Dr. Hans-Christoph Hirt is co-head of Hermes EOS, the stewardship team of Hermes Investment Management. He leads and oversees the global engagement program and the quality of Hermes EOS services. Hans also leads high-profile stewardship activities, including priority engagements with major companies in Asia and Germany, as well as interactions with key regulators and organizations. He is a member of the Steering Committee of the UN PRI Investor Engagement Clearinghouse and the Shareholder Responsibilities Committee of the International Corporate Governance Network. In 2015, he joined the Institutional Investor Council in Malaysia. Prior to joining Hermes EOS, Hans worked with international law firm Ashurst. He is the author of numerous publications on corporate governance and law, responsible investment and stewardship.
Christopher P. Skroupa: What is the role of investors in the corporate governance of companies?
Hans-Christoph Hirt: Investors have fiduciary responsibilities and should regard themselves as stewards or responsible owners of the companies in which they invest and act accordingly. Stewardship effectively means mitigating the principal-agent conflicts which are inherent in any company where ownership and control lie in the hands of different people or entities. The agents (the management and board) manage the company on behalf of the principals (the owners or shareholders) and this relationship may at times lead to significant conflicts of interests. Through stewardship by investors, better oversight and, if necessary, accountability of the agent is achieved—sometimes through intervention by the principal. Stewardship is therefore particularly important for companies with dispersed ownership structures.
By strengthening the relationship between investors on the one hand and the board and management on the other, transparency, trust and accountability in the corporate and investment chain is enhanced. In addition, taking the fiduciary relationships between the ultimate beneficiaries, asset owners and asset managers into account, there is a strong case for appropriate stewardship activities.
Investor stewardship is a crucial factor in implementing the widely adopted comply-or-explain approach of corporate governance codes. In other words, principals, who review and assess how the agents implement corporate governance codes, play a crucial role in making them work in practice. In the absence of investor oversight, this guidance will remain in a vacuum and result in little more than tick-box disclosures.
Skroupa: What are stewardship codes and why are they introduced around the globe?
Hirt: The UK Stewardship Code (the Code) was launched in 2010 in response to questions about the role institutional investors had played in the wake of the Global Financial Crisis (the GFC), when they not just failed to intervene effectively in the governance of banks but arguably encouraged some of the short-term focused, high risk behaviors that contributed to it. It has been a remarkable success as a blueprint for similar codes and guidance around the world, for example in Japan and South Africa. Later this month, a stewardship code will be launched in Brazil.
The Code sets out seven principles and related guidance regarding the role of institutional investors as stewards of assets invested in publicly listed companies which they ultimately own or manage. The areas covered in the Code include monitoring of investee companies, voting related shareholdings and engagement with corporate representatives, as well as related policies and disclosures.
Following the successful model of the UK Corporate Governance Code, which can be classified as soft-regulation, the Code is implemented on a comply-or-explain basis which means that its application is voluntary. However, since December 2010 it has a regulatory underpinning, as all UK authorised asset managers are required under the Conduct of Business Rules of the Financial Conduct Authority (FCA) to produce a statement of commitment to the Code or explain why it is not appropriate to their business model. Moreover, the Financial Reporting Council (FRC) requires a compliance statement from all signatories.
Skroupa: What does effective engagement between investors and boards of companies look like? Are there differences between the UK and, for example, Germany or the U.S.?
Hirt: Effective engagement with companies delivering changes that enhance or protect value requires interaction and if necessary intervention at senior management and board level. It is generally based on constructive relationships with the c-suite and executive and non-executive directors developed over a period of time involving multiple interactions, including in-person meetings. It is critical to the success of engagements to make realistic and realizable demands of companies, informed by significant hands-on experience of business management and strategy setting. We believe that such engagement requires significant and dedicated resources and individuals with experience and skills not typically found at asset managers.
In the UK, dialogue between investors and both executive and non-executive board members is strongly encouraged, for example through the country’s Corporate Governance and Stewardship Codes. As such, dialogue between major institutional investors and non-executive directors is a well-established part of the communications of companies in the UK and conducted regularly, not just in particular company scenarios. The situation in Germany is very different: Company law does not envisage that members of the supervisory board (all non-executive directors), including the chair, represent the company vis-à-vis third parties, such as investors. This role is reserved for the executive directors who sit on the management board. Historically, investors could thus hear from the chair once a year at the annual general meeting. Practice—at least among larger German companies—has changed significantly over the last decade, partly because investors, not least those from abroad, have sought dialogue with the chairs of supervisory boards. Somewhat similarly to Germany, until a few years ago, there has been limited interaction between board members and investors in the U.S.
Skroupa: How do you measure success and impact of your engagement work?
Hirt: We have developed a proprietary milestone system which allows us to track progress in our engagements relative to objectives set at the beginning of our interactions with companies. The specific milestones used to measure progress in an engagement vary depending on each concern and its related objective. In 2015, we engaged with 466 companies on 1,150 issues and objectives. Good progress was made and at least one milestone was moved forward for about half of our objectives during the year.
Moreover, there is high-quality academic evidence that shows that engagement pays off financially and non-financially. For example, successful engagement can translate into significant outperformance, ranging from 4.4% per annum to 7.1% cumulative abnormal returns after successful engagement. In 2014, Hermes proprietary research showed that corporate governance standards have a meaningful impact on shareholder returns, proving that companies with poor or worsening standards of corporate governance have tended to underperform by up to 30 basis points.
Last but not least, we produce public case studies of our work, which are approved by the companies, describing our interactions, interventions and the impact of our engagements.
Christopher P. Skroupa is the founder and CEO of Skytop Strategies, a global organizer of conferences.