Article published by The Telegraph on 27 October 2017
Written by David Walker
Featuring: Big Innovation Centre’s “purposeful company” proposed an excellent report suggesting an array of public policy initiatives.
However measured, the UK’s productivity record is weak and the Office for Budget Responsibility now envisages a further reduction in its growth over the next five years. Obviously, no silver-bullet remedy exists, but one major area for focus is the working of the market-based model for listed companies.
An excellent policy report by the Big Innovation Centre earlier this year on the “purposeful company” proposed an array of mainly public policy initiatives. But given the seriousness and urgency of improving Britain’s overall economic performance, the immediate priority should be initiatives that do not rely on slow-motion regulatory or statutory change.
There is widespread recognition that effective shareholder stewardship can support good governance and business performance, and spur necessary change. This is reflected in the Financial Reporting Council’s Stewardship Code, to which a majority of fund managers operating in the UK are at least nominally committed.
But the ability of even a large fund manager to be meaningfully supportive or constructively critical of the board of a company is limited. Leaving aside the free-rider problem – the benefit of a successful initiative is enjoyed by all, while its cost is borne wholly by the initiating shareholder – two important constraints stand out.
First, the increasingly fragmented and international ownership structure of UK companies means few shareholders acting alone have sufficient heft for effective strategic engagement.
The second is the widening of the agency gap between ultimate beneficial owners and the board and management of a listed company.
This reflects the complexity of links in the chain: first, the fiduciary responsibility of the board vis-à-vis not only the company’s shareholders but other stakeholders; and second, the contractual accountabilities of fund managers to asset owners as their principals (as set out in fund management mandates), with an increasing proportion of portfolios managed indirectly by third-party fund managers rather than directly by asset owners. These accountabilities are not always aligned. For example, the board of a company might pursue a long-term strategy, while the fund management mandates of its major shareholders might focus on short-term performance.
Such constraints on effective stewardship, while present in other countries, are greater in the UK. In particular, holdings of blocks, defined as 5pc or more, are significantly lower here. There are fewer shareholders in UK companies with the resource, capability and disposition to build a database of intelligence relevant to the long-term strategy and prospects of their investee companies. This leads to an emphasis, to some extent by default, on short-term earnings performance and guidance. So while the recent removal of the regulatory obligation on listed companies to publish quarterly earnings provides welcome relief from one source of short-term pressure, the extent of the benefit is likely to be limited.
Two common misconceptions need to be addressed. One is that passive or index managers cannot act as stewards. By virtue of their required – and often long-term – ownership of stock, index managers have a clear interest in supporting sound strategy. The second is the notion that selling stock is evidence of short-termism. In practice, collaboration whether by index or active managers does not and should not preclude stock sales. What matters is not whether an investor trades, but rather whether the trading decision is preceded by dialogue with the investee company relating to long-term strategic information or short-term information such as quarterly earnings updates.
In this situation, two complementary initiatives would go with the grain of existing institutional arrangements without need for regulatory change. The first would be to extend and intensify the practice of collaboration among major fund managers. Such collaboration has focused until now on FTSE companies with relatively critical immediate issues. This should be extended into collaborative engagement on a less exceptional and longer-term basis. Specifically, the Investor Forum – a platform for collective engagement – should promote collaboration among the UK and international investment community more generally, increasing the frequency and proactivity of such engagement on stewardship issues such as succession, strategy and capital allocation.
Such collaboration should be explicitly encouraged in the next iteration of the FRC’s Stewardship Code, with asset owners encouraged to incorporate in mandates a requirement for their fund managers to act collaboratively where appropriate. Consultation will of course be necessary on the principles and modalities of extending stewardship collaboration in this way so that it becomes, so to speak, normal good practice. But none of these would appear to be intractable against the potentially substantial upside of boosting business performance through the greater assurance provided to company boards in pursuing sound strategies.
The second proposal is for the design and institution of a survey of stewardship performance of major fund managers, as experienced by FTSE 100 chairmen. Just as companies are, justifiably, under increasing pressure to be attentive to peer group product comparison and service delivery, so similar benchmarking might be appropriate for fund managers.
Careful appraisal would be needed to establish the survey questions, methodology and regularity. But criteria should include fund manager accessibility and willingness to engage with chairmen of investee companies; their level of knowledge; and their readiness to offer long-term support and guidance. There is increasing recognition in business generally of the benefit from access to the considered views of critical clients and counter-parties. Fund managers are surely no exception.
Embarking on such a survey would be a sensitive and significant departure. But it would be consistent with the FRC’s goal of promoting better stewardship and respond to criticism of corporate and shareholder behaviour.
The survey would need professional organisation and steering by a group of experienced investment practitioners and board members. The absence of effective communication between concerned shareholders and company boards creates a vacuum for one or more activist investors to exploit. Activism can be constructive by, for example, re-energising a sluggish board. But previous cases suggest activists are likely to push short-term outcomes at least as much as promoting the sustainable long-term corporate strategy that is the much surer path to improved overall economic performance and productivity.
Sir David Walker, chairman of Winton Group and SETL, writes here in a personal capacity. He is the former chairman of Morgan Stanley International and Barclays, and the author of the 2009 Walker Report on corporate governance of the financial sector.