Britain's 'Shareholder Spring'

Most years the annual shareholder meeting of your average British public company is a sleepy affair. This isn't most years.

Typically, small investors catch the train to London for some free sandwiches and the chance to lob a couple of awkward questions at the board of directors. On rare occasions retail investors might back an activist governance reform, but it's the block votes of the big shareholders that count, and they always back management.

That is, until now. Many institutional shareholders, criticized for being absent owners during the financial crisis, have decided to challenge management on a host of issues, making the shareholder meeting season a bruising one for many companies in the United Kingdom.

U.S. companies are watching what governance experts are calling Britain's “Shareholder Spring” closely, concerned that increased shareholder activism is on its way across the pond. Indeed, corporate governance trends in Europe tend to be a harbinger of things to come for U.S. companies.

A non-binding vote on executive compensation has been a staple of shareholder meetings in Britain since 2003. Generally, shareholders of U.K. companies have approved pay plans for most companies by a wide margin.  In recent weeks, however, there's been a string of companies either losing “say-on-pay” votes outright or recording significant minority opposition.

Votes of 30 percent against a pay report, which would have been newsworthy a few months ago, are now commonplace. The average vote against a remuneration report is currently 8.5 percent, says PIRC, a U.K. proxy advisory firm, up from just a 6 percent level last year. That's a modest increase, but some companies are seeing much higher levels of negative votes on pay.  For example, 67 percent of shareholders of oil exploration company Cairn Energy voted against the executive compensation plan. Investors didn't like the fact that Sir Bill Gammell had moved from chief executive of Cairn to chairman, a move that breaches the U.K. Corporate Governance Code, and received a £1.4 million ($2.19 million) “loss of office” payment for his troubles. At media company UBM, 36 percent of shareholders voted down the executive pay plan.

In fact, shareholder ire at the pay practices of some U.K. companies played a role in the resignations of CEOs at three different companies. At Aviva, one of Britain's largest insurance companies, Andrew Moss stepped down as CEO after 54 percent of shareholders voted against the remuneration report. AstraZeneca Chief Executive Officer David Brennan left the drugs company under pressure from shareholders. And publisher Trinity Mirror said farewell to Chief Executive Sly Bailey just days before 46 percent of shareholders rejected its board pay deals. There have also been shareholder rebellions at car dealer Pendragon, Regus, Tullow, Prudential, and others.

Government statistics on executive pay give some indications on why shareholders are angry. Between 1998 and 2010, average total remuneration for FTSE 100 chief executives increased from £1 million ($1.56 million) to £4.2 million ($6.57 million) without any comparable increase in shareholder returns. The gap between what the top brass earn compared to the rank and file has widened considerably too.

“It seems highly unlikely that this trend will be confined to the United Kingdom.”

—Bob Mecrate-Butcher,

Partner,

Charles Russell

Martin Taylor, a former Barclay's chief executive, has blamed the revolt on excessive pay in the financial sector. “Perhaps the most surprising thing about the shareholder revolts on pay is that they took so long,” he wrote in an editorial in the Financial Times. “By failing to handle a business problem at the proper time, the boards of banks have managed to turn it into a wider social issue that is resonating well beyond the banking industry.”

Binding Votes on the Way?

It's clear, too, that institutional shareholders want to show the government that they can flex their muscles. Frustrated by large shareholders' inability—or refusal—to deal with executive excess, the government is considering new legislation to control executive pay this year.

EXECUTIVE REMUNERATION PRINCIPLES

Below, the Association of British Insurers offers its principles of executive remuneration:

I.The Role of Shareholders

A.ABI members as institutional investors are interested in long-term value creation for the benefit of our ultimate clients. We have a fiduciary responsibility to our clients, who are primarily individual savers and pensioners.

B.This responsibility involves ensuring that clients' capital is allocated efficiently and that the companies we own are well governed and run in the interests of their shareholders.

C.As part of this, members seek to ensure that remuneration practices and policies of companies they invest in are aligned with shareholder interests and promote sustainable value creation.

D.ABI members are committed to responsible ownership as outlined in FRC's Stewardship Code, but it is not the role of shareholders to micro-manage companies.

II.The Role of the Board and Directors

A.Boards of Directors are appointed by shareholders to run companies and act in their interests. They have a fiduciary duty to act in the best interests of their shareholders when determining remuneration. It is their responsibility to promote the long-term success of the company, taking into account the interests of employees, suppliers, customers, community, the environment and society.

B.Executive directors develop and implement strategy for the company. Non-executive directors should constructively challenge and contribute to this process, scrutinise the performance of the executives, and ensure that risk management systems are robust.

C.Non-executive directors, particularly those serving on the Remuneration Committee, should oversee executive remuneration.

III.Remuneration Committee

A.Shareholders look to the Remuneration Committee to protect and promote their interests in setting executive remuneration. As directors, committee members are accountable to shareholders for the structure and quantum of remuneration.

B.Remuneration Committees should set remuneration within the context of overall corporate performance. Structure should be aligned with strategy and agreed risk appetite, reward success fairly and avoid paying more than is necessary.

C.Remuneration Committees should look at executive remuneration in terms of the pay policy of the company as a whole, pay and conditions elsewhere in the Group, and the overall cost to shareholders.

IV.Remuneration Policies

A.Remuneration policies should be set so as to promote value creation through transparent alignment with the agreed corporate strategy.

B.Remuneration policies should support performance, encourage the underlying sustainable financial health of the business and promote sound risk management for the benefit of all investors, including shareholders and creditors.

C.Excessive or undeserved remuneration undermines the efficient operation of the company, adversely affects its reputation and is not aligned with shareholder interests.

D.The board as a whole must consider the aggregate impact of employee remuneration on the finances of the company, its investment and capital needs, and dividends to shareholders.

V.Remuneration Structures

A.Undue complexity should be avoided and incentive structures should have a long-term focus.

B.Remuneration structures should be efficient and cost-effective in delivering strategy. The market environment, performance of the company and individuals, and the size and complexity of the business should be considered when determining remuneration.

C.Executives and shareholders can have divergent interests, particularly in relation to time horizons and the consequences of failure or corporate underperformance. Remuneration structures should seek to address this.

D.To avoid payment for failure and promote a long-term focus, remuneration structures should contain a careful balance of fixed and variable pay. They should include a high degree of deferral and measurement of performance over the long-term. Structures should also include provisions that allow the company to implement malus or claw-back arrangements.

E.Executives should build up a high level of personal shareholding to ensure alignment of interest with shareholders.

F.Dilution of shareholders through the issuing of shares to employees represents a significant transfer of value. Dilution limits are an important shareholder protection and should be respected.

Source: The Association of British Insurers.

The plan is to give shareholders a binding vote on compensation for the year ahead and a separate annual vote, requiring 75 percent approval, on how the company applied its remuneration policy over the previous year. To stop companies from rewarding executives for failure, shareholders would also get a vote on any severance payment to a departing executive in excess of 12 months' basic salary.

The European Commission is also working on a plan to give shareholders a binding vote on pay, with proposals expected later this year.

How shareholders would use a binding vote on pay remains to be seen. In Britain, they already have a binding vote on the re-election of directors, but during the Shareholder Spring they've voted to keep individual officeholders in place, even where they have voted against the executive pay report. Instead of chucking directors out, they've invited them to fall on their swords.

Nonetheless, the government's plans would give shareholders much more power to challenge pay packages and could have a major impact, says Bob Mecrate-Butcher, a partner at law firm Charles Russell. “There would need to be much more active consultation with investors and possibly a major shift of practice regarding executive severance packages and the drafting of service agreements.”

In the meantime, one clear lesson from Shareholder Spring is that companies need to rethink the way they engage with investors. The traditional methods of dealing with rumbling dissent— such as a quiet word from the chairman— have failed.

Ahead of the pay vote at industrial materials group Cookson, its chairman, Jeff Harris, wrote to investors asking them to vote in favor of the pay report. Over 31 percent of shareholders rejected his plea. Aviva and Trinity Mirror offered to change the pay packets of their chief executives, but that did nothing to calm investor anger.

After Aviva lost its vote on pay, Scott Wheway, head of its pay committee, said in a statement: “We, and I personally, recognize that we can and should have done more to engage with our shareholders.” Marcus Agius, chairman of Barclays, where a third of shareholders voted against its pay report, said sorry for not having done "a good enough job in articulating our case."

But not all boardrooms are bowing down to shareholder pressure. When bookmaker William Hill won its pay vote by a thin margin, Gareth Davis, its chairman, shrugged off the result. “We consulted all our major shareholders on remuneration. Most of those who are able to vote as they feel supported us, including our top two shareholders,” he said in a statement. Davis said the pay revolt was stoked by a “box ticking” approach to governance at proxy agency ISS.

Daniel Bellau, a partner at law firm Hamlins, is cautious about giving investors more power over pay. “There is an argument that an individual shareholder's activism might be borne out of self interest and not the interests of a shareholder class as a whole or indeed the best interests of a company itself,” he says.

Whatever their motivations, institutional shareholders are clearly more willing to throw their weight around. U.S. companies should take note, says Mecrate-Butcher. “It seems highly unlikely that this trend will be confined to the United Kingdom,” he says.