As listed companies well know, proxy advisers today exert more influence on institutional investor voting behaviour than ever before.
While proxy advisers play an important role in assisting institutional investors to decide how to vote at company general meetings, there is increasing concern over the role they play in influencing voting behaviour.
In the interests of market integrity, it is time to reform the way proxy advisers and institutional investors exercise their voting decisions.
In particular, proxy advisers should be licensed under the Australian Financial Services regime and in cases where the adviser’s voting recommendation differs to that of the company’s board, advisers should be required to provide a copy of their draft report to the company. This would provide the company with an opportunity to respond and clarify issues relevant to the recommendation.
THE AUSENCO EXPERIENCE
Ausenco’s AGM last year is a stark example of what can happen when a proxy adviser makes an ‘against’ recommendation by highlighting irrelevant matters, not considering relevant matters and placing undue weight on ‘light touch’ disclosure rather than clarifying the actual position with the company, ultimately resulting in Ausenco suffering a ‘first strike’ on its remuneration report.
Ahead of its 2013 AGM, Ausenco posted strong 2012 results with NPAT, EPS and dividends all up more than 50%. In the same year, Ausenco increased the base salaries of its key management between 13.8% and 25%. (Prior to 2012, management salary increases had averaged 6.1% per year.)
Apart from the salary increases, there were no other changes to Ausenco’s remuneration practices during 2012.
At its AGM on 2 May 2013, Ausenco received a ‘first strike’ when more than 25% of eligible shareholders (equivalent to only 11.3% of all Ausenco shareholders) voted against the adoption of the remuneration report. Key management personnel (including major shareholders in the CEO and certain directors) were ineligible to vote on the remuneration report resolution. The exclusion of key management personnel from the voting process can heavily influence the outcome of the resolution, particularly for companies outside the S&P/ASX 200 where major shareholders often have director or management representation. Our thinking on the shortcomings of the ‘two strikes’ rule can be read here.
In light of the exclusion of key management personnel from voting, a key factor in Ausenco recording a ‘first strike’ was the ‘against’ recommendation of a proxy adviser which was followed by a number of institutional investors.
Corrs’ analysis of the key issues raised by the proxy adviser identified that they had:
- highlighted irrelevant matters – for instance, in assessing whether the CEO’s remuneration was reasonable, the proxy adviser took into account dividend income he received on his existing holding of Ausenco shares (including shares acquired other than as remuneration);
- not considered relevant matters – the proxy adviser did not consider matters which may have justified the increases including salary freezes in prior years. The lesson for proxy advisers is that they need to consider a company’s historic, and not just most recent, remuneration practices to ensure they understand the context in which remuneration changes have occurred before reaching a conclusion;
- concentrated on their view of preferred market practice in Australia without considering the approach of Ausenco’s international peers or the nature of its international operations – the proxy adviser made no reference to the remuneration practices of Ausenco’s global competitors in their report; and
- placed undue weight on less fulsome disclosure by Ausenco in the remuneration report (which could have been clarified with Ausenco) – a reason for recommending a ‘no’ vote was that the KPI inputs of the short term incentive plan were listed, but a specific breakdown for each senior executive was not provided.
PROXY ADVISERS SHOULD BE SUBJECT TO THE PRINCIPLES OF NATURAL JUSTICE
It is concerning that our market is so unsophisticated that the way a proxy adviser most usually communicates with a company on remuneration issues is through an ‘against’ recommendation to its clients (not the company). This has to change.
The principles of natural justice (also known as the duty to act fairly) were established to maintain public confidence in the legal system.
Applied to the proxy advisers reporting on Ausenco, natural justice would have required the provision of a draft report to Ausenco in advance of the report (and recommendation) being provided to institutional investor clients. Although it is difficult to know whether the adviser’s recommendation would have changed, it would have provided Ausenco with an opportunity to clarify matters which may have had a bearing on the recommendation.
The application of natural justice to proxy adviser recommendations would increase communication, reduce the likelihood of inappropriate ‘against’ recommendations and ensure public confidence is maintained in financial markets.
It is particularly important to consider applying a fairness principle to recommendations when there are also disincentives to the employees of institutional investors (who are often custodians of passive superannuation investments) challenging a recommendation. These disincentives can include:
- policies which require internal escalation of an employee’s decision to recommend a voting decision different to the recommendation of the proxy adviser;
- the additional effort involved in making (and limited time available to make) a case for a different voting decision to be escalated to more senior employees or an investment committee, particularly during the peak AGM season in October-November when internal resources are at a premium; and
- a tendency to avoid escalation procedures for fear of having one’s judgment (and therefore performance) critically analysed by more senior employees in an organisation.
WHAT NOW FOR AUSENCO?
Following its ‘first strike’, Ausenco undertook an internal and external review of its remuneration practices and policies. While this resulted in some changes, the ‘first strike’ also meant that Ausenco took a ‘bells and whistles’ approach to disclosure in its 2013 remuneration report, increasing its length by 58%.
Although this approach was understandable in the circumstances, we do not think that more disclosure will necessarily be better disclosure for most listed companies. It would be a shame if the double whammy of the first strike rule and proxy adviser misgivings contribute to remuneration reports becoming information dumps that are less relevant to their target audience – shareholders. The application of natural justice to proxy advisers should help prevent such disclosure becoming the norm in Australia.
At Ausenco’s AGM on 1 May 2014, the resolution to adopt the 2013 remuneration report was passed on a show of hands. Almost 98% of proxies were directed to vote in favour of the resolution, thereby ensuring that Ausenco comfortably avoided a ‘second strike’.
POSTSCRIPT: CAMAC DISCUSSION PAPER AND THE ROLE OF PROXY ADVISERS
In 2012, the Corporations and Markets Advisory Committee (CAMAC) released a discussion paper requesting comment on, among other things, the role and regulation of proxy advisers. Corrs contributed to the response prepared by the Law Council of Australia that advocated for:
- Proxy advisers being required to hold an AFSL with an appropriate licensing regime.
- As part of their AFSL conditions, proxy advisers being required, where their proposed voting recommendation differs to the voting recommendation of the company’s board, to:
- distribute a copy of their draft report to the company free of charge;
- include in their final report any comments provided by the company; and
- correct any substantive errors in the report identified by the company.
- Institutional investors ensuring that there are not structural incentives to agree (and not to disagree) with a proxy adviser’s recommendation.
The Law Council’s submissions can be viewed here.
While we await CAMAC’s response, Ausenco’s experience at its 2013 AGM reaffirms the need for reform in this area.