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The U.K. may overhaul shareholder rules. Companies are not happy.

Democratic candidates for the presidential nomination may wish to take note

- September 11, 2019

Politics in Britain are imploding, and not only because of Brexit. This week, Boris Johnson’s Tory government announced it would be ditching its party’s program of economic austerity and boosting spending on public services to a level not seen in 15 years. On the other side of the aisle, Jeremy Corbyn’s Labour Party has overhauled the 1990s New Labour agenda and outlined a plan to redistribute ownership of companies to the public and workers. Regardless of the eventual outcome of London’s negotiations with Brussels, if Labour wins the next election, Britain’s domestic economic policy may be fundamentally remade.

Economic commentators and reporters have speculated that Labour’s plans could be hamstrung by the U.K.’s international legal commitments. What’s this all about?

Labour’s plan to remake shareholder capitalism

The Corbyn project dates to September 2018, when John McDonnell, Labour’s leading economic policymaker, proposed that British corporations be required to establish “Inclusive Ownership Funds” (IOFs). These would grant employees of large companies 10 percent of their employer’s shares, the right to a share of economic profits, and a voice in corporate governance. The plan would create employee trusts, where employees are granted equity shares collectively as a right of employment, which they do not have to pay for and cannot sell. The funds would give employees a collective voice in electing the board of directors and would ensure that employees participate in the wealth created as a corporation’s shares appreciate.

The economic logic behind the plan is inspired by criticisms of the ideology of “shareholder primacy,” which has governed corporations for decades. Shareholder primacy requires corporate executives to deliver as much value as possible to shareholders, elevating their interests above those of employees and other stakeholders. Shareholder primacy depicts the corporation as made out of contracts rather than human relationships. Advocates of this perspective emphasize market efficiency, and they suggest corporations work best when they’re structured like markets, rather than a set of relationships among different stakeholders such as shareholders, managers, employees, customers, and communities, all with obligations to one another.

Critics blame shareholder primacy for the fact that wages have been flat for typical workers on both sides of the Atlantic, while firms’ reinvestments in themselves have lagged behind. Senators, including Elizabeth Warren (D-Mass.) and Marco Rubio (R-Fla.), have argued that shareholder primacy threatens the economic future of the United States. Even the Business Roundtable has recently issued a groundbreaking statement arguing that a corporation should promote “an economy that serves all Americans.”

Supporters of Corbyn’s plan see it as a bold alternative to shareholder primacy, as well as the policies of economic austerity and bank bailouts that previous Labour governments pursued. Creating inclusive ownership structures would try to build a very different understanding of how businesses operate and what they owe their employees and other stakeholders.

What’s international law got to do with it?

Business groups are not happy with Labour’s plan. Law firm Clifford Chance estimates that adding employee shares will dilute the value of current shareholders’ shares, costing these investors more than 300 billion pounds ($370 billion). Most losses will accrue to investors outside Britain, in the Americas and elsewhere. “The novel (indeed unprecedented) nature of the proposal makes litigation highly likely,” writes the firm, predicting a Labour government would be sued by overseas investors under one of more than 100 international investment treaties or through the European Court of Human Rights system — which operates independently of the European Union and so would be unaffected by Brexit.

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These predictions are not far-fetched. International rules generally require countries to refrain from expropriating shares without compensation, and investment treaties moreover require a fair and equitable investment environment that investment arbitrators have interpreted as requiring unyielding regulatory stability. If Clifford Chance’s clients brought cases against the Corbyn policy and won, the U.K. might be ordered by arbitrators to refund investors the values of their shares and would certainly incur considerable legal costs.

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Would a Labour government have any way around these challenges? It could withdraw from the ECHR, though this may be unpopular with the party’s liberal, pro-human rights base. It may have better options in dealing with investment treaties. These pacts matter primarily because national courts in the U.K. and elsewhere have agreed to enforce them. After a decision is rendered by, say, the private sector London Court of International Arbitration, investors can walk across town and have a public sector British judge attach sovereign assets. That enforcement is what gives the system its punch. As research by Georgetown University’s Nikhil Kalyanpur has shown, London is a central hub for this type of legal activity.

Yet this investment law system has become increasingly controversial in recent years. In the United States, the Trump administration and many of its leading Democratic challengers have criticized investment treaties as offering too much to wealthy interests. Even conservative Chief Justice John Roberts is on the record as criticizing arbitrators’ ability to “sit in judgment” on a nation’s “sovereign acts.” European activists, governments, and judges are also increasingly wary of the system.

Corbyn could mobilize this ferment and leverage London’s importance as an enforcement center to push for fundamental changes to the way investment law works. If Washington, London, and Brussels agreed to shut down foreign investors’ access to national courts until investment treaties’ compensation rules were pared back, Corbyn would gain breathing room to institute his ownership funds plan in peace.

If Johnson’s prospects continue to dim and Corbyn’s rise, expect international investors to ring the alarm bells more fervently, and law firms like Clifford Chance to start vigorously advertising arbitration services to possible clients. Will a transatlantic diplomatic alliance emerge to head them off?

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Lenore Palladino (@LenorePalladino) is senior economist at the Roosevelt Institute and associate professor at the University of Massachusetts at Amherst.

Todd N. Tucker (@ToddNTucker) is a political scientist at the Roosevelt Institute and author of Judge Knot: Politics and Development in International Investment Law (Anthem Press 2018).