Thomas Dubbs of Labaton Sucharow and Daniel Summerfield, co-head of Responsible Investment For The Universities Superannuation Scheme, discuss developments in corporate governance and look at some of the differences between the UK and the US.
Thomas Dubbs (TD): Daniel, at the end of your presentation at Bournemouth, you referenced, generally, the view that UK shareholders had substantial shareholder rights. Could you elaborate on that?
Daniel Summerfield (DS): In the UK, the ability, at the annual meeting for example, for shareholders to vote out directors every year is a very powerful tool that we have at our disposal. Although the tool is rarely utilised, it certainly helps to focus the minds of directors and ensures real accountability to investors. The enhanced shareholder rights we have in the UK also facilitate much greater access to boards of directors than we have in other markets.
TD: Among the various issues in the corporate governance world, is it easier to concentrate on executive compensation because it’s easily understood? Is there too much emphasis on executive compensation? What are your views on this?
DS: As compensation is generally quantitative in nature as opposed to the more subjective and qualitative governance issues such as the quality of directors, there tends to be more of a focus on the former. In general, I believe there is too much emphasis on compensation in and of itself, rather than viewing it as part of the company’s overall governance, operational and strategic performance. However, that said, it is an issue that needs to be addressed and reformed.
TD: At Bournemouth, you made the case for a “bespoke” approach to engagements; what did you mean by that?
DS: In short, every company is different and rather than apply a “one size fits all” approach, such as with compensation, any engagement should focus on the specifics of a company, taking into account its own unique situation, challenges and opportunities. The objective should be to adopt a bespoke engagement approach rather than apply a “tick-box” process or use a set of generic metrics.
TD: Back to compensation, what do you think about the “clawback” approach?
DS: It is clearly one approach, but obviously “clawbacks” occur after something unfortunate has happened. The goal should be to prevent the need for this to be applied in the first instance by adopting a greater focus on corporate governance, the quality of directors, and a better dialogue with shareholders.
TD: USS joined several other shareholder activist organisations including the NAPF in a position paper addressing accounting issues in November. In your view, what were the most important factor or factors that were being looked at?
DS: The key issue for us is ensuring audit quality. By that we mean a reliable view of whether company accounts form a “true and fair view” of the companies’ underlying health. We believe that audit quality is, in turn, underpinned by auditor independence as well as technical expertise. At present, there is a lack of competition in the audit sector, and companies keep the same auditors for far too long. The ostensible reduction of objectivity and independence in the audit process of companies which arises from a lengthy tenure is not aligned with shareholder interests. In some cases, the audit firms have held their positions for upwards of 30 years, which is clearly an untenable situation. How is it that the UK’s Corporate Governance Code views directors to be no longer independent after nine years, but the UK government feels satisfied that auditors remain independent after, in some cases, generations? Our view is that there should be a mandatory retendering of the account every five years with a compulsory rotation of firms at least every 15 years.
TD: The position paper also deals with comparisons of the US accounting practices versus the UK approach while also noting that there is growing “convergence” between GAAP and UK accounting standards. What is your take on that?
DS: Although the attempt to obtain international harmony on accounting standards is understandable, this is really only desirable if we are converging on the right standards. In our opinion, IFRS is not suited to our system of corporate governance, and indeed contributed to the build-up of risk in our financial system prior to the crisis. It is important to understand that accounting standards have critical impacts for company executives’ incentives, since bonus payments are often linked to these numbers. The numbers are also vital for shareholders to be able to assess executives’ performance. We cannot do this where profits are not accurately reported, or we are unsure of a company’s underlying capital position. We are, therefore, working hard to raise awareness around this matter, and to ideally see the principle of “prudence” restored to the heart of our accounting system.
TD: What lessons can the US learn from the UK with respect to corporate governance and vice-versa?
DS: For the US, there needs to be a cultural shift that allows for constructive and confidential engagement between investors and companies. This is only likely to happen if there is clear and unequivocal guidance on Regulation Fair Disclosure which is often used as an excuse to inhibit shareholder engagement and access to board directors. More generally, there are problems with the US proxy system in terms of how boards have been able to ignore significant votes directed against individual directors by shareholders. In the US, litigation is also more generally seen as one tool to accomplish some of these goals. That is not the approach in the UK, though concern for legitimate shareholders’ redress and compensation is growing. As to the UK, we need to create a more effective institution which represents investors’ interests.
TD: Do you mean like the Council of Institutional Investors in the US?
DS: Yes, that would be a good example.
TD: There is constant talk both in the US and the UK as to the amount and degree of what is generally called “regulation” and the risk of “over regulation”. From your point of view, has the UK’s “light touch” regulatory approach gone away and is that a good thing?
DS: My view is that no problem is so bad that government interference can’t make it worse. We need to retain a self-regulatory approach as far as possible.