Some ways forward on corporate governance
Tunnel-digging and corporate governance. Not things that you'd normally associate with each other - unless reference is being made to poorly performing directors who dig themselves further into holes in an effort to get out of trouble.
But put those metaphorical tunnel ideas out of your head - this is the real thing. We're talking about the type of holes you dig to enable a train to cross the Channel, or to get out of jail, for example. Ah-ha, you cry, now it's becoming clearer. This is obviously a reference to Eurotunnel's ongoing spat with shareholders over its debt position.
Wrong again. Consider this: when you're digging a tunnel you have a stark choice. You can either go for broke in a mad dash to your destination without giving two hoots about whether it all caves in. Or you can take a little bit more time and shore up the sides carefully as you go along. Both options have the same final goal - but only the latter allows for a few more colleagues to see the light at the end of the tunnel.
The corporate governance movement faces a similar choice. It's all very well for those at the forefront to keep tunneling towards a final goal of being more responsive to shareholders but there's the danger of leaving many stranded in their wake. Shoring up the argument may be in order.
Why Bother?
Speak to IROs in developed markets - particularly outside the US - and the need for clarification becomes apparent. Many don't get the dynamic. And why should they? Why should corporate managements waste time responding to corporate governance concerns? Who cares whether there are independent directors on the board? What relevance do corporate governance issues really have to corporate performance?
These views are strengthened by the failure of many portfolio managers to vote their holdings. Many don't see it as part of their remit; others firmly believe that private meetings are the only way to communicate views to management, considering voting is costly, time-consuming and impractical.
But several trends indicate that shareholder voting is likely to become more crucial as a means of keeping underperforming companies in line. First, the ongoing move towards indexation means that portfolio managers do not have the option of simply selling their stock when dissatisfied with performance. Secondly, increased global diversification of portfolios implies that it is less practical to seek regular meetings with management to force an issue.
Finally, politicians in several markets are considering ways of keeping companies in check through increased accountability to shareholders. At the same time, there is a desire to ensure that fund trustees fulfil their fiduciary responsibilities to savers. Eyes have turned towards the US in this regard and the success of the Erisa fund regulations which require votes to be cast on both domestic and - where practical - overseas holdings. The theory here is that stronger oversight from shareholders creates better performing companies.
In theory, of course, it's a fine idea. But in practice, there are many barriers to shareholder voting in domestic markets, let alone overseas. Ian Matheson, executive director of the Australian Investment Managers' Association (Aima), points out that many of the issues which his organization has been working to change in the Australian market are mirrored in other jurisdictions. 'The whole system currently works against encouraging people to vote their holdings,' he says. 'Voting methods evolved when ownership was concentrated in the hands of individuals, but that has all changed.'
Aima has looked at several aspects of the proxy voting process over the last few years and tried to make it more shareholder friendly in order to encourage its members to vote. Its work has included drawing up a standard proxy form and lobbying the government to increase the minimum amount of time by which companies must release agenda material to shareholders. And changing the voting system at annual meetings is vital, too, Matheson argues. The current rules dictate that a resolution will only go to a poll if there is sufficient support physically present at a meeting to do so. Otherwise, resolutions are just decided on a show-of-hands at the meeting.
'We believe it should go to a poll on every resolution, so that every shareholder - foreign or domestic - can vote either at or before the meeting,' says Matheson. 'It's just an extension of one-share, one-vote - the current system is archaic.' He believes that the practice discourages institutions from voting because there is disproportionate influence carried by those who actually turn up at the meeting - invariably private investors with small holdings. 'We have a situation where you may have just 0.1 percent of the shareholders deciding the issues.'
Political Issue
The same show-of-hands system is used in the UK where there is also no shortage of those clamoring for reform. But, as in Australia, it becomes a sensitive political issue when any move towards a full poll on every resolution might be seen as taking power away from the private investor.
One senior London-based fund manager - who regularly votes his holdings - is happy for the show-of-hands system to continue at annual meetings. He argues that it lets private investors have their say - institutions have more regular access to management in private meetings. 'As an institution, if you want to get things done, you do it behind the scenes. You're not going to achieve as much in open forum - it will just turn into a conflict with management.'
The greatest barrier to voting, in his opinion, is a lack of good disclosure and transparency from companies. There is no point in voting when you don't have all the facts to hand, he maintains.
Stephen Davis, director of Boston-based Davis Global Advisors (DGA), agrees with that point but is against the continued existence of a show-of-hands poll at annual meetings in any jurisdiction. He says that it deters non-domestic institutions from voting their holdings as they question whether there is any fiduciary value in doing so.
DGA has submitted a proposal to the UK's Hampel committee on corporate governance arguing that the system be changed to a poll on all resolutions. Davis points out that non-domestic institutions are less likely to convey their views to management in private meetings as often as their UK counterparts, so the argument of behind-the-scenes pressure doesn't wash.
Davis had a chance to expound his views on cross-border voting in more detail in a recent paper entitled 'Shareholder Voting in Europe' (see Investor Relations, March 1997). Written in conjunction with Karel Lannoo of the Centre for European Policy Studies in Brussels, the paper argues that barriers to voting in Europe prevent the efficient exercise of voting as a means of improving corporate performance.
'There are legal, cost and procedural barriers to voting in many countries which amount to a real structural impediment to accountability,' comments Davis. 'A warren of walls limits the ability of owners to oversee the companies they own. Pressure is building up to lower these walls - often from US institutions - but it's a slow process.'
In their paper, Davis and Lannoo point out that the current situation permits US funds - which are bound to vote by regulations - to exert an undue level of influence on their European holdings simply because many of the European institutions do not vote outside of their home market. Barriers to voting they cite include poor information on foreign holdings, cost, and different voting systems in different jurisdictions.
The solutions proposed include earlier release of AGM agendas, voting by mail, an end to share blocking and lower voting costs. They also point out that one-share, one-vote capital structures are important to convince institutions that their vote would not be wasted. 'Some investors clearly prefer owning and voting shares where they can be confident that every shareholder has equal influence based on the size of his capital contribution. The incentive to vote is lower if other investors have voting power that is out of proportion to their stakes.'
Pressure Point
Disproportionate voting power is a key pressure point for reform of the system in many markets. Just as it has been criticized for years when it's embedded in a company's capital structure, so critics are gaining ground when it's laid down in the law which governs voting at annual meetings in some markets. As Matheson says, the show-of-hands system is 'archaic' and ripe for reform.
Indeed, the disproportionate voting power US institutions hold in many other markets simply due to their requirements to vote may also prod other markets to encourage their own institutions to vote. All indications are that the power of US funds in global voting is set to increase.
Barton Hill, head of global proxy services at Automatic Data Processing in Boston, says the figures he has collated from his clients so far this year seem to indicate an increase in the level of non-domestic voting by US portfolio managers. He adds that vote response rates for different markets appear to be 'more closely correlated to the factors of ease and expense of voting in a particular market than other investment features of the market itself.'
Hill will not be drawn as to whether he thinks a more unified voting system across various markets would lead to a further increase in voting. It may make logical and intuitive sense, but Hill believes it goes beyond his charter to confirm this point.
However, Davis at DGA does believe that ironing out some of the inconsistencies will lead to an increase in voting from all markets and into all markets. He points out that global custodians are trying to take the various rules and regulations from different jurisdictions and fit them into a standard system to present back to their clients. As they become more adept at that task so the voting process becomes easier. He recommends the creation of an international body to work on ways to harmonize the voting process in different markets. 'My own view is that this a natural role for the International Corporate Governance Network to take on at its conference in Paris.'
Whether that happens or not, pressures to increase the level of institutional voting domestically and overseas are certainly evident. Those that remain to be convinced that the corporate governance movement is here to stay may well sit up and take notice when more regular voting from institutions becomes established in markets outside of the US, helping shore up the sides of the corporate governance tunnel. It's more difficult to doubt the reason for corporate governance when votes are tallying up against you at an annual meeting.