Shareholder Rules: Why a Compulsory Code Won't Work
Companies are bound by tight governance rules to satisfy shareholders. Shouldn't the playing field be levelled by giving investors a rulebook, too?
That's what Sir David Walker thought when he reviewed how the banks had come off the rails, but government thought any new code should apply to all companies and the author of the government rules for companies, the Financial Reporting Council, will shortly come up with a Stewardship Code for shareholders.
But will it work? The premise behind equity is that all shares are equal. But not all shareholders have common objectives. Traditional institutions such as UK life and pension funds now control only around 40 percent of the typical company.
Private shareholders have been gradually squeezed out too, though increasingly invest through collective vehicles that make decisions for them.
Some investors are activists, others buy because a stock is in an index. Hedge funds admit they are short-term shareholders: long-term investors sell as soon as a good offer appears.
How can one code suit such an assortment of shareholders? And how can it be policed? Why should an overseas investor play by UK rules, never mind an offshore hedge fund dealing in derivatives?
What sanction can a British watchdog hope to apply to such a ragbag of interests? Trying to engage with so diverse a group is headache that company chairmen already encounter and they solve it by approaching each group in a different way: trying to produce a one-size-fits-all code that covers everyone risks resulting in a rulebook that achieves little.
A stewardship code will set out terms of engagement for investors in contact with companies -- continuing the assumption that owners ought to scrutinize management and vote on all issues rather than take a view on a company and invest in it until their view changes.
So not only should shareholders not be 'absentee landlords', they should publish how they vote, even if they have no underlying investors to whom they answer.
In fact, the annual meeting and its endless polls would be increasingly irrelevant if engagement has turned confrontation into co-operation and resolved all conflicts beforehand by convincing shareholders to accept the corporate policy or making management change their practices.
And in reality, rather than engage actively with so many boards and report the outcomes, investors signing up to a code are likely to trim their portfolios, concentrating on a small number of large holdings despite the resulting lack of diversity. For companies, that means a smaller register but investors so large they can dictate the direction of the board.
When the stewardship code is produced, it would be wise to keep the rules as flexible as possible -- guidance rather than compulsion, principles rather than prescription, and capable of accommodating shareholders of all shapes, sizes and eagerness to connect with companies.
In an ideal world it would be voluntary but in practice, most institutions will be shamed into adopting the code.