Earlier this year, during the annual general meeting (AGM) season in the UK, we witnessed the boards of several of the UK’s top companies being challenged by shareholders regarding executive remuneration and strategy in a phenomenon that has been dubbed the “Shareholder Spring.”
High profile cases in the UK included Barclays, where over 30% of shareholders voted against the remuneration report; Aviva, where chief executive Andrew Moss resigned following the revolt by shareholders; WPP, where almost 60% of shareholders rejected Sir Martin Sorrell’s proposed pay package; and Astra Zeneca, where chief executive David Brennan stepped down after shareholders demanded a shake-up of management following falling profits and poor returns to shareholders.
This phenomenon was not unique to the UK and extended to the US, where Citigroup’s remuneration report was rejected by shareholders in April (in a non-binding vote) and CEO Vikram Pandit subsequently left in October amid rumours of a boardroom clash over pay and strategy.
REVOLT OR STEWARDSHIP?
However, high-profile public revolts and protest votes, which often demonstrate a breakdown in the relationship between shareholders and company executives, are not considered to be the ideal solution; rather, long-term stewardship, including ongoing dialogue between shareholders and company executives is regarded as a more effective approach.
In July, Professor John Kay released his highly anticipated review of the UK equity market adding further weight to the stewardship agenda.1 The Kay Review concludes that short-termism continues to be a significant systematic problem in the UK equity market principally due to “the decline of trust and the misalignment of incentives throughout the equity investment chain.”
The Kay Review sets out 10 principles that are designed to provide a foundation for long-term decision making and highlight the future direction that regulatory policy and market practice should take. The proposals of the Kay Review aim to:
- Reduce the pressure for short-term decision making
- Improve the quality of engagement between investee companies, investment managers and asset owners
- Tackle misaligned incentives
The Kay Review sets out 17 recommendations, including:
- Expanding the existing concept of stewardship to focus on strategic issues as well as corporate governance
- The adoption of good practice statements by company directors, investment managers and asset owners
- Facilitating collective engagement by the establishment of an investors’ forum
- The application of fiduciary standards to all relationships in the investment chain involving discretion over the investments of others and advice on investment decisions
- The full disclosure of all costs by investment managers
- The removal of mandatory quarterly reporting requirements
- Improved alignment of interest between the remuneration of investment managers and the interests and timeframes of their clients as well as the alignment of directors’ remuneration with long-term sustainable business performance
STEWARDSHIP: HERE TO STAY
While the Shareholder Spring has placed the spotlight on executive remuneration, given the recommendations of the Kay Review and the recent changes to the Financial Reporting Council’s UK Stewardship Code, we believe the broader issue of stewardship and corporate governance will remain an area of focus for the foreseeable future.
The Code has recently been updated and the revised version has clarified the respective responsibilities of investment managers and asset owners with regards to stewardship and for stewardship activities that they have chosen to outsource.
When considering the delegation of stewardship activities, asset owners must keep in mind that while it is acceptable to delegate some activities relating to stewardship, the responsibility cannot be delegated away. The Code is now much more explicit regarding the role of asset owners stating that:
“...asset owners should seek to hold their managers to account for their stewardship activities. In doing so, they better fulfil their duty to their beneficiaries to exercise stewardship over their assets.” 2
This puts the focus on pension scheme trustees, as most schemes delegate the exercise of governance responsibilities to external investment managers. The trustees should view stewardship as a means of enhancing the existing investment manager monitoring process and a key part of their duty to beneficiaries. If practiced consistently, effective monitoring and engagement should lead to improved oversight and understanding of delegated activities.
We continue to recommend that pension fund trustees, as asset owners, review and monitor the stewardship activities of their investment managers. In line with the best practice guidance of the Code, we believe monitoring of stewardship activities should be conducted on an annual basis.
Here are some of the questions we believe trustees should be asking in their capacity as stewards of members’ assets:
- Do our investment managers effectively engage with companies regarding Environmental, Social and Governance (ESG) issues on behalf of our scheme?
- Do our investment managers effectively report on their engagement and voting activity? Is there any additional disclosure that would be beneficial to the scheme?
- Do we effectively report our scheme’s stewardship activities to members?
- Are we (and our investment managers) making best use of collective engagement opportunities?
While it will be interesting to see if there is a repeat of the “Shareholder Spring” next year, one thing is clear: the focus on stewardship and corporate governance is not going away, and the spotlight will remain on asset owners for the foreseeable future.