Time for a real shareholder revolution
FOR too long, shareholders have been the City’s absentee landlords. So it has been good to see some of the institutions that control much of the FTSE 100 start to flex their muscles. Four UK listed companies, including Shell, have had their remuneration reports rejected since January; let us hope there are many more.
There have been several structural reasons why shareholders have failed to exercise their rights and duties as owners in recent years. Institutions became far too close to boards, with some fund managers failing to act properly in the interest of their own investors. With the exception of a few activist hedge funds, most institutional investors angry at the performance of a company tended to prefer selling their shares rather than agitating for a change of personnel at the top. And investors often allowed potentially useful incentivisation mechanisms to become captured by boards; this was often the case with stock options, which allowed even underperforming executives to enrich themselves. The same became true of termination payoff clauses in contracts and, as we all know too well by now, of bonuses, another useful concept perverted into rewarding failure.
The economy has thus been subjected to a strange form of reverse Marxism: a small class of workers has been looting the capitalists, running firms they do not own for their own profit rather than for that of their shareholders. Economists have long highlighted this issue, which they call the principal-agent problem, and which is rife when those who run a firm are not its owners. All too often, shareholders feel that it is not worth trying to control their management, because the costs to themselves may outweigh rewards. There is also a free rider problem: all shareholders benefit from an improvement in management, yet only those who complain suffer the costs. So it can be rational for shareholders to do nothing and hope others do the dirty work; and then nobody ends up doing anything.
All of this needs to stop. Institutional investors must work together and vote down proposals they dislike. They must start forcing down excessive wage rates and ensure that executives are only remunerated for creating real value. They need to be prepared to throw out CEOs and entire boards. There must be more sackings and contracts need to be changed to block rewards for failure.
The government should also take a look at proposals outlined yesterday by the Securities and Exchange Commission. In America, shareholders can only nominate directors through a difficult and costly process of mailing other investors at their own expense. The new rule would allow shareholders of big firms to have their nominees included in corporate proxy materials if they owned a one per cent stake in a firm for the past year and if they promise that they didn’t just buy the shares to propose new directors; for smaller firms, the stake would have to be between three and five per cent. Crucially, shareholders would be able to combine their shares to meet the thresholds; they would be able to nominate up to a quarter of directors.
This particular measure may not be right for the UK. But we must make it easier for investors to exercise control over boards of directors. The era of the absentee institutional shareholder needs to be consigned to the dustbins of history.
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