Position Paper August 2016
Corporate Governance Policy in the European Union
Through an Investor's Lens
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This report provides an evaluation of the corporate governance landscape in the European Union (EU) and sets forth investors’ perspectives to strengthen governance policy and practices. The report is informed by a series of workshop discussions with investors and other stakeholders. It develops a narrative of the history of governance regulation in the EU since 2000; assesses the current state of the corporate governance agenda; and considers the future of corporate governance reform, articulated through an investor’s lens. It concludes with a series of action memoranda to shape governance standards and practices.
European corporate governance reform is at a crossroads. For the past 15 years, the European Union (EU) has, with some success, been pursuing a policy of strengthening company boards, increasing information flows, and encouraging institutional investor oversight. However, following the completion of the revised Shareholder Rights Directive (SRD II), which is characterised by a series of arguably “disparate” initiatives,1 the future governance agenda in Europe lacks clarity.
In this report, CFA Institute aims to help define a practical future vision for European corporate governance. Our findings are developed on the basis of interviews with leading European institutions and three half-day workshops with 30 investors and governance professionals who have responsibility for governance oversight. These professionals were drawn from Europe’s leading institutional investment firms, with geographic representation from a range of European countries.
The workshops identified that investors believe there is still much that could be done in Europe to simplify mechanisms to enhance corporate accountability and realise maximum value from reforms that have already been undertaken. The findings note that investors are open to many stakeholder issues, such as promoting board diversity, environmental reporting, or good corporate citizenship more generally. Importantly, however, the findings also highlight investors’ concerns that there is still inadequate protection against abuse by controlling shareholders as well as a continued opportunity to further enhance board accountability to minority shareholders.
Workshop participants felt that governance systems need to be flexible and that the flexibility might best be achieved by comply-or-explain mechanisms along with some limited hard laws to ensure accountability. They also noted that currently, the investment industry falls short in carrying out its full stewardship responsibilities and that those in the industry as well as other participants in the governance ecosystem need to be reminded and encouraged to carry out their proper roles and responsibilities.
For the future, the report findings suggest that pressures influencing governance policies will reflect differing views of capital markets and corporate purpose. Champions of a shareholder-focussed governance system may be at odds with advocates of a stakeholder-focussed system, or an “open market” system, in which governance requirements may be laissez faire and more subject to market forces than standard setters. These competing propositions with a shareholder primacy model will not go away and will continue to exert an influence on the policy process. A distinctive feature of this report is the examination of policy options through these different lenses.
Investors will need to understand these differing perspectives and how to adapt to them. While promoting their own rights and responsibilities, shareholders must recognise stakeholder needs as well as the broader economic need for capital markets to stimulate sustainable economic growth and development.
However, there is a considerable opportunity to aspire to a “sweet spot” in which shareholder, stakeholder, and open market perspectives can be reconciled—as a type of trialectic synthesis. Our discussions identified a number of opportunities for progress and at least a general aspiration that the shareholder, stakeholder, and open market perspectives can fit together in relative harmony. Many stakeholder interests can be accommodated without diluting investors’ rights or interests. Indeed, stakeholder considerations can strengthen long-term value creation. This approach suggests a common understanding of roles and responsibilities can be found, which can have lasting positive effects for both shareholders and stakeholders.
This vision is one that European policymakers and investors alike should seek to explore in their future policy agenda. With a renewal of the investor vision for European corporate governance and with proper attention to the governance “ecosystem,” there is a considerable prize to be won in the growth, productivity, social, and environmental responsibility of European public companies. But it is unclear whether we are currently on a course to realise these benefits.
We conclude this report with action memoranda directed to the different policymakers and market participants involved in framing and implementing good governance. Better corporate governance, similar to better political governance, cannot be achieved by regulation alone. It also depends on an understanding among participants of their appropriate roles, rights, and responsibilities. Properly framed, we believe that there is considerable room for the development of better governance in the EU.
The action memoranda speak for themselves, but the following provides a summary.
Companies should accept the need for accountability and either comply with an established corporate governance code or provide a thoughtful and legitimate explanation for code deviation. Companies should enable better monitoring of governance compliance.
We encourage companies to build a constructive attitude towards engagement with investors to establish mutual understanding and long-term relationships.
Policymakers should be clear about what they want to achieve from corporate governance. We trust that the goals will be compatible with the investor vision outlined in Section VI of this report.
Policymakers should consider developing a guidance statement for company boards and for institutional investors that articulates stewardship expectations stemming from SRD II. This guidance should reflect sensitivity to the complexities of large asset managers that deal with widely diversified holdings, multiple mandates, and differing investment strategies. It might also establish the expectation that companies have a role to play in engaging with investors to achieve the broader goals of investor stewardship.
The European Commission should encourage strong monitoring mechanisms in individual European member states to ensure that companies and investors either adhere to governance and stewardship code requirements or provide a credible explanation. Different monitoring systems exist in some European markets, and the Commission should at least seek to ensure that individual member states have an appropriate mechanism to give substance to soft law.
The Commission should consider how further governance policy work might integrate with the Capital Markets Union (CMU). Governance is exercised through the capital markets. In this context, we emphasise the importance of ensuring coherence and joined up thinking between the governance mandates of DG JUST (Directorate-General for Justice and Consumers) and DG FISMA (Directorate-General for Financial Stability, Financial Services, and Capital Markets Union).
One of the most pressing practical concerns of investors is the protection of minority shareholder rights, particularly in the context of controlled companies. Measures needed to uphold minority investor protections include the following:
- Promoting better board accountability to minority shareholders, perhaps through more robust independence standards, a greater role in “hiring and firing” the board members, and stronger board diversity
- Continuing to press for rights relating to material related-party transaction votes (for example, as initially proposed under SRD II)
- Not promoting differential ownership rights and dual class share structures, which undermine open accountability
Regulators should continue to work with market participants to fix the “plumbing” of cross-border proxy voting to ensure that shareholders are able to vote in an informed way and that all legitimately owned and cast votes by shareholders are formally counted and ultimately confirmable to the voting shareholder.
This policy direction places responsibilities on institutional shareholders to behave as fiduciaries. Institutional investors should regularly review their own internal governance standards. They should ensure appropriate tone from top management and clear expectations with regard to stewardship responsibilities.
Investors should be explicit in the need for corporate management to take a long-term view, and although financial considerations are likely to be at the fore, investors also should consider incorporating environmental, social, and other governance issues into risk analysis and the investment process. In this context, investors should accept the legitimate interests of stakeholders and note the considerable overlap between those interests and their own fiduciary duty to deliver value for their beneficiaries.
Investors should report to clients on how they discharge their fiduciary responsibilities. They should also report publicly on their compliance (or otherwise) with applicable stewardship codes and standards.
See Hopt (2015) for more information.
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