Those of us with an interest in corporate governance will each have our own ideas about how the concept should be advanced, or indeed, how it is likely to develop. In this first article in the new blog, we look at 9 current influences on corporate governance developments.
We at Applied Corporate Governance define corporate governance holistically, putting compliance with codes into a sub-set of what good corporate governance is all about. So it would seem interesting to consider the various drivers currently influencing development in that holistic context.
To recap, our holistic definition comprises five elements to good governance:
- an ethical approach which is in tune with the societies and cultures in which a company operates
- balanced objectives which fulfil the goals of all the key stakeholders
- strategic management rather than opportunism or clientelism driving the policy and decision-making process approach
- an organisation structured and resourced to deliver the strategic plan
- a culture of accountability and transparency to all stakeholders.
This approach recognises that the interests of different stakeholders carry different weight, but also that all stakeholders should be treated with respect. This isn’t as simple as it might be wished, as we can see by looking at the potentially conflicting aims of the main stakeholder groups:
- long-term investors, some of whom may be looking for a steady income with maybe the need to finance dividends out of borrowing, others at long-term capital growth and minimal distributions
- short term shareholders who are most likely to be looking at rapid capital gains, but who may also include short-sellers
- customers: who will be looking at the company’s ability to survive and grow and to supply consistent quality without making excessive profits at their expense; possibly with the more demanding requirement for regular innovation in the products and services they supply and hence investment
- employees: who will expect security of employment, which in turn requires financial soundness, but not at the expense of restricting levels of remuneration
- suppliers: who will look to financial soundness and the ability to pay their bills on time
- bankers: who will be expecting financial soundness and security against loans, coupled with an adequate level of cover on interest payments
- general public: whose interest is likely to be in maintaining existing levels of employment in local communities or even in expanding them, which may conflict with the company’s need to restructure to preserve its future
- government and regulatory authorities: who will be relying on compliance with rules and the payment of as much tax as possible.
The main current influencers of corporate governance developments and the evolution of governance practice include the following:
- long term investors
- asset managers
- sovereign wealth funds
- activist investors
- private equity
- proxy advisers
- regulators and lawmakers
- educators and academics.
Let us look at each of these in turn:
Long term investors
These are those relatively rare organisations like Warren Buffett’s Berkshire Hathaway, whose aim is to select carefully a company which they believe has a strong market position, is well-run and has a long term future. Berkshire Hathaway’s philosophy is to give management a free hand and to stay invested and supportive unless and until some aspect changes irrevocably. Hence they have been a shareholder in Coca Cola for decades, but came out of Tesco after a number of years following evidence of questionable management practices (see our article on Tesco and whistleblowing) and indications that Tesco had lost its way both internationally and domestically.
In our view, though they would be unlikely to express it in these terms, Berkshire Hathaway almost certainly would subscribe to our Five Golden Rules of good corporate governance when assessing whether to make a long term investment and also in their regular reviews of performance by their investee companies.
It is interesting that Warren Buffett has recently convened a group, with Jamie Dimon of J P Morgan, to put together a new set of principles for corporate governance in public companies. According to a report in the Financial Times, this group includes Black Rock, Fidelity, Capital Group, T Rowe Price, Vanguard and others. The purpose is to encourage longer term investment and reduce friction between investors and shareholders. We have to hope that, encouraged by Warren Buffett, they take a holistic approach rather than simply go for better communication between the owner stakeholder group and management. This would certainly be a positive development.
The term asset manager covers a wide spectrum with an equally wide approach to investing clients’ funds (see our article on active versus passive managers). To the extent that these fund managers take a long view, we can probably regard them as being interested in all five of our golden rules of good governance. However, stewardship is increasingly featuring in critical discussions about the poor contribution of these investment organisations to corporate governance. This indicates that the majority of them don’t get very involved, or indeed wish to get involved, with the organisations in which they are invested (see our articles on stewardship and investment organisations).
There are good reasons why this is so, including a sheer lack of resource to participate to any degree in discussions with the boards of the large number of companies comprising their portfolios. Couple this with an unwillingness to cross swords on strategy with in-house specialists and a wariness of finding themselves privy to inside information and laying themselves open to regulatory criticism. Notwithstanding, in the UK at least, there has been a specific effort to improve things in the shape of the Sir David Walker’s Stewardship Code, introduced in 2010, a potentially significant development. However, in its review of progress in 2015, the Financial Reporting Council said “Our chief aim is to foster a better quality of engagement between companies and investors ….”, while expressing concern at a lack of real progress.
One way or another, the current position is a generally limited engagement between the group of owners represented by institutional investment and the companies they (part-) own. This is compounded in the UK, at least, by a steadily reducing proportion of investment in equities by the more stable, longer term investors represented by the pension funds and insurance companies, who have been turning more and more into bonds and overseas shareholdings, where there is even less chance of meaningful engagement. So the trend is unlikely to create any meaningful influence on corporate governance by asset managers as a class, whatever the well-meaning intentions of the Stewardship Code.
Sovereign wealth funds
In one of the most significant corporate governance developments in recent years, the funds built up by certain countries have begun to make an impact on the global investment scene. One of the most notable is that of Norway, which is acknowledged to be the world’s largest, with a fund of c$800m. It has also taken one of the most outspoken positions on corporate governance.
The Norwegian fund said in its second report on responsible investing that it had sold out of a record number of companies, including many which were involved in the coal industry. The chief executive of its fund manager told the Financial Times that the aim of its votes against resolutions at AGMs in companies including such global leaders as Exxon, ABInBev and Toyota was to “raise the stakes a bit”. The fund has also attacked the corporate governance of VW describing it as “complex and problematic”.
The reputation, and clout, of this huge fund clearly makes its view influential, and it appears to have achieved some changes in policy through making its views public. But we see no public expression of a comprehensive, holistic set of principles, such as those comprising our Applied Corporate Governance approach, supported by independent surveys. As such, we see limited impact on governance from the big sovereign wealth funds.
In the 1980s, the likes of Carl Icahn and T Boone Pickens were known as corporate raiders, whose purpose in acquiring a big enough stake in a company to be able to exercise influence, was to force changes which increased the value of their stockholding. Often the route they took would disadvantage other shareholders as the boards bought them off to get rid of them. And the employees’ interests wouldn’t generally have figured highly in their priorities.
More recently hedge funds such as Bill Ackman’s Pershing Square have become serious players in the game of engineering corporate change. But the aim has always been to ramp up shareholder value. This could be by direct investment or by backing groups whose policy is to consolidate in an industry. Hence Bill Ackman’s backing for Valeant Pharmaceuticals, the Canadian company whose business model has been described as a “platform company”. This model involves a string of acquisitions funded by debt, with the aim of driving rapid growth. Sadly for Mr Ackman, platform companies haven’t worked very well recently and he has lost a lot of money. But the policy of backing this type of company relies on a constant flow of acquisitions which cannot be sustained indefinitely. Holistic corporate governance it is not.
A more measured approach has been taken by ValueAct in persuading the board of RollsRoyce to consider its ideas and even to accept the appointment of a director to its board. It remains to be seen whether the input from ValueAct will turn out to provide a holistically beneficial impact on Rolls Royce and whether they will be a long term investor supporting not only improved profitability but helping to secure the long term future of Rolls Royce and its employees through appropriate and well-directed investment.
Longstanding firms such as KKR, Carlyle, Blackstone and Apollo have grown huge in the past thirty years, but their aim has remained the same, to take large public companies private and restructure them to increase their value, out of the public eye and free from the constraints attached to public companies. The formula for generating and extracting shareholder value, broadly speaking, relied on improving the business performance, then gearing the company to the maximum extent feasible to take out as much cash as possible before floating it with a good, but short, track record and optimistic forecasts. The result, too often, was the crippling of the company with an unsustainable level of debt when market conditions changed. However, over the years it is probably fair to say that the time horizons of the big private equity firms have grown rather longer, and the quick turn-round followed by trade sale or IPO is less time-driven than earlier. Though difficult market conditions in recent years have been a factor, this is probably also due to the combination of the size and maturity of these firms enabling them to take a more measured view, and the influence of global thinking on responsible investing and good corporate governance, coupled with regulatory changes.
Collectively, though, the fact that the owner (the private equity firm) is directly in charge and in a near all-powerful position, instead of being a remote investor, should make it easier for the exercise of good corporate governance. The current reputation of these big firms as owner/investors is generally quite high and must reflect governance which genuinely balances the interests of the key stakeholder groups: themselves as owners, together with the customers and the employees. They are not a group naturally given to grandstanding, and have historically preferred to keep a low profile, but it would be good to see them come out with a set of holistic corporate governance principles.
Leading international firms such as ISS and Glass Lewis have built their reputation on assessing companies’ corporate governance performance, and research by Corporate Secretary showed that nearly half of the companies surveyed had communicated with either ISS or Glass Lewis to correct a mistake or get a voting recommendation changed.
But how do these firms define corporate governance? We would say essentially by reference to the regulatory requirements, and to us, their approach is very much focused on the way the board reacts with shareholders.
To the extent that their scrutiny makes it difficult for large (and smaller) companies to skimp on regulatory reporting compliance or to disadvantage groups of shareholders, they perform a valuable role. But in essence they are doing the regulator’s job for them and as such their contribution is subject to all the limitations we have always pointed to in the regulatory regime. Moreover, they are unlikely ever to extend this approach to include the other stakeholder groups, as in our holistic definition, unless they change their business model. Consequently, they are hardly more likely than the regulator to prevent another Enron or Lehman type of catastrophe.
Regulators and lawmakers
Compliance with company constitutions, company law, industry regulations and corporate governance codes, while all very desirable, does not amount to corporate governance and does not necessarily even lead to good corporate governance.
Anyone doubting this need only look to the major corporate disasters of the current century. To quote just a few examples:
- WorldCom and Enron, respectively the first and second biggest bankruptcies in US history at the time, led to Sarbanes-Oxley.
- In 2008, Lehman Bros and Washington Mutual collapsed, creating two even bigger bankruptcies and leading in turn to the later Dodds-Frank regulations
- Also in 2008, RBS had to be rescued by the UK Government following its disastrous joint takeover of Dutch bank ABN Amro.
All five companies complied with all the necessary regulations for years until everything blew up – in two cases due to fraudulent accounting, in two cases due to being dangerously over-exposed in their business models and in the final case due to a “bet the farm” decision which lost the farm.
In the UK, the Corporate Governance Code is seen as having improved corporate behaviour and the Stewardship Code is seen as well-intentioned though probably not very effective. But neither, in our view, approaches corporate governance holistically. In the US, SarBox was widely criticised as being over-bureaucratic and clearly failed to prevent the unacceptable practices in banking which led to the financial crisis of 2008. In turn, Dodds-Frank is criticised for being even more bureaucratic and may already be in the process of being emasculated on the basis that it is restricting the ability of financial services to support vital business growth and that it probably won’t prevent the next breakdown anyway.
The general criticism of regulation is threefold:
- it is invariably backward-looking, trying to fight the last war, and will always miss the next major problem
- it very often has unexpected consequences, which may create huge and unanticipated new problems
- bureaucrats administering these regulations have a vested interest in extending their remit, regardless of whether this is in the best public interest.
So, in our view, the regulatory authorities and lawmakers aren’t ever going to contribute to holistic corporate governance.
There has been a significant increase in populism since the 2008 crash and the resulting austerity initially in developed nations and now in emerging markets. Business, particularly financial services, has taken a beating in the media and populist leaders such as Marine Le Pen in France, Podemos in Spain and Donald Trump in the US, have been the beneficiaries.
An international communications firm, Edelman, has released its 2016 Edelman Trust Barometer, a global survey of peoples’ trust in four groupings to do the right thing in their behaviour: government, business, NGOs and media. The result as far as business is concerned is both concerning and a source of opportunity. The survey shows a big gap between the views of the better educated and wealthy citizens and their poorer, less well-educated fellow citizens. Basically the elite trust the leadership of business much more than do the rest of societies. But Edelman’s reading of the situation is that the non-elite are much better connected and informed than ever before and are no longer willing to take a lead from the elite. Therefore the elite can’t any longer expect their more knowledgeable and better-informed views to carry the day and populist, anti-business views may increasingly prevail.
The opportunity lies in the finding that business as a whole is more trusted than government and seen as more likely to be able to solve the problems of the future. Moreover, well-respected business leaders of firms which address social issues, like Unilever recently, command respect with the public. So the lesson is that companies which embrace good corporate governance in the wider sense (as we would advocate) are likely to command the support of the general public and be in a better position to protect themselves from populist attacks.
Educators and academics
While recognising the key role of Sir Adrian Cadbury and his committee in getting the concept of corporate governance introduced to, and accepted, by boards of large companies, we would argue that the Corporate Governance Code is at best a subset of holistic corporate governance. Real advances in thinking about corporate governance have been driven by academics and taught by educators.
We don’t need to go into the history of research into corporate governance in the US after the last War, but arguably the introduction in the UK of the Corporate Governance Code gave weight and legitimacy to the work done by academics over the years.
Our view on corporate governance developments
In developing the principles which we espouse, we were insistent that these should lead to a practical structure which could stand independent of in-house systems. Moreover, this structure should link to existing feed-back processes which reinforce good management practices while providing the basis of a system for continuous improvement in performance in corporate governance. This would entail defining measurable metrics which provide the basis for management of the key factors and using external independent surveys to avoid organisational capture. Hence our naming it Applied Corporate Governance. In our view, this holistic approach will lead future corporate governance developments and the regulators will follow behind.