Research Policy 35 (2006) 160–180

Corporate governance and innovation: The UK compared

with the US and ‘insider’ economies
Andrew Tylecote a,∗ , Paulina Ramirez b
a Sheffield University Management School, 9 Mappin Street, Sheffield S1 4DT, UK
b Birmingham Business School, University House, Edgbaston Park Road,

Birmingham B15 2TX, UK

Received 27 July 2004; received in revised form 23 September 2005; accepted 27 September 2005
Available online 16 November 2005

Abstract

How well does the UK corporate governance and financial system (CG&FS) support and encourage innovation? Each CG&FS
faces four challenges which vary by sector: novelty, reconfiguration, visibility and spill-overs. High novelty in technologies and
markets requires high industry-wide expertise; need for radical reconfiguration requires strong pressure for shareholder value.
Low visibility of innovation processes requires shareholder engagement; high spill-overs to and from stakeholders require
substantial stakeholder inclusion. The UK CG&FS is rated in these terms against the US and ‘insider’ economies, drawing on
recent fieldwork, and the ratings are shown to account well for the relative R&D intensity and specialisation of UK-owned firms.
© 2005 Elsevier B.V. All rights reserved.

Keywords: Corporate governance and financial system; Technological specialisation; Shareholder engagement; Industry-wide expertise; Stake-
holder inclusion

1. Introduction systems being in the latter category. Other work, like

There has been much comparative work on the
‘national innovation systems’ of the advanced coun-
tries, starting from Lundvall (1992) and Nelson (1993).
Some of it has argued the superiority of one system over
another – thus the distinction made by Patel and Pavitt
(1988) between ‘myopic’ and ‘dynamic’ national
systems of innovation – the Japanese and German
∗ Corresponding author. Tel.: +44 114 2223415.
E-mail address: a.tylecote@sheffield.ac.uk (A. Tylecote).
that of Guerrieri and Tylecote (1997) has rather sought
to explain their specialisation by sector and family of
technology. With the same aim, Soskice (1997, 1999)
counterposes the ‘coordinated market economies’ of
Germany, Switzerland and Sweden and the ‘liberal
market economies’ of the US and UK. He argues that in
the former, the close long-term relations between firms
and a range of stakeholders provide a comparative
advantage in ‘high-quality incremental innovation’ in
established technologies, while as a result of their ‘rela-
tively deregulated institutional frameworks’ the US and

0048-7333/$ – see front matter © 2005 Elsevier B.V. All rights reserved.
doi:10.1016/j.respol.2005.09.004
 A. Tylecote, P. Ramirez / Research Policy 35 (2006) 160–180
UK are strong in radical innovation in newly emerging
technologies, sophisticated internationally competi-
tive services, and large complex systems with rapidly
changing technology. Casper and Whitley (2004)
show how similar distinctions among economies can
explain their specialisation within two sectors.
Less has been written on the narrower issue of the
effect of national systems of corporate governance and
finance on innovation. (‘Corporate governance’ is here
understood as the system by which companies are con-
trolled and directed, and made accountable to share-
holders and other stakeholders.) Some have clearly
favoured one broad type of corporate governance and
finance system over another. Lazonick and O’Sullivan
(1996) argue that because innovation is a collective
and cumulative activity in firms, it requires a con-
siderable degree of immobility on the part of finance
(and labour), and thus organisational integration and
financial commitment. Successful nations – like Japan
and Germany recently and the United States earlier –
have had institutions which promoted these conditions.
Others argue, instead, that different systems of corpo-
rate governance and finance suit different industries.
From outside the NIS framework, Carlin and Mayer
(2000) explain the specialisation of 14 OECD countries
in terms of their financial and corporate governance
systems. From inside it, Christensen (1992), OECD
(1995), Tylecote and Conesa (1999) and Casper and
Matraves (2003) have pursued a similar aim.1
Such work should not be seen as some kind of bid
for dominance of the NIS framework. It may be equally
valid to use differences in labour market institutions as
a ‘first cut’ explanation (Bassanini and Ernst, 2002);
nor should it be surprising if patterns of difference
from one point of view resemble those from another.
It is at all events reasonable, when discussing capital-
ist systems, to pay attention to capitalists. Moreover
it may help in addressing an increasing difficulty with
the national innovation systems approach: that as large
firms are increasingly multinational, if not yet global,
innovation is less and less a national matter. However,
multinational it may be, a firm will almost always have
roots in one national system of corporate governance
1 Lundvall (2002) comes to a similar conclusion in his work on
Denmark: “Governance regimes – the role of ownership and finance
in managing the firms – affect the intensity but also the direction of
the transformation pressures” (p. 5).
161
and finance.2 If the CG&F system of country A suits
sector X then we may expect firms based in A to be
strong in X. This argument may be complementary to
one starting from labour markets, which would lead
rather to a prediction of the country in which the pro-
duction of X would be located.
The purpose of the present paper is to examine the
UK corporate governance and finance system and the
way it is changing, and to show how this can explain key
features of UK performance and specialisation. Section
2 sets out briefly what industry requires from the finan-
cial and corporate governance system for successful
innovation, using a modified version of Tylecote and
Conesa’s (1999) framework. Section 3 reviews the lit-
erature on the UK system by comparison with other
advanced economies, particularly the United States.
Section 4 presents the findings of the authors’ field-
work, involving interviews with a range of senior man-
agers in institutional investment houses of the City of
London, and senior managers in innovative firms in
science-based sectors. The fieldwork, consisting of 14
interviews, cannot test any propositions about the UK
financial system: it was designed to help develop a
hypothesis about the UK financial and corporate gov-
ernance system. As such it was in the relativist research
tradition (Easterby-Smith et al., 2002) and forms part
of a ‘triangulation’ with the literature described in Sec-
tion 3 and the account given in Section 5. Section 5
shows how the characterisation of the UK CG&F sys-
tem can help to explain the pattern of specialisation
of UK-based firms. Section 6 concludes, with reflec-
tions on the implications for future UK performance
and policy.
2. Industry’s requirements from the financial
and corporate governance system for successful
innovation
2.1. Challenges and requirements
We shall assume that innovation poses at least four
challenges for corporate governance and financial
2 Two important exceptions are the Anglo-Dutch firm Unilever and
the new ‘Airbus’ firm EADS, incorporated in the Netherlands but not
really based there.
162 A. Tylecote, P. Ramirez / Research Policy 35 (2006) 160–180
systems, each of which they can meet, given the
appropriate capabilities or characteristics:
• The novelty of innovation: How far does a product or
process of innovation involve, or need, radically new
ways of organising its development or production,
radically new technologies, and/or radically new
markets or selling methods? High novelty demands
high industry-wide expertise among controllers and
financiers. If in the face of high novelty they do not
have such expertise – a good understanding of the
relevant technologies and markets, including ones
not yet used or entered – they will not be able to
evaluate management’s plans and strategies compe-
tently, and provide or refuse support and funding
accordingly.
• The need for reconfiguration: To what extent does
the organisation of the firm need to be reconfigured
in order to succeed in innovation? As Teece and
Pisano (1998) argue, ‘in rapidly changing environ-
ments, there is . . . value in the ability to reconfigure
the firm’s asset structure and to accomplish the nec-
essary internal and external transformation’ (p. 201).
Radical reconfiguration will naturally meet strong
resistance from within the organisation; this resis-
tance can most readily be overcome where there is
strong pressure for shareholder value.3
• The visibility of innovation: How easy is it for con-
trollers or financiers not closely involved in manag-
ing the development of a new product or process,
to judge what resources are being devoted to it, and
how efficiently? The lower the visibility, the more the
monitors need firm-specific perceptiveness, which
can be developed through engagement with the
firm.
• The appropriability of innovation: Can the firm
ensure straightforwardly (for example, by patents)
that the bulk of the returns on it accrue to the share-
holders; or does innovation in the industry naturally
tend to involve large spill-overs to, or from, other
stakeholders? The latter case, of low appropriability,
can be met by some form of stakeholder inclusion:
formal or informal arrangements which (at best) give
3 Soskice (1999) refers to the extent that industrial relations sys-
tems facilitate ‘unilateral control by top management’—which would
remove a constraint to reconfiguration. Our emphasis on shareholder
pressure for reconfiguration is complementary to this.
stakeholders influence over the firm (and vice versa)
while ensuring some proportionality between the
inputs from and benefits to each party.4
Sectors vary in the intensity of these challenges. The
following pair of propositions offers a simple ‘first cut’
(to be modified later):
1. High-technology sectors have high novelty and need
for reconfiguration.
2. Medium-technology sectors have low visibility and
appropriability.
High-technology sectors are defined by their high
R&D intensity: aerospace, pharmaceuticals, office,
accounting and computing machinery, radio, televi-
sion and telecommunications equipment, and medical,
precision and scientific instruments, from the OECD
classification of manufacturing industries, plus soft-
ware and IT services (Table 1). Other things being
equal, it is reasonable to take their high rate of R&D
as both an indicator and a cause of high novelty and
need for reconfiguration: they are changing fast. (We
shall exclude the smallest, medical (etc.) instruments,
because of data difficulties.)
Under ‘medium’ technology we are only concerned
with four of the five ‘medium-high-technology’ sec-
tors in the OECD’s classification: electrical machinery,
motor vehicles, chemicals excluding pharmaceuticals,
and machinery not elsewhere classified.5 Within ser-
vices we add telecommunications: among the service
sectors its R&D intensity is next after software and
IT services. Again, their lower R&D intensity suggests
that these sectors are changing less rapidly and less rad-
ically (though see below). In that case we can predict
that their progress will be more incremental and as such
more likely to involve the cumulation of knowledge
among the existing workforce, and the exploitation
of cooperative relationships with established suppliers
and customers.
The ‘first cut’, if accurate, would combine neatly
with a second pair of propositions about corporate gov-
ernance and financial systems—again no more than a
4 The accepted means of dealing with appropriation problems is
that of Teece (1986). For an explanation of the differences in our
formulation of the problem and its solution, see Tylecote (2005).
5 We exclude railroad equipment and transport equipment n.e.c. as
a small sector which is very much a special case.
 A. Tylecote, P. Ramirez / Research Policy 35 (2006) 160–180
Table 1
High-technology and medium-high-technology industries and their R&D intensity
ISIC Rev.3
High-technology industries
Aircraft and spacecraft 353
Pharmaceuticals 2423
Office, accounting and computing machinery 30
Radio, TV and communications equipment 32
Medical, precision and optical instruments 33
Software and IT services 72
Medium-high-technology industries
Electrical machinery and apparatus, n.e.c. 31
Motor vehicles, trailers and semi-trailers 34
Chemicals excluding pharmaceuticals 24–2423
Machinery and equipment, n.e.c. 29
Telecommunications services 642
Source: OECD (2001), Annexe 1.1, except for software and IT services, and telecommunications services, for which the data is from DTI (2001)
and relates to the average R&D intensity in 2000 of the largest world companies in the sector (numbering 36 in software and IT services, and
13 in telecommunications). The production/value added figure is calculated from the two previous columns.
first approximation, to be examined and justified or
where appropriate revised later:
1. ‘Outsider-dominated’ systems such as those of the
UK and US generate high industry-wide expertise
and pressure for shareholder value.
2. ‘Insider-dominated’ systems, at least the ‘stake-
holder capitalist versions’ of Germany and Japan,
display high engagement and stakeholder inclusion.
We would then, expect the UK and the US to be
strong in high-technology sectors and Germany and
Japan to be strong in medium-high-technology. This
is generally the case – see, for example, the manufac-
turing trade balances in OECD STI Scoreboard 2001 –
but it is a familiar prediction, being made, more or less,
by Soskice (1997) and Carlin and Mayer (2000). Mat-
ters are, however, not so simple. In the next section, we
reconsider the characterisation of the UK CG&FS. In
the rest of this section, we reconsider our categorisation
of sectors.
2.2. A revision of sectoral stereotypes
Novelty and need for reconfiguration are not simply
a function of R&D intensity. There may be high R&D
spending along an established trajectory of change; or
a complete paradigm shift in which all the rules of
the game are rewritten and only new firms, or firms
163
R&D/production, R&D/value added,
1997 (%) 1997 (%)
12.7 36.5
11.3 25.4
10.5 39.7
8.2 19.9
7.9 20.6
14.3
3.8 10.3
3.5 13.4
2.6 7.9
1.9 5.0
1.8
prepared to make radical organisational and technical
changes, will prosper. The most pervasive paradigm
shift of the last 30 years has been the advent of the
information and communication technology ‘techno-
economic paradigm’ (Perez, 1983; Tylecote, 1991;
Freeman and Louça, 2001) which has left no industry
unaffected but has naturally had most effect on those
which make ICT’s tools: office, accounting and com-
puting machinery, and radio, television and telecom-
munications equipment. Bioinformatics is now hav-
ing profound effects on pharmaceuticals, but the main
paradigm shift to affect this sector is one of equal depth
though narrower scope, biotechnology (Ramirez and
Tylecote, 2004). The high-technology industry least
affected by a change of paradigm(s) appears to be
aerospace. Of course ICT has affected it, but there is
a striking continuity of physical configuration, so far
as the product is concerned: planes continue to have
fuselages, wings and tails of similar shape and made
from similar materials to those of 40 years ago and to be
powered by jet engines which have changed only incre-
mentally in that time. As for process change, it was in
aerospace that numerically controlled and computer-
numerically controlled machine tools were first intro-
duced, in the 1950s (Freeman and Louça, 2001), and it
has now had ample time to digest that shift.
There is no reason to suppose that any of the
medium-high-technology industries has gone through
164 A. Tylecote, P. Ramirez / Research Policy 35 (2006) 160–180
any paradigm shift comparable to the three sec-
tors above. The automotive sector is like aerospace
only more so in its physical continuity, though in
terms of process change the advent of CNC machine
tools and associated changes has been rather more
recent (Womack et al., 1990).6 Biotechnology has not
really affected chemicals yet, though it is expected
to do so soon (Swan, 2001). Machinery necessar-
ily moves with its users, which is to say mostly
incrementally, apart from the particularly advanced
machinery included in the high-technology sectors.
So there is only one change in category to make,
in manufacturing: aerospace belongs more with the
more smoothly changing medium-high-technology
sectors.
Visibility and appropriability were argued to be
higher in high-technology. They are, but most in
pharmaceuticals, which has a relatively effective
system of patent protection (Archibugi and Pianta,
1996; Mansfield, 1986), and its innovation process
is uniquely tightly regulated by government. Con-
sequently it is relatively safe for management to
be communicative to shareholders in the later, more
expensive stages of product development (Ramirez
and Tylecote, 2004). The high-technology manufac-
turing sector which appears to be least visible is
aerospace, which is heavily dependent on military
orders, and so must be extremely secretive about
innovations.
There remain the two service sectors, software and
IT services, and telecommunications. Both are diverse.
Telecommunications divides into fixed line and mobile,
which has come from nowhere in 20 years. Fixed line
has been changing rather fast in process and prod-
uct (the main new product being the internet) but the
changes could still be described as incremental from
an organisational point of view. In order to prosper in
mobiles, it can be assumed that radical reconfiguration
would have been required—from the pre-mobile con-
figuration. Software and IT services need to be looked
at separately; the former having the higher R&D inten-
sity. Casper and Whitley (2004) distinguished between
6 Harnischfeger (2003) claims there has been a ‘massive paradigm
shift’ in the car industry, largely consisting of ‘the growing impor-
tance of brand image against technology’ (p. 5). While significant,
this does not appear to be of comparable magnitude to the convul-
sions in most of the high-technology sectors.
standard (or application-based) software, middleware
and enterprise software.7 They find that standard soft-
ware, which is created for large homogeneous mar-
kets, has high ‘competence destruction’ through rad-
ical innovation, but limited ‘appropriability risks’—it
is relatively easy to protect through some combina-
tion of patent/copyright protection, secrecy over its
‘source code’, and lock-in effects once successful. This
clearly is a sub-sector requiring radical reconfiguration
and little ‘nurturing of cumulative shop-floor knowl-
edge and long-term customer–supplier relationships’.
At the other extreme is enterprise software, with limited
competence destruction but high appropriability risk,
due to relatively weak intellectual property regimes.
The opposite conclusion follows. Middleware is in the
middle: ‘radically innovative’, with low technologi-
cal cumulativeness, and with limited appropriability
risk. But unlike standard software it has an inter-firm
co-ordination problem because it must integrate inter-
dependent kinds of knowledge provided by different
firms. Trusting relationships are therefore very valu-
able, particularly with large firms which dominate a
technology cluster.8 Casper and Whitley do not deal
with IT services, but they would appear to have at least
as much need as enterprise software for long-term trust-
ing relationships with customers and the workforce:
their IP regime is presumably even weaker, the intellec-
tual property residing almost entirely in their employ-
ees’ heads. Nor is competence destruction likely to
be stronger, since much of the competence resides in
7 Standard software includes graphic application software (e.g.
CAD/CAM), multimedia and computer entertainment software, and
a variety of application software used to run computer networks, such
as email and groupware. Middleware includes secure payments sys-
tems used in e-commerce, and search engines used for navigation on
the web. Enterprise software is extensively customised for individual
clients. It includes enterprise resource planning and customer rela-
tionship management products as well as sector-specific enterprise
tools such as logistics and supply chain management tools (Casper
and Whitley, 2004).
8 Berggren and Nomura (1997) make a cruder distinction between
packaged and customised software, which is similar to Casper and
Whitley’s between ‘standard’ and ‘enterprise’. Much ‘customised’
software is produced in-house by hardware producers as part of com-
plex industrial and technical equipment. Other software is embedded
in consumer products, such as camcorders. It is thus not surprising
that whereas the US dominates in packaged software, ‘in . . . com-
plex technical system engineering . . . there are no signs of a Japanese
software lag’ (Berggren and Nomura, 1997, p. 178).
 A. Tylecote, P. Ramirez / Research Policy 35 (2006) 160–180
Table 2
Types of corporate governance and financial system
Share of control-oriented finance
Financial markets
Share of all firms listed on exchanges
Ownership of debt and equity
Investor orientation
Use of mechanisms for separating control and capital base
Dominant agency conflict
Role of board of directors
Role of hostile take-overs
Source: Berglöf (1997), pp. 93–123, Table 1.
understanding customer needs and the organisational
difficulties of getting IT to suit them.
3. The UK system of finance and corporate
governance: a classic case of
outsider-domination
3.1. Insider-dominated versus outsider-dominated
systems
There is a well-known distinction between ‘insider-
dominated’ corporate governance and finance systems
and ‘outsider-dominated’ ones; alternatively ‘control-
oriented’ and ‘arms-length’ systems (see, for example,
Jenkinson and Mayer, 1992; Mayer, 1996; Berglöf,
1997). The UK and USA, with the other English-
speaking countries, are usually portrayed as the only
clear-cut outsider-dominated systems. The East Asian
and Continental European countries are all treated as
in some degree insider-dominated systems. We abbre-
viate Berglöf’s summary of the differences in Table 2.
There is clearly a close link between these corporate
governance and finance types and the characteristics
which we have identified as key for funding and con-
trolling innovation:
1. The arms-length/outsider-dominated type will tend
to inhibit shareholder engagement, and thus
the development of firm-specific perceptiveness.
Where firms are constantly exposed to takeover they
will find it difficult to make a credible commitment
to a co-operative relationship with stakeholders. On
the other hand, this exposure, and the other pres-
sures of stock markets, may be expected to engender
165
Type of financial system
Control-oriented (insider-dominated) Arm’s length (outsider-dominated)
High Low
Small, less liquid Large, highly liquid
Small Large
Concentrated Dispersed
Control-oriented Portfolio-oriented
Frequent Limited (often by regulation)
Controlling vs. minority shareholders Shareholders vs. management
Limited Important
Very limited Potentially important
strong pressure for shareholder value. The existence
of large, highly liquid stock markets gives the incen-
tive and opportunity for financial institutions oper-
ating within them to develop industry-wide exper-
tise. This applies to what are called the ‘buy-side’
institutions—the pension funds, insurance compa-
nies, and mutual funds (which own shares) and the
‘asset management houses’ which manage invest-
ment portfolios for them. These institutions are
likely to own shares in several firms in a sector, and
thus to have good use for industry-wide expertise,
i.e. an understanding of the sector as a whole, in
deciding their choice of investments. The incentive
is even greater for the ‘sell-side’ – the major stock-
broking houses – because they will be buying and
selling shares (and advising on whether to buy or
sell) right across a sector.
2. The insider-dominated type almost by definition
involves shareholder engagement, and thus the
development of firm-specific perceptiveness. The
stability of ownership and control characteristic of
insider-domination gives at least the opportunity to
commit to stakeholder inclusion. On the other hand,
insider control carries the risk of ‘going native’: of
acquiring the mind-set and prejudices of manage-
ment to the point where pressure for shareholder
value is inadequate to force through organisational
reconfiguration.9 Further, insider shareholders with
controlling stakes in one firm cannot be involved
9 This does not mean that the reconfiguration will not take place
at all. It may well take place a few years later than in an ‘outsider-
dominated’ firm, driven by competition with already-reconfigured
firms, and the force of their example. This was what we heard from
(for example) German managers with respect to IT outsourcing.
166 A. Tylecote, P. Ramirez / Research Policy 35 (2006) 160–180
with its rivals across the sector without breaching
anti-trust rules, so they are less likely to have an
industry-wide view of technologies and markets.
The outsider/insider dichotomy is a powerful
explanatory tool, but we have to ask for each country
how far it conforms to its stereotype.
3.2. The evidence on ‘outsider-domination’ in the
UK and US corporate governance and finance
systems
A stock market listing can be taken as neces-
sary, though not sufficient, for a firm to be ‘outsider-
dominated’. Unlisted firms are almost always con-
trolled by one individual, partners, or a family. Thus, a
first indicator of ‘outsider-domination’ is a high stock
market capitalisation as a percentage of GDP. In both
the US and the UK this is well above the average, but
it is lower in the US—as of 1997, 121% as against
151% in the UK (Casper and Whitley, p. 96). This,
and the much higher proportion of individual share-
holdings in listed firms (48% in the US, 19% in the
UK, as of 1993 (Berglöf, 1997)) suggests that US firms
are younger, on average, and thus in more of them the
insiders have not had time to lose interest and go pub-
lic, or sell out to a larger firm; and/or that controlling
families are more inclined to hold on to control. Both
appear to be true, and to relate to large firms which are
listed, as well as smaller ones which are not. The UK
has nothing to match huge young firms like Microsoft
and Cisco, nor much older firms like Ford, still firmly
under family control. British family owners have shown
themselves uniquely willing to give up control (Burns
and Whitehouse, 1996; Franks et al., 2003).
Insiders need not only be individual entrepreneurs
or their family heirs. Neither in the US nor the UK do
the classic financial insiders, the banks, have a signif-
icant direct role in ownership and control, but in both
countries an important role is played by private equity
firms—investing in large control-oriented equity stakes
on behalf of other financial institutions like pension
funds. A subset of private equity is venture capital:10
private equity put into new or young firms in high
10 Confusingly, venture capital is generally taken to include buy-
out capital, in Britain and Europe. We use the term in the strict and
narrow American sense.
growth (normally high-technology) sectors. Most of
the rest is buy-out capital: equity invested in existing
listed firms, or divisions of them, in order to take them,
for a time, out of the stock exchange.
Venture capital has played a key role in the develop-
ment of US high-technology industry: in 2003 venture
capital-funded (‘ventured’) companies accounted for
9.4% of private sector employment overall, but 88%
of employment in computer software (Global Insight,
2004). Ventured firms, adjusted for size, spent over
twice as much on R&D as non-ventured firms. The
fifth, seventh and eighth-largest spenders on R&D
in 2001 (Microsoft, Cisco and Intel) are ‘ventured’
firms.11 Venture capital is mainly responsible for the
remarkable rise in the proportion of R&D performed
by firms with below 500 employees, from 5.9% in 1984
to 20.7% in 2003 (Global Insight, 2004). The radical
innovations which are a recurrent feature of the devel-
opment of high-technology sectors, are competence-
destroying, and as such bound to be fiercely resisted
within established firms. New firms can carry them
through without internal resistance, as for example,
Intel and Apple did in their day—but they need to raise
large amounts of capital, without the collateral which
banks usually require or the track record on which both
banks and stock markets insist. Only individuals and
organisations capable of making an expert assessment
of the competence of the entrepreneurs and the techno-
logical and commercial feasibility of their projects can
provide such capital. Such capability is, or rather may
be, possessed by venture capitalists.
US venture capitalists expect to share in governance
as well as finance. ‘It is the venture capitalists’ experi-
ence, connections and willingness to become involved
that differentiate them from other sources of capital’
(Kenney et al., 2004, p. 56). They always provide one
or more non-executive directors, and these directors
sometimes continue to serve long after the IPO (initial
public offering, on the stock market) gives them
the opportunity to sell out (Kenney et al., 2004).12
11 The first and sixth are Ford and Motorola, family controlled firms.
Thus, five of the top eight R&D spenders are in some sense insider-
dominated firms.
12 Arthur Rock, the lead venture capitalist in funding Intel, remained
on its board for two decades. Donald Valentine, who did the same for
Cisco, was still on its board more than a decade after it went public
(Kenney et al., 2004, note 7).
 A. Tylecote, P. Ramirez / Research Policy 35 (2006) 160–180
Involvement cannot be at long range: thus, US venture
capital and the firms which have developed with its
help are locally concentrated, in the Silicon Valley
area of California round Stanford University, on Route
128 in Massachusetts, and in parts of Texas (Bank
of England, 1996; Global Insight, 200413 ). (Venture
capital firms, at least in the US, are not themselves
‘outsider-dominated’, it should be noted. ‘Venture
capital firms generally are private partnerships or
closely held corporations. . .’ (Global Insight, 2004,
p. 2). This is in addition to the ‘business angels’ who
provide ‘informal’ venture capital and are wealthy
individuals.)
The UK, having a similar financial system, was the
quickest to follow the US lead, and even in 2000 was
still providing the largest venture capital investment
into high-technology in Europe (European Innovation
Scoreboard, 2001), with 49% of the European venture
capital industry (Crossley, 2001). Its preponderance
in Europe is similar in private equity (BVCA, 2004).
The evaluation of British venture capital and private
equity depends very much on the direction of com-
parison. In size as a proportion of the economy, and
experience, which is largely a matter of time, it is supe-
rior to its rivals everywhere outside the United States.
On both counts it is far behind the United States, and
this is particularly true for the less easily measured
but vital contribution of ‘business angels’—individuals
who usually make the first external investment (Bank
of England, 1996; Gill et al. 200014 ).15
A further difference between the two countries is in
company law. The centralised UK has one set of laws
relating to corporate governance; the US has a set for
each state. Firms can choose in which state to incor-
porate, and most large firms have chosen Delaware,
because its laws are unusually favourable to incum-
13 VC-backed firms with HQs in California, Texas and Mas-
sachusetts accounted for 45% of total employment in VC-backed
firms in 2003. However, the fastest rate of growth of employment
was in VC-backed firms headquartered in Pennsylvania, Georgia,
Tennessee and Washington State, which accounted for a further 22%.
Thus, two-thirds of employment was in firms based in seven states.
14 As of 1999, there were more than 50,000 ‘accredited investors’
– business angels – in the Seattle area alone. In the whole of the UK
at the same point there were 18,000 (Gill et al., 2000, p. 24).
15 The US also has specialist banks willing to work alongside ven-
ture capitalists and provide significant debt finance; the UK does not
(Gill et al., 2000, p. 3).
167
bent management, notably in permitting various anti-
takeover devices (Roe, 1994). There is nothing in US
laws (even Delaware’s) which prevents insiders, such
as families, maintaining control: but it is easier to
resist outsider shareholder pressure when incorporated
in Delaware than incorporated in the UK. Such Fed-
eral legislation as applies – notably the 1933 Federal
Securities Act – is decidedly less favourable to outsider
shareholders than the corresponding British legislation
(Bush, 2004).
Not only is the US a far less perfect case of outsider-
domination than the UK: it also displays a good deal of
stakeholder inclusion, specifically employee inclusion.
Like many other differences between the two countries,
this is concealed by some obvious similarities. Neither
country has any sort of co-determination legislation:
employees per se do not have control rights. While all
the insider systems in some sense share the view that
firms are not simply commodities to be bought and
sold, that is precisely what they are, according both to
UK and US law and custom (Kay and Silberston, 1995;
Wymeersch, 1994). Accordingly, the UK lags behind
other members of the EU in worker participation. As of
the late 1980s ‘the UK is alone in the European Com-
munity in not having a formal institutionalised system
of industrial democracy at company level’ (CEC, 1990,
p. 162). Largely in consequence the UK was rela-
tively poor in participation in planning for new tech-
nology (p. 121). There is however nothing to prevent
employees being, or becoming, shareholders—a form
of inclusion with the additional merit that (if it goes
far enough) it may provide employees with an incen-
tive to go along with reconfiguration. “Whether it is
direct co-operation, full or shared ownership, there is
no doubt that employee commitment is enhanced by
such arrangements” (Wheeler and Sillanpää, 1997, p.
69). Indeed, some studies (e.g. RSA, 1995) have found
a significant relationship between employee ownership
and profitability.
In the US, massively, employees are shareholders:
in young high-technology firms largely through the
use of stock options or direct share distribution in lieu
of high pay. It is standard practice in venture capital-
backed firms to use stock option plans to motivate all
workers (Global Insight, 2004). About 3 million non-
executive employees (about 3% of the private sector
workforce) receive stock options on an annual basis
(Blasi et al., 2003b). Employees are shareholders in
168 A. Tylecote, P. Ramirez / Research Policy 35 (2006) 160–180
older firms mainly through tax-supported schemes like
Employee Stock Ownership Plans (ESOPs) (Blasi and
Kruse, 1991; Walkush et al., 1997). (Delaware law
allows ESOP shares, with employee permission, to be
deployed in management’s support during a takeover
bid.) In total 24.1 million workers, that is about 23% of
the total US private-sector workforce, were in 2002
involved in some sort of stock ownership plan giv-
ing them share stakes in their own firms.16 The stakes
which have been built up are substantial. Fifty-five
percent of stock option plans had produced employee
(non-executive) shareholding over 10% (Blasi et al.,
2003b). In 100 large high-technology firms examined
by Blasi et al. (2003a), in addition to the 14% of shares
held on average by top management, 19% were held by
other employees. Thirty-eight percent of public com-
pany ESOPs and 80% of private company ESOPs had
built up non-executive employee shareholdings over
10% (Blasi et al., 2003b).
As with private equity the UK is following the
US—but here, even further behind. In the mid-1990s,
the percentage of work sites with employee owner-
ship in the UK was 11%. On the Continent of Europe
that percentage ranged from 1% (France and Sweden)
through Italy (2%) and Germany and the Netherlands
(3%) to Denmark (5%) (Blasi et al., 2003b). However,
in the UK the number of ESOPs – the form most rele-
vant to corporate governance because they are capable
of giving some power to the employees – was very
small, around 100 in the late 1990s, as against more
than 6000 in the US (Poutsma, 2000; Robinson et al.,
2002).
Cross-holdings between firms can indicate merely
a form of insider-control, or a type of stakeholder
inclusion—bolstering inter-firm relationships, notably
with suppliers and customers. While in 1993, the per-
centage of shares in listed stocks held by non-financial
firms was 21, 39, 22 and 28 in France, Germany,
Italy and Japan, respectively, it was 9 in the United
States and 2 in the UK (Berglöf, 1997). Comparative
studies (Lane, 1989; Sako, 1994) find buyer–supplier
relationships in the UK tenuous and essentially short-
term and contractual in nature. Cooke and Morgan
16 3.4 million were involved in ESOPs. Most of them, 13.6 million,
were involved in 401Ks, tax-sheltered retirement savings plans to
which both employee and employer contribute. 4.8 million were in
KSOPs, hybrids between ESOPs and 401Ks (Blasi et al., 2003b).
(1998) analyse and indict the poor quality of inter-
firm relationships in Britain in the food processing
industry:
“With some notable exceptions . . . British firms dis-
play the same kind of low-trust, short-term ethos in
dealing with their suppliers in manufacturing as the
City [of London, i.e. the financial institutions] does to
manufacturing in general . . . An inquiry into the trade
gap [of more than £3 billion, in food products and
beverages] found that one of the key factors was the
lack of collaboration between producers, processors,
and retailers . . . weak inter-firm networks . . . pervade
the food chain in Britain.” (Cooke and Morgan, 1998,
pp. 138–140).
Cooke and Morgan take this sector to be typi-
cal; so do we. Cantista and Tylecote (2003), in a
study of relationships with suppliers and customers
in the UK fine chemicals and electrical equipment
industries, found a correlation between the quality
of relationships, and the ownership status of the
firm: UK firms listed on the stock exchange were
more likely to have loose, low-trust relationships
than subsidiaries of Continental firms or unlisted UK
firms.
3.3. The nature of outsider-domination in the UK
system
To an extent unique among major economies,
non-bank financial institutions dominate British share
registers. As of 1993, Berglöf (1997) found that
British financial institutions owned 62% of listed UK
stocks, up from 36% in 1969 (against 37% in the
US, up from 28%) and the ‘foreign owner’ share
of 16% (as against 6% in the US) would have
included a substantial stake by foreign financial insti-
tutions. Charkham (1994, Table 3.11) shows that in
the UK (as in the US) the shareholdings of banks
are negligible, and those of other financial insti-
tutions break down (as of 1989/1990) 33:53:13 in
the UK (compared to 14:69:17 in the US) between
insurance companies, pension funds and mutual
funds.
One can distinguish two post-war eras in UK corpo-
rate governance. The first, during the 1950s and 1960s,
was the era of management control, in which share
ownership was fragmented, family owners had largely
given up trying to maintain control over large firms, and
 A. Tylecote, P. Ramirez / Research Policy 35 (2006) 160–180
the financial institutions had not yet begun to play any
important role. This was a time of generally slack man-
agement (to judge by the slow rate of growth of produc-
tivity) but quite high R&D spending, by international
standards. During the 1980s (after a transition) came
the era of indirect owner-control, in which the dominant
shareholders were institutional and they exercised a sort
of control by paying close attention to financial results
of firms and being prepared to sell their shares to hostile
bidders if the offer price was right (see Demirag et al.,
1994).
The second era displays an outsider-dominated
financial system, par excellence. As a result of the
institutional investors’ historical position in the UK
stock market, they were unlikely to show an active
interest in their investee companies; indeed, “... insti-
tutions used not to take much interest in corporate
governance. They tried to achieve their target perfor-
mance by buying and selling shares, relying on their
judgement of the underlying strength of companies and
their ability to exploit anomalies in share prices. Insti-
tutions tended not to vote their shares regularly, and
to intervene directly with company managements only
in circumstances of crisis” (The Hampel Report, 1998,
s5.2).
This era saw a fall in business-financed R&D spend-
ing and strong ‘short-term pressures’ on most firms
and industries, particularly those (like engineering)
in which, in our terms, visibility is low. Since the
1960s, when the UK was one of the biggest spenders
internationally (before the present inhibiting CG&FS
regime took shape), there has been a steady and con-
tinuing decline in the UK’s business-financed R&D
intensity (expenditure relative to turnover) relative to
its main competitors. It continued during the 1990s
(Fig. 1). As a result business-financed R&D inten-
sity was by 1999 below the OECD average and well
below that of such key rivals as Germany and the
USA (Fig. 2). Yet one would expect that a system that
encouraged specialisation in high-technology sectors
(which by definition have high R&D intensity) would,
other things being equal, encourage R&D expendi-
ture. Such appears to be the case in the United States,
which has a significantly higher level and a slightly
higher rate of growth of business-financed R&D expen-
diture than the OECD average. (Across a number
of R&D-based sectors, the UK’s rate of spend on
R&D plus Capex (fixed capital expenditure) is less
169
than half that on acquisitions; the rate of spend in
the same sectors in the US is well above that on
acquisitions (DTI, 2004).)17 The poor British perfor-
mance, like the good US performance, is however well
explained by our more nuanced characterisation of
the two countries’ corporate governance and financial
system.
How far have we now moved on to a third era in
which the outsiders have moved to some extent inside
and are vigorously intervening in corporate gover-
nance? Certainly, an increasing concentration of own-
ership has increased both the ability and incentive for
activism. As the proportion of shares held by institu-
tional investors has increased, so has the proportion
of the market held by a select number of institutional
investors. Eleven percent of the UK stock market was
owned by the three largest institutional investors in
1996. The largest institutional stake in the top 10
FTSE100 companies ranged from 12 to 22% (Mallin,
1999).
The larger the absolute value of an institution’s stake
in a firm, the more it will gain from a given improve-
ment in performance. Moreover the larger the percent-
age stake, the easier it will be to get the management
to listen to it; and the harder to sell the stake without
lowering share prices:
“The proportion of shares which [institutions] own has
increased, and it is more difficult for them to sell large
numbers of shares without depressing the market . . ..
As a result, some institutions now take a more active
interest in corporate governance. They can do this by
voting on resolutions in General Meetings, and infor-
mally through contact with the company” (The Hampel
Report, 1998, s5.3).
But what the more general studies of corporate gov-
ernance have not examined, is the understanding shown
by such investors of firms’ policies with respect to inno-
vation and technological change.
17 The link between pressures from shareholders and spending on
R&D is confirmed by a study by Pugh et al. (1999) which finds for
the US that adoption of an Employee Stock Ownership Plan (ESOP),
which is a form of anti-takeover protection, is followed by R&D
increases.
170 A. Tylecote, P. Ramirez / Research Policy 35 (2006) 160–180

Fig. 1. Evolution of gross domestic expenditure on R&D. Average annual growth rate for 1991–1999 (Source: OECD (2001), A.2).

4. How the British financial and corporate
governance system impacts on innovation
4.1. New evidence on behaviour with respect to
innovation
Between autumn 1998 and summer 2000 the authors
conducted semi-structured interviews with:
• six senior managers of City institutions (three of the
top 10 institutional investors, two of the top 10 stock-
brokers, and the Association of British Insurers);
• six senior managers of UK-based high-technology
firms, all but one listed (one in chemicals, two in
pharmaceuticals, and one in electronics); the posi-
tions occupied being chairman (ex-CEO), R&D
director (two), finance director (CFO), and head of
corporate affairs (two).
The interviews and our interpretation of them are
discussed in detail in Ramirez and Tylecote (2004) and
Tylecote et al. (2002). Here the insights gained are
summarised under two headings: shareholder under-
standing and intervention; and outcomes in terms of
pressures on management.
 A. Tylecote, P. Ramirez / Research Policy 35 (2006) 160–180 171

Fig. 2. R&D intensity (Source: OECD (2001), A.2).

4.2. The quality of shareholder understanding –
industry-wide expertise and firm-specific
perceptiveness – and the circumstances in which
shareholders intervene
All agreed, shareholders were better informed than
5 or 10 years earlier. As argued in Tylecote and Conesa
(1999), a key advantage of the outsider-dominated US
and UK systems in coping with high novelty is that
the ‘industry analysts’ who advise outsider investors
take an industry-wide view which allows them to build
the maximum industry-wide expertise. The industry
managers were agreed that the analysts were getting
steadily better—but they rated US analysts higher:
more interested in and better-informed about longer-
term technology and market issues as opposed to short-
term financial outcomes. The US advantage was agreed
to be much greater on the ‘buy side’ (the institutional
investors themselves) than on the ‘sell side’ (the stock-
brokers on whom the investors frequently depend for
advice as well as for transactions in shares). This was
unsurprising given the view expressed by the senior
City managers: they saw no need for their fund man-
agers or analysts to have a background in the industry or
any relevant technical qualification—indeed any tech-
nical qualification at all. Instead they saw it as their
172 A. Tylecote, P. Ramirez / Research Policy 35 (2006) 160–180
job mainly to ‘filter information’ from analysts in the
broking houses, many of whom did have appropriate
qualifications.
The problem with such dependence is that in
their nature the sell-side analysts will have industry-
wide expertise rather than firm-specific perceptiveness.
Their employers do not own a stake in the compa-
nies, and they are therefore inherently outsiders: their
information about the companies in their sector is all
public information. They cannot probe, they cannot
interrogate senior managers. Large investors can, but it
appeared that they were not much interested in doing
this except when there were clearly problems in a firm.
The chairman of our electronics firm considered that
one of his most recent US institutional shareholders
already understood his firm much better than one of
his oldest and largest British institutional shareholders
because they took much more trouble to engage with
the firm; a similar view was expressed by one of the
pharmaceutical managers.
Although shareholders are more inclined to inter-
vene than 5 or 10 years earlier, this is still done reluc-
tantly. When major investors become aware of under-
performance by a firm, the clear hierarchy of preference
is, exit if possible, voice if necessary, and preferably
voice in favour of moves which could be advocated
with rather little knowledge of the firm’s business. Only
in extremis is action undertaken collectively, with other
major shareholders—though there are no legal obsta-
cles to this in the UK, and the people who would have
to work together know each other and are only minutes
apart. The first solution looked for then would be a
take-over, showing again a preference for action which
demands little if any firm-specific perceptiveness. Tra-
ditions die hard in the City of London.
4.3. Resulting pressures on management
We identified clear advantages to British firms, in the
context of reconfiguration, from their exposure to pres-
sures from capital markets for shareholder value, and
their freedom from constraint either by mechanisms
like co-determination or legal inhibitions on dismissals.
(Or indeed from strong unions, the main constraint in
the past.) As we expected, this was particularly valued
in high-technology. One of the pharmaceuticals CFOs
argued that in Britain it was much easier than in France
or Germany to reconfigure the organisation. Employ-
ees in Britain understood very well that capital markets
imposed pressure for shareholder value, which could
not be resisted. Moreover share options gave manage-
ment and senior employees in R&D a strong incentive
to take ‘value-enhancing’ initiatives themselves.
However, if the operation of the capital market
imposes beneficial pressures for reconfiguration, it
also, top managers believe, imposes pressures for short-
termism: to sacrifice long-term profit to the attainment
of short term financial targets. One of the pharma senior
managers, after describing the short-term pressures to
which his firm was subjected, added that it was now
being somewhat protected from them because a US
asset management house had become its largest share-
holder and was behaving very much as an engaged
investor (Ramirez and Tylecote, 2004).
Like Marsh (1990) on their behalf, institutional
investors generally blame short-termism on managers
themselves, through the effects of the profit-based
bonuses in their remuneration packages. However, they
clearly feel that management have a constant duty to
justify their investments, whether on R&D or other-
wise. In practice, this is asymmetrical: it is much more
likely that a firm will be condemned for wasteful over-
spending than for not spending enough. There is also
investor reluctance to let adequate funding go on the
longer-term sorts of innovative investment, which are
unlikely to pay off for 5, even 10 years. We had heard
from the management side that ignorance of what firms
were doing for longer-term technological development
was a problem. Even the rare investment houses able
to evaluate the longer-term prospects of pharmaceuti-
cal firms held back from buying the shares of the more
innovative ones, confident that they could wait until
shortly before their more myopic rivals realised what
was in the pipeline. Thus, even the best-informed UK
investors appear to do little or nothing by their invest-
ment decisions to mitigate short-term pressures—in the
industry where investors are most supportive of R&D
because of the rich rewards they are reaping from past
investment in it.
4.4. The situation since the stock market downturn
Two further interviews were conducted in winter
2004–2005, to find out whether there had been sig-
nificant changes in the behaviour of City of London
institutions since the stock market downturn of 2000.
 A. Tylecote, P. Ramirez / Research Policy 35 (2006) 160–180
One was with a Senior Adviser in a major pension
fund, the other with a recently retired director of two
FTSE 100 companies. From either side of the fence,
they took essentially the same view: that investors were
showing disappointment with the decline in returns,
but were not reacting to this by any increased engage-
ment with firms. On the contrary (said the company
director) they were exerting even more short-term pres-
sure than before. The senior adviser indicated one way
in which this might be happening: the great expan-
sion of hedge funds which specialised in selling shares
short.18 They would make large profits by engineering
a speculative run against a firm—which could only be
one which had disappointed the markets. (As Woolley
(2004) points out, the concurrent expansion of passive,
index-tracking portfolios gives the hedge funds dispro-
portionate influence: their activity already accounts for
about 40% of trading in the US and UK equity mar-
kets.) The fear of such a run must add to short-term
pressures on any under-performing firm.
5. How can the UK corporate governance and
finance system explain Britain’s technological
specialisation?
5.1. The nature of the system: résumé
We have characterised the UK financial and corpo-
rate governance system as an outsider-dominated sys-
tem which (by comparison with the insider-dominated
systems in most of the rest of the world) has:
• high pressure for shareholder value and high
industry-wide expertise;
• low firm-specific perceptiveness and little stake-
holder inclusion through traditional methods such
as co-determination and cross-holdings.
On the other hand, we have found that by compar-
ison with the other main outsider-dominated system,
the United States, the UK FCGS displays:
• less industry-wide expertise;
• less engagement, and thus less firm-specific percep-
tiveness;
18 That is, committing to a sale of their shares in the forward/futures
market, so that a profit would be made if their shares fell.
173
• less employee inclusion through shareholdings—the
means of inclusion which least blocks reconfigura-
tion;
• more pressure for shareholder value.
Given the broad similarities (and close relationship)
between the US and UK systems, we would expect
these differences to be less marked than those between
the UK and the insider-dominated systems.
It was clear that UK industry continues to be
exposed to short-term pressures from investors. These
are not deliberate pressures to over-emphasise the short
term over longer-term innovation and performance, but
nonetheless this is their effect, because the demand
for profit is not balanced by an adequate appreciation
of the value of work with a longer-term perspective.
Moreover, as our investors explained, those managers
who wish to spend heavily on innovation are con-
stantly under pressure to justify this heavy spending;
but those who wish to spend little (and thus for a
time increase their profit-related bonuses) are under
no such pressure. The existence of such pressures is
confirmed, as we have seen, by senior managers even
in pharmaceuticals—where investors have long had the
best understanding of the value of R&D and innovation
generally.
One indication of these pressures is given by recent
calculations of the cost of funds, which is taken to equal
interest on debt plus dividends. The UK has a CoF of
4.9% of sales, followed by the USA at 4.3%, France
and Germany at 3.8/3.7% and Japan at 1.3%. The dif-
ferences in CoF as % of sales are largely driven by
differences in dividends, which account for 61% of UK
CoF, 55% in the USA, and 30–40% in France, Germany
and Japan (DTI, 2003). Against value-added, the cost
of funds (dividends) in Britain is 18.7% (12.0%), in
Germany 12.3% (3.1%) and in France 11.3% (4.7%)
(DTI, 2004).
5.2. Implications for technological performance
and specialisation
Data on firms sorted by nationality is limited. The
best and most recent available is in the UK R&D Score-
board, 2004, for the top 700 firms in the world in
terms of their R&D expenditures (DTI, 2004). The
data we have drawn from this is on R&D expenditure
and sales. We take R&D intensity (R&D spend/sales)
174 A. Tylecote, P. Ramirez / Research Policy 35 (2006) 160–180
as a reasonable proxy for expenditure on technologi-
cal innovation. We would predict that such expenditure
will be a function of:
• the engagement of owners and financiers, to the
extent that visibility is low;
• their industry-wide expertise, to the extent that nov-
elty is high;
• the degree of stakeholder inclusion, to the extent that
spill-overs are high.
Of course engaged owners may act to stop or dis-
courage expenditure that they recognise as undesirable,
and so may those with industry-wide expertise; but it
seems reasonable to suppose that the net effect will still
be positive: well-directed spending will help to pro-
vide funds and encouragement for further spending,
whereas misdirected spending will not.
On the other hand, R&D intensity will not be a
(positive) function of pressure for shareholder value,
but rather a negative one, at least where engagement
or industry-wide expertise are low: as we saw in the
previous section, shareholders who do not understand
the value of spending on innovation (in practice, even
if they support it in principle) will impose short-term
pressures which discourage it.19 As to sales data, we
shall assume, if the sales of Country A’s firms in sec-
tor I make up a relatively high proportion of the sales
of Country A’s firms overall (so it is ‘specialised’ in
that sector), that its corporate governance and financial
system shows a good fit with that sector’s require-
ments, as defined in Section 3; and conversely if it is
‘under-specialised’. (The Scoreboard gives 32 sectors,
of which only 9 have been identified as high-technology
or medium-high-technology, so there is scope for vari-
ation in the extent to which a country is specialised in
high-/medium-high-technology as a whole, as well as
variation within this broad group of 9.) All firms, with
the exception of those from other English-speaking
countries, have been assigned to one of the three ‘corpo-
rate governance system’ categories: US, UK, insider.20
19 Moreover innovation which promises a return somewhat less than
the cost of capital will certainly be discouraged by pressure for share-
holder value—whereas a management free of such pressure might
well favour it, particularly where there was stakeholder inclusion.
20 The exclusion of smaller firms from the Scoreboard data is a more
serious distortion for sales than it is for R&D intensity. Recorded
R&D for small firms is an understatement anyway since it excludes
What can be predicted about the R&D intensity and
specialisation of British-based firms?
1. That they will in general under-spend on R&D
(show low R&D intensity) relative to both firms
based in the insider-dominated countries and firms
based in the United States; that this under-spend will
be worse relative to the insider-dominated coun-
tries, in the medium-high-technology sectors (plus
aerospace),21 with the possible exception of mobile
telecoms;22 and worse relative to the United States
in the high-technology sectors; that the British firms
might out-spend the insider-firms in some high-
technology sectors, of which the best relative per-
former will be pharmaceuticals.23 These general-
isations will be unsafe (however) in any sector
where British-based firms are predominantly untyp-
ical in corporate governance terms—because they
are venture-capital based or for some other reason.
2. That British-based firms will be specialised, rela-
tive to the insider-dominated countries’ firms, in
the high-technology sectors (less aerospace), par-
ticularly in pharmaceuticals; they will be ‘under-
specialised’ relative to these firms in the medium-
high-technology sectors, plus aerospace—with the
exception of mobile telecoms. They will be under-
specialised, relative to US-based firms, in high-
technology sectors, with the possible exception of
pharmaceuticals; they will also be under-specialised
relative to US-based firms in the medium-high-
informal activity, and if we allow for that, R&D intensity of large
firms may not be far above theirs. Taking only large firms under-
states the share of countries like Italy, which have many small firms;
however, to the extent that this is true for all sectors it does not affect
our relative measure of specialisation.
21 These sectors, as argued in Section 3, have generally low vis-
ibility and high spill-overs, and thus benefit much from ‘insider’
engagement and inclusion, while with low engagement and inclu-
sion, high pressure for shareholder value will be disastrous; their
modest novelty means that high industry-wide expertise is not much
of an advantage.
22 As we have seen in Section 3, mobile telecoms has an exception-
ally high degree of novelty and need for reconfiguration relative to
the rest of the telecoms sector.
23 As argued in Section 3, the high-technology sectors generally
have high novelty, which gives the UK an advantage over the insiders
but the US an advantage over both. The fact that even in high-
technology visibility is limited and spill-overs are significant gives
the US a further advantage over the UK—but least in pharmaceuti-
cals, where visibility appears highest and spill-overs lowest.
 A. Tylecote, P. Ramirez / Research Policy 35 (2006) 160–180 175

Table 3 A’s firms in all sectors. The figure given is the ‘relative
R&D intensity and relative specialisation by sector and FCGS, 2003a specialisation’ of Country A in sector I, which is the
Sector Corporate governance system above figure/figure for the US.
Insiders UK US Most of the figures in Table 3 conform to predic-
Aerospace and defence 8.0% 9.8%b 4.3% 2.8%
tions: this is true on R&D intensity for automotive,
0.24 0.64 chemicals, electronics and electrical,25 engineering
and machinery, and pharmaceuticals. The surprises are
Automotive and parts 4.5% 3.4% 3.7%
1.29 0.07 in software and IT services, where the insiders out-
spend the US; and in IT hardware and aerospace. In
Chemicals 4.4% 2.1% 3.5%
1.67 0.81
telecoms, where the British just out-spend both, this
may be put down to the mobile part of the sector.
Electronics and electrical 6.2% 4.2% 4.5%
We shall return to these after considering specialisa-
5.11 0.371
tion. Here again, automotive, chemicals, engineering
Engineering and machinery 2.8% 1.9%c 2.6% and machinery, and pharmaceuticals conform to pre-
1.43 0.18
dictions, as (this time) does software and IT services.
IT hardware 7.9% 15.5% 10.97% No prediction can be made about electronics and elec-
0.65 0.04
trical, nor about telecoms, since it is not disaggregated
Pharmaceuticals and 14.6% 14.9% 15.6% into fixed and mobile. The surprises here are in IT hard-
biotechnology ware, where the insiders far outsell the British, and in
0.51 1.07
aerospace yet again.
Software and IT services 12.6% 6.8% 10.2% The surprises can be explained, and largely within
0.06 0.13
our framework. The US specialisation in aerospace can
Telecommunications 1.8% 1.9% 0.8%d easily be explained by the military past and present, as
6.48 9.53 can the (lesser) British specialisation. That lies outside
Source: DTI (2004). our framework, but what falls within it is the special
a The % figure given is for R&D intensity. The other figure given
corporate governance status of the two main British
is for specialisation relative to that of the United States, whose figure
is thus taken in all cases to be 1.
firms in the sector, BAe and Rolls-Royce: the British
b Golden share firms; the second figure is for the others. government – no doubt for military reasons – has,
c Data is for 1 firm only. exceptionally, a ‘golden share’ in both of them (Osborn,
d Data is for 1 firm only.
2002) which makes them immune to take-over, and
thus almost immune to shareholder short-term pres-
technology firms, plus aerospace.24 The same reser- sures. They contribute 85% of the R&D spend among
vation applies. the British firms in the sector. It is their very high R&D
intensity which is exceptional and exceeds that of the
Table 3 gives R&D intensity and specialisation data insider-firms. Likewise, the high R&D intensity of the
for our nine sectors. Not all of these correspond neatly British IT hardware firms is because they comprise only
to the OECD categories: ‘electronic and electrical’ three new venture-capital backed firms (Spirent, ARM,
spans 32 and 33, and some of 30, from the high- Bookham Technology) plus Marconi, which belongs
technology categories, and 31 from the medium-high. to the high-spending telecoms manufacturing sector;
Thus, it is hard to ‘read’ in terms of our frameworks. what is missing is any presence in computer manufac-
‘IT hardware’ spans 30 and 32, both high-technology turing, a much lower-spending sector (vide Dell, with
sectors—thus it is not a problem. The ‘absolute’ spe- <1%). A similar situation accounts for the respectable
cialisation of Country A in sector I was measured as R&D intensity of the British auto firms: by far the
sales of Country A’s firms in sector I/sales of Country higher in intensity of the two entries is Phoenix, the

24 We may recall that the greater importance of family control 25 As this industry is a mixture of high-technology and medium-

and employee shareholdings in ‘mature’ industries gives the United high-technology, no prediction could be made about the relative
States an advantage over the UK in medium-high-technology sectors. performance of the US and the insider-dominated countries.
176 A. Tylecote, P. Ramirez / Research Policy 35 (2006) 160–180

unlisted legacy of BMW’s ill-fated takeover of Rover; nesmann, which was still largely an engineering firm
the listed GKN spends a mere 2.1% of sales.26 when it was acquired by Vodafone in 2001. Such clean
It is possible to give slightly more detail for three breaks are what the British financial and corporate gov-
of the ‘unsurprising’ sectors. The chemicals sector ernance system is best at—the shareholders like them.
is of interest because, while it now conforms to the For the pattern of British strength and weakness
general pattern of low R&D intensity among British- in software we return to Casper and Whitley (2004).
based firms, this has only recently become the case. In While the UK has the largest software industry in
debates over British technological strength and weak- Europe, only 26% of British firms were in enterprise
ness around 1990, chemicals was identified as an area software (against 90% in Germany and 44% in Swe-
of strength (together of course with pharmaceuticals), den); 7% were in middleware (against 5% in Germany
with some speculation that Britain was for some reason and 22% in Sweden). The British strength was over-
well-suited to chemistry-based industries (SCITEB, whelmingly in standard software—66%, against 5%
1991). There was another explanation: the dominance in Germany and 34% in Sweden. The strength here,
of chemicals by one firm, ICI, with unusual corpo- and weakness in the enterprise software area, is exactly
rate governance characteristics. Asked how the City what would have been predicted given the characteri-
of London had tolerated ICI’s relatively slow rate of sation of these sub-sectors in Section 2. The British
increase of its dividend, and fast rate of increase of weakness in middleware is of particular interest since,
its R&D, ‘a chemicals sector analyst observed that the as Casper and Whitley point out, the US excels in mid-
company concerned was virtually takeover proof, due dleware. The key appears to be that ‘middleware firms
to its size and national importance’ (IAB, 1990, p. 5). are most likely to exist within technology clusters dom-
This changed sharply with the hostile takeover bid from inated by a large firm that can entice them to commit to
Hanson Trust in 1991 (Demirag and Tylecote, 1992) a technical standard . . .’ (p. 102). The US has a number
and the subsequent demerger. Even at that stage, how- of such ‘dominant technology firms’; Sweden has one;
ever, the pattern of British strength was tilted towards Britain has none. The failure of Marconi, the obvious
consumer chemicals (detergents, etc.), a ‘deviant’ part British candidate, to play this role may well be precisely
of the sector in which insider-style relationships among because the British corporate governance system mili-
firms are not particularly helpful.27 tates against the ‘inter-firm coordination’ which Casper
The British specialisation in telecoms can be and Whitley show is needed in middleware.
explained by one firm, Vodafone, whose great success
exactly bears out the high need for reconfiguration in
mobile telecoms argued in Section 2. Vodafone origi- Table 4
nated as a unit of the British defence electronics firm Estimated company shares of the UK computer services market by
Racal, but was spun off into complete independence value (%) 2000
between 1988 and 1991 when its parent recognised its IBM USA 8.4
potential.28 Since then it has been a ‘pure-play’ mobiles EDS USA 8.2
firm, unlike any of its main rivals, mostly part of the Fujitsu (ex-ICL) Japan 5.6
fixed-line firms which set them up—except for Man- Reuters UK 4.9
Cap Gemini Ernst & Young France 4.4
CSC USA 4.0
26 Most of the automotive R&D performed in Britain is carried out Accenture USA 3.9
by Ford: a family owned firm which appears to display very strong PricewaterhouseCoopers USA 3.6
shareholder engagement, the CEO as of early 2004 being Bill Ford, SchlumbergerSema US/France 3.1
and which had the distinction in 2000 of conducting more R&D than Compaq USA 2.6
any other firm in the world in any sector (DTI, 2001, p.90). Logica UK 2.1
27 See Tylecote and Conesa (1999, Table 10), where this is demon- Computer People Swiss 1.7
strated by trade and patent data. Syntegra UK 1.6
28 It had been a subsidiary of Racal Electronics plc from 1984 Capita UK 1.5
(www.vodafone.com). The most focused of the mobile manufac- Xansa UK 1.5
turers, Nokia, took until 1994 to divest itself of its non-electronics Others 42.9
businesses (Ali-Yrkko et al., 2000). Source: Key Note (2001).
 A. Tylecote, P. Ramirez / Research Policy 35 (2006) 160–180
Table 5
The main constituent parts of business services
IT-enabled services % of total employment in
business services, UK,
2002–2003
Labour recruitment and provision of personnel 19.3
Industrial cleaning 10.6
Architectural activities and technical consultancy 9.6
‘Other business activities’ 8.9
Market research and management consultancy 8.5
Legal activities 7.7
Accountancy 5.6
Investigation and security activities 4.3
Renting of machinery, equipment, etc. 4.2
Research and development 2.6
Advertising 2.4
Source: Abramovsky et al., 2004, Fig. 1.
We also have some detail for IT services, albeit only
for the UK market (Table 4). Again what would have
been predicted from the characterisation in Section 2 –
performance as bad as enterprise software because of
low appropriability and visibility – appears to be borne
out: the UK market is dominated by foreign firms,
mostly US. This weakness is worth stressing because
of the widespread perception that business services,
including IT services, is a British success story. So it
is, in locational terms.29 We shall give a brief account
of this success because it too appears to arise largely,
though rather indirectly, from the British corporate gov-
ernance system.
In 2002, business services employed around one in
seven of the UK labour force; between 1984 and 2001
employment in business services grew by 92%, that is
over half the total growth in UK employment during the
period (Abramovsky et al., 2004). For its constituent
parts, see Table 5. Most of them belong to one of the
two types of Knowledge-Intensive Business Services,
traditional professional services, and new services con-
nected with technology (Miles et al., 1995). As can
be seen, they are highly heterogeneous: they are all
services which are provided for industrial customers
(and the public sector) who could in principle pro-
29 We have no space to examine the nationality of firms in the sector
outside IT services, and the data we have is limited. However, what
we have on management consultancy gives a similar picture to IT.
177
IT-computer services % of total employment in
business services, UK,
2002–2003
Software consultancy 8.2
Data processing and 1.6
database activities
Hardware consultancy 0.5
Maintenance and repair 0.4
of computing machinery
vide them for themselves, in-house.30 Until the 1980s,
that was overwhelmingly what happened. The creation
of the business services sector involved the reconfig-
uration of existing businesses to cut out much or all
of those providing those services in-house. To push
this through over what can be assumed to be internal
resistance required a motive—presumably, so far as the
private sector was concerned, the prospect of increased
profit. (That prospect arose partly because of the devel-
opment, in ‘post-Fordism’, of networked production
systems in which firms depend on external services to
supplement their internal resources (Castells, 2000).)
The stronger the pressure for shareholder value, the
more this motive would have counted. We would there-
fore predict that the speed of growth of the business
services sector in general in an economy would be a
function of the pressure for shareholder value in its
finance and corporate governance system. Where it
grew quickly, it would have advantages in international
competition from internal and external economies of
scale and experience. We would therefore expect, other
things being equal, that the UK’s trade performance in
30 The ‘public administration and other services’ share of business
services purchasing in the UK was 11.1% in 2001, having risen from
3.9% in 1984 through 4.3% in 1990 to a peak of 13.3% in 1995
(Abramovsky et al., 2004, Table 2). This suggests that UK busi-
ness services in general may not have benefited crucially from the
Thatcher government’s drive for privatisation and contracting out.
178 A. Tylecote, P. Ramirez / Research Policy 35 (2006) 160–180
business services would be somewhat better than the
United States’, and much better than the main ‘insider-
dominated’ economies. The UK trade surplus in 2002
was even in absolute terms greater than that of the US$
24 billion against US$ 22 billion, in an economy less
than one fifth of the size of the United States. The
French trade surplus was a mere US$ 1.5 billion; Ger-
many and Japan had trade deficits, of US$ 12 and 9
billion, respectively (Abramovsky et al., 2004, Fig. 3).
6. Conclusions
We have seen that the broad-brush characterisation
of the UK corporate governance and financial system
as ‘outsider-dominated’, like that of the whole eco-
nomic system as a ‘liberal market economy’, explains
the technological performance and specialisation of
the UK only up to a point. It explains its similarities
with the United States, but not its differences from
the US. These can only be explained in terms of the
CG&FS if clear differences between the US and UK
systems can be identified. The more nuanced charac-
terisation of the UK CG&FS presented here, showing
by comparison with the US its inferiority in industry-
wide expertise, engagement, and employee inclusion,
but greater pressure for shareholder value, is able to
account for all the main features of the technological
performance and specialisation of British-owned firms
in the high-technology and medium-high-technology
sectors—the sectors in which it is most reasonable to
assume that technological innovation is the key deter-
minant of success. Notably it explains British strength
in pharmaceuticals (the sector shown to be most suited
to ‘outsider-domination’, though still more suited to
the American variant of it) and (through golden shares)
aerospace. It accounts equally well for UK weakness
in most of electronics-based high-technology sectors,
and in all the medium-high-technology sectors; also
for British strength in mobile telecommunications ser-
vices, and the contrast in software between strength in
the ‘standard’ and weakness in the ‘middleware’ and
‘enterprise’ sub-sectors. Humility is in order: no one
variable, however broadly defined and however pow-
erful, can possibly provide a complete explanation of
such matters. A full account of British strength in phar-
maceuticals, for example, would certainly include the
role of government (Howells and Neary, 1995).
Further work is needed to explore the power of the
framework presented here to explain wider interna-
tional patterns of specialisation, and changes in them. It
can however already offer conclusions for policy. The
increasing weight and experience of British venture
capital and private equity more generally is a strength
which must be reinforced—by (for example) removing
regulations which tend to reduce the institutions’ allo-
cation of funds to private equity. The deficiencies of
British institutional investors in industry-wide exper-
tise and engagement are damaging, and only partly
compensated by the participation of US investors in
London. Their disillusion with traditional disengaged
‘active management’ will be of no benefit if it merely
drives them to the super-speculative hedge funds. They
would be forced to move towards engagement – as
proposed in the Myners Report (Myners, 2001) – if
tax changes made it less attractive to ‘buy and sell’ as
opposed to ‘buying and holding’ for the long-term.
Acknowledgments
The research reported here was funded by the Euro-
pean Union, in Project no.: PL 98.0221 of the Targeted
Socio-Economic Research Programme. We are grateful
for their support and for the cooperation of intervie-
wees. This paper has benefited considerably from the
criticisms of two anonymous referees.
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