Dr Richard Leblanc

(Continued from Part 1.)

Shareholders:

13. Are there any EU legal rules that are contributing to inappropriate short-termism among investors?  If so, how could these rules be changed to prevent such behaviour?  (Short-termism could occur via asset manager relationships resulting from increased intermediation, automated and high-frequency trading and shorter retention periods, or “regulatory bias” (Green Paper wording) that could cause mispricing, herd behavior and increased volatility.)
14. Are there measures to be undertaken in regards to the incentives and performance evaluation of asset managers (e.g., fees and commissions based on short term, relative performance), who manage long-term institutional shareholder portfolios, with a view to better aligning interests of asset managers with those of long-term institutional investors?
15. Should EU law promote more effective monitoring by institutional investors (i.e., asset owners) over asset managers (i.e., agents of institutional investors) with regard to strategies, costs, trading and the extent to which asset managers engage with investee companies, with a view to greater transparency of fiduciary duties by asset managers, greater monitoring of activities that are beneficial for the long term interests of institutional investors, and more active stewardship of investee companies by asset managers?
16. Should EU rules require a certain independence of the governing bodies of asset managers, or are other measures (e.g., legislation) needed to strengthen the disclosure and management of conflicts of interest?
17. What is the best way for the EU to facilitate shareholder cooperation? (Shareholder cooperation means the ability of institutional investors, in particular those with diversified portfolios, to engage with one another successfully, without being in contravention of EU laws on “acting in concert,” which could hinder shareholder cooperation.  Shareholder cooperation may be facilitated by setting up shareholder fora, for example, or an EU proxy solicitation system whereby companies set up a specific function on their website enabling shareholders to post information on certain agenda items and seek proxies from other shareholders.)
    Shareholder cooperation is part of shareholder engagement. Shareholder engagement means “actively monitoring companies, engaging in a dialogue with the company’s board, and using shareholder rights, including voting and cooperation with other shareholders, if need be to improve the governance of the investee company in the interests of long-term value creation” (from the Green Paper).
18. Should the transparency of proxy advisors be enhanced (e.g., with regard to analytical methods, conflicts of interest, and whether and how a code of conduct is applied)? If so, how?
19. Are legislative restrictions on proxy advisors necessary (e.g., to restrict the providing of consulting services to investee companies)?
20. Should a mechanism (technical and/or legal) be in place to facilitate the identification of shareholders by issuers, in order to facilitate dialogue on corporate governance?  If so, would this mechanism benefit cooperation between investors?  If so, what would be the details of such a mechanism (e.g., the objectives to be pursued, preferred instrument, frequency and cost)?
21. Should minority shareholders be accorded additional rights to represent their interests within companies with a controlling or dominant shareholder?  (A controlling shareholder (the predominant governance ownership model in European companies) can be defined (by the author, as it is undefined in the Green Paper) as a shareholder with the ability, either in fact or law, to exercise a majority of the votes for the election of the board of directors.  A significant shareholder could be an individual, a group of individuals (e.g., a family, a voting trust, etc.), or a corporation.)
    The word “rights” and “represent,” above, can be interpreted to mean something more than simply augmenting the influence of minority shareholders, and stems from difficulties identified in the Green Paper that minority shareholders have in protecting their interests in companies with a significant shareholder and a within a “comply or explain” regime.  Certain Member States for example have reserved the appointment of some board seats to minority shareholders.
22. Do minority shareholders need greater protection against related-party transactions? If so, what measures should be taken?  (A related party transaction is defined (by the author, using concepts from a corporate governance proposals from the Canadian Securities Administrators in December, 2008) to be a conflict of interest between the related party (e.g., a control person, a significant shareholder, an officer, or a director of the corporation) and the corporation itself.  If (in the author’s view) the board of directors does not take all appropriate action in light of the conflict, or shareholders (all shareholders, including minority) do not have full knowledge of, and the opportunity to approve, a significant related party transaction, the result could be self-dealing and appropriation of monies or opportunities by the related party at the expense of the corporation and/or minority shareholders.  The Green Paper uses the terms “protection against potential abuse” in describing the extraction of benefits by controlling shareholders and/or boards to the detriment of minority shareholders. Examples of a related party transaction may be a contract, arrangement or transaction entered into between the company and a significant shareholder or control person; or a contract or decision that will benefit an officer or director.
23. Should measures be taken at the EU level to promote share ownership by employees?

Monitoring and Implementation of Corporate Governance Codes:

24. Should companies departing from corporate governance codes be required to provide detailed explanations for such departures, and describe alternative solutions employed? (Under a “comply or explain” regime, adopted by many countries and widely endorsed for its flexibility, it is permitted for companies to depart or diverge from the corporate governance code recommendations, providing that there is adequate disclosure to explain the rationale for the departure, and how the practices or actions taken achieve the objective of the principle or recommendation, for example – hence “comply or explain”.  The issue has been the adequacy of disclosure, both for the “comply” and “explain” planks of the regime.)
25. Should monitoring bodies (e.g., securities regulators and stock exchanges) be authorized to assess the informational quality of corporate governance compliance statements, and require more detailed explanations as necessary?  If so, how should this be done, and what exactly should be their role?

Conclusion:

In response to the commentary, the European Commission will take next steps, with any future legislative or non-legislative changes to be accompanied by extensive impact analysis.  The Green Paper is instructive because it provides Member States, the European Parliament, and other countries and legislative bodies an indication of what corporate governance reforms, many of which are significant and go beyond other global developments, may be emerging within Europe in the coming months.

For interested readers, a group of Canadians responded to 23 of the 25 questions, here (PDF). This group consisted of a mixture of academics and practitioners, was self-organizing, possessed expertise across a range of governance topics in order to address as many of the Green Paper questions as possible, and offered examples and experience from the Canadian setting and group’s work wherever possible.

The European Commission is proposing a series of corporate governance reforms for EU member countries. As the reform’s “Green Paper” (as it is called) sets out in its introduction, the G20 Finance Ministers and Central Bank Governors emphasized in late 2009 that actions should be taken to ensure sustainable growth and to build a strong international financial system. Corporate governance is seen as a means to prevent excessive risk taking and undue influence on the short term, in this regard. The purpose of the EU’s corporate governance Green Paper is to respond to the G20’s edict, under the auspices of the European Commission’s Corporate Governance and Financial Crime Unit, and propose wide-ranging and long-awaited corporate governance reforms within European Member States.

There are 25 corporate governance proposals in total, under four general categories: (i) General; (ii) Boards of Directors; (iii) Shareholders; and (iv) Monitoring and Implementation of Corporate Governance Codes. The full text of the proposals is available online, in downloadable PDF format, at the European Commission’s website here (PDF).

The proposals are comprehensive and are a major step forward. Proposals address the governance of small and mid-cap companies (SMEs) and unlisted companies (as well as listed companies); the separation of chair and CEO; board diversity; external board evaluations; having boards be responsible for risk appetite, and potentially overseeing disclosure of “societal risks”; disclosure of director remuneration (executive and non-executive) for shareholder advisory votes; the governance of asset managers and proxy advisors (including addressing conflicts of interest); greater shareholder engagement; strengthening the rights of minority shareholders; employee stock ownership; and possibly strengthening authority to monitoring bodies (e.g., securities regulators and stock exchanges) to assess information quality of listed companies’ compliance (or explanations of non-compliance) with governance code provisions.

The overall tone and direction of the EU’s governance proposals are significant because they not only reflect several reforms already undertaken in other countries, but go beyond many of these in a prescriptive way, particularly those involving proxy advisors, asset managers, institutional shareholders, the relationship between controlling and minority shareholders, and the role of regulators in overseeing the informational adequacy of company disclosure within the voluntary “comply or explain” regime more effectively.

The 25 proposals are as paraphrased as follows (the first 12 of 25 proposals are in this Part; with the next 13 to 25 and conclusion to follow in Part 2):

General Questions:

1. Should the EU take into account a company’s size when instituting governance reforms? (For example, there could be a separate code for SMEs, or a certain size threshold, above which corporate governance measures would apply.)
2. Should governance measures be instituted for unlisted companies? Or should they apply only to listed companies?

Boards of Directors:

3. Should the duties and responsibilities of the Chair and CEO be clearly divided?
4. Should the recruitment policies of directors (including the board chair) be more explicit about the profile of directors, to ensure that boards have the right skills (e.g., competencies and other attributes)? Should these policies also ensure that the board is suitably diverse?
5. Should companies be required to disclose whether or not they have a diversity policy (e.g., to apply to the board, senior management and the organization), and if so, should the objectives and progress of the policy also be disclosed?
6. Should companies be required to ensure a greater gender balance on boards (e.g., through disclosure of objectives and progress, through quotas, or through other mechanisms)? If so, how should this be done?
7. Should the number of mandates that a non-executive director (NED) holds be limited? If so, how should this be done? (This limitation may include consideration of various types of directorships, whether the NED also occupies an executive position, and whether leadership positions are also occupied (e.g., chair).)
8. Should listed companies be encouraged to conduct externally facilitated board evaluations regularly (e.g., “every three years”)? If so, how should this be done? (Given that the UK Code (2010) recommends a similar time frame for externally facilitated board evaluations (“at least every three years”), this may be a move towards standardizing board evaluations, and frequency may be a potential variable, too.)
9. Should disclosure of an organization’s board remuneration policy and its implementation, and the remuneration of executive and non-executive directors be mandatory?
10. Should the remuneration policy and report on its implementation be put to shareholders for an advisory vote? (This proposal would constitute a European version of ‘say-on-pay’.)
11. Should the board approve and take responsibility for a company’s risk appetite and report this appetite to shareholders? Should this disclosure include societal risks (such as risks related to climate change, the environment, health, safety, human rights, etc.)?
12. Should a board take reasonable steps to ensure that the company’s risk-management arrangements are effective and aligned with its risk profile?