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Institutional Activism SESSION I Institutional Activism: Pros and Cons 8 Dr Paul Flather Secretary- General, the Europaeum, and Fellow, Mansfield College, University of Oxford For this first session we have two very well-known speakers: Alastair Ross Goobey and Sir Ronnie Grierson. Both have been active in the field of corporate governance and I am going to ask Alastair if he might kick off. Alastair has developed a powerful reputation travelling in America and Europe, talking about notions of institutional involvement and shareholder activism, and has developed a coherent philosophy which is relevant for our discussions today. Alastair Ross Goobey Chairman of the International Corporate Governance Network, and a Senior Advisor for Morgan Stanley bank It is an unusual pleasure for me to be here. It is also an unusual position for me to be on the extreme left and Sir Ronnie Grierson on the extreme right! The title of this session is “Institutional Activism: Pros and Cons,” and when I talk about institutional activism I mean going well beyond what you would call normal corporate monitoring, and actually intervening in companies in some way. Let us look at this concept from four angles: Why should the institutions do this Where should they intervene How should they make this intervention Who should actually intervene What is the role for shareholders (by which I mean institutional shareholders or their clients) It is widely understood that companies must be controlled and directed by the board. Boards have different roles and different structures under the different regulatory regimes we have within Europe, but whether they are supervisory or unitary, what happens when these boards are ineffective, when they are not structured in an appropriate way, or where the company seems to be drifting or worse The only people that can intervene are the shareholders. I do think there are times where the institutional shareholders (who are the only ones with sufficient resources) have to step up and question the boards. What are they entitled to question It could be purely the governance of the company: if the board is made up of the chief executive, his wife, his brother, the core shareholders, and government shareholders, then the outside shareholder has very little chance of getting a fair crack of the whip. Shareholders may equally want to intervene regarding the company’s strategy, its management, or its capital structure (or a combination of all four of those things). How should they intervene There is a lot to be said for both sides of this debate, and Sir Ronald may use the word ‘micro-management’ when he replies. There is, naturally, a great resistance amongst corporate boards and corporate management to the idea that shareholders should come and tell them how to run their company, because shareholders simply don’t have the depth of knowledge about the company and the environment in which it works. Nonetheless, I see absolutely no reason why the institutional shareholder, properly resourced, should not be able to go to a board and say: “This is our analysis of the problems you face, and here are some ideas about what you might do about. The decision is over to you, this is your responsibility, you are the board of directors. We are just giving you some ideas; our responsibility stops at the boardroom door. Yours starts behind the boardroom door. But if we do not like what you are doing, we will use our opportunity to vote you off.” In the UK, and in most European countries now, you have that option. In the United States, on the other hand, you do not have the opportunity because the board does not have a simple majority vote for individual directors. That is why American shareholders are very concerned about staggered board terms, because they can prevent the change of control over a board. In practice, to do this, you start off by maybe talking to the management about your concerns about the strategy, or the corporate governance or the capital structure. You don’t talk to the management about your concerns about the management – you talk to the non-executive directors about that. You can then escalate things to put the matter before a meeting of the whole board. If that is ineffective, you can start
Institutional Activism talking to other investors, and ultimately you can go public and you can, certainly in some environments, call meetings to dismiss the board. This is one of the great fears the Americans have about opening the proxy to shareholders: there will be constant demands, and votes against the whole board. My reply is that it has happened very, very rarely in the UK, although we do have a fairly “open” system for doing such things. In my experience, we only voted off one board, and that was only an investment trust, not a huge commercial organisation. When it comes to it, most people put their hands up and say: “If the shareholders are against this sufficiently, we will go quietly rather than make a fuss.” Institutional investors can be a catalyst for change and a catalyst for improved performance in companies, as the board themselves can be too blinkered to see that change is necessary. This brings us to my fourth question, which is who should do this As many people have pointed out, institutional fund managers are not qualified to manage companies (arguably, many of them are not qualified to manage institutional funds!) – at any rate, they are certainly not business people. What we found when we set up the Hermes Focus Fund, which I still chair, was that in order to do this in a professional, commercial way, it is no good just having fund managers trying to intervene. For one thing the executives or the boards of companies will say, “what do you know about it You couldn’t run a candy floss stall.” So that’s what we worked on at Hermes. We built up a skills base of business people and strategic consultants, in addition to fund management analysis people (because you have to do the fundamental analysis of the company in a normal investment way, to make sure there is a value gap there that might be addressed by the changes you are seeking to catalyse). This is a very interesting change in the way that institutional investors can address the situation, and the great problem for the institutions is to be properly resourced. Very, very few of them are properly resourced in this, and corporate governance monitoring tends to be done by very few people within the organisation. We’ve got Guy Jubb coming this afternoon from Standard Life. I think he has three or four people who work for him, and he has a larger department than many. At the Pru (Prudential), you have Hugh Jones, whose job title is Corporate Finance Executive. He is behind the Chinese wall, so we can talk in confidence to him about these issues because he is not involved in buying and selling the shares. But there are very few institutions which have sufficient resources and the right sort of people to be proficient in the kind of activism that I am discussing. Hermes now has 47 people involved in all this, and it’s only because we set up these commercial funds, in order to earn hedge-type fees, that we have been able to allocate the resources that we require. I say that we are only scratching the surface, but that is because it is very difficult to do this right. I talk to a lot of institutions about this wearing my Morgan Stanley hat, and many of the investing institutions say, “Well, it’s not going to add one basis point to my performance, so why should I invest in all this There is a huge free rider problem. We do all the work, at our cost, and every investor gets the benefit.” It is a conundrum for the institutions, and I don’t think the institutions are doing better than, say, six out of ten (possibly seven out of ten) in their attempts at appropriate interventions in companies. It is better than it used to be, but we’re not doing a great job, and if you look around the world at all the companies that institutions invest in, there are really too many companies to look at and not enough people looking at them in this context. Well, I’ve taken my fifteen minutes, but those are the four questions, and I hope I have answered my own questions too. There are probably lots of other questions I hope you will ask aside from the “why,” “what,” “how” and “who.” I would also be interested to hear whether Ronnie thinks this is a reasonable approach or whether he thinks this is outrageous and that we should get our tanks off his lawn. Sir Ronald Grierson, our next speaker, has had an extremely distinguished career in British corporate life, Dr Paul Flather but I always think of him as a sort of European Britisher, or a British European, as he is so involved in so many different projects – not least ours, of course. Ronnie, do you think boards are “too blinkered” I heard “not qualified” and then “tanks on the lawn” - what do you think Thank you for that Sir Ronald over-generous introduction. I would European Grierson like, first, to express my Chairman, Blackstone pleasure that the Group, and former Vice Europaeum, which I helped to co-found with President, GEC my friend George Weidenfeld, has flourished so remarkably under Dr Flather’s leadership. He has done a fantastic job and we’re all enjoying the fruits of it in this room today. I hope it is not too disappointing, but I don’t disagree with anything that Alastair has said. I have never taken the view that it is wrong for shareholders to make their wishes known, in whatever form is most appropriate and most 9
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