Share The Wealth

More militant institutions, egged on by a tabloid press working itself up into a fresh frenzy of ‘fat cat’ headlines, have been exercising their newfound right to vote on remuneration policies at AGMs. The biggest casualty so far has been GlaxoSmithKline, whose remuneration report was rejected by investors after a row over the severance package awarded to chief executive Jean-Pierre Garnier. But other companies have been forced to justify arrangements that don’t seem in tune with governance best practice.

Supermarket chain Safeway has been on the back foot over chairman David Webster’s contract, which runs to 2005, longer than the 12-month best practice recommended by the Greenbury report eight years ago. It also faced likely revolts against the two-year contracts of FD Simon Laffin and group services director Richard Williams at its AGM in July.

Investors voted down the remuneration report at Shire, Britain’s third-largest pharmaceutical company, over concerns about the pension payoff for former chief executive Rolf Stahel. And institutions criticised a £4.2m payoff to Brian Gilbertson, former chief executive of mining company BHP Billiton.

“Shareholder activism seems more intense now because of the visibility given to remuneration issues,” says Robin Key, a partner in the investor relations practice at Financial Dynamics. Yet while remuneration issues are grabbing the headlines, Key points out that much of the more important shareholder activism has been going on behind the scenes for some time on issues such as corporate strategy, capital structure, cashflow and balance sheet issues. This is likely to continue and be more important for corporate policy-making than public rows over remuneration.

Even so, boards shouldn’t take the remuneration issue lightly, whatever the fate of Rewards for Failure, the much-criticised consultative paper produced by DTI secretary Patricia Hewitt. The National Association of Pension Funds and the Association of British Insurers says the advice contained in its own statement on executive contracts and severance pay is starting to have an effect, making the need for legislation less pressing.

And there have been a few signs in the past couple of months that some companies are bowing to shareholder activism and taking a more circumspect line over contracts and severance. Under pressure, chemicals giant ICI altered the severance package of former chief executive Brendan O’Neill so that he receives only six months pay and benefits (instead of a year) if he finds a new job on the same or better terms before the six months are up.

Yet beyond the cut and thrust of individual remuneration packages lies some behind-the-scenes activity that could end up having more impact on shareholder activism in its broadest sense than anything seen so far.

NAPF recently hired Matthew Gaved, former editor of the magazine Governance, to work on a root-and-branch revision of NAPF’s governance guidelines.

Geoff Lindey, strategic adviser on corporate governance at NAPF, calls it a taxonomical approach. “We’re developing a classification of different corporate governance issues and then determining what the best practice is in each area,” he says. Lindey believes the work could result in a completely new set of corporate governance guidelines by the end of the year.

NAPF is also reviving its use of case committees. The idea is that any institution with concerns about an investment can make informal contact with other investors with similar concerns before approaching the target company for private discussions. “We might have investors with, say, 15-20% of the company before approaching it,” says Lindey. “This would be done with no publicity at all.”

A third area that could lead to more shareholder activism of this kind is NAPF’s joint venture with US-based governance organisation Institutional Shareholder Services. From January 2004, the new company will offer a service to NAPF’s existing clients and ISS’s UK customers. Advice will be based on voting recommendations determined by NAPF.

Given that US and Canadian companies own about 30% of UK shares, the new service will strengthen NAPF’s influence considerably. Significantly, the service will, for the first time, extend beyond the FTSE-350 to the All-Share Index. Between them, NAPF and the Association of British Insurers could represent as much as 70% of the equity market.

This concentration of power could prove even more potent if the Cooperative Insurance Society’s policy of publishing its complete voting record catches on among other institutions. Last year, the CIS voted on 12,043 motions at 1,551 AGMs. “Institutions have a duty to exercise their voting rights,” says chief operating officer Finion O’Boyle. “Companies have an opportunity to express an opinion on a wide range of issues, and in the interests of transparency institutions should reveal how and why they have voted on any one issue.”

Not all institutions see it that way. Michelle Edkins, head of institutional relations at Hermes, told an NAPF conference that discussions with companies should remain private. “We want to support our investments, not damage them through public spats,” she says.

But whether they are public or private, shareholder activism is going to be a potent new force and FDs will need to learn new skills to manage it. “FDs need to keep up with the broader issues that dominate the news agenda, be it remuneration, balance sheet organisation or pressure for share buy-backs.” Being alive to what’s happening in the wider world might provide some insight on where shareholder activism will roll next.

DRIVING BETTER PERFORMANCE Consultancy Stern Stewart has developed three pay and performance metrics it believes drive the kind of behaviour that will both increase long-term shareholder value and allow companies to measure the links between pay and company performance.

Economic Value Added (EVA) – net operating profit after a tax, less a charge for the capital invested in the business – encourages managers to do four things that increase value, claims European MD Erik Stern.

1. Increase returns from the business’ assets

2. Invest additional capital and aggressively build the business as long as the returns on new investments exceed the cost of capital

3. Release capital from existing operations where the returns are inadequate

4. Reduce the cost of capital

The Wealth Added Index (WAI) improves on total shareholder return as a performance measure, while Relative Wealth Added (RWA) measures how a company performs against a peer group. Stern advocates using the two in conjunction – RWA for the short term and WAI for the long term – to encourage managers to beat their peers over the business cycle. “Maximising EVA (improves) wealth added and should be considered a basis for incentives,” says Stern.