset class.
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