Archive for July, 2009|Monthly archive page

Rethinking Corporate Governance

Sir David Walker’s government-commissioned review of corporate governance in UK banks and other financial entities was published on 16 July 2009, and a new acronym joins the corporate governance lexicon: BOFI boards: boards of banks and other financial institutions.

Britain has already produced more reports on corporate governance than any other country in the world. (Corporate Governance – principles, policies and practices, OUP 2009, page146). This is the tenth, if we include the UK combined code.  With 140 pages, Walker’s report is significantly longer than the first and paragon Cadbury Report in 1992 which had 90 pages. 

Walker believes that UK corporate governance should stay with the ‘comply with the Combined Code or explain why you have not’ principle.  No US corporate governance by law and Sarbanes Oxley Act for the UK.  

He concludes that the principal deficiency is the way directors behave.  They do not challenge the executives enough.  The right sequence in board discussion on major issues, says Walker, should be presentation by the executive, a disciplined process of challenge, decision on the policy or strategy to be adopted and then full empowerment of the executive to implement.  Yes.  One wonders what they did before.

A board structure needs the right mix of both financial industry capability and critical perspective from high-level experience in other major business, Walker concludes.  “Independence of mind is more relevant than formal independence.”  He also calls for a materially increased time commitment from non-executive directors. 

Leadership skills of the chairman of the board are important, too, Walker says, together with the “ability to get confidently and competently to grips with major strategic issues.”   So true.  One has only to read the Northern Rock case (Corporate Governance page 344) to see why.  The challenge to chairman is such that “the chairman’s role will involve a priority of commitment that will leave little time for other business activity.” 

The report calls for better risk management, with more attention to the monitoring of risk, with NED involvement in enterprise risk management, including risk strategies, quite separate from the work of the management risk committee.

Then Walker echoes a call heard many times before that shareholders should engage with the companies they invest in for long-term performance improvement. And the reaction is likely to be the same: some fund managers will continue their initiatives to improve governance and the rest will take the short-term view, voting with their feet when they feel like it.

Finally, Walker proposes that the “remit and responsibility of board remuneration committees be extended beyond board members to cover the remuneration framework for the whole entity.”  This is a response to the prevailing public anger at allegedly excessive executive bonuses and perceived rewards for failure. 

In other words, Walker calls for more of the same, only more so.  But as long as grandees of the City of London continue to write these reports, this is what we should expect. 

The metamorphosis of corporate governance will not happen until the 19th century concept of the limited liability company is rethought and brought in line with the reality of business in the 21st century. 

Alternatives that might be considered include:

  • public companies to have realistic constitutions, which define and limit their objectives as society’s price for allowing their incorporation of the entity with limited liability
  • a new governance structure – a governing body of independent directors appointed by the shareholders – not to run the company but to govern it
  • this governing body to question the directors in public, scrutinizing strategies, policies and outcomes (as previously mentioned on this site)
  • the external auditors to report to the regulators not the directors who appoint and pay them (as previously discussed on this site)
  • developing a taxonomy for companies that reflects the way power is actually exercised over them

Voting – Having a Say

Voting ones’ shares is seen as one of the main tools of corporate governance.  In recent times, votes have been cast against adoption of the annual report and accounts, against the appointment, or re-appointment, of certain directors, and against certain proposed strategies.  Votes can also be used via the ‘say on pay’ to signal displeasure at executive remuneration packages.  Although the ‘say on pay ‘ (discussed in more detail in this blog on 6th April 09) is an advisory vote, it may nonetheless be quite effective at making boards think twice about the proposed pay packages for executive directors. 

However companies do not always take as much notice of the votes cast as one would like.  For example, the recent annual general meeting of Marks and Spencer is a case in point as regards the use of voting as a (vociferous) voice.  Andrea Felsted and Samantha Pearson (FT Page 17, 9th July 09) in their article ‘M&S chief defiant amid revolt by investors’ highlight that nearly 38% of votes cast backed a resolution seeking the appointment of an independent chairman within the next year.  Sir Stuart Rose, who has been the centre of much criticism since taking on the roles of both chairman and chief executive, did not seem overly bothered by the investors’ views on this matter.  There was also much shareholder dissent over the re-election of the chairman of the remuneration committee and over the adoption of the remuneration committee report.

Withheld votes

Whilst the importance of the vote is universally accepted, let us consider what happens in the UK when a vote is withheld.  A withheld vote may signal that an investor has reservations about a resolution, or it may be a stronger expression that an investor is unhappy about a resolution, whilst falling short of actually voting against the resolution.  However when the ‘vote withheld box’ is ticked on proxy forms in the UK, the withheld votes are not counted as part of the votes cast. 

For example, after its annual general meeting in May 2009, Shell published the voting results on its website.  On Resolution 1 : Adoption of Annual Report & Accounts, there were:  ‘votes for’  3,301,631,965, ‘ votes against’  3,394,595, and ‘votes withheld’ 16,026,721.  However when indicating the percentage split of the votes, ‘votes for’ are shown as 99.90% and ‘votes against’ as 0.10%.   The votes withheld were nearly 5 times that of the votes against but nowhere are they reflected in the percentage totals of votes cast.  Similarly, on Resolution 4 : Re-appointment of Lord Kerr of Kinlochard as a Director of the Company, there were ‘votes for’  3,161,974,849, ‘votes against’  77,443,311, and ‘votes withheld’ 77,876,289.  The percentage allocation indicated 97.61% ‘votes for’ and 2.39% ‘votes against’.  The ‘votes withheld’ which again exceeded the ‘votes against’ were not reflected at all in the percentage totals.  It should be said that Shell does clearly state that “a ‘vote withheld’ is not a vote under English Law and is not counted in the calculation of the proportion of the votes ‘for’ and ‘against’ a resolution.”

The Combined Code on Corporate Governance (2008) under Code provision D.2.1, states that  ‘For each resolution, proxy appointment forms should provide shareholders with the option to direct their proxy to vote either for or against the resolution or to withhold their vote. The proxy form and any announcement of the results of a vote should make it clear that a ’vote withheld’ is not a vote in law and will not be counted in the calculation of the proportion of the votes for and against the resolution.  However it’s interesting to note that a decade ago, the Report of the Committee of Inquiry into UK Vote Execution (1999), published by the National Association of Pension Funds, stated that whilst it was initially attracted to the idea of adding a third box (being an ‘abstention’ or ‘vote withheld’ box), it then decided that there were several arguments against the inclusion of such a third box.  Firstly it might provide investors with an ‘easy option’ so that rather than voting against, they withheld their votes; and secondly since withheld votes are not counted, and have no legal effect, then it could drive down the level of recorded votes. 

However as we have seen, the Combined Code (2008) does advocate the inclusion of a ‘vote withheld’ box on the proxy form.   Therefore, it could be that in practice the addition of a third box which allows a withheld vote but which is not counted, may lead to the understatement of the level of dissatisfaction with some resolutions.  Given that institutional investors are coming under more and more pressure to be seen to be active owners of shares, it may be that a ‘vote withheld’ will increasingly become seen as sitting on the fence, rather than taking a decision to vote against.

In the US, it would seem that abstentions do have a legal effect under a majority voting system.  For example, in a director election if there were more votes withheld than were voted for the candidate, then the candidate would not be elected, hence the abstentions (votes withheld) would have a legal effect.

Broker votes

Turning to US issues, the SEC has recently made some important changes to proxy voting.  Weil, Gotshal and Manges (2009) report that ‘the SEC approved a change to NYSE Rule 452, eliminating broker discretionary voting of uninstructed shares in uncontested director elections, which will have the effect of reducing the number of votes cast in favor of the board’s nominees in the election of directors and strengthen the influence of institutional investors and activist shareholders.’

Blank votes

However James McRitchie has brought to our attention the problem of blank proxy votes which go to management.  He highlights that fact that the broker vote issue that the SEC took care of is ‘where retail shareowners don’t submit a proxy (or voter information form) at all.  When that happens, the broker or bank can vote within 10 days of the meeting. The “blank vote” issue arises when the shareowner votes at least one item on their proxy but leaves some other items blank……..[the voting] platform for institutional investors doesn’t allow submission of blank votes, [but the] platform for retail holders does and the SEC allows them to fill in the blanks as instructed by brokers and banks (always with management)’.  Furthermore he states that ‘As shareowners who believe in democracy, we have filed suggested amendments to take away that discretionary authority to change blank votes, or non-votes, as they might be termed. We believe that when voting fields are left blank on the proxy by the shareowner, they should be counted as abstentions.’

Concluding thoughts

Clearly the area of voting is a complex one and changes are being brought in over time to remove barriers to voting and to help ensure that votes are cast in a way which fairly reflects the owners’ intentions. A decade ago it would have seemed highly unlikely that many institutional shareholders would publish their voting levels in individual companies and on individual resolutions  but many institutional shareholders now do this.  In the US a number of institutional shareholders have gone a stage further and disclose their voting intentions prior to a company’s AGM.  Hopefully institutional shareholders in other countries will adopt this approach in future.

Chris Mallin 10th July 2009.