The recently updated UK Corporate Governance Code and imminent consultation on the UK Stewardship Code has kept scrutiny on the relationship between corporates boards and investors firmly in the spotlight.
Despite this, the recent AGM season was again characterised by a catalogue of high-profile shareholder revolts spanning both large and mid-cap companies. In many cases, this was indicative of failed engagement between boards and their shareholders, largely due to the quality and timeliness of the dialogue rather than an unwillingness from companies to engage.
Looking ahead, it is imperative that company boards shift their mindsets on the objective of engagement, from gaining support for specific management proposals to building deep and long-standing relationships with their owners. To achieve this, we would encourage companies to consider the following.
Engagement with shareholders is too often undertaken in silos and based on specific topics. Boards must become better at framing these discussions within the holistic context of the long-term prospects and strategic opportunities and needs of the business.
The appointment of directors, assessments of board effectiveness and diversity, selection of performance targets governing pay, environmental impacts and corporate restructuring are all inextricably linked and fundamentally grounded in the strategic priorities of the board.
Investors will be better placed to understand, challenge and support board decisions when they can appreciate the broader business rationale. In most cases, we view companies as either disrupters or being disrupted and look for boards to demonstrate how their governance culture and approach is being adapted accordingly.
Fundamentals of pay
It has been 15 years since shareholders were first given the opportunity to vote on directors’ pay in the UK. Since then, there have been extensive debates on topics such as pensions, salary increases, bonus targets, deferrals, share-based structures and termination payments. Although there have been substantial improvements in the structural elements of directors’ remuneration, it is harder to argue that there has been the same level of success in controlling pay outcomes.
While we accept that there is some merit in the ongoing tweaking of remuneration structures, such as the UK governance code’s stronger approach to bonus deferrals, more fundamental change requires the revisiting of base principles, responsibilities and values.
Ultimately, we believe remuneration committees need to reflect on two core questions. First, who are the primary stakeholders they are seeking to act on behalf of? Is it their mandate to get the best deal for shareholders or management? Secondly, what criteria are they using to determine “fair and reasonable” compensation for the outcomes delivered by management?
The misuse of industry benchmarking alongside vague measures of business complexity have arguably been the most significant factors behind executive pay inflation. If shareholders become more comfortable with how remuneration committees answer these critical questions, dialogue surrounding the details of executive pay will gradually become more constructive and less adversarial, and the exercise of remuneration committee discretion will be welcomed rather than viewed with suspicion.
For businesses to thrive over the long-term, they need to ensure strong and constructive relationships with a broad base of key stakeholders. Consequently, we strongly supported revisions to both secondary legislation and the corporate governance code that placed additional reporting obligations on companies to demonstrate how they have taken account of stakeholder views.
We expect company engagement with shareholders to include commentary on how the strength of their relationships with employees, customers, suppliers, local communities and regulators is a source of competitive strength.
To ensure that reporting results in meaningful behavioural and cultural change, discussions about strategy, execution, restructuring, transactions and capital allocation should be presented to investors with reference to stakeholder considerations. As shareholders, we would view this as a positive indicator of the alignment between boards and our long-term investment horizon.
The public perception that the relationship between corporate boards and shareholders is fundamentally broken is an imbalanced caricature of the current state of play. Nevertheless, there is much more that can be done on both sides of the table. The approaches outlined above would be a positive step forward in helping to rebuild those relationships and, therefore, trust.