In this month’s Off the Record we return to the ticklish subject of corporate governance and shareholder activism. Six months ago, it appeared you had little enthusiasm for interfering in a company’s affairs or ‘micro-management’ as it has been described.
The consensus then was that it is the job of investment managers, as the pension funds’ agents, to keep an eye on the companies they invest in or to engage with them where necessary. It is not the job of pension funds, or their trustees, to intervene.
However, since then, the International Corporate Governance Network (ICGN) which includes the largest pension funds in the US (TIAA-CREFF), continental Europe, (PGGM and ABP) and the UK (Hermes and the Universities Superannuation Scheme), has issued a draft statement on institutional shareholder responsibilities which takes an altogether tougher line on corporate activism.
The statement warns that “some institutional investors have conflicts of interest that could impair an independent approach towards the companies they have invested in, generally because they directly or indirectly have… relationships with the companies themselves”.
It also issues clear instructions about what action to take when such conflicts arise: “When such a conflict has the potential to harm the interests of the beneficiaries of their investment in the company, they should consider outsourcing the power to perform their ownership responsibility to a separate independent agent or trust company set up for that purpose.”
The same applies to agents of the investor – that is, the investment manager. If there is any doubt about their independence, their corporate governance responsibilities should be removed and given to some third party.
Other ICGN proposals are that institutional investors and their agents should reveal how they voted at shareholders meeting on contentious issues such as the remuneration of executives.
The tough talking follows the tough line taken by the ‘high level group’ of company law experts under the chairmanship of Jaap Winter. In its report to the European Commission last November, the Winter Group said that institutional investors such as pension funds and insurance companies should be legally obliged to disclose their voting record. Furthermore, the EU should ensure that members states impose this obligation in their regulation of institutional investors.
The Winter Group stopped short of actually requiring institutional investors to use their voting rights, as some institutional investors in the US are required to do.
So has there been a change of heart among the pension fund managers and administrators who reads IPE? Certainly, there is little doubt where you think the ownership responsibilities of pensions funds, with regard to the companies they invest in, properly belong. A large majority (87%) say these rest with the pension fund or its trustees. Only a third (35%) think that they belong to the investment managers that act as a pension fund’s agents. And there is negligible (4%) support for the idea that corporate governance responsibilities are best left to some external advisory body.
However, a UK pension fund manager points out that although the ownership responsibilities belong to the fund, it may delegate the voting decision both to investment managers and external advisory bodies. So, in this sense, ownership responsibilities can belong to all three.
There is fairly strong and consistent support for some degree of corporate activism. Two in three pension fund managers (65%) agree that pension funds should require their investment managers to develop or apply strategies for shareholder activism. A similar percentage agree with the proposal, floated in the UK Myners Review, that an investment mandate should include a requirement for investors to intervene in a company where it is in the shareholders’ best interest to do so.
However, slightly more (70%) agree with the caveat that a pension plan’s investment managers should consider corporate governance issues only if they are likely to affect the value of the plan’s investment.
Pension fund managers also feel the ICGN’s concerns about conflicts of interest faced by pension funds and their agents are justified. A majority of the pension fund managers in our poll (65%) agree that investment managers could face conflicts of interest that would prevent them taking an independent approach to the companies in which they invest.
There is also broad agreement about what should be done about it. A substantial majority (78%) say that a pension fund should remove corporate governance responsibilities from an asset manager if there are any doubts about their independence.
The ICGN advise that when this happens the pension fund should “outsource the power to perform the ownership responsibilities to a separate independent agent or trust company set up for that purpose”. However, this idea gains little backing from our poll. Most pension fund managers (74%) feel that governance responsibilities should be brought in-house. Only one in four (26%) would consider handing the responsibilities to a separate independent agent, and there is no support whatsoever for ICGN’s proposal that they should be given to a special trust, created for the purpose.
Bringing corporate governance in-house has already begun to happen in Europe. For example, Hermes Focus Asset Management in the UK handles the corporate governance responsibilities of the BT pension fund, and ABP Investment in the Netherlands plans to take over the corporate government responsibilities of the investment managers who run its US equities and emerging markets mandates.
Voting policies and voting is clearly a contentious issue. The Winter Group recommended that “regulation of institutional investors should include an obligation on the institutional investor to disclose its investment policy and its policy with respect to the exercise of voting rights in companies in which it invests, and to disclose to beneficial holders at their request the voting records showing how these rights have been used in a particular case”. The ICGN also supports the man-datory disclosure of voting policy.
Public disclosure of voting policy has been criticised by investment managers as undermining the voting process. They argue that public awareness of disagreements revealed by the disclosure of voting could have an adverse effect on shareholder value. They also believe that smaller institutional investors and their agents should be allowed to opt out of the voting process, and its public disclosure, on the grounds of cost.
The Winter Group’s strong line on disclosure draws a lukewarm response from pension fund managers. Only a small majority (56%) agree with the suggestion that pension funds and their investment managers should be obliged to reveal how they voted – that is, whether they voted for or against the company’s proposals. A similar percentage (59%) think that pension funds (or their agents) should be obliged to reveal the names of the companies they invest in.
Finally, we wanted to know where you stand in the ‘fat cats’ issue – currently the most contentious and publicly aired part of the corporate governance debate. The argument is that companies should reward their chief executives for success rather than failure. But how do you measure the success of a chief executive? The traditional way to assess the success of a company has been to consider earnings per share. Yet a growing number of asset managers believe this is unsatisfactory. They prefer a measure of how effectively the company has performed such as the return on capital employed
The simplest measure for many people is the share price. If the share price goes up who would object to an increase in the chief executive’s salary? The answer is – all of you. There is unanimous opposition to the idea that good performance, measured simply by the share price, always justifies an increase in salary for the chief executive. Perhaps corporate activism starts here.