A cornerstone of good corporate governance, stewardship is a growing global concept, though focus is generally only on institutional investors
Over the last 20 years the UK has probably led the world in raising to prominence the need for good corporate governance. The “comply or explain” approach to regulation has distinguished the UK from other more dirigiste regimes, but overall there is no question that the UK Corporate Governance Code and its siblings round the world have contributed to a radical change in attitudes over the years. There are very few dinosaurs of corporate behaviour still around at least in the developed world.
However, the Code has still failed as the complete insurance policy which it was hoped to be against periodic catastrophic failures of governance such as those which devastated RBS and Lloyds TSB in the UK and Lehman and AIG in the US. The latest development in the UK is the Stewardship Code, which endeavours to improve corporate governance by getting owners to engage more closely with their investee companies’ managements.
Other countries, regions and international organisations have introduced new codes or updated existing corporate governance codes and principles, including the ICGN Statement of Principles on Institutional Shareholder Responsibilities, South Africa’s CRISA and the EFAMA Code for External Governance.
How do you define Stewardship?
Interestingly, the UK Stewardship Code issued by the Financial Reporting Council (FRC) in 2010 doesn’t define Stewardship and various dictionaries simply describe it as “exercising the duties of a steward”. One of the definitions of a Steward is “a person employed to manage another’s property”, which seems straightforward enough. In the days when a landowner employed a manager to look after his farms, the oversight by the landowner was clear, as were the duties of the manager or steward. From time to time the steward was found wanting, but the responsibilities were clear, as was any failing, and the holding to account resulted in dismissal or worse for the errant steward. However, today, stewardship is generally taken to refer to the role of the numerous fund managers employed by major institutions to invest many trillions of pounds, dollars, yen etc, belonging to billions of people via millions of corporations around the world.
Who are the Stewards today?
Today’s stewards work for mutual funds, pension funds, investment banks, hedge funds, insurance companies etc. These money managers are huge. The 25 largest US money managers hold $6tn of stocks. The biggest, such as Black Rock, State Street Global and Fidelity, hold around $3tn between them. There is room for argument as to who is the steward in these organisations. Does responsibility lie with the investment manager or with the Board which decides investment policy and sets the rules for behaviour? The FRC’s Stewardship Code refers to fund managers but also to pension fund trustees and other owners. So the implication from this font of good Corporate Governance guidance is that the primary responsibility for stewardship lies with the senior governing bodies of these organisations.
Who are the Stewards responsible to?
This should be a straightforward question to answer. The stewards are responsible to the investors for the security of the property invested. However, this becomes a little more cloudy when we consider that the executives of a fund manager have a dual role. One is a responsibility to invest the funds wisely, but the other is a responsibility to generate business for the institution as an independent corporate body – that is to gain new clients. These new clients may be drawn from the same groups of very large corporations which are investment targets. The potential conflict of interest here between the duties of the steward acting in loco the owner and the salesman aiming to persuade a potential client to invest, is clear.
What are the Stewards’ duties?
Duties towards the investors in the funds are clearly to safeguard the capital invested and to maximise the returns on that capital in the funds in which it is invested. However, the duties of the fund managers towards their own major shareholders ought to reflect the goals of those shareholders to maximise the return on their own capital. As the saying goes: a man cannot serve two masters. Here is another conflict of interest.
The UK Stewardship Code lays out the following principles:
Institutional investors should:
- publicly disclose their policy on how they will discharge their
- stewardship responsibilities
- have a robust policy on managing conflicts of interest in relation to
- stewardship and this policy should be publicly disclosed.
- monitor their investee companies.
- establish clear guidelines on when and how they will escalate their
- activities as a method of protecting and enhancing shareholder
- be willing to act collectively with other investors where appropriate.
- have a clear policy on voting and disclosure of voting activity.
- report periodically on their stewardship and voting activities.
What are the problems?
The purpose of the UK Stewardship Code is to try to get owners more engaged with management. However, large scale engagement seems quite impractical on purely logistical grounds, and, anyway, most investors would rather sell than fight to change a strategy of which they disapproved. This is because all but active investors are reluctant to get involved in high profile challenges.
More recently, the audit profession in the UK has produced its own Audit Firm Governance Code which, amongst other things, requires auditors to follow the guidance of the Stewardship Code and engage regularly with the owners of the companies which they audit. The practical problems of linking this with the demands made on these same owners to engage regularly with their investees would seem to have been ignored by the proponents of these Codes.
So we now have a logistical problem in key parties being able to devote enough time to engage in meaningful dialogue with a significant number of investees, coupled with the in-built conflicts of interest referred to above and made worse by the fact that most cautious investors will steer clear of anything resembling activism. Hence, despite leading institutions signing up to the Stewardship Code, it seems unlikely the new Code will achieve any significant change in behaviour.
Is there a solution?
A potential solution lies in our Applied Corporate Governance Research methodology, based on a Stakeholder Survey which can be devised to link management, owners and auditors in a commonly funded, co-managed exercise, carried out at regular intervals.
The survey would be led by the Senior Independent Director of, say, a FTSE 100 corporation, on behalf of the major shareholders and the auditors. It would question the key stakeholder groups (customers, employees, owners, suppliers etc.) regarding their views on the company’s performance against our five golden rules of good corporate governance. Hence the major stakeholders would be asked to express their opinion on whether the company had a strong ethical approach, whether they shared its business goals, if it seemed to be managed and organised soundly and if it operated in an open, transparent way and recognised its responsibilities to be accountable.
The feedback would enable the owners to judge the quality of the stewardship exercised by management and the auditors to assess how well their audit picked up failings by management as reflected by the survey.
Being conducted by the company, using an independent director to oversee the project and an independent professional market research firm to conduct the survey, the logistical problem would be solved and independence would be assured. This practical exercise would be carried out annually or biennially and would neatlysolve the problem of stewardship and how to be a good steward.