27 Apr 2012 11:03am

The awkward squad

Rebellious shareholders are making life uncomfortable in the boardroom, calling directors to account for poor performance and high pay. Peter Bartram asks, can they really make a difference?

There is nothing like an activist shareholder to make a company’s directors nervous. And, in recent years, they haven’t come much more active than Sir Stelios Haji-Ioannou, the founder of and now a major shareholder in easyJet.

When the easyJet board proposed a bonus scheme that could see directors pocketing payments totalling £8m, Sir Stelios went to war. He urged shareholders to vote down the remuneration report, presented at the company’s February AGM, and oppose the re-election of non-executive director Sir Michael Rake on the grounds he already held time-consuming board jobs at BT and Barclays.

Sir Stelios lost the vote but recorded a victory. He said the board was now reconsidering how it rewarded executives with bonuses. “Change is in the air. This is a great victory for shareholder activism,” he proclaimed. He was right. The row at easyJet was a symptom of the fact that more activist shareholders are on the warpath and demanding change.

Active shareholders are more concerned with the concept of stewardship and the long-term development of the company’s value

Michael Mitchell, general manager of the Investor Relations Society

Sir Michael was in the firing line again at Barclays, where the corporate governance consultancy Pirc called for his removal as audit committee chairman and for the non-reappointment of auditors PwC.

Last year, more FTSE 100 companies than ever before had at least 20% of their shareholders voting against or abstaining on remuneration reports. Companies in the firing line included HSBC, Standard Life, BP and National Grid. Other companies who felt the sting of shareholders were Hargreaves Lansdown, Rio Tinto, Bunzl, Reckitt Benckiser, Standard Chartered and Capital Shopping Centres.

Executive excess

The driving force behind shareholder activism has been the perceived excesses of executive pay and bonuses. One of the largest shareholder pay revolts in the last few months was at Smiths Group, the engineering and technology company, where 43% of shareholders failed to support a £200,000 bonus payment to chief executive Philip Bowman.

At what was described as a rowdy AGM for HSBC last year, 13% of shareholders failed to back a new pay and incentive plan for the company’s 50 top bankers. Critics worried the plan based payments less on total shareholder return and more on new measures including capital strength, reputation and strategy.

Communications group Cable & Wireless Worldwide and advertising company WPP saw shareholder revolts on executive pay in 2011. And in March this year, Michael Queen resigned as chief executive of equity investor 3i amid shareholder pressure.

But it’s not only executive pay that stirs shareholders; activists are worried by a number of issues. And even if they don’t defeat the board, they can cause an unseemly row at the AGM and inflict reputational damage on a company.

Last year, Labour MP Tom Watson, scourge of the News of the World  phone hacking perpetrators, generated worldwide media coverage when he  flew to Los Angeles to confront  Rupert Murdoch personally at  News Corporation’s AGM.

In an earlier protest, TV chef Hugh Fearnley-Whittingstall turned up at Tesco’s 2008 AGM to back a resolution that would force the supermarket chain to improve the welfare standards of the chickens it sold. The resolution was lost – fewer than 10% supported it – but Tesco took a reputational hit, especially when it demanded that Fearnley-Whittingstall stump up £87,000 to send the text of the resolution to 240,000 shareholders.

Tesco seems to have learned from its brush with shareholder activism. When Fearnley-Whittingstall targeted the company earlier this year in his over-fishing campaign, it swiftly announced plans to switch to pole and line-caught fish for its own-brand tinned tuna.

Crumbling foundations

The Association of British Insurers (ABI)closely watches the corporate governance of Britain’s quoted companies. It writes  a report for the AGM of every company listed in the FTSE All-Share Index. Where it has concerns, it issues an amber or red alert. James Upton, head of corporate governance at the ABI, says that the long-term average of 10% red and 25% amber alerts rose to around 12% and 30% respectively in 2011.

But directors and others worried about a rise in the numbers of concerned shareholders need to distinguish between two kinds, argues Michael Mitchell, general manager of the Investor Relations Society. It’s important to understand the difference between shareholder activists and active shareholders, says Mitchell, who is also chairman of the Global Investor Relations Network, which seeks to develop relationships between investor relations professionals around the world.

“Shareholder activists are people who have a change agenda,” he says. “They may want structural change in the company or they may have environmental or social goals. They may come onto the share register with short-term aims to benefit a small group of investors, but not for the long term. They may wake up or ginger up sleepy management and they sometimes have the effect of getting management to focus on improving shareholder value.”

Active shareholders are a different breed, says Mitchell. “They’re more concerned with the concept of stewardship and the long-term development of value.”

Shareholder activists, such as Watson and Fearnley-Whittingstall, find their own causes, but the big game changer for active shareholders was publication of The UK Stewardship Code by the Financial Reporting Council (FRC) in 2010. The Code is a list of seven principles that set out how asset managers and institutional shareholders should approach their work.

Each of the principles – such as the need to monitor investee companies and to have a clear policy on voting and disclosure of voting activity – is supported by guidance notes. For example, the notes say that, “Institutional investors should seek to vote all shares held. They should not automatically support the board.”

“The Stewardship Code has a bit to do with the rise in shareholder activism,” argues David Paterson, head of corporate governance at the National Association of Pension Funds. “It has focused investors’ minds on issues which they were familiar with but which they were, perhaps, not addressing as directly as they should.”

Elizabeth Murrall, director of corporate governance and reporting at the Investment Management Association (IMA), whose members manage more than £3.9trn of assets, says that its larger members have always been engaged with their investee companies. “While interactions with investee companies may not change significantly, the disclosures and reporting expected under the Code are likely to help encourage a more systematic approach and increased transparency,” she says.

Transparent business

Between the December reporting dates in 2010 and 2011, the number of firms signed up to the Code jumped from 80  to 175. “The increase in the number of signatories to the Code means that more investors are likely to interact with and seek to influence their investee companies,” says Murrall.

So will CFOs and other members of the board be taking more calls from concerned investors in the future? It seems likely as the Stewardship Code aims to make investors both more active in promoting dialogues with investee companies and more transparent in what they are doing – especially in how they vote the shares they hold.

Yet there is a curious, and potentially worrying, trend in the way active investors approach their investee companies. The IMA’s first review of how the Code is working noted that the majority of institutional investors rarely engage with the chairman and non-executive directors of their investee companies. They hold meetings with members of the management team, but often only get in touch with chairmen and non-execs when trouble blows up or a crisis is looming.

Simon Lowe, chairman of the Grant Thornton Governance Institute, says  the reason for this may lie in how institutional investors are organised,   with a main team of investment analysts but a smaller group of corporate governance specialists. “Investment analysts direct their questions to the  chief executive or financial director,” he says. “They tend only to seek out the chairman when there is a crisis.”

But Lowe says institutional investors who want to fulfil their full stewardship responsibilities could be missing important perspectives by missing out on meetings with the chairman and the non-execs.

“The chairman has overall responsibility for setting the company’s governance tone and, through that, managing the board of the company,” Lowe says. “So close engagement with the chairman should give the investor or analyst greater comfort for how the business is being run.”

In fact, Lowe says that many chairmen he has spoken to have found it difficult to get “face time” with their key investee institutions. “It seems that while the chairmen and non-executive directors have an increased appetite to converse, it is the shareholders themselves that are reticent,” Lowe says. “Investors need to broaden their engagement if the checks and balances of governance are to work.”

But perhaps it shouldn’t be such a surprise that investors sometimes seem to show little appetite for being active. In its most recent published research, the IMA found asset managers have, on average, holdings in 450 UK businesses. Two-thirds of the asset managers monitor all their investee companies, but fewer than half engage with all of them. 

Yet as the Stewardship Code takes root, more institutional investors may seek to become more active. At the same time, the combustible mix of anger at perceived executive excesses allied to the passions of single-issue campaigners in areas such as the environment, workers’ rights, animal welfare and a host of other topics, could give shareholder activists renewed vim.

United they stand

Indeed, the campaigning of shareholder activists could even start to influence the way institutional investors – generally the “active shareholders” as opposed to the “shareholder activists” – choose to fulfil their responsibilities. The Stewardship Code says that institutional investors should report periodically on their voting activity. It also says they should be willing to act collectively with other investors “where appropriate”. So it is possible that single-issue shareholder activists will start to focus on institutional investors in future as well as the companies which are their primary targets.

Which all means that quoted companies will need to do more to keep the majority of their shareholders on side. The UK Corporate Governance Code makes it quite clear where the onus lies: “The board as a whole has the responsibility for ensuring that a satisfactory dialogue with shareholders takes place.”

It adds further: “The chairman should discuss governance and strategy with  major shareholders.”

According to Grant Thornton’s Corporate Governance Review 2011 however, 62% of companies provide detailed information on the steps they take to communicate with shareholders. Lowe says there is a notable gulf between the FTSE 100, where 79% provide the information and the mid-market FTSE 250, where only 53% do.

“A company should discuss issues and respond to concerns,” says Murrall. “An investor then has the decision on whether to continue to work with the company to bring about change or, if the company does not respond, an active investor can reduce or sell out of its investment.”

The company’s broker can help gauge shareholder feeling, notes Paterson. “The brokers wouldn’t act as an intermediary between the company and shareholders, but to find out whether the views expressed by a particular shareholder are shared by others,” he says. “One of the challenges faced by companies is that there are often disparate views among investors depending on their time-frames, their investment objectives, and so on.”

What this means is that, sometimes, a company will find itself in a position where there will be a row, no matter what. But in this situation, directors can show they are being even-handed when they talk to shareholders holding different views and make it clear they are considering opposing views with an open mind.

In January, Vince Cable, secretary of  state for business, innovation and skills, said he was asking the FRC to update the Stewardship Code to ensure shareholders are “incentivised to use the new powers that will be available to them”. Cable also said he was looking at a range of ideas, including annual elections of directors and binding votes on pay policies, adding to the activists’ arsenal.

All this means that investor relations will need to figure higher up the agenda for company boards and especially financial directors and chief executives. The companies that run into trouble will be those that think shareholders’ concerns can be brushed aside or fobbed off. As  the Stewardship Code becomes integral to investor practice, it will be less easy to rely on the passive acquiescence of institutional investors to side-line the awkward squad of shareholder activists.

“With good investor relations, you’ll get early warning signs that there are potential issues on the horizon,” says Mitchell.

It’s important to listen to the views of shareholder activists, he says. “But keep talking to other shareholders and long-term investors because it’s their views that will determine whether the activists can rally enough support to win the day.”

Revolting: What happens when shareholders turn restless?

Barclays: The global bank had to contend with corporate governance consultancy Pirc, which has called on all banks’ shareholders to vote against the reappointment of auditors as a way of highlighting what it sees as the inadequacies of IFRS reporting. It also called for the removal of audit committee chair Sir Michael Rake and voted against the remuneration report, which included £17m for CEO Bob Diamond, including paying his £5.7m tax bill.

Kofax: The software company faced revolt at its last AGM. Shareholders rejected extending a share incentive scheme, even though management held 28% of the shares. Pirc said the plan failed to reveal maximum reward levels and had unclear targets. In an advisory vote, 34% of shareholders opposed the remuneration.

Mitchells & Butlers: Pub operator M&B, which owns the Harvester and All Bar One brands, faced a revolt at its 2010 AGM in the wake of a bad derivatives deal that cost £500m. In 2010, Bahamas-based billionaire Joe Lewis, backed Irish racing millionaires JP McManus and John Magnier to sack chairman Simon Laffin and vote in non executives effectively nominated by Lewis. Other investors questioned the new NEDs’ independence. A move to oust them in 2011 fizzled out.

Diageo: The drinks company saw 20% of shareholders vote against last year’s remuneration report. The Co-operative Asset Management, which held a 0.25% stake, said targets for directors’ share options were not tough enough and that finance director Deirdre Mahlan’s bonus scheme was too generous. The Co-op also wanted detail on the executive performance share plan. The revolt followed a review of Diageo’s executive pay a year earlier by Lord Hollick, chairman of the remuneration committee. The company promised to take the vote “into account in the future.”

Trinity: Mirror Rebellious shareholders are said to be gearing up to protest at the newspaper publishing company’s AGM in May about CEO Sly Bailey’s pay. Her package topped £1m last year and she has pocketed more than £12.5m since becoming CEO in 2003. During that time the company’s value has fallen to a 10th of its 2003 valuation of £1.1bn amid mutterings about “rewards for failure”. At last year’s AGM, 11% of shareholders voted against her pay package.