Technically Speaking: Shareholders must get militant and hold directors responsible

Thursday 22nd March 2001

A tide of dissatisfaction is rising over the performance of some NZSE listings and the accountability of their directors.

Company reporting seasons are marred by poor business performances that are in some cases chronic, while at the same time boards seek to be better remunerated.

Shareholder revolt is evident in moves to block increases in directors' fees.

Certainly it appears that while companies often compensate senior staff with performance-related pay, the same logic is not applied to board members. Only shareholders can ultimately impose discipline on directors who do not deliver the goods, by firing them or docking their pay.

Part of the problem lies in the small pool of directors available. Sorting out the wheat from the chaff could leave many companies short of directorial guidance, especially where independent directors are concerned.

New Zealand is not alone in this. The Economist reported a while back that in both the UK and the US high-quality independent directors were as scarce as hen's teeth.

One solution could be for tertiary institutions to offer degrees or diplomas in company directorship to establish the career option.

Another reform could be to bar the chief executive from also being company chairman. It is difficult to see how a board can impose sufficient discipline on a CEO when he also heads the board and controls the agenda. Some countries enforce this prohibition, whereas in others analysts mark companies down for not separating the roles.

The concern could be described as a variety of governance risk, a blight in some NZSE-listed firms, and should set off warning bells in shareholders' minds.

Increased legislation has been touted as the answer to shareholder discontent but can only ever provide part of the needed result. In the end, companies must run themselves. The law cannot do that for them.

In turn, shareholders must exercise their rights. Companies represent a version of first-past-the-post democracy wherein shareholders are voters.

As with government, winning and losing all comes down to vote numbers. Shareholders need to organise themselves into effective voting blocks if they want to stop hearing excuses from boards and instead earn financial return that justifies investment. Put bluntly, shareholder democracy's principal functions in respect of company boards, the corporate version of government, are to keep the b******s honest and throw out the rascals.

It is encouraging that small shareholders are moving down the path to organised voting. It has been reported that shareholder activist Bruce Sheppard is aiming to set up a shareholders' lobby group after the pattern of the Australian Shareholders' Association.

There should be more fireworks at company meetings if small shareholders organise. The problem is numbers, in that small shareholders often do not dominate the company register.

That is where institutions come in. Frequently fund managers represent substantial voting blocks that could make all the difference in getting boards brought to heel. These voting blocks are in turn proxies for investors in managed funds, who could be described as de facto small shareholders.

The accountability chain runs from company boards to shareholding institutions to fund unit holders. Fund managers are supposed to invest their unit-holders' money responsibly and secure worthwhile returns. This would make institutional shareholders eminently suitable to drive a clean-up of boards.

The key problem with institutions is potential conflict of interest. The investment officers of fund managers aim to match or outperform benchmarks and often rely on cozy relationships with company officers to obtain information that would lead to informed investment theoretically superior to that offered by competitor institutions.

Once invested, the fund is then supposed to wear its other hat of going in to do battle as a shareholder on behalf of its unit holders. All too often, it seems, institutions side with boards when disgruntled shareholders try to push through changes, yet there is commonality of interest between small shareholders and fund unit holders.

Perhaps a solution is for unitholders to get militant with institutions and form their own organisation such as Mr Sheppard is seeking to establish for small shareholders. The Achilles heel of managed funds for this strategy to work is the role of the trustee appointed to oversee unit holders' funds. The trustee has a fiduciary duty to investors that precludes it from acting against their best interests.

A representative action lawsuit brought against a trustee of a fund that was supporting a company board against the interests of unit holders could have a salutary effect throughout the managed funds industry. A managed funds unit holders' association could finance such an action.

Additionally, shareholders in listed institutions - including the mooted small shareholders' and unit holders' associations - could exert pressure for a stronger stance on unitholder rights at company meetings.

The need for institutional activism is increased in light of the government's proposal to requisition vast amounts of taxpayers' money for investment into a pension fund for baby boomers. The present performance of many of our listed companies would argue against public investment in them until institutions and small shareholders collectively enforce economic return on capital as the norm.

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