Archive for the ‘shareholders’ Category

British Airways loses IT – a case study

British Airways (BA) used to be called ‘the worlds favourite airline.’  Not any more.   On May 27 2017, a world-wide systems failure grounded all BA flights.  Check-in desks at London’s Heathrow and Gatwick and other airports around the world were unable to access passenger details.  470 flights were cancelled in London and a further 183 on the following day, with many more flights stranded around the world. Tens of thousands of passengers were left standing around for hours with no information, until being told to ‘come back tomorrow’.  BA airport staff seemed unprepared for the huge numbers of stranded passengers. BA web sites and inquiry operators had little information, other than that all flights had been cancelled. Passenger baggage piled up and did not reach them for days.  Compensation claims for delays and lost baggage were estimated at over £100 million.   The reputation loss for BA was immeasurable.

Although some immediately thought this must be a cyber attack, it was not.  BA’s initial explanation for the systems breakdown was loss of power to servers on the central reservation system. Other systems reliant on access to passenger data, including the flight loading system and the baggage handling system, then shut down.

IT experts suggested that with such sophisticated systems, BA must have included back-up power supplies.  Indeed they had, but it emerged that the power had failed totally because a maintenance worker had turned it off.  The back-up systems, a generator and batteries were working perfectly.  Then, once power was restored, efforts to re-boot the systems were bungled.

Some BA ex-employees, who had been laid off as a result of a head office cost cutting drive, suggested that the heart of the problem was a decision to out-source IT work to an Indian company.  ‘The BA system is a legacy system that has evolved over generations of equipment and software changes,’ they said. ‘The inter-relatedness of the systems and the complexity of the data is immense.  BA needed people who had grown up with the system.  This is not the first time the system has failed this year.’  BA denied this suggestion.

British Airways, once the country’s flag-carrier, is now a subsidiary of the International Airline Group (IAG), a Spanish company, which also owns Iberia, the Spanish airline.  IAG’s shares had risen significantly in the previous year and suffered only a small fall following the BA systems saga.

The CEO of IAG, Willie Walsh (who had previously headed BA) did not appear during the crisis, leaving the situation to be handled by BA’s CEO, Alex Cruz.  They were both criticised for delays in offering explanations or apologies.  An official raised a storm by suggesting that passengers would receive full refunds on their tickets, but BA would not pay for the cost of missed connecting flights, alternative travel arrangements, or accommodation.

Subsequently, BA apologised to its customers and commissioned an independent inquiry.  The British airlines’ regulator, the Civil Aviation Authority, was also called on to examine the case.

At the previous AGM of IAG, shareholders had received a letter from a corporate governance advisory group that ‘the board should consider bolstering the IT experience of its non-executive cohort: only one of the serving non-executive directors has IT experience.’

 

Discussion questions:

  1.  Who was responsible for this debacle?
  2. How might such a situation have been avoided?
Advertisements

New Developments in UK Corporate Governance

New Developments in UK Corporate Governance

In previous blogs, I discussed the Department for Business, Energy & Industrial Strategy (BEIS) Green Paper on Corporate Governance Reform issued in November 2016 and the BEIS report which detailed its recommendations and conclusions based on the consultation of this Green Paper.  On 29th August 2017, the UK Government published ‘Corporate Governance Reform, The Government Response to the Green Paper Consultation’, available at: https://www.gov.uk/government/uploads/system/uploads/attachment_data/file/640631/corporate-governance-reform-government-response.pdf

In the Executive Summary, it states that ‘The purpose of corporate governance is to facilitate effective, entrepreneurial and prudent management that can deliver the long-term success of a company. It involves a framework of legislation, codes and voluntary practices.  A key element is protecting the interests of shareholders where they are distant from the directors running a company. It also involves having regard to the interests of employees, customers, suppliers and others with a direct interest in the performance of a company. Good corporate governance provides confidence that a company is being well run and supports better access to external finance and investment.’

The Executive Summary goes on to say that there are nine headline proposals for reform across the three specific aspects of corporate governance on which they consulted, ‘these being executive pay;  strengthening the employee, customer and supplier voice; and corporate governance in large privately-held businesses. It also takes into account the need for effective enforcement of the corporate governance framework.’

Of particular note are that all listed companies will have to reveal the pay ratio between bosses and workers; all listed companies with significant shareholder opposition to executive pay packages will have their names published on a new public register;  and new measures will seek to ensure employee voice is heard in the boardroom.

https://www.gov.uk/government/news/world-leading-package-of-corporate-governance-reforms-announced-to-increase-boardroom-accountability-and-enhance-trust-in-business

 

George Parker highlighted the emphasis on boardroom pay in his article ‘May maintains focus on boardroom pay’ (Financial Times, 26th/27th August 2017, page 2). The High Pay Centre welcomes the requirement for all listed companies to publish their pay ratios ‘Most significant of all, from our point of view, was the announcement that the pay ratio between the CEO and the average UK employee will now have to be published by every listed company. We have never claimed that this measure will solve the problem of excessive pay at the top, nor that it will suddenly halt and reverse a trend that has developed over 20 years and more. Unfair or misleading comparisons between pay ratios in very different businesses or organisations should not be made. But finally we will have a meaningful way of tracking the gap in pay between the top and the average employee. Shareholders and other stakeholders will be able to scrutinise these gaps and apply pressure to close them. And this can be done, of course, not just by restraining pay at the top but raising pay for those lower down the scale.’ (Stefan Stern September Update, High Pay Centre).

The Financial Reporting Council (FRC) will be undertaking a consultation on a fundamental review of the UK Corporate Governance Code later this year as the 25th anniversary of the UK Corporate Governance Code approaches later in 2017.

 

Chris Mallin

September 2017

Shareholder Committees

In a previous blog post, I discussed the Department for Business, Energy & Industrial Strategy (BEIS) Green Paper on Corporate Governance Reform issued in November 2016.

One of the options suggested in the Green Paper in relation to shareholder engagement on pay, was to ‘Establish a senior “shareholder” committee to engage with executive remuneration arrangements’. According to para 1.36, ‘A complementary or alternative way to enable greater shareholder engagement on pay might be to establish a senior Shareholder Committee to scrutinize remuneration and other key corporate issues such as long term strategy and directors’ appointments. The full implications of adapting any such model in the UK, however, would need careful consideration given its potential impact on our long-established unitary board structure.’

The idea of a shareholder committee received support from some organisations including a joint response to the Green Paper from The UK Shareholders’ Association (UKSA) and the UK Individual Shareholders’ Society (ShareSoc).  Both of these organisations represent the interests of private shareholders who invest directly or indirectly via nominee accounts in public companies or in other forms of equity-based investment.

Their joint response stated ‘We strongly support the concept of Shareholder Committees, provided that they represent the interests of all shareholders, including private investors and investors in employee share plans.’ They are of the view that ‘Shareholder  Committees  are  a  core  part  of  the  solution  to  the  problems  of  corporate  governance. There are many  other elements of governance and control that can be improved and we have commented  in  our  response  on  those  where  we  have  specific  knowledge.  However, without Shareholder  Committees,  and  concomitant  reform  to  restore  the  rights  of  individual  shareholders, other changes to corporate governance are unlikely to produce meaningful change.’

However, certain organisations, for example, Tomorrow’s Company, are wary of widening the scope to include issues such as remuneration.  Tomorrow’s Company’s website states that ‘The original idea proposed by Tomorrow’s Company in 2010 was for a Shareholder Committee which would involve shareholders large (and small) in the most important single governance decision – who represents them on boards. Later variants, like this one and that by Chris Philp MP, have widened the scope to involving investors in discussions about remuneration.’ Tomorrow’s Company then points out that ‘The risk of this more complicated approach is that it compromises the clear leadership responsibility of the board.’

 

Royal Bank of Scotland

A case in point is that of the Royal Bank of Scotland (RBS).  With over 70% ownership by UK taxpayers, there is a very real argument that its governance is of interest to the public more generally.  Aime Williams in her article ‘Shareholders clash with RBS’, (1st April 2017, Financial Times) reports that ‘About 160 individual investors are pushing RBS to form a shareholders’ committee, which would allow retail investors to have a formal say on RBS proposals, such as executive pay, company strategy and director appointments.’

However, RBS’ preference is for a stakeholder committee which would allow a wider stakeholder group to have a voice and air any concerns to directors.  A key difference though, is that a stakeholder panel would have less power and therefore would likely be less effective than a shareholder committee, which would be able to wield more influence.

The RBS Annual General Meeting will be held on 11th May 2017.  It will be interesting to see the outcomes of various resolutions, especially on potentially contentious issues such as executive remuneration, and whether a shareholder committee is established in the future.

 

 

Chris Mallin

April 2017

Developing a shareholder strategy

A survey of shareholder communications in more than 400 companies listed on the Hong Kong Stock Exchange (HKSE) was published recently by the Hong Kong Institute of Chartered Secretaries (HKICS).   Since the HKSE ranks third equal with the Singapore Stock Exchange in world rankings (behind London and New York), it is likely that the findings have a wider significance.

The report, which I drafted, suggested that effective shareholder communications rest on an understanding of the shareholder base and their information needs. A key conclusion was that whilst some listed companies recognize that shareholder communications are vital, the majority do not and have some way to go to be effective.

Some of the key findings in the study were that:

  • A sizeable proportion of listed companies did not know much about their shareholders – the survey results showed that a third of respondent companies did not know who their shareholders were. They did not regularly or routinely monitor their shareholder base.
  • Some listed companies were not even bothered to find out – 5% of respondents said that they felt that they should be routinely monitoring who their shareholders were but did not: and a further 15.5% said they should be monitoring them on an ad hoc basis but did not.
  • The majority of listed companies lack a shareholder communication strategy

–  58.3% of respondents recognized that their communications with their shareholders were inadequate or ‘somewhat inadequate’.  Most saw the need for improvement.  But 8.6%, although they recognized that their communications were inadequate, saw no need for change. Only 33.1%% thought that their shareholder communications were adequate.

  • The vast majority did not think that all shareholders should be treated equally – Whilst respondents strongly believed that shareholders should be engaged more effectively, only a few (92) felt that all shareholders should be involved, whilst the majority (269) felt that engagement should only be with institutional investors and long-term shareholders. However, respondents believed that these investors had a stewardship role to proactively engage with the company.
  • There is little accountability for shareholder communications at the CEO or board levels – Many companies (172) report information on their shareholder profile to senior management, the board, or board committees. But more companies (241) did not report the data or did not know how it was used.
  • The company secretary is a source of help on investor relations profiling the shareholder base in 52.5% of the companies responding, followed by the Head of Investor Relations (21.0%). Companies reported devoting more resources to investor relations activities including shareholder communication and engagement, with increasing significance for an investor relations function.

Five ‘imperatives’ were developed to give practical and effective guidance to the board of directors and senior management to enhance shareholder communications and investor relations for listed companies, namely to:

  1. Develop an investor relations strategy within the corporate strategy
  2. Know and regularly review the shareholder base
  3. Formulate and regularly review shareholder communication policies
  4. Formulate and regularly review shareholder engagement policies
  5. Review the responsibility and accountability for investor relations

‘The full report can be read at: https://www.hkics.org.hk/index.php?_room=10&_action=detail&_page=3

(Click for the English or Chinese versions)

-Bob Tricker, 2017

 

A new idea in corporate governance – Shareholder Senates

Around twenty years ago I wrote that while the twentieth century had been the era of management, with its new management schools, management consultants, and management gurus, the twenty-first century would be the era of corporate governance.   Corporate governance has certainly now moved centre stage. Google has 52 million references to the phrase.

Interest in corporate governance has flourished. The late Sir Adrian Cadbury wrote the first corporate governance code – the UK’s Financial Aspects of Corporate Governance (1992).  He always emphasized that his report was not a comprehensive approach to corporate governance, but focused on the financial aspects. Nevertheless, he made proposals that are still pertinent ̶ the creation of board level audit committees, remuneration committees, and nomination committees, with independent outside directors; the separation of the board chairman from the CEO; and public reporting that the company had complied with the code or explaining why it had not.

Since then, corporate governance codes, often as stock exchange requirements, cover almost all listed companies around the world. But despite countless amendments, revisions, and rewrites most corporate governance development has been piecemeal. There has been relatively little original thinking. Most codes still adopt Cadbury’s voluntary ‘comply or explain’ approach. The principle exception is in the United States, where regulation and legislation are used to oversee the governance of corporations.

The development of corporate governance practice has almost always been in response to corporate failure or economic malaise. In the United States, the Securities and Exchange Commission (SEC) was set up in 1932–3, after the stock market crash of 1929 and the great depression that followed. The Cadbury report responded to concerns about corruption found in UK Government inspectors’ reports on failed companies including the collapse of Robert Maxwell’s’ corporate empire.

The US Sarbanes-Oxley Act (SOX 2002), was a response to the failure of Enron, Waste Management, and other companies, followed by the folding of the ‘Big Five’ accounting firm, Arthur Andersen, reducing the big five to the even bigger four. Unfortunately, SOX did not prevent the global financial crisis, starting around 2008, in which US companies such as Lehman Brothers failed and American International Group, Fannie Mae, Freddie Mac, and others were bailed-out by the US government. The result was further federal legislation. The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, called by some SOX 2, attempted to improve American financial regulation and the governance of the US financial services industry.

As yet, no over-arching theory of corporate governance has emerged. New thinking and new ideas are badly needed in the governance of organizations. A fundamental governance question for the modern public company, for example, is: What role should the shareholders play in corporate governance?

In the original mid-nineteenth model of the joint-stock limited liability company, the shareholders were mostly individuals–aristocrats and members of the newly forming affluent middle class. These shareholders appointed the directors who reported to them on their stewardship of the company. The directors may have known their shareholders personally. Shareholder meetings and votes were the way boards of directors were held to account. Indeed, in the original model accounts were audited by an audit committee, elected from among the shareholders themselves.

But today, individuals running their own portfolios form only a small part of the shareholder base. These ‘retail shareholders’ typically have relatively small holdings and little influence. They might also include directors, executives, and other employees of the company.

Significant shareholders are more likely to be:

  • active institutional investors, such as mutual funds, pension funds, and financial institutions, closely interested in the company’s affairs who may be actively involved in corporate governance matters; and
  • passive institutional investors, such as index-tracking funds required by their constitutions to invest in a given range of securities, using computer algorithms to make investment decisions, with little interest in corporate governance issues. The shareholder base could also include:
        • hedge funds gambling against the market and selling short, with real short-term interests in the business, but not in longer-term corporate governance;
        • private equity investors seeking short term strategic opportunities;
        • dominant investors, perhaps the company’s founders or their family trusts, who are closely interested in, and possibly actively involved in company affairs. Though they might hold only a minority of the voting equity, in some jurisdictions they can maintain ownership power through dual-class shares;
        • state-owned corporations, perhaps with a minority of their shares traded publically, and possibly influenced by state economic and political interests; and
        • sovereign funds, using state capital to invest, possibly with political or economic implications as well as financial interests.Concerns over corporate behaviour, such as allegedly excessive director remuneration, unclear or over-ambitious corporate strategies, or the lack of board diversity have led some politicians and other commentators to call for shareholders to exercise their duty to oversee board behaviour more fully. This has led to the emergence of proxy advisers; firms that study issues facing companies and advise institutional investors on voting decisions.

But votes in shareholder meetings are advisory; exhortatory at best. Shareholders’ votes do not bind the board. Directors do not have to follow them. Energetic efforts by some institutional investors, including grouping together, have not changed the underlying power structure.

Bob Monks, in his book Corpocracy (New York: Wiley, 2007), showed how power had moved over the years from owners to directors. Concerned by what he saw as an abuse of power, he co-founded Institutional Shareholder Services (ISS) in 1985 to wage proxy warfare on companies. These proxy battles continue to this day. However, the fundamental question remains: In the modern public company what should the role of shareholders be?

Is it, on the one hand, to preserve the nineteenth-century legal concept of the corporation–that the shareholders own the company and are expected to play a basic role in its governance by electing the directors and holding them to account. Or is it, on the other hand, for the shareholders to accept a corporate stakeholder role providing finance, just as suppliers provide goods and services, customers produce sales revenues, and the employees provide the work force?

I have just completed a study on shareholder communication for the Hong Kong Institute of Chartered Secretaries, which will be published shortly and duly noted in this blog. In a survey Hong Kong’s listed companies gave overwhelming support for the idea that shareholders should exercise a stewardship role in the governance of listed companies. In this they are in line with the opinions of many authorities around the world–regulators, legislators, and corporate governance commentators.

Had the alternative view been taken, that shareholders are just one of the various stakeholders in a corporation, appropriate governance models could be developed. The German supervisory level two-tier board could provide a start; members are nominated to represent both labour and capital (the employees and the investors). Representatives of other stakeholders could be added.

Such a development would reflect a change in the UK Companies’ law in 2006. Prior to that company law in the UK required directors to act in the best interests of the company, which effectively meant in the interest of the shareholders, in other words, by attempting to maximize shareholder value in the long term. But the Companies Act 2006 specifically spelled out a statutory duty to recognize the effect of board decisions on a wider public. For the first time in UK company law, corporate social responsibility (CSR) responsibilities were included among the formal duties of company directors:

‘A director of a company must act in the way he considers, in good faith, would be most likely to promote the success of the company for the benefit of its members as a whole, and in doing so have regard to:

(a) the likely consequences of any decision in the long term

(b) the interests of the company’s employees

(c) the need to foster the company’s business relations with suppliers, customers, and others

(d) the impact of the company’s operations on the community and the environment

(e) the desirability of the company maintaining a reputation for high standards of business conduct, and

(f) the need to act fairly as between members of the company.’

Thus UK company law now requires companies to consider employees, suppliers, customers, and other business partners, as well as the community and the environment, in their decisions.

However, if shareholders are to continue to be a responsible part of the corporate governance mechanism, how might that be achieved? If shareholders are really to affect corporate governance in the companies in which they invest, they need more power. New corporate governance models will have to be devised. One idea might be a Shareholder Senate.

Shareholder Senates

A Shareholder Senate would be a new governance body set mid-way between the company and the body of shareholders. Members of the Senate would be nominated by long-term institutional investors and elected by all the shareholders.

The Senate would meet formally with the board’s remuneration committee, its nomination committee, and its audit committee with the auditors. Periodically, it would have discussions with the Chairman and the entire board. It would also meet independently to formulate reports and make recommendations to shareholders.

The overall responsibility for the company and its management would remain with the board of directors. The Senate would have the authority to question, to advise, and to influence the company on its strategies, operational performance, and financial matters. For example, a Senate could question and challenge levels and methods of executive remuneration, the adequacy of risk assessment systems, the balance of skills, experience, and adequacy of the directors, and confirm that succession plans existed for all senior executives.

The Senate would not have the power to block the board’s decisions, nor could it hire and fire directors (as the German supervisory board can). But it would have the responsibility to liaise with the shareholders, and the power to recommend how they vote on specific motions. It could also introduce motions for shareholder meetings. Over time, Shareholder Senates would supplement and probably replace the work of proxy advisers.

Shareholder Senates would become a fundamental component of companies’ corporate governance structures and processes. Accordingly, members of the Senate would have fees and expenses reimbursed by the company, just as non-executive, outside directors have. The company would be responsible for publishing Senate reports and other communications with investors, just as it publishes other corporate reports.

Concern might be expressed that members of Shareholder Senates would receive unfair insider information. But Senate members could be placed in a similar position to directors who may not trade shares prior to the announcement of results. In fact, Senate members would be in a less exposed position than a nominee director elected by a major shareholder, because they would not attend board deliberations.

In fact, it would not be difficult to introduce a requirement for shareholder senates into companies’ legislation or to include them in corporate governance codes, operating on the ‘comply or explain’ principle.

The proposal for Shareholder Senates will not be welcomed by most directors and their boards, because they would inevitably mean a shift of power away from the boardroom back to the owners. However, there was plenty of antagonism in British board rooms to the original Cadbury Report proposals: many thought independent outside directors were an unnecessary imposition and an infringement of executive directors’ right to run their own companies.

There is little doubt that Shareholder Senates will not be achieved without legislation and regulation. Such developments could be prompted by the ongoing dissatisfaction with the governance of the modern corporation. The newly appointed British prime minster, Theresa May, following the UK’s referendum vote to leave the European Union, mentioned problems with the governance of British companies in her inaugural statement.

Corporate governance evolves. Dissatisfaction exists over the present corporate governance model. Some boards readily accept a responsibility to engage with their shareholders. Others do not. Some companies are run for the benefit of their owners. Others are not. Criticisms multiply of board-level excess, particularly over board-level remuneration. Shareholder Senates would provide an opportunity to re-establish owners’ rights. They would give investors a more effective say in the governance of their companies. Power would no longer be abdicated by the owners to the directors.

 

Bob Tricker
September 2016

Share Ownership in the UK

Increasing ownership by ‘rest of the world’

At the end of 2012, the UK stock market was valued at £1,756.3 billion. The ownership of UK shares has changed dramatically over a 40 year period. The Office of National Statistics (ONS) surveys indicate that the ownership of UK shares by individuals has fallen from 54% in 1963 to under 11% in 2012. On the other hand, the ‘rest of the world’, which held just 7% of UK shares in 1963, now own over 53% of UK quoted shares. This decrease in individual share ownership and increase in the ‘rest of the world’ ownership is perhaps the most notable change in the overall share ownership figures reported by the ONS in its publication ‘Ownership of UK Quoted Shares, 2012’ which is available at:

http://www.ons.gov.uk/ons/rel/pnfc1/share-ownership—share-register-survey-report/2012/stb-share-ownership-2012.html

The ONS analysis of the ‘rest of the world’ shareholding of 53% of UK quoted shares finds that some 48% of this is owned by investors in North America, just under 26% by European investors and around 10% by investors in Asia. The balance is made up of investors from various regions including Africa and the Middle East.

Corporate governance activism

One of the possible implications of the increase in ‘rest of the world’ ownership, and particularly ownership by investors in North America, is in relation to corporate governance activism. Such investors may tend to be more pro-active than many UK institutional investors have traditionally been and may engage more in their investee companies especially where these are underperforming or where there are corporate governance issues. The California Public Employees’ Retirement System (CalPERS) is a well-known example of a US pension fund which actively engages with underperforming companies and/or with those where there are corporate governance issues. In years gone by its strategy was to ‘name and shame’ with its focus lists but these days it concentrates more on a particular issue, for example, executive remuneration, and engages privately with the company to try to bring about improvements before then progressing to any more public approach.

Improved Investor Engagement

Nonetheless the UK’s ‘vanguard’ institutional investors including Hermes, Aviva, and Standard Life all have a high corporate governance profile and actively engage with their investee companies. Moreover the Investment Management Association (IMA) reported increased levels of monitoring and engagement in June 2013 in their survey of ‘Adherence to the FRC’s Stewardship Code, At 30 September 2012’, available at:

http://www.investmentuk.org/research/stewardship-survey/

The report indicated that more institutional investors monitor all their investee companies; that more resources are being put into the stewardship role and that there is ongoing integration of stewardship into the wider investment process. Investors are also prioritising engagement on key issues. Furthermore there has been an increase in voting level with the decision of how to vote the shares being made independently of proxy agencies.

Concluding comments

The UK’s Stewardship Code set the standard in terms of providing a framework for institutional shareholders to monitor, and engage with, their investee companies. There have been a number of encouraging signs that shareholder engagement is on the increase in a number of countries. In her article, ‘Shareholder campaigns more than double in three years’ (FT, Page 20, 11th November 2013), Sam Jones points out that ‘the past 12 months have seen more than 415 instances of corporate activism across the world, up from 172 in 2010’. This trend is expected to continue as institutional investors, with sensitivities highlighted in the aftermath of the financial crisis, increasingly seek to ensure that their investee companies both have appropriate standards of corporate governance and sustainable returns.

Chris Mallin 5th December 2013

Executive Pay – the Days of the Golden Packages Are Numbered?

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.

 

Recent trends

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 UK Stewardship Code

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.

 

Other issues

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

Concluding comments

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:

http://www.frc.org.uk/images/uploaded/documents/UK%20Stewardship%20Code%20July%2020103.pdf

http://www.frc.org.uk/images/uploaded/documents/Implementation%20of%20Stewardship%20Code%20July%2020103.pdf

Chris Mallin 5th July 2010

Rethinking the Exercise of Power over Corporate Entities

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.

Bob Tricker

Risk Management

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

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’.

Asset managers

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’.

Concluding comments

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