Views on improving the integrity of global capital markets
26 March 2014

Shareholder Engagement: Bridging the Divide Between Boards and Investors

One of the most interesting recent developments in the corporate governance world — and in the corporate world, for that matter — is the move toward more engagement between issuers and investors. Investors and companies are sitting down at the table more often these days, and whether the rise in engagement is spurred by the increase of “say-on-pay” votes, majority voting for the election of directors, the elimination of broker voting in board election (in the US), or activist investor activities, the development is a welcome one.

Engagement codes seem to be all the rage these days; since August 2013, groups in Australia, the United Kingdom, Japan, Malaysia, and most recently the United States have been falling all over themselves to get investors and boards talking. Kudos to these groups — as is the case with any relationship, frequent and meaningful communication and engagement build trust and make collaboration more fruitful.

Global Trends in Board-Shareowner Engagement

In August 2013, the Sydney, Australia-based Responsible Investment Association Australasia (RIAA) initiated a working group to tackle how best to foster collaboration between investors and issuers via engagement. This working group was established as a forum to test models of better collaboration and information sharing on engagements amongst RIAA’s membership.

A few months later, the Global Network of Director Institutes published a paper reviewing some of the efforts of other director groups around the world and endorsing more shareowner-director engagement, including recommended best practices for those on both sides of the table.

Some of the recommendations for boards include:

  • Board oversight of important company and board disclosures
  • Regular dialogue between company leaders and significant investors
  • Having a channel of communication linking shareholders to the board
  • Remaining open and responsive to face-to-face meetings
  • Ensuring that communications reach all shareholders

Also in December, the Investor Working Group on Collective Engagement in the UK launched an investor forum to tackle collective engagement strategies. The initial report of the group calls for “engagement action groups” led by a single or group of investors to first engage with an issuer. The report also called on issuers to initiate an annual strategy meeting with shareowners. The forum is open to non-UK investors and is currently slated to start actions after the 2014 proxy season, in the summer of 2014.

The creation of such a forum was one of the recommendations of the influential Kay Review that looked at the UK equity markets and long-term decision making. The UK’s Financial Reporting Council applauded the launch of the forum, stating that collaboration will often be the most effective way of having a constructive dialogue with companies.

Following closely on its heels in January, the Securities Commission Malaysia and the Minority Shareholder Watchdog Group issued a joint consultation paper seeking public feedback on the Malaysian Code for Institutional Investors 2014.

The code sets out eight principles together with guidance for institutional investors on effective exercise of stewardship responsibilities towards the delivery of sustainable long-term value to the institutional investors’ ultimate beneficiaries or clients.

Meanwhile, in Japan — taking a cue from the Kay Review — there have been efforts to adopt an investor stewardship code. The Japanese version of the original draft of the code was published in late 2013, with an English version of the code following in early 2014. The code plans to adopt a “comply-or-explain” model asking institutional investors to have a clear policy detailing how they fulfill their stewardship responsibilities and how they handle conflicts of interests.

The code calls on institutional investors to enhance medium to long-term investment returns for clients and beneficiaries by improving and fostering the investee companies’ corporate value and sustainable growth through constructive engagement, or purposeful dialogue, based on in-depth knowledge of the companies and their business environment. However, the current Japanese code does not go into much detail concerning engagement best practices.

Although efforts in the United States around engagement originally lagged behind efforts in some other markets, the past two months have seen two entries into the engagement fray. The first was the Shareholder-Director Exchange (SDX) Protocol, created by a group of issuer and investor representatives. The SDX Protocol is a 10-point guide for public company boards and shareholders to use in determining when engagement is appropriate, and when it is best to engage in a manner that is fruitful for both parties.

The 10 points of the SDX Protocol are:

  1. Scope of the SDX Protocol
  2. Adopting a clear policy for engagement
  3. Identifying engagement topics
  4. Requesting engagement
  5. Selecting participants
  6. Determining how to engage
  7. Preparing for the engagement
  8. Participating in the engagement
  9. Reviewing and revising approaches to engagement
  10. Customizing the SDX Protocol

And in early March, the Conference Board Task Force on Corporate/Investor Engagement published its own thoughts on engagement. The task force brought together directors of public companies and leading investors in a series of public forums, expert reports, and commissioned research. The task force concluded that fixing corporate governance — and, ultimately, restoring trust in business — calls for an open, yet purpose-driven process of re-establishing alignment between corporate strategy and investor interests.

These efforts produced three papers on governance and engagement (available for download after free registration), a white paper on the state of governance and trust in the United States, a set of recommendations for improving governance, and a set of guidelines for engagement.

Finally, the accounting and consulting firm PWC collaborated with law firm Weil, Gotshal & Manges to produce a short piece on engagement best practices that focuses on engagement best practices while providing perspective from both issuers and investors.

Civilized Barbarians at the Gate?

So why is engagement a good thing? Well, it isn’t good in and of itself — it must be something that is seen as beneficial by both sides, and it must be sustained. The purpose of engagement is to build trust and understanding between a company or its board and investors. If a board engages with shareowners only in a crisis the benefits to both parties will be fleeting.

One of the early fruits of engagement can be seen in the record number of shareholder resolutions in the United States that are withdrawn each year by shareholders after their concerns are met by a company. In 2013, shareholder proponents withdrew approximately 28% of the proposals submitted for shareholder meetings, according to data from Institutional Shareholder Services. That compares to a withdrawal rate of approximately 26% for proposals submitted for 2012 meetings (number are through the middle of the year, when most annual meeting have taken place).

A positive outcome of engagement that more companies should consider is that fruitful and sustained engagement can help inoculate companies from some of the demands of short-term activist investors and negative recommendations from proxy advisory firms that a company sees as unwarranted.

In the latest issue of Columbia Law Review, Leo Strine, chief justice in Delaware — where most US companies are incorporated — calls for regulatory changes to stem the tide of activist votes. Strine feels that overzealous activism from investors could “turn the corporate governance process into a constant ‘Model United Nations’ where managers are repeatedly distracted by referenda on a variety of topics proposed by investors with trifling stakes.”

The taming of the activists may indeed be happening, but by different methods than Justice Strine envisions. Indeed, engagement can be a powerful tool in beating back activists with bad ideas. Earlier this year, a number of institutional investors including the influential CalPERS publicly disagreed with activist investor Carl Icahn over his efforts to get Apple to buy back more of its shares. We don’t know exactly what level of engagement Apple had with CalPERS and others over this issue (if indeed it had any).However, when an activist such as Icahn challenges a company to a contest of ideas (in this case around Apple’s dividend policy), it just stands to reason that having a good relationship with your investors would be beneficial to a company.

You Get What You Pay for

Engagement between companies or their boards and investors can be useful to both parties, but it isn’t free.

On the corporate side, this likely means dedicating resources to investor outreach beyond the bare minimum of ensuring that proxies are mailed to the right people and that investor e-mails are forwarded to the board. Serious and ongoing engagement with shareowners involves dedicating someone or a group of people to an investor outreach role on a permanent basis to keep the board informed about investor questions or concerns. It makes sense to designate such a liaison so that legitimate concerns make their way to the board, while filtering out the more esoteric investor demands. Some firms may decide this is the responsibility of the CFO, general counsel’s office, or investor relations, and those with the resources to do this often find the return on such an investment worthwhile — particularly when a proxy adviser or activist comes calling with a challenge to the board’s ideas. If the board’s ideas are better, it is often an easy sell to the engaged investors they have on their side.

From an investor perspective, limited resources also play a role in the level of engagement an investor can undertake. Many may prefer to take the “Wall Street walk” and simply sell their shares if they are dissatisfied with management or board performance. However, many institutional investors and indexed investors who essentially own the market don’t have such an option, and often find more value in dedicating resources to engagement. Their argument is that the cost of staff and time spent is likely a fraction of a basis point and well worth it to have their concerns heard and addressed by the companies in which they invest.

What say you? Is engagement worth it from a corporate and investor point of view?

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About the Author(s)
Matt Orsagh, CFA, CIPM

Matt Orsagh, CFA, CIPM, is a senior director of capital markets policy at CFA Institute, where he focuses on corporate governance, ESG, and climate change analysis. He writes and speaks frequently on these topics on behalf of CFA Institute. His paper, Climate Change Analysis in the Investment Process was named “Best ESG Paper” by Savvy Investor in 2021.

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