Friday, 30 January 2009

Select committee stuff - shareholder bodies

The Treasury committee has been holding its inquiry into the banking crisis over the past few weeks, and you can now access written evidence via the committee website. I thought I'd take a look at what some of the big investor bodies had to say about the role of shareholders so here are a few snippets. (There's also some stuff from the ISLA (stocklending trade body) which I'll do in a separate post.) I've emphasised the bits I think are most interesting.

ABI (page 67 onwards in this doc):
Insurers as investors recognise the responsibilities of shareholders to ensure that companies in which they invest are properly managed. The ABI’s activities in corporate governance reflect both members’ role as long term shareowners in their own right and also their responsibility to policyholders who depend on the investment return.

45. The government has acknowledged that institutions have made strides forward in recent years, but it is clear that more could be done to improve the techniques and approaches to dialogue. We are keen to work on this, with particular focus on improving mutual understanding between independent directors and shareholders, how they interact at times of corporate stress, and on ensuring that dialogue appropriately addresses key issues such as risk management.

46. We also wish to work with companies and others to promote greater focus on long-term investment issues. Partly because of the ambition of brokers to generate fee income from trading, analysts have tended to place great stress on the impact of short-term developments, including quarterly financial statements. It is now clear that the desire for short-term profit encouraged some financial institutions to take excessive risks, which subsequently led to serious losses. We need to shift the culture away from this. This objective will not be achieved through regulation, but the aim of introducing a longer term perspective should be an important priority for dialogue between shareholders and companies.

47. Dialogue between companies and shareholders is not guaranteed to work, however. Ownership of UK equities has become more fragmented in recent years with the insurance industry now owning only around 15 per cent of the market and pension funds somewhat less. With other owners sometimes less concerned about governance, this makes it easier for companies to override efforts by concerned shareholders to achieve change. It is important therefore that there is more consensus in the shareholder community about the need to hold Boards to account.

48. It is vitally important that corporate engagement, especially on corporate governance and sustainability issues, is integrated effectively into the investment management processes. Such engagement is resource intensive. Therefore, beneficiaries and their representatives, such as pension fund trustees should ensure that appropriate resources are available.

The IMA has a long subimission (page 226 onwards, same doc as above). This is from the introduction:
The role of investors

12. There are two broad ways by which shareholders exercise discipline over the companies in which they invest: by selling shares or engaging with management and boards. Both were used in relation to the banks in the period leading up to the crisis. But neither was effective in preventing it.

13. From about 2005, a number of active investment managers concluded that the strategies being followed by many banks were unsustainable, and that they should not keep their clients invested in the sector. The resulting sales of shares were likely to have been one factor in the underperformance of the banking sector relative to the market as a whole, which was by some 9% in 2005. But these market signals appear to have had little or no restraining effect.

14. During this time, those managers not in a position to sell their shares, for example those running index funds or with mandates from pension fund clients which did not allow them to depart very far from the index, began to express concerns to some bank boards about strategic direction, and stepped up the amount of engagement they undertook. However, it is now apparent that this engagement did not achieve the desired results, and this highlights the limits on what engagement can achieve. We expect this to be confirmed by the IMA’s fifth survey of shareholder engagement, which is currently underway and will be published later this year.

15. Although shareholder approval is required for major corporate actions they do not set strategy nor are they insiders, in that they only have access to information that is available to the market as a whole. Managers compensate for such information asymmetries by diversifying portfolio construction. Furthermore, it is now apparent that some bank boards and even managements seem to have been unaware of the risks they were running, so it was difficult for shareholders to second guess them.

16. The IMA considers that the investment management industry needs to consider carefully the events of the last two years in banking and to draw lessons for the future.

And this from the more detailed bit on shareholder engagement:
112. However, it is now apparent that this engagement was not necessarily effective and it is important to recognise that there are limits on what engagement can achieve. In particular at a time of relatively easy credit banks are able to raise funds at very fine prices, and may become less reliant on their shareholder base.

113. First, investment managers are restricted in terms of the information that is made available to them. They do not have insider status and were not privy to the same information as the executive or indeed the non-executive directors. Furthermore, in many instances it is now apparent that the boards and management of financial institutions failed to fully appreciate the risks on their balance sheets, thus, investment managers could not have been expected to either; this was not a problem which could have been avoided by better engagement. Managers compensate for such information asymmetries by diversifying portfolio construction.

As most of you will probably realise, this all rings very true with me. I'm skeptical that institutions engage with companies as much as these excerpts suggest (they need to cover themselves obviously), but I have no doubt that the broad outlines are accurate. Even institutional investors are relatively weak in terms of their restraining influence on companies, even if they seek to exercise what power they do have, especially when the bubble is expanding. Meanwhile the IMA says that you can't expect shareholders to second guess risks that boards themselves haven't spotted. I agree entirely.

But then the obvious question is why on earth do we genuflect to this ideal of shareholders as owners when it patently does not work effectively - as shareholder representative groups themselves acknowledge above? This is vitally important to remember for example when (inevitably) some remuneration consultant or other apologist repeats the idiotic claim that executive pay is a matter for companies and shareholders. That model is patently broken. Obviously I am not suggesting that shareholders play no role in governance issues, but a shareholder-centric model has clearly failed because of both inherent flaws and the lack of desire for shareholders to act like owners. The sooner we recognise this the sooner we can try and figure out what should come next.

PS. NAPF does not appear to have made a submission.


Antony said...

Nice one Tommo, interesting stuff as usual from your beady eye! All the best for poppa leave.
The Scarlet Pimpernell

Tom P said...

Not long to go now!