Banking: Rarely pointed finger
By John Plender
Published: January 17 2010 18:40
| Last updated: January 17 2010 18:40
Possession without obligation to the object possessed approaches felicity.
George Meredith might not have had
institutional investors in mind when he wrote The Egoist. Yet this
cynical aphorism in his comic novel from the high Victorian period applies
very neatly to the widespread view that the shareholders of the last decade
behaved like absentee owners when confronted with excessive risk-taking by
shareholders make themselves heard
The UK version of
shareholders’ say on pay, introduced in 2002, entails a non-binding
advisory vote on all listed companies’ remuneration reports, which set
out overall remuneration policy, boardroom pay and incentive
structures. The aim was to permit shareholders to influence pay,
securing a better alignment of interests between directors and
A report last year
by Railpen Investments, manager of UK rail industry pensions, and Pirc,
the corporate governance consultancy, found that say on pay had
strengthened the pay-for-performance culture, cut back rewards for
failure and enhanced dialogue between institutional shareholders and
management. In a handful of cases, there have been majority votes
against remuneration reports, including at some large companies such
Royal Dutch Shell. The level of No votes has increased markedly
since the onset of the financial crisis.
Yet boardroom pay
continues to rise remorselessly, often regardless of overall corporate
performance, not least because most non-executive directors want their
chief executives to receive rewards above the average. Bank bonuses in
particular are perceived by public and politicians to be out of
control, prompting moves in the US, UK and France to impose either
levies on bank liabilities or bonus taxes to recoup some of the costs
of the financial crisis. The UK Treasury select committee concluded
last May that say on pay “has largely failed to promote enhanced
scrutiny of, or provide an effective check on, remuneration policies
within the [financial] sector”.
To strengthen say
on pay in banking, Sir David Walker’s 2009 review of corporate
governance in the UK financial sector proposed that chairmen of
remuneration committees should be required to stand automatically for
re-election where, of the votes cast, remuneration reports attract
fewer than 75 per cent in favour.
There are also signs of greater
institutional militancy. Some are beginning to vote against the
reappointment of directors who have sat on remuneration committees
that have done a poor job, implying that say on pay, while a
non-binding vote, could be reinforced through the back door.
Sir David Walker, author of the recent UK
government-sponsored review of corporate governance in the financial sector,
argues for example that “board and director shortcomings ... would have been
tackled more effectively had there been more vigorous scrutiny and
engagement by major investors acting as owners”.
For Lord Myners, UK financial services
secretary, shareholders should have paid closer attention to the strategies,
motives and competence of the boards and chairmen of banks.
Lord Mandelson, the business secretary,
speaking in the context of takeovers, told investors and industrialists
last week that he wanted to “ask if London can set a new standard for
high-quality, long-term engagement between investors and company owners”.
These views are echoed with a different
nuance in the US, where a panel of industry and market experts told the
Senate banking committee last month that the global financial crisis
represented “a massive failure of oversight” but that “share owners
currently have few ways to hold directors’ feet to the fire”.
In spite of the transatlantic focus on the
need for greater shareholder engagement, the proposition that it could
prevent a recurrence of the crisis is questionable. Is it possible that the
expectations of investors are pitched too high?
In the light of the UK institutional
investors’ inability to prevent banks passing on the cost of the new tax on
bonuses to shareholders, the extent of big investors’ power over the
companies in which they invest appears a moot point. An equally fundamental
question is whether they have the competence to second-guess boardroom
decisions and whether they would do so for better or worse.
What cannot be denied is that the scope for
shareholder activism appears greater than ever. In the US, where federal
regulation on corporate governance has focused more on the efficiency of
securities markets than on the accountability of management to shareholders,
there are the beginnings of a shift in the power balance. A number of
companies have moved to give shareholders the right to propose nominees for
At the same time, the drive for “say on pay”
– whereby shareholders are granted a non-binding vote on compensation
reports – finds increasing support among companies. For recipients of US
government money under the troubled asset relief programme, providing a say
on pay is obligatory. There is a good chance, too, that US legislation for
financial reform under discussion in the Senate will make it easier for
shareholders to influence directors’ appointments.
In Canada, the Toronto Stock Exchange last
year joined other mainstream exchanges in requiring companies to seek
shareholder approval for takeovers involving substantial issues of stock,
after a tough battle between management and investors. A number of leading
Canadian companies have also adopted say on pay.
In Europe, where the UK introduced
legislation to require a say-on-pay vote in 2002, many countries have
followed suit. The latest is Germany, where Gerhard Cromme, chairman of both
Siemens, the engineering group, and steelmaker
ThyssenKrupp, last week met leading shareholders to discuss
boardroom pay before they cast their first votes on the issue.
The UK has the best claim to provide a
laboratory to test the assertion that institutions can have a benign
influence on board decisions. Institutional investor activism has a long
history; as far back as the 1950s, Prudential Assurance led a shareholder
putsch to unseat the free-spending Sir Bernard Docker from Birmingham Small
Arms, an engineer. Much of the spending had been lavished on his exuberant
spouse, who featured large and often in the tabloid press.
Many UK shareholders hold larger percentages
of the companies in which they invest than their US counterparts, making it
harder to perform the equivalent of the “Wall Street walk” – dumping the
shares – because the holdings may be too large for the market to absorb. Yet
these large stakes also give the institutions a more powerful voice in the
dialogue with management.
In terms of their legal powers, it is
relatively easy, as it is in much of continental Europe, for shareholders to
throw out underperforming boards. This is in contrast to the US, where the
so-called plurality voting system allows shareholders to vote for, but not
against, nominees for the board, and where they cannot usually put forward
their own candidates without a costly, full-blown election contest.
Yet in spite of these advantages, serious
weaknesses in UK governance and shareholder accountability have been exposed
by the banking crisis.
Exhibit one is Royal Bank of Scotland’s
takeover of ABN Amro in 2007. Here many leading UK investment institutions
had long been worried that Sir Fred Goodwin, RBS chief executive, was bent
on expansion regardless of shareholder value. Their fears were borne out
when he led a consortium bid for the Dutch bank. Not only did many analysts
think the €71bn bid too high but, in addition, ABN Amro sold its crown jewel
– the LaSalle subsidiary in the US, which Sir Fred had initially said was
his main objective – to Bank of America in the course of the bid battle.
Worried UK shareholders did at least have the
chance to vote on the transaction. Given the onset of the credit crunch,
they could also point out to RBS management that the change in circumstance
provided a respectable excuse to back down. Yet when it came to the vote,
most of the big institutions, with one or two exceptions such as the fund
management arm of the Co-operative Group, backed the board.
As much as anything, that reflects the
difficulty of second-guessing ambitious, articulate managers of complex
businesses engaged in complex transactions – both for non-executives
performing their monitoring role with less information than executives, and
for shareholders, who stand at an even further remove.
It requires expertise, judgment and courage
for shareholders to say no on big strategic issues. That is given to the
likes of Warren Buffett, the investment guru and Kraft shareholder – who has
expressed a pungent view on the US company’s bid for
Cadbury, the UK chocolate maker – or to the more aggressive hedge
funds, but not to many managers of conventional institutional money.
Exhibit two concerns bankers’ bonuses, which
Barack Obama, US president, last week branded as obscene. Bank shareholders
have lost huge sums as a result of collapsing stock prices since the crisis
began. They have pumped unprecedented amounts of capital back into the
sector. Yet the increase in earnings now coming through courtesy of central
banks’ exceptionally low interest rates is expected chiefly to fatten
managers’ bonuses when announcements are made this month and next, leaving
Royal Bank of Scotland led a
consortium in a hostile €71bn bid for ABN
Amro of the Netherlands, one of many value-destroying
mega-acquisitions to which UK institutional investors failed to mount
serious opposition. Others include:
paper acquisition in 2008 of HBOS,
valued initially at £12bn. HBOS’s overdependence on wholesale funding
and exposure to commercial and residential property proved
catastrophic for Lloyds.
£112bn bid for Germany’s Mannesmann
in 2000. Overpayment led to huge goodwill write-offs.
●The US high-technology acquisitions in
the late 1990s that brought Marconi
to its knees, inflicting losses of more than £5bn on the
telecommunications group when the tech bubble collapsed.
£4.8bn purchase of Unilever’s
speciality chemicals business in 1997, which caused Britain’s former
leading manufacturer to plunge into technical insolvency.
In this instance, the question is less about
shareholder competence than impotence. The managers are clearly running the
banks in their own interest, not the shareholders’. Short of selling the
shares, which larger institutions and passive funds cannot do, shareholders
have not been able to impose restraint because using their voting power
against a united board could result in an empty boardroom. Governments are
an exception to this rule, since they can afford to be assertive over
bonuses at banks in which they have taken large equity stakes.
Exhibit three concerns the structure of bank
boards. The institutions unquestionably have the power to influence board
composition. In spite of this, the two biggest casualties of the crisis, RBS
and HBOS, the UK bank taken over by Lloyds TSB, were chaired by non-bankers
– and, as Lord Myners has argued, their boards were deficient in
understanding of risk and complex financial plumbing.
Moreover, the investment institutions are as
much part of the problem as the solution because they are as prone to
faddish thinking and bubble euphoria as are corporate or financial managers.
Before the crisis, most institutions on both sides of the Atlantic were
relaxed about the banks’ pursuit of high returns on equity regardless of the
resulting dramatic reduction in the capital base of the banking system. Like
the regulators, they underestimated the importance of liquidity to the
The institutions also applied considerable
pressure for high dividends and share buy-backs that depleted capital. Many
derided cautious management. Lloyds TSB was criticised before its takeover
of HBOS for failing to be more adventurous. In the technology bubble of the
1990s, the shareholders in Marconi notoriously egged on the UK company in
its catastrophic US telecommunications acquisitions.
In part this reflects what Ira Millstein, a
US corporate governance pioneer, calls “a relentlessly short-term investment
focus”, often founded on performance measured over periods as short as three
Where institutions have been reluctant to
address corporate underperformance, they are often influenced by conflicts
of interest. Fund managers, for example, are reluctant to alienate company
management from which they hope to win pension fund investment business.
Lord Myners sees a failure by those such as trustees who speak for
end-investors, including pension beneficiaries. They must ask, he says,
“whether they are fully fulfilling their fiduciary responsibility to hold
assets in good care if they do not pay proper regard for stewardship and
This is not to say there are no responsible
institutional investors or that shareholder engagement has had no
successes. Yet all too often there is a flawed chain of accountability from
management to the institutions’ ultimate beneficiaries. This means looking
to a shareholder bill of rights as the answer to governance weaknesses
revealed by the financial crisis is not enough. As Mr Millstein says: “If
corporate law or other public policy mechanisms are to give institutional
investors even more clout, it is vital that these institutions are focused
on the interests of their ultimate investors and of society as a whole in
promoting sustainable, long-term growth.
“There is little point to fixing executive
short-termism,” he adds, “if we don’t fix shareholder short-termism first –
we need better incentives to turn investor heads in the desired direction.”