By Matthew Orsagh – Director of Capital Markets policy for the CFA Institute
Engagement between issuers and shareowners is growing. Increased activity by activist investors, a rise in say-on-pay votes and majority voting for directors are some of the reasons behind the growth in engagement in recent years. Whatever the motivating factors, the results are what are most interesting.
More investors are having their concerns heard and more boards are getting insights from beyond the boardroom – proof that when engagement is done right, everyone benefits. It is therefore in the interest of both issuers and investors to ensure that they are fully committed to an engagement process that is fulfilling for both sides.
Companies should use engagement to communicate with and garner support from their investors. It is in investors’ best interests to be knowledgeable about factors relevant to corporate performance and strategy, including corporate governance. The parties may not always agree with one another, but are nearly always better off sitting down at the table to ensure that each adequately understands the other’s point of view and attempts to work out differences, rather than talking past each other in the media or ignoring each other altogether.
For confirmation that engagement is benefiting both issuers and investors, look to the record number of shareholder resolutions in the United States that have been withdrawn in the past few years by shareholders. In 2013 alone, shareholder proponents withdrew approximately 28 per cent of the proposals submitted for shareholder meetings, according to Institutional Shareholder Services. The percentage of shareholder proposals withdrawn was up slightly from the approximately 26 per cent for proposals withdrawn for 2012 meetings. These withdrawals of shareholder proposals typically come about when an issuer engages with an investor that submitted a proposal and sufficiently addresses some or all of the concerns raised in the original proposal, leading the shareholder to withdraw their proposal.
“Companies and investors have historically been reluctant about dedicating resources to engagement”
How To Improve Engagement
Engagement codes and protocols are proliferating around the world. This trend began in 2012 when the Financial Reporting Council launched the UK Stewardship Code that September. In just the past two years, there have been codes that address investor and/or issuer engagement launched by organisations in Australia, Japan, Malaysia, and the United States, while an investor working group in the United Kingdom was launched to address collective engagement strategies. The Global Directors Network also recently put out best practices on board-shareholder communications.
Clearly, both investors and companies are working to improve the process of engaging around a set of best practices in light of an increasing interest in a number of corporate governance issues. At this point standards for engagement vary from market to market, if there is even a standard at all. Some investors and companies are uncertain as to whether engagement on governance issues is useful, and when they do engage, may do so ineffectively. It is therefore in a board’s best interest to craft an engagement strategy and engagement policy that results in an engagement process that is useful for all parties.
Engagement has been on the rise because both issuers and investors see its benefits. A quick look at some of the engagement codes and papers referenced above show that there are many different ways for boards to ensure that engagement is done well. There are a few broad principles to highlight, however, that can help a board build a foundation of successful engagement.
The Proxy As First Line Of Engagement
In discussions we have had with issuers and investors on many corporate governance-related projects at CFA Institute, one thing is consistently emphasised by both sides – the corporate proxy should be treated as a communications document, not a compliance document. The corporate proxy is the first place many investors go to find out information about a company’s corporate governance practices, especially on the contentious issue of pay. Companies that clearly and succinctly tell their governance story are ahead of the engagement game. Many investors don’t have the time or manpower to engage with the thousands of companies they own – and use the information found in the corporate proxy (as well as a company’s website and other governance documents) to first gauge whether there is a governance problem. If information is communicated clearly and succinctly, they are usually happy. It is often when information is hidden, obfuscated, or not explained clearly that the problems begin.
Make It Someone’s Responsibility
The path of engagement between issuers and boards can take many forms. At some companies engagement is coordinated by the office of the general counsel; in other instances investor relations professionals take the lead. In some instances there is a dedicated individual such as a director of corporate governance who acts as a liaison between investors and the board. How it happens doesn’t matter, but it is in a company’s best interest to ensure that someone (or a team of someone’s) is responsible for ensuring that the board is hearing any legitimate concerns from investors, and that shareowners see that the board addresses those concerns. The individual who acts as such a liaison between a board and investors will be responsible for filtering through investor concerns and prioritising them, then requesting information for, or meetings with, the board. Such a liaison will also need to ensure that communications from the board to investors flows as freely as is possible and appropriate.
Companies and investors have historically been reluctant about dedicating resources to engagement, but that is slowly changing. It does take time and money to foster meaningful engagement on both sides. For large institutions, many of whom are indexed and own everything, active engagement is a way to potentially unlock long-term value and arguably worth the effort. For issuers and their boards such an investment in long-term shareowner relationship-building pays off in a shareowner base that is more trusting of a board, and willing to give them the benefit of the doubt in turbulent times.
Have A Plan, Have A Process
Once someone is responsible for the free flow of information between board members and shareowners, a plan of action is needed. There are many ways to ensure that engagement between the board and shareowners is fruitful for both parties. Some – but not all – things to consider include:
■ With resources available internally, what engagement can be done short- and long-term?
■ Which investors should be targeted for engagement?
■ Make sure investors and the board get consistent and complete messages from each other.
■ Which directors are appropriate to speak to shareowners on which issues?
■ Which directors are appropriate to speak publicly on which issues?
■ What is the timeline for creating the proxy, and what commitment is needed from the board?
■ What short-term issues need to be addressed?
■ What long-term issues need to be addressed?
■ What is the appropriate time commitment to expect from the board for engagement?
■ What is the process, taking into account resources available, to achieve desired engagement outcomes?
■ Be prepared — investors and issuers need to respect the process and the time of their counterparts at these meetings. A meeting is counterproductive if both sides are not engaged.
Build A Relationship
The main point of engagement is to build a relationship of trust between investors and the board. The main benefits of engagement accrue over the long-term, when years of respectful, perhaps even cordial communications between a board and its shareowners builds a trust in which both sides feel they are not only heard, but that their points of view is understood.
Investors who have a trusting relationship with a board built through years of engagement are more likely to give a company and its board the benefit of the doubt in times of trouble, whether that be a proxy contest, an unwanted takeover offer, a complicated compensation plan or any number of governance issues. Investors who only hear from a company weeks before a tight vote are less likely to have a sympathetic ear than if that company has built a trusting relationship based on sustained communications.
Investors don’t always need to hear from companies, however. Their engagement resources are often limited, and they have to prioritise engagement as well, so don’t be offended if a shareowner says ‘no, thank you’ to engagement in the short term. That is often a good sign, evidence that they don’t see anything wrong in the short term. A company and its board should still make sure that long-term communication personnel and processes are in place that build relationships with core investors over the long term.
“Engagement works best when it is cultivated by an open and honest communications process that takes place over the long term and yields a trusting relationship for both issuers and investors”
Don’t be Afraid To Interact With Shareowners
In some markets there is trepidation about whether it is appropriate, or even legally advisable for directors to meet directly with shareowners. In the United States, for example, companies often voice concerns about potential violations of Regulation Fair Disclosure (Reg FD) when turning down requests for meetings from shareowners.
Such concerns are largely overblown. For the most part, large institutional investors who are most likely to meet with a board member employ knowledgeable corporate governance staff who understand concerns about Regulation Fair Disclosure (Reg FD) and are not likely to pursue a topic they know a board member cannot discuss. Institutional investors are typically more concerned with getting answers about corporate governance or compensation than they are about getting a piece of information that the rest of the market does not have. If such an investor were to ask inappropriate questions they would be jeopardising a relationship of trust they should be looking to build.
Board members can avoid any Reg FD concerns by bringing counsel with them to any meetings if they feel that such a step is necessary, and they can make it clear to investors that they are primarily at the meeting to listen. Any board member meeting with an investor can make it clear that they will answer what questions they can, but may have to consult with company staff, a committee of the board, or the whole board itself before providing further answers to some questions.
Listen And Prove You Are Listening
Both parties in any conversation want to know they are being heard. It is therefore important for boards to follow up on the engagement process with shareowners. It is not enough to simply have a meeting if one is requested. Boards and their liaisons need to follow up with shareowners to ensure that investor concerns are being addressed to the best of the board’s ability. Boards and their shareowners need not agree on every issue. They will often respectfully disagree.
Boards also need to understand what shareowners think of as engagement. A recent paper by the IRRC Institute and ISS titled: Defining Engagement: An Update on the Evolving Relationship Between Shareholders, Directors and Executives, showed that issuers and investors have very different ideas about how long engagement lasts. Nearly two-thirds of issuers surveyed for the paper felt that engagement typically lasts a week or less – meaning that issuers generally think of engagement as one call or one meeting. A majority of investors on the other hand see engagement as a process lasting more than one month.
Boards therefore are best advised to treat engagement as an ongoing, not intermittent communications process with investors. Solid relationships do not start in a day and end in a week, then start again for another week sometime in the future. Engagement works best when it is cultivated by an open and honest communications process that takes place over the long term, and yields a trusting relationship for both issuers and investors.
About the Author:
Matthew Orsagh is a director of capital markets policy for the CFA Institute. His responsibilities include serving as spokesperson for the CFA Institute Centre; identifying and developing new corporate disclosure project ideas; promulgating Capital Markets Policy Group corporate disclosure positions, policies, and standards; and coordinating and supporting related public awareness activities.
Previously, Mr. Orsagh was a research analyst at Governance Metrics International, where he scrutinized financial statements and company filings to evaluate the corporate governance practices of numerous global companies. Mr Orsagh was named one of the 2008 “Rising Stars of Corporate Governance” by the Millstein Center for Corporate Governance and Performance at the Yale School of Management. Mr. Orsagh is a member of the New York Society of Security Analysts (NYSSA) and is an advisory board member of SASB (Sustainability Accounting Standards Board).
