Corporate governance shake-up: Investors called to action

Hot on the heels of the current Walker review of corporate governance into the UK's beleaguered banking industry and the Financial Reporting Council's review of the combined code on corporate governance, the UK's most influential group of institutional investors has outlined its thoughts on what needs to be done to improve accountability in the boardroom.

The Institutional Shareholders Committee (ISC), which is made up of the Association of British Insurers, the Association of Investment Companies, the Investment Management Association and the National Association of Pension Funds, has issued a paper which sets out what changes could be made to encourage greater shareholder engagement with companies to enhance their corporate governance.

Called Improving institutional investors' role in governance, the paper sets out a number of ideas where shareholders could be more active in encouraging boards to justify or change their strategies.

ISC's PROPOSALS
Clear mandates The ISC says those responsible for appointing fund managers should specify in their mandates what type of commitment to corporate engagement, if any, they expect. Where shareholders delegate responsibility for such dialogue to third parties, they should agree a policy and, where appropriate, publish that policy and take steps to ensure it is followed.

Effective dialogue
Many institutional investors seek regular dialogue with companies on corporate governance matters. Mostly, this is conducted on an individual basis and works well. But when an individual approach fails, a collective approach by several institutional investors may be useful to ensure their message is heard. The ISC says a broader network might include foreign investors and sovereign wealth funds with an interest in long-term value.

However, the group says 'it is important there are no regulatory impediments, real or imagined, to the development of collective dialogue as uncertainty about the rules on acting in concert can be a deterrent to such initiatives'.

The ISC says the authorities should make it clear that collective dialogue is permitted and that it is possible for individuals to receive price-sensitive information in the course of dialogue – provided there is appropriate ring-fencing.

While the ISC says dialogue between investors and company boards is the preferred form of engagement, it also stresses that investors have a duty to use their 'full range of powers', such as voting against company resolutions at the annual general meeting, where 'dialogue fails to produce an appropriate response'. The ISC believes investors have been too reluctant to act in this way.

Board accountability
The ISC is keen to ensure that concerns investors raise with company chairmen are shared with the rest of the board, as it believes all board members have a duty to act in accordance with the best interests of the company and its shareholders.

The ISC says that one way of making boards more accountable would be for the chairs of leading committees to stand for re-election each year. If support for any individual fell below 75% (and note that abstentions would effectively count as a vote ëagainstí), the chairman of the board should be expected to stand for re-election the following year.

The ISC believes this would be a powerful incentive to resolve concerns during the intervening period. Indeed, the requirement for chairs of committees to put themselves up for re-election would motivate them to keep abreast of investors' views and ensure concerns are addressed in a timely way, it says. The ISC adds that in practice it should lead to improved dialogue with investors about issues that might be controversial. It would also broaden the agenda beyond the remuneration issues that dominate dialogue at present, it says.

Combined code
As the FRC is carrying out a review of the combined code, the ISC has made a number of suggestions to enhance the quality of the dialogue between companies and investors:
• Chairmen should retain overall responsibility for communication with shareholders and their agents and be encouraged to inform the board of concerns expressed. The chairman and the board should ensure they understand the nature of the concerns and respond formally if appropriate.
• The senior independent director (SID) should intervene when appropriate communication between board members and shareholders does not happen.
• The code should also encourage the SID to take independent soundings with shareholders and their agents and work with the chairman to ensure an appropriate response from the board.
• The code should emphasise succession planning more clearly with chairmen reporting annually on the process being followed and progress made.
• The audit committee's terms of reference should be expanded to include oversight of the risk appetite and control framework of the company. The ISC adds that it may be more practical to establish a separate risk committee dedicated to this function.
• Board evaluation with external input should be expected of banks given their regulated status and the public interest aspect.
• The combined code already gives independent directors the right to seek expert advice. The ISC believes it should also encourage non-executives to do so in cases where they feel it may be necessary to their understanding.

ISC chairman Keith Skeoch said: 'We believe this paper is a useful contribution to the evolving debate. Institutional investors wish to be more effective and have an important role to play. The ideas set out in this paper are an important step in this direction and should make a real difference.'

Useful links
www. institutionalshareholderscommittee.org.uk
www.frc.org.uk
www.hm-treasury.gov.uk/walker_review_information.htm