Issue: December 2011 / February 2012


Actors must act

By fortunate coincidence, on the eve of the Code for Responsible Investing in SA (CRISA) being launched for implementation, Robert Monks has thrown down the gauntlet. His impassioned plea is marked by doses of realism.

There has been no effective response to the financial crisis by the US and UK governments. Neither have there been reform proposals which address the powerful incentives for myopic, short-term investment strategies that contributed to it.

The mode of stewardship is essential if owners are to be effective in preventing future financial crises. We must struggle to find a credible and persuasive call to action by institutional investors. There is no other solution.

The day is long past when the principal fiduciary of a trust organisation discharges his responsibility by maintaining a satisfactory growth in market values, with due regard to the corporations' public and social responsibilities. If our system is to survive, top public fiduciary shareholders must be equally concerned with protecting and preserving the system itself.

There is the quite understandable reluctance on the part of any one organisation to get too far out in front and to make itself too visible a target. The role of the UN Principles for Responsible Investment is therefore vital. Other organisations should join in the effort, but no other organisation appears to be as well situated as the UNPRI.

However, as Lord Paul Myners has trenchantly observed: “The expression of worthy sentiments does not automatically translate into useful results. I'd rather see proper governance conviction. It's hard to identify what the UNPRI has done so far outside of collecting a lot of names."

As every institutional investor knows, few elements of society today have as little influence as the millions of corporate stockholders. The shareholder is truly the forgotten man.

The threat to the system of "ownership capitalism" is not merely a matter of economics. It is also a threat to individual freedom. Shareholder silence has enabled power to accrue with an agenda not necessarily in their interest as owners or as citizens.

Shareholders, acting as responsible stewards, can require disclosure and prior approval of the use of corporate resources; they can impose limits. Nobody else can do this. And, if this is not done, shareholder involvement will continue to be trivialised.

Involved shareholders can require that their directors be meaningfully accountable. Shareholders are the first to appreciate that they should not manage enterprises in which they invest. Their role is more subtle. It’s to assure that those they have selected run the business according to the preferences expressed by the owners.

When I say "selected", what I mean in the context of directors is not that shareholders chose the persons who are to be nominated, but that those who are nominated meaningfully serve only so long as such is acceptable to ownership. Shareholders can and must exercise the power to remove directors as a way of compelling management to be accountable to their wishes as to who should be nominated.

The inability and unwillingness of institutional investors effectively to monitor and require accountability of management is one of the principal causes of the continuing financial crisis.

The whole question of specifying the precise interests of shareholders is complicated by the diversity of the shareholder population. It ranges from holders for a nano-second pursuant to a computer algorithm, to those permanent holders in index funds.

A certain arbitrariness is necessary in designating an individual beneficiary class. This will enable courts and enforcement agencies to put content into the new holistic accounting vocabulary.

Many reasons, not the least of which is relative size, suggest that the typical beneficiary of a defined-benefit plan with 18 years before retirement has a desire not only to have the funds for a comfortable life but also the desire to live in a clean, civil and conscious society.

Institutions do not participate as activist shareholders because they sense no legal imperative and they calculate no economic benefit from doing so. Indeed, when they do engage portfolio companies, they risk loss from unresolved conflict of interest inside their own organisation and from customers resenting what appears to be their intrusiveness.

In the absence of enforcement of the clear legal requirements that trustees must act as stewards of portfolio companies, the world of "shareholder activism" has, unfortunately, been defined by self-selection. Many fiduciary organisations have opted not to be involved.

There can be no effective corporate governance until, unless and to the extent that the major institutions become involved. This will not happen until and unless there is a formal legal policy that shareholder activism is in the public interest and is the national policy. Governmental response to the existing crisis does not give confidence that we are finished with major crises.

Stewardship will involve levels of expense, exposure to criticism, co-operation and focus heretofore lacking in global shareholder activism. The only energy that can inform and focus the creating of effective stewardship is recognition that it is the only course that will enable real limits on corporate conduct.

Ultimately, only the owners have power symmetrical with that of management and, therefore, capable of monitoring corporate impact on society. Stewardship is not only a necessary element to prevent harm; it is needed to protect value.

Also at stake is the sustainability of the traditional real return on equity investments at around 6% annually. Whether we live in a poor or an adequately-financed society requires an effective system of corporate governance. The absence of effective corporate governance threatens the scenario of adequate resources to meet societies' needs.

Shareholding institutions must take the initiative to protect their relevance as a wealth-preserving energy in a free society. They cannot wait for others, nor can they decline to act. Institutions must take the lead because all other courses have failed.

Robert Monks

For many years, Robert Monks has been one of the world’s leading proponents of shareholder activism. This is a summarised and edited version of his address in September to the International Corporate Governance Network, a non-profit organisation whose institutional members represent assets under management of some $18 trillion.