"Only when the tide goes out do you discover who’s been swimming naked."
Warren Buffett’s famous analogy highlights how a downturn in the strength of the markets or the economy, reveals previously-hidden risks and weaknesses for companies and investors. Although many investors have recently given most of their attention to the "E" and "S" parts of environmental, social and governance (ESG) world, we’re again seeing a renewed focus on the "G" by cautious investors as Buffett’s tide recedes.
Energy price spikes, rising interest rates, and falling equity and bond prices are making it harder for structurally-vulnerable businesses to just finance their way out of trouble.
Additionally, scandals in less-regulated markets such as crypto, alongside ongoing governance quarrels at Tesla, seem to capture the zeitgeist.
Shareholders Resolved
All this has prompted fresh scrutiny from investors on governance and oversight issues, which is feeding into asset managers’ and asset owners’ stewardship priorities. Increasingly, shareholders want to ensure the right people are leading the businesses they invest in, and that they can be held to account for their performance and oversight of the company.
One particular area of focus for asset managers and owners is management entrenchment. This refers to mechanisms some companies use to limit shareholders' ability to demand changes in leadership.
US companies are getting pushback on these issues from shareholders. Over the last three proxy voting years, there were 88 shareholder proposals at US companies requesting changes to company bylaws to permit simple majority voting on director elections and other corporate governance matters, replacing the much higher "supermajority" votes some companies demand. These proposals received an average 61% support from shareholders with 22 receiving above 90% support, according to Morningstar data.
Over the same period, a further 19 shareholder resolutions requested that a company’s board be declassified – that is, to submit all director elections to a shareholder vote at the same time rather than in separate classes staggered over several years (which prevents shareholders from rotating board members if they see fit). These proposals gained an average 76% support from shareholders.
In contrast to the US, the UK corporate governance regime limits London-listed companies' ability to use management entrenchment mechanisms like these – most votes at company meetings are binding and decided by simple majority, while the UK Corporate Governance Code requests annual elections of all directors. However, one corporate governance area is of increasing concern on both sides of the Atlantic.
Unfair Advantage
Many US firms have dual-class share schemes allowing greater voting rights for shares held by company founders and insiders, compared with the wider shareholder base. This includes some of the world’s largest companies: Google-owner Alphabet; Berkshire Hathaway, led by Buffett; and Facebook-owner Meta Platforms are all prominent examples.
Such share structures are rare in the UK, with institutional investors strongly committed to the "one share, one vote" principle. However, a recent review of the UK’s capital markets advocated for greater use of dual-class share schemes to increase the UK’s attractiveness.
Responding to these trends, in 2022, asset owners in the UK and the US set up the Investor Coalition on Equal Votes (ICEV), which aims to "push back against unequal voting rights at companies". The Council of Institutional Investors (CII) – an association of US asset owners and partner in the ICEV – believes that dual-class shares "enable founders to wield control far beyond their equity stake, with little interference from boards they effectively control."
The CII continues: "over time, this founder-knows-best approach can entrench management and blindside executives to a need for change in strategy." As a result they advocate for a time limit of seven years for any company that lists with a dual-class share structure.
Institutional shareholders are clearly highly engaged across all of these governance and corporate structure issues, and with the 2023 proxy voting season around the corner, we’re sure to see further key developments on they way companies are directed and controlled.
