The Role Of Transparency In Shareholder Engagement–UK vs. U.S.
Jan Weber is a Managing Director in Morgan Stanley’s M&A team based in London. In addition to advising on many cross-border M&A situations, he is responsible for corporate defense and shareholder activism advisory in Europe. Weber has 16 years of experience in the industry and joined Morgan Stanley in 2003. His experience includes a broad range of public takeover advisory events including Kabel Deutschland/Vodafone, Kuoni/EQT, ScottishPower/Iberdrola, Sky/Sky Deutschland, ICI/Akzo Nobel. In addition, Weber is actively advising a large number of Morgan Stanley clients in Europe on Shareholder Engagement.
Christopher P. Skroupa: Would you say that modern shareholder engagement should be pursued by management, pursued by boards, or should it be a collaborative pursuit?
Jan Weber: There is clearly an expectation, especially from institutional investors, that boards have to play an increasingly meaningful and prominent role in shareholder engagement. The traditional approach where the exposure of the full board to shareholders is limited to the annual “meet and greet” at the general meeting is no longer adequate. When we look at which companies are doing best in shareholder engagement, in an environment where they are held accountable for shortcomings in strategy, governance or performance by shareholder activists—and frankly by institutional investors—the ones that are doing well are the ones that have managed to get really robust outside-in views and feedback.
Traditionally, a board would get their briefing through investor relations on shareholder base composition and investor sentiment, which continues to remain an important ingredient for the strategy formulation process at board level. However, there is a risk of becoming blindsided by solely depending on data emerging through management and passing through the unavoidable filter based on its view of the world. Companies that are doing well in shareholder engagement are the ones that have adopted processes that allow for direct interaction between shareholders and boards. In the U.S., we see that done in the form of senior independent directors having shareholder engagement. In Europe, there’s probably more engagement based around non-executive Chairmen. Some companies have even created specific shareholder liaison committees at board level.
Obviously, there is a balancing act companies need to achieve as it remains essential that the board portrays a unified consensus on key strategic issues towards the outside world to avoid mixed messages and the risk of exposure to board subversion tactics frequently employed by activists. That is best achieved by fostering a culture where strategy debates are vigorous, frequent and all-encompassing—no taboos—but strictly kept in the boardroom.
Skroupa: So how does effective engagement translate to long-term value for shareholders, and should the process be more collaborative as in a strategic partnership or a reporting relationship centered around board accountability?
Weber: I think you need to also look at market dynamics to really understand the interdependent relationship between shareholder engagement and long-term value creation. In fact, you could argue that due to the emergence of activists, institutional shareholders had to up their game and demand more shareholder engagement to ensure they communicate their objectives effectively, which is clearly a driver of long-term value creation. The companies that are navigating that environment are having more engagement with institutional shareholders who are meeting to ensure long-term success in what they’re doing.
There is one interesting shift in the market that I think has forced that trend. In 2006, about ten years ago, passively managed funds constituted about 5% of the S&P 500—these days, it’s 20%. Furthermore, about 30% of all mutual funds and ETFs are index funds. What does that mean for shareholder engagement? Well, Index funds cannot vote with their feet in case of underperformance, they need to remain invested as long as the company remains in the index.
Because they’re bonded, index funds or passively managed funds are really the embodiment of long termism.. They have no choice but to advocate long-term shareholder value creation, and with that and the threat from activism—which, rightly or wrongly, are often accused of short-termism—they had to up their game. We see that with big industry initiatives, like the Common Sense Corporate Governance principles or Focusing Capital on the Long-Term, which have the support of some of the largest institutional investors.
As a result of all of this, an institutional investor world has developed with a strong focus on board-related governance issues. Institutional investors have developed strong guidelines around corporate governance, the proxy voting process and invested heavily in internal proxy advisory departments. Companies in turn have adapted and many, in particular large cap companies, have now robust shareholder engagement processes in place. With all of the focus now on board-related governance there is a risk that it has come at the cost of having diminished the role of shareholders as the sounding board, adviser and partner of boards and management teams on strategic matters. Often we come across companies that say, “We would really like to engage with shareholders on strategy, but we don’t know who to call, and if we have someone to call, chances are, we don’t get substantive feedback on strategy.” Effective shareholder engagement has to be a two way process. In an environment where the passive ETF or index fund has gained ground, the often strategically insightful and also easily contactable portfolio manager of the actively managed fund is increasingly being missed by companies.
Skroupa: So it sounds like from the management side, they do want to see an increased level of engagement, which brings me into my next question: Can we expect to see increased levels of transparency in business, and as a double-edged sword, do you see higher levels of transparency as beneficial or detrimental to profits and shareholder relations?
Weber: I believe there is an overwhelming and wide consensus that transparency is critical for the integrity and efficiency of capital markets—there’s no question about that. When we think about shareholder engagement specifically, there are several transparency issues that play an important role, like equal treatment of shareholders in relation to information dissemination, and what companies say in a meeting with an activist versus with the other shareholders. There are also questions around time sensitive disclosure of non-public information. So for managements and boards it’s about navigating the challenge where, on the one side they’re encouraged to engage more frequently and in greater detail with shareholders, and then you have on the other hand very clearly the need to fully comply with all your disclosure obligations and regulations. Frankly, this is something that managers are expected to master and it has become a much more prominent aspect of their daily roles.
The interesting question for me comes up when we think about frequency of disclosure, which is another perspective of transparency. With ever improving technology, systems and controls are we heading towards a business world where companies are compelled to publish monthly, weekly, or even daily trading updates electronically? Once it becomes technologically feasible, is it desirable? The dilemma with transparency is whether it actually leads to better or worse decision making on the part of the recipient of the information. The concern really arises when the leadership of companies reveal in private that they believe a certain strategic repositioning or operational restructuring would be the right course of action but the payback period is considered as too long to keep pace with shareholder expectations around quarterly results hence they decide not to do it, although arguably, that would be in the interest of long-term value creation.
That’s when the wish for a long term anchor shareholder with entrepreneurial DNA, such as a sovereign wealth fund investor, or a take-private by a private equity fund arises to provide the extra space and freedom to implement slightly more radical changes that may be required. Now, paradoxically, these types of initiatives should be compatible with institutional shareholders that are in there for the long-term. They may struggle with it. There is the question as to whether they are equipped to assess these strategic opportunities and see beyond quarterly performance benchmarking: Are they really equipped to be the stewards in stormy water for these companies?
The result is that the professional activist shareholder with vast resources and analytical capabilities is better suited to help these companies actually achieve long-term value creation. That outcome clearly all depends on whether the activist refrains from employing the quick-win playbook of simply breaking up the company or putting it up for sale, obviously. They need to show that they’re in for the long run.
Skroupa: This idea of activists kind of generating long-term value versus short-term value is something that’s been talked about a lot in the United States. Actually, recently, at our Shareholder Activism 2 program, our Big Debate really centered around whether you had to hold a board seat for a long period of time in order to generate long-term value, but in your experience in M&A, have you seen an increase in activist campaigns in the UK? And what is the difference between their approach versus what we’re seeing in the U.S.?
Weber: The UK was the scene of 43 public campaigns in 2016, compared to 27 in 2015, based on data from Activist Insight. I think it’s a remarkable outcome if you consider that we had the ‘Brexit’ referendum somewhere in between, and some macro uncertainty and forex volatility as a result, and activity around activism was not deterred. In the UK, we’ve now witnessed our first ever appointment of a representative of an activist fund to a FTSE 100 company with Rolls Royce and ValueAct. This is probably a reflection of a broader theme of U.K. institutional shareholders taking a more consistent stance that good arguments from an activist should get a fair hearing.
In terms of themes, we’ve seen campaigns range from board-related governance matters to say-on-pay to M&A “bumpitrage”, which you’ve also seen in the U.S., as well as M&A facilitation and all shades of demands for strategic change. A lot of the activism activity in Europe is driven by a European base of activists, and seems to be more by vocational activists than by funds that have activism as their core strategy.
In terms of similarities between the U.K. and the U.S., I actually would say that we’ve seen a big convergence in the activism styles of both countries in recent years. While there has been a long tradition of extensive shareholder engagement behind closed doors in the U.K, we have recently witnessed increasing willingness of U.K. institutional shareholders to seek a public forum for the right cause. If you look at the U.S., there is a trend away from a focus on proxy contests towards European-style settlements behind closed doors. To the point where several large U.S. institutional shareholders have voiced concerns over companies settling too quickly with activists to the potential detriment of long term shareholder value creation.
Christopher P. Skroupa is the founder and CEO of Skytop Strategies, a global organizer of conferences.