Shareholders' activism in corporate governance

While so much discussion is being held world-wide to improve the corporate governance after the sudden collapse of major industrial and commercial giants, like Enron, Marconi and others, very little and slow progress is being made to improve the process of activism among the shareholders to improve corporate governance.
Good governance simply means what the shareholders want from their companies they own and that they exert the effort necessary to keep the directors accountable.
Leading industrialised countries are proposing to give shareholders of the listed companies a direct say in fixing the pay and benefits of top executives and board members as part of their efforts to toughen up their corporate governance code.
The proposals are being discussed by the Organisation for Economic Co-operation and Developments steering group on corporate governance.
This was set up last year to recommend new measures to reinforce the principles of corporate governance approved by the organisation's 30-member countries four years ago.
Although the OECD principles have established the standards of corporate governance behaviour since 1999, member countries have serious concerns that it may be difficult to rebuild investor's confidence after the spectacular cases of corporate governance failure on both sides of the Atlantic.
Though several steps have been taken to streamline the governance code individually by member states, it has been felt that there was a need to pass some sort of combined measures to draw up a tougher set of principles to be approved at the OECD annual ministerial meeting next May.
In the US and Europe, excessive levels of executive pays have prompted policy makers and OECD governments to encourage greater shareholders activism, including the latest call for participation in the nomination and election of board members and the approval of remuneration schemes of key executives and board members.
It was argued that company by-laws and corporate practices continued to limit questions being posed to the board, and the power to propose or oppose individual board members was almost non-existent.
It is thought that there is a greater need for the "proper and effective role" of the shareholders in determining executive and board remuneration.
It is being debated if they should be allowed only an advisory vote on remuneration pay policy or should their rights be more extensive, allowing a formal say in terms of structure and size of the remuneration package?
Or alternatively, is this a matter that should be left to the technical expertise of a compensation committee comprising independent board members?
The appointment of directors is the responsibility of the shareholders, as they may not be appointed without the requisite support of the shareholders.
In reality, as the management owns a majority shareholding in a corporation, the election seems only a formality unless the remaining shareholding is owned by an institution or an interested group who would like to contest directorship positions with the ultimate objective to pressurise the management to improve the payouts to the shareholders.
We have historically believed that a company with a poor payout does not perform well. This idea has been proven wrong in this country where a sudden change of government policy could destabilise the operations of the company.
A recent example is that a sudden policy change by the government to allow the import of second hand cars would have a bad operational impact upon the auto industry in Pakistan, which has invested millions of dollars to expand its manufacturing facilities.
This decision will certainly have a financial impact upon the auto industry. If the management does not have a cautious approach towards building its reserves through the retention of profits or no adequate attention has been paid to consistent growth through internal cash retention, the operational results are going to be affected sooner or later and with the tough competition ahead the company may be treated a sick unit, unable to compete.
Pakistan is a place, where there are hardly any acquisitions taking place in real terms or hardly there is any example of a group which could really provide alternative leadership and managerial skills to improve the performance of the existing corporation by taking over the management.
A few efforts were made in the past, which were nullified by either the actions of the regulating authorities or by resorting to a legal battle, which became so lengthy and costly that it became futile effort to pursue the objectives in mind.
Our corporate laws must be tailored to meet the local requirements to ensure that the acquisitions and mergers are encouraged and not made impossible to achieve.
We have hardly seen that any group, which wishes to make a take over bid, would make an open bid to the institutional or other investors to take over the major portion of their shareholding to improve the corporate governance, which is the usual method of take over and acquisitions in mature economies.
ACCOUNTABILITY BY SHAREHOLDERS: How best the accountability process could be introduced effectively remains a million dollar question.
Various efforts have been made in several countries to improve this process and much more may follow with the passage of time, but it has been universally agreed that the shareholders may be better placed to play an effective role in this process.
As shareholders elect the directors, they are in a better position to be vigilant and can influence the management for better corporate governance.
Historically, this influence has been lacking throughout the world, but recently, due to the collapse of the big companies, it has been emphasised that this influence must be strengthened if any meaningful results are to be achieved.
Consequently, the Secretary of Trade and Industry in the United Kingdom threatened the institutional and other investors to perform their responsibility in this regard or the government would enact legislation to force their duty to be performed effectively.
This threat has resulted in the awareness among the shareholders and has produced the following positive results.
Boards were supposed to act as the final line of defence against the management actions that were not consistent with the shareholders interests. But recently, in a number of countries, there was a serious concern that boards acted too leniently towards the chief executives and the chairman to protect the interests of the shareholders. This resulted in serious erosion of shareholders trust on the board.
In Pakistan, there has been practically no control of shareholders to monitor and review the remuneration packages being offered to the senior executive management staff, including CEO and Chairman for the listed companies.
This is evident from the examination of the annual reports that even, if the company is incurring losses over several years, or the performance is poor, still the payments made to the executive directors are out of proportion to its performance. There seems to be no one to object to these payments.
There have been some controls of Securities and Exchange Commission of Pakistan regarding the approval of the terms and conditions of the CEOs and Chairman, but these are outdated and do not attract professional management.
This control has often led to either braindrain or resulted in payments being made out of books, contrary to the interest of the shareholders.
In fact it is arguable, if there is any need to regulate this area and why it should not be left to the shareholders to review and monitor to make it more transparent.
INSTITUTIONAL INVESTORS: According to a survey published by March M Gaved, in Institutional Investors and Corporate Governance, it has been estimated that on the basis of January 1996 data, twenty largest institutional shareholders owned almost onethird to one half of the share capital of the 300 biggest companies.
This also indicates that the direct share ownership by individual investors accounts for less than one-fifth of the stock market value.
In simple terms, it means that the institutional investors are aggressively building up their portfolios and very little portion is left with the small investors.
It is surprising that no such research has ever been conducted in Pakistan regarding the ownership of liquid stock of bigger companies, being owned by the institutions.
With the introduction of Central Depository Company, such a survey would have been easily compiled.
Recently, the trend of ownership of securities in Pakistan has also changed dramatically during the last two years, therefore it is fair to conclude that a majority of the liquid stocks have been accumulated by institutional investors on the same pattern as existed in mature economies.
The pattern of ownership has changed from small investors to institutional investors. This change in ownership pattern has provided stability to the market.
A large sum of money is invested in securities by the pension funds in the Western world,. whereas in Pakistan, institutions like NIT, Pakistan Life Insurance Corporation, various ICP privatised funds, other open-ended mutual funds and above all the banks themselves have been active in the investment of securities.
Pakistan, being a small equity market, is more influenced by the entry of these institutions in the capital markets.
It is easier for the institutional investors to influence the corporate management to be accountable and to change the corporate governance style than the small investors, who are scattered and have no effective platform to raise an effective voice.
We have hardly seen this influence being exerted on these corporations in Pakistan compared with the outside world, which has not only taken a lead on us but has started producing favourable results.
SHAREHOLDERS SHORTCOMINGS: The shareholders have shown very little activism in protecting their rights. They have not been aware of what their rights are. They have failed to establish exactly what they want from the executives?
Most of the research conducted on the large institutional investors revealed that only a few institutions spend very small amount on shareholders activism. They do not act jointly to pursue an objective.
They do not collect proxies from the small shareholders to represent their interest.
They do not like to involve small investors; with the result that the small investor's attitude becomes an attitude of "couldn't careless", which helps the management to ignore the wishes of the institutional investors.
The institutional investors have been a silent spectator. They are the ones investing others' money in companies, which are not being managed properly.
They owe a duty of care towards their shareholders to account for the bad investments they have made for their shareholders. They have an obligation to be intelligent shareholders.
They must read and vote for the proxies, understand the factors affecting their business and make their views on important issues known to managers and directors.
Where there is something wrong, it is the easiest way to sell their shareholding and get out of these companies. But that would not improve the corporate governance.
The managements must be checked and warned. It is only the institutional investors, who could exert proper influence and control by taking the small investors with them to change the management attitude towards achievement of the objectives set by the shareholders.
The institutional investors need to change not only their attitude towards small investors but also their strategies towards influencing the corporate management to improve their governance.
This does not mean that there should be an open fight between the institutional shareholders and the corporate governors but the objectives should be achieved and changes should be brought to meet the desires of the real owners for the betterment of the corporations.
This objective may be achieved by quiet diplomacy through backdoor meetings with the management conveying them a clear message from the shareholders that a change is desired to improve corporate governance
A serious obstacle in the way of shareholders is lack of information on which they could show more activism.
This is not an easy task, as the executives usually control the flow of information and some limitation has also been imposed by the statutory and listing requirements.
The various corporate rules and legislation make it obligatory to provide certain information to the shareholders, this effectively puts a limit on that flow of information and nothing else is disclosed.
An investor, who is known to be active or critical may find it harder to get honest answers in future. He will thus be at a disadvantageous position when it comes to making informed investment decisions.
The critical investor may also suffer commercial reprisals from the companies in which he takes an active interest.
Managements are unlikely to award pension fund managements or insurance or banking business to those institutions, which show very aggressive attitude towards corporate governance through their shareholding.
One reason for the institutional buyer of not becoming an active investor may be that even if, he exert, pressures on the management to improve governance, he may not be getting the reward, as he is an intermediary and only acting to protect the interest of the share-holders.
This means, he would only be concerned up to a point in the same manner, as the company is treating the shareholders. It may be a vicious cycle.
SHAREHOLDER'S ACTIVISM: In Western countries, it has been felt that corporate governance may not be improved, if there is no activism from the shareholders, especially the institutional investors, having a most powerful say compared with the small groups of investors.
Therefore, in the United Kingdom the government has threatened to bring out legislation, which should ensure that there should be activism from the investors if they do not become more interventionist.
The government feels that there should be more force applied from the investors to improve efficiency.
In this regard, Patricia Hewitt, the Trade Secretary, said: " Too many fund managers, faced with an under-performing company, continue to support an inadequate management."
Financial secretary to the treasury has been meeting the fund managers to find out how activism could be ensured to have effective control on the board.
Likewise, it is important that the concept of shareholders activism be promoted in Pakistan also.
We have a very poor record on this front. We need to toughen our policies toward this area and must educate the small, as well as institutional investors, to come out openly and question the management performance, their business policies and actions to bring in the desired improvement in corporate governance.
This aspect should not be left to the regulatory authority only to see that the shareholders aspirations are being looked after properly.
Institutional investors need to exercise their ownership responsibilities more than once a year and if they do so effectively, there is no reason why corporate governance cannot be improved.
It would undoubtedly serve the shareholders interest better, if institutional investors can be persuaded to take a longer-term view rather than to concentrate on quarterly performance figures. This may require a cultural change in the investment sector.
It should be made obligatory for the open-ended mutual funds, NIT and other institutional investors to disclose their investment strategies clearly, which should alert the company's management to improve.
The real key to persuading institutional investors to engage in seeking long-term success of the companies lies in improving the quality of portfolio fund managers.
In the United Kingdom shareholders activism has already started producing results, thus resulting in improvement of corporate governance, which is evident from the following shareholders reactions.
The shareholders protested at an annual general meeting of British Sky Broadcasting over the appointment of a non-executive director. Some shareholders were also likely to express concerns over pay by opposing the report of remuneration committee.
Activist shareholder has rejected the Glaxo-Smithkline's pay policy. The Association of British Insurers demanded an explanation from Barclays Bank for its elevation of the chief executive to the chairmanship in defiance of post-Higgs best practices.
With Carlton, the big shareholders are waging war with a new aggression that could have repercussions on their relations with business leaders for a long time to come.
Institutional investors have been unhappy with the company's lackluster performance for some time.
Fidelity group of US Fund management, spearheading the revolt, moved into action demanding the chairman's removal and his replacement with an independent chairman.
The group holds 40% stake in the capital structure of the company and is seeking to impose a particular solution through a pre-emptive strike that leaves no discretion to the board - and against a tight deadline.
The shareholders are going to question the payment to the chairman of Carlton's Communication of £1.4million payoff, when he leaves his job.
He is ousted following a revolt of institutional investors that he should quit his job.
Behind this activism, there are signs of the economic gloom and the performance of stock markets and the investors are increasingly emphasising the need for good corporate governance on the grounds that this is likely to produce better performance.
Additionally, the government has been applying increasing pressure on investors to be activist, particularly in the wake of Enron-type corporate scandals in the US and the collapse of British companies such as Marconi.
This resulted in investors having a right to vote on pay issues at annual meetings.
The above are only a few examples regarding the shareholders activism in developed countries.
No doubt, it is not an easy task to implement the same type of activism in a developing market like Pakistan, but the process needs to be started at least by educating the small and institutional investor to play their due role by attending the meetings and questioning the matters relating to corporate governance.
An absentee shareholder is indirectly approving and strengthening the bad corporate governance.
The activism may not be achievable by either of the small or institutional investor alone, but may be possible by forming investor's associations, which should have a support of the institutional investors to force the managements to ensure good governance in all areas of their operations.
Unfortunately, there are no such associations operating in Pakistan, where three bourses are in operation and the country is striving hard to attract foreign investment in equity markets.
It is still to be seen how additional investments could be attracted, and how the investors rights are protected, thereby providing inherent strength to the market.
Institutions are intermediaries investing money on behalf of their clients. The investment strategies should be transparent so that the institutions can be held responsible for their activities.
These institutions must spell out if their investments are for long-term to make capital gains or these are meant to be a trading stock to be invested for a shorter period of time.
These strategies must be disclosed in their annual reports for public information.
(The author is currently working on a research project on corporate governance at the School of Law at University of Northumbria in Newcastle-Upon-Tyne, United Kingdom.)