Yesterday, the Government launched its consultation on corporate governance and economic short-termism, trailed by Vince Cable during the Autumn conference season.
As the UK economy begins its journey towards recovery after the turbulent events of the last few years, the consultation, "A long-term focus for Corporate Britain", looks at whether more can be done to help secure the long-term economic growth needed. When announcing that there would be a consultation back in September, the Rt Hon Dr Cable highlighted factors which can help build a framework founded on long-term economic logic, such as shareholder responsibility and corporate incentives and pay. He stated that short-termism and shareholder disengagement are an increasing problem for the economy and emphasised the need for shareholders to act like long-term owners.
Against this background, the first stage of the consultation process is a call for evidence which examines and requests views on the roles of, and relationships between, those who own companies and those who manage them. In short, the call for evidence seeks to establish whether the system in which companies and shareholders interact promotes or undermines long-term growth. This interaction is explored generally and then the Government considers in more detail issues relating to directors' remuneration and takeovers.
The call for evidence sets out a high level summary of the issues it seeks to address and then a number of broad questions on which interested parties are asked to submit their views. The call for evidence closes on 14 January 2011, and the outcome, along with the Government's proposals, will be published by 14 April next year. It is not clear what the next steps will be after that. Copies of the call for evidence are available from the BIS website.
The call for evidence considers some issues which have been examined in other recent consultations (some of which are referred to in the call for evidence, including the Company Law Review (which culminated in the Companies Act 2006), Takeover Panel's consultation earlier this year on the Takeover Code, the Walker Review and the FRC's consultation on the Combined Code (which led to the UK Corporate Governance Code and the Stewardship Code)). We strongly encourage listed companies and other interested stakeholders, however, to participate in this consultation process. It looks to examine or re-examine significant areas of corporate governance and corporate law and any changes which follow could have a considerable impact on listed companies and their shareholders.
Set out below is a summary of the issues raised in the call for evidence and the questions on which views are sought.
The legal and regulatory structures making up the UK's corporate governance framework
The call for evidence opens with a scene-setter: a brief analysis of the size of the UK equity market and the legal and regulatory requirements which make up the corporate governance framework for UK listed companies. With over £70 billion in new equity raised on the London Stock Exchange by UK listed companies in 2009, it is clear that the public markets continue to be a key source of funding for listed companies.
The board of directors
The call for evidence summarises at a high level the role of the board, directors' duties, and the influence of shareholders and equity markets on the board. The Companies Act 2006, which codified directors' duties, recognises the need for directors to consider the wider community and the long-term consequences of board decisions whilst promoting the success of the company for the benefit of shareholders as a whole.
The call for evidence notes that the quality of the relationship between a company's shareholders and its board is pivotal to the long-term success of that company, due to the influence that shareholders have on board decision-making (eg through their power to approve certain transactions under the Listing Rules or to remove directors under the Companies Act). How the board communicates with the shareholders will in turn impact on how shareholders view the quality of the board and the decisions it takes. The call for evidence identifies two key factors: how effectively the board communicates with the shareholders and, in order to do so, how informed the board is of the identity of the shareholders. Issues in relation to shareholder communication are already being considered in separate consultations (for example the Government consultation on the future of narrative reporting - see corporate e-bulletin 2010/24 for more details). In this call for evidence, the Government therefore asks:
- Do UK boards have a long-term focus - if not, why not?
- Does the legal framework sufficiently allow the boards of listed companies to access full and up-to-date information on the beneficial ownership of company shares?
Shareholders and their role in equity markets
The nature of UK share ownership has changed dramatically over recent years, with, in particular, foreign investors now key players in UK company ownership and the call for evidence sets out some relevant statistics. The call for evidence asks:
- What are the implications of the changing nature of UK share ownership for corporate governance and equity markets?
The call for evidence discusses what it refers to as the chain of ownership and control of companies looking at the different types of institutional shareholders and the different bases on which institutional managers make their decisions.
What the call for evidence sees as the key relationship for the long-term success of a company between its board and its shareholders is examined from both sides of the relationship and the nature and quality of shareholder engagement is considered. The call for evidence notes as a major development in this context the publication of the Stewardship Code by the FRC earlier this year. Now the Government is asking:
- What are the most effective forms of shareholder engagement?
- Is there sufficient dialogue within investment firms between managers with different functions (ie corporate governance and investment teams)? - the call for evidence questioning whether, even where there is effective engagement, there is a disconnect between these two teams within the investment manager.
- how important is voting as a form of shareholder engagement? What are the benefits and costs of institutional shareholders and fund managers disclosing publically how they have voted?
Finally in this area, the drivers of short-term investment are explored. In particular, the principal-agent relationships between shareholders and directors and between investors and fund managers are considered. The Government notes that there may be pressure on directors/fund managers where their performance is judged in the context of short-term indicators such as quarterly reports and share price. These themes have already been explored in the wake of the financial crisis, for example during the Walker Review (for more details, see our briefing on the Walker Review). The Government however is asking interested parties:
- Is short-termism in equity markets a problem? If so, how should it be addressed?
- What action, if any, should be taken to encourage a long-term focus in UK equity investment decisions? What are the benefits and costs of possible action to encourage longer holding periods?
- Are there agency problems in the investment chain and, if so, how should they be addressed?
- What are the benefits and costs of more transparency in the role of fund managers, their mandates and pay?
Given the clear conflict for directors when setting their pay, directors' remuneration is a key corporate governance issue. A number of regulatory measures are in place to address executive remuneration issues, covering the level, structure and disclosure of directors' pay. Executive remuneration has, however, increased at a far faster rate than pay for employees generally and there is little evidence, according to the Government, that company performance is the main driver of the level of executive pay. The Government therefore wants to explore whether the current measures are operating effectively and whether they are contributing to long-term sustainable behaviour in this regard.
The call for evidence seeks views on:
- What the main reasons for the increase in directors' remuneration? Are these appropriate?
- What would be the effect of widening the membership of the remuneration committee on directors' remuneration?
- Are shareholders effective in holding companies to account over pay? Are there further areas of pay, eg golden parachutes, it would be beneficial to subject to shareholder approval?
- What would be the impact of greater transparency of directors' pay in respect of: linkage between pay and meeting corporate objectives; performance criteria for annual bonus schemes; and relationship between directors' pay and employees' pay?
The Government highlights takeover bids as an area where questions in relation to long-termism and shareholder engagement are brought into sharp focus. The Government cites research that concludes that often takeovers result in zero or negative returns for the shareholders of the successful bidder, that there is no strong evidence that targets have underperformed prior to takeovers and that not all takeovers succeed in producing long-term economic benefit.
Last week the Takeover Panel announced the results of its comprehensive review of the Takeover Code (see our e-bulletin) and whilst the Government welcomes the steps taken by the Panel (and in particular agrees that the rules governing takeovers should be rebalanced back in favour of targets), it wishes to explore certain broader issues relating to the economic and corporate law framework for takeovers. For example, the Government is interested to consider whether the economic framework for takeovers is likely to improve long-term competitiveness of UK companies.
The specific questions set out in the call for evidence on takeovers are:
- Do boards understand the long-term implications of takeovers, and communicate the long-term implications of bids effectively?
- Should shareholders of an acquiring company in all cases be invited to vote on takeover bids, and what would be the benefits and costs of this?
Immediate reaction to the launch of the consultation
Launched by Dr Cable at the CBI conference yesterday, the call for evidence has already provoked public reaction by a number of interested bodies, including the Institute of Directors, Unite and the CBI.
Given the wide scope of issues covered in the call for evidence, it is anticipated that responses will range from those who believe that the current system should be left intact, without further tinkering, to those who are keen to see a fundamental shift in behaviour. We encourage our clients to take part in this consultation process and use the opportunity now to express their views on the issues covered by the call for evidence.