The Board has a clear governance role. The purpose of a corporate Board is surely to focus on increasing the value of the company. As Fidelio supports Boards internationally through Development and Search across a range of companies of different sizes and sectors, we hear a common refrain: the sheer weight of regulation aimed at improving governance threatens to distract the Board from its purpose of increasing value. For Boards focussed on increasing value, in this edition of Overture Fidelio cuts a path through the dense regulatory forest.
Gillian Karran-Cumberlege
Across Europe Boards are being tasked with increased regulation intended to promote good governance. Demands on Boards are multi-pronged and not always consistent.
In the UK over the past five years the Corporate Governance Code has been updated three times. Financial Services Boards have been subject to additional regulation and oversight by the newly created Prudential Regulation Authority and Financial Conduct Authority with the Banking Industry also to be subject to a new Chartered Banker Professional Standards Board, under the stewardship of Sir Richard Lambert, former Director General of the Confederation of British Industry. The Davies Report, 2011, set out clear expectations around Board composition – by 2015 FTSE 100 Boards are expected to comprise 25% women. And from 1st October 2013 an update of the Companies Act Regulations requires UK companies to include Human Rights and environmental issues in the newly prescribed Strategic Report.
Against a backdrop of the Stewardship Code, 2010, and the Kay Review, 2012, shareholders are increasingly assuming an international policeman role in enforcing good governance. Pre-2008 there was a much simpler focus on dividend yield and share price performance. Nowadays UK Boards are also expected to deliver shareholder expectations on remuneration, diversity and sustainability.
And while major institutional shareholders prefer to use the velvet glove of engagement, there is an iron fist. Fidelity Worldwide Investment has recently published its guidance on aligning executive pay to long-term performance. Aviva Investors has published its expectations on gender diversity. The penalty for Boards failing to comply or describe a clear path towards compliance is a negative vote at the AGM.
Aviva and Fidelity have billions under management. Moreover their lead is likely to be followed by a sizeable portion of investors that have signed up to the UN Principles for Responsible Investment (UNPRI) with a total of just under US $35 trillion under management internationally. A negative investor vote on a high profile issue of governance is likely to make the position of the Chairman uncomfortable and potentially untenable.
We may not support the resolution to adopt the Report & Accounts if there has been no progress on gender diversity AND there is no explanation or description of the company’s approach to diversity. From 2014, this is likely to escalate to voting against chairmen and/ or nomination committee chairs.
– Aviva Investors UK Corporate Governance and Corporate Responsibility Voting Policy 2013
Multinationals with a strong B2C brand have long been dealing with complex and sometimes conflicting demands of shareholders and stakeholders. This is particularly true in sectors which have traditionally been heavily regulated. The Boards of these companies rely heavily upon the often sizeable and highly experienced Corporate Affairs and IR teams that can make sense of the myriad issues that are critical to Corporate Reputation.
It does indeed seem that smaller companies lacking this internal resource are at a disadvantage in dealing with the tsunami of regulation and compliance facing Boards today. Traditionally being below the radar screen of public scrutiny had advantages. Today scrutiny has intensified and being below the radar screen can also restrict access to capital. At the UK IR Society Conference 2013, which I was pleased to Chair, the IR Director of Old Mutual moderated a debate “IR in a new world of global funds.” The panel concluded that global investors do not have the scope and resource to follow companies with a market cap below US $10 billion.
No investor expects the Board of a mid-cap B2B company to preside over a Corporate Affairs team more suited to a FTSE 10 global behemoth. Investors are, for example, sympathetic to the specific obstacles facing the Board of an engineering or technology company in implementing a company-wide gender diversity policy. Increasingly however investors are likely to shun companies where the Board is in denial about major societal changes.
Since 2008 a profound shift has been underway in how regulators and, increasingly, investors are defining value. This was abundantly clear at the recent British Bankers Association Annual International Banking Conference, entitled “Customers – Growth – Standards”, where powerful speeches were delivered by regulators and stakeholders. Bill Michael, EMA Head of Financial Services, KPMG, spoke on the “The Future Shape of Banking”. He clearly outlined how prior to 2008 banks were competing on an increasingly global stage to service hungry shareholders; now there is recognition that banks have a duty to add value at country level, which includes a broader social obligation. Bank Boards fail to recognise the imperative for cultural reform at their peril.
A populist anti-business sentiment extends well beyond the banks. The political expression is an expectation of corporate probity and a willingness to punish Boards and executives who fall short. The Bribery Act 2010 provides the clearest expression in the UK. But we have also seen a strong public and political the backlash against price rises in regulated industries such as Rail Travel and Energy Providers. Again there is a clear concept of the public good which is perceived to be in conflict with shareholder value.
Increasingly Boards are being asked to look beyond return to shareholders. Mitigating the impact of climate change, promoting diversity and minimising social inequality are all to be found on the Board agenda. Quite obviously in Western society major corporates are a powerful force for change. Corporates respond to regulation and they also respond to the stipulations of the capital providers.
Critically, Fidelio sees coalescence in the thinking of academics, governments and investors on the definition of value. Prior to 2008, certainly in the US and the UK, shareholder value was the accepted purpose of corporate life. Boards and executives were handsomely rewarded for delivering shareholder value and nagging questions about collateral damage to the interests of stakeholders or inappropriate timeframes favouring the short over the medium to long-term were often swept under the carpet.
Since 2008 there has been a much more profound questioning of this narrowly defined model of shareholder value. While there were clear beneficiaries, particularly bankers, hedge funds and private equity, society as a whole was arguably poorly served. Clay Christensen, Kim B. Clark Professor of Business Administration at Harvard Business School, argues in “How Will You Measure Your Life?”, 2012, that the Return on Capital metrics championed by the Business School and Wall Street have failed to promote the type of innovative and disruptive growth that society needs to keep creating jobs and wealth.
The Kay Review, the Stewardship Code and the Davies Report are all predicated upon an understanding of shareholder value that is (a) explicitly not short–term and (b) also to the benefit of stakeholders. The wall of money that has signed up to the UNPRI is also professing a very similar understanding of value. Indeed Narrative Reporting in the UK against a backdrop of the more radical Integrated Reporting agenda requires companies to show a commitment to longer-term value generation.
If it is organised and regulated properly – something that was by no means a given – a vibrant UK financial sector can serve as a ‘global good and a national asset’.
– Mark Carney, Governor of the Bank of England, FT, 25th October 2013
Therefore it is increasingly incumbent on Boards to demonstrate that they understand the new face of shareholder value and are ensuring that the company is run accordingly. This does not make it easier to meet the barrage of sometimes conflicting regulatory and governance requirements. But there are some lessons for Boards to be learned from major companies perceived to be best in class at delivering sustainable value.
First, have a clearly articulated narrative of three to five year corporate objectives. What are the biggest risks to achieving these objectives? The mitigation of these risks is the bedrock of a sustainability strategy and determines materiality. Investors want to see a clear prioritisation of issues and want to be guided by companies. Where a company falls short of investor expectations, a dialogue can begin based on materiality. If a target that is important to an investor cannot be met in the short term, most investors respond favourably if they can see a clear pathway towards reaching that goal. Two companies that have successfully linked sustainability with the underlying business model are Unilever and BAT. All quoted Boards should be insisting on this linkage.
Boards should also note that companies handling the sustainability agenda well do not do so by chance. Typically a custodian of reputation – usually the Corporate Affairs Director – sits on the Executive Committee informing each step of the business debate. This reputational perspective at the Executive level seamlessly connects with the deliberations of the Board through committees and good communication on the part of the Chairman and the CEO.
Since 2008 substantially more is expected of Boards. It makes little sense to resist each new wave of regulation with rear-guard action. Smart companies recognise the prize is not compliance; it is access to capital and approval in the court of public opinion. Boards which can deliver value against this backdrop will be characterised by their ability to synthesize commercial goals with stakeholder demands. This will shake up Board composition!
Coming Up…
Overture explores how leadership drives valuation. Future editions of Overture will include:
• Plc readiness and the IPO
• How Boards keep on learning
• Building leadership teams for new markets
• The disruptive force of digital media
Please contact us with comments or for more information on Fidelio Partners at info@fideliopartners.com