Patrick Yau, Managing Director of Strategic Investor Relations, Edison Group, says all parties must adjust to a new paradigm of shareholder democracy.
Effective two-way communication between company boards and shareholders plays a vital role in strategic planning, ensuring transparency and accountability, delivering greater shareholder democracy and ultimately improving performance. However, despite the increased use of digital technology to provide such communications, the process and quality of engagement is generally considered weak with plenty of room for improvement.
Step back 25 years or so to before when digital interactions became the norm, and it was a time when the expectations of shareholders were simply to get a decent dividend and share price appreciation. There was an acceptance that transparency, accountability and having a say in the direction of the business was not for them. Few shareholders went to annual general meetings and proxy votes were largely ignored. Voting was essentially a rubber-stamping exercise. Shareholder influence, including that of institutional investors, was minimal.
All parties seemed to know their place and were for the most part happy with it. Even today, despite advances in technology to improve the efficiency of processes in which shareholders exercise their voice, there has been little progress in building closer relationships between boards and shareholders. The recent ‘State of Stewardship’ report illustrates this; progress has been made but room for improvement undoubtedly remains. Apathy and/or abstention still very often characterise AGMs and shareholder voting, which tends to overwhelmingly back the board’s recommendations. The fact the most AGM resolutions get passed by 95% or more is a case in point, one that clearly flags an inherent problem: active communications between companies and shareholders is weak and can result in poorer business performance and strategy that doesn’t maximise value to the investor. The solution? An overhaul of communication strategies that is rooted in technology; the availability of real-time digital communications should be leveraged as companies and shareholders look to open up a more frequent and robust stream of communication.
Passive investing leads to less interaction
The ‘State of Stewardship’ report, published in November, highlights the rise of “passive” index-tracking funds and fewer investment portfolios allocating to UK equities. A consequence is that less time is spent engaging with and examining UK-based portfolio companies, which means investor interaction and best practice can fall short.
Another significant observation in the report is the growing use of third-party proxy voting agencies by fund managers looking to reduce costs by outsourcing. While this approach may be cheaper and more convenient for asset managers and other institutional investors, company boards say these agencies often deliver poor quality work and are hard to engage with. It also means that shareholders are not exercising their ownership rights as intended.
To be fair, most AGM decisions are routine and uncontentious, such as declaring a dividend, reappointing the auditors and share buybacks. But feathers can get ruffled around executive remuneration, appointments and re-appointments. Company board members may feel that the lack of engagement with shareholders, attributed to the proxy voting agencies, means the AGM decisions don’t always go the way they want.
Real-time digital tools needed
Effective, real-time digital communications between companies and their shareholders can undoubtedly reduce the burden of very fast turnaround times for investors to make important decisions. The technology is there. By making the process easier, the need for third-party proxy voting agencies would be lessened.
An example of how fast and effective digital communications tools can offer a win-win to companies and shareholders is with the notice period for AGMs. By law, at least 21 days’ notice is required for all such meetings, but some boards would like to shorten the period to 14 days. They say it would enable them to respond faster to urgent corporate events, such as takeover bids. But such a move would mean some shareholders could not attend at short notice and give less time to fund managers to do their analysis to make the right decisions.
The use of digital proxy voting services will provide a more efficient channel of communication between companies and their shareholders, and vice-versa. Smart use of technology would enable a traditionally analogue process to be shortened exponentially, if not by more than seven days.
As a result of ineffective and inefficient methods of communication, investors have turned towards activism in order to be heard by companies.
Accountability and profit
Activist investors look for companies that they believe to be mismanaged and therefore undervalued, and then buy a large stake to make changes to the way the business is run. Sometimes that includes making changes in the company’s leadership, which would typically require the activist investor to use its own large stake plus proxy votes, or those that other shareholders give them, to make it happen.
Activist investors can be a wealthy individual, but more commonly are associated with private equity firms and hedge funds. They understand that the biggest investors are generally passive ones, so they only need to communicate with and persuade relatively few individuals of the need for change.
Company management may feel threatened by activist investors because they are under scrutiny, but with effective engagement and interaction it’s possible to turn that ‘threat’ into an opportunity. After all, activist shareholders are like any other shareholders in wanting to see the company grow and generate profits. The company directors will clearly be looking for the same too. In fact, when an activist investor starts taking an interest in a company, the general rule is for investors to hold on.
There’s plenty of evidence around of activist investors improving performance and, in some cases, being represented on the board to the benefit of the company. With investors increasingly purpose-driven, in particular around ESG issues, along with sustainability and ethics, the need for greater transparency and accountability with regard to meeting commitments on these issues looks only set to grow.
It’s clear that the old technology is inefficient, lacks transparency and fails to bring companies and their shareholders closer together – it’s no longer fit for purpose. Current proxy voting systems evidently do not give boards a means to directly communicate with their investors. The outcome is shareholders without a voice and companies needing to do expensive research to understand voting activity. And when all that’s done, investors still don’t know if their voice has been heard.
The problem has been laid out clearly and the solution is out there, already available in the market. With a long track record in helping companies and their shareholders connect through investor engagement activities, we at Edison have seen how some of the antagonism between companies and their shareholders could easily be put to rest with better communication from all parties. It is clear that a new paradigm of shareholder democracy is emerging.
Changing features in the world of corporate governance have prompted companies to take a serious look at the strategic role of dialogue between boards and investors. Shareholders have welcomed increased communication with senior leadership, and in some cases, demanded it. As representatives of shareholder interest, boards should engage more readily and frequently with their investors. Direct dialogue between companies and shareholders, expedited by the availability of new proxy voting technologies, will play an important role communicating business choices and decisions, and should be embraced to build more productive and symbiotic stakeholder relationships over time.