Archive for the ‘investors’ Tag

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

Divide and Conquer? Splitting the Roles of Chair and CEO

 It is widely recognised that corporate scandals and collapses often occur when there is a single powerful individual in control of a company.  This is exacerbated when there is a lack of independent non-executive directors on the board.  Therefore it seems axiomatic that powerful individuals can be constrained, and the temptations they may face conquered, by having in place a sound corporate governance structure achieved through dividing the roles of Chair and CEO.

UK Context

Back in 1992, the much lauded Report of the Committee on the Financial Aspects of Corporate  Governance, often referred to as the Cadbury Report after the Chair of the Committee, Sir Adrian Cadbury, identified the potential danger of combining the roles of Chair and CEO in one person.  The Cadbury report recommended ‘there should be a clearly accepted division of responsibilities at the head of a company, which will ensure a balance of power and authority, such that no one individual has unfettered powers of decision’.  This principle was embodied in corporate governance best practice in the UK, with the Combined Code on Corporate Governance (2008) stating ‘there should be a clear division of responsibilities at the head of the company between the running of the board and the executive responsibility for the running of the company’s business. No one individual should have unfettered powers of decision’, and furthermore the Combined Code explicitly states ‘the roles of chairman and chief executive should not be exercised by the same individual.’

Whilst combining the roles of Chair and CEO is rare in the UK’s largest companies, Marks and Spencer PLC is a notable exception.  In May 2004 Sir Stuart Rose was appointed to the position of Chief Executive and subsequently in 2008 he became both chairman and CEO until July 2011.  This combination of roles goes against the Combined Code’s recommendations of best practice.  As a result in 2008 some 22 per cent of the shareholders did not support the appointment of Sir Stuart Rose as chairman.  Nonetheless he remains in the combined role although there is still considerable shareholder unrest and 2009 has seen more dissent by shareholders on this issue.

US Context

In the US, the roles of Chair and CEO have often been combined but now more and more companies are appointing separate individuals to the two roles.  A recent example of a US company which has decided to appoint an independent chairman is Sara Lee, the famous producer of gateaux, beverages and body care products.  Sara Lee has decided to make this change as a response to investor pressure and also the growing trend in the US to split the two roles.  Kate Burgess (FT Page 27, 9th October 09) in her article ‘Sara Lee to separate executive roles’ explores this case in more detail.

Institutional Investor Pressure

In the UK there has long been pressure brought to bear by institutional investors on companies which have tried to combine these roles.  This pressure, together with the long history in UK corporate governance codes against the combination of roles, means that few large companies seek to combine the roles (although as noted above, Marks and Spencer plc is an exception).

Recently Norges Bank Investment Management (NBIM), a separate part of the Norwegian central bank (Norges Bank) and responsible for investing the international assets of the Norwegian Government Pension Fund, has started a campaign to convince US companies to split the roles of Chair and CEO and appoint independent chairmen.   Kate Burgess (FTfm Page 10, 12th October 09) in her article ‘Norwegian fund steps up campaign’ highlights how NBIM has submitted resolutions to four US companies calling on them to appoint independent chairmen.  The four companies are Harris Corporation, Parker Hannifin, Cardinal Health Inc, and Clorox.  In addition NBIM has also voted against combined Chair/CEOs at some 700 US companies.  Interestingly Sara Lee had also been the focus of action by NBIM before agreeing to appoint separate individuals to the roles in future. Also in Kate Burgess’ article, Nell Minow of The Corporate Library http://www.thecorporatelibrary.com/ states ‘NBIM can leverage a lot of shareholder frustration and a widespread sense that this is a sensible, meaningful but not disruptive initiative’.

Concluding comments

It seems to be only a matter of time before the vast majority of companies will split the roles of Chair and CEO.   Of course the individuals appointed to those roles must be both capable of fulfilling the tasks expected of them, and of ensuring that ultimately the two roles, carried out by separate individuals, unite the company under a common leadership approach.  That may prove more difficult than many imagine and so the appointments process must consider fully the many traits needed to ensure success.

 Chris Mallin 16th October 2009

UN Principles for Responsible Investment (PRI)

The UN Principles for Responsible Investment (PRI) were issued in 2006. The PRI were developed by an international group of institutional investors reflecting the increasing relevance of environmental, social and corporate governance issues to investment practices. The process was convened by the United Nations Secretary-General.  The PRI state: “As institutional investors, we have a duty to act in the best long-term interests of our beneficiaries. In this fiduciary role, we believe that environmental, social, and corporate governance (ESG) issues can affect the performance of investment portfolios (to varying degrees across companies, sectors, regions, asset classes and through time). We also recognise that applying these Principles may better align investors with broader objectives of society”.  http://www.unpri.org/principles/

Signatories to the PRI commit to incorporating ESG issues into investment analysis and decision-making processes; being active owners and incorporating ESG issues into ownership policies and practice; seeking appropriate disclosure on ESG issues by the entities in which they invest; promoting acceptance and implementation of the Principles within the investment industry; working together to enhance their effectiveness in implementing the Principles and reporting on their activities and progress towards implementing the Principles.

PRI Report on Progress (2008)

The ‘PRI Report on Progress 2008’ was published.  The report highlights progress made to date, special initiatives that have been undertaken, and areas for improvement.  Interestingly the PRI encourages signatories to disclose their responses to the annual Reporting and Assessment survey, and every year a number of signatories agree to make their responses publicly available.  The responses can be viewed at: http://www.unpri.org/report09/

One of the questions on the annual Reporting and Assessment survey asks respondents to rank the six principles on the level of difficulty of implementation of the principles.

There are currently 574 signatories to the Principles, comprising 183 asset owners, 282 investment managers, and 109 professional service partners. 

Aviva Investors is one of the signatories and their Head of Research and Engagement, Steve Waygood is quoted as saying: “There is now a critical mass of institutional investors who believe management of corporate responsibility or ESG issues is highly relevant to the long-term financial success of their investments”.

UN PRI Delists Members

The UN PRI recently delisted five of its signatories after they failed to report on their activities.  Sophia Grene (FTfm Page 6, 24th August 09) in her article ‘UN Principles need sharper teeth’ states ‘it is a significant step forward for the UNPRI to demonstrate there are consequences to treating the principles as nothing but a brand-enhancer’.

Concluding thoughts

The UN PRI have taken some clear steps to hold its members (signatories) to account.  The UN PRI are also working on a transparency framework which, according to Grene, will give  ‘clients, customers, members and other stakeholders…a clear sense of their responsible investment processes, activities and capabilities’.   It will be interesting to see how the UN PRI evolve over time given the growing interest in this area.

Chris Mallin 24th August  2009

Rights Issues

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’.

Governance implications

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.

Chris Mallin