Corporate code could foster short-termism
CORPORATE PARTNER, HOGAN LOVELLS
TIDJANE Thiam of the Pru may well be grateful that the new Corporate Governance Code – with its requirement for all directors of FTSE 350 companies to be subject to annual re-election by shareholders – only takes effect from 29 June this year.
At the heart of the new code is a focus on the long-term success of a company. Yet with the new proposal, directors must effectively justify their performance to shareholders annually or face being voted out at the AGM. Does this raise the spectre of short-termism? And how can this new requirement of annual re-election – with the result that directors may feel the need to take short-term decisions for the sake of investor backing – sit with the need to focus on what is best for the company over a longer time-frame? Can long-term success be gained by a mechanic which potentially encourages short-term behaviour?
The proposal of annual re-election had attracted a mixed response during the consultation phase. Sir David Walker had worried that annual elections might be “accountability in too short a time frame” and did not recommend it in his Walker Review, although he has subsequently publicly stated he now regards it as a good thing. The view as to whether annual re-election is likely to be an effective tool for ensuring better boardroom behaviour is typically split depending on which camp you are in. Those who do not like the proposal – typically companies and directors – point to the potentially destabilising effect. Annual re-election, its detractors say, can amount to little more than a popularity contest, so that to continue to be supported by shareholders, directors have to make potentially unwise decisions that deliver an immediate or obvious benefit to those shareholders. The benefits of some decisions may also not be best viewed on their short-term merits – often more time is needed to appreciate the full benefit.
Conversely, investors have made the point that annual re-election gives shareholders – who are, after all, the owners of the company – a more direct voice into the key issues affecting the company and that, going forward, directors will ignore that shareholder voice at their peril. If ignoring the concerns of shareholders means those shareholders voting against you, the feeling is that there is now a very real impetus to listen to what shareholders have to say.
Boards could, of course, choose to overlook this: as a “comply or explain” requirement, a FTSE 350 board could “explain” why it thinks annual re-election is not appropriate in its case. But it is hard to see many standing their ground on this one. So how concerned do directors have to be? Currently the requirement is for directors to seek re-election at least every three years and to date blocking re-election is not a remedy that has been widely or lightly used. It is reported that between 2000 and 2009 only 19 directors in nine companies across the whole FTSE all-share index were not reappointed. Clearly investors are a long way from being “trigger happy” where this right is concerned.
This brings us to another part of the code – the need for shareholder engagement. The code requires boards to speak regularly to shareholders and shareholders to express their views to the board. Properly done, the spectre of being voted off should not be a tangible threat. It is a weapon in the armoury of dissatisfied shareholders, but the evidence would suggest that speaking to shareholders regularly means it is one that they do not need or want to deploy.