Archive for the ‘shareholders’ Category
The disquiet over excessive executive remuneration packages and a lack of appropriate links with relevant performance measures has been a matter of concern in recent years. After the financial crisis, there is even more of a focus on this aspect with shareholders becoming increasingly frustrated with both the amount and the design of executive remuneration packages.
The latest Manifest and MM&K Total Remuneration Survey 2011 finds little link between remuneration, performance and shareholder value, reporting that the median FTSE100 CEO remuneration increased by 32% to £3.5million in 2010 compared to 2009, whilst the FTSE100 index only rose 9% over the same period. Moreover over a 12 year time horizon, CEO remuneration has quadrupled whilst share prices have been flat.
In the US, the BDO 600: 2011 Survey of Board Compensation Practices of 600 Mid-Market Public Companies reported that ‘director pay in the middle market is up seven percent, reflecting the increased responsibilities, time commitment, and regulatory issues – such as the Dodd-Frank Act – that boards face today’. The report states that these factors, coupled with a rebounding stock market, have allowed companies to increase director pay to $110,155, up from $102,809 in 2009, and that much of this increase can be attributed to a greater use of full-value equity vehicles, which are up 22% from last year, indicating that the recovering stock market is adding to compensation growth overall.
Issues of concern
Concern has been expressed at a number of companies where shareholders have thought that executive directors would receive remuneration in excess of what they deserved in relation to their performance or in relation to the company’s performance. For example, Andrew Parker in his articles (FT, Page 17, 29th June 2011 ‘Strategy and pay fuel anger at C&WW’ and FT, Page 15, 5th July 2011 ‘Amber-top alert over C&W pay’) highlighted that the Association of British Insurers (ABI) issued an ‘amber top’ to alert shareholders about a number of issues at C&W including aspects of the planned new pay scheme at C&W Worldwide. The ABI was concerned that ‘given C&W Worldwide’s depressed stock price, the chief executive and finance director could be awarded too many performance shares’.
Robert Wright in his article (FT, Page 4, 24th June 2011) ‘Ex-rail chief defends £1m payoff’ stated that that Mr Coucher, the former CEO of Network Rail, had defended the £1.07m payout that he received on leaving the company saying that it represented a payment in lieu of his notice period and the bonuses he would have received if he had been allowed to work his notice period after resigning.
In some companies chief executives have forfeited their bonus if the company has not performed to expected standards. In his article (FT, Page 16, 28th June 2011) ‘TalkTalk struggles see chief’s bonus cut’, Andrew Parker pointed out that Dido Harding, chief executive of TalkTalk, had secured only 20% of her maximum potential bonus in 2010/11 as there were ‘acute customer service problems’. Justin King, the CEO of J. Sainsbury, saw his salary and bonus fall significantly because the company did not achieve key profit targets, reported Andrea Felsted (FT, Page 19, 8th June 2011) ‘Sainsbury chief’s pay drops sharply after missed targets’.
Elsewhere Vodafone has decided to place more emphasis on profit improvement in its executive pay plan. Andrew Parker in his article (FT, page 20, 2nd June 2011) ‘Vodafone refocuses executive pay plan’, reported that greater account would be taken in future of profit-based targets by reducing the relative importance of revenue-based targets.
Banking and insurance sector
In the banking and insurance sector, some banks have slashed cash bonuses, for example, Michiyo Nakamoto reported in his article (FT, Page 15, 4-5 June 2011) ‘Nomura slashes cash bonuses’ that Japan’s largest investment bank, Nomura, had slashed the cash bonuses paid to its top executives and directors by 95% after suffering a decline in profits and its share price. As a result only 6 out of 23 directors/executives received a cash bonus in the year to March 2011. Patrick Jenkins reported in his article (FT, page 19, 1st July 2011) ‘Europe’s banks and insurers lead in withholding bonuses’, that nearly three-quarters of banks and insurers in Europe have introduced a system to withhold bonuses from staff if their performance does not match up to expectations. One of the contributors to the financial crisis was thought to be overly generous short-term bonuses, and many banks have decided to put in place a system of deferred payments. There are also malus or clawback arrangements which may be used, for example, for a breach of code of conduct.
Increased use of ‘say on pay’
The use of ‘say on pay’, whereby shareholders have an advisory vote on executive pay proposals (remuneration committee report), has been utilised much more in recent months. Tim Bradshaw and Kate Burgess (FT, page 20, 3rd June 2011) in their article ‘WPP suffers shareholder revolt over pay’ highlighted that WPP had a large shareholder revolt when over 40% of shareholders voted against the WPP pay policies. They report that one large fund manager stated ‘Investors are increasingly concerned by salary creep. It is a topical issue at the moment. Some companies seem to think after a couple of years of restraint that they can claw back the pay rises they would have got’. Roger Blitz (FT, Page 19, 14th June 2011) ‘William Hill expects fallout over chief’s pay deal’ points out that some 38% of votes cast either opposed or did not endorse the group’s remuneration report, with Ralph Topping, the Chief Executive, receiving a salary increase of 11% and shares worth £1.2m by way of a ‘golden handcuffs’ retention payment.
In the US, the say on pay has also been used frequently in recent weeks, as Dan McCrum finds in his article (FT, Page 17, 6th July 2011) ‘Shareholders quick to put ‘say on pay’ powers to work’. He reports that Hewlett-Packard and Jacobs Engineering saw their pay packages rejected outright whilst Monsanto and Northern Trust faced stiff shareholder protest votes, during this, the first year that large public companies have been required to have an advisory vote on executive compensation as part of the Dodd Frank legislation.
It may be that, with the advent of a more widespread use of say on pay in a number of markets, the days of golden executive remuneration packages are numbered.
Chris Mallin 13th July 2011
The Financial Reporting Council (FRC) has issued the UK Stewardship Code which ‘aims to enhance the quality of engagement between institutional investors and companies to help improve long-term returns to shareholders and the efficient exercise of governance responsibilities’.
The UK Corporate Governance Code has traditionally emphasised the value of a constructive dialogue between institutional shareholders and companies based on a ‘mutual understanding of objectives’. Now, in the Stewardship Code, the FRC sets out the good practice on engagement with investee companies which it believes institutional shareholders should aspire to.
Kate Burgess and Miles Johnson in their article ‘FRC’s blueprint for investor engagement’ (FT, page 18, 2nd July 2010) describe the Stewardship Code as ‘the first of its type in the world and designed to sit side by side with the UK’s code on corporate governance recently reworked by the FRC’.
Background to the UK Stewardship Code
The Institutional Shareholders’ Committee (ISC) is a forum which allows the UK’s institutional shareholding community to exchange views and, on occasion, coordinate their activities in support of the interests of UK investors. Its constituent members are: The Association of British Insurers (ABI), the Association of Investment Companies (AIC), the Investment Management Association (IMA) and the National Association of Pension Funds (NAPF) http://www.institutionalshareholderscommittee.org.uk/
In November 2009, the ISC issued the ‘Code on the Responsibilities of Institutional Investors’. The ISC stated that ‘the Code aims to enhance the quality of the dialogue of institutional investors with companies to help improve long-term returns to shareholders, reduce the risk of catastrophic outcomes due to bad strategic decisions, and help with the efficient exercise of governance responsibilities’ and ‘the Code sets out best practice for institutional investors that choose to engage with the companies in which they invest. The Code does not constitute an obligation to micro-manage the affairs of investee companies or preclude a decision to sell a holding, where this is considered the most effective response to concerns’.
Further detail is available at: http://institutionalshareholderscommittee.org.uk/sitebuildercontent/sitebuilderfiles/ISCCode161109.pdf
UK Stewardship Code Principles
Following a consultation earlier this year, the FRC assumed responsibility for the oversight of the Stewardship Code. The ISC Code discussed above contained seven principles which now form the basis for the Stewardship Code and indeed the Principles were adopted with only minor amendments. The minor amendments relate to Principle 3 about the monitoring of companies. In the Stewardship Code, institutional investors are encouraged to meet the chairman of investee companies, and other board members as appropriate, as part of the ongoing monitoring, and not only when they have concerns; attend, where appropriate and practicable, the general meetings of companies in which they have a major holding; and give careful consideration the any explanations given by investee companies for departures from the UK Corporate Governance Code, advising the company where they do not accept its stance.
The principles of the UK Stewardship Code are:
Principle 1: Institutional investors should publicly disclose their policy on how they will discharge their stewardship responsibilities.
Principle 2: Institutional investors should have a robust policy on managing conflicts of interest in relation to stewardship and this policy should be publicly disclosed.
Principle 3: Institutional investors should monitor their investee companies.
Principle 4: Institutional investors should establish clear guidelines on when and how they will escalate their activities as a method of protecting and enhancing shareholder value.
Principle 5: Institutional investors should be willing to act collectively with other investors where appropriate.
Principle 6: Institutional investors should have a clear policy on voting and disclosure of voting activity.
Principle 7: Institutional investors should report periodically on their stewardship and voting activities.
Who the UK Stewardship Code applies to
The Stewardship Code is to be applied on a ‘comply or explain’ basis. The UK Stewardship Code is ‘addressed in the first instance to firms who manage assets on behalf of institutional shareholders such as pension funds, insurance companies, investment trusts, and other collective vehicles’. The FRC expects such firms to disclose on their websites how they have applied the Stewardship Code or to explain why it has not been complied with.
However it has been pointed out that it is not the responsibility of fund managers alone to monitor company performance ‘as pension fund trustees and other owners can also do so either directly or indirectly through the mandates given to fund managers’. Therefore the FRC encourages all institutional investors to report whether, and how, they have complied with the Stewardship Code.
The FRC plans to list on its website all investors who have published a statement indicating the extent to which they have complied with the Stewardship Code. This list will be made available from October 2010.
Monitoring and review of the application of the Stewardship Code will be in two phases. As an interim measure, the Investment Management Association (IMA), will carry out its regular engagement survey which will also cover adherence to the Stewardship Code in 2010. The first full monitoring exercise will then take place in the second half of 2011.
The FRC points out that there are a number of significant issues which were raised during the consultation phase which are not addressed in the UK Stewardship Code. These include disclosure by institutional investors of their policies in relation to stock lending; arrangements for voting pooled funds; and the information to be disclosed in relation to voting records. The FRC will undertake additional work in relation to these areas prior to the monitoring exercise in 2011.
A recent EU Green Paper ‘Corporate governance in financial institutions and remuneration policies’ (June 2010) may also have ramifications for the UK Stewardship Code as in section 5.5, the Green Paper mentions that the Commission intends to carry out a review centred around, inter alia, ‘institutional investors adherence to ‘stewardship codes’ of best practice’. http://ec.europa.eu/internal_market/company/docs/modern/com2010_284_en.pdf
It is apposite to conclude with a comment from Bob Campion in his article ‘Managers on alert to comply or explain’ (FTfm Page 5, 5th July 2010) ‘The new code is a timely opportunity for pension trustees to finally get to grips with their role as institutional shareholders. If they do, it will be up to fund managers to demonstrate their own expertise in this area or risk losing business’.
The UK Stewardship Code, together with a report on its implementation, can be found at:
Chris Mallin 5th July 2010
Society, acting through their legislative processes, provides for the incorporation of corporate entities in their midst, and permits companies to limit the liability of their shareholders for the debts of those companies. But over time, the accountability of those companies to society, and the way that power is exercised over them has slipped for society to shareholders, and from shareholders to incumbent management.
We need to re-think the way that power is exercised over companies for the good of all affected by their activities. But before such ideas can evolve, some fundamental dilemmas have to be resolved. We lack a coherent unifying theory of corporate governance. The most widely used research tool, agency theory, is proving to be a straight jacket: useful in context but inevitably constraining. We need some new theoretical insights that will take us beyond agency theory or the perspectives of jurisprudence.
The corporate governance principles published by the Organisation for Economic Co-operation and Development (OECD) were designed to assist countries develop their own corporate governance codes. They reflected what was considered best practice in the UK and USA. This so-called Anglo-Saxon model of corporate governance required listed companies to have unitary boards, independent outside directors, and board committees. The principles focused on enhancing shareholder value, and in the process richly rewarded top executives. In this model shareholders are widely dispersed, in markets that are liquid, with the discipline of hostile bids.
This so-called ‘Anglo-American approach’ to corporate governance, became the basis for governance codes around the world. Indeed, in the United States it was widely assumed that the rest of the world would eventually converge with American corporate governance norms and reporting requirements, simply because it was thought the rest of the world needed access to American capital.
But a schism has emerged in the ‘Anglo-American approach’. In the United States, Sarbanes Oxley mandated conformance with corporate governance by law. Whilst in the United Kingdom and those other jurisdictions whose company law has been influenced over the years by UK common law, including Australia, Hong Kong, India, Singapore and South Africa, compliance is based on a voluntary ‘comply or explain’ philosophy. Companies report compliance with the corporate governance code or explain why they have not. This ‘rules versus principles’ dilemma seems to have been amplified by the ongoing global financial crisis. It needs resolving.
But the Anglo-Saxon system is not the only governance model and some are questioning whether it is necessarily the best. Corporate governance is concerned with the way power is exercised over corporate entities. In other parts of the world, alternative insider-relationship systems exercise power through corporate groups in chains, pyramids or power networks, by dominant families, or by states. These markets are less likely to be liquid, the market for control poor, and the interests of employees, and other stakeholders more important.
In Japan, keiretsu organizational networks spread power around a group of inter-connected companies in ways that might provide insights for complex western groups. The view that business involves relationships with all those involved – employees, customers, suppliers, and society, as well as shareholders, has only recently been recognized in the West under the umbrella of ‘corporate social responsibility’.
The governance of Chinese family businesses throughout East Asia can provide some valuable insights: for example, the emphasis on top-level leadership, the view that the independence of outside directors is less important than their character and business ability, and the way that the Chinese family business sees business more as a succession of trades rather than the building of empires.
In China, the link between state, at the national, provincial and local levels, and companies relies on a network of relationships, and policies can be pursued in the interests of the people, seen as the Party.
Of course there are problems with Asian approaches: corruption, insider trading, unfair treatment of minority shareholders, and domination by company leaders, to name a few. But these are not uniquely eastern attributes as case-studies of US and UK company failures show.
These diverse models reflect more concentrated ownership, different cultures, and varied company law jurisdictions. But they also show different perceptions about the way power should be exercised over corporate entities. The eastern experience suggests that board leadership and board-level culture, in other words people and the way they behave, are more important than board structures and strictures, rules and regulations. New theoretical perspectives will need to embrace such diversity.
One of the main areas in corporate governance that has caught the headlines recently is risk management. There is a widely held perception that in recent years many boards have not managed the risks associated with their businesses well – whether that was because they did not identify the risks fully or whether because having identified the risks, they did not take appropriate action to manage them.
Review of UK’s Combined Code
The Financial Reporting Council (FRC)’s Review of the UK’s Combined Code published in December 2009 http://www.frc.org.uk/corporate/reviewCombined.cfm states that ‘One of the strongest themes to emerge from the review was the need for boards to take responsibility for assessing the major risks facing the company, agreeing the company’s risk profile and tolerance of risk, and overseeing the risk management systems. There was a view that not all boards had carried out this role adequately and in discussion with the
chairmen of listed companies many agreed that the financial crisis had led their boards to devote more time to consideration of the major risks facing the company.’ The FRC therefore proposes to make the board’s responsibility for risk more explicit in the Code through a new principle and provision. Moreover it also intends to carry out a limited review of the Turnbull Guidance on internal control during 2010.
Many companies, and especially those in the financial sector, have already established risk committees whilst other companies especially smaller companies, may combine the consideration of risk with the role and responsibilities of the audit committee.
Alternative investment market
The UK’s Alternative Investment Market (AIM) expanded rapidly during the 12 years following its inception in 1995. Then from 2007 onwards it went into decline. David Blackwell, in his article ‘Signs of recovery seen after years of famine’ (FT, page 23, 16th December 2009) states that ‘Hundreds of companies have left the market, the number of flotations has collapsed and fines for Regal Petroleum and others – albeit for regulatory infringements dating back years – have once again sullied the market’s reputation’. Nonetheless he points out that 2009 saw an improvement with the AIM index rising by 62 per cent over the year compared to a rise of 22 per cent in the FTSE 100.
The lighter regulatory touch on AIM has both attractions and drawbacks. On the one hand, companies find it easier to gain a London listing (albeit on AIM rather than the main market); on the other hand, this may bring concomitant risks for investors as they will be investing in companies which may well be riskier than their main market counterparts.
Family firms are the dominant form of business in many countries around the world and range from very small businesses to multinational corporations. Richard Milne in his article ‘Blood ties serve business well during the crisis’ (FT, Page 19, 28th December 2009) points out that the attributes of a typical family business will have stood it in good stead during the recent financial crisis: ‘Long-term thinking, conservative, risk-averse: the very characteristics of the typical family business seem to be the ones needed in the economic crisis of the past two years’. Given that they tend to be more conservative, family firms will take less risks, for example, by not over extending themselves with their gearing (leverage).
Banks and financial institutions
Many banks and financial institutions were widely criticised because of the perceived overly generous bonuses paid to some executive directors and senior management at a time when the world is suffering the consequences of a global financial crisis precipitated by bankers who did not seem to fully appreciate the risks involved with some of the products they were trading in. And yet already we see banks again paying out enormous bonuses. Megan Murphy in her article ‘Tycoon attacks return of bankers’ bonuses’ (FT, Page 3, 28th December 2009) quotes Guy Hands, the private equity tycoon, who is highly critical of these big bonuses and speaks of bankers ‘taking home “wheelbarrows of money” on the back of taxpayers’ support’. Moreover he is quoted as saying ‘It cannot be right to continue with a system that allows risk to be taken in the knowledge that, if things go right, bankers will take on average 60-80 per cent of the profits generated through compensation and, if they go wrong, shareholders and ultimately the government will pick up the costs’.
Managing risk is, of course, relevant to all parties in the business and financial world as the article by Sophia Grene ‘Managing risk is the main task ahead’ (FTfm, Pg 1, 4thJanuary 2010) illustrates. In her article, Sophia points out that ‘many financial models failed in the past two years as markets demonstrated they did not behave according to conventional assumptions’ and that ‘the main challenge for asset managers in the coming decade is understanding, managing and communicating risk’.
Managing risk and managing it well is an important consideration for boards of directors, whether in main market firms, second tier markets, or family firms. Firms, and especially those in the banking and financial sector, need to pay particular attention to executive director remuneration packages which should not encourage adverse decision-making in terms of the impact on risk, that is, remuneration packages should be designed so that they do not lead to unacceptable risk-taking which may be to the detriment of the long-term sustainability of the company and potentially, as we have already seen, the wider economy.
Please refer to the newly published third edition of my book ‘Corporate Governance’ for updates to various national and international corporate governance codes and guidelines; board committees including risk and ethics committees; the Alternative Investment Market (AIM); family firms; remuneration packages, and the global financial crisis.
In addition, new material on many other areas including: private equity and sovereign wealth funds; governance in NGOs, public sector/non-profit organisations, and charities; and board diversity. Many examples, mini case studies and clippings from the Financial Times are included to illustrate the application of corporate governance in the real world.
Chris Mallin 7th January 2010