The global economic turmoil has resulted in a period of reflection on the causes and consequences of the financial crisis. Government and industry led initiatives have identified a series of varying, albeit overlapping and interdependent factors, which contributed to the breakdown of the global market model. However, the existence of fundamental failings in the structure of corporate governance is widely believed to be at the heart of the problem.
Over the last few months the Financial Services Authority, Sir David Walker and the Financial Reporting Council in its capacity as guardian of the Combined Code have each sought to outline key areas of governance reform which they consider necessary to restore confidence in the UK Market.
These reviews have raised serious questions over the effectiveness of the principles-based governance model employed in the UK. The success of the ‘comply or explain’ doctrine is premised on high quality disclosure and an active shareholder base. However, in the absence of either element, governance practices have tended to become formulaic and overly prescriptive with limited connection to value.
There are several reasons why shareholders appear to have become (or to some extent always have been) ‘absent’ owners. For some it is a matter of resource constraints, or a conscious investment strategy; while for others it is a conditioned response to unresponsive boards.
However, a combination of pressure from City Minister, Lord Myners, and industry led initiatives such as the ISC Statement of Principles has created a real momentum for change. Provided the ISC paper becomes a formal code, transparency of industry practices will allow asset owners to make informed choices when selecting investment managers and may drive them to include additional conditions in investment mandates.
Assuming such initiatives are successful in galvanising the investor community, the real challenge is nurturing a constructive two-way dialogue between boards and their investors. It is evident that the gap between large and small-cap companies with respect to the frequency and quality of shareholder engagement has been widening for a number of years. In many respects this is expected due to vastly differing resources, expectations and needs. However, as major shareholders in small and mid-cap companies, we would encourage all boards to consider the following:
- The chairman is ultimately responsible for leading the board, setting strategy, providing oversight of the executive team and managing relations with shareholders. The chairman may be required to commit additional time to the company to ensure that these responsibilities are discharged to an acceptable standard. Shareholders will generally accept an increase in fees to support this.
- The chairman should not restrict shareholder contact to occasions where the board is seeking to resolve a specific issue. It is good practice for the chairman to meet major shareholder on an annual basis. This will allow the chairman to communicate to investors, long- term corporate issues beyond financial results and operational performance, which tend to dominate meetings with the executive team. It will also provide the chairman the opportunity to form an independent view of the market which can be used to inform board discussions.
- The chairman of the board (or a relevant committee chairman) would be expected to consult shareholders on issues of succession planning, board effectiveness, executive compensation and other such matters which may affect the stewardship of the business.
- The governance report and other relevant sections of the report and accounts must be designed to allow the reader to form qualitative judgements on the company and its management. Shareholders will favour short and insightful disclosures prepared by the board. Legal teams should only be used to ensure compliance with legal obligations and not to dilute the value of the report through unduly sanitising disclosure.
Enhanced dialogue will result in a more transparent and engaged shareholder base and a more accountable and responsible board; thereby creating an environment conducive to responsible stewardship and sustainable value creation.
Mirza Baig is Associate Director of F&C Asset Management’s Governance and Sustainable Investment Team.
