Last year’s corporate scandals caused by you-know-who have raised the suspicion that executives are more interested in satisfying their own egos than looking after the interests of their shareholders. Now investors who used to be happy to let boards work away behind closed doors are demanding an open door policy.
Institutions like Calpers, TIAA-Cref and Hermes have made corporate governance their business for over a decade. The pension fund folks at the Teamsters or the AFL-CIO are no strangers to the corporate boardroom either. But today more and more mainstream investment houses like Merrill Lynch, Fidelity and Barclays Global Investors are appointing corporate governance experts to their research teams.
The mission of this new breed of buy-side officer is first to design their own in-house corporate governance guidelines, usually based on existing rules, laws and codes. Then they keep track of portfolio companies in relation to their benchmarks, focusing on what hurts share price from a governance point of view. The final, occasional step is trying to get boards to mend their ways.
‘At the end of the day, financial performance is related to corporate governance,’ maintains Anita Skipper, head of corporate governance at London-based Morley Fund Managers. ‘If you look at some of the largest catastrophes that occurred recently, they have been governance failures and management failures. So I think all institutional investors should have someone filling that role because management risk is real.’
On the other hand, according to Thomas Richter, a spokesman for Frankfurt-based mutual fund group DWS Investment, part of Deutsche Bank, having a corporate governance officer is more a ‘marketing tool’ for some buy-side firms than it is a sign of serious corporate governance engagement. ‘We invest in more than 1,000 companies around the world and it’s impossible for one person to overview what’s happening in all of them,’ he notes. At his firm, it’s the analysts themselves who monitor the governance policies of the companies they research and inform the money managers when they detect problems.
New investment style
‘We have always considered corporate governance to be an important part of our investment assessment,’ claims Robert Lake, who is the head of SRI engagement and corporate governance at Henderson Global Investors. ‘But clearly a lot more interest has been expressed by our clients in the last two years.’
‘With all the scandals and new regulations, corporate governance is becoming a more high-profile aspect of investment processes,’ agrees Colin Melvin, head of corporate governance at Hermes Pensions Management. He adds, ‘There is a general understanding that shareholders have a role to play in the governance of companies; they are no longer merely passive investors.’
Shareholder activism is not new to the pension fund world of Calpers, TIAA-Cref or Hermes; nor to the socially conscious community of institutions like Henderson and Morley. Calpers, the California Public Employees’ Retirement System, one of the world’s biggest pension funds with around $133 bn, began putting pressure on companies to change in the late 1980s. The fund trustees were denied the option of voting with their feet by selling underperforming stocks, since Calpers’ portfolio was indexed. So the pension fund adopted another tactic aimed at increasing returns for its beneficiaries: a combination of media pressure and shareholder activism to improve corporate governance. The changes prompted by Calpers often translated into better stock price performance.
In the public eye
Under the 1974 Employee Retirement Income Security Act (Erisa), US pension funds are obliged to participate in the proxy voting process. Calpers was the first big fund to take the process a step further, and the rules of engagement it developed have since been adopted by many other indexed pension funds.
TIAA-Cref (Teachers Insurance and Annuity Association/College Retirement Equities Fund) is the other old-timer on the shareholder activist circuit. Ken Bertsch, now Moody’s Investors Service’s director of corporate governance, coordinated the corporate assessment plan at TIAA-Cref from 1999 to 2002 after spending 14 years at the Investor Responsibility Research Center in Washington, DC.
‘My team at TIAA-Cref was created because we had the majority of our investments indexed and we felt we needed to engage with companies to improve their governance policies and increase the value of their shares,’ Bertsch sums up. He adds that when behind-the-scenes discussions failed to yield results, TIAA-Cref’s plan B was to take disagreements public. He adds, ‘For us, investor relations officers were critical in helping with all these discussions.’
‘Our preference is to deal with these issues in discussions with companies rather than to coerce,’ says Hermes’ Melvin. Similarly, Henderson’s Lake says, ‘When we detect a problem, our first step is to have a conversation with the company. IR officers tend to be our first point of contact. We see what they have to say about what we think is wrong. If the company agrees there is a problem, we can guide them on how to change it. Sometimes they have a different view to ours, and then we want the corporate secretary and the chairman to explain to us why the arrangement they have is acceptable. But if we still see a problem we can exercise our voting rights to make our position clear.’
Closed-door discussions can extend over a long period, even years. Only when the institutional investor concludes there’s no chance of change will it go public or, if their firm’s investment style allows it, sell off the shares.
High priority
UK companies are generally expected to comply with the Combined Code, a regularly expanded collection of various governance principles. But asset managers don’t simply assume companies follow every aspect of the code. Instead they take a flexible approach by looking at individual companies and their circumstances. The issues raising the most concern among investors these days are board structure, the professionalism of both executive and non-executive directors, their compensation, their relationship with shareholders, and the independence of audit and compensation committee members. The governance experts interviewed for this article say they’re usually satisfied as long as a company is transparent and can justify its particular governance arrangements.
The buy-side approach to governance compliance has to be even more flexible when it comes to foreign companies. Indeed, there are dozens of governance codes around the world for them to choose from. ‘For other European companies, we use a broader-brush approach because it’s not fair to apply the same UK principles to businesses with different cultures, different regulations and different laws,’ says Morley’s Skipper. She explains that when it comes to investing overseas, Morley gets governance research from local consultants to help set benchmarks.
Still, with some foreign markets relying heavily on UK and US institutions for capital, the pressure is on to adopt Anglo-Saxon corporate governance practices. In Spain, for instance, local asset managers used to think monitoring corporate governance didn’t benefit their investments. But they’re now realizing that companies managed in a responsible way perform better in the long term, according to Ramon Barriga, an analyst at Corporate Governance Spain, a division of Soler-Padro law firm. Furthermore, Spain is considering a law requiring institutional fund managers to vote at companies’ annual meetings. ‘That would compel money managers to get more involved in the management of the companies and to request more reports on corporate governance,’ Barriga says.
IROs may once have seen corporate governance as far outside their remit. Does that still hold true? ‘It would be helpful to include a bit more on governance issues in their presentations,’ pleads Lake at Henderson. He and other fund managers say basic corporate governance information helps them form opinions, even if it’s not an investment trigger itself. ‘There are some IROs who just call us up to let us know what they are doing in this area, which gives us a very good feeling about the company,’ says Skipper. ‘At the end of the day it’s all about impressions,’ concludes Richter in Germany. And in these days of disillusioned investors, the impression of taking care of shareholder interests is definitely a good one.
