EC Green Paper is sceptical about shareholder oversight to prevent another financial crisis.
You could be forgiven, on the basis of recent developments, for thinking that we are about to enter a new era of shareholder engagement. The UK’s decision to press ahead with the introduction of a Stewardship Code for institutional investors, to mirror the Corporate Governance Code for public companies, does seem to enshrine the shareholder-oversight approach to governance. Meanwhile the Financial Services Authority is currently consulting on how to require asset managers to disclose the nature of their commitment, or otherwise, to the Stewardship Code, which will give the initiative a little regulatory bite. Finally, it seems, the need for shareholders to act like owners is given some official backing. However, it doesn’t look like everyone agrees that this is the right approach to take to reform in the wake of the financial crisis. One document in particular is causing a few waves in the governance community – the European Commission’s Green Paper on corporate governance in financial institutions. On the face of it, the EC Green Paper covers similar territory to the UK’s Walker Review, although it doesn’t include the same kind of analysis of governance failures that Sir David’s review contained. The subject areas on which views are sought
are very familiar – board structure, risk management, audit, remuneration, shareholder engagement and so on. The key difference is the emphasis within the consultation document on the future direction of travel.
Put simply, there is clear scepticism about shareholder oversight as a model for mitigating future governance failures. For example, the paper states that: “The financial crisis has shown that confidence in the model of the shareholder-owner who contributes to the company’s long-term viability has been severely shaken, to say the least.” One of the consultation questions specifically asks whether respondents consider that “shareholder control of financial institutions is still realistic”. The Commission also states that it is considering whether financial institutions need to take better account of other stakeholders’ interests, in addition to those of shareholders. And, digging into the detail a little, the Commission seeks views on whether employees and their representatives could have a stronger role in remuneration policy. It’s hardly a revolutionary manifesto, and some will no doubt interpret the language in the Green Paper as a return to old attitudes about the Anglo-Saxon model of capitalism. But it is important to
recognise that the Green Paper starts from a difference place from the Walker Review – it suggests that shareholder oversight may be ineffective as an approach to governance, whereas the implication in Walker’s recommendations (in relation to shareholders) was that engagement didn’t fail, rather it hadn’t been properly tried. In addition, at the risk of stating the obvious, advocates of a broadly market-driven approach to governance, as opposed to seeking to address such issues through law and regulation, are not in the strongest position in light of recent events. This is primarily a reflection of the fact that the US and UK were amongst those hardest hit by the crisis, but subsequent lobbying may not have helped either. In an effort to excuse themselves of blame for governance failures at the banks, some organisations did their best to argue that actually shareholders couldn’t have made much of a difference anyway. It will take something of a volte-face to now tell the EC to rely on shareholder oversight, rather than consider alternative models. Now clearly supporting free markets and advocating a shareholder-focused corporate governance model are by no means synonymous. Alan Greenspan, to take just one example, was rather sceptical about the possibility of shareholders really playing the ownership role. He argued in his autobiography that there wasn’t a credible alternative in corporate governance to chief executive command and control. Similarly there will be many investment institutions that have never really bought into the idea of
shareholders being owners of public companies. This is a respectable intellectual position, even if at PIRC we don’t share that perspective. However, we need to be alert to the fact that if the investment industry doesn’t support, let alone advocate, a renewed push to make shareholder oversight – or stewardship – function more effectively, then attention will move elsewhere. And the potential for a turn away from the shareholder-as-owner model has been remarked upon by a number of senior figures, including Labour’s former City minister Lord Myners, and Stephen Haddrill, chief executive of the Financial Reporting Council, the body that will oversee the UK Stewardship Code. Haddrill warned recently that if shareholders aren’t seen to rise to the challenge then there may even be pressure to restrict their rights in respect of governance, rather than extend them. There is nothing predestined about any of this, of course, and the UK and other markets will push ahead with their own approaches to governance reform in any case. But there is an unmistakeable sense that we have reached an important juncture in the approach to how companies are run. There may yet be an appetite for a radical change in direction. If institutional investors believe that a shareholder-as-owner model of oversight is both workable and desirable, now is the time to speak out in its favour, and, more importantly, to put the theory into practice.