Articles, Thought Pieces
2017 AGM proxy season recap
Trends for the 2017 voting season:
Remuneration Policies – A marked increase in policy votes for the year due to the first three-year renewal cycle coming to an end. This comes amidst growing calls for stronger investor policing of director pay and ever-present Government interest in this topic. However, a repeat of the ‘Shareholder Spring’ of 2012 has remained outstanding, with the level of average support having increased slightly compared to 2016;
Restricted Share Awards – The final report of the Executive Remuneration Working Group was published in July 2016 suggesting that remuneration structures need to be more flexible. The Working Group suggests that time-vested restricted share awards are revisited to simplify pay structures, causing a rift in the market;
Updated Investor and Proxy Adviser Policies – To deal with the expected uptick in engagement activity on remuneration policies this year, and to head off misunderstandings during the shareholder voting period, the predominant Proxy Advisers and many investors have disclosed their updated policy stance early. Changes include commentary on time-vested share awards and the potential to escalate long-standing remuneration concerns by holding individual directors, in particular remuneration committee chairmen, to account – the latter resulting in a strong trend towards increased investor dissent on director re-elections;
Director Time Commitments and Board Diversity – There continues to be pressure on boards to reduce the number of outside roles held by each director (e.g. ‘overboarding’), and to increase board diversity in the process;
Shareholder Activism Increases – The flood of M&A activity feared after the Pound’s decline following the Brexit vote has remained largely outstanding. However, shareholders have become more vocal and demanding in their engagement with management, and the largest institutions appear more willing to support activist campaigns for board change and increased remuneration scrutiny; and
Non Pre-emptive Share Issuances – New guidelines published by the Pre-Emption Group settle down and ‘Template Resolutions’ have been provided to add guidance to the market in seeking larger non pre-emptive issuances of shares.
The annual shareholder voting season in the UK, and many other jurisdictions, plays out across only a few months in the Spring of each year. During the months of April to June, most companies with a calendar year-end will have to hold their annual general meetings (‘AGMs’). In the UK, a much smaller number of companies reports their activities on a tax-year cycle, which tends to run to the end of March. These companies would generally hold their AGMs in July to September, thus splitting the UK voting season into two peak periods, the former busier than the latter.
It therefore pays for companies, investors and third party advisory bodies to start their planning for next year’s voting period early. The 2017 season was an extra busy one, which many observers believed would be a particularly contentious voting season. Ever since the 2008 financial crisis and the so-called ‘Shareholder Spring’ in 2012, the relationship between corporates and their shareholders has been on tenterhooks. In years of plenty, shareholders are often less vocal or diligent in their policing of the portfolio companies in which they hold shares. However, when profitability, dividends and shareholder values are threatened, the great army of institutional investors and their advisory agents descents on the corporate world, demanding explanations, improved disclosure, and more autonomous governance structures.
There have been a large number of changes with regard to shareholder rights globally, and these have often been implemented by conscientious regulators and as the direct result of shareholder pressure, and this may be more true for the UK market than others. While the UK has historically been a self-regulating market, recent years have seen increased Government involvement in the more detailed minutia of corporate organisation and practices, in particular surrounding director pay. There have been white papers, green papers, and new regulations, at a pace that does not seem to have slowed since the Cadbury Report was released a quarter of a century ago.
A Changing Remuneration Landscape
Remuneration Policy Renewal
The 2017 AGM season was always going to be a rather frantic affair, given that it marked the third year since the Government’s new remuneration regulations were implemented in 2013. These require UK traded companies to seek a binding vote – subject to a simple majority support – on their director remuneration policies at a minimum frequency of every three years (or whenever changes are proposed). Following this vote, remuneration may only be paid within the parameters determined within the approved remuneration policy, and any payments outside the policy limits would have to be repaid.
In addition to the triannual remuneration policy vote, companies also continue to be required to seek a non-binding vote on the approval of their remuneration reports in respect of pay awards made for the year under review (this regulation has been in place since 2002). A rejection of such a vote, while not resulting in any legal consequences, tends to cause the affected company much embarrassment and reputational damage in the capital market. Following the new remuneration regulations, a rejected remuneration report vote would now also necessitate a renewed policy vote ahead of schedule.
The first sets of remuneration policies were required to be approved by shareholders at the AGMs presenting financial statements for years ending on, or after, 30 September 2013. While these regulations were rushed out without much guidance being provided, and with few companies or investors knowing what to expect, the 2014 AGM season developed into an engagement-heavy voting season for issuers and investors alike.
Given that the remuneration regulations have now been in place for in excess of three years, many companies that did not seek a renewal of their remuneration policies in the intermediate years, were required to go back to their shareholders with a batch of new remuneration policies for approval in 2017. Data shows that there were close to 300 companies across the UK indices holding their AGM in the first half of 2017 alone, all of which had to seek renewed shareholder approval for their remuneration policies which were not amended in the intermediate years.
While not all companies wished to make substantial changes to their policies, shareholder expectations on remuneration structures have changed substantially over the last years, and investors’ remuneration policies have noticeably tightened. Therefore, some companies that have had shareholder support for their long-standing remuneration structures – and anticipated similar voting support for a renewal of substantially unchanged policies this year – suddenly and unexpectedly found themselves at the receiving end of shareholder ire this year, with voting dissent on their policy renewals above 20 per cent. These companies will need to contact their shareholders and engage in detail in the current financial year, to determine whether trust and good will with shareholders can be rebuilt and a common understanding be reached between investors and their remuneration committees.
Another element of remuneration has received much attention over last years: the perceived complexity and lack of clear linkage between pay and performance, and in particular the role which long-term incentives play in this. This, and the continued public scrutiny placed on remuneration yet again pushed this emotive subject to the top of most investors’ agendas in 2017; especially once other regulatory and best-practice interest groups also decided to enter into the fray. Of particular note here is the final report published by the Executive Remuneration Working Group in July 2016. Their broad findings, while not backed by legislation or regulation, had an impact on the remuneration structures proposed by companies during the 2017 AGM season (and are likely to continue to crop up in discussions for future voting seasons to come), and prompted a review of investor and proxy adviser policies rather earlier in the year than normal.
Restricted Share Awards
To discuss the issue of complexity in director remuneration, the Executive Remuneration Working Group (the ‘Working Group’) was established by the UK Investment Association in the Autumn of 2015. The Working Group was set up as an independent panel of experts, comprising members of the investment community and the corporate world, and engaged extensively with over 360 participants across the field. The Working Group published its final report in July 2016, including guidelines to improve the remuneration engagement process between issuers and shareholders, and ensure that remuneration structures are relevant and suitable for the different companies they aid in retaining and incentivising management. One of the most controversial and wide-reaching of their guidelines, the Working Group suggests that ‘one size does not fit all’ in respect of long-term share incentives (‘LTIPs’), and that traditionally structured LTIPs may ultimately cause executive pay to ratchet up without any perceived increase in value attached to such awards by the executives they are meant to incentivise.
To this end, the Working Group suggested companies revisit the structure of time-vested share awards – in the form of Restricted Shares – without the requirement to meet additional substantial performance criteria. For those companies that consider the introduction of such structures, this should come with an succinct explanation why this is best suited for the company and its strategic alignment with the business, as well as a review of director shareholding guidelines and long-term vesting periods, to ensure that participants remain appropriately aligned with the shareholder experience and long-term value creation.
While such pay structures are not advised by the Working Group without appropriate consideration by each and every company, there has been some concern voiced by the institutional investor community as to the appropriate link between performance and pay, and the possibility of reward for failure. To address such concerns of their clients, the predominant proxy advisers in the UK have this year published their policy updates in good time prior to the busy voting period (March-June) to include additional considerations in respect of such awards prior to their proposal for shareholder approval.
Interestingly, often the ‘opposing’ parties in the remuneration approval process – investors and issuers – tend to read such policy statements and reach entirely different interpretations. While companies tend to consider that the Working Group’s final report now provides for the distinct possibility of time-vested share awards as part of best-practice remuneration structures in the UK, many institutional investors continue to balk at the idea that directors should be given essentially free shares without a clear link to corporate performance. Those companies that attempted to include such structures have therefore found much investor push back in 2017, and remuneration policies that provided for the use of non-performance Restricted Share awards often had to be either withdrawn or substantially watered down before shareholders were willing to lend their support on such resolutions.
As an example, in 2016 the industrial engineering company Weir Group plc, sought to include restricted share awards in its remuneration structures for board and below-board personnel. This move was strongly rebuffed by its shareholders who overwhelmingly voted down the amended policy with over 72% of those voting registering a vote against the changed policy. Weir Group, along with hundreds of other UK companies, were in 2017 required to seek renewed shareholder approval of its remuneration policy, and were generally much more wary of proposing remuneration structures which fall outside the standard practice acceptable in the UK.
Remuneration Committee Chairmen
While the renewal of their remuneration policy vote is one concern for companies this year, much importance has also been placed on directors’ direct accountability to investors. While this topic is discussed in more detail in respect of individuals’ duties and accessibility below, one board role which received additional scrutiny and possible voting sanctions is that of the remuneration committee chairman. In addition to the annual advisory vote on a company’s remuneration report, institutional shareholders have more and more sought to place personal responsibility for continuing poor remuneration practices with the committee members which are supposed to oversee these, and in particular the chairman.
As such, a number of advisory bodies, such as Institutional Shareholder Services (ISS), Glass Lewis, and the Pensions and Lifetime Savings Association (PLSA) have included this possibility within their voting guidelines for 2017, to allow for the escalation of voting sanctions where repeated breaches of good practice occur over the years without noticeable improvements. To this end, the PLSA said that if the AGM vote fails to produce a remuneration policy that shareholders support: “a vote against the remuneration policy should in most circumstances be accompanied by a vote against the chair of the remuneration committee, if they have been in post for more than one year.” These moves have also been supported by large investors who have started to follow suit, with Blackrock, the world’s largest fund manager, who wrote to the chairman of every FTSE 350 firm at the end of 2016, outlining their hardened stance on pay for 2017 and urging them to cap executive remuneration.
This has led to a substantial uptick in the level of dissent on the re-election of non-executive directors heading the remuneration committees at companies at which shareholders noted concerns on remuneration matters for a number of years, including at high street names such as Pearson, BP and WPP.
Diversity and Time Commitments – Director Skills and the Gender Gap
A director’s duties are enshrined in UK company law (particularly under sections 170-175 of the Companies Act 2006) and include the duty to exercise reasonable care, skill and diligence in promoting the success of the company. These legal requirements have permeated through to form the basis for the UK Corporate Governance Code’s (the ‘UK Code’) provisions regulating the effective running of corporate boards, and, amongst other things, require that “directors should be able to allocate sufficient time to the company to discharge their responsibilities”.
As the duties and responsibilities of, in particular, non-executive directors have increased significantly over recent years, and the pool of available candidates for non-executive roles has remained relatively constant, the expectations on existing non-executive directors and correspondingly their work-load has multiplied. The increased importance and reliance placed on non-executive directors these days, both in regulatory oversight especially in the financial industry, but also in terms of their increasing accountability and accessibility to shareholders, has brought the time commitments of these individuals under closer scrutiny by investors, and consequently their research providers.
This is a topic which has found its way into the policies of the various proxy advisory agencies used by the largest institutional investors, and is a point which has received increased scrutiny when assessing the accountability and suitability of directors standing for re-election at companies across the world. Given that the UK Code recommends mid-to-large caps to seek re-election of all directors each year, this agenda item is unlikely to decrease in importance during 2017 and future voting season.
Investors review a director’s other responsibilities outside their directorship at the portfolio company, as well as their attendance record at board and committee meeting during the year, as a pro-forma indication as to their ability to undertake their oversight duties properly. Proxy advisers have accordingly tightened up their voting policies and now provide clear guidelines as to the number of other directorships which may be held before a director is deemed ‘overboarded’, upon which a voting sanction would now apply to that individual. The allowable number of other positions may also be further reduced, when reviewing overall workload at in these roles, where a director holds multiple committee chairmanships.
Board Refreshment, Succession Planning and Board Diversity
Succession planning and board evaluations are integral parts to a well-functioning, effective board, and should be used in any appointments and board strengthening activities. It is expected that such processes are undertaken on a regular basis, and early on in any director’s appointment period. (Many investors in fact consider that the succession planning for the CEO role should really be started on ‘day zero’ of the appointment of a new CEO; thus ensuring preparedness for unexpected need to replace them, and reducing awkwardness when a director’s usefulness during a particular business period may be coming to a natural end.)
Best practice as set out in the UK Code, highlights that systems should be in place to provide the “orderly succession for appointments to the board and to senior management, so as to maintain an appropriate balance of skills and experience within the company and on the board and to ensure progressive refreshing of the board” (Principle B.2). This means in practice that nomination committees should evaluate the current balance of skills, experience and tenure, independence and knowledge on the board and then highlight the role and capabilities required, or that need replacing. The Financial Reporting Council (FRC) has produced a Discussion Paper to this effect.
Therefore, investors are increasingly asking for better disclosure surrounding board refreshment activities, in seeking to understand how boards really undertake board refreshments and how independent and effective their selection and recruitment procedures are. The robustness of succession planning and how this effects the makeup and diversity of the board has also come into the focus of investors in order to better prepare boards for changing business needs.
In reviewing directors’ skills and experience, shareholders and proxy advisers are placing greater importance on board diversity, including gender diversity – in accordance with the Davies Report on ‘Women on Boards’. In his Report, Lord Davies finds that company boards perform better when they can choose from the widest possible pool of talent, to include people from a range of perspectives and backgrounds. He goes on to say that “evidence suggest that companies with a strong female representation at board and top management level perform better than those without”. To kick-start the drive for better representation of women on UK boards, Lord Davies therefore recommended an aspirational ratio (if not a quota) for FTSE 100 boards to comprise of at least 25% women directors by 2015. Some headway has been made towards this target to date (see 5-Year Summary Report here), with many smaller companies also disclosing their diversity policies and goals.
However, many commentators still argue that too little has been done to truly change the mind-set of business leaders in the UK and globally. While few openly advocate the appointment of women directors purely to fulfil a target, more needs to be done to improve the pipeline of female executives from below board level within corporates. This is therefore acknowledged as a multi-year process, and many investors closely review a company’s succession planning and hiring practice in recent years when considering their vote on board roles such as nomination committee chairmen. Where a company continues to have no or little female board representation and nothing appears to have been done about this in recent years, voting sanction are likely to be applied. Whereas companies which remain below the desired 25%-representation but are seen to address this with recent hires, may well buy themselves some time.
There is a growing raft of research that supports more diversified boards. One recent paper reviewing how this is associated with shareholder activism has been published by turnaround specialists Alvarez & Marsal. Interestingly, in their September 2017 research report it is noted that there seems to be a correlation between the number of women on a board and a reduced risk of shareholder activism.
We expect that the scrutiny placed on director elections will continue to intensify, with both the individual’s attendance record and time commitments reviewed closely. In discussion with market participants, it has also been noted that investors will not merely review director skill-sets and diversity ratios per se, but instead consider the board’s overall trajectory of travel in terms of board refreshment and improved diversity in skills, background and gender.
Over time, an increased emphasis on diversity in corporate boardrooms worldwide, should increase the pool of director candidates available, and therefore reducing time commitments of existing professional non-executive directors.
Shareholder Activism Increases
Just as the number of shareholder proposed resolutions declines in the USA there has been an increase in the UK, and certainly more incidents of activist engagement. The decline in the USA is being reported by some observers as companies meeting the demands of activists before a public battle ensues. Although, some may simply be a function of cyclicality, with investors now seeking value elsewhere.
The flood of M&A activity feared after the Pound’s decline following the Brexit vote has remained largely outstanding, especially with continuing uncertainty around the form which the UK’s exit from Europe may take. However, shareholders have become more vocal and demanding in their engagement with management. Moreover, activist investors, many of whom have imported their specific version of activism from the United States, are no longer content to resolve their issues behind closed doors – the preferred methodology in the UK until now.
There also appears to be increased activity from the largest assets managers flexing their muscles, especially as voting records and engagement activities of these important fund custodians are scrutinised by their clients and the market in general, in line with their stewardship responsibilities. An example of this trend is BlackRock, who are currently noted as voting against management on say-on-pay resolutions just 9% of the time, and only one-in-four of the times when ISS has recommended a negative vote, as reported in a Proxy Insight study from late January 2017. However, there is likely more scrutiny and engagement on remuneration issues on the horizon from such investors as a result of new approaches to executive remuneration launched in 2017. In the UK market, this development may have been as a direct response to the threat of a binding vote on the remuneration report, as has been set out in the recent Green Paper by the Business, Energy and Industrial Strategy Committee (BEIS Committee).
To this end, a number of institutional investors have published policy updates and statements of strong scrutiny towards remuneration structures not deemed in the best interests of shareholders, or failing to rein in poor pay-for-performance alignment. As recently reported in the press, at a late-January meeting of the Investment Association, a group of 13 large asset managers has agreed to work together in curbing excessive executive pay. Well-known fund manager names, such as Aberdeen Asset Management, M&G Investments and Standard Life Investments are believed part of the group of active institutional investors. The largest asset managers have bolstered their corporate governance teams and focused them on understanding the reasons why executive pay is excessive in some companies before seeking to recommend action. This investment in engagement and environmental, social and governance (ESG) research teams at asset managers could also translate into, or be an early response to, growing voting opposition levels.
One other trend which has been observed in the past years, is the propensity of the largest active institutions becoming more vocal in their support of activist campaigns for board changes at UK companies, previously considered as ‘un-British’. There have already been a number of instances where traditional long-only institutions side with a hedge fund activist to bring about change at the top of UK-PLC. Notably, at Speedy Hire plc, where Schroders stood alongside Toscafund Asset Management in their push for board change, and at Stock Spirits Group plc, where a number of blue-chip investors were quoted in the press as supporting top shareholder, Western Gate Private Investments, the family-office of Portuguese tycoon Luis Amaral. Thus, activism has long left the closet and – even in the more traditional, stalwart UK capital markets – is increasingly accepted as mainstream and a valid form of shareholder value creation in a time where such value is hard to come by.
An initial view of the UK market and activism post Brexit is that UK companies are 32 per cent more likely to be targeted by activist investors than their peers in other major European markets according to a September 2017 report by turnaround specialists Alvarez & Marsal. This research also shows that as well as activism from the US and Asia, that European activists are also increasing their activities as funds are increasingly invested in this asset class.
Non Pre-Emptive Share Issuances
Another issue that came to the fore in 2017 is reflected in the small changes brought about over the last year in respect of issuances of shares without first offering them to existing shareholders in proportion to their holdings. Such pre-emption rights are a cornerstone of UK shareholder privileges, and are therefore enshrined in company law. Accordingly, every shareholder in a UK company has the right not to have their holding diluted by the issuance of new company shares into the market or to particular shareholders over others. However, this right may be dis-applied at a shareholder meeting via a special resolution (requiring a 75%-super majority to pass). In accordance with the Pre-Emption Group Statement of Principles (as updated in March 2015), companies are now permitted to issue up to 5% of share capital for general issuances, plus another 5% for specified capital purposes and acquisitions.
Updated Pre-Emption Group Guidelines
The Pre-Emption Group updated its Statement of Principles in 2015 to take account of market practice in the UK. Market observers had noted an increased number of so-called ‘cash-box’ placings being undertaken by companies seeking to circumvent the UK pre-emption restrictions.
Cash box placings are undertaken via an off-shore vehicle, in which ‘shares’ are purchased by investors. The company seeking to raise capital then issues its PLC shares in exchange for the Jersey company shares – i.e. not for cash, which would require a dis-application resolution under the Companies Act – thus circumventing UK legislation in this respect. Another benefit to the issuing company is that, through the cash box structure, funds are generally received much quicker and do not require an accounting juggle to convert non-distributable share premium accounts into distributable reserves. Cash box placings are still restricted to 10% of ISC as they would otherwise require a prospectus to be issued.
However, as cash box placing do not provide shareholders with the right to protect against dilution of their holding in a company, they are generally frowned upon in the City. To prevent further misuse of such opaque structures, but retain flexibility for companies to raise slightly larger amounts of capital without incurring further cost and additional time, the Pre-Emption Group has updated its Guidelines. Therefore, the Guidelines now allow for a total of 10% of share capital to be issued without pre-emption rights being applied, with a number of caveats as to their use. However, the updated Guidelines also make it clear that any such non pre-emptive issuances are to include issuances undertaken in the form of cash boxes. This was a trade-off that was introduced to gradually bring such issuances out into the open.
The majority of companies have taken opportunity of this extended limit pretty quickly, and issued meeting notices for their AGMs in 2016 and 2017 accordingly. In addition, the main proxy advisers (one exception being PIRC) quickly amended their voting policies on these routine resolutions to take account of the new Guideline threshold. Therefore, the additional 5% authority is generally viewed by most as relatively non-contentious.
Template Resolutions for Non Pre-emptive Issuances
Following the change in Guidelines, hackles were raised in 2016 with regard to Glencore plc’s (non-UK incorporated) 10% placing for general capital raising purposes, despite the board having previously noted their intention to only use the additional 5% obtained at their last AGM for specified capital purposes or acquisitions. In response to pressure from investor bodies, the Pre-Emption Group has therefore now provided Template Resolutions which stipulate two separate resolutions to be sought, each allowing for the issue of up to 5% of share capital.
During the 2017 voting season, most companies therefore sought any additional 5% authorities via two separate resolutions, rather than opting for a combined 10% authority, giving shareholders the option to support one but not the other. When analysing such enabling resolutions, investors may also consider the company’s use (or misuse) of such authorities in previous years, and the number of opposing votes may increase marginally beyond its traditionally low levels.
Disclaimer: All reasonable care has been taken to ensure that the information in the report is accurate and not misleading at the time of publication. No independent verification has been undertaken of this information. Please be aware that the corporate governance environment is fluid and those policies and allegiances are subject to change. In no event shall Boudicca Proxy Ltd be liable for any direct, indirect, incidental, economic or consequential damage rising out of the use of the documents and/or the information within this publication.