UK IROs don’t like talking about Higgs. You know something’s wrong after contacting 23 IROs at FTSE 350 companies for a comment and getting only one reply. But if all the rules that emerged from the Higgs review are adopted in the UK’s corporate governance code, it will alter the way shareholders communicate with UK companies. IROs definitely need to watch this space.
The Higgs review is a major attempt to overhaul UK boardroom practice and increase transparency through a range of different measures. Most of these have been widely covered in the business press. But with IROs bearing the main responsibility for communicating with shareholders, relatively little has been said about how the introduction of a senior independent non-executive director with a similar responsibility could affect them.
There are two main questions: if there’s a senior independent director (let’s call him a Sid) who will answer questions from shareholders separate from the channels that institutions take to get to the chairman and the CEO, then what role will the IRO play in all this? And how involved will IROs be in the clause to ‘comply or explain’ when meeting – or not – the terms of the governance code?
Not the done thing
First a little background. On the face of it, it could be extremely confusing, both for investors and the board itself, to establish a new communications link, given that it’s usually been the job of the chairman to be the main communicator on behalf of the board with the shareholder base.
If investors want to understand what’s happening in a company in terms of trading or in terms of prospects, the Sid will probably be the last person they’re going to want to talk to. But if an institution is particularly unhappy with management and think both the CEO and chairman are part of the problem, then they could approach the Sid.
‘There is an illogicality, and it’s fundamental. Historically and traditionally, it is the chairman or designated director who is the main figurehead for the company,’ comments Jeffrey Coorsh, founder and CEO of PCG Worldwide, a provider of online corporate governance products. ‘By bringing in a specific non-executive or independent director to do this role, they are immediately removing that part of the responsibility from the chairman,’ he says.
‘We’re almost setting up a supervisory board in a European sense,’ says Scott Fulton, head of investor relations at business communications consultancy Financial Dynamics, adding, ‘which I have to say is probably a good idea.’
Either way, governance experts say IROs should be seen to be communicating with and on behalf of Sids.
Communications muddle
In light of the Higgs review, a certain amount of confusion is foreseeable, both from investors and within the company itself. Communications will be, at the very least, much more intense, especially when it comes to who says what to whom and when.
According to Bob Haville, director of IR at UK financial PR consultancy College Hill, ‘traffic accidents’ may occur as boardrooms and the IRO move into the new setup. ‘If the company has an established IRO in place, you’ve then got three groups of people nominally responsible for the same thing, but coming from different sides,’ he explains. ‘I’m sure it’s manageable, but mechanisms will have to be put in place.’
PCGW’s Coorsh agrees: ‘Communication is going to have to be organized and I can’t see how an independent non-executive director is going to organize it if he’s remote from the company. I would have thought that the IRO will be the same as he is for institutional briefings of the CEO and the FD – he will be a conduit for making that happen, planning the program and so on.’ Indeed, it would be unreasonable to expect CEOs and CFOs to be briefing independent directors on a day-to-day basis – considering that they have to be independent.
For example, there could be a situation in which press reports on changes to a company’s forecast by one of the major investment banks are picked up by an investor, who then sees fit to contact the Sid to find out why. In such cases it could also be the responsibility of the IRO to get through to the Sid first in order to give some background on the news item.
And this leads to an interesting question: if and when a non-executive director is asked to go and visit investors, does he go alone or does he take senior management with him, even if they have to twiddle their thumbs in an anteroom? Does the IRO go, and are they allowed in – if only to make sure no material, price-sensitive information is accidentally conveyed?
‘If I was a non-independent director who was summoned by some big hairy-arsed institution, I wouldn’t want to go on my own. I’d want someone to take notes and be a witness,’ says a partner at one City advisory firm.
New responsibilities
So the IRO has a key role in guarding against breakdowns in communication, which is partly why Higgs will be particularly burdensome for smaller companies that don’t have a dedicated IRO, and where the responsibility is likely to fall back on whoever’s dealing with investor communications in general.
‘This is going to cause the IRO a lot of problems,’ says Coorsh. ‘You’ve got a situation where an independent director, if there is such a thing, is imposing themselves between a company and investors, without necessarily having the knowledge, the experience or the day-to-day background to deal with things effectively.’
IROs are likely to see an increase in their role and workload, as they will have to spend time with senior independent directors. The amount of time that each IRO will have to put into the adjustment process will ultimately depend on how knowledgeable the independent directors are about the business in the first place.
‘The IRO will be the channel of communication from the company to the independent director,’ says Fulton. ‘In order for senior independent directors to comply with their new role, and for chief executives to comply with issues of universal simultaneous dissemination, non-selective briefings, market abuse, etc, you’ve got to have somebody in-house who checks everything.’
Comply or explain
According to Angus Prentice, IR partner at Brunswick Group, another increasingly important role for IROs will be in explaining how and whether their company is complying with the revised code.
‘I’m thinking especially about compliance with the provisions surrounding the appointment of independent non-executive directors, the nomination committee and how that pulls together,’ says Prentice. ‘IROs should have a proactive voice in demonstrating how their company complies with these provisions.’
Fulton also agrees that IROs are in a good position to adopt that compliance role. ‘As IR evolves and becomes a more important practice, we’ve been recommending to clients that they must consider the appointment or indeed the extension of their IR responsibilities to include that of compliance officer,’ he says.
According to College Hill’s Haville, if compliance is going to form the focus of investor questioning, ‘then IROs might need outside help, not only in complying, but in explaining in quite brutal terms why it is they may not have complied. These actions are likely to increase the frequency of statements as well as their complexity.’
While most compliance issues would be addressed in the annual report, IROs can increase their importance by ensuring the IR section on the company’s web site regarding the appointment of directors and other governance matters is up-to-date on anything not included in the last annual report.
Information gap
‘Governance is an ongoing issue, and one of the reasons why the rating agencies are beginning to look at corporate governance is that there is a gap between the period between governance changes and the changes being propagated to anybody,’ says Coorsh. ‘I think IROs should be much more proactive about informing investors about what’s going on.’
Some investment institutions will welcome more contact with non-executive directors, particularly the Sid, regardless of how much companies choose to explain rather than comply. Others may see it as one more drain on their valuable time. Either way, it will be the role of IROs to make sure things run smoothly between them both, and that Sids are ready to take on the tasks they’ve been appointed to.
Chapter 11
All the brouhaha over Sids in the Higgs code has largely overshadowed the content of chapter 11 – actually the only chapter that really adds new principles to the UK’s combined code. Among its recommendations, the most important is that companies undertake an annual evaluation of both the board as a whole and of individual directors.
It is the second of these recommendations that is likely to cause the most discomfort among UK directors. According to a study conducted by the Centre for Business Research at the University of Cambridge, entitled Job Insecurity and Work Intensification, British employees regard individual performance evaluations as a distinctively negative aspect of their job and associate them with stress, lower motivation and destructive to team cohesion.
While some investors may delight at subjecting directors to such a humiliating process, Higgs’s chapter 11 fails to specify exactly who is qualified to undertake the task. The only guidelines contained in the review are that an independent third party should conduct the evaluations. These may be management consultants, HR consultancies or governance consultants. But what if headhunters do them?
‘We’ve already heard from a chairman of one of the high street banks that these executive search firms are sending several letters a week offering board evaluations and reviews,’ says David Ladipo, joint investigator of the Job Insecurity report and director at UK corporate governance consultant Lintstock. ‘They’re saying they can do a performance evaluation of individual directors – even when they’re effectively evaluating their own performance.’
So what does this mean for IROs? According to Ladipo, the vast majority of FTSE 100 companies will have complied with the principle within two years, meaning that IROs will probably begin to detect investor interest in the near future.
‘You won’t see a great deal of questioning this year but it’ll become a question that IROs have to answer,’ says Ladipo. ‘Next year investors will be saying, Okay, Higgs came out last year. What have you done about it? According to Ladipo, smart IROs are already talking with the company secretary about this issue to consider options and strategy while running internal evaluation trial runs.
Higgs in a box: the main proposals
Senior independent directors
A senior independent director should be appointed who is available to shareholders when they feel their concerns have not been resolved through the normal channels of communication via the CEO or chairman.
Board structure and Neds
At least half the members of the board, excluding the chairman, should be independent non-executive directors (Neds). Although this is already the case for the majority of FTSE 100 companies, it is not for many mid caps and small caps.
The review contemplates a more rigorous process for the appointment of Neds. Newly appointed Neds must meet with major investors upon appointment and meet with shareholders from time to time or when they request it. Also, no one Ned should sit on all three main board committees, and should serve no more than two three-year terms.
The performance of individual directors and the board should be evaluated at least annually (chapter 11 of Higgs), and the annual report should state if these reviews are taking place and how they are conducted.
Chairman and committees
The role of CEO and chairman should be separate and no CEO should become chairman of the same company. Also, the company chairman should not chair the nominations committee.
A full-time executive should not take on more than one non-executive directorship, nor become chairman of a major company. Moreover, no individual should chair the board of more than one major company.
All companies, except for small ones, should have a nominations committee to conduct board appointments and make recommendations to the board. The nomination committee should consist mainly of independent non-executive directors, while the remuneration and audit committees should be entirely comprised of Neds.
At least one member of the audit committee must have significant, recent and relevant financial experience and the number of meetings of the board and its main committees should be stated in the annual report, with the attendance of individual directors.
For an online copy of the complete review, check out: www.dti.gov.uk/cld/non_exec_review/pdfs/higgsreport.pdf
