Businesses should be forced to pay a levy to support robust shareholder engagement, says Peter Butler, chief executive of Governance for Owners (GO), a UK shareholder rights partnership, because effective stewardship will only become a fixture of the institutional investment industry when it carries a big price tag. He spoke with Simon Mumme.
At the turn of the century, a market for shareholder engagement among institutional investors did not exist: many consultants advised pension funds not to spend money on stewardship – “because other people would pay for it, and they could free-ride,” says Butler, who developed Hermes’ Corporate and Focus Funds before co-founding GO, says.
But engagement has now become a prominent topic for discussion, as governments and the changing attitudes of memberships pressure funds to demonstrate how successful they have become at improving the governance and sustainability performance of investee companies.
“But by how much do they really do it?” Butler asks, adding that the ‘free-rider’ syndrome – in which inactive shareholders benefit from the stewardship efforts of active shareholders – still exists. He says the industry has not “got the foundations right” for effective and widespread engagement.
“It’s a two-part problem: who should do it, and who should pay for it? …[and] nobody has been looking at the more radical things that need to be done to address the causes of the problem.”Â
Butler reckons an ‘engagement levy’ paid by listed companies would fund a viable solution: this revenue stream would feed a pool of capital set aside to lure shareholder engagement specialists to compete for stewardship mandates among pension funds.
“The only way of dealing with the free-rider issue is some form of levy, and the easiest way of doing it is on companies,” he says.
“We need a competitive market for stewardship…We would create, through the levy, a market-based stewardship.”Â
His proposal applies only to the UK market, given the difficulties of introducing and policing an international levy. The cost to companies – a fraction of a basis point of their market capitalisation – would be larger for bigger businesses, and would apply only to the largest companies for an initial three-year period, to “see how it works”. For investors, it would seem like a good arrangement. But companies would only ever comply if it was forced through legislation handed down by the government, Butler says.
“I can imagine howls of protest, and I can understand [companies] not liking it. But by charging companies, at least all investors in that company are paying something towards stewardship. You’ve done away with free-riders and created a pot of money.
“None of this is easy. It’s all difficult. The only way it will happen is if the government comes in and wants it to happen.
“Everybody seems to believe that more stewardship is what’s needed. The question is how to do it.”
The capital drawn from companies would need to be used efficiently – otherwise the levy will seem like an abused tax – and the government should hold the power to claw back the money if engagement is not executed well.
To justify the levy, stewardship must become a professional function – not a bolt-on service provided by managers or pension funds, and be registered with financial authorities.
“Currently, it’s done pretty badly. I have a view that the best people, the most skilled and experienced people to engage boards of directors on behalf of shareholders, are those who themselves have had experience as directors, both executive and non-executive. They have credibility,” Butler says.
These qualified specialists would be paid an hourly rate – “at the level of a top lawyer or investment banker” – and work part-time. Butler says this attractive compensation would lure seasoned executives, and put them on par with what the directors of the investee company boards earn themselves.
“If there was more money, people would be attracted to it.”
Butler says extensive corporate experience is required from stewardship specialists. This is a major reason why fund managers might not be the best people to engage company boards.
“The funds management industry is dominated by bright young people who are focused on picking stocks,” he says. And when they try their hand at engagement, “not only is there an age gap, but a skills gap”.
“It’s not obvious that fund managers are the right people to effect governance, because their business model is about collecting and retaining assets under management. Once they’ve got that, they need to minimise their costs, and stewardship is expensive.”Â
One dimension of corporate governance that needs an immediate remedy is the shamefully predictable outcome that business people within the ‘directors’ club’ are voted to board positions, Butler says. This could be combated by forcing board nomination committees to reserve at least one seat for a major shareholder who would have a clearer understanding of what investors want from the company.
Currently, major shareholders are routinely neglected during nomination votes, he says.
“hen a head-hunter is searching for a CEO or chairman, how often do they engage with shareholders in the process? They say that companies don’t want to do it.
“The first thing in their process should be to talk to the 10 largest shareholders about what they think is needed by the company.”Â
So far, Butler has been consulted twice by recruiters in search of candidates to fill senior executive roles during his career in stewardship.
Butler says the levy would need to be proved worthwhile in the UK before any effort to apply it to international markets is made.
“If we can tackle, here, these issues and get them right, the rest of the world can catch up.”
GO is an independent partnership between large institutional shareholders, a long-term financial backer and senior GO executives.
