'The failure of the Royal Bank of Scotland'

Even the title of this report carries the sense of gloom that fell upon the streets of many of the cities and towns in the UK in the autumn of 2008. Royal Bank of Scotland, one of the world's largest banking groups following its acquisition of National Westminster Bank at the end of the 1990s, had gone too far when it led a consortium of bank to buy and break up the Dutch bank ABN Amro. That deal – combined with the subprime crisis - was its undoing. Three years later, and after much prodding, the Financial Services Authority has released a blockbuster report – detailing the bank's and the regulator's failings – in the affair. While the global market context played an important role, the FSA devoted consideration space to the problems of leadership and governance at RBS, and noting: "banks are run by people and those in board and senior management positions are responsible for the decisions they make. It is only with hindsight that it is clear that there were specific decisions taken by the RBS Board and senior management which placed RBS in a more vulnerable position than other banks when the financial crisis developed between 2007 and 2008." The expression "only with hindsight" may be that the regulator's foresight wasn't very good at the time, when quite a few people, including some shareholders, wondered whether RBS had taken a step too far. The FSA says that beyond the mistakes in the ABN Amro takeover, the errors at the top included:

• Capital: Keeping RBS lightly capitalised in order to maintain an "efficient" balance sheet.
  
• Funding: Adopting a business model that was highly dependent on wholesale funding and therefore choosing to run with a high level of liquidity risk.;
  
• Lending: Expanding commercial real estate lending with inadequate monitoring and mitigation of concentration risk.
  
• Asset allocation: Rapidly increasing lending in a number of other sectors which subsequently gave rise to substantial losses, eroding RBS’s capital resources.
  
• Structured credit: Expanding the structured credit business in 2006 and early 2007 when signs of underlying deterioration in the market were already starting to emerge.

These are first-level errors, but they point to underlying factors that made them systemic. The FSA inquiry went beyond board minutes, pursuing through interviews and other means to reach a view about how the culture, management and governance led to such a catastrophic situation. It does not make happy reading, especially for a bank that nominally complied with pretty much all the demands of the UK Combined Code.

"The FSA announced in December 2010 that, in the context of its enforcement work:

'We did not identify …… a failure of governance on the part of the Board.'

"However, it is important to note that this conclusion was reached in the context of whether there was a basis for the FSA successfully to bring an enforcement case in relation to the issues that were investigated," the FSA continues. "It should not be regarded as providing a positive assessment by the FSA of the general quality of corporate governance at RBS during the Review Period." Perhaps that's another sign of the failings at the FSA.

Source document: The index page for the report provides links to a section-by-section breakdown as well as the full 452-page document.

SEC chairman wants better 'engagement', whatever that is

Mary Schapiro has been a regulator and a board director. As chairman of the US Securities and Exchange Commission, she's in charge of drawing up rules that govern the relations between companies and their shareholders and she thinks better engagement is a good thing. The problem is, she doesn't know what it means. "Effective engagement is a strong positive. But, in attempting to foster effective engagement we face a challenge: the definition of 'effective engagement' is imprecise," she told the Transatlantic Corporate Governance Dialogue, a conference of practitioners, regulators and academics. "In fact, the definition of effective engagement can vary significantly from company to company, as investors and boards interact in very different ways, but achieve similarly positive financial results and equally satisfying relationships between shareholders and boards," she added.

The SEC is trying to define it, at least in part, by looking again at disclosure, but also at voting processes. It is considering whether to regulate the proxy advisory industry and perhaps doing something about ensure vote confirmations are more fixed. It's looking into enhanced disclosure concerning beneficial ownership and the reporting of equity swaps, too.

Source document: The Schapiro speech gives further details.

There's more to corporate governance than governance

Annie Pye is one of those academics who pick a topic and won't let go. Back in 1988 she started interviewing directors of UK corporations, work that continued a decade later once the Cadbury Code had come to dominate UK board practice. Her team at the University of Exeter has been at it again. This is not just a random sample survey approach. In many cases they have been talking to the same senior people for decades. The latest version comes with a quantitative element, focusing on boardroom and executive pay, and well as profiles of board composition. Her work details how each major corporate scandal has led to increased regulation. Each cycle of boom and bust has been succeeded by wider, deeper and longer-lasting recessions. "Ever more regulation shows an increasing trust in a system of rules rather than in the people who run companies. If this pattern persists then perhaps the next step is global regulation which my research shows is neither feasible nor desirable," she notes. "In other areas very little has changed – the number of women on boards remains pitifully low and the relationship between Chief Executive and Chairman remains crucial and defines the effectiveness, or otherwise, of boards."

Non-executives: The report notes that regulatory changes may have sharpened the role of non-executive director, but they have "also exacerbated its paradoxes". Non-execs must be coaches and referees, support and challenge, and remain independent even as they share hopes and aspirations with the executive with whom they serve.

In this uncomfortable state of affairs, corporate governance still seems important, but the report concludes – as her previous work did – that codes and regulation may be necessary, but they aren't sufficient for board effectiveness. "There is more to corporate directing than corporate governance," the latest report concludes. "Responsibility for setting direction/strategy, risk management, leadership, corporate conduct, reward and incentives, reputation and performance remain key elements of a director's governance role."

That is, there's more to corporate governance than corporate governance.

Source document: The synopsis of the report is a 12-page pdf file.

Olympus should 'remove its malignant tumor'

The investigation by a committee of prominent outsiders recommends large changes in the culture and governance of Olympus Corp., the Japanese camera-maker caught up in a crisis after firing its new CEO for questioning payments and acquisitions made by his predecessor and approved by the board. When the scandal broke, the board belatedly appointed what it called the "Third-Party Committee", a team of lawyers and accountants headed by a retired judge, to find out what had happened. Though the report was not comfortable reading, it gave some succour to the workforce: "Olympus had originally been a sound company, with diligent employees and high technical strength. Not all part [sic] of the company was involved in this misconduct," the committee's report concludes, with the following sting in the tail: "Olympus should remove its malignant tumor and literally renew itself."

Source document: The Third-Party Committee report is a 38-page pdf file, in its unofficial English translation.

Voting disclosure too much of a good thing?

Pension funds would seem to be the archetypal investor in equity markets. They hold assets for long periods and look for sustainable investments, and they are thus the natural partners for strategic conversations with corporate management. Mutual funds, by contrast, are vehicles for shorter term performance, and mutual fund managers become obsessed by – because their clients obsess about – the latest quarterly fund performance metrics. They are natural shareholder activists, demanding that corporate management stays on its toes, delivering the numbers every three months. But there's a problem, one long noted among both theoreticians and policy-makers: Mutual fund managers often administer corporate pension funds. There's a danger they will tone down their activism for the sake of winning and retaining pension fund business, and use their proxy votes in a pro-management manner, thus hindering shareholder value. Such concerns led the US Securities and Exchange Commission to require that mutual funds disclose their proxy votes, starting in 2003.

A study at the London School of Economics has come up with a model of mutual fund proxy voting in the presence of potential business ties, suggesting how funds would vote both prior and subsequent to mandatory disclosure. It claims to "demonstrate that mandatory disclosure is not a panacea". Moreover, the strategic interaction between multiple mutual funds holding blocks of shares of comparable size can generate counterintuitive relationships.

"These findings raise the question of whether disclosure is a desirable regulation, even from the perspective of those in support of shareholder activism," they suggest.

Source document: The working paper "Delegated Activism and Disclosure, by Amil Dasgupta and Konstantinos Zachariadis of the London School of Economics, is a 38-page pdf file.

Activism - Can't walk? Can't run? Hide?

It's long been argued that institutional investors are the natural safeguard against managerial opportunism. Institutions hold blocks of shares large enough that their voices are taken seriously by management. Even those that choose not to engage actively can have an effect through what a now-famous research paper once called the Wall Street Walk. It's a catchy title for a simple phenomenon: If they don't like what a company's management is doing, shareholders can sell their shares and go away. The argument about the Wall Street Walk is, however, that if the blocks of shares are big enough, and if management is conscious of share price developments, then corporate governance exercised through "exit" can be as effective as when it's undertaken by "voice".

Now a new study has shed some doubt on those conclusions. Very often a shareholder in possession of the block isn't really the principal, but rather another agent in a long chain of agency. "How do agency frictions arising from the delegation of portfolio management affect the ability of blockholders to govern via the threat of exit?" the researchers wonder. "We show that when blockholders are sufficiently career concerned exit will fail as a disciplining device. Our results have testable implications on the relative degree to which different classes of delegated portfolio managers use exit as a form of governance."

It's worth noting that the "blockholders" mentioned aren't the ones we know so well in continental Europe. Holders of very large, controlling stakes often can't exit at all, but they certainly can exercise voice.

Source document: The discussion paper "The Wall Street Walk when Blockholders Compete for Flows", by Amil Dasgupta and Giorgia Piacentino of the London School of Economics, is a 42-page pdf file.

Selective access remains, even after 'end' of selective disclosure

Regulation FD – for "fair disclosure" – was meant to have ended the pernicious effects of selective disclosure in the US equity market, but there are signs that the benefits of selective access remain. Investors continue to seek the chance to meet corporate managements and quiz them about their plans, even though executives are under strict orders not to stray from the official story. Regulation FD came into force in the US about a decade ago, one of the reactions to the dot-com bubble, when stocks were being ramped up by investment banks, bought and then dumped by investors-in-the-know. In its aftermath, the authorities in jurisdictions around the world either introduced or tightened their own disclosure obligations to create a new ethos of openness. It led to a wave of webcasting and similar other measure to use technologies to prevent some people learning more than others. Everyone should know all, or at least everything that anyone knew.

So what's happened in the intervening decade? A study by three US scholars has examined the practices surrounding two potential opportunities for selective access, even if they may not confer selective disclosure:

• Conferences: Invitation-only investor conferences, where senior managers present the company's plans and positions.
  
• Roadshows: Formal "offline" meetings that outside of the webcast presentation and CEO attendance at the conference.

"We find significant increases in trade sizes during the hours when firms provide off-line access to investors and after the presentation when the CEO is present," they write. This result is consistent with selective access providing investors with information that they perceive to be valuable enough to trade upon, they conclude. Significant potential trading gains occur over three- to 30-day horizons after the conference for firms providing formal off-line access, suggesting that this selective access is profitable, too. "While we cannot conclusively determine that managers are providing selective disclosure in these off-line settings, our evidence does suggest that selective access to management conveys more benefits to investors than public access even in the post-Reg FD period," they write.

Source documents: A discussion of the findings appears on the Knowledge@Wharton website. The working paper "Do Investors Benefit from Selective Access to Management?," by Brian Bushee of Wharton, Michael Jung of New York University and Gregory Miller of the University of Michigan, is a 53-page pdf file.

Brussels pushes for shake-up of audit

The European Commission is pressing ahead with rather radical plans to transform the market for audit services in the European Union. In one possible scenario the draft regulation might see a reconfiguration of the networks of the Big Four accountancy firms and a split between audit and non-audit services. The key elements of the planned regulation are:

• Mandatory rotation of auditors: With some exceptions, organizations would need to change auditors every six years, and there would be a "cooling off" period of four years before an auditor could return to work for the client.
  
• Mandatory tendering: Audits of public-interest entities would be made by an open tendering process, in which the organisation's audit committee would play a central role.
  
• Ban on non-audit work: Audit firms would be barred from providing non-audit services to audit clients. Large firms would need to legally separate audit and non-audit activities to reduce conflicts of interest.
  
• EU supervision: Regulation of the audit industry would be overseen by the European Securities and Markets Authority.
  
• EU passport: Auditors in one member state could offer audit services in others under a "passport" system. This would make it easier for smaller audit businesses to compete with the big networks.

Internal market commissioner Michel Barnier said: "Investor confidence in audit has been shaken by the crisis and I believe changes in this sector are necessary: we need to restore confidence in the financial statements of companies. Today's proposals address the current weaknesses in the EU audit market, by eliminating conflicts of interest, ensuring independence and robust supervision and by facilitating more diversity in what is an overly concentrated market, especially at the top-end."

The commission's proposal is for what the special language of Brussels calls a "regulation". That means that whatever measure is finally adopted by the European Parliament and the European Council of national governments would become mandatory across all 27 member states, without scope for national variations in approach.

Source documents: The draft regulation is an 87-page pdf file. The version we saw was a late draft, due to be replaced by a final version with the correct date. The audit website has links to other documentation.

UK chairmen slow to use reports to inform governance – Grant Thornton

Chairmen of the larger UK companies have missed the opportunity to steer corporate governance through their reporting to shareholders. A study by the accountancy firm Grant Thornton suggests that only one in 10 of the chairmen of the top 350 companies shed any genuine light on their companies' governance in the annual report. The new UK Corporate Governance Code, adopted in May 2010, called upon chairmen to "report personally" on corporate governance, rather than delegating the practice to, say, the company secretary. Moreover, the Financial Reporting Council March 2011 guidance on board effectiveness emphasised a need for the chairman's guidance and direction for the board. Grant Thornton said: "As old challenges are addressed, new ones emerge," and then listed several:

• Gender bias: Seventy two per cent of companies do not discuss gender, with only 6 per cent measuring and describing their progress against gender quotas and 140 companies still having all-male boards
  
• Audit tenure: The average tenure of a FTSE 350 audit appointment is 34 years, with 248 companies making no mention of when they last tendered their external audit
  
• Internal control: Only 25 per cent of companies give real insight into how they review the effectiveness of their internal control systems
  
• Board evaluation: External board evaluations may have been embraced by nearly all companies, but only 24 per cent share the outputs of such evaluation

The report notes that the European Union is examining whether voluntary codes are really the best way to conduct corporate governance. "Our review suggests that the Code's 'comply or explain' approach has achieved significant success over the last ten years," it said. "But, as stakeholders and regulators call for more informed reporting, the bar will continue to rise. So, as guidance and practice evolve, companies and the audit committees must recalibrate their expectations."

Source document: The Grant Thornton review is a 33-page pdf file.

Moody's wary of Europe, affirms US rating

Moody's Investor Services has signalled its worry that the creditworthiness of the eurozone and even European countries outside the 17-country bloc is threatened by issues with sovereign debt in the area. "In the absence of policy measures that stabilise market conditions over the short term, or those conditions stabilising for any other reason, credit risk will continue to rise," it said. Some countries may lose access to funding in light of the lack of political impetus to find a solution, threatening to move those countries' ratings into speculative grade. Moody's said the likelihood of "even more negative scenarios" had risen in recent weeks. Moody's said: "the situation is fluid and fast-moving. Policymakers are likely to respond to the escalating risks with new measures, the credit implications of which will require careful consideration. In the meantime, new shocks to financing conditions -- whether the announcement of new programmes or simply a further acceleration in the rise of funding cost across the euro area -- are likely to lead to selective rating changes."

By contrast, the failure of a so-called "supercommittee" of legislators in the US to reach a political agreement on budget deficit reduction will not affect the country's Triple-A rating, the agency said. That's because the lack of agreement triggers an automatic cut of the same amount. It added, however: "the committee outcome indicates that significant deficit reduction measures are unlikely to be adopted before the November 2012 elections". Moody's currently has a negative outlook on the US rating given the need over time for further deficit reduction to reverse the country's upward debt trajectory.

Source documents: The eurozone warning followed hard upon the US affirmation.

After Olympus, Japanese government rethinks company law

The Japanese government is planning to revamp company law in response to the ongoing controversy of mysterious payments made by Olympus Corp., exposing by the abrupt firing of its newly appointed, non-Japanese CEO last month. The ruling Democratic Party of Japan is holding one inquiry, and the Legislative Council, which advises the justice minister, is conducting a second review, according the Yomiuri Shimbun, a major Japanese newspaper. Current company law provides two options: a board of directors with a separate board of internal auditors, or a US- or UK-style board with an audit committee, as well as other committees where outside members dominate discussions of remuneration and nomination. Despite the greater transparency and accountability of the second type, only 63 of the country's 4,000-odd listed companies use it. Moreover, Yomiuri reports that only about half the listed companies have any outside directors on their boards.

Last month, the Japan Association of Corporate Directors released a corporate governance survey showing that only 61 per cent of the outside directors on Japanese listed companies were independent of management, and only 35 per cent of the 577 companies listed in the first-tier of the Tokyo Stock Exchange had appointed any. Among larger listed companies, those in the Nikkei 100, more than two in five lacked any independent directors.

Source documents: The Yomiuri news story gives an overview. The JACD report is a seven-page pdf file.

Guarded responses to EU corporate governance consultation

Some clear views emerged from responses to the European Union's green paper on corporate governance earlier this year, though it's far from clear whether the ideas it tossed into the debate will see the light of legislation. The consultation attracted more than 400 responses, a large number for a specialist subject, and for a green paper, which by definition is still quite a long way from generating legislation. In its summary document, the European Commission avoided strong policy guidance – that may come later – but it did give its view about what the respondents had to say.

• Tiered recommendations: A majority of respondents – of those, that is, who expressed a clear view – rejected the idea that member states should develop different governance recommendations for large and smaller companies. "Opposition to the idea was particularly strong from business (companies and business federations) and investors (both institutional and retail) alike," it noted. The summary of arguments against is so powerful that you have to wonder who supported the idea.
  
• Codes for unlisted companies: Here the views split, and in a way that would seem to make it difficult to create a policy. Some 70 per cent of respondent took a clear stance, and of those 70 per cent didn't like the idea that the EU should get involved. The other 30 per cent, however, were pretty uniformly representatives of employees, retail investors and civil society groups, pitting the big and powerful against the small and defenceless.
  
• Split chair and CEO: Three quarters of the respondents were clear on the matter, but that's as far as clarity goes. Half those with clear views wanted a split, the other half didn't. Employees, institutional and retail investors, civil society groups, the insurance sector, proxy agents and accountants were generally in favour; companies were generally opposed.
  
• Diversity and skills: What should EU policy say about recruiting the right skills to the board, and the right mix? Here the responses were muddy. Some of those who liked the idea of a strong policy didn't want the EU to get involved in enacting it. National standards would be more appropriate. Others wanted the EU involved, but only with "soft law". Others saw no need. If this were any provision other than the one involving the gender mix on boards, you would expect to see no action at all. This question wasn't quite the same as two others:
  
• Diversity policy: Most respondents thought it would be okay to tell companies to publish a policy statement, on the basis that transparency would give investors the information to act as they saw fit.
  
• Gender balance: Should listed companies have to have a certain proportion of women on the board? The majority rejected a compulsory quota system, like the one that operates in Norway, but some thought a policy that urged companies to adopt a target was fine.

And more. Limiting the number of directorships an individual could hold didn't win very much favour. The idea of getting an outsider to conduct a board evaluation every three years split the respondent pretty much down the middle.

Source document: There are more questions and answers in the feedback statement, an 18-page pdf file.

EU pushes for country-based financial reporting

The European Commission is seeking changes to the Transparency Directive of 2004 and two accounting directives to require listed companies and large private ones to reporting their financial results on a country-by-country basis, and not just on a global level. It also plans to widen the range of reporting required when an investor builds a stake in a business, to include all instruments with a link to equity, rather than just the shares themselves.

• Country-based reporting: The move is quite a controversial one, and not just because of the increased cost associated with it. Country-based reporting could yield a trove of commercially sensitive information for competitors, and especially those based outside the EU, who would not have to make such disclosures themselves. Moreover, such reporting could expose the value of individual customer transactions or trading volumes, if a reporting company has only one or two clients in a particular jurisdiction. More importantly from an investor's viewpoint, country-based reporting may have little to do with the shape of the business model for some companies. But, as the commission points out, investors are not the prime beneficiary. Rather, this move is intended to give outsiders a view. The commission puts it this way: "Reporting taxes, royalties and bonuses that a multinational pays to a host government will show a company's financial impact in host countries."
  
• Stake-building: The reason for this proposal is to reduce scope for market abuse, and it follows cases of covert stake-building in a variety of companies through the use of derivative instruments, including contracts for difference. Of particular note was the market distortion surrounding the failed attempt by Porsche to build a stake in Volkswagen, and the resulting attempt by Volkswagen to secure control over Porsche. It wants trading in all instruments to be reported, once they achieve a certain threshold.

At the same time, the changes to the directive would end a requirement for small and medium-sized companies to report on a quarterly basis.

Source document: The proposal is a 25-page pdf file.

EU wants curbs – but not stops – on sovereign ratings

When the shot came, it fell short of its threatened power of penetration. The European Commission is laid out paid to regulate the credit rating industry in quite fundamental ways, but not quite so fundamentally as the commission itself had trailed in the weeks before the announcement. Credit rating agencies already have to register to do business in the European Union. If the commission's plans go ahead, they will need to do a lot more than that. The commission's plan seeks to achieve four main goals:

• Reduce investor demand: Institutional investors use credit ratings in lieu of making their own analysis. So the commission wants to eliminate many references to ratings in the Capital Requirements Directive and then require financial institution "to do their own due diligence".
  
• More transparency and frequency: Ratings of sovereign debt will need to be issued at least every six months, not once a year, as it is at present. Moreover, agencies will need to inform investors and governments of the reasons for the ratings. Ratings should only be published after close of business to avoid disrupting the market.
  
• Reduce conflicts of interest: The commission wants greater diversity of ratings and greater independence. So it proposes that borrowers rotate their ratings agencies every three years. Two ratings would be required for more complex structured products, and a big shareholder of a credit rating agency should not simultaneously be a big shareholder in another credit rating agency.
  
• Greater accountability: Ratings agencies should liable for infringements of the planned "regulation", if they did so intentionally or with gross negligence, and thus harm the investor who relied on the rating. Investors "should bring their civil liability claims before national courts", it said. "The burden of proof would rest on the credit rating agency."

The plan involves both a "directive" and a "regulation". In the parlance of the European Union, a directive is only outline legislation, which member states then "transpose", giving the law its final form. A regulation is fixed; member states have to enact it as is. The directive here concerns how investors use ratings. The regulation affects the agencies themselves.

Internal Market Commissioner Michel Barnier said: "Ratings have a direct impact on the markets and the wider economy and thus on the prosperity of European citizens. They are not just simple opinions." Indeed, they are not simple at all. "We can't let ratings increase market volatility further. My first objective is to reduce the over-reliance on ratings, while at the same time improving the quality of the rating process," he added. "Credit rating agencies should follow stricter rules, be more transparent about their ratings and be held accountable for their mistakes. I also want to see increased competition in this sector."

Barnier said, correctly, that rating agencies have made serious mistakes, too. But others of his concerns seem less clear-cut. He worried, for example, about the timing of announcements of rating changes. Why did the agencies make rating changes during the negotiations about an international aid programme for a country? Why? Because the risk profile of the borrower that changed materially, which might materially impair investors' assets.

Source document: The project website has links to the news release and related documentation.

Shaking the habit of ratings – or debt?

When addicts try to come off drugs, they often suffer symptoms of the withdrawal. They sweat more profusely and more easily. They grow paranoid, thinking everyone is out to get them. They get angry and lash out, sometimes inappropriately. The crisis in European sovereign debt feels a little like that sometimes. Now we read these words:
Ratings currently have a quasi-institutional role. We need to reduce our reliance on them.

They come from the European Commission's news release concerning plans for what the European Union calls a directive and a regulation on credit ratings. While the commission backed off its threat to demand that rating agencies withhold comments on sovereign borrowers that undertake financial restructuring, its plans are still at best something to address the symptoms without addressing the cause. Cold turkey it isn't.

Ratings do have a "quasi-institutional role", but that's because they are designed to give confidence in and achieve legitimacy for the borrowers and their ability to pay back their loans. Suspending credit ratings in a time of distress would make little sense as the suspension would be just a downgrade in disguise. One way or the other, credit ratings would still be a part of the institutional framework in which public borrowers operate. Reducing reliance on them could mean things like ensuring that legislation and regulation avoids measures that embed credit ratings in their fabric. But it's not really the borrower or the legislation that "relies" on ratings. The investors rely on them as a check on the system, as a mechanism to ensure the borrowers don't lie. Borrowers "rely" on credit ratings the way a drug addict "relies" on needles. Borrowers "need" money the way a drug addict "needs" a fix.

The solution to the sovereign debt issue in Europe is likely to involve a slow and painful adjustment to the withdrawal of money. Only when that happens will the reliance of credit ratings disappear. If the credit ratings themselves disappeared while the need was still present, borrowers would still be in a fix.

Source document: The news release outlines the commission's planned move.

Consob commissioner sees virtue in governance dualism

Luca Enriques is both a scholar and a practitioner. His seat at the University of Bologna has been empty much of the last several years that he has spent on the Italian securities commission Consob. He brings, therefore, a dual perspective to issues in corporate governance and financial regulation, and he thinks the dual tracks may be the right way forward. He told a meeting of the European Union's Corporate Governance Forum in Warsaw to cut through the red tape company law needs to head in two different directions, which some people may find contradictory.

• Protection against expropriation …: Investors in European companies need better protection from managers and dominant shareholders, who can extract economic rents at the cost of "minority" shareholders. Europe needs to extend rules on insider trading to require notification of trades by controlling shareholders as well as managers.
  
• … but with limited application: Controlling shareholders are a big and powerful force, and they would seek to block such legislation, enlisting other vested interests in their support. So Enriques suggests the new rules apply only to companies newly coming to the stock market. "A new regime, lighter in terms of strings attached to ordinary course of business, non-conflicted decisions, and specifically and effectively addressing expropriation by managers and dominant shareholders, could be one way ahead," he said.

To get around the stigma of a company listing under a lighter weight regulatory regime, he suggests that such newly listed companies would, by default, still meet the tighter rules, but could choose to opt out of them in exchange for greater minority protection.

Source document: The remarks of Enriques can be read in full in a five-page pdf file.

SEC chairman sees more rules, soon, on governance and pay

Mary Schapiro thinks that investors are pretty happy with the say-on-pay rules in the US, used for the first time in the proxy season this year. The chairman of the Securities and Exchange Commission said she hoped it would lead boards to start asking themselves some penetrating questions. But say-on-pay is only the most high-profile of the measure that the SEC has had to deal with in response to the Dodd-Frank Act, and there's more to come, soon.

• Proxy voting services: The SEC staff are looking into possible rules to governance the governance agencies and their perceived conflicts of interest, where concern has grown with the introduction of say-on-pay. "I can’t guarantee our timing in light of all that we have on our plate," Schapiro told an industry workshop. "I hope we can address concerns over their role, including disclosure of conflicts of interest and the information upon which they base recommendations, by the end of the year or early in 2012."
• Four other measures: The Dodd-Frank Act requires the SEC to make rules in four further areas relating to governance and compensation matters: pay ratio, pay-for-performance, claw-backs, and employee hedging of company stock. Schapiro said she recognised that the requirements may be costly to implement. "As we move forward, however, please keep in mind that the statutory framework for these rulemakings is, in some cases, quite prescriptive," she added. "As with all other aspects of Dodd-Frank implementation, we have made outreach to stakeholders a linchpin of our rulemaking efforts. I encourage you to reach out to us as we work to complete our Dodd-Frank requirements and to address other issues of concern." Subtext: "not my fault."

While the act doesn't set a deadline for SEC rulemakings, the SEC itself has. It hopes to propose them by the end of this year or early in 2012.

Source document: The Schapiro speech gives further details of her views on the virtues of say-on-pay.

Study shows political spending, board oversight on the rise in US

This is one of those stories journalists like to call "dog bites man" – that is, it's no surprise. Such stories are rarely worth reporting. But this one is. Two think-tanks – the Investor Responsibility Research Center and the Sustainable Investment Institute – have been looking into how much money has been flowing from US corporations into the political system, and who's responsible for it. They found that the boards of 31 per cent of S&P 500 companies now explicitly oversee such spending, compared to 23 per cent in 2010. This increased oversight and transparency does not, however, translate into less spending. Companies with board oversight of political expenditures spent about 30 per cent more in 2010 than those without such explicit policies.

It's been almost two years now since the US Supreme Court ruled that companies could make unlimited campaign contributions and other donations to political parties. That made political giving an issue for board scrutiny because of its potential dimension and the resulting materiality of the cost. It also made such gifts a tool for corporate strategy.

Source document: The IRRC-Si2 report "Corporate Governance of Political Expenditures: 2011 Benchmark Report on S&P 500 Companies" is a 92-page pdf file.

Shareholders value female directors – look at the share price

Around the world, the movement to get more women on boards of directors in gaining momentum. The move comes in part of the dissatisfaction that all the things we've tried in corporate governance haven't seem to have provided any benefit. If the "problem of corporate governance" is rampant executive pay, without demonstrable downside risk for the executive and without demonstrable upside benefit for shareholders, then clearly not much has happened. The "agenda problem" of the literature is still in full force. If the "problem" is risk management, in which corporate governance is an insurance policy, then the insurer has gone bust. Again. So all the mechanisms of incentive alignment, board independence, structure, procedures and disciplines haven't done the trick. Perhaps it's time to try something else.

According to a study by three Asian-based scholars, there is some evidence that putting women on boards helps the share price. Their working paper uses data on mandatory announcements of new director appointments, and the analysis shows that on average, "shareholders value additions of female directors more than they value additions of male directors". Moreover, companies with workplace practices that promote workplace equality seem to benefit the most from boardroom gender diversity. "This suggests that appointing female directors may help resolve value-decreasing stakeholder conflicts," they conclude.

This isn't just another study. The leader of the research, Renée Adams at the University of Queensland, was author of a related study a couple of years ago that showed rather mixed messages coming for woman on boards. Simplifying a subtle argument a bit too much, they found gender-diverse boards were better at monitoring but less good at strategising.

Source document: The working paper "Does Gender Matter in the Boardroom? Evidence from the Market Reaction to Mandatory New Director Announcements," by Renée Adams and Stephen Gray of the University of Queensland and John Nowland of City University in Hong Kong, is a 55-page pdf file.

What good are independent directors?

Some good, and possibly quite a lot. A study of German companies, focused on the role that outside directors play on supervisory boards, threw up evidence that for innovation, the right outsiders can bring a lot of benefit. Three academics examined the patent applications of innovative companies to see if there was a link to the configuration of the boards. Supervisory boards can be quite distant from the business. They have no representation of senior management. Moreover, the German variety must also have half the seats in the hands of members of the ordinary workforce. So logically, you might think, such boards would serve a narrow, compliance function. That's not the place to expect to see new ideas getting knocked around, leading to the occasional stunning breakthrough. But this study shows a rather different story. Based on panel data of the largest German companies the econometric analysis they found a "robust and significant positive influence of external executives on innovative firm performance", as measured by patent applications. When the outside directors came from innovative companies patenting activities were higher. When people from non-innovative companies dominate, the opposite occurs. "The results indicate that outside board memberships can serve as a channel for scarce specific knowledge and expertise," they conclude. It's a conclusion a lot of directors would like to believe, too.

Source document: The research paper "Outside Directors on the Board and Innovative Firm Performance," by Benjamin Balsmeier , Achim Buchwald and Joel Stiebale of Nottingham University Business School, is a 50-page pdf file.

Climbing Mount Olympus – the story of lesser peaks

There's a saying in corporate governance – and in economics – that we settle for second best because having climbed the lesser peak, it's too difficult to go down and climb a higher one. Having got to the top of a smaller mountain, the view is good enough, so we stay put. Perhaps.

The events unfolding at Olympus Corp. in Japan are nothing short of stunning. It's too early to say with any certainty whether there was any malfeasance, but what facts are certain suggest that corporate governance in the company left something to be desired. A newly installed chief executive fired after 30 years with the company but only a few weeks in post would be bad enough. The company says it was a personal and cultural mismatch. "Michael C. Woodford has largely diverted from the rest of the management team in regard to the management direction and method, and it is now causing problems for decision making by the management team," it said. That doesn't chime with the Woodford having already brandished an auditor's report on television questioning the propriety and even legality of payments to advisers totalling two-thirds of a billion dollars. Had the board hoped that a British CEO would not be willing or able to look into advisory fees amounting to a third of the value of a takeover? That the advisers in question seem to have disappeared from the Caribbean tax haven they once occupied is one of the allegations that both the Serious Fraud Office in the UK and the US Federal Bureau of Investigations will now seek to examine. A fine mess. We might even call it a Greek tragedy, if the Greeks themselves hadn't been occupying that position in the eurozone mess.

In the corporate governance world, Japan is often seen as a counterpoint to the Anglo-American way of working. Japanese governance follows a "stakeholder" approach, in which shareholders are only one of a number of constituencies the board must take into account. Rapacious capitalism of the US and UK variety is thus held at bay. The "agency problem" that dominates worries in the large capital markets is supposed to play less of a role. Perhaps.

But in this case the disclosures from the company served only to confuse the issues, as in the October 19 news release that detailed but did not clarify the fee structure. Disclosure ought to involve understanding as well as facts. Whose "agency" – whose decision and choice – was involved in selecting the agents for the acquisitions? Whose "agency" agreed the sums involved, even if, as the company's statements declare, the transactions will eventually pay off.

So, a new CEO, then a new chairman ("president" in the terminology used at Olympus), a new auditor – and a new beginning? Perhaps.

They will have a mountain to climb to win back respect for a company that makes rather nice cameras. Reputation is more than customer satisfaction.

Source documents: The Olympus news headlines page contains links to the various documents issued. The October 19 news release is a four-page pdf file. The October 27 statement is a 10-page pdf.

News Corp. 'votes against' target James, Lachlan, Bancroft, not Rupert

When the votes were finally counted the News Corp. board of directors won re-election. But if we leave aside those from the Murdoch family and close allies, the story we can read from the rest of the votes suggest that shareholders wanted to rock the boat, but not too much. Sure, a majority of the so-called "independent" shareholders votes against having James and Lachlan – Rupert Murdoch's two sons on the board – as directors. They also vented almost equal anger, though, at Natalie Bancroft, who has represented the Bancroft family since they agreed, reluctantly, to accept News Corp.'s controversial 2007 bid for Dow Jones & Co., the company they once controlled. But the octogenarian chairman and CEO saw much more modest dissent. And the shareholder resolution to split the chairman and CEO role garnered little more than 1.5 million votes, of more than 680 million cast. Read another way, barely 0.2 per cent supported the iconic mechanism of corporate governance, and only about a third of a per cent of the "independents".

What the vote seems to show is that shareholders want to protest, but they don't really want change. News Corp. has performed well by most measures. The phone-hacking scandal that led to the abrupt closure of the oldest newspaper in the stable was worth a wrist-slapping, but not worth destabilising the company. It would be a different story in a different company, especially if the family of the founder didn't have 40+ per cent of the votes in his pocket. News is different from most industries. And the ownership and voting at News Corp. isn't that different from a lot of other news companies.

Source document: The News Corp. 8-K filing gives detail of the vote.

News Corp. withstands challenge on governance

Activist investors and the proxy voting agencies teamed up for an assault on the governance structures at News Corporation, but to no avail. The octogenarian chairman and chief executive, Rupert Murdoch, won re-election to his post as a director, as did his sons, James and Lachlan. A shareholder resolution to split the roles of chairman and CEO failed. The outcome wasn't all that surprising. The Murdoch family controls about 40 per cent of the votes with a 12 per cent equity stake, thanks to differential voting rights embedded in the articles of association. Even a modest number of shares not-voted would have ensured the defence success. That News Corp. was a target this year is linked in large part to the phone-hacking scandal at one of the company's newspaper titles in the UK, the now-defunct News of the World. James Murdoch was chairman of News International at the time and he and his father had faced a public grilling in the British parliament a few months ago. The story has died down since then, but its embers burn on, not least with an appearance at the annual meeting of a shareholder-and-UK-MP, who asked the Murdochs whether they were aware of a new investigation into alleged computer-spying by the UK newspapers. The patriarch said they weren't.

The opposition: Both Institutional Shareholder Services and Glass Lewis, two of the most prominent proxy voting agencies, recommended that clients support the shareholder resolution and called on shareholders to vote against re-election of one or more of the Murdochs. The California Public Employees Retirement System, known as CalPERS, joined the protest with a pre-meeting declaration of intent, as did a number asset management firms specialised in "ethical" investing or representing charities.

Equalising voting rights: Equally far from winning support were the calls from some investors to eliminate the family's control by eliminating the preferential voting. Investors bought the shares knowing there was a governance risk, and eliminating the share might thus allow them to capture a governance premium. But it wasn't – and probably isn't – to be. As most shareholder resolutions are only advisory, it seems unlikely that this board and this management would heed what these shareholders wanted, even if they mustered a majority. That the Murdochs have created considerable shareholder value has proved enough to keep enough shareholders happy, for now. But the story isn't going away. Next year, same time, same place … ?

Source documents: You can listen to the News Corp. annual meeting through a webcast. The Reuters account of the ISS move also gives the News Corp. rebuttal. There's also a story about the Glass Lewis recommendation in AdWeek. The two firms' own website didn't have public statements about their recommendations.

Dodd-Frank governance as political football

How well does legislation do on the playing field of corporate governance? That's the question behind a little fable penned by a pair of governance scholar-consultants, to mark the anniversary of the passage of the Dodds-Frank Act in the US. They imagine trying to apply its strictures to a real-life case much on the minds of US business people, though for reasons normally associated with leisure, not business. In their brief paper, David Larcker and Brian Tayan ask us to consider the governance failures in the National Collegiate Athletic Association. In recent years, NCAA football has been rocked by a string of high-profile violations, including teams at some of the most prominent names in American college sport: the University of Southern California, Ohio State, the University of Miami and Auburn University. These are big business. The football teams generate very large surpluses that help to fund the rest of the university. The build pride among the alumni, too, who then fill the coffers with yet more funds. "In many ways, these violations were similar to the governance breakdowns at financial and other corporations leading up to the financial crisis of 2008 and 2009," the scholars write. So what if we imposed the Dodd-Frank Act on them. What would happen?

• Sport vs business: If these requirements would not work in an athletic setting, should we expect them to work in business?
• Mandatory vs voluntary: Why are the governance provisions of Dodd-Frank legally required, rather than voluntarily adopted by individual companies?
• Money vs failure: Why does Dodd-Frank place such emphasis on executive compensation and disclosure? Will its compensation requirements reduce governance failures?

We won't give the game away by recounting all of the highlights. For that, take a look at their "Closer Look" case study.

Source document: The tall tale "The NCAA Adopts 'Dodd-Frank': A Fable," by David Larcker and Brian Tayan of the Stanford Graduate School of Business, is a six-page pdf file.

UK competition inquiry target Big Four audit power

It's been coming for quite a while, but now it's official: The UK Office of Fair Trading has asked the Competition Commission to conduct an inquiry into the dominance of the Big Four accountancy firms in the market for audit services. The decision confirms a provisional decision a few months ago and put the firms under careful scrutiny. Regulatory attention to audit has been mounting as the number of audit firms has shrunk and evidence of competition for mandates has dried up. The OFT said that in 2010, the four largest firms – PricewaterhouseCoopers, KPMG, Deloitte and Ernst & Young – earned 99 per cent of audit fees paid by FTSE-100 companies. That should come as no surprise, as only one of the 100 companies uses an auditor other than the Big Four.

More interesting is the finding that between 2002 and 2010, the average annual switching rate among FTSE-100 companies was 2.3 per cent. The OFT put the word "only" in that sentence, ahead of 2.3 per cent. You might be surprised to hear it's that high. But remember a large number of non-UK companies in the FTSE-100, especially natural resource companies, are listed in London. Often facing rapid growth in size and scale, they may have found the need to change auditors to accommodate their internationalisation.

Even more interesting is the PwC alone earned 47 per cent of the FTSE-100 fees. The OFT said: "Non-Big Four audit firms can face substantial barriers to entry in terms of gaining relevant experience, establishing their reputation, overcoming switching costs and inertia, surmounting regulatory barriers and banking requirements, taking on liability risks, and raising capital to finance expansion."

These investigations take time, and the audit market is a sensitive one, so don't expect a radical decision soon. Finding a solution to the concentration of audit has been on the agenda of regulators all around the world for several years. The implosion of the firm Arthur Andersen in the aftermath of the collapse of Enron in 2001 and WorldCom in 2002 reduced competition and left other would-be rivals in the audit profession wary of trying to join the elite club. As the financial crisis took hold, a lot of people wondered whether the audit giants might now be too big to fail.

Source document: The OFT referral document is a 78-page pdf file.

Votes in on 'say-on-pay' – investors like it

Investors got their first chance to exercise the muscles they were given under the Dodd-Frank Act in the US to have a "say on pay" at the companies in which they invest. They seem to have liked the experience, but it was tiring and not very much happened. Nonetheless, they would like to do it again next year and the year after, and the year after that. The proxy voting agency Institutional Shareholder Services analysed the results of the 2010 proxy season and determined that investors signalled approval of pay plans at 92.1 per cent of the cases. They voted down proposals at just 1.6 per cent of the cases among the Russell 3000 companies, mainly as a result of concern over links to performance.

"'Say on pay' votes increased investors' workloads, but spurred greater engagement by companies and prompted some firms to make late changes to their pay practices to win support," the firm said. In more than 80 per cent of the cases, they voted to have annual votes on pay policy, rather than once every three years. Moreover, say-on-pay made life easier for directors, at least in one way. There were fewer votes against directors who sit on compensation committees. In the past, activists voted against re-electing directors as a protest over pay. Now with a direct say, their activism followed a different channel.

Source document: The ISS US post-season report is a 36-page pdf file.

European shareholder voting better if lacking drama – ISS

Shareholders in Europe voted more this proxy season than ever before, but that did not translate into radical action. Institutional Shareholder Services, the proxy voting agency owned by MSCI, calculated that the UK saw the biggest rise in participation in company annual meetings, thanks to the new Stewardship Code, which many of the largest asset managers adopted for the 2011 proxy season. Despite the turbulence in European markets in the past year, dissent from investors over management proposals was steady overall. Greater resistance to requests to authorise additional capital was offset by less concern about electing directors, discharging them of their responsibilities, or rejected proposals on mergers and acquisitions. Some highlights:

• Turnout: Participation in the UK moved above 70 per cent, the highest level in ISS's record and probably in living memory. It wasn't the best in Europe, however. That honour goes to Portugal, at 73 per cent. Greece and Ireland saw large increases, too, for reasons that may be obvious. The EU average was 62.6 per cent. Voting in Denmark was the lowest – just 37.2 per cent.
• Dissent: French companies saw the highest level of shareholder dissent about management proposals, but at 6.0 per cent it was the lowest in the four years surveyed in the report.
• Result disclosure: More companies reported the outcome of votes but that didn't stop ISS from complaining: "… given that full disclosure is now legally required in most markets surveyed, it is disappointing to record that only five markets have all companies disclosing their results in full."

Source document: The ISS European voting report is a 23-page pdf file.

Brussels wants new rules for financial trading

The European Commission has proposed a radical rethink of the rules that govern trading in securities in the 27 member states of the European Union. The Markets in Financial Instruments Directive, known as MiFID, came into force in 2007. That's ages ago, the commission seems to be saying. "In recent years, financial markets have changed enormously. New trading venues and products have come onto the scene and technological developments such as high frequency trading have altered the landscape," it noted. The lessons of the financial crisis have to be taken into account as well, and it wants to close the loophole that have seen derivatives trading on "organised trading facilities" originally intended for the underlying instruments only. Small and medium-sized companies need better access to equity capital markets. High frequency trading needs to be better regulated, and "dark pools" will get greater sunlight through increased transparency.

A new framework: The upshot is a plan of action that will no doubt get the lobbying industry whirring at full speed. The commissions said: "These proposals consist of a Directive and a Regulation and aim to make financial markets more efficient, resilient and transparent, and to strengthen the protection of investors." And a bit of interpretation is needed here for clarity: a directive gives national government discretion over how to word the new laws; a regulation doesn't. The commission said the new framework would also increase the supervisory powers of regulators and "provide clear operating rules for all trading activities". Other global financial centres were undertaking similar discussions, it noted. But that won't stop the industry from seeking out opportunities for regulatory arbitrage.

Source document: The news release has details and a link to frequently asked questions.

EU wants to close loopholes on insider trading

Insider trading has been illegal in the European Union for many years now, but variations in national law have allowed some of them to escape prosecution. The European Commission wants to change that. "Some countries' authorities lack effective sanctioning powers while in others criminal sanctions are not available for certain insider dealing and market manipulation offences," it said. "Effective sanctions can have a strong deterrent effect and reinforce the integrity of the EU’s financial markets." So it has proposed new rules that would ensure minimum criminal sanctions for insider dealing and market manipulation.

Separately, the commission said it would review the Market Abuse Directive to examine how to bolster it to take account of new technologies that expand the scope and power for market manipulation. Regulators would get stronger investigative and sanctioning powers. Small and medium-sized issuers would see their administrative burden fall, however, or so it believes.

Source documents: The news release explains a bit more of the proposal. The market abuse review has links to the existing legislation.

Belgian companies do better on code compliance

Belgian companies are getting better at complying with the code of corporate governance. The Financial Services and Markets Authority said it was "delighted" with the progress, but don't get too excited. Its study indicated that a number of the code's provisions weren't being followed, which is a matter of concern as the country brings into force a new law requiring compliance, that is on a "comply-or-explain" basis. Improvements since 2009 include:

• Risk: Some 92 per cent of companies now have and apply internal control and risk management systems. The figures were less than half two years ago.
  
• Evaluation: Information on the evaluation process is complied with by 53 per cent and applied by 66 per cent of the companies. Those are up from 30 and 36 per cent respectively in the previous study.

More companies are reporting on executive pay and setting remuneration policies, too. Some 81 per cent of companies give information of share options, up from 61 per cent.

Source document: The FSMA news release summarises the findings.

FRC wants more board diversity in update to UK governance code

Many of the voices close to the debate call it a sensible move. Others will probably think it lacks ambition. But because the UK Corporate Governance Code will now require companies to disclose what they are doing to promote more diverse boards, everyone will have easy access to data to press their arguments with the companies in the future. The Financial Reporting Council, which oversees the accounting profession as well as the code, wants listed companies to report annually on their boardroom diversity policy, including gender, and on "any measurable objectives that the board has set for implementing the policy and the progress it had made in achieving the objectives". Diversity of the board should also feature as one of the factors to be considered when companies consider board effectiveness. The requirement reinforces a provision, introduced after the last major change in the code, which came into effect in June 2010. That provision states: "The search for board candidates should be conducted, and appointments made, on merit, against objective criteria and will due regard for the benefits of diversity on the board, including gender."

The new provisions on diversity will apply to financial years beginning on or after October 1, 2012, but the FRC wants companies to start right away. The FRC will also consult on other changes on narrative reporting and company stewardship.

Baroness Hogg, chairman of the Financial Reporting Council, said the changes would reduce the risk of "groupthink" on boards. "We believe this gives a further opportunity to show that Britain’s 'comply or explain', Code-based approach can deliver a flexible and rapid response and is therefore preferable to detailed legal regulation, and we urge companies to demonstrate this as quickly as possible."

The change has been in the wind since the British government commissioned a report on board diversity – the Davies Review – last year. Lord Davies made a variety of suggestions that steered clear of quotas for women on boards, despite growing pressure in that direction that uses the Norwegian example of legislated quotas as its model. The European Commission received such recommendations in responses to its green paper on corporate governance a few months ago. That means the issue is on the legislative agenda in the European Union, but there may be time for the voluntary UK to show progress and prevent a showdown over quotas.

Source document: The FRC feedback statement is a 14-page pdf file.

ESMA wants views on 'empty voting'

Damned if you do. Damned if you don't. Voting the shares you own – or don't own – is fraught with issues. Let's look for a minute at the "old" way most companies in Europe ran their voting. If you hold the shares, you vote. It's straightforward, unambiguous, and it stinks. It was designed for old capital, before capital had markets. It was clear cut, but it assumed you rarely if ever traded shares. It suited the families who set up the companies and the financiers who provided early and long-term capital. But it made it difficult for any "modern" institutional investor to exercise voting rights, and thus entrenched the rights of certain shareholders at the cost of all the others. As capital markets developed, pressure on European Union practices led to the adoption of something like the US and UK practice of record dates. Holders of shares on a certain date – often about two weeks before the shareholders meeting – are entitled to vote. That way, active traders can draw a line under things and vote. As they buy one day, sell the next, then buy again, it didn't matter too much that some might be voting when they didn't actually own the shares and others who did might not be able to. A compromise, and not too messy. But then comes high frequency trading, stock lending, leverage short positions, and presto: you've got the problem often called "empty voting": large-scale investments where the economic interest runs counter to the shareholding.

The European Securities and Markets Authority wants to take another look at the issues and possible regulatory action to find ways to reduce some of the more perverse effects. "Discussion on empty voting is often connected to discussion on hidden ownership," it says. "Whereas empty voting relates to situations where shareholders have voting power without corresponding economic interest, hidden ownership relates to situations where investors have long economic exposure to a company without having corresponding voting power." Empty voting and hidden ownership are often each other's mirror image. It has issued a call for evidence, a consultation, that is, without a consultation paper, as a way of generating ideas about what, if anything, it might propose.

Source document: The ESMA call for evidence is an eight-page pdf file. Comments, please, by November 25.

British insurers tell boards how to be better

What makes for an effective board of directors? There are guide books galore and academic studies that seek to turn hunches into evidence. But what makes any group work well – or poorly – is a subject fraught with complexity. The Association of British Insurers has decided to have a go at publishing its first version. Not content with the Guide to Board Effectiveness issues by the UK Financial Reporting Council six months ago, the ABI thinks it worthwhile to dwell somewhat longer over three areas of board practice that don't get a lot of attention from the FRC.

A guide to the players: Before we start, let's remember who these folks are. The Financial Reporting Council is the body that oversees the accounting and audit professions in the UK. A government-funded agency, it is also custodian of the UK Corporate Governance Code. Its guidance for directors grew out of the Higgs Review in 2003, which stresses the importance of independent, non-executive directors, reworked following the financial crisis by the Institute of Chartered Secretaries and Administrators. The ABI has two roles: A trade association for insurance companies, many of which are listed on the stock exchange, and a club of institutional investors. So the ABI guide on board effectiveness comes from experience of being companies and being investors.

The ABI reckons that boards ought to pay more attention

• Diversity: and especially the number and quality of women directors,
• Succession planning: making sure there are contingency plans in place for new directors and senior managers, and
• Board evaluation: the annual appraisal of performance that has been commonplace if not quite universal in the years since the Higgs Review put them firmly on the agenda.

"These issues do not stand alone, the ABI states. "Selecting the best individuals from a diverse talent pool, planning for succession and replacement, and regularly evaluating the board to determine its effectiveness, cover the lifecycle of a board. That is why they are important."

And the meaning? On diversity, the ABI thinks companies can do more, and probably ought to set targets and do more internally to fill the pipeline, especially with women who might then be in a position to win a place on boards without the need for quotas. On succession planning, it wants boards to go beyond just identifying potential candidates for board membership and get involved in looking at the planning for the whole top end of management. On evaluation, it wants to see companies explain the methodology they use, and to use a methodology that involves external advisers more rather than less.

These aren't particularly stunning insights or even challenges to board practice. But they are a higher level of prescription in an area of conduct that has long resisted prescription only to relent later on and comply. The ABI guide does, however, give companies another thing to stand behind in a bid to stave off mandatory measure. They can wrap themselves in the voluntarism of compliance, for a while longer at least. That suits well the membership, which sits on both sides of the divide between investor and investee.

Source document: The ABI guide, entitled "Report on Board Effectiveness – Highlighting best practice: encouraging progress" is a 52-page pdf file.

How and what to pay – the ABI's view

As part of its greater public assertiveness, the Association of British Insurers has decided it's time to make noise about executive pay. But it focuses not on the level of pay as such, but rather on the processes through which companies reward top management. The ABI, a trade association representing organisations that are both companies and investors, thinks shareholders have a role to play in the process, alongside boards and board remuneration committees. Moreover, policies and pay structures could do with some fresh ideas.

• Role of shareholders: As shareholders, insurance companies generally look after the long-term interests of their beneficiaries. They don't want to micro-manage companies, but they do want remuneration practices and policies of companies they invest in to be aligned with shareholder interests.
• Role of the board and directors: Non-executive directors, particularly those serving on the remuneration committee, should oversee executive remuneration.
• Remuneration Committee: Shareholders want remuneration committees to protect and promote their interests. Pay structures should be aligned with strategy and agreed risk appetite, reward success fairly and avoid paying more than is necessary. "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," it states.
• Remuneration policies: Pay should promote value creation through transparent alignment with the agreed corporate strategy. "Excessive or undeserved remuneration undermines the efficient operation of the company, adversely affects its reputation and is not aligned with shareholder interests," it says.
• Remuneration structures: The ABI wants the board as a whole to consider the aggregate impact of employee remuneration on the finances of the company, its investment and capital needs, and dividends to shareholders. "To avoid payment for failure and promote a long-term focus, remuneration structures should contain a careful balance of fixed and variable pay," it said. "They should include a high degree of deferral and measurement of performance over the long-term." It wants claw-back clauses, too.

If this summary sounds pretty much the same as you've always heard, you would be right. There's nothing radical here, no call for a clampdown, not quantitative limits and only a few echoes of the idea of setting top pay in relation to the median level in the company. The ABI doesn't do radicalism very much. That it is doing this at all is an indication of the steam building up in society about doing something, and maybe something serious.

Source document: The ABI remuneration guide gives further details.

Readability brings success in analyst reports

What makes an investment report influential? Is it the sophisticated analysis? The trading idea? The reputation of the analyst or the firm? Is it perhaps the colour, glossy pictures with circles and arrows? According to a study by a team of US and Canadian academics, it's none of those things. What matters is how readable the document is. The researchers examined 356,463 sell-side equity analyst reports from 2002 to 2009, testing the relationship between readability and stock trading volume reactions and then analysing the determinants of variation in report readability. They found that trading volume increase with the readability of text. Moreover, the analysts deemed to be "high quality" ones are the ones who write the most readable reports.

Source document: The working paper "Ambiguous Language in Analyst Reports," by Gus de Franco and Ole-Kristian Hope at the University of Toronto, Dushyantkumar Vyas from Minnesota, and Yibin Zhou from the University of Texas, is a 41-page pdf file.

Say-on-pay gets serious response from investors in first US season

The proxy season is over in the US and the results are in. In the first year under the new rules mandated by the Dodd-Frank Act, investors have the right to a non-binding vote on the pay of the CEO and certain named executive officers, called NEOs in the new parlance. Overwhelmingly the pay arrangements this year won shareholder support. But among several thousand companies involved in the first season were a handful where investors voted against. The Council of Institutional Investors, a strong proponent of "say on pay", commissioned an analysis of those to find out what happened. The study, conducted by Farient Advisors, looked at 37 cases where pay packages fell short of majority support. It also looked at another 37 cases where "against" votes reached 40 to 50 per cent. "While 37 'failed' votes is a tiny fraction (less than 2 percent) of the 2,340 say-on-pay votes at U.S. companies in the first half of the year, the total was surprisingly large compared with the track record of say on pay in other countries and the expectations of corporate governance professionals," CII commented. So why did investors object?

Farient found that investors cast votes against executive compensation at the 37 companies for a variety of reasons, but the factors most frequently cited were:

• Discrepancies: A disconnect between pay and performance (92 per cent of the cases cited this as a reason).
• Poor process: Poor pay practices (57 per cent).
• Disclosure gaps: Poor disclosure (35 per cent).
• Disproportion: Inappropriately high level of compensation for the company’s size, industry and performance (16 per cent).

"Investors were extremely thoughtful about evaluating executive compensation for say-on-pay votes," the report concluded. Resource constraints meant that investors used proxy advisory firms' analyses a lot, but to varying degrees. They also evaluated performance and pay over multiple years, and focused on total absolute shareholder return (TSR) over one-, three- and five-year periods. Investors also focused on CEO pay, rather than the pay of other NEOs, and on the overall "reasonableness" of the level of pay.

Source document: The CII report is a 36-page pdf file.

UK sets up panel to recommend ways to end 'short-termism'

Now that it has collected the testimony, it's time to get an interpretation. The UK Department of Business, Innovation and Skills has asked a prominent public economist to make sense of the evidence concerning the barriers companies face to taking a long-term view of their future, or in the language of the department: "to examine investment in UK equity markets and its impact on the long-term performance and governance of UK quoted companies". John Kay, best known as a columnist for the Financial Times newspaper, has been asked to review responses to the consultation the government conducted in late 2010 and the early weeks of 2011. Kay will produce an interim report by February and then a final report by July. Expect government action thereafter. Or perhaps government inaction in the face of an intractable problem.

Kay is a noted proponent of what's often called "long-termism", and therefore something of a sceptic about the way that institutional investment has come to colour the nature of corporate governance. Many collective investments turn over their portfolio every two years or so. Increasingly fund managers are evaluated – for their own remuneration, as well as by end-investor decisions on where to place their money – on quarterly fund-performance statistics. Combined with the growth of algorithmic trading and the prominence of hedge funds in the mix of equity holders on any given day, and any notion of shareholder primary in corporate decision-making is almost certain to bend towards a short-term orientation.

Source document: The government update has links to the original consultation and the list of responses.

Jouyet on governing corporations and financial services – more work needed

Who should govern, or at least, who should set the framework for governance? This question was on the mind of Jean-Pierre Jouyet, chairman of the French securities regulator AMF, as he discussed the failure of governance in the financial services sector that led to the crisis that threatens, again, the stability of banks and insurers. Jouyet told the International Corporate Governance Network that there were corporate governance failures, when bank boards failed to act. There were also failures in the governance of financial regulation. Regulators failed to share information, detect emerging risks and prevent regulatory arbitrage, despite the existence of a variety of coordinating entities. Moreover, there were governance failures among investors, who missed the risks inherent in some of the structured financial products they bought. Since the financial crisis, many measures have been introduced, of course. But Jouyet's not sure they address the core problem. So who should be in charge?

Stakeholders of all types "must participate in the elaboration of governance frameworks", he said. Governance must work for the "company as a whole", so, "the company's governance cannot be determined by the sole [sic] executive directors, shareholders, employees or customers, but must be determined jointly by all these different categories." In particular, shareholders had to do their homework, which was why the AMF recently issued guidance that any shareholder using the services of a proxy voting agency ought to make their own assessments and not just follow the proxy service's recommendations. American and Asian registry firms need to communicate better with European ones to facilitate cross-border voting.

A global framework? Jouyet also raised the question of whether the world ought to be moving towards a single framework for corporate governance. It was a question he wasn't ready to answer, however. Instead, he suggested that the ICGN ought to work out what's the best balance between global convergence and local translation of principles.

Source document: The Jouyet speech to the ICGN is an 11-page pdf file, in English.

SEC decides not to appeal shareholder access verdict

The US Securities and Exchange Commission won't be seeking to reverse a court ruling that threw out its shareholder access rule, which was designed to give shareholders the right – under some circumstances – to nominate directors. Chairman Mary Schapiro said she firmly believed the rule was in the best interest of investors and markets. "It is a process that helps make boards more accountable for the risks undertaken by the companies they manage. I remain committed to finding a way to make it easier for shareholders to nominate candidates to corporate boards," she said. "At the same time, I want to be sure that we carefully consider and learn from the Court's objections as we determine the best path forward."

SEC staff will, as a result, go back to the drawing board, and not for the first time. An attempt at a shareholder access rule in 2003 met a similar fate. When this one was proposed in 2009, one of the Republican commissioners, Kathleen Casey, who is now stepping down from the SEC, complained that it was the fourth attempt in six year to come up with a rule. Now there may be a fifth in nine years.

Source document: The SEC statement is a brief news release with some additional background on the issue.

Toronto exchange pushes for end to director 'slates'

The Toronto Stock Exchange is taking steps to end the practice of having directors stand for election together and instead giving shareholders the right to votes on each individual. In a filing with the Ontario Securities Commission, the exchange said it was moving ahead with a consultation on the proposed change in its listing requirements after because the OSC's own consideration of wider issues were still at an early stage. Current arrangements mean that directors stand for election every year, but most companies give shareholders the right only to vote yes for the slate or "withhold" their vote from all directors. This combination of "slate" voting and the "plurality" approach prevent votes against means that shareholders have little practical influence over the boards. In the United States, plurality voting is common, but directors stand individually. That means a director might well be elected with a plurality, but it would be apparent that s/he received a sizeable number of "withheld" votes. In the UK, directors stand individually and "majority" voting applies – shareholders can vote against and a director must receive a majority to be elected.

Another rule change would ensure that directors face annual elections. Most companies listed in Toronto do this in combination with the "slate" approach. But the exchange wanted to ensure that companies don't seek to introduce "staggered" elections, under which directors serve three-year terms and a third stand each year. That practice, commonplace in the US, is been by shareholder activists as entrenching boards. The 2010 UK Corporate Governance Code seeks to make annual elections the norm for the top 350 companies.

The exchange didn't opt to shift from plurality to majority voting, but its rule change would seek to have companies publish whether they permit majority voting, and if not explain the rationale. The larger OSC inquiry will examine that issue.

Source document: The request for comment is a seven-page pdf file. The comment period runs until October 11.

What's wrong with the system? The case of Italy

"Stewardship" is all the rage now. Investors are supposed to be taking more interest in the companies in which they invest. There's a need for dialogue between companies and shareholders, and – is it first and foremost, or last but not least? – shareholders need to vote. Well, they can't, not always. The European Union has been trying to enact measures that tear down some of the barriers to voting, harmonise procedures in different countries and, simply put, get rid of some of the cost and hassle of voting. A working paper from a pair of academics in the US looks specifically at one of the reputed worst places for shareholder voting – Italy. Notwithstanding the 2007 EU Shareholder Rights Directive, Italy maintains voting impediments that have the dual effect of a) putting investors off voting, and because of that b) put them off investing. It raises the cost of capital, gums up the financial system, and puts Italy in a worse competitive position. The paper suggests that moving to a centralised or "direct" share registration system would reduce voting-chain complexity, and highlights examples from the Nordic countries where their use reduces so-called "empty" voting, too.

Source document: The working paper "Reforming Share-Voting Systems: The Case of Italy," by B. Espen Eckbo and Guilia Paone of the Tuck School at Dartmouth, is a 21-page pdf file.

Need a non-executive director? Why not a CEO?

In the US – but in other places as well – there's a crying need for more non-executive directors, those outsiders who help the company make the toughest decisions. Complaints of "shortages" are often countered with assertions that the old-boys-club of boardrooms ought to look at women, ethnic minorities, even academics, rather than simply at themselves. But there's another channel for directors, the future members of the old-boys-club. They are the sitting CEOs. People who are already CEOs have clearly got something going for them, right?. Maybe it will rub off on us. Having a CEO from a big-name company on our board will raise our profile, build our reputation. What could be wrong with that?

Plenty, according to a think-piece published by Stanford University's corporate governance research centre. There is currently "no widely accepted, rigorous study" that shows that sitting CEOs are better board members than other outsiders or that companies with CEO directors get better advice or monitoring. "In fact, recent survey data suggests that active CEOs might not always be the best board members because of the time constraints of their full time job and personality attributes that may make it difficult for them to contribute constructively to a boardroom environment," they write.

Source document: The discussion paper "Are Current CEOs the Best Board Members?," by David Larcker and Brian Tayan, is a six-page pdf file.

Creative economy and beyond

Leadership is a rather fuzzy, impressionistic part of the field of management studies. There are those who would like to see more scientific approaches to the study of leadership – and those who would like to reduce it to a simple recipe. But there's another view that leadership is simply a complex social phenomenon – perhaps not even a skill, since skills can be taught and learned. Nancy Adler, a leadership scholar at McGill University, thinks even that approach falls short of describing what phenomenon she has studied. In the context of a global financial crisis, a steep recession in most of the western world, and geo-political and politico-economic strife, not to mentioned climate change, she argues that leadership needs to look to the arts for inspiration. In a video, she explains – among other examples – how medical students at Yale University undertook an experiment where some took art classes and others stayed narrowly focused on learning medicine. The "artists" proved better at diagnosis, they were less likely to jump to conclusions, and once they had decided they were more willing to change their minds than the "pure" medical students when new evidence emerged. Why? Because they learned to look at the whole picture. They took in more data. They saw what was there rather than using a pre-existing mental model. In short, they thought differently. So stunning were the results that a number of medical schools in the US have followed this prescription.

Artists as leaders: Artists may produce a lot of rubbish along the way, but Adler's convinced that they lead insights. Business leaders, and the business schools that hope to teach them, could stand to learn from that. The Journal of Management Inquiry, an academic journal of considerable standing, despite (or perhaps because of) its often eccentric stance, has published a paper drawn from Adler's speech. In it she writes:

Embracing creative solutions is no longer a luxury; it has become a necessity. What would a creative economy look like? It would require an economy in which people combine an aspiration for "the beautiful" and the use of extreme creativity, with huge market potential, to solve problems worth solving; solutions worthy of our humanity. The question we need to ask ourselves is what would it take for the world to operate as a creative economy. What would it take to embrace beauty and artistry, in addition to analysis, to sustainably solve the planet's most challenging problems?

It is a stunning insight, and one worth some contemplation. Why do we like art so much? Why do we admire the artist? Is that virtue not similar to what we see in the business people we admire, too? Adler quotes Warren Buffett, the "sage of Omaha", the world's most famous investor, and chairman of Berkshire Hathaway. Buffett, she recalls, says he's not a businessman but an artist. Artists look at things differently, they question pre-set models, they challenge assumptions. That's not the same thing as leadership, but it has something to do with vision. Leadership may be a fuzzy, impressionistic part of management studies. But the Impressionists, with their fuzzy pictures, were certainly interested in new ways of seeing. That's why we admire them, as well as their work.

Source documents: The film version of Leading Beautifully plays in Windows Media format and runs for about an hour. The article is available as an "Online First" version at the Journal of Management Inquiry. When Adler isn't teaching leadership at McGill, she is – you guessed it – an artist.

UK disclosure regime takes aim at strategic risks

The UK Financial Reporting Council has leapt ahead in the debate over the future of corporate narrative reporting. It published a manifesto called "Effective Company Stewardship" that in some ways pre-empts a host of other discussions about companies ought to communicate with shareholders. Following a consultation but ahead of a government announcement on narrative reporting and the results of deliberations in the European Union, the FRC has declared its intention that corporate disclosure should focus on strategic risks rather than operational ones. Companies should disclose the risks inherent in the business model and in their strategies for implementing the business model. It will update guidance on risk management – the so-called Turnbull recommendations – after it gets result from the Sharman inquiry looking into liquidity reporting. Separately it issued a summary of views on how companies can respond to heightened and more differentiated risk.

The initiative comes in conjunction with other measures of considerable significance. It is looking into asking audit committees to become responsible for vetting the whole annual report, rather than focusing on financial matters, to "enable effective interaction" with shareholders, and thus buttress the comply-or-explain regime in corporate governance. It favours putting this responsibility in the hands of the audit committee, rather than following the approach of the US Public Company Accounting Oversight Board, which made it a responsibility of auditors.

Auditors report changes, too: The FRC believes "auditors can and should provide increased insight into the audit process so as to reassure users of financial statements that all material matters have been properly disclosed", so there will be changes coming in how auditors discuss their findings that go beyond the boiler-plate of the typical audit report.

Source document: The FRC report "Effective Company Stewardship: The Next Steps" is a 25-page pdf file.