Social license

More than ever, investors are holding boards accountable when things go wrong. Misalignment of pay and performance, organisation scandals, inadequate risk management and poor firm performance headline a long list of flashpoints.

Less considered is investor accountability and its contribution to governance. Or if enough investors are sufficiently engaged in governance processes and outcomes, and helping the board – the agents they elect to safeguard their interests – perform.

That is not to overlook poor board performance or excuse a recurring pattern of scandals in corporate Australia and lingering problems with executive pay. Shareholders are right to expect that boards take responsibility for bad behaviour or reputation damage in their organisation.

Nor is a focus on investor accountability meant to downplay the efforts of institutional investors to lift their company engagement and investment stewardship, assess Environment, Social and Governance (ESG) issues, and form an opinion on voting matters rather than outsource the process to proxy advisers and blindly follow their recommendations.

But the facts are plain. Most retail investors are disengaged in governance and attendance at Annual General Meetings keeps falling. Fewer than 1 per cent of shareholders attend company meetings and only 4 per cent of shareholders vote, shows March 2018 Computershare research on AGMs. Shareholders voting at AGMs have declined 21.5 per cent over five years.

Australia’s army of Self-Managed Superannuation Funds (SMSF) is seemingly disengaged with governance. The SMSF community has almost $750 billion of assets and is the largest segment of Australia’s $2.7 trillion superannuation pool, APRA data shows. Yet there is scant coordinated effort to engage SMSFs in governance and connect them with boards.

Pleasingly, many institutional investors are taking an ‘active’ rather than ‘activist’ approach to monitoring their investments and meeting with boards. But too many funds do not have a published investment stewardship policy or disclose how and why they voted at AGMs.

The Australian Asset Owner Stewardship Code, released in May 2018 by the Australian Council of Superannuation Investors (ACSI), is an excellent initiative that aims to increase stewardship transparency and accountability in this market. The Code so far has five asset-owner signatories, shows the ACSI website.

Global index funds have increased their focus on investment stewardship and are using their investment power for governance change. But investment-stewardship standards and governance focus across index funds varies and not enough is known their voting rationale.

Proxy advisers have become an influential part of the Australian governance landscape but there are notable differences in the engagement process of different proxy firms, according to the Australian Securities and Investments Commission (ASIC) in its June 2018 review of proxy adviser engagement practices.

Separately, there are persistent board concerns about the resourcing of proxy firms, the willingness of some firms to engage earlier in the process, to correct or clarify incorrect reports when needed, or give boards an opportunity to review their draft report.

Moreover, activist hedge funds are wreaking havoc on some listed companies and forcing them to respond to a short-seller’s damaging research report that was leaked to media, even though that research is not widely available and the market is not fully informed.

“For all the good governance work this decade, the relationship between the investors and listed-company boards is becoming more combative than collaborative; more reactive than proactive.”

Litigation funding, fast becoming an investment vehicle in its own right, is driving growth in shareholder class actions, distracting boards and driving up premiums for Directors & Officers liability insurance. Yet Australia still does not have a comprehensive licensing regime for litigation funders that ensures funders are suitably qualified and capitalised.

I could provide other examples where investor accountability is lacking. For all the good governance work this decade, the relationship between the investors and listed-company boards is becoming more combative than collaborative; more reactive than proactive.

There is no easy answer to this multi-faceted problem. To my thinking, a broad solution must have four core parts. First, greater awareness and understanding of the role of boards so that investors have reasonable expectations of directors.

Second, boards providing greater opportunity for investors to engage with them, so they can listen to the concerns, respond where appropriate and be accountable. Third, greater transparency and disclsoure from the investment community on its engagement with listed companies and voting rationale on key issues.

And fourth, better reporting on the engagement process by companies and investors, so that the process can be benchmarked across sectors and engagement leaders and laggards identified.

The list below includes a range of ideas on strengthening the relationship between investors and boards, and creating a more collaborative, proactive approach to governance. The ideas, far from exhaustive, are meant to encourage debate on the investor accountability in governance – a topic that is not considered enough in board debates.

1. Raise awareness of governance

For all the discussion about governance, most retail investors arguably have limited understanding of the board’s role and how it is evolving. If the governance community wants small investors to be more engaged, it needs to better explain how it adds values and protects their interests.

2. Raise the profile of directors

The idea of the Chairman being the face of the board, shareholders only getting to ‘eyeball’ the board at the AGM, or having to rely on short, static bios in the annual report seems antiquated. Retail investors might be better engaged in the governance process, and willing to support the board, if they knew more about the directors they elect to represent them. And if boards were more visible rather than doing most of their work behind closed doors.

3. Quicken the AGM transition

For all the talk about hybrid and virtual AGMs, most meetings Australia still have an outdated format. It is any wonder fewer retail investors attend AGMs when too many are bogged in procedure, are dull or inaccessible for lots of investors. Bolder innovation in the AGM format, to bring back retail investors to this important engagement device, is needed.

4. Crowdsourcing

Again, it seems antiquated that boards still rely mostly on static shareholder surveys or investor meetings when they could also use technology to gauge shareholder sentiment. Australian boards can do much more to embrace smartphone apps and other devices, and listen to shareholder concerns and respond in real time.

5. Reach the SMSF community

Companies can struggle to understand their SMSF shareholder base because such funds are not always easily identifiable on share registers. But SMSF, with their multi-year or multi-decade investment horizon, can be ideal shareholders. Listed-company boards need to better understand the needs of SMSF and engage with them.

6. Rethink, upgrade the role of investor relations

If Corporate Australia is serious about engaging more with shareholders, it needs to upgrade the role of investor relations (IR) professionals. That process is underway, but much more can be done to elevate and expand the IR role (particularly with ESG matters), similar to the development of the Company Secretary role and its interaction with the board.

7. Expand board engagement with institutional investors

ASX200 company boards have mostly lifted their engagement with institutions. Now, boards must consider what level of extra engagement is required and how that will affect their resourcing and focus. Professor David Beatty, a Canadian governance expert, believes investor relations will become a critical board task in coming years, given the rise of shareholder activism. He belive boards rather than management will own the IR function.

8. More directors engaging with investors

It is understandable that the Chairman leads the Board’s engagement with investors or is accompanied by the Chair of the Remuneration Committee. That limits the risk of mixed messages and continuous disclosure breaches. But as the board’s investor relations workload grows, the case for more directors meeting with investors and forming a relationship is building. Such an approach would give investors an opportunity to better assess the board.

9. Engagement reporting

The idea of management and boards disclosing their engagement activities with investors in a section in the annual report has merit. Little is known about the level of investor engagement and a lack of data makes it impossible to benchmark firms on the issue.

Outlining, in bullet-point form, the main engagement activities with a range of stakeholders would identify board leaders in this area. It would also raise awareness of board efforts to listen to investors and be accountable, and pressure laggards to lift their game.

There’s also merit in large investors disclosing which boards they met with annually, to help their members make an informed assessment of their fund’s governance engagement.

10. Investment stewardship policies

More asset managers need to develop and publish an investment stewardship policy that outlines their governance expectations and how they engage with companies - and report against that policy. It’s remarkable that many asset managers do not have a published policy on their approach to governance (if one at all), when members increasingly expect the manager to invest responsibly on their behalf.

11. Index funds

Big index funds, with their long-term passive approach that requires holding shares in an index, are ideally positioned to drive governance change. Blackrock, Vanguard and other index funds have lifted their governance focus, but too many index funds are still mostly silent on governance. Boards will need to rethink how they engage with index funds on governance, given the rapid growth in the US$5 trillion global Exchange Traded Fund (ETF) market.

12. Voting bulletins

Blackrock made headlines in 2017 when it started disclosing the rationale behind some of its voting practices in AGM motions. The voting bulletins provided a rare glimpse into how large asset managers approach investment stewardships on an issue-by-issue basis.

Other managers could follow this approach because it improves voting-rationale transparency, raises public awareness of governance issues and provides insights that are usually not made public.