Institutional investors are often accused of failing to take an active stance in their role as shareholders and engage with the companies in which they invest. They tend to show little real interest in the business, are obsessed with remuneration issues and complain only after an event or scandal has occurred, when it is too late to do anything about it.
In the UK, it was the threat of legislation that forced shareholders to come up with a voluntary code to engage in shareholder activism, i.e. the Higgs report.
It is argued that shareholders should intervene earlier on in company issues and must be ready to vote against boards that persistently ignore shareholder concerns.
Proponents of engagement argue that this will create stronger companies and better returns for investors and pension funds. True, investors’ job is to invest, not to micro-manage, but they need to ensure that the decision-making process within companies is efficient and robust.
Nina Mehra puts the questions and the panel responds.
Nina Mehra: What are the challenges of extending engagement with companies and maintaining cost-effective governance standards?
Alastair Ross Goobey: Shareholder engagement is one of the great areas of governance and it has been seen to be lacking particularly in the US. In the 1990s they were all too happy to point to their buoyant economy and stock markets. Now they have realised there is a problem and to their credit have reacted quickly, perhaps not entirely the way we wanted but at least they have reacted. The idea of international accounting standards or splitting the role of the chairman and chief executive pre-Enron is just impossible to conceive. So there is great change there.
But overall shareholders have been rather lax in engaging. The great problem for fund managers is that we are not paid to do it and it is a very expensive process. If you are going to do it properly – engage with companies and do more than just tick the boxes – it becomes very expensive to have good quality, reasonably senior people on board to do the job. Clients are being forced to take responsibility but are sub-contracting that to their fund managers who must then find a way of fulfilling that obligation. I sit on the board as a governor of a large charitable fund, which has lots of fund managers. I was struck by how little reporting we get on governance questions and why people vote the way they do, and this has got to change. The clients have got to hold the fund manager’s fee to the flame and make them engage.
Eric Borremans: It is also important to recognise that there are various degrees of engagement, from buying or selling the stock, to deciding voting rights, to activism, to really focused engagement à la Warren Buffet. I personally believe that engagement à la Warren Buffet makes sense in the context of a fund that deliberately invests in companies that do not manage specific issues well with a view to turning it around and adding value. But I think one runs the risk of confusing the issue if one looks at engagement as one big issue and one does not recognise different levels and agree which of these levels meet the specific needs of investors.
Alan Banks: One of the problems is that engagement is a very expensive and time-consuming process. I suspect that as engagement becomes a strong feature of the market place, there will be sufficient economies of scale to be had in terms of asset managers joining together and sharing the costs.
Mark Goyder: One of the things that our 21st Century Investment inquiry is beginning to think about is the nature of the mandate that the pension trustees provide – why are there not a few more mandates being given that account for increased interest in a proportion of the fund’s asset being managed by asset managers who will exercise this stewardship responsibility?
There is a lot of evidence that this approach seems to bear fruit in terms of returns. If you can select companies with good governance, but also engage with those companies, then there is an opportunity for a much greater diversity of fund management offering. Within this there would also be a visible sector on governance, which could in a sense make it difficult for companies to evade accountability in that area.
Alastair Ross Goobey: There is a very easy answer to that. It is because most of the fund managers are impossibly conflicted.
Mark Goyder: Is it impossible to think of a transparency obligation here to deal with conflicts of interests, just like you have a transparency obligation to deal with insider trading?
Emma Howard Boyd: If we look specifically at engagement on a CSR agenda, since the pension Statement of Investment Principles (SIPs) came out in the UK in 2000, there have been a whole lot of policies on CSR written and filed without further action. We need to see more deliverance and actual demand from our clients for these policies to be fully implemented and one way around that is for the agenda of disclosure to move from the fund management community back to its clients – not only on the traditional corporate governance and voting but also where they are taking account of the wider issues.
Daniel Summerfield: I fully agree with this point, that until pension funds – who are nearer to the end beneficiaries and fund managers – get our act together and give the fund managers a clear mandate as to what is required, we are never going to get anywhere. Hopefully the ISC guidelines will create a level playing field in setting up some agenda for activism among all institutional shareholders whether they are pension funds, fund managers or investment consultants. It can be a very lonely experience being a pension fund trying to find other like-minded pension funds with which we can collaborate with and form alliances on other strategic issues.
Julie Macgregor: There ought to be some onus on the companies themselves to actually actively seek their shareholders’ views. At the moment we are saying fund managers ought to do something about costs and voting at annual general meetings (AGMs), but these efforts are only as good as the companies being prepared to listen unless there is some onus on them also to actively engage the other way.
Daniel Summerfield: Voting for example is a blunt instrument without any follow up engagement activity unless we write letters or do the follow up. This is a tremendous drain on resources, if we are writing letters and all trying to meet the same people whether it is the fund managers or the corporate governance practitioners. Unless we have an integrated approach and share information with others, at a corporate governance level it should work but this is not the case as we are all asking the same questions of the same people.
Mark Goyder: When I hear fund managers talk about the companies they really admire, they are they ones who come to them with a very strong, clear picture of where the company is going and what its drivers for success are. They are actually educating their fund managers, they are telling them why they are going to be the ones that will make progress in a few years time because they have identified the areas on which they are focusing.
Julie Macgregor: But again, those are the companies that have embraced good corporate governance in all its aspects and are prepared to engage in that two-way dialogue. The ones that really need engagement are the ones that haven’t embraced that in terms of wanting to have an open and honest dialogue with the shareholders.
Mark Goyder: I think that is right and part of the lever needs to be what we were talking about previously – we need this wider language of how we judge a company. This is a challenge and I would love to see the mandates that are being offered to fund managers start to be more demanding and encourage them to deploy the range of tools and analysis that really put chief executives to the challenge. It is true that what gets measured gets managed, it is also true that what gets measured gets manipulated but we need a wider range of measures to protect ourselves against that.
Paul Toyne: Again, if you have a very selective approach to identifying what a subset of the issues on engagement might be you could also be criticised because you have just gone to one portion of your stakeholders. Particularly for smaller businesses there needs to be a great deal more thinking about how they can effectively go out into the wider community amongst their stakeholders to try and ensure that they are reporting back on the types of issues that they want to see, whether they are social, ethical or environmental safeguards. How to do this is the really key question.
Alan Banks: On the other hand, what is very important when you do engagement is to go to the board of directors with a genuine concern and to be able to show your actions have a clear potential investment impact. The response is then generally very good. I think it is important that the asset management community not become tools for NGOs and beat up companies on ethical issues. It has to be about value for asset managers and there has to be a very clear route into value otherwise companies find it hard to see what the purpose is.
The point on SIPs and how they have been discharged and practised is very important. The vast majority of pension funds have passed on the responsibility of that to the asset managers most of whom have agreed to accept it. But most of them don’t have the processes to deal with these issues, with the exception of people around the table who have invested enormous amounts on processes to achieve this. They are not necessarily being differentiated properly by trustees of pension funds by the fact that they are prepared to do this work.
Eric Borremans: Engagement is only a tool to an end and the end should be spelt out clearly. I am sometimes concerned that this is not the case, especially if the boundaries are not clearly defined. Then one runs the risk of creating something in the SRI sphere that actually was already accounted for in the mainstream through regular meetings between analysts and companies.
Mark Goyder: I would like to bring us back almost to where we started. As Eric says engagement is a means to an end. What is the end? We are trying to understand whether as shareholders we are invested in a well-led company, which is stewarding the assets well, and which is dynamically developing its future. In that context I would argue that shareholders should expect companies to stand up to them. I think a well-led company is one that sticks to its strategic goals. We have witnessed too often, both in CSR and in corporate governance, too much willingness to make compliant noises when actually that is not what leadership is about.
Emma Howard Boyd: But we have also heard a lot of people say that they focus on company and sector-specific issues. Ideally we end up with every analyst looking at these things in an integrated fashion. A number of people on this table are moving towards this but we know that it is not going to happen overnight. Training people to have a wider expertise that is not just financial will take some time but is probably something many of us are aiming to do.
Note:
Dr Paul Toyne is a co-founder and director of Article 13, a consultancy innovating through business responsibility and corporate governance. Paul’s first-hand international experience in policy and development issues is supported by a strong academic background and proven campaigning and media skills.
This article was first published in April 2003 in the Corporate Governance and CSR supplement of Funds Europe. Reproduced with the permission of Funds Europe, May 2003.
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