Holding companies to account
Institutional investors have the size to force change at companies on excessive executive pay
A protester, dressed to look like the Barclays Bank logo, demonstrates outside the bank’s annual general meeting for shareholders in central London recently. Photograph: Alastair Grant/AP
It’s no secret that a pension crisis is looming. Many companies have made generous promises to present and past employees that they cannot afford. Pension fund trustees are now cutting pension entitlements and forcing the institutional investors/managers they employ to improve performance.
However, in Ireland, institutional investors still appear too relaxed, failing to take action when company directors reward themselves handsomely for failure.
Fortunately, change is emerging. In the UK, the Local Authority Pension Fund Forum, a voluntary association of 39 public sector funds, has set out “to promote the investment interests of local authority pension funds, and to maximise their influence as shareholders to promote corporate responsibility”.
Already this year, it has voted down generous salaries and bonuses to directors and has questioned the legality of concealing losses and mistakes to prop up bonuses.
The initiative is in response to various investigations into the world of the institutional investor. Former fund manager Paul Myners* expressed concern that they were not always managing their investments correctly. Similar US studies have shown that many votes are cast on behalf of shareholders but not necessarily in their interests.
The risk in Ireland is that pension funds, which are often managed by banks, in turn buy shares in Irish banks. In theory, these fund managers should vote against bankers who act recklessly but if the banks are controlling the votes, the conflict of interest is obvious and may partly explain why Irish banks are dysfunctional.
The Local Authority Pension Fund Forum, on the other hand, which is more independent, is not shy about revealing conflicts of interest and sets out how they can be “minimised or dealt with”.
Which is not to say that it always persuades fellow shareholders of its position. Its recent opposition to the pay package of incoming AstraZeneca CEO Pascal Soriot garnered support from only 6 per cent of shareholders at the pharma giant’s recent annual general meeting.
Mood for change
However, Computershare, which maintains shareholder registers on behalf of companies, has also observed a change. It says: “The number of companies facing high levels of shareholder opposition (more than 20 per cent against the resolution), has risen from 6.2 per cent in 2010, to 11.1 per cent in 2012.”
The days when directors can award themselves huge salaries for a dismal performance with impunity may soon end.
Pension funds have to decide whether to design their own policies on voting and engaging with thecompanies in which they are invested or adopt the policies of the fund manager they use.
The fund manager probably has more skill in these matters and, it could be argued, should therefore control the votes. However, the fund manager does not suffer the losses when bad decisions are made.
That burden falls on the pension beneficiaries, or the sponsoring company. Fund managers are therefore open to the temptation of doing nothing that upsets or embarrasses influential directors.
Delegating voting power to a fund manager can cause other problems. Sometimes a pension fund may have two fund managers investing in the same company and these managers may take opposing positions when they vote at the annual general meeting.
The forum believe trustees should be aware of “conflicts between the strategies of their different fund managers, and be able to set out ways of dealing with them”.
Another practice frowned upon is where institutional investors “rent their votes”.
There are cases, for instance, when hedge funds overbuy credit protection on a target company. This means that the hedge fund benefits if the company fails. The hedge fund then rents voting rights from an institutional shareholder so that it can vote in favour of a reckless takeover or expansion policy using borrowed money. This makes the company more dangerous which, in turn, pushes up the value of their credit insurance allowing the hedge fund to earn an easy, if immoral, profit.
The local authority group recommends that fund managers recall stocks lent out in advance of annual shareholder meetings so that voting power is not abused.
In Britain, the government believes pension fund managers may have a statutory duty in relation to shareholder activism. This involves setting a policy on when pension funds should intervene in the running of a company. It should also report on how this is monitored and the effectiveness of any intervention it has undertaken in the past.
For individual shareholders, the Local Authority Pension Fund Forum development is encouraging. Company directors often pay closer attention to powerful institutional investors, and ignore private shareholder activism. In their annual reports, companies are obliged to reveal who their major shareholders are. If these investors actively use their votes to improve the company, private shareholders will benefit.
Ireland’s pension industry is a little behind the curve in this area, unwilling to sack directors when they amass or even hide losses.
Private shareholders concerned about the way a company is run should of course raise their concerns with the company. If the response is disappointing, approach the major institutional investors. Those with an active policy on holding directors to account may well engage with you. If they don’t, this should set alarm bells ringing.
Cormac Butler is the author of Accounting for Financial Instruments and has led training seminars for bank regulators and investors on financial risk. He has traded equities and options