As shareholders make their feelings over middling performance and executive pay loud and clear, how can companies keep investors happy and businesses healthy?
Executive compensation, notably the alignment between pay and performance, has long been a lightning rod for investors. But in the aftermath of the financial crisis, and with many firms performing poorly in a tough economic environment, scrutiny of director remuneration has intensified.
Witness the revolt in May by shareholders at bookmaker William Hill, where one third either opposed pay awards to directors or withheld their vote. Or at easyJet, communications group WPP, games retailer Game Group, Lloyds, and Barclays, which also found themselves in hot water with investors.
And this isn't just about pay and bonuses. If the knives are out for chief executives, they're being sharpened for chairmen and non-executive directors, too. Dismayed at how large companies and their smaller, listed counterparts are being run and rewarded, the level of dissent among investors is rising. Whether that's refusing to back remuneration or re-election, or whether it's based on wider corporate governance issues such as director independence, or social issues – including the environment or country politics – they're flexing their muscles and making themselves heard.
We've seen Prudential chairman Harvey McGrath battling to retain his position after a sizeable minority of shareholders voted against his reappointment. Apple was on the back foot after nervous shareholders demanded that the company outline its succession plan, following chief executive Steve Jobs's illness. A hedge fund investor, Julian Treger, led a shareholder revolt at AIM-listed Sylvania Platinum, calling for the sale or break-up of the business. And Pirc, a research and advisory consultancy which provides services to institutional investors on corporate governance and corporate social responsibility, advised stakeholders to vote against the re-election of all six non-executive directors at Mitchells & Butlers, the pubs and restaurants group, claiming they lacked independence.
Pirc spokesman Tom Powdrill confirms a big rise in voting against remuneration reports, at least since 2008, as well as many more examples of directors being voted off boards – or "boardroom coups".
He believes there are two reasons driving the increased activism. One, he says, is simply the aftermath of the financial crisis, which exposed poor governance in some companies. "Whenever there's a dip in the market, corporate governance tends to come back into fashion and investors take a closer look at who is on the boards of these companies," he says.
"Are they the right people? Are they conflicted or independent? When the tide goes out, you get to see people swimming naked."
The other reason is the public policy response, which has emphasised the role of shareholders, in particular their failure to act like responsible owners of companies. "One recommendation that has come to fruition from the Walker Review is the idea that there should be a set of principles that are applied to shareholders to mirror the requirements of the Corporate Governance Code," says Powdrill. "That's the UK Stewardship Code for investors."
As a result, he continues, there's now pressure on shareholders, notably institutional shareholders, "to demonstrate that they have responsibilities as well as rights within companies".
Greater scrutiny
In the US, the passage of the Dodd-Frank Act last year and the resulting "Say on Pay" advisory vote afforded to shareholders, giving them greater power to vote down remuneration structures, has placed even more scrutiny on executive compensation. Now Australia has followed suit. On 1 July new legislation introduced a two-strikes rule that gave shareholders the right to vote on a motion to "spill" the board – or force fresh board elections – if a remuneration report received a No vote of 25 per cent or more at two consecutive annual meetings. It also bans directors from hedging their remuneration or voting on the pay packages of key company managers.
Increased activity in the UK could be because shareholders want to avoid more onerous legislation, suggests Professor Annie Pye, director of research at the Centre for Leadership Studies at Exeter University. "At that collective level there may be a bit more of an awareness that if they're not seen to be doing something then the best-practice guidance could become more restrictive regulation," she says.
So if we're definitely seeing rising dissent, how should companies manage the relationship with investors, especially since even smaller shareholders have now gained a voice? Is it too much to ask that the needs of all stakeholders in a business should be satisfied? And what about balancing short-term profit with long-term benefits for the business? How does a director keep the company as healthy as possible?
As Pye points out, it's "impossible to please all people all of the time". But you can learn more about who your key investors are, and what their performance metrics are. The way companies engage with shareholders has changed, she adds. "Forty per cent of UK equity is owned overseas now. So you've got to be able to do some of these analyst presentations in, for an SME, quite a sophisticated way."
As a US study commissioned by the IRRC Institute (which funds corporate governance research) and conducted by Institutional Shareholders Services (ISS)?confirms, routine engagement no longer means just a quarterly discussion about earnings and corporate strategy in company-designed forums such as analyst meetings. It has become "a year-round exercise via a variety of channels including videoconference calls, meetings, emails, public announcements, telephone calls and regulatory filings, along with traditional quarterly discussions".
But engagement is key. "If I was coming at this from a company perspective," says Powdrill, "particularly if I'm on the receiving end of activism from an investor or group of investors, I would say you need to engage with them. You can't talk to them at arm's length." Sensitivity to shareholder feelings about remuneration should never be far from an executive's mind and participation at general meetings should be supported.
Creative companies
After being criticised for having not done enough to prevent the banking collapse, investors are working together to build a common approach rather than just fall in line with other shareholders, says Powdrill.
In the US, the days of the "Wall Street Walk" are largely over, says Marc Goldstein, head of research engagement at ISS. "Investors are often unwilling or unable to sell shares when concerns arise about how a company is managed. Instead, they will engage with board executives to try to bring about change," he explains. "Investors are increasingly concerned with the sustainability of their portfolio companies, and are encouraged to exercise their responsibilities as owners. Engagement will only increase in importance."
With regards to the pressures of short-term thinking, Powdrill says there's scope for companies to become creative. Could they think of incentives to reward long-term shareholders, he asks? "We've floated the idea of paying a slightly larger dividend to investors that have held shares for a particular period of time," he says. "It's a way of tilting the playing field slightly in favour of long-term investors over those who look at shares as essentially a casino chip."
Now is the time to try to have these conversations, he says. "You probably won't get a better chance."
