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How the U.K.’s “shareholder spring” has put compliance in the driver’s seat

Stephen Davis and Jon Lukomnik | May 17, 2016

for DeAnnEvery once in a while, something arresting comes along in corporate governance that qualifies as a tipping point. Last year, it was the tide of votes in favor of proxy access resolutions. Once a surefire polarizer, access now seems almost a non-issue that will take root without drama at many companies. In 2016 the stunner with such potential was last month’s say-on-pay vote at BP. Might it be a harbinger of higher levels of scrutiny of executive compensation by institutional investors?

On Thursday, April 14 a jaw-dropping 59 percent of investors voted no confidence in the oil giant board’s compensation policies, including its decision to award a 20 percent raise to CEO Bob Dudley in a year that saw the firm lose $5.2 billion. The quantum involved would hardly have raised an eyebrow in the U.S. energy sector. Dudley’s total pay rose to $20 million, thanks largely to increases in pension contributions and deferred bonuses. By contrast, Exxon Chair/CEO Rex Tillerson was paid some $33 million in 2015. But investors rebelled in bulk at the London-based multinational, making a break with previous habits of voting solidly in support of compensation policies at BP.

It is hard to underestimate this outcome. BP is widely held, so for the total opposition to reach 59 percent—one of the highest ever negative pay votes in Britain—it had to include major mainstream institutional investors not usually known for rejecting management. And this wasn’t just any management. BP is known for its outreach and engagement, especially in the wake of the catastrophic Deepwater Horizon oil blowout in the Gulf of Mexico. Votes against the board must be seen as a repudiation of one of the best-known CEOs and boards in the United Kingdom.

Just hours later, a second FTSE 100 firm, the medical equipment manufacturer Smith & Nephew, posted another astonishing result: 53 percent of investors opposed its remuneration policies for 2015. In contention was the board’s decision to override its own policies and grant bonuses despite lagging performance. Then on April 21, a third top-index firm, Anglo American, saw a formidable 42 percent vote against compensation practices, including a tripling of the size of the firm’s bonus share pool.  By contrast, in 2015 just one U.K. company—Intertek, which is one twentieth the size of BP—lost a say-on-pay vote.

The surprising top U.K. vote-no fund in 2015 turns out to be Fidelity International, which manages $273 billion and is the London-based corporate cousin of Fidelity in the United States. It opposed a whopping 32.9 percent of U.K. compensation resolutions.

Some observers see this latest “shareholder spring” as something different. The High Pay Centre, a U.K. think tank, said about the BP vote “The shareholders have said: You have gone too far, and this level of pay cannot be justified or accepted. The board must think again.” Simon Walker of the Institute of Directors, the rough equivalent of the U.S. National Association of Corporate Directors, declared: “British boards are now in the last chance saloon. If the will of shareholders in cases like this is ignored, it will only be a matter of time before the government introduces tougher regulations on executive pay.”

But they may be missing the real and international significance of what has occurred. What this fresh high tide of no votes represents is hard evidence of the existential shift we highlighted in our column two months ago—namely, that big, mainstream investment firms are moving from treating governance principally as a compliance exercise to seeing it as a contributor to risk management and value creation.

Consider that among ringleaders of the shareholder revolt at BP was Legal & General Investment Management (LGIM), the arm of a life insurance giant, which manages $180 billion. LGIM would hardly have been on anyone’s list of potential insurgents just a few years ago. But in 2015 it voted against management at nearly one in five U.K. companies. Do a Google search on “LGIM and corporate governance” in 2011 and you get 5,370 hits. Last year you get 16,400. LGIM’s expansive annual voting report now spells out where it stands on the relationship of environmental, social and governance risks to value (www.lgim.com/uk/en/capabilities/corporate-governance/corporate-governance-report/index.html).

But here’s the thing: LGIM is no outlier as a mainstream fund in rebellion. The surprising top U.K. vote-no fund in 2015 turns out to be Fidelity International, which manages $273 billion and is the London-based corporate cousin of Fidelity in the United States. It opposed a whopping 32.9 percent of U.K. compensation resolutions, according to new data from Proxy Insight and The Daily Telegraph. Another dark horse rebel: Royal London, with $124 billion under management, owned by a large mutual life insurance and pensions firm. It voted against more than 15 percent of U.K. pay packages in 2015. Insurance companies are not the profiles one would have expected to see in the ranks of challengers.

Moreover, LGIM and other fund companies don’t seem to be stopping at say on pay. In particular, they are applying more engagement resources to pressing for climate change risk management at portfolio companies. The Paris climate accord seems to have spurred such action. So has pressure from watchdog groups; one called Preventable Surprises recently published a call for what it dubbed “Forceful Stewardship” by institutional investors (see “Institutional Investors and Climate-Related Systemic Risk” at www. preventablesurprises.com). Funds also now focus on diversity and board refreshment at companies in which they invest.

It is also true that U.K. government pressure on funds to step up scrutiny and oversight of portfolio companies appears finally to be paying off. A stewardship code now propels more shareholder oversight. Disclosure rules expose funds that fall short in exercising ownership responsibilities. But it took last month’s remarkable vote at BP to demonstrate that mainstream funds are really putting spine into their voting. There is every reason to believe that these same funds will apply a similar brand of enhanced scrutiny in respect to U.S. holdings. LGIM, for one, is already doing so out of its Chicago-based headquarters with new voting policies on board tenure. There is also every reason to expect that U.S. funds, already primed to enhanced engagement with their support of board accountability reforms we outlined last month, are headed in the same direction.