Archive for March, 2009|Monthly archive page
– in which Bob Tricker continues his call for a radical rethink of the way power is exercised over companies by society.
In a previous blog, I argued that the relationship between auditors and directors, in which directors de facto appoint the auditors who then report to them, was too close. I proposed that auditors should be appointed by and report to regulators and, through them, to other interested stakeholders. In this blog I explore the way directors communicate with their shareholders and again develop a radical alternative to accepted practice.
The global financial melt-down and on-going economic explosion continues to expose weaknesses in corporate governance practices and, more importantly, attitudes. Giving wider powers to regulators and introducing more regulations, as is now being proposed, will have little effect if those regulators continue to be closely associated with, and often come from, the industry they are regulating. Long standing assumptions about the way things should be done need to be questioned not reinforced. Expectations and attitudes have to change.
Taking directors remuneration as a dramatic example, in recent years we have seen a massive increase in the ratio of CEO pay to that of their hourly paid workers, in many cases as their firms eroded shareholder value. The old legal concept of fairness, what a reasonable man would expect, has long been forgotten. As Barack Obama has written “what accounts for the change in CEO pay is not any market imperative. It’s cultural. At a time when workers are experiencing little or no income growth, many of America’s CEOs have lost any sense of shame about grabbing whatever their pliant, hand-picked corporate boards will allow.” [The Audacity of Hope, Crown Publishing Group (Random House), New York, 2007]
The director/shareholder relationship
At the heart of corporate governance are the relationships between shareholder-investors and top-management decision-makers. Shareholders’ ability to question directors and directors’ accountability to shareholders are crucial. In the 19th century that was relatively easy for the joint-stock limited-liability company. Companies were then smaller, less complex and licensed by the state to pursue a single aim, build a railway, run an iron foundry, supply a town with gas, for example. Moreover, the shareholders were individuals and could be counted in tens or hundreds. Institutional investors, mutual funds, and pension funds had yet to be invented.
How different today. Complex corporate groups, with hundreds of subsidiaries, associate companies and joint ventures in pyramids, networks and geared chains, with multiple shareholders – institutional investors including hedge funds, mutual funds, pension funds, insurance companies, even sovereign funds – not just individuals. The challenge is how to communicate with them, to listen to them, and be accountable to them.
The classical solution, of course, was to require meetings of shareholders so that the board could explain their stewardship of the corporate funds. That requirement still holds for the public company. But we all know the ongoing farce of meetings tightly organised by the company secretary, dominated by the chairman, with questions so restricted that communication is essentially one way, seldom providing an adequate opportunity for genuine dialogue.
Companies were also required by law to provide their members with regular written reports with information laid out in company law and stock exchange listing rules. Today, electronic mail and corporate internet sites supplement the printed word. But such reporting is still one-way: company to shareholders. The opportunity for investors to seek information about their directors’ activities is limited.
How can shareholders really find out what they want to know? How can they genuinely exercise power over the directors they have appointed to be stewards of their funds? Successive reports, including the British Myners Report, have called for institutional investors to play a bigger part in corporate governance. A few institutional investors, like CalPers in the United States and Hermes in the UK, together with some investor organisations, such as the Association of British Insurers have certainly made their presence felt. But others still prefer the option of ‘doing the Wall Street walk’ or voting with their feet as they say in Britain, avoiding the potential costs of getting locked-in should they get involved in governance issues.
A new approach
But there is another way. Anyone watching the recent grilling of directors of financial institutions by Congressional Committees in the USA and Commons Treasury Select Committees in the UK saw an alternative approach. Why should investors not be able to wield similar power? After all they actually own the companies.
Who would do the grilling? It would have to be representatives of the shareholders, who have not been captured by the company and its directors. Skilled representatives from institutional investors or perhaps a new breed of professionals come to mind.
In Australia, Shann Turnbull has proposed a corporate senate that might be adapted. He believes that “most corporations in the English speaking world are essentially corrupt because their unitary board structures concentrate on conflicts of interest and corporate power.” His alternative is a dual board structure with a corporate senate elected on the basis of one vote per shareholder, not per share. In his model the senate has no pro-active power, just the right to veto where it feels the board has a conflict of interest. Its members could certainly be trained to grill directors on behalf of the other shareholders.
Would directors readily agree to be grilled? Of course not! Self-regulation, exhortation, or listing rules requirements would not suffice. Legislation will be needed. Shareholders, who actually are the company, would need to be given power to carry out the level of grilling and transparency given to US Congressional and UK Treasury Select Committees. Proceedings would need to be public, probably carried live through the internet and available as a record on a web site.
Directors have a fiduciary duty to act in the interests of shareholders, not their own. Somehow this has been forgotten. Professional grilling by shareholders of their directors would move the original concept of directors’ stewardship, fiduciary duty, and accountability towards the reality of 21st century expectations and demands.
Rights issues have been a traditional way to raise funds from existing shareholders in the UK, Europe, and Australasia. Existing shareholders are offered the chance to acquire new shares, at a discount, in proportion to their existing holding. In general the reasons for a rights issue fall into one of three categories: raising funds for an acquisition or expansion; (ii) internal working capital requirements; (iii) restructuring of the balance sheet. The latter often occurs in times of financial distress and it is for this reason that many of the companies seeking to raise money through rights issues are doing so now – they need to raise cash, and asking existing shareholders is one of the few ways to do it.
Banks and property companies making most rights issues
It has been noticeable that many UK companies are making rights issues at present. Many of the companies seeking to raise funds in this way are in sectors particularly badly affected by the economic downturn: the banking sector and the property sector.
HSBC, in the largest rights issue in UK history, is seeking to raise more than £12 billion from its investors. Peter Thal Larsen, Neil Hume and Kate Burgess (FT, Page 1, 28th Feb/01st Mar 09) in their article ‘HSBC to seek £12bn in record offering’ state that HSBC ‘is the latest in a long line of global banks to seek to strengthen its capital reserves by issuing shares’.
Peter Thal Larsen (FT Page 19, 3rd March 09) in his article ‘HSBC’s search for capital gives market the shudders’ reports that ‘…the bank’s decision to raise £12.5bn in fresh capital from its investors and cut its dividend for the first time any of its executives can remember was bound to send a shudder through the markets’. However HSBC is still seen as being in a stronger position than many other banks, and Stuart Gulliver, HSBC Chief Executive of Global Banking and Markets, stated ‘The rights issue is designed to get us a bullet-proof balance sheet’.
In their article ‘Segro to seek discounted rights issue’ (FT, Page 14, Financial Times 28th Feb/1st Mar 2009), Daniel Thomas and Neil Hume highlight Segro is seeking to raise 3300 million and that other property sector companies including Land Securities, British Land, and Hammerson have already approached investors with rights issues to the tune of more than £2 billion in recent weeks.
In similar vein, David Fickling, Kate Burgess and Neil Hume (FT, Page 17, 3rd Mar 09) in their article ‘Debt-laden Wolseley close to launching £1bn rights issue’ highlight the plight of Wolseley, the builders’ merchant whose ‘loss-making retail division [was] heavily exposed to the stagnant US housing market’.
Shareholders taking up the rights will retain the same proportion of the share capital overall as they had prior to the rights issue. However shareholders not taking up the rights issue shares will have a lower proportion of the company’s share capital than they did prior to the rights issue i.e. their stake will be diluted. To avoid any dilution that would occur when companies do not offer shares to their existing shareholders first, in some jurisdictions the concept of pre-emption rights (that is, new shares have to be offered to existing shareholders first) has long been enshrined in company law. However as Oliver Ralph (FT, Page 6, 28th Feb/1st Mar 09) points out in his article ‘The begging letters start to arrive’, noted ‘The institutions are getting uppity because they, too, have been left out on certain occasions. Witness the outrage that Barclays provoked when it raised money from Middle East investors last year. More recently, Rio Tinto has enraged its institutional shareholders by offering convertible bonds on favourable terms’.
There are clear governance implications where investors’ shareholdings are diluted and equally the investors are somewhat ‘over a barrel’ as if they wish to avoid dilution, they have to pour more money into companies for reasons, and at a time, when they may not wish to do so.
There were also some problems with rights issues last year, including low take-up rates, and claims of market abuse through short-selling, and as a result the Rights Issue Review Group was established and reported back late last year. The full report ‘A Report to the Chancellor of the Exchequer: by the Rights Issue Review Group’ is available at http://www.hm-treasury.gov.uk/d/pbr08_rightsissue_3050.pdf
Following the Review, the Association of British Insurers (ABI), an influential body representing the collective interests of the UK insurance industry, altered its guidelines on rights issues so that companies will be able to issue new shares amounting to up to two-thirds of their existing issued share capital (previously one third) without obtaining shareholder approval. The purpose of the change is to facilitate rights issues.
Rights issue wave
It remains to be seen how many more companies will make rights issues but at the present time it seems a good option for companies, many of which are in dire need of a cash injection, although investors may be becoming wary and viewing rights issues as a case of good money after bad.