Investor engagement is no longer the preserve of management, with interaction now expected of board directors. BNY Mellon noted in its tenth annual survey that, ‘Board of directors involvement with the outreach to investors has more than doubled since 2013, from 24% to 49% in 2015’.[1] While North American companies have the lowest rate of board/investor interaction at 26%, this is a greater trend in Western Europe, at 55%. While shareholder engagement in the UK for example might have dipped in the last year (a recent Grant Thornton report on the 2015 corporate governance trends noted that quality shareholder engagement fell to 55%, from 64% in the prior year), the numbers are still high by international standards, but still ‘the need for greater shareholder engagement remains a concern of the Financial Reporting Council’[2].
In the eyes of corporate regulators, the only way is up: the trajectory is clearly towards more and better engagement at board of director level. So what are the common challenges? Understanding these is important to get anywhere close to achieving quality engagement- ensuring there are a strong and conciliatory relationships and an open two-way channel of communication with shareholders representing a mix of interests.
Challenge #1: Understanding your shareholder-base and its changing and disparate interests
The company shareholder-base influences how and the extent to which the directors need to engage with the shareholders, and the topics likely to be of interest. Disparate interests are expanding the agenda, and the need to prepare across a broader spectrum of issues is increasing. Traditionally, shareholder influence has been proportionate to the holdings of voting shares and typically a holding of more than fifty percent of voting shares entitles that shareholder to unilaterally influence the direction of the company, director appointments and their remuneration – to the exclusion, sometime, of minority interests[3]. Exercising influence now, however, seems to be a long way from those early notions of this ‘shareholder democracy’[4]. In contrast with the 19th Century, some modern companies are seeing more numerous and geographically dispersed shareholder-bases with disparate interests. This follows the rise of the individual investor, institutional investors, and the growth in hedge funds and private equity houses. As such, the issues are more numerous and shareholder views are often not homogenous.
Looking at proxy access for example, a key flashpoint in the U.S. during 2015, we saw that the positions of the top ten equity institutional investors were very different. As reported by Proxy Insight in January 2016, “Blackrock, BNY Mellon, Legal & General and Norges all predominantly support the issue [proxy access], Fidelity, JP Morgan, Northern Trust, Wellington and to an extent Vanguard all oppose”[5]. Such radically different views do not make for simple management of those shareholders, especially if a company must maintain the confidence of several shareholders from across the spectrum. Proactive and well developed programmes are difficult but necessary to sufficiently mitigate risk, and understanding your shareholder-base and their views are critical.
Challenge #2: Balancing legal duties while having regard to shareholder rights and expectations
Directors need to keep their balance as they walk between shareholder rights and expectations, and their own legal duties to the company. Directors’ duties are generally twofold: to exercise fiduciary responsibility (a duty of trust), and to exercise reasonable care, diligence and skill (a duty of care). The fundamental underlying principle is that directors do not treat the company like it is for their own personal benefit, but that they should act honestly and in good faith, giving shareholders equal information on issues. Shareholders’ rights are determined usually by the company’s constitutional documents and company laws. The underlying rationale is to ensure that despite the separation between the owners of the company and those running the company[6], that there is sufficient transparency into the affairs of the management of the company to adequately inform investment and voting decisions.
What if there is a conflict between these? Where do large institutional shareholders’ expectations sit vis-à-vis other shareholders, especially as directors strive to maintain the confidence of their major investors? Institutional investors usually publish what’s important to them, including their recommendation and voting policies and guidelines. It can be tricky to understand what’s critical in all of this, and treading the fine line to avoid being voted down is a real challenge, not least when it comes to sensitive topics such as executive compensation, board tenure and shareholder rights – all of which have hit the headlines in recent years. Ensuring also that there is equal access to information by shareholders is an important legal consideration and logistical challenge, which calls for a company to maintain well-developed and holistic shareholder engagement policies and strategies.
Challenge #3: How you create long-term value under the pressure of short-term investor priorities
Directors have duties to promote the long-term success of the company. This can be in conflict with the increasing pressure to respond to short-term priorities, and the conflict between long- and short-term investment horizons can be difficult for directors to reconcile. An increasingly diverse shareholder base with disparate interests compounds this difficultly, and to strike an appropriate balance and promote the success of the company for the benefit of the shareholders as a whole is an important challenge to overcome.
Varied approaches taken to ownership rights are inevitable if company shareholders include pension funds that will likely buy and hold shares over the long term and also hedge funds that will do so over a much shorter time frame. Evidence suggests that the balance is tipping towards short termism, which was noted by Edward S. Knight, Nasdaq Executive Vice President, General Counsel and Chief Regulatory Officer to the U.S. Congress’ Garrett Roundtable on Corporate Governance of November 16, 2015:
‘The evidence that the balance between long term and short term investing has been lost is growing. For instance:
- Economic studies show investor holding periods have declined from over six years in the 1950s to less than one year in the 2000s.[7]
- An increasing proportion of public companies are owned by institutions and large investors (60% today vs. 16% in the 1960s) who are evaluated on their own short-term performance.[8]
- Companies are increasingly following the practice of providing frequent earnings guidance perhaps not knowing that this in turn focuses attention on short term performance.[9]
- Ironically, with trading costs down 90% over the past few years it is easier for investors to respond instantly to the ups and downs of company performance.[10]’
Within the European Union we see examples of conflicting regulations, the unintended consequence of which is a tilt to short-termism - for example high capital requirements imposed on insurers under Solvency II arguably causes a disincentive to hold equities. Mr. Knight continued: ‘Investor-driven campaigns, which seek to reshape the company’s investment strategy with the expressed intent to realize short-term profit, skyrocketed in number and intensity in 2014.[11]’
Without a sea change, short-termism will invariably remain a dominant influence, and it fundamentally goes against the grain of long-term value creation. The European Commission released an Action Plan in September 2015 on Building a Capital Markets Union (CMU) built around creating more opportunities for investors and connecting financing with the real economy, amongst other things. It remains in conflict with other regulations, and Nasdaq’s view – as expressed in the recently published paper: The Road to Sustainable Growth in Europe – called for the CMU to create a long-term ownership investment asset class, to reserve capital to make long-term investments. As recently reported by Business Insider, investment funds share this concern, with the Chairman of Blackrock recently releasing a letter asking CEOs to provide shareholders with an annual strategic framework for long-term value creation that has been reviewed by their boards.
For the time being, such competing short- and long-term interests remain, and fulfilling the duty to promote the success of the company for the benefit of its members [shareholders] as a whole[12] will remain a significant challenge while this is so.
These three challenges highlight the increasingly tricky balancing act for board directors, management, and the governance and IR professionals. The challenges are amplified when there is a need to meet with shareholders face-to-face to discuss key topics – some of which are sensitive and nuanced. In this context, the need for a strategic and co-ordinated approach within the company - with proactive engagement from the very top - has never been greater. Accordingly, public companies will want to plan ahead and consider how best to how best to engage before investors knock on the boardroom door. Don't sit on the side lines: an organzied and proactive approach to engaging shareholders is more important than ever, and requires a holistic investor relations and governance program.
Bonus Content: Five Top Tips for Quality Shareholder Engagement
The annual shareholder meeting has been a key channel of communication between the board and shareholder for years, but times are changing. This whitepaper reveals how companies can communicate effectively with their shareholders.
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