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.

FRC shares insights, not prescriptions, for boards on risk

The UK's accountancy regulator thinks it's time that boards of corporations think again about how they discuss and manage risk. In conjunction with a report on narrative reporting and audit, the Financial Reporting Council has also issued a summary of views about a discussion paper it had circulated on risk. The summary makes clear its intent to revisit the so-called Turnbull guidance on risk disclosure but also that it broadly finds those recommendations – first issued in 1999 and then updated in 2004 – still fit for purpose. But the paper acknowledges that board practice has moved on, and so the update to the guidance is really just a first step for boards. It said: "the approaches and techniques used by boards have been developing rapidly. One size very definitely does not fit all, but there were some common themes and techniques found to be useful. We therefore felt that the insights gained about the issues boards were facing, and the ways they were addressing them, should be shared more widely to reflect and contribute to best practice."

Among the conclusions are that better risk decision-making needn't and shouldn't lead to less risk-taking. The FRC doesn't want to dampen entrepreneurship spirit. That means that board committee structures may need to vary from industry to industry, so it won't be recommending, for example, that all companies establish risk committees. Board need to focus their attention, however, on "those risks capable of undermining the strategy or long-term viability of the company or damaging its reputation".

The FRC noted that the velocity of risk has increased, and with it the global transmission of risk. Companies needed "robust crisis management plans", with a clear distinction between the roles of the chairman and the CEO in dealing with them.

Source document: The FRC discussion summary "Boards and Risk" is a 17-page pdf file.