Constructive Engagement: Directors And Investors in Action

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Constructive Engagement

Dedication To Charles and Elizabeth Handy – alchemical catalysts extraordinaires. And to the Sector Dialogue Steering Group: Steve Robson, Richard Sykes, John Parker, Lindsay Tomlinson, John Fraser, Richard Lapthorne and Gay Huey Evans, without whose advice and support this work would have been quite impossible.

Constructive Engagement Directors and Investors in Action NICHOLAS BEALE

© Nicholas Beale 2005 All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by any means electronic, mechanical, photocopying, recording or otherwise without the prior permission of the publisher. Published by Gower Publishing Limited Gower House Croft Road Aldershot Hants GU11 3HR England Gower Publishing Company Suite 420 101 Cherry Street Burlington, VT 05401-4405 USA Nicholas Beale has asserted his right under the Copyright, Designs and Patents Act 1988 to be identiﬁed as the author of this work. British Library Cataloguing in Publication Data Beale, Nicholas Constructive engagement: directors and investors in action 1. Corporations – Investor relations 2. Corporations – Investor relations – Case studies 3. Communication in management 4. Communication in management – Case studies 5. Directors of corporations 6. Directors of corporations – Case studies I. Title 658.4 ISBN 0 566 08711 1 Library of Congress Cataloging-in-Publication Data Beale, Nicholas. Constructive engagement: directors and investors in action/Nicholas Beale. p. cm ISBN 0-566-08711-1 1. Corporations--Investor relations--Great Britain. 2. Boards of directors--Great Britain. 3. Stockholders--Great Britain. 4. Corporate governance--Great Britain. I. Title. HD2744.B43 2005 659.2'85--dc22 2005049429

Typeset by IML Typographers, Birkenhead, Merseyside. Printed and bound in Great Britain by MPG Books Ltd. Bodmin, Cornwall.

Contents Introduction Acknowledgements

xi xiii

PART ONE

THREE PIVOTAL ISSUES

1

Chapter 1

Axes of Engagement Directing Shareholders’ interests? How do we deal with conﬂict of interest? Relationships of INEDs with other parties

3 5 6 8 11

Chapter 2

Someone of Sound Mind Career development Broadening perspective Putting something back The soft landing

23 24 25 27 28

Chapter 3

A Policeman’s Lot Utopia, Limited Investors as policemen Potential conﬂicts for investors and policemen Practical issues around the policemen role for investors Investor interaction with a newly appointed Chairman Investor reaction to ‘explain’s

31 31 35 36 37 44 45

PART TWO

SEVEN PILLARS

49

Chapter 4

BP Anglo-Persian and beyond Outline of BP’s governance model BP’s approach to shareholder/NED contact BP’s approach to NED appointment and development BP’s approach to the policeman’s lot

51 51 58 66 68 70

vi

CONSTRUCTIVE ENGAGEMENT

Chapter 5

Tate & Lyle Out of the strong came forth sweetness T&L’s approach to shareholder/NED contact T&L’s approach to NED appointment and development T&L’s approach to the policeman’s lot

73 73 78 79 81

Chapter 6

Vodafone A decisive hat trick Digression on creating shareholder value Vodafone after Mannesmann Outline of Vodafone’s governance model How Vodafone handles investor/director dialogue Vodafone’s approach to NED appointment and development Vodafone’s approach to the policeman’s lot

83 83 86 87 89 91 93 95

Chapter 7

BGI The wagon wheel spins BGI’s approach to shareholder/NED contact BGI’s approach to NED appointment and development BGI’s approach to the policeman’s lot

99 99 101 102 102

Chapter 8

Fidelity Customer service and innovation Fidelity’s approach to shareholder/NED contact Fidelity’s approach to director development Fidelity’s approach to the policeman’s lot

105 105 107 111 112

Chapter 9

UBS Global Asset Management From Zurich and Basel to global UBS GAM’s approach to shareholder/NED contact UBS GAM’s approach to director development UBS GAM’s approach to the policeman’s lot

115 115 119 120 120

Chapter 10

Constructive Engagement in Action: Royal Dutch Shell A long pilgrimage The crisis The team Engagement begins Effective traction Decisive actions Reﬂections and lessons learned

123 123 125 130 132 137 142 144

CONTENTS

vii

PART THREE NOTES OF EXPERIENCE

149

Chapter 11

Chairmanship and Board Effectiveness The role of the Chairman The Chairman’s relationship with the CEO Coaching and developing executives and holding them to account Steering the Board agenda Balancing the Board Building Board effectiveness Balancing multiple chairmanships Board evaluation Appointment of Chairman Other

151 151 154

Chapter 12

The Independent Directors and Executive Directors The roles of independent directors, beyond the statutory The nature of independence Inﬂuence through wisdom, listening and questions The art of asking The SID Checks and balances: visible but not intrusive Making a real contribution Effective mentoring Committees: tips and pitfalls Board visits: formal and informal The fun element NED appointment Casting the net Remuneration of NEDs RemCo and ED remuneration Audit, Audit Committees and ﬁnancial experts The Company Secretary Points to consider before accepting a NEDship ED development NED development Other

169 169 173 174 174 175 175 176 177 178 178 178 179 180 180 182 186 188 188 191 192 192

Chapter 13

Reﬂections on the Investment Industry General reﬂections on investor engagement Frustrations Investor activism in practice

195 195 198 202

156 157 158 160 163 163 166 166

viii

CONSTRUCTIVE ENGAGEMENT

The evolving challenges of managing an investment management company Escape! Analysts and analysis International perspective Difﬁcult areas Pensions Other

204 206 207 208 208 209 210

Chapter 14

Perspective on the Governance Landscape and Trends Aims of corporate governance Some lessons from big failures Comply/conform or explain Government Higgs Sarbanes-Oxley Wider economic issues Other

213 213 214 215 216 217 217 218 219

PART FOUR

UNSCIENTIFIC POSTSCRIPT

221

Chapter 15

From Governance to Stewardship Board behaviour matters more than processes Evolving relationships with investors Suggestions to chairmen Suggestions to NEDs Suggestions to people considering a NED role Suggestions to executive directors Suggestions to investors Stewardship Conclusion

223 223 224 225 228 230 234 236 241 250

Appendix A

Outline of Lead Investor Idea Lead Investors – an SID in reverse? Implementation issues for the Lead Investor concept Incentives for constructive engagement rather than noise

251 251 253 253

Appendix B

Royal Dutch Shell Corporate Governance Arrangements The CEO Executive management The Board Board Chairman

255 255 256 258 259

CONTENTS

Deputy Chairman Board committees Glossary Partial bibliography Index

ix

260 261 265 267 275

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Introduction ‘You must be Miss Hope, the governess I’ve come to meet’ said the apparition, in a tone that admitted of very little argument. ‘Very well, if I must, I must’ said Lady Carlotta to herself, with dangerous meekness. Munro (1914) ‘You must write a book about this’ said Charles, smiling benignly over breakfast – not at all like an apparition. For the last 15 years, as part of my consulting work in strategy and search, I have run a Sector Dialogue Process, working quietly behind the scenes to improve communication, trust and understanding between industrialists, analysts and investors, guided by a distinguished steering group. In 2001 Paul Myners, who had previously been a member of our Steering Group, came in to lunch and said that he was getting increasingly interested in the relationship between investors and nonexecutive directors (NEDs). This seemed an excellent project for the Sector Dialogue work, and my colleagues and I spent the first six months asking around to try to understand what the issues were and what, if anything, it would be useful for us to do about it. We concluded we could take two useful initiatives: 1.

It became clear that there was very little real contact between chairmen and the top-management of major investors. So we started a series of investor/chairmen dinners, where the head (CEO, CIO, Chairman or occasionally Vice-Chairman) of a major investor would meet with two to six chairmen for an informal dinner discussion of some of the key issues.

2.

There was concern about finding the next generation of NEDs and chairmen, so we initiated the NEDX Process, whereby chairmen of a number of major UK companies have retained us to ﬁnd suitable NED roles for some of their best people, who are currently on, or just below, their own main Boards. This entailed arranging a series of masterclasses where we brought together a few of these nominees with a leading Chairman, an experienced NED and a representative of a leading investor for a frank discussion of the realities of the NED role – what chairmen want, what investors expect, what it’s really like serving as an NED.

xii

CONSTRUCTIVE ENGAGEMENT

All of these discussions were written up, sanitized, sent to the participants as a draft for checking and then, with the corrections incorporated, they were ready for aggregated circulation. We explained that people would only be identified as Chairman, Director, Investor or Other and that notes would be aggregated with at least three others. After three years of this, there is a lot of material (about 220 pages of comments) but, more importantly, a fair amount of understanding about what the issues are. Hence, when I went to brief Charles … This book is structured in four parts – if I could say four movements without sounding pretentious I would – each has a rather different voice and purpose, but I hope they form a coherent whole. In Three Pivotal Issues I try to set the scene and indicate three key issues about the relationships between investors and directors. In Seven Pillars I look at three companies (BP, Vodafone and Tate & Lyle) and three leading investors (Barclays Global Investors, Fidelity and UBS Global Asset Management) to see how each of them addresses these three issues and we then have an extended case study in terms of the investor engagement that led to major changes at Royal Dutch Shell: the first time many of the key players have talked on the record about this. In Notes of Experience the authorial voice is silent as I seek to share most of the comments that were made by the chairmen, investors, directors and others. Finally in Unscientiﬁc Postscript I offer some suggestions to the various constituencies.

Acknowledgements In addition to the dedicatees, firstly, thanks to my partner in every sense of the word, Christine, whose professional and personal support is beyond words. Thanks also to my PA Louise Crawford and to five former colleagues: Laura Sanderson, Rachel Quigley, Harriet Rees and Polly Paulusma whose assistance in various ways has been considerable, and to our summer intern Lucas Palmer. I would like to thank by name all the chairmen, directors, investors and others who have participated in the investor/chairmen dinners, masterclasses and other discussions on which this book is based – over 180 people at the last count. However to do so would risk breaching the anonymity of the comments, so I can merely say that amongst the participants in this work have been: Ashley Almanza, Norman Askew, Julie Baddeley, Andy Banks, Barbara Beckett, Charles Berry, Lord/Norman Blackwell, Tim Breedon, Adam Broadbent, Norman Broadhurst, Dr John Buchanan, Lord/Terry Burns, Richard Butler, Rodney Chase, Chris Cheetham, Sir David Clementi, Richard Clowes, Ross Courtier, Vivienne Cox, Grant Dawson, Peter Duffy, Patrick Dunne, Warren East, Sir John Egan, Douglas Flint, Bill Friedrich, Sir Christopher Gent, Sir Ian Gibson, Anthony Gilbert, Sydney Gillibrand, Sir Richard Giordano, Danuta Gray, Colin Green, Ian Grifﬁths, Judith Hanratty, Peter Hickson, Dame Julia Higgins, Derek Higgs, Sir Christopher Hogg, Steve Holliday, Richard Horlick, Martin Houston, David Jackson, Keith Jones, DeAnne Julius, Nigel Keen, Joanne Kennedy, Lord/John Kerr, Ian King, Kit Farrow, Larry Stone, Paul Lee, Sir David Lees, John Leighfield, Geoff Lindey, Lord/Ian Maclaurin, Strone MacPherson, Helen Mahy, Humza Malik, Rob Margetts, John Matthews, Michael McLintock, John Napier, Lord/Tony Newton, Derrick Nicholson, Sir Robin Nicholson, Thomas O’Malley, Gordon Page, Sir John Parker, Ian Peacock, David Pearl, Ian Pitfield, David Pitt-Watson, Tom Reid, Hubert Reid, Nigel Rich, Sir Ian Robinson, Philip Rogerson, George Rose, James Ross, James Sassoon, Sir Robin Saxby, Sir David Scholey, Jeremy Scudamore, Lord/David Simon, Simon Clift, Anita Skipper, Nigel Stein, Rolf Stomberg, Steve Surrall, Sean Sutcliffe, Peter

xiv

ACKNOWLEDGEMENTS

Sutherland, Barbara Thomas, Mike Toms, Philip Twyman, David Tyler, Geoff Unwin, David Varney, Sir Peter Walters, Tony Watson, Sir John Weston, Nigel Whitehead, John Whybrow, Trelawny Williams, Steve Williams, Nigel Williams, Sir Robert Wilson, Alison Wood and Roger Yates. I extend my thanks to all of them, including those I have not named. To any reader who thinks they have identified a comment to someone in this list: you probably haven’t. To any contributor whose name I have not included, please be assured that I do not thank you any the less, but have to leave some out of the list for reasons of confidentiality. If you’d like to be included in any subsequent edition, please let me know. I’m also extremely grateful to my publisher, Jonathan Norman at Gower Publishing, both for his wisdom, flexibility and guidance and also for having found a brilliant research assistant – Helen Parry, who played a key role in finally pulling this book together, especially in the Notes of Experience section. Warm thanks are also due to the Alex Cartoon Team (Russell Taylor and Charles Peattie) and to H.M. Bateman’s daughter Mrs Willis, and to my friends at BP, Fidelity, UBS, BGI and Tate & Lyle. Naturally, despite the input from all these talented people, there will be some mistakes in this book – the responsibility for which is entirely my own.

PART ONE

Three Pivotal Issues

This page intentionally left blank

CHAPTER 1

Axes of Engagement I understand that in this role I am meant to represent the investors. When do I get to meet them? He had accepted the invitation to join the Board of a famous company. The induction training had been most interesting. Chatting before his first meeting, he asked this logical question, and the CEO’s response was simple: ‘Over my dead body’. Later there was considerable investor discontent about this company. A leading investor, who expressed disquiet about the performance of the CFO, found the Chairman and the CEO in his office asking whether he thought that their CFO should be sacked. His response was, ‘to be honest, I was hoping that you’d take that decision for the shareholders rather than asking us to take it’. Investor concern continued. Representations were made to the non-executive directors (NEDs). The Board acted. Eventually, there was a complete clean-out of the executive directors and the Chairman. So perhaps the CEO was right after all. But perhaps with different attitudes and behaviour by all the parties, some of the mishaps that befell this company would have been avoided. In this vignette we see three axes of engagement: 1.

between the NEDs and the investors

2.

between the NEDs and the executives

3.

between the executives and the investors.

It is the ﬁrst two of these axes that are evolving rapidly, and it is these that we have been exploring intensively for the last few years and that I want to explore in this book. The relationships between NEDs and investors, and between the NEDs and their boardroom colleagues, are important because, if these relationships work well, the publicly quoted companies which drive modern capitalism work brilliantly and, if they do not, they can be derailed spectacularly. Business is fundamentally about people, their behaviour and attitudes, generating value and managing risk: it is not about ticking boxes, generating paperwork and a false sense of security based on form over substance. In the ‘old days’ it was simpler. The Chairman, who was also the CEO, ruled the company and the Board, and the NEDs, if any, had little real say. If investors didn’t like

4

CONSTRUCTIVE ENGAGEMENT

something they could complain to the Chairman, and if he1 didn’t listen they could sell the shares. Thus the only engagement was between the investors and the company – specifically the Chairman. This changed with the rising importance of NEDs and the separation of the roles of the Chairman and the CEO, so that in practice investors have the option of engaging with the executives (mainly the CEO and the CFO), the Chairman or the NEDs – the latter being usually a last resort when other options failed. The other change was the rise of the large-scale professional investor. If you have 0.1 per cent of a company then you can usually sell your shares at close to the market price, so if you are dissatisﬁed you can ‘walk’ fairly easily. But if you have 5 per cent or 10 per cent then attempting to sell the shares will substantially depress the price. It may be far better to get the company to change its policy, by effective engagement with the executives or the NEDs. Equally NEDs found that they were expected to be much more engaged with the business on whose Boards they served. Being an NED of a failed company could seriously damage your reputation and in the worst case result in major personal lawsuits. Let us offer a rough sketch of the landscape that we will explore in detail throughout the book. In a normal state the level of NED–investor engagement is low (routine meetings with the Chairman and maybe the Chairman of the Remunerations Committe or RemCo), with moderate engagement between the investors and the executives (regular meetings with the CEO and CFO) and high-ish engagement between the NEDs and the executives (a real effort to understand and add value to the business). If things start going wrong investor engagement with the executives and the NEDs is raised, which generally raises the level of engagement between the NEDs and the executives. If necessary, changes are made, and the situation reverts to the normal state. Achieving this engagement in a constructive rather than destructive manner is a craft rather than a science, and exploring this craft, with the aid of many master practitioners, is the theme of this book. The simplest statement of the relationship between directors, the business and the shareholders is that directors are generally expected to take decisions on the direction of the business in the interests of the shareholders.2 This raises three natural questions: 1

2

Female chairmen of companies were pretty well unheard of, though there were examples. Lady Charlotte Guest was Chairman of the Dowlais Iron Co (which became the core of GKN) in 1854. A remarkable lady (who had been romanced by Disraeli and translated the Mabinogion) and an astute businesswoman, she had been heavily involved in the business since her marriage to Sir John Guest in 1833, became Chairman on his death but retired when she remarried. I don’t want to get into the debates about what other legal or moral duties the directors have, which will vary from jurisdiction to jurisdiction and would require a book of at least comparable length to do it justice. In UK law the legislation talks about a duty to ‘the company’ as a whole. This is usually interpreted as meaning ‘the shareholders’, since ‘a member of the company’ is ‘a shareholder in the company’ in legal terms. There are those, such as Bob Garrett, who argue forcefully that this is a delusion – ‘The Delaware Delusion’ indeed. It’s certainly true that even in UK law directors also have other legal duties, such as to creditors, employees, government and regulators, and that it is prudent to consider, at some level, the

AXES OF ENGAGEMENT

1.

How do we direct the business?

2.

How do we determine the interests of the shareholders?

3.

How do we deal with conﬂicts?

5

DIRECTING The obvious way in which the directors direct the business is that they take explicit decisions, individually and collectively, either about specific issues such as a major acquisition or about policies. The less obvious way is that they set the tone: people have a view of the kind of decisions that the directors would approve and of the kinds of behaviour that the directors would reward, either financially or otherwise. This is more pervasive. As one leading Chairman put it: ‘There are often only around three really major decisions for a Board to make a year. Most of the time you are in monitoring/encouraging/mentoring mode.’ Knowing the kinds of decisions that will be closely scrutinized, the kinds of activities that will be applauded, is very important. Chairmen say things like ‘In my company we have a big focus on CSR and we see this as part of our processes of managing business and reputational risk’ or ‘One of the jobs of the Chairman is to set the tone within the Board in terms of reaction to outside pressures’. Another pointed out that a famous corporate disaster ‘was influenced by fashion … The Board got cheered to the skies by the City’. Different styles and outlooks of the Board will have different, and pervasive, effects within their companies. For every proposal that the Board approves there will be many that are abandoned before they get to the Board because it is believed in the company that ‘the Board would never agree to that’. In order to direct effectively you need information, and the kinds of information that the directors get significantly influences their outlook. One highly successful international business makes a point of giving the directors an exact balance of positive and negative comment from ﬁnancial analysts – other businesses rely on their brokers, investor relations departments or specialist firms on substantial retainers to give feedback from analysts and the balance of City opinion. There is clear danger that the latter will balance their feedback to their bosses/clients to what they think they will like to hear. People don’t like to give the directors bad news and many directors don’t like to hear bad news and will shoot the messenger, or consultant, who brings it to interests of the other ‘stakeholders’ in a company. In other jurisdictions directors have a different balance of duties, but there is a striking convergence towards most of the UK model both in the US (where splitting the Chairman and CEO roles is increasingly common) and in Continental Europe; for example, Shell and Unilever. A whole additional book could be written about engagement with other ‘stakeholders’ such as governments, NGOs, ‘animal rights’ campaigners or even criminal organizations (especially complex when an organization can be criminal in one jurisdiction and much lauded in another). I am ignoring these questions in this book, not because they are unimportant but because I have to limit the scope of the book.

6

CONSTRUCTIVE ENGAGEMENT

them. All this means that directors must be subtle in the ways in which they acquire and evaluate information. This is of course true for all directors but applies particularly to the non-executive directors or NEDs. They are not employees of the company and have no executive authority over the employees. They are part-timers, often with demanding day jobs, and generally chosen from outside the industry in which the company operates. The Chairman is usually somewhere in between an NED and an executive: spending much more time on the business than a typical NED, but nevertheless having other responsibilities and being careful not to interfere with the CEO and the executive team. If directors are not entirely happy that they have all the information they need they can ask questions and, unlike investors, they have a legal right to the answers in all but the most exceptional circumstances.3 This means that the questions directors ask are enormously powerful signals within an organization; as are the questions they don’t ask.

SHAREHOLDERS’ INTERESTS? There are some books whose titles alone make you want to buy them. Fad Surfing in the Boardroom encapsulated so much of the consultant-speak of the late 1990s, for example. In 1927 a Wall Street trainee was told of a visitor who was shown the impressive yachts anchored off New York. ‘Look, those are the bankers’ and brokers’ yachts.’ Where Are the Customers’ Yachts? asked the naïve visitor – thus producing the delicious title of the book which became the lasting fruit of that trainee’s labours. Yachts at least have the advantage of being tangible. Where, and indeed what, are the shareholders’ interests? It is axiomatic that investors want to make money. Thus it is tempting to suggest that acting in the shareholders’ interests is simply equivalent to maximizing the value of the shares. However, whilst this might be a good deﬁnition of the economic interests of option-holders, there are a number of difﬁculties. Dividends enrich shareholders at the expense, at least in the very short term, of the company. Very well, what about maximizing total shareholder return (TSR)? Better, but at any one moment, TSR gives a great weight to the current share price. Since, conceptually: Share price = Fair value × (1 + overvaluation factor) 3

Such as when there are issues of national security involved. This is why the chairmen of certain companies, such as BAE SYSTEMS and Cable & Wireless, have to be security-cleared to the highest levels by the relevant government. It is an additional complexity of owning defence companies in foreign countries that you end up owning subsidiaries whose managements are not allowed to tell you things.

AXES OF ENGAGEMENT

7

any changes to the overvaluation factor (which can of course be positive or negative) will have a large effect on TSR. Directors have many rather immediate levers to influence the overvaluation factor whereas influencing the fair value is hard work. Devotees of the strong Efﬁcient Markets Hypothesis (that shares are fairly valued at all times) will of course not see any difﬁculty, any more than ﬂat-earthers see the need for spherical trigonometry when navigating the oceans. However, a weak version of the hypothesis, such as that in the medium term the overvaluation factors in any reasonably well-understood company will tend to be zero on average, would suggest that any attempt by the directors to keep the overvaluation factor up is ‘enriching’ the current shareholders at the expense of the future shareholders. This still suggests that a strategy of ‘we aim to have our shares grossly overvalued and then use our overvalued shares to buy undervalued4 assets’ could have a lot to commend it. This was arguably the real idea behind the AOL/Time Warner merger. I have only come across one Chairman who admitted openly to this strategy: Our shares were driven sky-high by investors and are now down to a fraction of their peak value, but it is a much better company now than it was then. The large institutions pushed the shares up and it was something of a feeding frenzy. … We weren’t entirely sure what to do: we didn’t want to talk the shares down, but we tried hard not to talk them up. It’s a really super company, and eventually it will be worth what it was at the top. We’re on the way to doing it – and the fact that the shares were so high allowed us to do the right thing and build the base [by using our shares to acquire a] business whose profits can underpin the development of the [original longer-term] part of the business. There is an issue around sector overvaluation which is worth exploring here. If directors know, or strongly suspect, that the overvaluation factor of their company is high and so is that of company X, which they wish to acquire, then it arguably makes good sense to use their (overvalued) shares to buy X’s (overvalued) shares even though they are paying more than they would be worth in cash terms, provided the deal would still make sense if the overvaluation factors on both sides were zero. This is sweetened if you then sell some of X’s assets, which you don’t want or cannot hold, to third parties for cash. This is one description of the logic of Vodafone’s acquisition of Mannesmann, discussed in Chapter 6. Part of this relates to the question of whether shareholders pick stocks or whether they pick sectors and then stocks within the sector: if the latter then relative valuations in a sector become more important than absolute valuations. It is fair to suggest that many professional fund managers were working on a sectoral basis, especially in the bull market until 2000, and their own performance was evaluated on relative rather than absolute returns. However, fund managers are not, in general, the 4

Or at least less overvalued.

8

CONSTRUCTIVE ENGAGEMENT

ultimate shareholders, who are predominantly pension fund beneficiaries, life insurance policy holders, investors in mutual funds or unit trusts or investment trusts and increasingly hedge funds. Just as there are potential conﬂicts of interest between the executive directors and the shareholders in a company, so there are potential conflicts of interest between fund managers and the ultimate shareholders, of which more later. It is at least worth remembering that the interests of the shareholders and the interests of the fund managers are not necessarily identical. Nevertheless, the fund managers are employed to make money for their customers, and the best of them do work conscientiously in the interests of the ultimate shareholders. They also have a depth of information and expertise that the ultimate beneficiaries generally lack. It is, in practice, largely the fund managers to whom the directors can turn for a sense of investors’ opinions, from which they can try to infer investors’ interests.5

HOW DO WE DEAL WITH CONFLICTS OF INTEREST? There are in principle as many potential sets of conﬂicts of interest as there are pairs of parties in these relationships. Thus we can have conﬂicts of interest:

5 6

1.

Within the business, for example, which division gets extra investment.

2.

Amongst the directors, for example, the relative power of the Chairman, the CEO and the senior independent director (SID).

3.

Among fund managers, for example which fund managers are seen to be most influential and best informed.6 It is also worth remembering that if fund managers are judged on relative performance it is in the interests of fund managers for any stock in which they are underweight to perform relatively badly, even if they remain substantial holders. This leads to the bizarre spectacle of fund managers with substantial investments in major stocks who may be hoping that their largest investments do badly.

4.

Among shareholders, for example, between UK and non-UK shareholders in a situation where the company might do something which changes its eligibility requirements in, say, an index (tax is also a factor here). This was clearly one of the complicating factors in the decision to simplify the structure of Shell.

Why don’t companies try to map out directly the end beneﬁciaries of the various shareholdings and poll them? Since fund managers are usually in perpetual competition for clients – even in pension funds, although each individual mandate may last for three to ﬁve years, in a ﬁrm with many clients mandates come up for renewal on a weekly or daily basis.

AXES OF ENGAGEMENT

7

8

9

9

5.

Between the business and directors, for example, the number of outside directorships that the directors are allowed and the time they spend on them.7 In the Marks & Spencer saga of 2004 (Philip Green, a retail billionaire, wanted to buy M&S and assembled the financing to do so, subject to due diligence, but the Board would not allow him access to the figures) one contributory factor was that the Chairman in early 2004 was spending less and less time in the business.8 Nevertheless it took the threat of a hostile bid to get him (and his CEO) replaced.9

6.

Between the business and the fund managers, for example, when the fund managers want answers to certain questions that will help them make better investment decisions, but the business does not want to give these answers because the information is commercially sensitive and may damage the competitive position of the business if it becomes generally known.

7.

Between the business and the shareholders, for example, whether the proceeds of the sale of a subsidiary should be retained in the business as a cushion or given back to the shareholders by way of a special dividend.

8.

Between the directors and the fund managers, for example, whether the directors should appoint someone as Chairman who they think is right for the business but whom the fund managers dislike.

9.

Between the directors and the shareholders. The usual example is over the levels of directors’ remuneration including share options. In the UK the absolute sums involved tend to be very small compared to the overall proﬁtability of the company: there are nevertheless serious issues in terms of the signals remuneration sends, and in the US total remunerations including options were often large fractions of the real profitability. However, a more serious issue in economic terms is the conflict when it comes to acquisitions: acquiring another company usually increases the power, prestige and remuneration of the directors but usually loses the shareholders money. Conversely, being acquired usually costs the directors their jobs, but usually makes money for the shareholders in the acquired company. There is some reason to suppose that private equity

One deeply troubled business allowed its CEO to hold two outside directorships. We had the Chairman in to dinner but I never managed to get an explanation of why this was permitted. The Chairman said he was unaware that his CEO was also chairing the Nominations Committee of one of the companies of which he was an NED. His successor explained that the outgoing Chairman had advised the Board in December that he would have to step down due to his commitment to a friend to look after their family interests, and was only staying on until a successor was found. The outgoing Chairman had also become increasingly involved in private equity. This case is discussed in more detail below.

10

CONSTRUCTIVE ENGAGEMENT

acquirers tend to underpay and public companies tend to overpay. After all, most private equity acquirers aim to resell the business, either by trade sale or flotation, in three to five years, at a substantial profit for their shareholders. They are therefore very focused on whether they have overpaid, especially since they have used debt finance to leverage up the transaction. They usually have a track record of success in similar transactions – otherwise they would have difficulty in raising funds. And they also have a reward structure unambiguously geared to rewarding success in value generation for their shareholders, often with very substantial sums of their own capital invested in, or alongside, the funds they manage. 10.

Between the fund managers and the shareholders, for example, when it is in the interests of those fund managers who are invested but underweight in a company for it to underperform, but in the interests of the shareholders for it to perform well. The most fundamental, that is, the remuneration (overt and disguised) that the fund managers receive for their services, is not directly influenced by the directors and thus rather beyond the scope of this book. But of course when these fund managers are pitching to run corporate pension funds the roles are somewhat reversed, since it is common for at least one of the executive directors to be a trustee of the company’s pension fund. Pension fund trustees now routinely ask about the remuneration principles that are used within a fund manager.

Much attention is focused on potential conflicts between directors and shareholders but it’s worth remembering that this is only one of the ten types of conﬂict that can be identiﬁed – and all the rest have to be managed as well. A major thrust of corporate governance is to manage the conflicts of interest between directors and shareholders by relying heavily on the independent nonexecutive directors (INEDs). INEDs are supposed not to derive their main remuneration and status from the company on which they serve as a director. They are meant to be people of wide experience, who are able to ask the right questions and

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make judgements in the interests of the shareholders, so that on the, one hopes, rare occasions where there is a conﬂict between the interests of the shareholders and those of the executive directors, the Board as a whole can do the right thing. In some cases the INEDs form a majority on the Board, in other cases there are circumstances when they can require other directors, who may have a conflict, not to vote.10 In practice chairmen rarely put a controversial matter to the vote, so even on Boards where the INEDs are not in a majority, the united opposition of the INEDs is usually an effective veto on a course of action. The INEDs can also help in finding ways through some of the complex conflicts such as cases 1, 2, 5, 6 and 7 listed above. This puts a considerable strain on the other roles of the NEDs, a point which we come to in Chapter 3. The INEDs are, in an important sense, the investors’ agents, having access (in principle) to (virtually) all the information in the business. They are the pivot on which most of modern corporate governance hinges.

RELATIONSHIPS OF INEDs WITH OTHER PARTIES The introduction of INEDs into the picture raises a further set of questions which are a central focus of this book. These INEDs have a number of key relationships, of which the ones relevant to this book are: 1.

with each other

2.

with the other directors

3.

with the business

4.

with the fund managers

5.

with the shareholders

6.

with the Company Secretary

7.

with the auditors

8.

with the other advisers to the company.

We’ll consider each brieﬂy in turn, the detail will be in subsequent chapters.

RELATIONSHIPS BETWEEN INEDs It is important that the Board functions as an effective team. This means that the relationships in the boardroom have to be those of colleagues. Nevertheless a certain 10

It emerged at the time of the question of James Murdoch becoming CEO that the Articles of BSkyB had such a provision.

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amount of creative tension, at least, is inevitable and probably desirable. The INEDs will have different roles, backgrounds, styles and expertise. These differences may be reinforced by the fact that they meet fairly infrequently in a constrained format, which tends to encourage people to conform to roles within a group. One Company Secretary described to us how he watched a particular INED well known for his strong and somewhat contrarian views: ‘First comes the bottom shuffle, then the placing of the spectacles on the table, then the rolling of the eyeballs, and then the awkward questions.’ Directors tend to be pretty high achievers and a certain amount of jostling for position is inevitable. It is the responsibility of the Chairman to manage this. With the increasing differentiation of roles in the Board, the INEDs have specific designations which makes it easier to accommodate the natural desire for prominence and distinction and helps make it clearer who is to take the lead on specific matters. The Audit Committee and the Remuneration Committee have to be chaired by INEDs and in addition the Board is encouraged to appoint one of the INEDs as the SID to act as a point of contact for investors if they are for any reason unable to get a satisfactory response from the Chairman. There was a proposal in the Higgs Review to require that the Nominations Committee be chaired by an independent director and that the Chairman should not be a member of it – however this was dropped from the provisions that made their way into the Combined Code, mainly on the grounds that the Chairman should be accountable for the quality of the Board and its deliberations and could hardly be expected to be so if he or she were not on the Nominations Committee and therefore, at least in theory, had no influence over the Board membership. Many industrial companies have a Health, Safety and Environment Committee and/or a Corporate Social Responsibility Committee. And, to cap it all, both Sarbanes-Oxley (in the US) and the Smith Review (which is incorporated into the Combined Code in the UK) strongly encourage the Board to have a designated ﬁnancial expert on the Audit Committee. The requirements for this are so onerous that it is hard to see how anyone other than a serving CFO who is also a qualified accountant11 could be sure of meeting them fully. Since chairing the Audit Committee is also a time-consuming activity I expect an increasing trend of having the financial expert distinct from the Chairman of the Audit Committee. There are thus potentially seven distinct roles for INEDs:

11

1.

senior independent director

2.

Chairman of Audit Committee

3.

ﬁnancial expert (if different from 2)

In the UK this is almost invariable, but in the US it was until recently rather rare. This is both a cause and an effect of the relatively much lower status of accountants in US society than in the UK – possibly linked to the fact that, at least until recently, certiﬁed public accountants in the US had to have a degree in accountancy whereas becoming a chartered accountant in the UK did not require any speciﬁc degree. Thus the position was open to people with ﬁrst class degrees from elite universities – most unusual in the US.

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4.

Chairman of Remuneration Committee

5.

Chairman of Health, Safety and Environment Committee

6.

Chairman of Corporate Social Responsibility (CSR) Committee

7.

Chairman of Nominations Committee (if not done by the Chairman of the company).

Relatively few UK companies have more than seven INEDs so in principle everyone can be allotted a role. But it is important to emphasize that the Board as a whole remains accountable for the recommendations of the committees. If an INED, or the Chairman, is uncomfortable about something recommended by, say, the Audit Committee or the Remuneration Committee they should say so. They will be criticized, rightly, for a decision made by the Board if it is wrong and it is no defence, or at best a very partial one, to say ‘I was only following the recommendation of the relevant committee.’ All this can make for lively meetings and as always it is the Chairman who is responsible for holding the ring and getting the balance right, so that the debate is constructive and that sound decisions are made. For this, theories are no substitute for wisdom: which is why collecting and sharing the wisdom of experienced and successful chairmen is a major objective of the present book.

RELATIONSHIPS BETWEEN THE INEDs AND THE OTHER DIRECTORS These other directors fall into four categories: 1.

the Chairman

2.

the CEO

3.

the other executive directors

4.

other non-executive directors (who are not independent).

INEDs and the Chairman One of the most fundamental and problematic conflicts is when there is a conflict between INEDs and the Chairman. The current wisdom, after the Higgs Review, is that the Chairman cannot be considered independent after he or she is appointed, but should be independent on appointment unless the company explains that there is a good reason to the contrary. This is particularly important when the company needs to make significant strategic changes. For example Sainsbury’s, a major UK grocer, was formerly the number one in the UK had slipped to number three and was considered likely to slip to number four. Their CEO was promoted to Chairman and a bright young CEO was appointed. The strategic decline had been exacerbated by a poorly handled

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outsourcing of their IT infrastructure and it was clear that not only were they in strategic difficulties, they also had serious execution problems. Clearly in those circumstances a fresh look was needed and it was not surprising that the former CEO Chairman departed rapidly as soon as a successor was found. In another case there was a clash of styles, and a highly respected and competent Chairman was confronted by four NEDs who told him that in their view his style of chairmanship was inappropriate, and he resigned shortly thereafter. In principle the Chairman is elected by the Board, and it would be possible for the Board simply to elect someone else as Chairman, with the erstwhile Chairman continuing to serve as a director. In the UK the Chairman cannot, in theory, dismiss an NED from the Board although a director can be removed by a vote by over 50 per cent of the shareholders voting in General Meeting.12 In practice, though, the Chairman can ask an NED to step down and this request will almost always be followed. The Chairman in the UK is very much supposed to be primus inter pares although in practice most chairmen of large companies are far more primus than pares. Board appraisal, which has been the one feature of the Higgs Review that has been pretty well universally welcomed by chairmen, at least gives a mechanism for directors to be moved on in a structured manner, with the Nominations Committee having to formally recommend whether someone is re-appointed after their ﬁrst or second three-year term. But it still falls to the Chairman to deliver the bullet even if he or she may mumble something about colleagues on the Nominations Committee. It is not pleasant, but the negative effect of a bad director, or one who behaves inappropriately, on a Board can be considerable.

INEDs and the CEO ‘The CEO is the pivot’ explained a respected Chairman to general agreement of his peers. A highly successful and respected NED put it like this: ‘Your relationship with the CEO is very important. I don’t talk to my CEO every day or even every week but it’s essential that you can pick up where you left off.’ In practice the CEO is always involved in the selection of NEDs: best practice seems to be that it is driven by the Chairman but after the candidate has met the Chairman the next step is to meet the CEO, and only if the CEO agrees with the Chairman that the candidate is suitable do the next stages happen. In most cases the Chairman will have discussed the CV of the potential NED before even meeting them. In a number of cases, generally in smaller companies, the CEO actually drives the search process for an NED – which creates the anomalous situation that the CEO is picking the people who are responsible for judging his or her performance. 12

I recently heard a leading UK governance expert express his astonishment at recently ﬁnding out that this is not the case in Delaware – it is such a fundamental aspect of UK shareholder democracy that he had understandably assumed it applies in other Common Law jurisdictions. However as far as I know there is nothing to stop a Board from co-opting someone back onto the Board who has been removed by the shareholders. Executive directors are generally required in their contracts to resign from the Board if they cease to be employees.

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Since ultimately the role of the Board is to help the business to succeed in generating value for the shareholders, a large fraction of the job of the INEDs is to help the CEO succeed in leading the business to do this. So the role of encouragement and mentoring is important. Being CEO can be a very lonely job, and the wise CEO develops conﬁdential and trusted relationships with each of the INEDs in which each party can speak their mind: the wise NED reciprocates. Nevertheless, the relationship has to be professional and not too chummy – there is always the possibility that the CEO may need to be replaced or that his or her bonuses will have to be cut. Both parties must understand that INEDs have a professional role, and that personal relationships should not interfere with this. We have had very ethical EDs looking for NED roles state that they would not wish to serve on the Board of X plc, for which they would otherwise be highly suited, because one of the EDs of X was a close personal friend or neighbour.

INEDs and the executive directors This is one of the most important and least understood sets of relationships on the Board, which is not often discussed. In politics it is a standing joke that your enemies are your colleagues, not the members of the other party. It is inevitable that there will be some degree of competition between the EDs who are not the CEO – especially if more than one of them is seen as a possible successor. In these circumstances the understandable reaction of INEDs would be to hold themselves aloof from the EDs – but this would be a mistake. Appropriately handled, these relationships are valuable channels of information and inﬂuence for the INEDs, and even more importantly the INEDs can mentor the EDs. Just as the INEDs are evaluating the EDs, so the EDs evaluate the INEDs. INEDs have responsibility and considerable inﬂuence but relatively little direct power. If they want to effect change or get information they pretty well have to work through the EDs. In theory the opinions of the the EDs other than the CEO might be thought not to matter very much – after all they are employees and ‘have to take orders’. But in practice companies don’t really work like that, and building up respect from the EDs is an important part of becoming an effective NED.

INEDs and other NEDs In some Boards there are NEDs who are not independent. This is usually when there is a major shareholder.13 In most cases the interests of the major shareholder will coincide with those of the other shareholders, and the Board should work on a unitary basis, pooling knowledge and experience to develop the business. But there are clearly 13

For example in BSkyB (News Corporation), SAB Miller (Altria), Burberry (GUS). See also Chapter 5.

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possible cases of conflict – for example if the major shareholder wants to buy out the minority. In these circumstances the INEDs will have to look after the interests of the other shareholders and there may be sharp business disagreements. But this should not stand in the way of good personal and professional relationships at other times. Barristers who may be close personal friends and colleagues, in many cases from the same chambers, quite often have to take opposing sides in major cases.

RELATIONSHIPS OF INEDs WITH THE BUSINESS It is important that the INEDs do not limit their understanding of the business to reading the papers and talking to their colleagues in the Boardroom. Site visits are a traditional and helpful way of gaining additional insights. The ones that are formally part of the Board schedule are valuable but perhaps principally for the signals they send to the place visited and the bonding experiences they provide. There is nothing like a few hours on an uncomfortable bus together to get to know your boardroom colleagues. The advice of a wise Chairman and experienced NED is spot on: Try and visit the company away from Board days. When I was in the US recently, I went to visit one of my other company’s operations. It was a colossal facility … I was able to satisfy myself for real about, for example, safety issues etc. … You get a real feel for what’s going on. Of course you get the red carpet treatment to some extent (which could get in the way of being able to make a proper assessment) but you will get a sense of how things are and get a feel for what makes things tick. Get away from the dry numbers.

RELATIONSHIPS OF INEDs WITH THE FUND MANAGERS Fund managers are an interesting lot: very different from the typical business person or NED. They tend to be quite academic and reflective – double firsts and PhDs in difﬁcult subjects are quite common in fund managers and rare in business. Most fund managers would be hopeless at running a ‘real’ business: qualities like decisiveness, making strategies work by sheer willpower, determination and leadership, salesmanship, marketing, technological innovation and project management are rarer in fund management than PhDs in mathematics are among NEDs. Equally most business leaders would be hopeless fund managers. There is plenty of scope therefore for misapprehension and mutual suspicion bordering on contempt. Fund managers generally have to consider dozens if not hundreds of businesses and be familiar, at some level, with them and their key issues. This is something I ﬁnd myself having to continually explain to industrialists who understand it in their heads but not in their hearts. To chairmen, the business they chair is generally the most

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important in the world, and many of the people they interact with tend to reinforce this impression. But to the typical fund manager this company is just one investment, often a very small one in their portfolio: virtually never more than 10 per cent and quite often only 1–2 per cent. Furthermore, the focus in the 1980s and 1990s was heavily on building up quantitative models of business rather than making qualitative judgements of the soundness of Boards. A top manager of a major fund manager told us shortly before he retired in 2004: When I was a young man in the 1960s we were just starting to do detailed ﬁnancial analysis on companies – with slide rules – and an Old Codger close to retirement said to me ‘never mind all that rubbish – get the annual report, look at the photos of the Board and the proﬁles of the directors, and ask yourself – do I trust them? Are they competent and do they have integrity?’ I’m now coming round to the view, as I am close to retirement, that he wasn’t wrong: Board calibre is key – the financials ﬂow from that. However, most fund managers are not trained or equipped to form judgements of Board quality: there are no good formulae, very little in the way of theory, and such theory as is available has even less empirical support than usual in management. Most of the studies trying to ﬁnd a correlation between some quantitative measure of Board quality and financial performance have found either no correlation or a negative one. This is not surprising given that the measures are so poorly defined: for example one study took number of NED roles held as an increasing proxy measure of the quality of the NEDs. Since the wise NED limits the number of roles he or she has to three to five with no ‘day job’ and one or two with a ‘day job’ and any attempted correlation will be dominated by people who have large numbers of such roles (Lord Wakeham had 14 when he was on the Board of Enron) it is not surprising that this study found no correlation. One of the virtues of MacAvoy and Millstein (2004) is that they claim to ﬁnd some positive correlation between reasonably sensible measures of Board quality and company ﬁnancial performance. But the other confounding factor is that companies with poor/unconventional governance can often get away with it until things go wrong, especially if their share prices are going up. Thus, if only ‘successful’ companies can get away with poor/unconventional governance, it follows that the companies which get away with it will be successful – but they may be succeeding in spite of, rather than because of, their governance. This is reminiscent of the effect in evolutionary theory, where successful males (generally) display big decorative features (such as peacock’s tails) which demonstrate how successful they are, but do not confer any direct survival value – indeed the reverse. The reason they happen from an evolutionary point of view is related to sexual selection, which leads to fascinating speculations beyond the scope of this book.

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One of the major trends in the UK in 2003/4 was been the increasing assertiveness of fund managers in questions of Board composition. When the two main independent television companies (Granada and Carlton) merged in 2003 to become ITV it was agreed by both parties that the CEO of Granada would be CEO of the merged entity and the Chairman and CEO (and effective founder) of Carlton would become Chairman. After the merger had achieved the necessary regulatory approvals, investors made it clear that they wanted an independent Chairman – ﬁrst privately and then in public. The NEDs of Carlton opposed this change. However, when it became clear that the shareholders were entirely serious, and would if necessary vote down the appointment of this person as Chairman, the NEDs faced the inevitable and found a new Chairman.14 We talk about this a bit more in Chapter 8. In 2004 Sainsbury’s, already mentioned above, engaged headhunters to ﬁnd them a new Chairman who was so unpopular with investors that he was forced to withdraw his candidacy after it had been formally announced that he would join as Deputy Chairman with a view to becoming Chairman. There is now a general realization that it is better to take soundings of the major investors before a new Chairman is announced. Investors are also quite willing to be sceptical about the merits of takeovers even if they are recommended by the Board of the company to be acquired. In one case (that of Carnival taking over P&O, in 2002) two highly respected INEDs had meetings with the investors to convince them that the terms eventually agreed were fair and that the Board had indeed subjected them to rigorous scrutiny. Sir John Parker and Baroness Hogg were both well known to be people of the highest integrity, and were both chairmen of FTSE 100 companies, which meant that their continuing relationship with investors was evidently of great importance to them. Understandably, they won over the initially rather sceptical investors. INEDs can also meet investors in controversial circumstances when remuneration packages are under the spotlight. When Vodafone bought Mannesmann, the Board of Vodafone voted substantial bonuses to the EDs, partly because they knew that the bankers working on this would have been paid astronomical bonuses. Investors were concerned at this. Vodafone appointed one of their UK INEDs, Penny Hughes, as Chairman of the Remuneration Committee, and working with the Chairman Lord MacLaurin, she conducted a careful campaign of consultation with their leading investors – listened to their concerns about the draft remuneration proposals, and 14

There was an interesting sequel. The deposed Chairman had always made a point of not having a service contract with the company. Nevertheless the directors of Carlton decided that he was entitled to a payoff of several £m for loss of ofﬁce. It is widely assumed that the NEDs who made this decision would not be supported by investors as NEDs of any other companies. And the question remains: given that this kind of compromise on the ‘social issues’ is often necessary to get a merger agreed, if investors follow the logic of insisting on an independent Chairman whenever there is a merger, will that place a block on otherwise value-creating mergers?

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19

then modified them in the light of the concerns. The result was a world-class remuneration package tied to strict performance criteria that was overwhelmingly supported by investors. More about Vodafone in Chapter 6. In these kinds of situations the INEDs have rather strenuous and somewhat fraught discussions with fund managers. It is therefore highly desirable that this is not the first time that the INEDs and investors have talked. INEDs should get to understand something of how investors think and ideally should have met some of them in a semi-social context where there is no major company-speciﬁc controversy, so that if there is need for a controversial and difﬁcult meeting the chance of needless misunderstandings can be reduced.

RELATIONSHIPS OF INEDs WITH THE SHAREHOLDERS The direct relationships of INEDs with shareholders as opposed to fund managers are primarily through the AGM. Chairmen often complain that AGMs are a waste of time, and it is certainly true that some have a farcical aspect. Some AGMs are so uncontroversial that only a handful of shareholders attend, and sometimes it is possible to get through them in a few minutes. However, they do have a useful deterrent function – and without quite getting to the point of the famous H.M. Bateman cartoon there are occasions where ‘How would we get this through the AGM?’ can act as a salutary deterrent. In the UK in 2002 legislation15 gave the AGM an advisory vote on the report of the Remuneration Committee. This effectively has become a referendum on the reasonableness of the arrangements for directors’ remuneration – principally that of the CEO. As noted above, concern about Vodafone’s remuneration in 2002 meant that, although the report was approved, the company embarked on extensive consultations and revised the policy for 2003. By contrast, GlaxoSmithKline became, in 2003, the first substantial UK company to have its 15

The Directors’ Remuneration Report Regulations 2002 require each quoted company to put their RemCo report to a vote for ﬁnancial years ending on or after 31 December 2002. Interestingly the regulations provide (7(8)) that ‘No entitlement of a person to remuneration is made conditional on the resolution being passed by reason only of the provision made by this section.’ (italics added) so it is quite possible for companies to make remuneration conditional on such approval – although no one has done so yet.

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remuneration policy voted down. No one was quite sure what would happen if a remuneration report was voted down – it had been assumed that perhaps the RemCo would resign en masse. This didn’t happen, partly because the shareholders voted to reappoint some of the RemCo members, although there were some Board adjustments. The Chairman, Sir Christopher Hogg, was subject to a great deal of criticism, took personal charge of the situation and spent a great deal of time (and money) on a detailed review and revision of the remuneration policies, resulting in something that was accepted at the 2004 AGM. In these cases, as well as most others, it was the votes wielded by the large institutional investors that were decisive, and it is not clear how much influence the individual shareholders had. Possibly more than might be supposed – these votes are often quite close, and fund managers do not always have complete discretion in how they vote the shares which them manage. One situation in which individual investors seem to have had inﬂuence is in the 2004 shadow bid for Marks & Spencer. Philip Green, a retail entrepreneur who became a billionaire following a shrewd purchase of Arcadia plc (a retail group) whose profits he increased very substantially after buying it, announced his willingness in principle, subject to satisfactory answers to certain questions, to make a takeover bid for Marks & Spencer, formerly the most admired company in the UK but whose shares had underperformed substantially. The INEDs ousted the Chairman and the CEO installed one of their number, Paul Myners, as interim Chairman and appointed Stuart Rose, the former CEO of Arcadia, as CEO. The shares jumped and Philip Green raised his indicative offer to £8 bn as a ﬁnal offer, again conditional on receiving certain information from the Board and on the Board recommending the bid. M&S’s largest shareholder, Brandes, made it public that it would accept the bid if the Board recommended it. A presentation by the new CEO to institutional investors was received with only moderate enthusiasm and it was widely believed that the shareholders would want the chance to consider Philip Green’s bid. The individual shareholders turned out in force to one of the most interesting AGMs in recent times. They were overwhelmingly against allowing Philip Green the information he needed to bid. The Acting Chairman – Paul Myners – played the individual shareholders beautifully. He began his remarks by referring to ‘Mrs Powell, a shareholder since 1932’ whom he met in the lobby and took pleasure in informing her that ‘under the Takeover Code, I am not allowed to disclose what you said to me … or to give Mr Green the advice that you wanted me to give him.’ It is not clear whether the directors had already utterly resolved not to have discussions with Philip Green, but it is likely that the strong support they received from individual shareholders strengthened their resolve – equally, if the shareholders had been strongly in favour of their opening discussions with Philip Green then it would at least have been much more difﬁcult for them to hold their previous line.

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M&S is unusual, although by no means unique, in having such a large number of individual shareholders. Nevertheless it seems likely that the voice of the individual shareholder, along with that of the institutional investor, will become increasingly listened to as directors become more attuned to dialogue with the shareholders – not least because individual shareholders have votes and in consumer-facing businesses are often customers.

WITH THE COMPANY SECRETARY The role of the Company Secretary has also become more pivotal as the sophistication of corporate governance has grown. Although in some companies it is seen as a largely administrative role, and often combined with that of the General Counsel or the CFO16 in other companies the role has considerable power and a good Company Secretary will often have a strong and confidential relationship with the Chairman. As we shall see in Chapter 4, when BP re-engineered its corporate governance it did so around the role of the Company Secretary, which became an ofﬁce of great power and inﬂuence. Although no other company – to my knowledge – has yet gone this far, the wise NED builds a useful working relationship with the Company Secretary. Under normal circumstances it may not matter much, but if things start going wrong or getting difficult, with the need to convene urgent meetings and distribute special papers which often mean more than they can directly say, this relationship can be very important.

WITH THE AUDITORS Concerns about the conflicts of interest inherent in the role of auditors who also provide other services to the companies they audit have been a signiﬁcant issue in the latest wave of governance reforms. As often is the case, both greed and envy have been involved. It is not just that non-audit consulting work has been more proﬁtable – audit work is widely perceived as boring by accountants, many of whom who want to escape it as soon as possible. This was then exacerbated by CFOs trying to cut costs (and, cynics might suggest, get more pliant auditors) by putting audits out to tender on a cost basis, and auditors using the audit work as a ‘loss leader’. The accounting firms lobbied ferociously to avoid restrictions on their non-audit work, despite the fact that concerns about the conﬂict of interest involved were raised for years. Nevertheless, with the renewed focus on the integrity of audit, and the increased onus on the Audit Committee, the relationship with the auditors is increasingly important and visible. The prudent NED has a chat with the partner responsible for their audit before they join the Board, as part of their due diligence. NEDs who are on 16

Note for US readers: CFOs in the UK are generally higher status and more powerful than their US counterparts – they are usually the second most important executive after the CEO.

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the Audit Committee have a formal relationship with the auditors, and as with everything to do with audit, the informal relationships and ‘feel’ of the situation are more important than the paperwork, which often ignores the ‘known unknowns’ and pretty well inevitably ignores the ‘unknown unknowns’ which can be the real problems in any large organization.17

WITH THE OTHER ADVISERS TO THE COMPANY The most interesting and problematic relationships are those of the NEDs and the investment banks. The huge ﬁnancial incentives on the part of investment banks to do deals mean that the INEDs have to act as referees to resist the blandishments of extremely highly paid, highly skilled and slick salesmen. This is quite tricky – especially since investment banks have quite deep relationships with many people in business – and deep pockets for entertainment. Investment banks are also sometimes involved in recommending people for NED appointments – and if you owe your appointment to the investment bankers it requires greater strength of mind to object to a deal that may or may not generate value for your shareholders but will certainly generate $50 m of fees for the bankers who are recommending it. One Chairman explained how ‘the bankers recommended that we did a certain deal [selling something] at a lower price and I said “wait a minute – when we started this sale process, you said that we would get at least X, now you are recommending that we sell for signiﬁcantly less” and turned the deal down.’ Another slightly problematic relationship is that with headhunters. Because career development is so personal, these relationships can be fairly intense. There is also the natural thought process that ‘these headhunters have put me on the Board so they must be people of sound judgement’. But if these relationships become exclusive they are problematic. The priority is to get the best people available on the Board – and if people are serious about this, it will inevitably mean casting the net wider than the ideas of one headhunter, however good. We are aware of one situation where the HR director of a major company significantly distorted the selection process in a key Board appointment to protect the interests of a preferred ﬁrm of headhunters.

17

Donald Rumsfeld’s famous remark about known unknowns and unknown unknowns, which was probably one of most useful and profound things said by anyone in political life in the last few years, was widely mocked in the UK and bizarrely declared the most obscure piece of gobbledegook by the Plain English Campaign.

CHAPTER 2

Someone of Sound Mind The headhunter got through to the distinguished senior industrialist to sound him out on an important Board position. Would he perhaps be interested in serving? No. Well perhaps he could suggest someone? No again. The headhunter, like most in her profession, was persistent. ‘Surely you know most of the leading people in this area – can’t you suggest anyone?’ ‘Well, you want someone of sound mind don’t you?’ ‘Of course.’ ‘This Board is chaired by X. No one of sound mind would agree to serve under him. So I’m afraid I can’t help you.’ Difficult and autocratic chairmen still exist, though the separation of the roles Chairman and CEO and the tendency to have non-executive chairmen makes this role perhaps less appealing for autocrats than previously. However, the climate of increased accountability and scrutiny for NEDs creates a more pointed and widespread version of the dilemma mentioned. It is important that NEDs should be successful people with commercial acumen. However, the risks of being an NED if things go wrong are considerable. Sir Roger Hurn was one of the most respected industrialists in the UK when he took the chairmanship of GEC after very successful service as the CEO of Smiths Industries. After GEC had been renamed as Marconi and subsequently collapsed, Sir Roger had to resign as Chairman of the Prudential and from other Boards. As one of the NEDs in our masterclasses put it: Having opted now for a career as NED on various Boards, it has become clear to me that I am now Chairman and MD and major shareholder in my own ‘brand’ and I have to be a careful custodian of this. It’s only considered to be valuable as long as I am valuable to the Boards on which I sit. You should only go somewhere insofar as that will be valuable to your brand and reciprocally, if you feel you can add value to that Board over time. It only takes one mistake to ruin this. Since they receive a remuneration that is a small fraction of their earnings from their main job and since there is the potential for serious damage to their reputations and careers one wonders why executive directors of major companies actually serve as NEDs. In one case in the early 2000s we observed a troubled company undergoing a cross-border merger where the CEO was also an NED of two other companies in

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difﬁculties. It is perhaps easier to see why ‘professional NEDs’ would take on the role, but typical UK levels of remuneration (£30–50 k pa) lead to a level of financial reward which, while comfortable, is by no means stellar. The former directors of Equitable Life, a well-respected mutual insurer that effectively collapsed in 2001 due to unsustainable guarantees offered to certain investors, were sued for over £1 bn by the company for negligence. On a purely actuarial basis, even a minute risk of a £1 bn lawsuit is not worth a few £10 ks – the legal costs of defending such an action can run into millions. Concerns about ﬁnancial and reputational liability have actually deterred top-calibre industrialists from joining topcalibre Boards. There is widespread concern about this from investors as well as from directors. A leading investor put it like this: ‘The US levels of litigation have not yet reached the UK. Nevertheless there is more harassment of Boards and – although there are some justiﬁed concerns – on balance this is very bad news.’ There is an element of prestige in being invited to join the Board of a well-known company, and this is one factor in bringing people on as NEDs. In a world where many large corporations are built by merger and have names that are not widely known, it can be reassuring that, even if people have barely heard of your employer, they have heard of the company of which you are an NED, even if it’s much smaller. One UK Chairman who was perceived as having been rather over-committed was thought to have accepted too much because he was very nice and did not know how to say no. The most important motivations I believe are: 1.

career development

2.

broadening perspective

3.

putting something back

4.

the soft landing.

CAREER DEVELOPMENT This can be divided into two categories: ●

those executives who are not yet on their Main Boards, and

●

those who are (but are not yet group CEO).

People below the Main Board of their employers are an excellent and somewhat untapped source of INEDs. By encouraging such people, with the support of their own Chairman and line management, to serve as NEDs we can hope to remedy the

SOMEONE OF SOUND MIND

25

shortage of business-competent NEDs. Indeed it was this insight, and the fact that it was warmly supported by UK chairmen and investors when we floated the idea as a means of dealing with the emerging shortage in 2002, that led to our active involvement in developing the next generation of INEDs in the UK. By observing and participating in at first hand the decisions, issues and pressures faced by the Main Board – the buck really stops here – such people gain insights into business and Board behaviour which cannot be obtained elsewhere. Service as an INED also gives you a fundamentally different focus from service as an executive. Although in theory you are always mindful of the shareholders’ interest as an executive, in practice the main focus will be on achieving the objectives agreed with your boss, dealing with staff, customers, suppliers, colleagues, projects, participating in planning and budgeting and all the minutiae of the practical busy-ness of business. As an INED you see the business in the round, pared down to its essentials in some respects, and questions about what is really in the best interests of the shareholders are more at the forefront of your mind. This perspective inevitably gives you a wider view which you can bring back with advantage to your employer. This is not to say that all employees should serve as NEDs – one relatively junior employee of a large plc served as an NED of a small and rather unsuccessful UK listed company. When he left he was described as ‘his eyes are bigger than his tummy’ and one cannot help wondering whether this NED role had contributed to such a mindset. But for the right people, with real support from their employers, such service can be immensely valuable management development.

BROADENING PERSPECTIVE Success is never cost-free. Sometimes the cost is evident in personal terms, but there are also more subtle issues. One of these is that if people are very good at their job and rise to be CEO or a senior executive they tend to be in their company for a long time. Of the CEOs of the largest UK-listed companies, John Browne joined BP as a graduate in 1966, Stephen Green joined HSBC (after the Foreign Ofﬁce and McKinsey) in 198218, JP Garnier joined Schering Plough in 1975, moving in 1990 to SmithKline Beecham which later merged with Glaxo Wellcome to become GSK. Sir Christopher Gent (CEO of Vodafone until 2003) was a co-founder of the business and Arun Sarin (CEO from 2003) was a co-founder of a company that was bought by Vodafone – although he was very fortunate in many ways in having a couple of relatively quiet years as a telecomsrelated venture capitalist which allowed him some time to think – and to serve as an 18

Stephen Green is remarkable in many ways, but absolutely unique amongst CEOs of the world’s biggest companies in that he is an ordained priest in the Church of England. He is a ‘non-stipendiary minister’ which means that the Church does not pay him a salary – understandable given his remuneration from HSBC.

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CONSTRUCTIVE ENGAGEMENT

NED of Cisco and Gap amongst others. This illustrates the point that many top managers have spent the last few decades in one industry and often in one company. Indeed, as the table below shows, for the top 10 companies by market value in the US and the UK the average number of years spent by the CEO in their industry is 29, with no signiﬁcant difference between the US and the UK in this respect.

Company

CEO

GE ExxonMobil Microsoft Citigroup Pﬁzer J&J WalMart P&G Intel AIG US average BP HSBC Vodafone GlaxoSmithKline RBS AstraZeneca Barclays Shell HBOS Lloyds TSB UK average Average

Years in company

Years in industry

Split Chairman & CEO

Jeff Immelt Lee Raymond Steve Ballmer Charles Prince Henry McKinnell William Weldon Lee Scott AG Laﬂey Craig Barrett Martin Sullivan

23 42 25 26 34 34 25 28 31 31 30

23 42 25 30 34 34 25 28 41 31 31

No No 2003 2003 No No 2000 No 1987 2005

Lord Browne Stephen Green Arun Sarin Jean-Pierre Garnier Sir Fred Goodwin Sir Tom McKillop John Varley Jeroen van der Veer James Crosby Eric Daniels

39 13 7 15 7 36 23 30 11 4 19

39 23 21 30 10 36 23 30 28 30 27

1992 1990 1987 1980 1987 1993 1986 2004 199619 199320

24

29

This table is as at 18 April 2005. It would probably be possible to date such a table to within a month by looking at the names. In March 2005 AIG was still ruled by Hank Greenberg, in May 2005 Craig Barrett became Chairman of Intel and Paul Otellini (31 19

20

Or 1696. The Bank of Scotland was actually run by a chief general manager who was not even on the Board until Bruce Patullo became Deputy Governor and CEO in1988. However, he then served as Governor (that is, Chairman) and CEO, 1991–96, when the roles were again split. This may not be exact. It is also possible that Jeroen van der Veer has been at Shell 29 or 31 years.

SOMEONE OF SOUND MIND

27

years in company and Industry) becomes CEO. Note that 50 per cent of the US top 10 now have split Chairman and CEO, a situation reached by the UK in 1990. It is striking that the UK companies are much more willing to import CEOs. But no company, and no industry, is self-contained. All are dependent on customers and many are dependent on suppliers. Furthermore, especially for industry leaders, there are many lessons to be learned from well-run companies in different industries, and there is huge value in seeing another business from the inside. There is also a lot to be learned from badly run companies. Bob Townsend’s wonderful book Up the Organisation made the claim that he had learned most of what was important about management from his time at American Express – seeing what they did and resolving to do the opposite.21 For outstanding managers, the Nietzschean principle of what does not destroy me, makes me stronger22 seems to apply. Sir Bill Castell, longtime CEO of Amersham International and now a Vice-Chairman of GE, had a painful experience serving on the Board of Marconi, which nearly went bankrupt and was heavily criticized. It is encouraging that two of the designated inner circle of BP’s next generation top management have also served as NEDs of companies that have had ‘near death experiences’ (Tony Hayward on Corus and Vivienne Cox at Eurotunnel). Just as when having sailing instruction you want to run into a number of adverse conditions or near-emergencies so as to develop your technique, so you discover a great deal when a company gets into difficulties that never comes out in normal circumstances. I am not advocating that executives should actively seek out badly run businesses to hone their skills, but that serving as a director of a business which hits trouble can be a very valuable experience – and it is in your employer’s interest that this should be a business other than your own!

PUTTING SOMETHING BACK Although it is not fashionable to say so, many senior and successful business people do have a real sense of community duty. If they have signiﬁcant talents in the direction of wealth-creating businesses, one important way in which they can contribute is by serving on the Board of a wealth-creating business. I think for example of the former CFO of a multinational who agreed to the onerous role of Chairman of the Audit Committee of a rather new FTSE 100 company. The Chairman emphasized, ‘We are incredibly lucky to have him to chair our Audit Committee’ since the requirements are getting greater and greater. There was then a major potential transaction that needed a 21

22

My late father, a pioneer of computer-based mathematical optimization, had the view that although you learned a great deal from an excellent talk at a conference you could sometimes learn even more from a really bad one, which would provoke you into thinking – no no, that’s not the right approach at all, it ought to be done like this. ‘Aus der Kriegsschule des Lebens. – Was mich nicht umbringt, macht mich stärker.’ Götzen-Dämmerung (Twilight of the Idols), Aphorism 8. Like most of Nietzsche it is dangerous rubbish if taken too literally.

28

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great many meetings, and the value of having such an experienced executive, who had retired and therefore had some time available, was considerable. It is at least conceivable that, had X not been willing to serve, the company might have been taken over at a price significantly lower than that at which the shares are currently trading. Such service can help to create billions of dollars of value for shareholders.

THE SOFT LANDING At the age of 54, Richard Lapthorne had become something of a business hero. He had joined British Aerospace as CFO when it was in grave ﬁnancial difﬁculties in 1992 and working with the then CEO Dick Evans had restored it to solvency and profitability. The shares had risen from 28p when he joined (and was granted one million options) to nearly £5. However, he had been talking to the company psychologists and they had told him that people who worked in full-time jobs until they retired at 65 tended to drop dead after a couple of years, whereas people who phased down more gradually tended to live into their 70s or 80s. This helped him take a decision which I think he would have been leaning to anyway: to build a portfolio of non-executive directorships and chairmanships, and leave full-time employment. He had since 1988 been a non-executive director of Amersham International and served as non-executive Chairman from 1996 to 1997, when as part of a merger with Nycomed he had stood down from the chair so that the Amersham CEO (Bill Castell) could remain CEO whilst the Nycomed Chairman chaired the combined group. He had also become an NED of Orange in 1996 because at the time British Aerospace was a major shareholder. With this experience of serving as an NED of what even then were becoming remarkably successful companies, there was considerable demand for his services in this capacity! He became, for a year, executive Vice-Chairman of British Aerospace, and left them in 1999 and took on NED roles at Robert Fleming Holdings Ltd (an investment bank that was acquired by JP Morgan) and a leasing company in Abu Dabi23 non-executive chairmanships at Morse Group (a £200 m small computer systems distributor and integrator), Avecia (a €1 bn MBO of the international speciality chemicals business of Zeneca), Tunstall Telecoms and TI Automotive (two more private equity businesses). Over time the portfolio evolves: he left Amersham and Orange, took on the chairmanship of Cable & Wireless, left TI Automotive and took on New Look. A balanced portfolio of public company and private equity roles and a very focused and time-efficient style allows him the freedom to travel and have time with his family that is denied full-time executives. 23

Actually this was in 1997 – the chronology is somewhat simpliﬁed to make the point clearer.

SOMEONE OF SOUND MIND

29

Many of his former peer group look on this portfolio approach with admiration sometimes bordering on envy. It is not easy – there is always a risk that one of the portfolio will go badly wrong and stain a reputation – but it clearly has its advantages. It will be interesting to see how many other leading executive directors who have retired early from full-time jobs build this kind of portfolio life. And it doesn’t have to be as Chairman – as one leading ED on the point of retiring said to me, Being considered as Chairman [of a major plc] made me think hard about whether I really want to do that. As an NED you can go away and get on with life, but as a Chairman you are always having to think about the company, and always on the line if things go wrong.

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CHAPTER 3

A Policeman’s Lot ‘You are thought to be the most senseless and ﬁt man for the constable of the watch … This is your charge, you are to comprehend all vagrom24 men; you are to bid any man stand, in the Prince’s name.’ ‘How if he will not stand?’ ‘Why then take no note of him, but let him go and presently call the rest of the watch together, and thank God you are rid of a knave.’ Much Ado About Nothing, Act 3 Scene 3 Independent directors are there to contribute to the development of the business. Investment managers are there to invest money wisely in a way that will give better returns. How do we avoid abuses without creating a ‘box-ticking’ mentality that stiﬂes enterprise and reduces risk-adjusted returns? How can we encourage investment managers to engage intelligently with ﬁrms when their clients are unwilling to pay the costs and there is a free rider problem? How can we improve the returns to constructive engagement versus returns to noise? Policemen, as opposed to detectives, tend to have a poor image in literature. In Much Ado About Not(h)ing Shakespeare lampoons policemen in a way which the severest critics of NEDs and self-regulation might possibly recognize. If Shakespeare had added ‘and give him a few million dollars as a golden goodbye’ he might have been more topical for our present discussion, although he would have strained the credibility of his audience in days when remedies for wrongdoing were rather more robust. It is also worth remembering that the bumbling Watch manages to discover the truth which was not noted, or mis-noted, by the wiser and more educated characters who had been given clear expectations and then ‘seen’ what the manipulators of truth had wanted them to see (‘What your wisdoms could not discover, these shallow fools have brought to light’) which perhaps acts as a reminder of the value of asking apparently dumb questions occasionally.

UTOPIA, LIMITED Fast forward to 1879 and a sergeant of police from a remote small seaside town is lamenting that 24

Vagrom: illiterate alteration of vagrant, apparently coined by Shakespeare. Wandering actors were ofﬁcially classiﬁed as vagrants, liable to be apprehended, during Shakespeare’s earlier life.

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When a felon’s not engaged in his employment, or maturing his felonious little plans His capacity for innocent enjoyment is just a great as any Honest man’s Our feelings we with difficulty smother when constabulary duty’s to be done Ah, take one consideration with another, a policeman’s lot is not an happy one! Curiously, he is lamenting in New York for reasons of international copyright law.25 However, although the effect is, intentionally, comic, the problem is real. Police officers are members of their community and in a small and relatively close-knit community the effects of apprehending someone are very noticeable. There is a certain approach to corporate governance which sees the role of the NEDs as essentially that of stopping the executives from getting away with things that they should not get away with: for example excessive pay, contracts where there is a conﬂict of interest and so forth. In this approach the NEDs are agents of the shareholders exercising vigilance to prevent wrongdoing by the bosses. An alternative model for dealing with conﬂicts of interest would be to require that any transaction where there is a potential conﬂict of interest be approved by a vote of the shareholders. There seems to be a tendency in this direction: for example in the UK it was recently made a requirement for listed companies to submit the report of the Remuneration Committee to a vote of the shareholders. At present this vote is ‘advisory’ and covers the RemCo report as a whole. However, one could imagine a company deciding to go the whole hog and have a separate vote on the package of each director. As we will see below, BP have already decided that each director will submit themselves for re-election each year. Although there is an element of truth in this approach, this ‘policeman’ role sits awkwardly with the other aspects of the roles of the NED: working with their colleagues on the Board as a team to help the business generate value for the shareholders. Teams depend importantly on trust, but effective police work requires at least a degree of suspicion. There are teams where, for safety reasons, each member has to carefully check the work of others, but they tend to be slower-moving. Thus there is a fundamental weakness in a business model which overemphasizes the idea of NEDs acting as policemen to check on the work of the EDs and the Chairman. At best it will tend to slow things down, at worst it will prevent the Board from engaging effectively with the real business issues as we will see in Chapter 4 on BP. 25

(Gilbert 1879.) Six months after Gilbert and Sullivan’s previous operetta HMS Pinafore opened in London it was performed by a pirate company in Boston and within a few months more than 50 unauthorized companies were playing it up and down the country. Hence they and their impresario d’Oyly Carte resolved to make an authorized performance in New York and to establish the copyright of the Pirates of Penzance in the US at the same time.

A POLICEMAN’S LOT

33

Even slowing things down is a major problem. The time that Boards can spend in meetings is distinctly limited. The EDs are, or at least should be, valuable people to the business and the time they spend in Board meetings is time that they don’t spend doing directly value-generating activities such as seeing major customers or enthusing the staff. The NEDs also only have a limited amount of time to devote to the business – and if they are people of the requisite calibre there will almost certainly be many claims on their time. Unless there is a sufﬁcient element of fun and enjoyment in their Board activities, they are unlikely to give their best and may well not be willing to serve. As so often in human relationships, this is a question of balance. Everyone accepts that the NED role must have some element of vigilance – after all even in ordinary management situations although your subordinates may become close friends you still need to be sure that they are doing their jobs well and that they don’t have their fingers in the till. But if this element of surveillance becomes too onerous then it undermines effective working relationships. Getting this balance right is one of the fundamental responsibilities of the Chairman. This is partly a question of division of labour. For example, the Chairman of the Audit Committee must expect to have more of a policeman role when it comes to financial matters: as one such Audit Committee Chairman, a former FTSE 100 CFO, put it: The relationship between the FD and the Chairman of the Audit Committee has to be much more challenging than before. It is difﬁcult to be so friendly, and you have to ask challenging questions. A key skill as an NED is to know how to ask the right questions in the right way. If it is a technical question give the ED advance notice – you are not trying to make him or her look stupid or unprepared and if you want the answer, you need to give them time to gather the data and think about it . The balance is delicate: many audit committee chairs like the CFO to consult them informally about accounting issues so that they don’t see a controversial matter for the ﬁrst time in the committee. As another former CFO put it: I chair the Audit Committee and the FD often comes to me to discuss interesting financial issues. I’d far rather have notice of them and discuss them informally than see them for the first time in Audit Committee papers. But you don’t want a situation where the Audit Committee Chairman has been nobbled so that there is no effective opportunity for scrutiny by the committee as a whole. The potential ambiguities in the role of NED between policeman and colleague come to a head when the CEO or the Chairman needs to be replaced. If the CEO is clearly not up to the job then the Chairman has primary responsibility to see that he or

34

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she is replaced – just as the Chairman is responsible for other aspects of Board composition. Chairmen who have had to do this tend to lament that they did it too late. However, unless you have a new Chairman replacing an inherited CEO, the fact that a CEO is incompetent raises questions about the judgement, and hence competence, of the Chairman. Hence the dismal scenario of incompetence in the Chairman and in the CEO is far less uncommon than would be expected if these were uncorrelated events. In Gilbert and Sullivan’s final collaboration, Utopia Limited, Utopia is initially governed on the principle of ‘Despotism tempered with Dynamite’. The King has absolute power except that if, in the opinion of the two appointed Wise Men, the King lapses from political or social propriety then he is denounced to the Public Exploder whose duty is then to blow up His Majesty with dynamite and to reign in his stead. I don’t think this is actually a case of life imitating art, but the rough equivalent of the Public Exploder in modern UK governance is the SID. The SID is meant to be the point of contact if investors have concerns about the company which are not adequately addressed by the CEO or the Chairman. In practice their most important duty is deciding to remove the Chairman. In the US, where until recently a continued Chairman and CEO has been the norm, this duty is executed more frequently and dramatically. There have been four recent cases in FTSE 100 companies where the SID has played a decisive role in removing the Chairman:

26

1.

In Marks & Spencer both the Chairman and the CEO were seen as out of touch and ineffectual – to the point of widespread mockery in the press. At the threat of a takeover bid, the NEDs removed both the Chairman26 and the CEO, the SID took over as interim Chairman and they appointed an experienced retailer as CEO. An intense struggle began against the threatened takeover which was beaten away (at least for six months) and the interim Chairman agreed to extend his service for the time being.

2.

In Rentokil Initial the longtime CEO stepped up to be Chairman and many commentators doubted whether it would be possible for the new CEO to look objectively at the business and its strategies. It was nevertheless something of a surprise to the outside world when the SID and the NEDs removed the Chairman – citing a difference in styles rather than strategy – and installed the SID as Chairman. The new CEO was dismissed two months later and the former SID, now Chairman, became Acting CEO.

3.

At Sainsbury’s the CEO had again been elevated to Chairman with the brief to appoint a new CEO and a new Deputy Chairman who would step up to

Who had previously told the Board that he wanted to step aside, as noted above in Chapter 1.

A POLICEMAN’S LOT

35

the chair after a year. The young new CEO had an excellent retailing background: however, Sainsbury’s was widely perceived to be in a strategic bind compounded by serious tactical difficulties. A choice of Deputy Chairman was announced but after objections by investors the appointment was withdrawn and a new search for a Chairman was instituted by a new search firm. As soon as the new Chairman was found, who was available immediately, the Board concluded that he should take over at once and the previous Chairman stood down. The SID played a major role in the whole process but at no stage did he become Acting Chairman. 4.

Shell – discussed in Chapter 10.

Thus in these four recent (2004) cases we have seen all the three possible roles for the SID: Chairman, Chairman and (Acting) CEO and remaining in the background. Not quite the Public Exploder, but perhaps a little too close for complete comfort.

INVESTORS AS POLICEMEN When the NEDs act as policemen they are, at least in principle, acting in the interests of the shareholders and against the interests of at least one of their close colleagues. This is not an easy situation, and often they are acting in response to investor pressure. There are four main factors at work for the investors: 1.

If there are flagrant abuses in a company and the investors take no action then they can be seen as sharing some of the blame if things go wrong.

2.

Equally, if a change of management will create significant value then catalysing a change of management is in the interests of the shareholders – although there are complexities here that we will address later.

3.

At least some of the investors’ clients get concerned about such issues as excessive remuneration. Pension funds in particular are governed by trustees and although some of the trustees may be industrialists, many come from more modest backgrounds where any remuneration into six ﬁgures seems an enormous sum.

4.

Finally, investors have come under a fair amount of political pressure to be seen to be using their powers and influence to discourage undesirable corporate behaviour, with the threat of regulation and/or legislation if they do not get their house in order in this respect.

These forces have combined to encourage investors to increase their focus on what are generally called governance issues. They have in general responded by creating

36

CONSTRUCTIVE ENGAGEMENT

small teams to engage in these questions, rather than making them a part of the core activities of the analysts and fund managers they employ. There are a number of reasons for this: ●

Mainstream fund managers and analysts tend to be very quantitative and not particularly comfortable with making judgements about people issues such as NEDs.

●

Some of the bigger houses, such as M&G and Fidelity (see Chapter 8), have people with titles like Director of Corporate Finance who are Chinesewalled-off from the investment process and can be sounded out on issues such as potential takeovers without making the entire house unable to trade due to inside information.

●

Issues like remuneration schemes are so technical that there needs to be some speciﬁc subject-matter expertise. It is hard to resist entirely the cynical view that the job of the remuneration consultant is to make remuneration schemes sufﬁciently complex that the shareholders will not fully understand how heavily the executives are being rewarded – in which case there is a corresponding need for concentrated expertise at the investors to see through these schemes.

●

There are complicated potential conflicts of interest around institutional voting on governance issues, which are somewhat alleviated by having separate governance departments. I’ll explore this a little further, because it sets a rather uncomfortable backdrop to the rest of the discussion.

POTENTIAL CONFLICTS OF INTEREST FOR INVESTORS AND POLICEMEN Most investment management firms operate on thin margins and have fees which depend largely on funds under management, and, if they are quoted companies, market valuations which depend heavily on growth in funds under management. They are therefore very sensitive to the winning and losing of mandates. Although a typical mandate will run for three to five years, this still means that a large firm, which may have over 1000 mandates, will have several pitches a day. The decisions about which firm to select for pension fund management are made by trustees, with the advice of consulting actuaries, and industrialists have a signiﬁcant voice on the trustees. There may therefore an understandable nervousness about firms which have the mandate for running a part of X plc’s pension fund from actively campaigning against, say, the remuneration scheme for X’s executive directors. This nervousness may be shared by firms that expect to pitch for some of X’s pension fund business in the foreseeable future.

A POLICEMAN’S LOT

37

These conflicts are made worse in the case of investment management firms that are associated with major banks. A well-known case is the HP/Compaq merger which was vociferously opposed by a number of shareholders. Deutsche Asset Management (DeAM), an affiliate of Deutsche Bank, originally decided to vote all the 17 million proxies it controlled on behalf of clients against the merger. But when HP learned of this, HP asked senior people in Deutsche’s investment banking division to allow HP to make a last-minute presentation to the Asset Management Proxy Committee. HP had secretly retained Deutsche’s investment banking division ‘to assess shareholder sentiment concerning the vote, and provide market reconnaissance’, with an initial $1 m fee and a further $1 m if the merger went ahead. DeAM agreed, and also allowed the principal dissident shareholder opposing the merger to make a presentation. After the dissident’s presentation, the CIO informed the Proxy Committee that ‘we have an enormous banking relationship with HP’. HP then made a presentation, closing with HP’s CEO saying that the success of the merger was ‘of great importance to our ongoing relationship’. The Proxy Committee discussed whether it should switch its vote and voted four to one to cast the proxies in favour of the merger. DeAM was censured by the SEC for failing to disclose a material conflict of interest, and paid an agreed penalty of $750 000.27 It is not clear that situations where voting is inﬂuenced by the prospect of advisory work was especially unusual, although the SEC ﬁnding that it was a wilful breach of Section 206(2) of the Advisers Act not to disclose the potential conflict of interest will presumably ensure that such arrangement are disclosed to clients. What was unusual was that the highly contentious circumstances of the transaction resulted in these arrangements coming to light.

PRACTICAL ISSUES AROUND THE POLICEMAN ROLE FOR INVESTORS In the UK since Cadbury there has been a ‘comply or explain’ regime for much of corporate governance: you must either comply with a principle or explain why you have not done so. There is a growing consensus that this is an unfortunate choice of

27

See http://www.sec.gov/litigation/admin/ia-2160.htm

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language, since in financial services comply generally means ‘do this or risk prison’ and it would be better, as I will suggest in the conclusions, if we adjusted the vocabulary to ‘conform or explain’ with a clear understanding that a company has complied if it has either conformed or given an explanation that is not unsatisfactory. The double negative is signiﬁcant, the onus should be on a dissatisﬁed shareholder to indicate why an explanation is unsatisfactory rather than vice versa. However, the fundamental problems facing investors under any such regime are: ●

how to decide whether they are happy with the situation in a company (whether covered by an explanation or not); and

●

what to do if they are not happy.

Neither of these is straightforward.

HOW INVESTORS CAN DECIDE IF THEY ARE HAPPY Not just in the price The cynical view is simple: they are happy if the shares are going up and unhappy if they are going down. There is no doubt that the general mood music created by a bull, or bear, market has quite a bit of inﬂuence. The problem is that investor happiness and rising share prices can be self-feeding. There is a vicious cycle which goes something like this: 1.

A company starts doing well and investors like the stock. The shares start rising.

2.

This emboldens the management to grow the company – often by acquisition using relatively highly rated stock, resulting in growth in sales, earnings and earnings per share.

3.

Investors, seeing the growth, bid up the stock further, and smile on the issue of more and more stock options or TSR-related bonuses to management.

4.

Management feels compelled to keep hitting, or slightly beating, earnings expectations every six months (or quarter) and to commit themselves to growth rates substantially in excess of GDP growth in order to ‘justify’ the high prices of their shares.

5.

Investors, seeing that the earnings growth is accelerating, bid up the shares further.

A POLICEMAN’S LOT

39

6.

Management resorts to increasingly desperate and unsustainable or risky measures to keep hitting the numbers at almost any cost in terms of the medium-term future – hoping that they can get out/cash their options/ collect their TSR bonuses before the nature of these expedients becomes clear.

7.

When reality catches up, some of those responsible leave with substantial payoffs, and a new team is appointed which clears out the old problems (blaming the previous management and taking large write-offs).

8.

The company starts doing well and investors like the stock. The shares start rising …

It is an uncomfortable fact that this cycle of unsustainable over-delivery is in the interests of a great many people. It is much more fun, and prestigious (in the true sense of the word) to be part of a rapidly growing company, soaring Icarus-like above the pedestrian levels of normal business. Investment bankers will offer you amazingly imaginative transactions which, if pursued, will make tens of millions of dollars for them in a few months, whether or not they make, or lose, billions for your shareholders. Investment analysts generally (although by no means invariably) enhance they careers and reputations more by spotting winners than by sounding notes of caution.

The ‘Greater Fool’ theory Professional investors are at least tempted to operate on some variant of the ‘Greater Fool’ theory. Should a professional investor buy a share for $10 that they know is really worth only $1 if they also know that they will be able to sell it for $15 in 12 months’ time? From a purely mathematical perspective this is a question of the strength of their knowledge, but there are wider issues that make the matter more complex, if the asset or asset class is large enough to be visible, either in the market as a whole or to the performance ﬁgures of the funds that the investor runs. For example: ●

If an investor has a reputation for being an astute backer of good management teams, then the mere fact that they have a stake in a company will be seen as an endorsement. We often notice the presence of high-quality investors that are known to back management teams (such as Capital or Fidelity) when we are considering smaller companies as potential recipients for high-calibre NEDs, and mention these to the clients. A reputation for being a shrewd judge of management calibre is an important asset for an investor, and should not lightly be jeopardized by investing in companies whose positions are unsustainable.

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●

Investors notoriously tend to be judged by relative, rather than absolute, performance. This can make it risky to sell out of a stock too early. If, as an investor, you are underweight, or even out of, a stock that is a bubble too early you can drag down your performance for a couple of quarters and this may significantly impact your position in the league tables, since even if these are over three or five years the most recent quarters can make a lot of difference to your rank order if you are in the middle.

●

Buying the shares of a company that is pursuing a fundamentally unsound strategy can send misleading signals to the Board and dangerously delay the necessary adjustments. In one company that subsequently crashed badly at least some of the NEDs had serious doubts, but, as one of them put it to me, ‘We were worried about these deals, but every time they did a deal the share price went up, so what could we do?’

Falling not failing Just as a rising share price is not necessarily a sign of a healthy company, falling share prices may be due to rather extraneous factors. This is obvious in the case of companies such as the oil majors, whose share prices and whole financial performance are clearly linked to the price of oil. But the telecoms business provides an interesting case in point. In the September 2004 issue of Harvard Business Review, Stern Stewart provided a ranking of the European telecoms companies that have combined growth with value generation for shareholders over the last 20 years. At the top of their list are France Telecom (FT) and Deutsche Telekom (DT), and at the bottom of their list is Vodafone, which, although it grew by grew by far more than FT or DT, achieved this growth by equity-financed acquisitions and thus apparently ‘destroyed’ shareholder value, whereas FT and DT made their acquisitions largely by taking on debt and thus purportedly did better in value generation than Vodafone. The main reason for Vodafone’s purported value destruction is their acquisition of Mannesmann for £79 bn which was largely financed by shares at a time where telecoms stocks were grossly overvalued, and if the £79 bn of new Vodafone shares issued are treated as new cash raised from shareholders then indeed Vodafone has not done a good job, since the present market capitalization of the group post-acquisition is only £89 bn at present.28 However, shareholders in Mannesmann generally swapped their (highly overvalued) Mannesmann shares for (overvalued) Vodafone shares, so very little new cash was raised for shareholders. It is entirely reasonable to debate how much of this is due to Mannesmann and how the overall value creation should be apportioned, but 28

February 2005.

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the point here is that there is no simple or formulaic way of being sure whether a company is adding value of not. Indeed the chairmen of FT and DT were both forced to resign, whereas the Chairman of Vodafone remains in place and there was a highly orderly CEO succession, of which more anon. This will be discussed more in Chapter 4. Conversely, Royal Dutch/Shell had very serious disquiet from shareholders due to the problems about incorrect disclosure of reserves, which resulted in the ﬁring of the CEO and the managing director of exploration and production and the replacement of the CFO and a complete shake-up of the group’s governance, despite the fact that its shares were hitting record highs. These highs were of course to do with the high price of oil and on most measures there appeared to be a substantial governance discount compared with BP and Exxon Mobil. For all these reasons, it is not straightforward for the investors even to know whether they ought to be happy or not with the governance of a business. There is then the issue: if we are not happy, what should we do about it?

WHAT INVESTORS CAN DO IF THEY ARE NOT HAPPY When something has gone badly wrong with a business, it is clearly the responsibility of the Board. There is therefore an understandable feeling that the Board has to go. However, a complete defenestration is rarely the wisest course. It needs to be clearly stated that the Chairman is responsible, and accountable, for the quality of the Board. As the Combined Code puts it: The Chairman is responsible for leadership of the board, ensuring its effectiveness on all aspects of its role and setting its agenda. (A2, supporting principle) Therefore if there has been a major failure of the Board as a whole, the Chairman should be replaced. The focus of the investors should be: 1.

Getting an acceptable new Chairman.

2.

Encouraging them to get on with the job of rebuilding the Board, at the appropriate speed and to the appropriate extent.

Neither of these is totally straightforward.

Investor involvement in selection of a new Chairman There is an alarming paradox at the heart of selecting a new Chairman when there has been a Board failure. The very people whose failure has got the company into the mess are responsible for selecting the leader who will get the company out of the mess, and

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whose first action may be to sack them! Some of the worst situations in the past were created when the failing Chairman was personally leading the process of picking his successor. This practice is been discouraged by the Combined Code which states that The Chairman should not chair the nomination committee when it is dealing with the appointment of a successor to the chairmanship. (A4,1) but of course this does not prohibit the Chairman from serving on the committee and in practice a Chairman who is used to leading the Board may well play a leading role on a NomCo even if they are not formally chairing it. However, it is a bit simplistic to say that the Chairman of a failing board should never take the lead in finding his or her successor. Sometimes a Non-Executive Chairman is fundamentally competent but has not realized that things were as bad in the company as subsequent events showed. For example Sir Ralph Robbins, who was an outstandingly effective Chairman of Rolls Royce, also became Non-Executive Chairman of Cable & Wireless (C&W) in 1998. During the boom in telecoms and the Internet the company pursued a strategy, applauded to the skies by the shareholders and the press, of selling boring old assets for cash and investing in new-economy plays like Internet hosting. When the TMT boom turned to bust, serious weaknesses in the business were exposed and investor conﬁdence were severely undermined, but there was no question of fraud and compared with many of their competitors C&W was well managed. Sir Ralph, who was anyway at the age of retirement, found a successor but this person was subject to significant investor hostility and withdrew. Sir Ralph felt very strongly that this was a mess that he had to get the company out of, and played the pivotal role in ﬁnding and recruiting his successor, Richard Lapthorne. Whatever happens it is important that, if the company is remotely troubled, investors are properly consulted. In my view the best approach is to start by allowing the investors to comment on the criteria that are being applied – that is, what sort of person is being sought. Investors are generally very rational people who quite like processes, and in some ways ﬁnd commenting on criteria easier than commenting on specific personalities. Of course chemistry and character matter far more in a Chairman than formal qualifications or the specifics of previous experience. Nevertheless if investors understand, and believe they have been consulted over, the process that is being used, this in itself is a valuable step towards rebuilding investor conﬁdence, which in such situations has inevitably been somewhat shaken. When a suitable candidate has been identiﬁed it is highly desirable that the leading investors are sounded out in conﬁdence before he or she is announced. This is both to avoid the highly embarrassing débacle of a Chairman being rejected by the investors after the announcement, and a courteous recognition of mutual accountability. The

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Board is accountable to the investors for the selection of the Chairman and the Chairman is accountable to the investors for the quality and performance of the Board. It is also much easier for the Chairman to rebuild investor support they have been appointed with the advice and consent of the leading investors. It is, however, not reasonable to expect institutional investors to be deeply involved in the selection process unless there are very exceptional circumstances. They lack the time and resources and in any case this is rather too much abdication of Board responsibility.

Exceptional investor involvement in a new Chairman An example of such exceptional circumstances would be the merger of the two English independent television companies Carlton and Granada to create ITV plc. Carlton was still run by Michael Green, the entrepreneurial creator of the business, and Granada, which had a longer history, was run by Charles Allen, a professional manager. As is often the case, the merger required agreement on the social issues and it was agreed that Michael Green would become Chairman and Charles Allen CEO of the merged company. Regulatory clearance was needed for the deal, which created a monopoly of commercial regional television in England.29 After the deal was cleared, leading shareholders became increasingly convinced that Michael Green would not be the right person to chair the Board of the merged company – partly because his entire career had been as a very hands-on entrepreneur and partly because investors believed that an independent Chairman was needed rather than one who would be seen as a partisan of one side in a merger. This was before the adoption of the Combined Code, which explicitly discourages the appointment of the former CEO as Chairman and requires that the Chairman should be independent on appointment, so that argument could not be used. It fell to Anthony Bolton from Fidelity, as the largest institutional shareholder in the two companies, to inform the Boards of both companies of this investor view. As is made clear in Chapter 8, it was certainly not Fidelity’s intention or doing that their disquiet should ever reach the media: it was apparently leaked initially by a trusted media figure whom Anthony Bolton had consulted. However, Fidelity’s expression of serious concern led to some deplorable behaviour in the Carlton camp. First, they informed Fidelity that none of the other investors had raised these difficulties, suggesting that Fidelity was being eccentric in doing so. Fidelity responded that they would consult the other investors and indeed found that their view had such widespread support that several institutional investors were prepared to take the pretty well unprecedented step of co-signing a letter to the Boards urging them to resolve the Chairman issue. Second, articles in the financial 29

But not a monopoly either of television, with the BBC, BSkyB and Channels 4 and 5 having substantial market shares, or of electronic media advertising, with BSkyB, Channels 4 and 5, radio and the Internet all being considerable.

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press began to appear attacking Fidelity and pointing out that Fidelity’s own governance structures were not those which it was urging on others. If these articles were based on brieﬁngs from people who were directors or senior managers of Carlton at the time then it suggests that whoever was doing the briefing was both unaware of the impropriety of people employed by a public company whipping up a press campaign against one of their major institutional shareholders and unaware of the fundamental distinction between the governance obligations of a private company and one which is publicly listed – it is hard to know which is worse! There appeared to be similar brieﬁngs against shareholders in the case of Deutsche Borse30 and an ethical reminder to certain ﬁnancial PR ﬁrms might be in order. In the end the Boards backed down, accepted that the appointment of Michael Green as Chairman was not viable, and appointed an alternative candidate. The Board of Carlton then awarded Michael Green a substantial payment for loss of ofﬁce (£1.8 m, in addition to £13.2 m in share awards triggered by the merger) despite the fact that he had always made a point of not having a service contract. This triggered further understandable anger from some shareholders, but because of the merger there was no opportunity to vote against the Carlton remuneration report and votes against the appointment of the relevant Carlton directors to the Board of ITV were muted – most investors were pleased that they had achieved their main aim of a merger with a new Chairman and were not disposed to cavil about the payoff. A new Chairman was appointed who was not one of the people that investors had suggested, and they were quite content about this.

INVESTOR INTERACTION WITH A NEWLY APPOINTED CHAIRMAN Newly appointed chairmen tend to take their job very seriously, and rightly so. Their role is very responsible, both in the sense that the weightiest issues of the survival and development of the company depend to a significant extent on their judgement and also in the sense that a reputation which has been built up over many years of success as a CEO can be seriously damaged by a perceived failure as a chairman. Sir Roger Hurn, for example, was a highly successful and highly regarded CEO of Smiths Industries (now Smiths Group) but having been Chairman of Marconi when it collapsed was obliged to resign as Chairman of Prudential as well and later come off GlaxoSmithKline where he was Deputy Chairman and is now at the age of 66 on no UK Listed Boards. One senior and successful industrialist who was appointed Chairman of a somewhat smaller company than the one of which he was previously CEO explained

30

Deutsche Borse wanted to take over the London Stock Exchange and was prepared to offer a price that leading shareholders considered excessive. Fidelity and Capital publicly opposed the proposed deal, but the Deutsche management tried to tough it out for some weeks, before conceding defeat.

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that ‘as a trainee Chairman’ he was going around the major investors, asking them about their expectations, and that he planned to repeat the process once a year. Much of it would be getting feedback from the major shareholders he was visiting now, and getting a sense ‘of how am I doing?’. His company was still a major international business, and for the chairmen of smaller companies access to the investors may be more difﬁcult. Indeed there is a huge asymmetry between the effort chairmen make in their interactions with investors, and vice versa. This is, in part, a reﬂection of a basic power imbalance: investors have much more power over chairmen than chairmen have over investors.31 There are also issues of time and focus. A major investor may have shareholdings in over 600 companies and although companies have many millions of shareholders typically their top 20 will have the dominant voice, and the dominant inﬂuence in any vote. Equally investors are very conscious of their need to focus on the relatively few companies in their portfolio where the (in-)effectiveness of the Board is causing them concern – they have neither the skills nor the time to try and run the businesses in which they have invested their clients’ money and are conscious that they have delegated this responsibility to the Boards. It is very important that investors give the impression to chairmen that they are taking the interaction seriously, and that they appreciate the effort that chairmen put in to keep the major investors informed. I continually hear complaints from chairmen that ‘I wrote to 20 investors about a major issue, only three replied’. The typical investor response is that they would have replied if they had had a problem – coupled with an honest admission that they get inundated with such communications especially one to two months before the AGMs and that therefore they cannot give them all the attention they deserve. However, it’s amazing how much a courteous letter of acknowledgement would be appreciated. Chairmen are human beings too!

INVESTOR REACTION TO ‘EXPLAIN’S There seems to be a general presumption at present in favour of investors accepting an ‘Explain’ when it comes from a credible company. Recently companies have been somewhat pushing the boundaries – in terms of the independence criteria for NEDs, for example – and it will be interesting to see how investors react. 31

This statement deserves to be nuanced. In the past it was almost unheard of for investors to seriously oppose a chairman, let alone vote him or her down, so the theoretical power in investors was more latent than real. Everyone now understands that this power can be wielded and is. However, it also reﬂects the fact that UK corporate pension funds are a less dominant source of institutional investment than in the past. There used to be a concern that an investor who upset Sir Archibald might be disadvantaged whilst pitching for investment management business of Sir Archibald’s company’s pension fund. This is less serious now that UK pension funds hold less of their investments in UK equities and major players like Capital and Fidelity are on the UK scene with much less dependence on UK corporate pension funds in their client base, as well as these being an ethos of robust independence.

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For example, in December 2004 a large supermarket (Sainsbury’s) appointed an executive director of Cadbury Schweppes and an independent NED and chair of their RemCo. The justification of this was that Cadbury Schweppes was a top 50 supplier (number 43) but not a top 5, and that indeed only one contract, the petrol contract (worth £3–4 bn pa) was dealt with at Board level. Furthermore Cadbury Schweppes is a global company for whom sales to Sainsbury’s represent an insignificant fraction of turnover and profits, and their brands are so strong that they will be stocked by all leading supermarkets in any event. On the other hand, the RemCo Chairman does have far more influence on pocketbook issues of senior executives than an ordinary NED, and some investors might at least wonder what measures were being put in place to ensure that Cadbury Schweppes does not get over-favourable treatment. According to an article in The Times (23 December 2004) both Boards were satisfied that this executive director was independent as was one of the UK’s leading institutional shareholders (Morley Asset Management). Interestingly the current rules do not explicitly discuss the case of an ‘independent’ director who is on the Board of a company which wants a business relationship with a company, so if Sainsbury’s buys £3 bn pa of petrol from oil company A there is no explicit restraint on having an NED from oil company B even if the contract is up for renewal – although of course any director would have to absent themselves from any discussion on a contract that involved one of their companies. Another example of pushing the boundaries is the appointment as an independent NED of the CEO of BUPA (a private healthcare firm) to the Board of Standard & Chartered (an international bank) which is also chaired by the Chairman of BUPA. The appointment notice does not address this issue explicitly, merely noting that she ‘is not related to any directors, senior management or substantial or controlling shareholders of Standard Chartered plc’. However, the astute observer would notice that the usual laudatory comment on the appointee is made by the SID32 rather than the Chairman, who describes her, I’m sure quite fairly, as ‘a robust, independently minded executive, who will make a great contribution to the Board’. In such situations there is not a lot that the investors can do at the time – but they do have the right to vote against, or abstain on, the re-election of the director at the next AGM. In practice, as the example above shows, there will usually have been some prior consultation of some of the leading shareholders and it would be unusual to persist in the appointment of an independent NED who would not normally be 32

Interestingly this SID – like the Chairman, a retired director of BP, has no other listed directorships and was appointed over nine years before he made this statement. Under the Combined Code having served on a Board for more than nine years creates a presumption of non-independence, and the Board needs to explain why this director should be considered independent. The AGM of Standard Chartered at which this matter will be voted on is after this book is written but before it is due to be published – I would anticipate some problems but that any vote against will be small (it was, 0.3 per cent plus 1.5 per cent votes withheld). The issue of independence at Standard Chartered is a delicate one because they have seven EDs and eight NEDs.

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considered independent under the Combined Code if the major shareholders had indicated disquiet on this point. It is almost inconceivable that this person, whether or not deemed to be independent, would be appointed the SID, despite being well qualiﬁed in other respects. A major function of the SID is to be a check and balance on the Chairman and people would very much doubt that a CEO, however robust and independently minded, would be able to perform that role vis-à-vis the Chairman of her employer. One wise and well-informed investor put it like this: Corporate governance is not new. I started in the 70s and at the Pru they took it very seriously. They saw it as a dialogue, not box-ticking. The view was ‘we are long-term investors, so we want to have a dialogue directed towards the long term’. However, investors stopped investing in the 90s and started trading. This meant that corporate governance went out of the window with serious adverse consequences: CEOs became obsessed with boosting share prices in the short term and resorted to all sorts of tactics, some dubious and in a few cases clearly illegal. This led to a reaction, and the introduction of stricter standards of governance. But now there is a danger of over-reaction. It is not obvious that the particular approaches taken are necessarily the right ones. The key is dialogue not box-ticking. In my firm our policy is that we never vote against a proposal without a discussion with the management, explaining the reasons why.

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PART TWO

Seven Pillars

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CHAPTER 4

BP ANGLO-PERSIAN AND BEYOND From the earliest times the oil business has always been international and governments have always been involved in some way. A quick sketch of the origins of BP illustrates this. BP has Anglo-Australian-Parisian-Scottish-Canadian-BurmesePersian roots, and connections to Winston Churchill, Margaret Thatcher, Baron de Reuter and (tenuously) to Jane Austen. Our story starts with a man in possession of a large fortune called Mr D’Arcy. William Knox D’Arcy was born in Devon in 1849, the son of an Irish solicitor, whose family traced their descent to a fourteenth-century Lord Chief Justice of Ireland, Lord D’Arcy of Knayth.33 In 1866 he and his family emigrated to Queensland. He studied law and, when qualiﬁed, joined his father’s practice. He was practising as a solicitor when in 1882 he invested under £2000 in a goldmine which became immensely profitable. In 1889 he returned to England, purchased a mansion in Middlesex (Stanmore Hall), an estate in Norfolk (Bylaugh Park) and a town house (42 Grosvenor Square). Stranmore Hall was used as ﬁlm locations and the HQ of a Swiss trading organization and is now luxury ﬂats. There had been various attempts to discover oil in Persia, including two expeditions by Baron de Reuter, the founder of Reuters. These had foundered, partly for political reasons. However, at a meeting in Paris in 1900 involving a French geologist who had published a relevant paper, a former Director General of the Persian Customs (General Kitabgi), a certain M. Cotte, whose brother-in-law had been involved in one of the Reuters expeditions, and Sir Henry Drummond Wolff, a friend of Lord Randolph Churchill who has been British Ambassador to Tehran during the 33

It is irresistible to trace the connection with his famous literary namesake. Jane Austen’s one clearly documented serious love was with Tom Lefroy (1776–1896) an Irish law student whom she met in 1796. He went back to Ireland and later (in 1852) became Lord Chief Justice of Ireland. Our Mr D’Arcy’s father (William Francis D’Arcy) was a solicitor who left Ireland to set up practice in Newton Abbot and it is highly likely that his father or some other forebear was also a lawyer, in which case he might have been an acquaintance of the young Tom Lefroy. In any case, D’Arcy was quite a well known and distinguished name in Ireland at the time with legal connections. It was also the family name of the Earls of Holdernesse which died out with the 4th Earl (Robert Darcy, diplomatist and politician) in 1778, also descendants of Lord Darcy of Knayth. Interestingly the Barony of Knayth could pass to the female line, and indeed Robert’s daughter Amelia D’Arcy was Baroness de Knayth who married the Duke of Leeds and then John Byron, becoming the mother of Lord Byron. She could indeed have been referred to as ‘the Rt Hon Lady Amelia de Knayth’ and must surely have had some bearing on that comic creation of genius, Lady Catherine de Burgh. Jane Austen was not the only writer to beneﬁt from the extinction of the Holdernesse title: the Duke of Holdernesse is the key ﬁgure in the Sherlock Holmes story The Adventure of the Priory School.

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Reuters expeditions, a scheme was proposed to look for oil in Persia, and Sir Henry knew the very man who could ﬁnance it: Mr D’Arcy. The expedition began in 1901 and secured a 60-year concession from the Persian Government to prospect for oil. Mr D’Arcy put up most of the £600 000 capital of the company, though he never set foot in Persia. By 1905 even his resources had run low, and he brought in the Burmah Oil Company as an investor. This had been established in Glasgow in 1886 to develop oil interests in the Indian subcontinent, and by 1905 was a substantial concern. As might be expected, they drove a hard bargain and, as oil was not discovered until 1908, they ended up with 97 per cent of the shares in the enterprise: Mr D’Arcy became a director but the Chairman was Lord Strathcona (1820–1914) a Scottish Canadian ﬁnancier who combined being Canadian High Commissioner34 to London with being founding Chairman of Burmah Oil. Meanwhile Winston Churchill was appointed First Lord of the Admiralty by Asquith in 1911. Although his prior military experience had been exclusively in the Army, and despite his previous strong opposition to excessive construction of warships, he applied himself with his characteristic energy to increasing the number of Dreadnoughts (as the largest battleships were called) and to converting the ﬂeet to oil-ﬁred, rather than coalﬁred propulsion. In order to secure the supply of oil, mistrusting both Royal Dutch/Shell and the US Standard Oil, he purchased a government stake in the Anglo-Persian Oil Company for £2.001 m. Giving them a 50.0025 per cent shareholding and the right to appoint two directors (with restricted powers of veto) to Anglo-Persian’s Board, but with an undertaking not to interfere in the normal commercial operations of the company. Further discoveries were made in Iraq (1923 and 1927) and in Kuwait (1938, by a joint venture with Gulf Oil called the Kuwait Oil Company) and in 1932 the company formed a joint UK marketing company with Shell. Exploration also occurred in Canada, South America, Africa, Papua New Guinea and Europe. In 1935, the company was renamed the Anglo-Iranian Oil Company. In 1951, following the failure of long and complex negotiations the Iranian oil industry was nationalized and the company was expelled from Iran, but the company eventually managed to restart Iranian oil production in a consortium. In 1954 it changed its name to the British Petroleum Company.35 During the 1960s and 1970s the company pioneered oil and gas exploration and production in the North Sea and Alaska. In 1969 it announced the discovery of a large ﬁnd in Prudoe Bay in Alaska. When it became clear that BP owned a large part of the largest oil ﬁeld in North America it recognized that this would best be handled by an established US company and so struck an agreement with the Standard Oil Company of Ohio (Sohio) to acquire a 25 per cent stake from 1970, rising to a 34 35

Effectively ambassador, but at the time Canada was a British dominion. The name of a German-owned UK-registered company marketing oil products in Britian before 1914 which had been acquired by Anglo-Persian from the UK Trustee for Enemy Property in 1917.

BP

53

majority in 1978. However, they only had a minority of the Board seats and did not have management control. In 1974 Burmah Oil was faced with ﬁnancial collapse, and was rescued by selling their stake in BP to the British Government at a depressed price. In the 1970s and 1980s there was a programme of diversification which included the creation of BP Minerals, BP Coal, BP Nutrition and BP Ventures. In this they were following the lead of other major oil companies, in particular Exxon – whose slogan was ‘Put a tiger in your tank!’ – who invested in so many start-up companies that the saying in parts of the venture capital community was ‘Exxon want to put a tiger in every tank – and a turkey in every Boardroom.’ We now come to one of the great modern leaders of BP, Sir Peter Walters. Born in 1931, he joined BP in 1954, served as Vice-President of BP North America from 1965 to 1967, became one of the managing directors of BP in 1973 and was Chairman, which was then Chairman and CEO, from 1981 to 1990. As he explained:36 For eight years before I became BP Chairman, I had been a managing director of BP. There were five of these at BP who each represented an aspect of the business. Every Monday morning, we all sat round the Chairman’s table. The Chairman would ask each of us what was going on in their business, we’d ask for what we wanted, and provided the money was there, we were able to get it. When I took over as Chairman, at the first Monday morning meeting I told my colleagues that they weren’t their business’ emissaries to me, but mine to their businesses. They were to take back to their businesses the strategy that was decided round the table on Monday morning. The need for a more focused strategy and responsive operations soon became clear. During the early 1980s, BP’s refining, shipping and chemicals operations were suffering from the effects of industry-wide overcapacity and economic recession. Consequently, these activities were thoroughly rationalized. They also found the situation at Standard Oil increasingly frustrating. Despite having 55 per cent of the equity they did not have management control, and there were increasing concerns that the local management were not up to the job. In 1986 BP appointed one of their rising stars, Bob Horton, as Chairman and CEO of Sohio, discovering in the process some interesting things about US CEO contracts: the outgoing CEO’s contract allowed him to keep the contents of his ofﬁce and this included some valuable paintings from the company’s art collection! Bob Horton was accompanied by a younger rising star, John Browne, who was seen then as his financial ‘sidekick’, to the point that ‘being Horton-and-Browned’ entered the unofficial BP vocabulary. Assets that were not

36

Meeting with Sir Peter Walters, 12 March 2002.

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directly connected with the oil business, such as Minerals and Nutrition, were sold and BP bought the remaining 45 per cent of Sohio that they did not own for £4.7 bn in 1987. In October 1987 the UK Government decided to sell its remaining 31.7 per cent stake in BP. This involved offering the shares at a discounted price to existing shareholders. Unfortunately, after the offer opened there was a worldwide collapse of share prices, so that the discounted price became somewhat higher than the price at which the shares could be acquired on the open market. It says a lot for the loyalty that BP inspired in its shareholders that a considerable number nevertheless applied for these shares. However, most of the shares that were left with the underwriters were acquired by the Kuwait Investment Ofﬁce (KIO) which amassed a 21.6 per cent stake. A UK Monopolies and Mergers Commission report concluded that this could be against the public interest, and BP repurchased and cancelled 760 million shares from the KIO, thus reducing their stake to 9.9 per cent. Subsequent events showed that these were excellent investments for the other BP shareholders (BP shares have gone up by over 400 per cent since then, and the FTSE 100 by just under 200 per cent),37 but at the time these were enormous sums of money and required a steady nerve. The Sohio acquisition was seen as risky: no one had taken over a big US oil company before and the track record of large acquisitions of US businesses by UK companies was very disappointing. For example, in 1986 the Midland Bank had unwound their disastrous 1981 acquisition of Crocker National Bank in the US (‘a crock of worms’), by selling it at a hefty loss to Wells Fargo (see Chapter 5 ).38 In addition, no UK company had done a share cancellation on that scale before. However, there was a steady hand on the ﬁnancial tiller under Peter Walters: David Simon, who had joined BP in 1961, done his MBA at Insead in 1966 and had become managing director, Finance, in 1985. BP acquired Britoil in 1988, and focused on the core businesses of exploration, marketing and refining, and petrochemicals.39 Growth continued satisfactorily, although somewhat underperforming the then much larger Shell, until 1990 when Peter Walters reached retiring age. There were two possible candidates to succeed him: David Simon and Bob Horton. Bob Horton had a radical agenda for shaking up BP and made it clear that he would not serve under David Simon, whereas David Simon was happy to serve under Horton. So in 1989 Horton was nominated as Chairman, to take over in 1990. 37

38

39

Although curiously Shell’s shares have somewhat outperformed BP’s for most of the time since 1988 and only now has BP caught up. This is mainly due to the poor performance between 1990 and mid-1993, of which more later. Midland struggled on for ﬁve years but reached a crisis in 1991 when Sir Peter Walters was appointed Chairman at the instigation of the Bank of England (which was then responsible for banking supervision), and sold it to HSBC in 1992. The one signiﬁcant survivor from the years of diversiﬁcation is BP Solar which continued to grow during the 1990s and is now one of the world’s largest solar energy companies, part of the gas, power and renewables division of BP.

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Horton attacked BP’s bureaucratic culture with a vengeance. He spent his year as Chairman Designate with a team of bright young people on Project 1990, asking ‘In what ways should we change a successful organization still to be successful in ten years time?’ One of the products of this work was a Dear Colleagues letter from Bob Horton to all staff saying ‘These are the values BP will live by …’. They moved into a smaller HQ. Teams were encouraged to rethink the business in radical ways. Horton made no secret of the fact that in his view, there was much wrong with the old ways and that he was just smarter and better at making decisions than most people around him. There is no doubt that he was right about the first part: BP was too bureaucratic and needed to become a lot nimbler. He promoted a matrix/collaborative style of decision taking which probably helped to break down bureaucracy but which also blurred accountability elsewhere in the organization. Discontent with his rather autocratic style progressively increased and there was scant evidence, either in the financial results or in the reaction of investors as measured by the share price, that the medicine was doing much good. There were also increasing worries about his conviction that the price of oil would remain above $25 per barrel. But as Chairman and CEO Horton was lord of all he surveyed – it was unheard of for the Chairman and CEO of a major British company to be dismissed. Nevertheless, UK company law does in fact provide that a simple majority of the Board can dismiss the Chairman (and indeed that the Board can appoint whoever of their number they wish to chair a meeting). There was also significant stirrings of ‘corporate governance’ in the air, with Sir Adrian Cadbury’s Committee on the Financial Aspects of Corporate Governance reporting in 1992, generally encouraging the idea that the Chairman and the CEO should be separate and that there should be checks and balances in the governance of any company. I recall attending a conference on governance in 199240 and meeting someone connected with the BP Board who rolled his eyes in an eloquent gesture of wistful longing when we discussed mechanisms for removing a Chairman and CEO. And indeed in 1992 the BP Board forced out Bob Horton, installed David Simon as CEO and picked as Chairman one of their most senior NEDs, Lord Ashburton, a distinguished banker and member of the Baring family who had been Chairman of Barings until 1989 and a director of BP since 1982. At this point it was clear to the Board and to David Simon that a clear, written demarcation between the role of the Chairman and the role of the CEO was needed, and they turned to a remarkable barrister from New Zealand called Judith Hanratty. 40

My company, Sciteb, had undertaken a parallel investigation into the technological aspects of corporate governance with the encouragement of Sir Adrian, sending him the results of discussions with leading Chairmen on this topic as one small input to his report – although with the rueful reﬂection that in other business cultures the relative signiﬁcance of the ‘ﬁnancial’ and ‘technological’ might have been more balanced.

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Judith had practised as a barrister and worked as a legal academic in New Zealand, also advising the Government on privatizations. She joined BP in 1975, nine years after she qualified, so was unusual amongst BP senior management in having had a significant business life before BP. In 1986 she had moved to the Corporate Centre in London. She acted on a number of aspects of the acquisitions of Standard Oil and Britoil; the sale of HMG’s shareholding, the repurchase of BP shares from the Kuwait Investment Ofﬁce, all reporting to the Main Board. She also advised the Chairman on the future organization of legal function and developed/promulgated a written policy on business ethics across BP. In 1989 she had become MD of The Tanker Insurance Company Ltd, which was BP’s captive marine insurance business, and adviser to BP worldwide on insurance and risk financing, reporting to the Main Board. She proceeded from there to effect a quiet revolution in the insurance industry. First she consolidated all BP’s insurance broking and underwriting organizations into a single worldwide unit. Then she led the case, endorsed by the Board, for not using insurance as a ﬁnancial instrument for BP (unless it were a legal requirement); a decision having a value in 1991 equivalent to a capital investment in excess of $1 bn. This was based on the observation that, if you were dealing with competent insurers, over time the value of the premiums you pay greatly exceed the value of the claims you make and therefore for all but the largest risks it made much more sense for BP to self-insure, whilst using suitably advanced techniques to assess and manage risk. Judith’s expertise in insurance was such that she was subsequently appointed by the Bank of England to the Council of Lloyd’s, where she once more exercised her incisive ability to transform a business, and in 2005 she joined the Board of Partner Re, a Bermuda based reinsurer, as an NED in succession to Bob Horton. Judith applied her rigorous and iconoclastic mind to the topic of corporate governance with relish. The key idea is to have a rigorous distinction between the role of the executive in general (and the CEO in particular) and the role of the Board, with a small team of high-powered people, led by the Company Secretary reporting to the Chairman and not to the CEO, to support the Board as a whole and the NEDs in particular in their strategic and monitoring functions. The level of the team is indicated by the fact that (at the time of writing) one is a former Main Board FTSE 100 executive director, and another is a former country President for BP who was previously CFO of BP Asia/Pacific. Her scheme is essentially that which operates at present, and I’ll discuss the details in a moment, but let’s just bring the BP story up to date. Any hopes that David Simon would be less rigorous in pushing forward necessary changes and economies in BP were quickly dashed, indeed the workforce was reduced by about 60 000 to 125 000 and in 1995, when profits were surging and the shares were at an all time high (up over 150 per cent from their 1993 nadir, comfortably outperforming Shell and the Index). Lord Ashburton retired, David Simon took over as

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Chairman and John Browne became CEO. As far as I know, nobody said ‘you ain’t seen nothin’ yet.’ John Browne is by any standards one of the brightest, most dynamic and forceful professional managers of the late twentieth/early twenty-first century. Born in 1948 son of a BP employee, he read engineering at Cambridge and joined BP in 1966. He did his MBA at Stanford and by 1984 he had become group treasurer and chief executive of BP Finance International, which was run rather innovatively as a proﬁt centre.41 From 1986 to 1989 he was in America as CFO of Sohio/BP America and then CEO of Standard Oil Production Co. From 1989 to 1995 he was CEO of BP Exploration, becoming an MD of BP in 1991. He makes no secret of his committed Roman Catholicism, and indeed a faith that sees humility as a very important virtue is probably an important ingredient in the sustained success of an exceptionally able CEO who does not own a large slice of the business.42 Nevertheless, even someone as exceptional as John Browne might ﬁnd it difficult to function at peak effectiveness for a long time if they were untrammelled master of all they surveyed.43 Instead, to his and BP’s lasting advantage, he had probably the most rigorous system of accountability of any CEO. As a senior director of BP put it to me: ‘John Browne strongly supports these systems – he doesn’t really need to be kept in order but it is right that the systems are in place to do so.’ When Tony Blair became Prime Minister in 1997 one of his missions was to ‘put Britain at the heart of Europe’ and he persuaded David Simon, a lifelong committed Europhile, to join the Government as Minister for Europe at the Department of Trade and Industry, giving him a peerage (as Lord Simon of Highbury) and obliging him to renounce his chairmanship of BP and to sell his BP shares.44 Peter Sutherland, a former Irish Attorney General and European Commissioner who was also Chairman of Goldman Sachs International and who was Deputy Chairman of BP at the time, became Chairman. Browne became convinced that consolidation was needed in the oil industry, and in 1998 launched an audacious 60:40 merger with Amoco, renaming the company BP Amoco plc and having Peter Sutherland and the Chairman of Amoco as co-chairmen.

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42 43 44

The reader will notice an interested trend which is that BP tends to appoint not qualiﬁed accountants to CFO posts, but outstanding general managers. Indeed until Douglas Flint, the CFO of HSBC, joined the Board as an NED in 2004, they had no one on their Board who qualiﬁed as a ‘ﬁnancial expert’ under Sarbanes-Oxley – although their Deputy Chairman Sir Ian Prossor is a qualiﬁed accountant but was CEO of a major company before he was appointed an NED. Many people suspect that the contrast with much of British industry which tends to pack the Board with accountants is not an insigniﬁcant factor in BP’s greater success. It is interesting that the CEOs of both of the largest businesses in the UK are rather visibly committed Christians, with the CEO of HSBC being an ordained but unpaid priest in the Church of England. The admittedly much less able Jean Marie Messier of Vivendi became known as JM6, meaning ‘Jean Marie Messier, moi-même, mâitre du monde’ (myself, master of the world). A great ﬁnancial sacriﬁce, since the shares subsequently doubled.

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It is possible that this was made slightly easier by having a truly independent Chairman who is an Irish citizen working for a US investment bank – although no doubt the deal would also have been done had David Simon been Chairman since he is not someone to allow his ego or personal ambition stand in the way of doing the right thing. This deal sparked further consolidation, with Exxon and Mobil merging to form an even larger company, and not to be outdone BP Amoco made two further takeovers in 2000 – a mid-size US oil company called Atlantic Richfield Company (ARCO) and finally Burmah Castrol plc. which was indeed the old Burmah Oil Company that in 1966 had bought Castrol, a British lubricants business founded in 1899.45 In 2001 the company was renamed BP plc. In 2003 it became the largest publicly quoted oil company in the world by turnover, although Exxon Mobil remained ahead of it in terms of market capitalization.

OUTLINE OF BP’S GOVERNANCE MODEL As mentioned above the beginning of BP’s governance model is to have a rigorous separation between executive and Board matters and a clear accountability. The business is then run on the basis of a series of policies and performance contracts. Executive management of the business is rigorously delegated to the CEO: it is a fundamental principle of delegation in BP that authority and accountability are delegated to an individual and not a committee. Thus there are Board policies and a performance contract with the CEO and then, logically separate but of course appropriately dovetailed, there are the management policies and performance contracts within the business. Their clear view of governance is stated, in new and yet more precise language, in the 2004 governance report (released in 2005): Good governance is often defined in terms of the presence or absence of particular practices without reference to the underlying purpose of governance processes. We believe that governance is a more powerful concept. Governance is not an exercise in compliance nor is it a higher form of management. Governance lies at the heart of all the board does and it is 45

In 1963 BP and Shell had attempted a joint takeover of Burmah, with whom they had various exploration joint ventures, but this had been repulsed. Burmah is also noteworthy for two other reasons: in 1966 Burmah started exploring the North Sea for oil and was the ﬁrst company to ﬁnd oil there. Burmah or Castrol (it’s not quite clear from sources on the web which) also acquired a family-owned company called Atlas Preservatives in 1966 which was run by the son of a New Zealand businessman from Wangugi called Denis Thatcher, who had married a chemist-turned-politician called Margaret Roberts in 1951. The capital sum from this, and his income from continuing directorships of Burmah and eventually other companies, were a contributing factor in his wife being able to develop a successful political career.

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the task our owners entrust to the board. It has a clear objective – ensuring the pursuit of the company’s purpose. The board’s role is focused on this task, which is unique to it as the representative of BP’s owners. This task is discharged by the board through undertaking such activities as are necessary for the effective promotion of shareholder interest. Governance is the system by which the company’s owners and their representatives on the board ensure that it pursues, does not deviate from and only allocates resources to its deﬁned purpose. As a company, we recognize the importance of good governance and that it is a discrete task from management. Clarity of roles is key to our approach. Policies and processes depend upon the people who operate them. Governance requires distinct skills and processes. In the context of BP, governance is overseen by our board while management is delegated to the group chief executive by means of the board governance policies. Our board governance policies use a coherent, principles-based approach, which anticipated many developments in UK governance regulation. They ensure that our board and management operate within a clear and efficient governance framework that goes beyond regulatory compliance and places shareholder interest at the heart of all we do. Our board is accountable in a variety of ways. It is required to be proactive in obtaining an understanding of shareholder preferences and to evaluate systematically the economic, social, environmental and ethical matters that may influence or affect the interest of our shareholders. Our board is accountable to shareholders for the performance and activities of the entire BP group. It embeds shareholder interest in the goals established for the company. In carrying out its work in policy-making and monitoring and in its active consideration of group strategy, our board exercises judgement on how best to further shareholder interest. The board seeks to do so by maximizing the expected value of shareholders’ interest in the company, not by eliminating the possibility of any adverse outcomes.

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Reporting Our board makes use of a number of formal communication channels to account to shareholders for the performance of the company. These include the Annual Report and Accounts, the Annual Review, the Annual Report on Form 20-F, quarterly Forms 6-K and announcements made through stock exchanges on which BP shares are listed, as well as through the annual general meeting (AGM). Dialogue with directors Presentations given at appropriate intervals to representatives of the investment community are available to all shareholders by internet broadcast or open conference call. Less formal processes include contacts with institutional shareholders by the chairman and other non-executive directors. This is supported by the dialogue with shareholders concerning the governance and operation of the group maintained by the company secretary’s office, investor relations and other BP teams. AGM and voting Given the size and geographical diversity of our shareholder base, the opportunities for shareholder interaction at the AGM are limited. However, the chairman and all board committee chairmen were present at the 2004 AGM to answer shareholders’ questions and hear their views during the meeting. Members of the board met informally with shareholders afterwards. All votes at shareholder meetings, whether by proxy or in person, are counted since votes on all matters, except procedural issues, are taken by way of a poll. We have pioneered the use of electronic communications to facilitate the exercise of shareholder control rights and continue to promote the use of electronic voting through our registrar’s website and through CREST.

PERFORMANCE CONTRACTS The group CEO has a performance contract with the Board, each of the business segment CEOs has a performance contract with the CEO and each of the leaders of the business units and strategic performance units have a performance contract with their relevant ExCo (that is, the ExCo of the business segment into which they report.) At an operational level, performance contracts are in place for the performance leaders who run the many performance units that make up the business units. These performance contracts tend to be fairly short, focus on one-year deliverables and focus on ends and not means. Excuses are not encouraged so if, for example, you are responsible for trials of a new technology and you have a performance contact which says ‘initiate three pilot projects’ then if one of your pilot projects is impossible

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to initiate for reasons beyond your control, even if the problems are directly caused by the actions of other colleagues (such as someone freezing the relevant travel budgets) you are expected to ﬁnd another pilot project that you can initiate rather than to blame the colleague for frustrating your performance contract. In 2002 there was some concern that the culture of performance contracts was pressing some of the business unit leaders (known as BULs) towards short-termism, and this led to the creation of strategic performance units. It also led to the issue of The Green Book, which spells out the management policies within which the performance contracts can be achieved. What in other companies would be called the group executive is called the group chief executive’s meeting and consists of the CEOs of the business segments, the executive directors46 and the group General Counsel – who is not the same person as the Company Secretary and, like everyone else except the Company Secretary and his or her team, reports directly or indirectly to the CEO. In every instance, the performance contract is intended both to ensure that SPUs, BUs, performance units and individuals operate in compliance with group policies, but also to free and challenge the individuals to achieve outstanding results.

MANAGEMENT FRAMEWORK The Board has articulated a clear goal for BP: the maximization of long-term shareholder value. As a group, they have three high-level targets: to reinvest for longterm growth; to increase dividends; and to distribute to shareholders all cash in excess of investment and dividend needs. BP has clear principles on delegation, including the principle that authority and accountability in BP are delegated to individuals, not committees. This begins with the Board’s delegation of authority and related accountability for BP’s goal to the CEO. These same principles are applied by the CEO to ensure that delegated authority is driven to the most appropriate point in the organization. They have recently articulated a series of Group Values, which make it clear that the group aims:

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to have the best competitive corporate, operating and ﬁnancial performance;

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to improve, and to be accessible, inclusive and diverse;

Currently, two of the EDs are also business segment CEOs (Exploration and Production, and Reﬁning and Marketing).

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●

to engage the creative talents of their employees, and develop and apply leading, cost-effective technology and intellectual creativity to enhance innovation and new ideas;

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to carry on business in a manner that is environmentally responsible;

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to conduct their business relationships on the basis of mutual advantage.

They developed a code of conduct, to be launched to every BP employee in 2005.47 This sets out these rules more clearly and in more detail than ever before, updating those included in the previous guide entitled What We Stand For. The code of conduct covers ﬁve areas: ●

Health, safety, security and the environment This covers basic safety, health and environmental expectations, and stresses fundamental rules such as the need to report spills.

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Employees This explains what employees can expect of BP, highlights commitments such as supporting the effective abolition of child labour, and gives detailed guidance on dealing with cases of harassment or abuse.

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Business partners The code provides detailed guidance on receipt of gifts and entertainment, conflicts of interest, competition, trade restrictions, money laundering and working with suppliers.

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Governments and communities This covers issues such as bribery, money laundering, dealing with governments and political activity. For example, it underlines BP’s policy of making no corporate political contributions in cash or kind.

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Company assets and ﬁnancial integrity This covers personal use of company property, handling proprietary information, intellectual property, insider trading, data and digital systems.

There is an independent employee concerns programme, OpenTalk, run by a completely separate company, available to anyone working at BP as an alternative means of raising a concern about BP’s working practices and operations if for any reason discussion with their line management does not seem the best way to make progress. There is a clearly defined reporting chain and accountability for ensuring that the policies are complied with, which leads to the CFO on control and ﬁnance and to another executive director (once the Deputy CEO but, now that he has left, the role has been abolished and Ian Conn has taken this role as part of his responsibility as ED for health, safety and environment and for HR) on the other policies. 47

In June, after this manuscript has been ﬁnalized.

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BOARD OPERATION AND FUNCTION There is a very carefully crafted outline of how BP’s Board works on their website which is worth quoting in full:48 The policies recognize the board’s separate and unique role as the link in the chain of authority between the shareholders and the CEO. The dual role played by the CEO and EDs as both members of the board and leaders of the executive management is also recognized and addressed. The policies require a majority of the board to be composed of INEDs and delegate all aspects of the relationship between the board and the CEO to the NEDs. To discharge its governance function in the most effective manner, the board has laid down rules for its own activities in a board process policy that covers the conduct of members at meetings; the cycle of board activities and the setting of agendas; the provision of information to the board; board officers and their roles; board committees – their tasks and composition; qualifications for board membership and the process of the nomination committee; the assessment of board performance; the remuneration of non-executive directors; the process for directors to obtain independent advice; and the appointment and role of the company secretary. The responsibility for implementation of this policy, which includes training of directors, is placed on the chairman. At its heart, the board process policy recognizes that the board’s capacity, as a group, is limited. The board therefore reserves to itself the making of broad policy decisions, delegating more detailed considerations involved in meeting its stated requirements either to board committees and ofﬁcers (in the case of its own processes) or to the CEO (in the case of the management of the company’s business activity). The board’s role is to set general policy and to monitor its implementation by the CEO. To this end, the board-executive linkage policy sets out how the board delegates authority to the CEO and the extent of that authority. In its goals policy, the board states the longterm outcome it expects the CEO to deliver. The restrictions on the manner in which the CEO may achieve the required results are set out in the executive limitations policy, which addresses ethics, health, safety, the environment, financial distress, internal control, risk preferences, treatment of employees and political considerations. 48

Taken from www.bp.com with common abbreviations substituted: there are none in the original.

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The CEO explains how he intends to deliver the required outcome in annual and medium-term plans, which also respond to the group’s comprehensive assessment of risks. Progress towards the expected outcome forms the basis of a report to the board that covers actual results and a forecast of results for the current year. This report is reviewed at each board meeting. The board-executive linkage policy also sets out how the CEO’s performance will be monitored and recognizes that, in the multitude of changing circumstances, judgement is always involved. The CEO is obliged through dialogue and systematic review to discuss with the board all material matters currently or prospectively affecting the company and its performance and all strategic projects or developments. This key dialogue specifically includes any materially under-performing business activities and actions that breach the executive limitations policy. It also includes social, environmental and ethical considerations. The systems set out in the board-executive linkage policy are designed to manage, rather than to eliminate, the risk of failure to achieve the board goals policy or observe the executive limitations policy. They provide reasonable, not absolute, assurance against material misstatement or loss. One of the many remarkable aspects of this is that the Board does not seek to manage the company’s business activity, but delegates this to the CEO in a very explicit and structured way. This enables the Board to focus on long-range strategic and policy issues and is seen by BP as a significant source of competitive advantage. The delegated authority to the CEO is very considerable. For example, when the lawyers handling the £3 bn acquisition of Burmah Castrol asked to see a copy of the Board resolution approving the acquisition it was explained to them that there wasn’t one, because it was within the CEO’s delegated capital authority. This is not to say that the strategic issues around the deal were not discussed by the Board, but the rigour of the process meant that it was the CEO’s decision and not the Board’s. Consequently the CEO could be held accountable by the Board for its success (and for overpaying if that had happened) in a way that could not be achieved if these decisions were taken by the Board as a whole. It such matters the CEO’s delegated authority is balanced by the executive limitations policy, and this allows the Board to perform its proper governance role, in discussing with the CEO matters over which he is going to exercise his judgement. The fact that John Browne had served as CFO of Sohio and then as CFO of BP America as the two businesses were integrated, and then as CEO of the exploration and production business which included a significant fraction of these merged assets, probably gave him and his colleagues additional reason to be comfortable with this level of accountability on such major transactions.

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The BP Board typically holds eight Board meetings a year plus the AGM. In 2003 ﬁve were in the UK and three in the US, but the Board sometimes meets in a strategically significant location. Two of these eight meetings were two-day strategy sessions, and these are considered very valuable. Great care was taken from the beginning to get the arrangements right for productive informal dialogue, and the atmosphere really makes a difference. One and a half days of discussion when the Board is comfortable and examines strategic issues properly can set the agenda for a year or two. The Board process policy allocates the tasks of monitoring executive actions and assessing performance to three committees: ●

The Audit Committee monitors all reporting, accounting, financial and control aspects of the executive management’s activities.

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The Ethics and Environment Assurance Committee monitors the nonﬁnancial aspects of the executive management’s activities.

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The Remuneration Committee determines performance contracts, targets and the structure of the rewards for the CEO and the EDs and monitors the policies being applied in remunerating other senior executives. Note that this committee has an independent adviser who is part of the Company Secretary’s team, and they are not advised by group HR who of course report to the CEO and thus would have a potential conﬂict of interest.

In addition there are two other Board committees: ●

The Nominations Committee consists of the Chairman, the SID and the Chairmen of each of the three committees above. The CEO attends these meetings and participates in discussions where appropriate.

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The Chairman’s Committee consists of all NEDs, and considers broad issues of governance, including matters referred to it for an opinion from any other Board committee.

In relation to the five policy areas listed above, the Audit Committee deals with the control and ﬁnance policies and the others come under the purview of the ethics and Environment Assurance Committee. As well as reacting where necessary, these issues are addressed proactively. The committee cannot, of course, directly check on the ethical behaviour of all BP’s global staff, but they can, and do, ask senior management, both at the group and country level, to come and talk them through how ethical and environmental issues are handled. This helps the NEDs appreciate what is going on, and sends a very powerful message down the organization – that the Board’s commitment to ethical and environmental performance is not in any sense skin deep.

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With this background in mind, how does BP address the three specific issues that we were considering in earlier chapters?

BP’S APPROACH TO SHAREHOLDER/NED CONTACT BP explains its basic stance thus: The board makes use of a number of formal communication channels to account to shareholders for the performance and activities of the group … Presentations given at appropriate intervals to representatives of the investment community are available simultaneously to all shareholders, by live internet broadcast or open conference call. Less formal processes include the chairman’s contact with institutional shareholders, which is supported by the dialogue with shareholders concerning the governance and operation of the group maintained by the company secretary’s office. The executive management of the group and in particular the investor relations function lead the dialogue on the group’s business performance. Note the specific role of the Company Secretary’s office and the clear distinction drawn between ‘the governance and operation of the group’ and ‘the group’s business performance’. This means in practice that the Company Secretary often accompanies the Chairman for informal discussions with the shareholders, and that the Company Secretary’s office deals with the stream of questions and questionnaires that shareholder groups increasingly bombarded companies with in 2003/4. (There seems to be a bit of a reaction against this to simplify and reduce the load. A respected company Chairman of a much smaller FTSE 100 company told me that in their view an important function of the Chairman is to shield the CEO from the distraction of having to deal with all that stuff, so that they can get on with running the business. One cannot help thinking that when the level of ‘governance’ material reaches that pitch that something has gone wrong!) Committee chairmen can have informal discussions with shareholders on speciﬁc issues relating to their committee’s function. This is particularly the case with the remuneration committee. Executive remuneration is obviously a sensitive issue and John Browne is, understandably, one of the highest-paid CEOs in the UK, with a total cash remuneration in 2003 of £3.3 m and £1.8 m of long-term remuneration in the form of shares which are held in trust for three years and then released. Furthermore, he was granted 633 k ‘performance units’ which could be worth up to two shares each depending on performance, and 1.3 m share options at £3.88 per share. These have somewhat complicated performance conditions attached, and long retention periods, so it is not a straightforward matter to give a value to the total package, but it is clearly in

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the range of £6–12 m. As a proportion of BP’s profit before tax ($16.8 bn that year) it is clearly not signiﬁcant, but nevertheless it is important that the incentive structures are arranged wisely, especially since BP is the UK’s largest company and therefore sets precedents for others. From 2001 until his retirement in 2005 the Chairman of RemCo has been Sir Robin Nicholson FRS, an outstanding scientist who was chief scientific adviser to the UK Government and then research director of Pilkingtons.49 Following his retirement from that role he served with great distinction on the Boards of BP and Rolls Royce, bringing an independence of mind and rigour of judgement that was greatly appreciated by the chairmen of both companies. When he was appointed Chairman of the RemCo the NAPF convened a meeting where he was able to discuss remuneration principles with representatives of the leading UK pension funds. He then continued to have occasional dialogue with representatives of leading investors about RemCo issues. The other NEDs of BP include a number who have direct relationships of their own with investors. There are two serving chairmen, two recently retired chairmen and one serving CEO of major companies.50 In addition to the Chairman, eight NEDs are on the Boards of significant financial institutions.51 It would therefore not be difficult in principle for these NEDs to get a feel that something might be amiss if this were a widespread feeling in the investor community. In principle, if there were any investor issues that could not be addressed satisfactorily through the normal channels of dialogue with the executive management or the Chairman then investors are encouraged to contact the senior independent director who in this case is the Deputy Chairman, Sir Ian Prosser. Sir Ian was CEO of Bass which, after it sold its breweries, became Six Continents Group (where Sir Ian was Chairman) and after a sustained investor campaign demerged Intercontinetal Hotels and their pubs business. There was a feeling in some quarters that Sir Ian was not particularly responsive to investor concerns at that time, and when he was announced as the next Chairman of Sainsbury’s there was such a backlash from at least some investors, ampliﬁed by the press, that the appointment was withdrawn. Sir Ian also serves on the Board of GlaxoSmithKline which ran into a storm of investor criticism over a remuneration scheme for the CEO, becoming the only FTSE 100 company to date to have had its Remuneration Committee report voted down by the 49

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The famous glass company whose fortunes had been revived by Sir Alistair Pilkington FRS who invented the Float Glass process. Sir Alistair was, curiously, absolutely no relation of the founding Pilkington family and that Pilkington’s nearly refused to hire him on the grounds that if they did so he would be expected to become managing director in due course – which he did. Tony Burgmans chairs Unilever NV and Michael Miles chairs Johnson Matthey and Schroders, Charles Knight and Sir Ian Prosser were chairmen of Emerson Electric and Six Continents until 2004 and 2003 respectively, and Sir Tom McKillop is CEO of AstraZeneca. In addition John Bryan retired as Chairman of Sara Lee in 2001. John Bryan is on the Board of Goldman Sachs (as is John Browne); Tony Bergmans, Douglas Flint, DeAnne Julius, Charles Knight, Walter Massey and Tom McKillop are on the Boards of ABN Amro, HSBC, the Bank of England, Morgan Stanley, Bank of America and Lloyds TSB (respectively) and Michael Wilson is NonExecutive Chairman of UBS Global Asset Management (Canada).

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shareholders. He is nonetheless highly regarded on the BP Board. He is a qualified accountant and former FD, and also serves as Chairman of the Audit Committee – Douglas Flint, who is the FD of HSBC, joined the Board in 2004 and serves as the designated financial expert. There are many ways in which investors could make any concerns known to the NEDs, and if there were any investors who were reluctant to contact Sir Ian for any reason, there would be no shortage of alternative routes. BP offer all their directors for re-election each year. This was mainly to avoid any ‘age-ist’ singling out of one director for re-election, but also would allow any shareholder with real doubts about an NED to signal them clearly. At the last AGM each director got more than 99 per cent of the votes cast in favour. BP is of course a very well-run and successful business, but the events at Shell – which historically was even more admired than BP – demonstrate clearly the value of having transparent systems and checks and balances in place when everything is going well. Not only do these prove invaluable in times of crisis, but the very fact that they are there makes the crises less likely to occur. And BP has not been without its rocky moments recently: their production targets had to be abandoned which removed the always rather dangerous feeling that was developing that BP, under the current management, ‘walked on water’. As with all large companies with substantial shareholder bases, communicating effectively with individual shareholders is an additional challenge. The web is an enormous help, making it possible to put strategy presentations on the web and to webcast meetings, so that as far as possible the diligent individual shareholder with Internet access can keep abreast of developments at much the same time as the professionals. Ideally the web would be used as a medium for interaction with the company rather than simply as a ‘narrowcasting’ channel and this is an area where BP are keeping up to date with best practice as it emerges. One difﬁculty of course is that an AGM is, in principle, a private meeting with the shareholders and putting together a ‘shareholder extranet’ has its own challenges. It would be highly desirable on ecological and cost grounds if UK law encouraged shareholders to receive communications electronically – just producing and posting printed copies of their annual report and accounts to their 356 000 UK shareholders represents a considerable ﬁnancial and environmental cost.

BP’S APPROACH TO NED APPOINTMENT AND DEVELOPMENT BP is a long-termist business and gives considerable attention to succession planning. In 2004 they were making public statements about their succession planning based on planned retirements from the Board to 2007.

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In making appointments as non-executive directors, the opportunity is taken to ensure a broad range of skill-sets, in particular those skills identified following consideration of the board and board committee evaluation processes. The number of directors will therefore increase in the short term. While this will create a large board by UK standards, BP believes that this is necessary to allow not only sufficient executive director representation to cover the breadth of the group’s business activity but also sufficient non-executive representation to reflect the scale and complexity of the company and to staff the board committees. A board of this size will also allow necessary succession planning for key roles. They use headhunters but also consider suggestions from a variety of other sources, and have the advantage that, as one of the world’s largest, most famous and best run companies, they can get outstanding people to join their Board. Directors receive induction on their appointment to the board as appropriate, covering matters such as the operation and activities of the group (including key ﬁnancial, business, social and environmental risks to the group’s activities), the role of the board and the matters reserved for its decision, the tasks and membership of the principal board committees, and the powers delegated to those committees, the board’s governance policies and practices, and the latest ﬁnancial information about the group. The training and induction processes for directors are evolving to take into account the development of the group and applicable governance standards. Throughout their period in ofﬁce the directors are updated on BP’s business, the environment in which it operates and other matters. With the agreement of the board, executive directors are permitted to take up external board appointments. It is the company’s policy that executive directors may retain any fees received in respect of such external appointments. Directors are advised on appointment of their legal and other duties and obligations as directors of a listed company. The board regularly considers the implications of these duties under BP’s board governance policies. The directors addressed developments in corporate regulation and governance affecting BP and their role as directors, endorsing the approach to be taken by the company. The board continued annual evaluation processes to assess its performance and identify areas in which the effectiveness of the board,

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its policies or process might be enhanced. Directors completed questionnaires and subsequently met with the chairman to discuss their views. The results of the evaluation process were presented to the board and the matters identified addressed. Board committees have begun to conduct more structured evaluation of their performance, leading to reﬁnements in their processes, composition and work programmes. Company-specific induction is particularly useful because, although all Boards have their own particular style and ways of doing things, BP is more unique than most.

BP’S APPROACH TO THE POLICEMAN’S LOT As discussed above, BP has pretty rigorous systems in place to ensure that the ethical, environmental and other policies are really part of the way they work, and not simply paid lip-service to. The oil business has always been exceptionally visible, because it touches so many peoples lives in both developed and developing countries. Exxon suffered considerable damage to its brand and image through the Exxon Valdez tanker disaster in Alaska in 1989, as well as over $3.1 bn in clean-up costs, fines and civil penalties. Even before the reputational catastrophe suffered by Shell in 2004 (see Chapter 6), Shell had suffered considerable damage through concerns about its involvement in Nigeria and in the Brent Spar disposal controversy where, despite being probably the best option from a scientiﬁc point of view, the plan to dispose of the Brent Spar platform by sinking it in the North Sea was a PR disaster. BP therefore do take the view that it is worth over-investing in making sure that the policies and values are adhered to. This is not, however, seen as a simple ‘policing’ activity because the system of policies/values and performance contracts is integral to the whole way BP runs its business – from their perspective ‘governance’ is not ‘the add-ons to normal Board functions that are necessary to comply with the Combined Code and SarbOx’ but ‘what the Board does and how the company is run’ – of which the add-ons are a relatively small part. As noted above, the Ethics and Environment Assurance Committee monitors the non-financial aspects of the executive management’s activities. The committee is chaired by Dr Walter Massey who is President of Morehouse College, the US’s largest, private liberal arts college for African-American men which counts Martin Luther King among its alumni, and is also on the Boards of Motorola, Bank of America and McDonalds. It now meets five times a year, and the members are all INEDs. The external auditors’ lead partner and the BP general auditor (head of internal audit) attend each meeting at the request of the committee Chairman. The committee considers matters relating to the executive management’s processes to address

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environmental, social and reputation issues and the systems in place to manage nonﬁnancial risks to the group. It receives a report at each meeting from an ED on behalf of the executive management of the group. The committee considers topics such as environmental remediation, the company’s system of certifying adherence by staff to its ethical standards, greenhouse gas emissions and the management of risk in shipping operations. The committee also receives regular reports on health, safety, security and environmental (HSSE) performance and the company’s employee concerns programme – OpenTalk. BP publishes a detailed sustainability report each year which, in addition to explaining their ethical and sustainability policies and practices, gives performance statistics ranging from greenhouse gas emissions to the number of dismissals for noncompliance or unethical behaviour52 (252) and the number of supplier contracts terminated or not renewed for such reasons (41). Although some companies deal with these kinds of issues as part of the overall remit of the Audit Committee, in BP’s view they are sufﬁciently complex, strategically important and business critical to warrant a separate committee. There is also the concern that the Audit Committee is increasingly involved in highly technical aspects of accounting and disclosure regulations, which tend to grow in number and complexity each year. By contrast, ethics and environmental assurance is mostly about making sure that you have the right people, policies, values and systems in place: far ‘softer’ and more pervasive issues which require a rather different mindset from that needed to navigate complex ﬁnancial and disclosure regulations. But these soft issues are vital to maintain BP’s reputation as one of the world’s greatest companies – a reputation of which BP is justly proud and which it is determined to maintain and develop.53

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Excluding retail sites. The numbers quoted are for 2004. In the Fortune survey of most admired companies BP was the top oil company in 2003 and 2004, as well as most admired company in Britain. The 2004 FT/PWC survey puts BP 15th (up from 26th in 2003) also the top oil company, most respected in Britain and second in Europe.

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CHAPTER 5

Tate & Lyle OUT OF THE STRONG CAME FORTH SWEETNESS In 1855 Henry Tate was a successful businessman, with a chain of six shops in the Liverpool area. Not content with buying refined sugar, he formed a partnership with a sugar refiner operating in Liverpool, and when that partnership came to an end, he formed Henry Tate & Sons, building refineries in Liverpool (1872) and in London (1878), specializing in cube sugar. The enterprise prospered, Henry Tate was created a baronet in 1898 and died in 1899, bequeathing his collection of contemporary paintings to the nation and supporting the building of the Tate Gallery. Meanwhile, Abram Lyle, a Scot one year younger than Tate, had entered the sugar business from a different end – starting by transporting sugar by sea, and in 1865 adding sugar refining to his business interests. Sugar was a competitive business: in 1864 there were 74 sugar refineries in the country. In 1893 Lyle and his sons opened a reﬁnery specializing in the production of golden syrup, just one and half miles away from Tate’s refinery in London. Once the two firms had set up operations next to each other in East London, competition was intense. Yet there seems to have been a tacit understanding that Lyle would not produce sugar cubes and Tate would not venture into golden syrup. Tate and Lyle probably never met, and Lyle died in 1891. Both businesses experienced difficult times, as sugar cane importers faced new competition from European sugar beet. However, the First World War destroyed many beet growing areas, and demand for sugar cane rose once more. By this time, Tate and Lyle were refining 50 per cent of the country’s sugar between them. In 1921 the two companies merged to form Tate & Lyle. At the same time, expansion for the new company continued apace in both beet and sugar cane, and through acquisition of smaller UK refiners. In 1932 Tate & Lyle was one of the founder members of the FT Industrial Ordinary Shares Index (the FT-30), and is, alongside GKN and ICI, one of the only three founder members to survive largely unscathed to the present day. In the post-World War II era, the socialist government of Clement Attlee pursued a disastrous policy of nationalization for key industries. By 1949 it had become apparent that Tate & Lyle was to be included in the plan, but they waged a fierce and successful PR campaign to preserve their independence, enlisting the help of a cartoon character, Mr Cube, which became their much-recognized trademark for 50 years. In 1959 Tate &

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Lyle acquired 51 per cent of Redpath Sugars in Canada, a move that was to be followed by more acquisitions over the following decades taking them into other renewable resources such as corn (maize), wheat and molasses. Tate & Lyle now operates more than 41 plants together with 20 additional production facilities in 28 countries. In addition to building a global presence, Tate & Lyle were committed to research and development (R&D). In 1975 they were working with researchers at Queen Elizabeth College,54 part of the University of London, searching for ways to use sucrose as a chemical intermediate. The story goes that Shashikant Phadnis, a graduate student working on the project in the laboratories of Prof. Leslie Hough at King’s College London, misunderstood a request for ‘testing’ as a request for ‘tasting’ and this led to the discovery that many chlorinated sugars are hundreds of times sweeter than sucrose. Following this, Tate & Lyle arranged with Johnson & Johnson (J&J)to develop and test a new sweetener from chlorinated sugars, and in 1980 J&J formed a subsidiary called McNeil Specialty Products for this purpose. The long and arduous process of developing Sucralose and gaining regulatory approval was under way. During the 1980s Tate & Lyle expanded by acquisition, buying majority holdings in AE Staley Manufacturing in America and increasing its stake in Amylum.55 By the late 1980s and early 1990s the company had more or less stagnated, with turnover of nearly £3.2 bn in 1989 declining to £3.1 bn in 1992. Growth resumed and by 1996 turnover was £4.9 bn and proﬁts reached a peak of £340 m. When Sir David Lees joined the Board of Tate and Lyle as Chairman in 1998 the company had seen proﬁts reduced to £222 m in 1997. The CEO’s review for 1998 began by flatly stating that ‘this has been an unsatisfactory year’ but adding that ‘in the long run, businesses survive and prosper fundamentally because the adopt and execute the right strategies. This review explains what we are doing and why.’ It explained the special factors and mentioned the emphasis on new products, noting that the long-awaited US regulatory approval of Sucralose, our highintensity sweetener, was announced in April … Sucralose is approved for use in 30 countries worldwide and the European regulator petition is under active review. The natural reaction of an incoming Chairman would have been to change the management, but Sir David was satisﬁed that the core strategy was correct and indeed the same executive directors were in place four years later. 54 55

This fascinating institution was a spinout from King’s College London specializing in domestic science and social science, initially exclusively female. It was amalgamated with King’s College in 1985. A starch business originating in Belgium in 1873, in which they had ﬁrst made an investment in 1976: in 1988 they increased this to 63 per cent.

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However, Sir David believed that there needed to be greater focus and a concentration on improving returns on investment. In his next annual report, he outlined the strategy of: ●

continuing to develop higher-margin, higher-value-added and higher growth carbohydrate-based products, building on the group’s technology strengths in their worldwide starch business;

●

ensuring that all retained assets produce acceptable returns, divesting businesses which do not contribute to value creation, and/or are no longer core to the Group’s strategy.

In 2000 they divested certain non-core businesses56 and bought out the minority shareholders in AE Staley and Amylum. There was a strong focus on shareholder value generation and on economic value added. There were some Board changes: LR Wilson (formerly head of T&L North America who became Chairman of BCE Enterprises which was Canada’s largest telecoms company), Lady Prior, JE Taylor and Sir Saxon Tate (a grandson of the founder) stepped down and Mary Jo Jacobi (a MD of Lehman Brothers who had also worked in political circles) joined the Board. This dropped the average age of the NEDs other than the Chairman from 58 to 52, whilst the average age of the EDs went up from 51 to 52.8: the youngest director remained Carole Piwnica, a Belgian national and US and international lawyer who was then 42 and was Chairman of the Amylum group, in succession to her late father. Adjustments were made to the committee structure, with the Remuneration and Appointments Committee being split into a RemCo and a NomCo, the Corporate Affairs Committee being dissolved, and a Chairman’s Committee being formed consisting of the Chairman, the CEO and the NEDs which met before a Board meeting as required, providing an opportunity for the Chairman and Chief Executive to brief and obtain the views of the non-executive directors. The directors who retired during the period had all served as directors for longer than would now be considered appropriate for maintaining independence. As a result the company was not in compliance throughout the period with certain provisions for INEDs, but they were by the year end. Conditions remained difﬁcult in the year to March 2001: the US sugar market was depressed and energy costs were high. In addition T&L took a £307 m write-down on underperforming businesses that they planned to sell. Richard Delbridge (a former CFO of no fewer than three major banks) joined the Board and Lord (Peter) Walker 56

One of the non-core businesses was really ingenious. Since sugar prices were controlled in Zimbabwe the general manager of their business there, Stanley Musesengwa (of whom we will hear more later), decided they should diversify and, realising that all the local shop-keepers travelled to the T&L depots to buy sugar, hired in a cash and carry expert and set up a cash and carry business.

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stepped down, so the average age of the NEDs fell to 51. The committee structures were unchanged. By March 2002 trading conditions were improving, and the problematic US sugar business had been sold. Profitability returned and R&D spending increased from £13 m to £17 m. Data on Board attendance was disclosed in this 2001 annual report: The Board meets at least eight times each year. At least one meeting takes place at an operating subsidiary or joint venture company. During the year, the directors, overall rate of attendance at Board meetings was 98 per cent. All substantive agenda items have comprehensive briefing papers, which are circulated five days before the meeting. The Board reviews regularly the strategy of the group and at most Board meetings it reviews the strategy of one of the major units. The previous year the words were identical except that the Board met nine times and attendance was not disclosed. Carole Piwnica was given the additional title of ‘NonExecutive Vice-Chairman, Governmental Affairs’ on a €270 k pa consultancy contract. The year to 31 March 2003 saw another improvement in profitability. Sir David Lees dryly remarked that ‘the Group’s return on net operating assets … is starting to look more respectable, although there is more to go for’. There was also a change of CEO: Larry Pillard stood down at the end of 2002 as CEO to become Executive Chairman of Tetra Laval, the packaging giant, but remained on the Board as an NED. They appointed a senior VP of Unilever, Iain Ferguson, as CEO, who was able to start in May 2003, and promoted Stanley Musesengwa, a former refinery manager in Africa who had been with Tate & Lyle for 23 years, to be an executive director and COO, reporting to the CEO. Stanley, a shrewd international businessman with a great sense of humour and a can-do attitude, had started as a management trainee with Nestlé, moved to Tate & Lyle in his native Zimbabwe, and risen rapidly through the ranks to become head of their African businesses before being made CEO T&L Europe (including the UK) in 1999. John Walker, who had been ED for Europe, retired from the Board (after 35 years with the company), so the Board, although not the NEDs, got younger. The Chairman’s review was even able to comment on aspects of the Higgs Review that ‘needed further consideration’, most of which were dropped from the ﬁnal Combined Code.57 Interestingly, in 2003 they disclosed the overall attendance rate at each committee (100 per cent for audit, 98 per cent for RemCo, 93 per cent for NomCo which met nine times in the year, having to deal with the appointments of the CEO and COO). The company continued to decline to appoint a SID, offering the Chairman of the Audit Committee or of RemCo as points of contact ‘on any matters where investors

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Speciﬁcally: that the Chairman should not serve on NomCo and that no NED should be on all three committees were dropped, and the relationships between the SID and the investors were made less controversial. The idea that a third term of three years should be exceptional was retained.

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feel that an approach to the Chairman or the CEO would be inappropriate’. In this year the company’s five-year share price performance at last caught up with the FTSE 100 Index, which it had lagged since March 1998. This was due to a combination of a 40 per cent improvement in the T&L share price since March 2000 and a 30 per cent fall in the FTSE 100, so they converged on a 23 per cent decline – in the immortal words of Gerard Hoffnung ‘Half way up, I met the barrel coming down’, although in this case the collision caused no pain to either side, and T&L was much less than half way up! By June 2004 Sir David was able to report that ‘In the year to 31 March 2004, the Group performed satisfactorily.’ Although the profit was similar to the previous year, ‘The Group achieved for the ﬁrst time since 1996 its target of a 15 per cent return on net operating assets.’ Richard Delbridge, (who had joined the Board in September 2000), was appointed as SID and two new NEDs were appointed: Evert Henkes, former CEO of Shell Chemicals, and David Fish, a Mars veteran now a company Chairman and NED – he subsequently became Chairman of United Biscuits and thus had to resign from the T&L Board. Mary Jo Jacobi, who had moved to Shell as VP external affairs and was very busy in 2004 with the Shell crisis (see Chapter 10), decided not to stand for reelection at the AGM and Keith Hopkins also retired then, having served on the Board for nine years. Kai Nargolwala, an Indian-born UK/US national ED of Standard Chartered (Chairman of their wholesale bank and responsible for Asia) was appointed as an NED at the end of 2004. The RemCo met ten times in the year, and following a review of its composition and terms of reference both the company Chairman and Carole Piwnica stood down because they were not deemed independent under the Combined Code. The RemCo also reviewed and somewhat increased the remuneration of the Chairman and of Carole Piwnica. The attendance record of each director in the Board meetings and each committee was disclosed specifically – the only person who missed more than one meeting was Mary Jo Jacobi, which in the light of her commitments at Shell was understandable and no doubt contributed to her decision to leave the Board. They conducted the second Board evaluation during the year, looking at the effectiveness of the Board and the Board committees. This was an internal exercise conducted by the Chairman using a detailed questionnaire completed by all directors covering issues such as Board and committee composition, arrangements for and content of meetings, access to information, administrative procedures, induction programmes, director training and visits to operating sites. The results of the evaluation exercise were considered by the Board and recommendations were made and implemented. During the year, the NEDs met together without the Chairman present, under the chairmanship of the SID, to appraise the Chairman’s performance (the SID having first sought the views of the EDs). In addition, the Chairman held a private meeting with the NEDs to evaluate the CEO’s performance and to address any

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other matters the non-executive directors wished to raise. In the year to 31 March 2005, the Chairman announced his intent to have one-to-one performance evaluation meetings with each director. During 2004 the success of Sucralose and continued progress on other fronts caused a substantial increase in the shareprice, and Tate & Lyle had the satisfaction of rejoining the FTSE 100 Index, some seven years after it left. Few companies have managed to return to the top 100 after having been in the wilderness for so long. In 2005 Iain Ferguson was named European Businessman of the Year by Forbes Magazine, and it was announced in February that Coca-Cola would launch a Sucralose-sweetened version of Diet Coke in the US later in the year ‘in a bid to capitalize on the popularity of the sugar substitute’. Emphasizing their determination to develop as ‘the world’s leading renewable ingredients company’ they have appointed Prof. Barry Zoumas, a professor of agribusiness and food science and nutrition at Pennsylvania State University, who worked for Hershey Foods for 27 years as an NED. The shares went over £5 per share , having been below £3 in the year when Sir David became Chairman. On a ﬁve year view Tate & Lyle have now59 outperformed the FTSE 100 by 21 per cent pa, or c. 160 per cent overall.

T&L'S APPROACH TO SHAREHOLDER/NED CONTACT Having been both a CEO and a Chairman Sir David has a clear view about the demarcation of responsibilities between these roles. In terms of shareholders, the CEO and the FD are responsible for dialogue on strategy and operational effectiveness and to communicate to the shareholders their hopes and fears about the business as far as they are able to do so. The Chairman and the Company Secretary have the lead responsibility to the shareholders for the governance of the business. In February 2004, when the new Combined Code came out, Sir David wrote to all the top 20 shareholders saying that under the Combined Code we are required to work with you, make NEDs available and so on. How would you like to do this? He emphasized that he was available to them and would be happy to respond to any concerns they had at any time. He got six replies and none of them wanted to meet the NEDs. He did the same in March 2005. He was not discouraged by this, reasoning that this was an indication that the shareholders were probably pretty happy. He recognizes that the shareholders are inundated with communication materials and have to operate a management by exception policy. Especially when T&L has been doing rather well it is not surprising that they are happy – if there were particular performance or governance concerns then he would expect more contact. 58

5 May 2005.

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They have now appointed a SID – he is Chairman of their Audit Committee which was one of their two designated points of contact before: Richard Delbridge who is now on several Boards. Sir David would not have a SID who wasn’t effectively a Deputy Chairman. The new SID wrote to the shareholders and said he’d be happy to meet them. No one requested a meeting although he did go to visit a few at his initiative. As part of their governance review they had adopted written deﬁnitions of the roles of the Chairman and CEO. The Chairman’s was three lines, and the CEO’s (much to his chagrin) was one and a half lines (essentially CEO is responsible for the operations of the business and the presentation of strategy to the Board and the shareholders – this covers pretty well everything that the CEO does by implication). However, they then thought they should deﬁne the role of the SID and found that it took 30 lines, because there is not a very good deﬁnition of what the SID does. What they have found decidedly valuable, is to have NEDs sit in on results presentations – both the interims and the ﬁnals – and occasionally on other meetings with analysts/investors.59 This is not a three-line whip but it is very useful. Not all of them come to each presentation, but the CEO will make a point of introducing them (in the audience) and they can hear the Q&A and analysts can talk to them if they wish, although they tend not to. NEDs also occasionally go along as observers to presentations. As Chairman, Sir David goes on three to four investor visits a year: not saying much but being available and going with the team. He also knows some of the senior investors and they can always contact him if they want. They do not involve the NEDs in dinners with the investors, although the executives do have such informal dinner discussions. If there were greater investor concern about the company then they might.

T&L'S APPROACH TO NED APPOINTMENT AND DEVELOPMENT The whole impetus to encourage review of Board effectiveness is very helpful. Sir David has been doing this for some years and honing the process – indeed the questionnaires he uses have been much sought after by other chairmen. As a change from the very structured questionnaire in 2004/5 he circulated a list of 25 questions and invited each NED to pick the ones they’d like to take up (interestingly, there was a lot of overlap) The previous year they had all said that they were OK with the 59

This was something we had in our initial set of ideas on this topic, which was enthusiastically supported in our initial survey of chairmen and endorsed in the results we circulated in 2001. It had been suggested to us by Lord (Terry) Burns, based on his experience as a senior civil servant listening in to parliamentary questions. It would be nice to think that we played some small role in encouraging this.

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information and preparations, and so on, and clearly these are issues that need to be right ﬁrst. He has found one-on-one meetings with each NED very helpful to Board effectiveness and to NED development. It’s very important that: NEDs should enjoy being on the Board and that NEDs feel that they are asked to contribute and that their contributions are really wanted. The Chairman meets with the NED group collectively, as well as individually, to get the best out of them. The NEDs and the Chairman have dinner two to three times a year, usually with the CEO (you don’t need to assess the performance of the CEO all the time!). This would have a very informal agenda, for example: reflecting on how the City sees us; senior succession issues, below Board level; and is the organization really aligned in a way compatible with the strategy? They welcome NEDs going on courses, bringing courses to their attention and paying the fees where applicable (many are free and run by advisory ﬁrms as business development). These tend to be on topics like IFRS, pensions and special issues. There are quite good courses for RemCo and audit chairmen and so on. In their experience there is huge value from NEDs going on Board visits in terms of deepening understanding of the business and effectiveness of the Board. There is nothing quite like going away together. They do this twice a year, and also hold a strategy awayday. Sir David is keen on worker NEDs who are not just lending their names. For example the Asian market is increasingly important to T&L, and both Evert Hankes and Kai Nargolwala, who is based in Singapore, and have excellent Asian connections and have been very helpful to them. Their second Sucralose plant will be in Singapore and clearly the region is very important to them strategically. The balance of the Board is also very important: chairmen have got to spend a lot of time on the balance of the Board, recruitment and communicating with the NEDs. It’s pretty easy to let the standard of the Board drop. On some Boards you can see the EDs looking round at the NEDs and sometimes thinking ‘why?’. The Combined Code says that serving a third three-year term should be exceptional. Sir David agrees that there should be a high performance hurdle, but suggests that this should be set at the entry point: in his experience good NEDs don’t go stale after six years, indeed it is in years three to eight that they tend to be most effective – in theory people might well wind down in their last year, though I haven’t really seen this. What is more important is the average tenure of the Board – it would be worrying to see a group of NEDs who were all veterans, but in a steady state a maximum of nine years would mean an average of at most four and a half. However, all T&L NEDs understand that two and a half years into each of their three-year terms the NED leaves the room and the NomCo has a proper discussion as to whether they should be reappointed. This is written into their letter of appointment and is a good and helpful discipline.

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T&L'S APPROACH TO THE POLICEMAN’S LOT In terms of monitoring wrongdoing, like many companies (it’s mandatory under SarbOx for US-listed businesses) Tate & Lyle have a whistleblowers programme. In their case, this feeds into the Company Secretary, who is seen as executive enough to know what is going on and non-executive enough to take an independent view. His legal background is also helpful and he reports to the Chairman in his Company Secretary role – although like most companies smaller than BP the roles of Company Secretary and General Counsel are combined in one person with two ‘hats’. The Audit Committee provides detailed scrutiny of ﬁnancial matters: their terms of reference, which are rather detailed and carefully crafted (and on the company website) include both policeman’s activities and proactive measures. For example they are required: to review arrangements by which staff of the company may, in confidence, raise concerns about possible improprieties in matters of ﬁnancial reporting or other matters, ensuring that arrangements are in place for the proportionate and independent investigation of such matters and for appropriate follow-up action; to monitor the effectiveness of the internal auditor and to review the past and future internal audit programme, ensure co-ordination between the internal and external auditors, and ensure that the internal audit function is adequately resourced, has appropriate standing within the group and has regular access to the audit committee and its chairman; to discuss problems and reservations arising from the interim and ﬁnal audits, and any matters the auditor may wish to discuss (in the absence of management where necessary); to approve the appointment or dismissal of the head of corporate audit; to review the payment of commissions according to the group’s policy; to review the directors’ and company secretary’s expenses; to review at least annually reports made to it by management and the internal auditor on the group’s system of internal control and its effectiveness, and confirm to the Board that such a review has taken place. The reports to the committee will cover all controls including ﬁnancial, operational and compliance controls and risk management;

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And there is also the provision that: The committee shall conduct an annual review of its work and its terms of reference and make any recommendations to the Board. As it happens, the senior independent director is also Chairman of the Audit Committee, so there is a certain logic in having both the financial and non-financial aspects of the ‘policeman’ function concentrated in the Audit Committee. He is also an experienced banker, having been group FD of Midland Bank, HSBC and NatWest, therefore the combined roles of policeman and proactive support are well ingrained. As is so often the case, it is a question of personalities and effective chairmanship to ensure that the right balance is struck between rigorous monitoring and contributing to the development of the business. As noted earlier, NEDs should enjoy being on the Board, if they are to remain motivated and effective.

CHAPTER 6

Vodafone A DECISIVE HAT TRICK In the early 1980s the UK Government decided to introduce a nationwide mobile phone service. Being ideologically committed to competition and the private sector, it decided that two licences should be awarded. Sensing an opportunity, a US company called Millicom, which made mobile phone systems in the US, approached a mediumsized defence electronics company in Berkshire called Racal. After much to-ing and fro-ing a consortium was formed in which Racal, Millicom and and a venture capital fund called HATT had 80 per cent, 15 per cent and 5 per cent respectively, giving the whole business a valuation of £15 m. The head of Racal’s radio division, Gerry Whent, established Racal’s telecoms division in Newbury with fewer than 50 employees, and the ﬁrst call on the Vodafone network was made on 1 January 1985. To run this new business they hired Chris Gent (now Sir Christopher Gent.)60 Chris had started his career in banking in 1967 with NatWest, moved to Schroder Computer Services and then became managing director of Baric Computer Services, a JV between Barclays and ICL.61 Baric was mainly focused on services to small businesses and innovated by introducing value added network services and electronic document interchange services. His skills in building innovative IT-based services businesses, and in selling to banks and bankers, proved to be exactly what was needed. By the end of the year a then staggering 19 000 customers had signed up. In 1986 Racal shrewdly bought out the minority shareholders in exchange for Racal shares. By 1987 the Racal telecoms business was clearly looking successful and Sir Gerry Whent decided to export the business model, with Julian Horn-Smith (now Sir Julian) leading successful efforts to form local consortia in other countries and bid for mobile phone licences. By 1988 the business accounted for a third of Racal Group’s 60

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Non-UK readers may need to be warned that, as a confusing aspect of UK life, highly successful people get awarded knighthoods and sometimes peerages. This can give the misleading impression that UK Boards are peppered with quaint aristocrats, especially when Ian MacLaurin becomes Sir Ian MacLaurin and then Lord MacLaurin – but not Lord Ian MacLaurin which would mean he was the younger son of an Earl. Unlike most hereditary peers, people awarded peerages (like Lord MacLaurin, Lord Browne and Lord Broers) sit in the House of Lords of the UK Parliament, which results in an extremely well-informed upper house composed mostly of successful non-politicians who do not need to follow a party line. Schroders was at the time an independent merchant bank – they since sold their investment bank arm to Citigroup and are now purely a fund manager. ICL was a British computer manufacturer subsequently acquired by Fujitsu. After Baric, Chris Gent spent a year with ICL before joining Vodafone.

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proﬁts, and 20 per cent of the shares were ﬂoated in London and New York at a price of 170p/share. This crystallized the value of the business and was also designed to frustrate Cable & Wireless who were about to launch a takeover bid for Racal in order to acquire Vodafone. By 1991 Vodafone was worth so much more than Racal that the whole Racal business was valued at much the same as their 80 per cent stake in Vodafone, so the two were fully demerged – this was triggered by another move by Cable & Wireless. The original Racal was bought in January 2000 by Thompson-CSF (now called Thales) for £1.3 bn. During 1997 Chris Gent was promoted to CEO and in 1998 Sir Gerry Whent retired from the Vodafone Board, with Lord MacLaurin, the former Chairman of Tesco, taking over as Chairman, thus becoming Chairman late in Chris Gent’s first year as CEO. By 1 March 1999 Vodafone had over five million customers in the UK and over ten million worldwide. As 1998 turned to 1999 Lord MacLaurin and Chris Gent were watching England play Australia when Scott Mead, their investment banker from Goldman Sachs, rang on their mobile phone. Bell Atlantic, a US telecoms company, was in the last stages of merger negotiations with AirTouch, a US cellular telecoms company. They had to call him back, an English bowler was about to make a hat-trick. But the news was momentous. Vodafone had been courting AirTouch for six months but could not agree a merger because of a different approach between the two parties on structure and organization. However it was an attractive proposition, not merely because of its position in the US but because it also had positions in 12 other countries – thus combining the two businesses offered global leadership. Vodafone knew of Bell Atlantic’s interest and had therefore decided to wait and counter-strike with an outright acquisition instead of a merger. Because they had rehearsed the arguments in favour of this with the Board, they could counter-bid very quickly and agreed terms with AirTouch within a fortnight in January 1999. One of the initial sticking points had been AirTouch’s desire to have Sam Ginn as Chairman and Arun Sarin, a brilliant Indian engineer turned entrepreneurial manager who was their President and COO, as COO of the combined company, with Chris Gent as CEO. Instead, by making an outright acquisition Arun agreed to run the US business with oversight of the combined company’s Japanese shareholding and became part of

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the management team. Sam Ginn, the Chairman of AirTouch, briefly became Chairman of Vodafone, with Lord MacLaurin stepping aside to Deputy Chairman, resuming the chairmanship 11 months later in 2000. Meanwhile Bell Atlantic and GTE agreed to merge to form Verizon Communications and in September 1999 Vodafone announced an agreement with Bell Atlantic and GTE to combine their US cellular operations to create the largest mobile operator in the United States, Verizon Wireless. Following the completion of the merger on 10 July 2000, Vodafone’s interest in Verizon Wireless became 45 per cent. Arun left his executive role in April 2000 but remained on the Board as an NED. Vodafone was not the only company in the mobile telecoms market with engineering roots. Mannesman, a venerable German engineering company, had entered the German mobile phone market in rather the same way that Racal had. It had expanded into mobile telephony to the point where the stock market value of its telephone operations dwarfed its old engineering businesses. Meanwhile, the Hong Kong conglomerate Hutchison Wampoa had formed a joint venture with British Aerospace which was, initially, a major disappointment. British Aerospace was short of cash but the contract was tightly drawn and they could find no way to exit. So they realized they had to make it work, and found some remarkable management within the Hutchison empire, who renamed the business Orange. Supported with an innovative and hugely successful marketing campaign, Orange became a significant challenger to Vodafone in the UK market. In October 1999 Mannesmann made an agreed £19.8 bn bid for Orange, which in addition to its strong positions in Germany and Italy and investments in France, Austria, Belgium and Switzerland would have allowed it to challenge Vodafone as the largest mobile telecoms network in Europe. Analysts also said that if Mannesmann bought Orange it would not only establish the company as a player in the European mobile sector, but also put it out of the price range of potential buyers such as Vodafone AirTouch. This was, however, to underestimate the ingenuity and determination of Chris Gent and his team. They decided to buy Mannesmann, with a view to selling off Orange (which they could not keep for regulatory reasons) and all the non-mobile-telephony assets. There had never been a successful hostile takeover of a major German firm by a non-German company – and indeed hostile bids of any kind were very rare in Germany – but Vodafone’s can-do attitude saw this as a challenge rather than an insurmountable obstacle. Initially they approached Mannesmann with a friendly £65 bn offer, but when this was rejected in November 1999 they launched a £79 bn hostile offer. The German Government made it clear that it would allow the shareholders to decide and although Mannesmann made a ferocious defence in April 2000 it agreed to a £112 bn all-share takeover. Vodafone subsequently sold Orange to France Telecom

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for £25.1 bn62 and disposed of the other Mannesmann assets for a total of £12.5 bn. In the meantime the British Government, seeing the staggering sums at which the capital markets were valuing mobile telephony companies in the 1990s, decided to combine the rhetoric of free competition with the instinctive rapacity of a government that wanted to make massive increases in expenditure by conducting a fiendishly complicated auction of licences for the third generation spectrum. This was designed by experts to maximize the sum raised by the government without any regard for the consequences on the mobile telecoms industry, whose great success in Europe was in significant measure due to the development, funded and coordinated at a European level, of the GSM standard, and its imposition by European governments as part of the licence conditions. The UK Government alone raised £22.47 bn when the auction concluded, after 150 rounds in April 2000. The companies were widely perceived as having overpaid, although Vodafone has steadfastly refused to write down the cost of their UK 3G licence, with the result that it had stated net assets substantially in excess of its market capitalization for much of 2001–2004.63 Accounting standards only require writedowns if the net present value of the future cashflows is less than the value shown on the balance sheet.

DIGRESSION ON CREATING SHAREHOLDER VALUE This raises the very interesting question as to whether Vodafone has been a major creator, or destroyer, of shareholder value. At first sight the answer is obvious: at the beginning of 1989 the shares were trading at about 10p and at the end of 2004 they were trading at 141.6p, an increase of over 1300 per cent or a cumulative annual growth rate of just over 19 per cent pa, and outperforming the FTSE 100 index over that period by 600 per cent. It is therefore perhaps not an accident that Fidelity and Capital are Vodafone’s two largest shareholders. However, when the Harvard Business Review published in 2004 an analysis by Stern Stewart of the companies that had grown and created shareholder value, Vodafone was listed as one of the fastest-growing companies but the most spectacular destroyer of shareholder value in the sample. This was on the basis that the money they had raised from their shareholders to finance the various acquisitions was greater than the value of the resulting company. If Stern Stewart are right then the section on Vodafone’s corporate governance should

62

63

Plus the assumption of £1.8 bn of Orange’s debt and the obligation to pay £4.1 bn for the UK 3G licence. This deal was for £13.8 bn cash and £11.3 bn in shares, of which £1.3 bn were exchanged for loan notes and the shares and loan note were underwritten by France Telecom at £8.4 bn. When France Telecom’s shares subsequently collapsed it had to make two additional cash payments to Vodafone, so Vodafone became the second largest shareholder in France Telecom for a while, with 9.99 per cent. Effectively the deal was worth £22.2 bn (13.8 + 8.4). For example, £110 bn net assets at as September 2004 versus a market cap of £89 bn – the difference being substantially more than the market cap of the second largest UK telecoms ﬁrm (BT – valued then at £15 bn). They did take impairment charges in other intangible assets, to the tune of £6 bn in 2002 for example. But by 31 March 2005 they had £99 bn equity shareholders’ funds and a market cap of 90 bn.

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be seen as a cautionary tale rather than an example of good practices. Who is right, and why? If I raise £150 bn in cash from my shareholders to build up a business empire which is worth £90 bn then I have clearly destroyed at least64 £20 bn of value. But suppose I raise £3 bn from my shareholders, a euphoric market pushes my market cap up to £60 bn, I then make all paper acquisitions of two other companies for a total of £147 bn and, after the exuberance subsides, the business is worth £90 bn? The £3 bn has turned into that fraction of the £90 bn attributable to my original shareholders. In Vodafone’s case the AirTouch merger was a 60:40 deal and the Mannesman acquisition was a £200 bn company buying a £140 bn one (in round numbers) so roughly 60:40 again. Thus Vodafone’s original shareholders ended up with approximately 36 per cent of the combined company so on that basis the original £3 bn becomes £32 bn, which is clearly a considerable creation of value. The situation is of course more complicated, not least because, having bought Mannesmann largely for paper, they sold the unwanted parts mostly for cash. But the fundamental point remains: notwithstanding the superficial logic of the Stern Stewart calculations, when you consider economic reality and not accounting numbers, a different story emerges.

VODAFONE AFTER MANNESMANN The Mannesmann acquisition was both strategic and highly tactical. It was conducted at the height of the Internet boom and while Vivendi was an aspiring media colossus with ambitions of global domination. There had been rumours that Vivendi would be a ‘white knight’ counter-bidder for Mannesmann and a key tactic that helped clinch the takeover was bringing Vivendi into an alliance with Vodafone to develop an Internet portal called Vizzavi.65 This and other steps helped counter the allegation, which was a strong part of Manesmann’s defence, that Vodafone lacked an understanding of the Internet or indeed an Internet strategy. Arun Sarin, who ceased to be an executive director on 15 April 2000 and moved to being an NED, working in the venture capital world in California, was well plugged in to the Internet world, and made important contributions to the strategic thinking on this. When the bid was won, huge fees were payable to the investment bankers and the Board of Vodafone understandably felt that it was unfair that the achievements of Chris Gent and his team should not be recognized ﬁnancially. This was not just a question of having pulled off one audacious bid that would previously have been considered impossible. They had moved the business from being the 25th largest in the FTSE to the second largest in Europe, 64 65

For simplicity I am neglecting dividends, the time value of money, and risk-adjusted returns. They would need to be considered for a (very complex) exact calculation, but don’t greatly affect the basic point. In the light of what is now known about Vivendi’s ﬁnancial position this now seems rather ludicrous. The initial CEO of Vizzavi was an ex-Goldman Sachs banker, which says something, either about the heady days of the dot.com era, or about the real purpose of the enterprise, or both.

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growing very substantially in terms of revenue, scale and complexity in the space of two years, at a time when their previous compensation had not kept pace with these developments. The Board therefore agreed special cash bonuses of £11 m, of which £5 m went to Chris Gent, £2 m each to the CFO Ken Hydon and the COO Julian HornSmith, and £1 m each to Peter Bamford (another executive director but more UKfocused) and Arun Sarin (who was on a US-style compensation package with less need of catch-up). In addition to the cash bonuses, they received the same again in shares. It is perhaps significant that at the time the Remuneration Committee contained three Americans including a director of Exxon Mobil and the billionaire founder of Gap, and Sir David Scholey, an enormously experienced investment banker: they were thus well aware of world-class remuneration levels both in business and in the investment banking world. Indeed there is little doubt that the bonuses paid to Goldman Sachs bankers involved in the deal would have been a lot higher.66 After they had bought Mannesmann there was a considerable amount of tidying up to do: several parts had to be sold, most notably Orange which went to France Telecom. There was also a need to make the various pieces work together effectively. Finally Sir Christopher Gent wanted to leave at 55, having built up the company through such major changes and brought it out of the general slump in telecoms share prices. After a rigorous search involving internal and external candidates they announced that his successor would be Arun Sarin, who rejoined as an executive director and CEO Designate in March 2003 and became CEO four months later. Arun’s main priority was to bring the various parts of Vodafone together more effectively as ‘one Vodafone.’ There was a considerable amount of rebranding so that the members of the Vodafone family in various countries presented a more consistent face to the outside world. There were two signiﬁcant and somewhat troublesome complications:

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Vivendi holds a 56 per cent stake in SFR, the ‘Vodafone’ network in France. Despite Vivendi’s rather parlous financial condition they had in 2002 managed to turn down a bid from Vodafone to buy out their 35 per cent stake and instead bought BT’s 20 per cent stake. Nevertheless, by a patient logical approach Arun Sarin was able to convince Vivendi of the value of a large measure of operational integration into the Vodafone global business, even though ownership is distinct.

●

Verizon holds 55 per cent of Verizon Wireless, which is the Vodafone network in the USA and which uses an entirely different technology from that of the Vodafone GSM network elsewhere. AT&T put its mobile unit (AT&T Wireless) up for sale, which did use GSM technology. Although the timing was far from

I have not been able to ﬁnd a disclosure of the total fees paid to Goldman’s (possibly the Scott Mead secretary trial would have disclosed some information) but according to Business Week 21 February 2000 the total fees paid by Vodafone on the transaction were thought to be around $650 m, so it is reasonable to guess that Goldman’s share was in excess of $200 m.

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convenient Vodafone entered the auction: partly because there would have been obvious synergies and partly to stop it from falling into the hands of a competitor at an excessively low price. Eventually Cingular (a 60:40 JV between SBC and Bellsouth) bought it for $47 bn.67 All this naturally complicated the situation with Verizon. However, Arun Sarin’s good relationships with, and understanding of that business, combined with the fact that Andy Halford, the CFO of Verizon Wireless, took over as Vodafone’s CFO in July 2005, should ensure that relationships remain amicable and constructive.

OUTLINE OF VODAFONE'S GOVERNANCE MODEL Lord MacLaurin had been CEO and then Chairman of Tesco, and had laid the foundations there for its tremendous long-term success. He was very aware that he was moving from a business which he knew intimately to chair one which was rapidly evolving, in which he was not an insider, and whose technology and markets would change far more rapidly than retail. He was also very conscious of the distinction between Chairman and CEO. One of his ﬁrst key decisions was to have a separate small office in London and not to be based in Newbury – although he works three to four days a week on Vodafone you can’t stroll down the corridor to see him, as you could with the CEO, or even along the road.68 Although Vodafone has not gone as far down the road of carefully written and very explicit delegations and terms of reference as BP, it is very clear that the role of the Board is both to contribute to the development of the business and to hold the executive to account. In addition to the Chairman and Deputy Chairman there are eight INEDs who are chosen both for their overall calibre and ability to contribute and for their specific areas of expertise. From the start it was clear that finance, technology and international marketing were three key disciplines on which the success of Vodafone depended, and three remarkable and long-serving NEDs who cover these areas: ●

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Sir David Scholey was the key corporate financier in the City before the Americans came in and the British investment banks were sold. As Chairman of SG Warburg he was involved in many of the major corporate transactions

$41 bn cash and $6 bn assumed debt, but there was $5 bn of cash in AT&T Wireless so the parent companies had to put up $36 bn between them. The deal was announced on 17 February 2004 and closed on 26 October. There was a feeling at the time that Cingular might have overpaid, although SBC’s shares have performed since 17 February very much in line with Vodafone’s. An interesting aspect of Vodafone’s heritage of rapid growth was that until 2003 it occupied about 40 different small buildings in Newbury, so people were much less likely to bump into each other in their ofﬁces than in a more normal business. Recognition that this was hampering effective communications led to the construction of a large ofﬁce complex on the outskirts of Newbury, called The Connexion, where most of the group staff now work.

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of the 1980s and early 1990s, including the purchase of SG Warburg by Swiss Bank Corporation (now absorbed by UBS – see Chapter 9). He joined the Board in 1998, and retired at the 2005 AGM. ●

Sir Alec Broers (now Lord Broers) is an academic who had spent time at IBM and became Vice-Chancellor of Cambridge University, and President of the Royal Academy of Engineering. He brought a rigorous mind and a deep understanding of long-term technology rather than specific business experience.69 Historically Vodafone has spent very little on R&D, buying in the network infrastructure from vendors such as Ericsson, but clearly making sound long-term technical judgements is of great importance, and with Alec Broers on the Board it could not be blinded with science.

●

Penny Hughes shot to prominence when she was appointed President of Coca-Cola GB and Ireland at the age of 31. One of the ﬁrst things she did was walk round the building saying hi to everyone, to the astonishment of some staff who claimed that the President had never even been on that floor. Her core focus is brands, consumers and customers, but as general manager she obviously learnt how to run a business and deliver a proﬁt. She left Coca-Cola in 1994 and in 1995 took her ﬁrst NED role – Vodafone in 1998 was her third – and she is currently70 an NED of Vodafone, Gap, Reuters and SK Banken. She has a strong international marketing background and acts as mentor to a number of senior people in Vodafone involved in marketing and new product development.

Other directors joined the Board later, sometimes along with acquisitions: Paul Hazen (Deputy Chairman) and Michael Boskin were on the Board of AirTouch, as was Arun Sarin. Jürgen Schrempp was a member of the Supervisory Board of Mannesmann. More recently three people with additional specific expertise joined the Board: Luc Vandevelde (retail71), Dr John Buchanan (who had just retired as CFO of BP72) and Sir John Bond who is Chairman of HSBC. In addition to their obvious sectoral expertise, the latter two bring experience of lifetime careers in successfully integrated global business. 69 70

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Although from 1995 to 1996 he had served on the Board of Lucas Industries, a famous but underperforming engineering business that was taken over by Varity Inc. As at 6 May 2005. Penny gets many approaches to join Boards and politely declines most of them, but it is quite possible that by the time this book is published she will be on another one. She is also on the European Advisory Board of Bridgepoint Capital, an NED of Molton Brown Ltd, a former NED of Trinity Mirror, Body Shop, Enodis, SC Johnson, Web Angel and the Great Little Trading Company, and President of the Advertising Association. When he joined in 2003 he was Chairman of Marks & Spencer, ‘one of the UK’s leading retailers’. His reputation suffered in 2004 when the Marks & Spencer Board replaced him and his CEO as part of their successful defence against a threatened hostile bid. He was appointed to the Carrefour board in 2004 as a representative of the Halley family, which holds a 13 per cent stake, and became President of their Supervisory Board in 2005. BP has an interesting tradition of appointing PhDs rather than qualiﬁed accountants as group CFO. It appears to have done their bottom line no harm at all.

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Vodafone has three Board committees: ●

The Audit Committee (chaired by Paul Hazen the Deputy Chairman) reviews the company’s results and financial statements, reviews the activity of the internal and external auditors and monitors compliance with statutory and listing requirements. The terms of reference of this committee are pretty standard, although quite interestingly their remit includes ‘to establish and review procedures for the receipt, retention and treatment of complaints received by the company regarding accounting, internal accounting controls, auditing or other matters and for the anonymous and confidential submission and treatment of employee concerns regarding questionable accounting, auditing or other matters’ (italics added).

●

The Nominations and Governance Committee (chaired by Lord MacLaurin). This leads the process for Board appointments; annually evaluates the performance of the Chairman and the CEO; monitors the performance and composition of the Board73; and reviews succession and development plans for EDs and succession plans for executive heads of the operating subsidiaries.

●

The Remuneration Committee (chaired by Penny Hughes) determines on behalf of the Board and the shareholders the company’s broad policy for executive remuneration and the remuneration packages for each of the EDs and the Chairman. They expressly state that, in doing so, they aim ‘to give the EDs every encouragement to enhance the company’s performance and to ensure that they are fairly but responsibly rewarded for their individual contributions.’

HOW VODAFONE HANDLES INVESTOR/DIRECTOR DIALOGUE Vodafone was aware from the start of the importance of their relationships with investors, both when they floated and when they embarked on their ambitious acquisition trail, mostly ﬁnanced by the issue of shares. Chris Gent was famous for his red braces and spent a lot of time in dialogue with the City, with investment bankers, analysts and investors. At Tesco, Lord MacLaurin used to meet the institutions in his

73

The way this is put in the terms of reference is worth quoting in full: ‘To monitor and evaluate the performance and effectiveness of the Board and the contribution of each director on the Board including, in relation to NEDs, whether the NED is spending enough time to fulﬁl his or her duties to the company. The committee will also seek the views of executive directors on the performance of NEDs … to review regularly the Board structure, size and composition and the balance of skills, knowledge and experience on the Board and make recommendations to the Board with regard to any adjustments that are deemed necessary.’

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capacity as Executive Chairman, together with a couple of executives. They’d meet the top management of major investors once a year to talk about the business. Thus both Lord MacLaurin and Chris Gent were experienced and sophisticated at relating with investors. However, in the 2000 and 2001 AGMs they had a signiﬁcant level of investor concern about their remuneration policy. ‘We’ve been through an interesting time concerning remuneration,’ as Lord MacLaurin put it to me dryly in March 2002. He didn’t regret anything they’d done for the executives in monetary terms, but he regretted not communicating it in a better way. In particular the impression had arisen, somewhat unfairly but understandably, that the bonus payments of 2000 had been transaction bonuses rather than recognition of a whole series of achievements. They had two uncomfortable AGMs which he chaired, and at the last he promised a review of Vodafone’s remuneration policy, which was quite complex as the company had grown so fast. Penny Hughes was appointed Chairman of RemCo and Ian, Penny and Phil Williams (the group HR director) met with the ten most important shareholders and the NAPF and so on before Christmas 2001. This was a three- or four-day exercise during which they said to them ‘what do you think?’. Then in February/March 2002 they met to brief the major investors on what they’d decided to do. They met the institutions individually and gave them one and a half hours each. They asked the investors to write with their feelings about it before 12 March. The feedback was that this has been the best example of a company discussing remuneration with shareholders, and that it had opened new horizons for communication between the RemCo and investors. This is confirmed by my contact with investors. One of them told me that, although they didn’t really agree with the proposals, at least initially, they were so impressed by the thoroughness and professionalism which the Vodafone delegation displayed, and the way they had answered questions demonstrating that they had thought the issues through, that they felt they had no option but to vote in favour. This also illustrates an important principle of constructive engagement, of which sensible investors are well aware: if the management’s view is reasonable and well thought through, you should back them – you are not there to second-guess the management. Because of the press controversy Vodafone also prepared a briefing pack for each of their major investors listing some of the questions that they thought might be asked about remuneration in the run up to the 2002 AGM, together with their answers. This useful staffwork recognized the fact that investors, especially those within the firms responsible for governance issues, are exceptionally busy at AGM time and welcome professional preparation. Although there have been no further controversies on governance, Lord MacLaurin and Penny Hughes have maintained a round of annual meetings, which although the initial focus is remuneration, gets into wider governance issues. This level of engagement seems to be enjoyed by the major shareholders and

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continues. In addition Lord MacLaurin and Arun Sarin have done a number of dinners with senior people at institutional investors. They obviously have all the normal dialogue between the executive management and analysts and investors around their results. In addition they have occasional specific presentations: for example on 27 September 2004 they had a day for analysts and investors and ‘gave soup to nuts presentations’ bringing in the regional CEOs and the CEOs of major countries like Italy, Germany, Japan. In common with most major companies they also gave a presentation focusing on the effect of converting to IFRS. These presentations are of course also placed on the web. They have a considerable US shareholder base and treat their ADR holders just like full shareholders to the extent allowed by law.

VODAFONE'S APPROACH TO NED APPOINTMENT AND DEVELOPMENT As Vodafone has grown to its present stature of a major global business, it has been possible for them to attract outstanding global business leaders onto their Board. As noted above, they have a Nominations and Governance Committee which has rather more scope than a traditional NomCo. Some relevant aspects of the terms of reference are given below, with the extra scope italicized. ●

To lead the process for appointments to the Board and Board committees and to recommend all new appointments to the Board and Board committees, whether of executive or non-executive directors.

●

To evaluate annually the performance of the Chairman, the chief executive and [all] other members of the Board.

●

To monitor and evaluate the performance and effectiveness of the Board and Board committees and the contribution of each director including, in relation to non-executive directors, whether the non-executive director is spending enough time to fulfil his or her duties to the company. The committee will also seek the views of executive directors on the performance of non-executive directors.

●

To review regularly the structure, size and composition of the Board and Board committees and the balance of skills, knowledge and experience on the Board and Board committees and make recommendations to the Board or, where appropriate, the relevant committee with regard to any adjustments that are deemed necessary.

The CEO, Arun Sarin, is a member of this committee – though naturally he is absent when his own performance is being evaluated. Over the last few years the

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whole process of top-management development and appointment, including that of NEDs, was strongly supported by a group leadership development director, reporting to the group HR director but with a significant ‘dotted line’ to the Chairman. Understandably, Vodafone set their standards very high when looking for NEDs. They will work with a search ﬁrm selected as appropriate for the appointment in hand, and the focus is on global excellence. The people they approach are typically highly selective about the Boards they will join. There is thus a very considerable twoway dialogue in the appointment process. In addition to meeting all the NomCo members, prospective NEDs are encouraged to ask whatever questions they wish and are impressed by the level of openness. Examples include a dinner with all the executive directors before joining, with a frank exchange of views; the opportunity to see the effects on the accounts of changing any assumptions or major accounting decisions; and full access to all the internal strategy presentations. They take the attitude that if you can’t trust the people by the time you are ready to invite them to join your Board then you shouldn’t be considering making the invitation in the first place. This openness naturally continues when people are on the Board. The attitude to NEDs is that ‘You are entitled to go anywhere you want in this company.’ There is no door through which the NEDs cannot go. They are presented with financial information in considerable depth, and encouraged to have mentoring relationships with executives both on and below the Main Board. Although the NEDs other than the Chairman do not generally attend the two-day strategy workshop, they have an opportunity at the preceding Board meeting to help shape the agenda, and they have an extra Board meeting after the workshop, focusing on strategy. In addition each NED is expected to serve on at least one Board committee. This allows them to deepen their knowledge of at least one aspect of the company, and in each committee meeting there is an agenda item for updates and recent developments in the ﬁeld of the committee’s work. In common with most major companies they do one overseas board meeting a year, which allows the NEDs to see the business from a different perspective, and also contributes, as overseas visits generally do, to deeper relationships on the Board. Working in a pretty new industry, which is at the cusp of major social and technological changes and in a company which has a global leadership position, keeps the NEDs engaged and stimulated. In the words of a Vodafone insider, ‘We are always challenging our NEDs with new developments, in markets and technology – it’s an exciting ride.’

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VODAFONE'S APPROACH TO THE POLICEMAN'S LOT As required by SarbOx, the Board of Vodafone has adopted a code of ethics, whose purpose is to: ●

promote honest and ethical conduct, including the ethical handling of actual or apparent conﬂicts of interest;

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promote the full, fair, accurate, timely and understandable disclosure of the company’s financial results in accordance with applicable disclosure standards, including, where appropriate, standards of materiality;

●

promote compliance with applicable governmental laws, rules and regulations;

●

deter wrongdoing; and

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require prompt internal reporting of breaches of, and accountability for adherence to, the code.

The code may be amended only by resolution of the Board. The relevant offices to whom this code applies are somewhat wider than required by SarbOx. Although the Board can grant waivers under SarbOx (which must be disclosed to the SEC), ‘It is not the company’s intention to grant or permit waivers from the requirements of this Code.’ The Audit Committee is responsible for applying the code, and to take any actions it considers appropriate to investigate any breaches reported to it. Any relevant officer who becomes aware of any existing or potential breach of the code is required to notify the group General Counsel and Company Secretary promptly – failure to do so is itself a breach of this code. If a breach has occurred, the Board decides appropriate disciplinary or preventive action. This SarbOx code of ethics is speciﬁcally applicable to the key ﬁnancial ofﬁcers and the CEO. However, Vodafone has also had for some time a published set of business principles which apply to all Vodafone companies in which they have a majority equity interest and to all Vodafone employees. They state publicly that: ‘We understand that we will be judged on whether we live up to our business principles … We will measure, review and report openly on our performance against our business principles.’ These principles cover: 1.

Value creation. They support competition in a market economy, pursued in an ethical way.

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2.

Public policy. They will not make gifts to political parties or intervene in party political matters.74

3.

Communication: openly and transparently with all stakeholders subject to conﬁdentiality.

4.

Customers: providing safe, reliable products and services that represent good value for money.

5.

Employees: basing relationships with and between employees upon respect for individuals and their human rights.

6.

Individual conduct: expecting all their employees to act with honesty, integrity and fairness.

7.

Environment. They are committed to sustainable business practices and environmental protection.

8.

Communities and society: engaging with communities and supporting charities.

9.

Health and safety of customers employees and the communities in which they operate.

10

Business partners and suppliers aiming for mutually beneficial relationships.

Vodafone see their culture of openness as a major factor in ensuring that there is the right balance between constructive contributions and rigour in review. They have long held the view that compliance with good corporate governance was where they wanted to be. This does not mean slavish conformity – they would be happy to ‘explain’ if there were a good business reason for not conforming to a recommendation of the Combined Code.75 Equally, apart from section 404 requiring a much more detailed paper trail, SarbOx didn’t require them to do a tremendous amount – it was mainly a matter of documenting a few things which they already did. The Audit Committee’s terms of reference are highly detailed, and include approval of the appointment or the dismissal of the group audit director (the head of 74

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In full ‘We will voice our opinions on government proposals and other matters that may affect our stakeholders but we will not make gifts or donations to political parties or intervene in party political matters.’ In the past, the widespread US business practice of giving ﬁnancial support to the campaigns of individual politicians could have made this problematic if Verizon Wireless had been a subsidiary of Vodafone, but US campaign ﬁnance law has been tightened up and companies such as Verizon are no longer making contributions, even though loopholes in the US law allow them to do something very similar (‘527 groups’). BP, which has had large wholly owned US operations since the full takeover of Sohio (see Chapter 4), ‘does not make corporate political contributions anywhere in the world’. In common with many major UK companies, some of the original Higgs proposals would have been problematic for them, but they made comments in the review process and most of these were taken.

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internal audit effectively reports to the Chairman of the Audit Committee and not to the CFO) and ‘to hold separate and private discussions, as often as the audit committee deems necessary but on at least two occasions each year, with the external auditors, with the group audit director and with management without the others being present at those discussions’. They have to approve any non-audit services delivered by the auditors and to review and discuss with management and auditors the preliminary results, interim information and annual financial statements before reporting to the Board focusing particularly on such topics as: ●

the quality and acceptability of: –

–

the accounting policies and practices, including without limitation critical accounting policies and practices, all alternative accounting treatments within generally accepted accounting principles for policies and procedures related to material items that have been discussed with management, ramiﬁcations of the use of such alternative treatments and the treatment preferred by the external auditors; and ﬁnancial reporting disclosures and changes thereto, including a review of any material items of correspondence between the company and the external auditors;

●

areas involving significant judgement, estimation or uncertainty, and the provisions in the group’s ﬁnancial results;

●

the extent to which the financial statements are affected by any unusual transactions or any off-balance-sheet arrangements, including any disclosable guarantees, indemnification agreements or interests in unconsolidated special purpose entities, in the year and how they are disclosed.

They are quietly but intensely proud of what has been accomplished at Vodafone, determined that it shall continue to succeed, and that nothing remotely resembling an Enron situation should be able to develop. They have some interesting challenges: for example the Chinese parts of the Vodafone family, in which Vodafone have just a 3.3 per cent stake, had 204 million subscribers as at 31 December 2004 compared to Vodafone’s proportionate group total of 151 million, and we have already discussed the situation in the USA. However, if talent, dedication and a determined attitude of stewardship are the determinants of success, then on present form Vodafone will continue to succeed.

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CHAPTER 7

BGI THE WAGON WHEEL SPINS In 1852 the California Gold Rush was under way. People poured west and those who got lucky would strike it rich. As with the Internet boom about 150 years later, a whole infrastructure developed to serve the prospectors, providing goods and services from the respectable to the debauched. Henry Wells and William Fargo were at the respectable end, and founded Wells, Fargo & Co to offer banking (buying gold, selling paper bank drafts as good as gold) and express (rapid delivery of the gold and anything else valuable). Wells Fargo opened for business in the gold rush port of San Francisco, and soon Wells Fargo’s agents opened offices in the other new cities and mining camps of the West. Just over 150 years earlier, in 1690, two goldsmith/bankers called John Freame and Thomas Gould set up in partnership in London, in Lombard Street. In 1736 John Freame’s son-in-law, a certain James Barclay, became a partner. Until 1826 the only joint stock bank allowed to operate in England was the Bank of England,76 but in 1833 new joint stock banks were allowed to be formed in London. In 1896, the year Tom Lefroy – the prototype Mr D’Arcy – died, 20 private banks formed such a joint stock bank called Barclay & Co. The new bank had 182 branches, mainly in the east and south east of England, and deposits of £26 million – a substantial sum in those days. In 1900 there were around 250 private and joint stock banks in Britain and London was undoubtedly the world’s largest and busiest banking centre. Barclays & Co expanded its branch network rapidly by taking over other banks.77 In 1981, Barclays became the ﬁrst foreign bank to ﬁle with the US SEC and raise longterm capital on the New York market, and in 1986 (the so-called Big Bang in London) Barclays, in common with many of its competitors, bought a respected stockbroker78

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The Country Bankers Act of 1826 permitted the establishment of joint stock banks with more than six partners but not within 65 miles of London. Including Bolithos in Cornwall and the south west in 1905 and United Counties Bank in the Midlands in 1916. In 1918 the company amalgamated with the London, Provincial and South Western Bank and in 1925 the Colonial Bank, the Anglo Egyptian Bank and the National Bank of South Africa merged to form Barclays’ international operations. Before 1986 the London Stock Exchange was the preserve of independent partnerships called stockbrokers (who dealt with companies and investors) and stockjobbers (who actually made markets in shares). De Zoete & Bevan was a stockbroker and Wedd Durlacher Mordaunt (which Barclays also bought) was a stockjobber. They paid £150 m for the two. After substantial investments (and inﬂation) BZW’s equities and advisory business was sold to CSFB in 1997 for £100 m – £50 m less than book.

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called de Zoete & Bevan and went into investment banking as Barclays de Zoete Wedd or BZW. I was able to formulate one of my only slightly tongue-in-cheek laws of acquisition after observing the results of the bank’s collective forays into broking: Never buy a stockbroker (from its partners) – because the core skill of a stockbroker is to know whether a business is over- or undervalued so if they are competent you will have overpaid and if they are incompetent … However in this case there was a valuable unexpected outcome from the débacle. Although the main BZW business had to be ignominiously sold off with substantial write-offs, de Zoete and Bevan had an investment management business which they combined with Barclays Investment Management to make BZW Investment Management and this proved to be a success. They also kept and developed a debt-focused investment bank called Barclays Capital. Both of these proved to be strategic assets of the ﬁrst magnitude – although in both cases they could have been developed without the Big Bang acquisitions.79 Back in California, Wells Fargo, shorn of its famous stagecoach business by the US Government during the First World War, had developed into a major US bank. In 1986 it bought Crocker National Bank (the seventeenth largest bank in the US at the time) from the UK’s Midland Bank80 and in 1988 it acquired Barclays Bank of California with assets of $1.3 bn. So the two banks had experience of doing deals with each other. Wells Fargo had a nice business called Wells Fargo Investment Advisers which had pioneered index funds – introducing the world’s first index fund in 1971.81 The majority of stock-picking investors do not outperform the index, so in theory if you ﬁre all the stock-pickers you can outperform the majority of them at very low cost to your clients by having index tracking funds, and charge lower fees to boot. This was an attractive proposition but to get the greatest value you needed scale. Nikko Securities, the third of the ‘big four’ Japanese securities houses, came in as a JV investor in 1990. However, in 1994 Wells Fargo had a strategic review and decided to become a ‘superregional’ bank rather than compete internationally. They were the first US bank to close their office in London – at which the shares went up appreciably, and as part of their focusing they sold the business in 1995 to Barclays for $440 m. Interestingly the Chairman of Wells Fargo at the time was Paul Hazen who is now on the Board of Vodafone. Wells Fargo Nikkon Investment Advisers was the largest US pension investment manager, with c. $171 billion in assets under management as of 31 March 1995, more than 500 employees around the world, with offices in San Francisco, 79

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Barclays Investment Management ran unit trusts. The slightly moribund investment management division of de Zoete ran 21 local authority pension funds. In the old days this was a highly proﬁtable source of commission income and provided guaranteed placing power for ﬂotations, but under the new rules this was not so simple. Funds under management were about the same for both business, and it was run by Donald Brydon who was from Barclays. An ill-judged acquisition by Midland Bank that went horribly wrong, and became indeed a ‘crock of worms’. There are also claims that Vanguard introduced the world’s ﬁrst index tracker in 1976.

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London, Tokyo and Toronto, and offered more than 190 globally diversified funds. BZW Investment Management had a quantitative group which was the largest quantitative fund manager in Europe, with approximately $32 bn assets under management as at 31 March 1995. So with just over $200 bn under management they had some useful scale. The description of ‘quantitative funds’ indicates that even at that time the business had moved beyond simply index tracking. Tracking ‘the index’ is all very well, but the question arises: which index? Depending on the geographical and risk proﬁles needed, there is a wide choice, and this accounted for some of the proliferation of funds. But the concentration of a lot of bright quantitative investment managers with access to a global infrastructure encouraged the development of quantitative strategies other than straight index-tracking. The business introduced the first quantitative active strategy in 1978. Essentially these strategies use algorithms which base buy/sell decisions on quantitative data, such as stock prices, trading volumes, insider sales and purchases, earnings fundamentals and analyst forecasts. One advantage of such an approach is that, with a suitable database, the algorithms can be tried out against historical data to see how a particular strategy would have performed. Clearly there are limitations to such an approach: some correlations will be coincidental and if you search a big enough database you have an excellent chance of finding pure coincidences which have only a one-in-a-million chance of happening by accident82 but equally it is entirely conceivable that there will be some such strategies that will give risk-adjusted out-performance, at least until there are enough funds following analogous strategies to drive down the returns. In addition there may be clients whose required risk proﬁles can be matched by speciﬁc quantitative strategies.

BGI’S APPROACH TO SHAREHOLDER/NED CONTACT It would be tempting, as a purely quantitative manager, for BGI to avoid governance issues altogether. Until decent quantitative measures of governance quality are developed, it is, by deﬁnition, impossible for these issues to be covered in their active quantitative strategies, and index tracking funds have to hold a stock regardless of the management quality. However, BGI do not take this attitude. This is partly because in the US there is established law that the rights of ownership are an essential asset and fund managers who neglect to wield these can be held to be negligent. There is also a recognition that there is a moral responsibility for one of the world’s largest investors to take ownership seriously. If a cynic were to say that they could save money by leaving such issues to others, an enlightened economist would point out that scandals which dent public conﬁdence in stock markets are bad for BGI’s business, and that at 82

In a database of 10 000 entirely random data series you’d expect about 100 pairs which correlated to that extent.

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least some trustees do give some weight to effective engagement in governance issues when considering where to award mandates. BGI beneﬁts from having an owner which is well capitalized and respected and not particularly controversial. Although the elevation of their CEO to Chairman just before the Higgs-enhanced Combined Code came into force raised some press comment, there was a clear explanation which, even had the Combined Code been in force, would surely have been accepted. Remuneration issues haven’t been too controversial – dampened down by the fact that, until Bob Diamond was elevated in June 2005, no one from Barclays Capital is was subject to the onerous disclosure requirements of Main Board directors. This is of course entirely reasonable – it is only when directors set their own remuneration that there is a potential conflict of interest between the directors and the shareholders. If a director decides to pay an employee several £m more than he or she receives, it is likely that this will be done after careful reflection and for good business reasons. One of BGI’s most senior directors – Lindsay Tomlinson (formerly CEO, Europe and now Vice-Chairman) – spends a significant part of his time on industry issues and served as Chairman of the Investment Management Association during the critical time of the development and initial implementation of the Higgs Review and the Combined Code, and also serves on the takeover panel.

BGI’S APPROACH TO NED APPOINTMENT AND DEVELOPMENT BGI has participated actively in Sciteb’s work on developing NEDs through masterclasses and the NEDX process, and also in the investor/Chairman dinners. They are actively looking for quantiﬁable correlations between metrics of good governance and share price performance for their quantitative programmes – a major handicap being the lack of meaningful measures of governance quality since things like ‘number of independent directors’ are not useful proxies. I have wondered out loud to them whether looking at votes cast against director re-appointment could be meaningful, and it will be interesting to see how this type of research develops.

BGI’S APPROACH TO THE POLICEMAN’S LOT Because they cover so many stocks BGI don’t like to take a lead on a controversial issue – preferring to coordinate behind the scenes along the very efficient network that exists between heads of governance/engagement in the major UK investors. They are heavy subscribers to collaborative services like the ABI and RREV (the joint venture between the National Association of Pension Funds and Institutional Shareholder

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Services). If they decide to vote against the management of a UK company on an issue, they do not slavishly follow voting guidelines but have a defined process whereby either the Vice-Chairman or one of his senior colleagues on their shareholder engagement committee has to sign off on it. They recognize the essential role that NEDs play in creating and maintaining a culture of high standards on Boards. Indeed the more they see of the workload of an NED, the more respect they have for the role and the people who do it – at remunerations per diem which, as they well realize, are very much lower than people of comparable calibre would receive in the investment management industry. BGI had a particularly sharp experience of constructive engagements when their then CEO, Pattie Dunn,83 became embroiled in one of the most bitterly fought proxy battles of recent times, the HP/Compaq merger. BGI very properly outsourced the actual voting on that issue to Institutional Shareholder Services, but Ms Dunn cosigned the letter in February 2002 urging the proxy-holders to vote Yes which pointed out prominently that she, as CEO of BGI, ‘oversees the management of $800 billion worth of investor assets’ and confidently stated that, ‘By 2003, we expect the profit margin of our enterprise business to reach 9 per cent … our services business … 14 per cent … the PC business … +3 per cent.’84 Ms Dunne stepped down as CEO for health reasons in September 2002, remaining with BGI as a Vice-Chairman, and it seems unlikely that a subsequent CEO would wish to be embroiled in a similar way. Her role was split into two co-CEOs, Blake Grossman and Andrew Skirton, both reporting to the Chairman, Bob Diamond, who is also CEO of Barclays Capital. After I had written these words there was a rather sensational development on the HP saga: the Board fired the CEO Carly Fiorina and decided to split the roles of Chairman and CEO, installing Pattie Dunn as Chairman. ‘[Ms Fiorina] executed the merger [with Compaq] in superior fashion,’ she said. ‘But looking forward, the job is very related to hands-on execution and we thought a new set of capabilities were required.’ Since Ms Fiorina was criticized for being aloof and rather above her staff, the words ‘in a superior fashion’ seem particularly well chosen. Ms Fiorina left with a payout worth approximately $21 m85 – the value placed on Ms Fiorina’s leadership by investors was indicated by the fact that HP’s market value increased by just over $4 bn on the day of her departure (so arguably showing a 50-fold RoI!). Interestingly the FT also reported Brian Sullivan, chief executive of Christian & Timbers, the executive search firm that placed Ms Fiorina, cautioning that the Board 83

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Who had started at Wells Fargo Investment Advisers as a temporary secretary in 1976 and joined permanently in 1978 having graduated from Berkeley. She played a major role in building up the business, being appointed Co-Chairman of BGI in 1997 and Chairman in 1998. In fact they achieved 1%, 11%, and 0.1% in 2003, and 1.1%, 0.9% and 9.2% in 2004. In addition to stock options which were estimated as being worth approximately $23 m.

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risked alienating candidates. ‘The message is, “come and implement”. CEOs don’t want to hear that. They want to work with a Board to develop strategy and then implement that strategy,’ he said. This comment is rather eloquent about search ﬁrms, and CEOs! According to Fortune the HP Board had a three-day planning meeting in January 2005 and Ms Dunne, acting like a SID (or lead director as the role is called in the US)86 worked with other directors to draw up the agenda, and then she met Ms Fiorina (who was of course Chairman and CEO) with two other NEDs and read it through with her. However, during that session there were disagreements about some key management issues87 and following leaks to the press a second Board meeting was held at which the management issues were still not agreed between the Board and the CEO, so the Board went into ‘executive session’ (that is, session without the CEO) and after three hours Ms Dunne and another director asked Ms Fiorina for her resignation, which was tendered. By September 2004 their funds under management had grown to $1200 bn, a sixfold increase in a decade. Of this 70 per cent was index tracking, 10 per cent was cash and 20 per cent was in various forms of active strategies. In 2004 they were the second largest institutional fund manager in the world88 notwithstanding their determination not to chase ‘growth in funds under management’ for its own sake – like any wellmanaged bank they are conscious of profitability and return on investment. How, then, does BGI address the three pivotal issues we have identiﬁed?

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By 2004 53 per cent of S&P 500 companies had appointed a lead or presiding director, up from 26 per cent in 2003. Some directors wanted HP’s chief strategy and technology ofﬁcer to take charge of the ‘enterprise’ side of the business. Fiorina was reportedly opposed, ﬁrst because he had never run a business and secondly because it was her prerogative as CEO to make executive appointments: in which she was undoubtedly correct in normal circumstances. According to Pensions & Investments (May 2005) the number one was State Street at $1.4 m.

CHAPTER 8

Fidelity CUSTOMER SERVICE AND INNOVATION In 1841, Charles Fox Hovey and his two partners set up as importers and wholesale dealers in dry goods in Boston. By 1848 they had diversiﬁed into retail. C.F. Hovey and Company became an innovator in department store merchandizing: plainly marked goods with a one-price system, the adoption of early closing hours, profit-sharing for employees and a credit system utilizing monthly bills were some of the practices they pioneered. In addition to the store in Boston, the company maintained ofﬁces in New York and Paris, and were sufficiently trusted internationally by 1854 for a certain Leopold Schwabe to grant them a power of attorney from Liverpool, sealed by the recently appointed US Consul, a certain Nathaniel Hawthorne. Samuel Johnson, hired in 1846, became a partner in 1851 and remained with Hovey’s until he died 1899, one year after his son, Edward C. Johnson, presented him with a grandson, Edward C. Johnson Jr. This Mr Johnson did not join the store, but the themes of choosing stock carefully, innovative service to the public, international operations and trustworthiness were to re-emerge in another way. He was, fortunately, just too young to serve in the First World War, and qualiﬁed as a lawyer after studying at Harvard. He was also somewhat too old to serve in the Second World War. But as a lawyer he was responsible for investing funds on his own behalf and for family members and clients. In 1943 he became President and director of an ailing mutual fund business called The Fidelity Fund which had been established in 1930, both to indulge his passion for investing and to provide consolidated investment management for some of the funds for which he was responsible. He sacked the professional managers and did it himself. The results were pretty spectacular! In 1946 he founded Fidelity Management and Research Co (FMR) as a corporation to act as investment adviser to The Fidelity Funds. Assets under management were $13 m. At the outset, the firm differed from many competitors in that Mr Johnson didn’t manage the fund by committee. He read the works of sociologist Eric Hoffer, who believed that granting autonomy to individuals could unleash creative energy. ‘When we are in competition with ourselves, and match our todays against our yesterdays, we derive encouragement from past misfortunes,’ Hoffer wrote. In 1947 Mr Johnson founded the Fidelity Puritan Fund – the ﬁrst income-oriented mutual fund to invest largely in a portfolio of common stocks. He hired a brilliant analyst called Jerry Tsai and it looked for a time as though Tsai would be his successor:

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Tsai ran the Fidelity Capital Fund in a highly ﬂamboyant and successful style, and was very much in the media spotlight. But Mr Johnson’s son, Edward C. Johnson III (Ned) joined as a research analyst in 1957, took over the management of the Fidelity Trend Fund in 1960 and in 1963 the Fidelity International Fund was launched, also under Ned’s management (later renamed the Magellan Fund).89 Ned Johnson was quiet and disliked the limelight, but his fund generally outperformed the Capital Fund. In 1965 Tsai (who owned 20 per cent of FMR) confronted Mr Johnson (who owned 40 per cent) with the succession issue, and when it was made clear that Ned was the preferred successor, Tsai sold his stock back to the company90 and left. By 1966 AUM had reached $2.7 bn a CAGR of 30 per cent pa. Fidelity was not, even then, a one- or two-man show. Even by 1969, reputable authors91 could say that Fidelity attracted and developed ‘legendary masters’ and that ‘Old Fidelians speak of it with … lavish nostalgia’. In 1969 Fidelity International was founded in Bermuda to manage funds available exclusively to non-US investors, and the FMR Service Company was created to bring shareholder recordkeeping in-house.92 In 1972 FMR Corp was formed as a holding company and Ned Johnson was named President: by that stage there was $3 bn under management – the late 1960s and early 1970s were a turbulent period for stocks and conﬁdence in the market was somewhat dented.93 By 1976 AUM were $3.5 bn. In 1977 Ned Johnson became Chairman and CEO, and Peter Lynch became portfolio manager of the Magellan Fund. When Mr Lynch retired in 1990 the Magellan Fund had $13 bn in AUM. In 1979 Fidelity Investments Institutional Services formed to sell products and services to ﬁnancial intermediaries. Ned Johnson was, and is, fascinated by technology as well as investment, and this gave, and gives, Fidelity a surprisingly different proﬁle of interests from the traditional fund manager. A proﬁle in 199294 said that ‘his idea of fun is to spend days immersing himself in a new computer system’ and claimed that it is ‘thanks largely to Fidelity’s marketing and service innovations’, many of which were promptly copied by other players, that mutual funds expanded to a $1 trillion industry from 1980 to 1990. Many impressive technology firsts are chronicled on the Fidelity website – which was, naturally, the first of any mutual fund company, launched in February 1995. As 89 90

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Ned Johnson ran it until the end of 1971, beating the S&P 500 by an annual average of 22.7 per cent during that time. At book value – $2.2 m or 1.3 times earnings in accordance (presumably) with the terms under which he held it. He subsequently set up another fund, courting celebrity status, and eventually built up Travellers which became a key element in Citigroup. Kaplan and West – The Money Managers (New York 1969) – excerpted in Ellis and Vertin (2001). It became Fidelity Service Co in 1980. This was after the Dow Jones Industrial Average had fallen from 976 at the beginning of 1965 to 774 by the end of September, denting conﬁdence in the stockmarket. By 1969 it had recovered to 979 but it fell back to 688 in 1970, and by mid-1972 was around the 950 mark. By Dan Rattenberg in Town & Country (April, 1992) – excerpted in Ellis and Vertin 2001.

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another example, in 1993 Fidelity backed COLT Telecom, a specialist telecoms provider in London, which is now a UK listed company of which they own over 50 per cent. In addition to COLT, Fidelity has investments in a range of telecommunications companies, a venture capital arm that specializes in go-to-market capital for technology-based business which was an early investor in such companies as MCI and NexTel, and a very strong systems business. Fidelity’s CIO was named in the top 20 on the Networking Power List 2004, a fact trumpeted by Fidelity Ventures. It is also an interesting comment on the Fidelity style that they focused one of the vice-chairmen, Jim Curvey, exclusively on looking after their telecoms stakes in 2001. ‘We have been developing and investing in telecommunications companies for many years, and today we have substantial interests in firms serving Europe, Latin America and Japan,’ said Ned Johnson. ‘Realizing this industry is currently out of favor, we want to take advantage of Jim’s personal expertise and Fidelity’s experience in the telecommunications ﬁeld to position our companies to excel when the cycle turns. We believe this is a great business opportunity.’ It is difficult to imagine any other fund manager saying or doing that.95 Equally remarkable: in 2002 Fidelity and IBM signed an outsourcing agreement which resulted in the transfer of 300 staff from IBM to Fidelity Employer Services Company (FESCo), which provides retirement, beneﬁt and human resources outsourcing, workforce effectiveness, payroll solutions and stock plan services. Curiously Fidelity are not currently the largest investment management ﬁrm based in Boston by assets – that title is held by State Street which traces its origins to 1792, was custodian of the first mutual fund in 1924, and has grown an enormous custody business and a substantial investment management business, with AUM in excess of $1400 bn. However, their index funds approach is at the other end of the spectrum from the research-based stock-picking that has served Fidelity so well. Fidelity is in the process of transition to the next generation. Abigail Johnson, Ned’s daughter, was made President and the largest shareholder of FMR in May 2001 and in May 2005 she switched to run FESCo which by then had over 10 000 employees and represented 43 per cent of Fidelity’s AUM. But the family consistently regard their ownership as stewardship rather than an opportunity for ostentatious display.

FIDELITY'S APPROACH TO SHAREHOLDER/NED CONTACT Fidelity believes in detailed in-house research and also in empowering the individual fund managers. Although a consensus may develop about a particular company, a 95

A comparable illustration of a very speciﬁc corporate culture would be Capital’s decision to turn down the offer of having their name emblazoned on a building in LA of which they had become the major tenant (Ellis, 2004).

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large Fidelity stake in a business will be the result of many different fund managers’ buying decisions. As noted above, Fidelity International is a separate company from the US operations of Fidelity, and it is of Fidelity International (FIL) that we now speak. In 2002 they hired Trelawny Williams from M&G (part of Prudential plc) to lead their governance and engagement work, as director of corporate finance. This is a slightly confusing title initially – his role is not to initiate corporate transactions, but to be a focal point for engagement and consultation. Initially much of the thinking was around the need for a point of contact so that companies could sound out major investors in conﬁdence about proposed transactions without making the investor as a whole an insider. Nevertheless, as shareholder engagement has developed Trelawny has been a key player. Since his recruitment Fidelity has published a set of Principles of Ownership, brought a four-man proxy voting team into its London headquarters near St Paul’s to be closer to the investment team, introduced a new internal structure for engagement with companies and started quarterly reports to institutional clients on its voting and intervention. Fidelity begin their Principles of Ownership with a focus on stewardship. They make it clear that: As a general policy we are supportive of the management of the companies in which we invest but … On occasion our views will differ from those of management and where this is accompanied by a failure to achieve our reasonable expectations we will consider promoting change. Our speciﬁc response will be determined on a case by case basis and we will weigh up the relative merit of intervention or a sale of the shares. Typically we will choose to intervene to promote change when the expected benefits of intervention (through increased returns to our investors) outweigh the anticipated cost. This raises some interesting questions. The first question is: benefits and costs to whom? The costs of intervention fall on the fund manager while the benefits, if successful, accrue to the shareholders as a whole. One of the reasons that Hermes is able to devote so much money to active intervention is that it is owned by the BT pension fund which it manages and which accounts for most of Hermes’s AUM: thus the bulk of any benefits from a Hermes intervention go to Hermes’s owners. But a typical fund manager is remunerated on the basis of a relatively small percentage of their AUM, and even with an incentive clause for out-performance, it is unlikely that more than 5–10 per cent of the value of an intervention to the funds would accrue directly to the manager. So it is easy to envisage a situation where an intervention might benefit the investors whose funds Fidelity manages, but not benefit Fidelity. The answer to that, of course, is that investors who

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entrust Fidelity with their money understand that they will be asked to bear Fidelity’s costs over the medium term, with a reasonable profit, and if Fidelity’s actions have generated superior returns then they will be happy to bear the costs. But it does depend on being able to take a medium- to long-term view, which is easier in a large, privately owned ﬁrm like Fidelity than a smaller ﬁrm under the pressure of quarterly reporting. The second issue concerns situations whereby it may be in the interests of the shareholders as a whole. With the notable exception of COLT, Fidelity typically has a stake of 2–8 per cent in a business. Suppose the expected benefits of intervention are ten times the anticipated costs? The benefits of intervention may outweigh the costs for the shareholders as a whole, but will not, in a narrow sense, be in the interests of any particular shareholder. Again, there is a medium-term amelioration of this problem: an investor that leads a successful intervention will generally ﬁnd that other companies, in similar situations, are more likely to come quietly, so some of the intervention costs can be amortized over future situations. Again, these are judgements which are probably easier to make in a large, privately owned firm like Fidelity (or Capital) than in a publicly quoted company. And if you are a major shareholder, the costs of non-intervention can be considerable. Selling the shares of a company where you believe that the strategy or governance (or both) are poor – the so-called Wall Street Walk – may be simple if you are a small shareholder, but if you have 2–8 per cent of the company, simply putting the stock on the market can depress the price significantly. So when a company embarks on an ill-conceived strategy, which depresses the share price, and then suggests that if major shareholders don’t like it, they should sell their shares, they are effectively saying to these investors: ‘You’ve lost money because of our poor strategy, now we want you to lose more money by dumping your stock.’ Understandably, active and constructive engagement to change the strategy, governance or management (or all three) may be a more attractive option. Fidelity go on to say, in their Principles: Where there is disagreement we will initially promote our views through discussions with the company’s advisors and/or independent directors although we may also speak to other shareholders and third parties. Wherever possible we seek to achieve our objectives in a consensual and conﬁdential manner but in extremis we will consider requisitioning an extraordinary general meeting to enable shareholders as a whole to vote on matters in dispute. The cause celèbre in this respect has of course been the ITV chairmanship issue, to which I have alluded earlier. However, Fidelity have repeatedly made it clear, both in

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private conversations and in publications,96 that it was not their intention or doing that this saga should have come to the media. In addition to the over 2500 routine meetings their analysts and investors typically have with companies in a year, they have about 120 which are of a corporate governance nature: normally meetings with the Chairman, NEDs or advisers, and there are about 50 cases a year where they intervene and act as some sort of catalyst for change. They point out in their Principles that: FIL is able to accept price sensitive information through its corporate ﬁnance group. The corporate ﬁnance group operates separately from the dealing and fund management activities and is able to discuss proposals with companies without compromising the fund managers’ ability to deal. This facilitates a full and open dialogue with the companies in which we are invested and we encourage companies to consult with us at an early stage when they are contemplating major strategic or corporate initiatives. The corporate finance group also provides a focus for intervention if that is deemed necessary. Although the media at the time of the ITV saga focused on Anthony Bolton, the legendary fund manager who runs their special situations fund, and who indeed had major concerns about the chairmanship, he was typically accompanied in meeting the NEDs of the two companies by Trelawny Williams and by Simon Fraser (the CIO) and in one such meeting he actually said nothing. One imagines that the NEDs drew their own conclusions from the fact that three such senior people from such a major firm turned up to the meetings. But it should be re-emphasized that, in common with the other major fund managers, behind-the-scenes intervention is very much more their style. Reflecting on the ITV experience has made them wonder whether there was a possible miscommunication due to a mismatch of styles. CEOs, especially ones who have built up their businesses, can be very blunt and direct. Fund managers, especially in firms like Fidelity, tend to be more softly spoken. A fund manager might say ‘we’re really not very happy about X’ and a CEO might say ‘there is absolutely no way we’d ever agree to X’ and both might mean much the same. It is characteristic of Fidelity that, despite having been clearly in the right on this matter (as the present top management of ITV would be the first to admit) and being backed by all the major investors, they are still reflective and wonder how they could have handled it better. Simon Fraser says: 96

I am using Davis (2004) as a source for much of the detail since it is in the public domain with Fidelity’s support. It is certainly coherent with my understanding from our conﬁdential discussions. Quotes from my discussion with Simon Fraser are used with his permission.

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Anthony Bolton is quite a difficult person to know what he is really thinking – that’s one of the reasons why he is so successful. … However it can mean that sometimes, when we think we have explained something, it is not clear that the company has really understood it. We think this could have been a problem on the ITV case – though we really don’t think we were being unclear. This could be exacerbated by the fact that the people from the company may have many shareholder meetings in a day, where the messages may be slightly different at each. However I think it is more likely to be the classic problem of telling the chairman bad news. I have no idea whether this happened in the ITV case, but one can imagine a dialogue like this: Adviser: Chairman:

Adviser: Chairman: Adviser: Chairman:

‘The investors really not very happy about this, Chairman’ ‘What!? Outrageous! Typical box-ticking [etc … etc …] Well did they say that they’d definitely oppose it in all circumstances?’ ‘Well not exactly, Chairman, but …’ ‘So it’s possible that they could be won round?’ ‘Well it is possible, Chairman, but …’ ‘Never mind the buts – I didn’t get to where I am today by … [etc … etc …]. I’m sure I can count on your loyalty in this?! Or if you don’t think you can achieve this, maybe I should get some other assistance – there are plenty of people who …’

It’s one of the really important systemic problems in all companies to make sure that, when necessary, the Chairman, the Board and the NEDs can hear bad news. The professionalism and integrity of advisers and all those involved in dialogue with investors is of great importance here.

FIDELITY'S APPROACH TO DIRECTOR DEVELOPMENT Fidelity engages in depth with the companies in which they invest. The meetings with the CEOs, CFOs and other directors with whom they meet are two-way learning experiences and, since most CEOs and CFOs serve as NEDs at some point in their careers, this is in itself a development process. They have also participated most valuably in initiatives to develop NEDs such as the NEDX masterclasses and in initiatives to improve dialogue and understanding between investors and chairmen such as the investor/Chairman dinners. They are very supportive of keeping the NEDs informed of investor reaction, and have asked that synopses of meetings with investors should be sent to the whole Board

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including the NEDs. They welcome the occasional attendance of NEDs as observers in routine investor meetings – which was one of the nicer ideas that came out in our initial research to help keep NEDs informed without adding appreciably to the costs or effort for investors or companies, bringing an NED along for the ride. In the normal course of events they don’t really like to have one-to-one meetings with the NEDs, since it risks prejudicing the clarity of the relationships and accountability. But as Simon Fraser points out, ‘there is no downside in getting to know them – and should there ever be a problem it can be helpful’. Anthony Bolton has publicly expressed concern that there is a shortage of suitably qualiﬁed NEDs97 and although in his own 53-page essay on his investment approach98 he doesn’t explicitly refer to the NEDs or Board quality as opposed to management quality, he does remark that insider buys are a valuable conﬁrming or non-conﬁrming tool, and that some directors have better records than others which suggests that a well-regarded and shrewd NED ‘putting their money where their name is’ has some value. Simon Fraser is clear, both from his point of view and that of his colleagues, that ‘it deﬁnitely does help if people of stature and integrity are on the Board.’

FIDELITY'S APPROACH TO THE POLICEMAN'S LOT At Fidelity we believe we have a duty to satisfy ourselves that the companies we invest in are managed legally and responsibly. This responsibility is part of share-ownership and is a key element of our commitment always to act in the best interests of our clients.99 Fidelity believes that, in most cases, investors and directors have essentially the same ends. ‘We really do believe that the interests of investors, NEDs and management should all be aligned,’ says Simon Fraser. Everyone does want the company to succeed. The media view is distorted to make it seem that there is a conﬂict – but at least nine times out of ten it works very well. It’s only a problem when there is an accident or a serious mistake, or when people’s egos get in the way of working appropriately. The last thing we want to do is manage the companies, so the first port of call is always the Chairman – and if we had a problem with the Chairman we’d go to the SID. We will say, for example, ‘We don’t think 97 98 99

Interview in July 2004 with Real IR, quoted in Davis 2004. Chapter 2 of Davis 2004. Preamble to their corporate governance section http://www.ﬁdelity.co.uk/adviser/aboutus/ corporategovernance/index.html

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that an appropriate governance structure is in place’ but we won’t try to dictate what that governance structure should be. Similarly, we are prepared to say ‘We don’t think X ought to be Chairman’ but then it is up to the company to ﬁnd an appropriate alternative – we don’t want to be telling the company who the Chairman should be. Simon agrees that the level of engagement between investors and NEDs should be low (although constructive when it happens) almost all of the time. It is only when there are problems that the level of engagement needs to be increased. Especially in a special situations fund, which is FIL’s largest and most visible fund – though only a smallish proportion of their total AUM – there is the potential to make significant returns by investing in companies where the management is disliked, either because the market fails to appreciate the underlying strength of the business or because a change of management could make the company a lot more valuable.100 However, to quote Anthony Bolton: I used to think the dynamics of a strong-looking business would make up even for ‘dodgy’ management … [however] managements that are either unethical or that sail close to the wind are now complete no-go areas for me. What I’ve learned is that, even with corporate governance checks and outside accountants, there are too many ways that senior people can pull the wool over an investor’s eyes. Several years ago an Italian contact told me not to touch Parmalat for that reason. It turned out to be an excellent piece of advice. Thus, in common with other large and responsible investors, Fidelity is very aware of the need for INEDs to combine being a constructive member of the board with steps to ensure the integrity of the business. Bolton quotes Warren Buffett, ‘the CEO who misleads others in public may eventually mislead himself in private’. A very similar sentiment, ‘No man, for any considerable period, can wear one face to himself and another to the multitude, without finally getting bewildered as to which may be true’101 was expressed in 1850 by the US Consul who sealed Leopold Schwabe’s power of attorney, Nathaniel Hawthorne.

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Fidelity was a top ten institutional shareholder in HP (1.8 per cent) – as was Capital (4.6 per cent) and BGI (4.2 per cent) (as at 16 Februbary 2005). Capital had 5.2 per cent as at 31 December 2004 so they may have sold down a bit prior to Carly Fiorina’s departure. Hawthorne, 1850 The Scarlet Letter – Chapter 20 referring to a clergyman who is contemplating absconding after a major public sermon.

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CHAPTER 9

UBS Global Asset Management FROM ZURICH AND BASEL TO GLOBAL In 1854, just four years after the creation of the Swiss franc102 a consortium of six private banking houses in Basel formed a Bankverein which acted as an underwriting syndicate for these banks. By 1896, the year that Barclays Bank was formed, it became the Swiss Bankverein or Swiss Bank Corporation (or SBC) after a series of mergers and takeovers. Two years later a London ofﬁce opened. In 1912 two Swiss banks which had been founded in the latter part of the nineteenth century, merged to form Union de Banques Suisses or Union Bank of Switzerland103 which was under half the size of SBC. By the end of 1918 SBC’s total assets exceeded CHF1 bn and Union Bank’s exceed CHF300 m. Both banks grew through the 1920s and then shrank in the 1930s as a result of the great depression. In 1938 Union Bank established the management company for the bank’s investment trusts (mutual funds), and the America-Canada Trust Fund, the first of its kind in Switzerland. In 1939 SBC opened an agency in New York, and in 1940 Union Bank set up the Union American Corporation (UACo) in New York for custodian purposes. Both banks had been steadily growing by acquisition throughout the century, and in 1945 they each rescued a major Swiss bank which had become illiquid by the end of the Second World War. By this time SBC’s total assets were CHF1.8 bn and Union Bank’s exceeded CHF1 bn. Expansion continued in the succeeding years with a succession of international offices and Swiss acquisitions. In 1962 Union Bank became the largest bank in Switzerland with assets of CHF6.96 bn: SBC and Credit Suisse were second and third with CHF6.9 bn and CHF6.8 bn respectively: by 1965 SBC was ahead – by 1968 Union Bank was back in the lead with CHF18.5 bn to SBC’s CHF16.9 bn. In 1970 UBS established the American UBS Corporation. Organic growth, acquisitions, and greater internationalization continued with both banks in the next decades. Of the many deals, the ones that are most relevant to us are that Union Bank acquired:

102 103

Until 1850 there were over 800 different coins circulating in Switzerland – all legal tender. To avoid confusion we refer to Union Bank rather than UBS until 1998. SBC and Union Bank had slightly different English names until 1917 and 1921 respectively.

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Phillips and Drew, a London stockbroker with a significant investment management business.104 Union Bank also set up UBS Asset Management (UK) Ltd in London;

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Chase Investors, New York, renamed as UBS Asset Management (New York) Inc. and that SBC acquired. – Brinson Partners Inc. of Chicago, an institutional asset management ﬁrm founded in 1980. This continued to be run by its founder Gary Brinson who had a very particular methodology for value investing and asset allocation; but attempts at integrating the Swiss and US asset management businesses faltered.

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SG Warburg plc, a leading European investment bank which had been founded in 1934 by Siegmund Warburg.105 Sir David Scholey (see Chapter 6) had become Chairman after Warburg’s death, and had with some regret concluded that his firm could only continue to compete with the major US investment banks as part of a big global bank.

Marcel Ospel was made CEO of SBC Warburg. He had begun his career at SBC, and after a stint at Merrill Lynch from 1984 to 1987 returned as head of securities trading and sales and had joined the executive board of SBC in 1990. In 1996 he became President and CEO of SBC, and Union Bank had a similar change, making Mathis Cabiallavetta President and CEO. For both banks 1996 was a somewhat traumatic year, they both made heavy provisions against bad loans and thus reported losses for the ﬁrst time in the century. In 1997 SBC acquired Dillon Read, a midsize US investment bank which traced its origins back to 1832106 but this deal was dwarfed by the stunning announcement of a merger between SBC and Union Bank in December, ending a century of rivalry and creating one of the largest banks in Europe and the world’s largest private banking and asset management institution. The merged company, called UBS AG, had CHF1320 bn of client funds under management and total assets of over CHF1000 bn. 104 105

106

They took 29.9 per cent in 1984 and 100 per cent in 1986. Not to be outdone, SBC acquired a broker called Savory Millin. Acquired in 1995. When it was founded it was called the New Trading Company and only became SG Warburg & Co in 1946. It became one of London’s premier investment banks and also had an afﬁliate called Mercury Asset Management which became one of the UK’s leading institutional investors. Mercury Asset Management was not bought by SBC and eventually sold out to Merill Lynch. Carpenter & Vermilye, which became Vermilye & Co in 1862. In 1886 William Reed became a partner and in 1906 it became William A. Reed & Co. Clarence Dillon succeeded Reed as President in 1916, renamed the ﬁrm Dillon Reed in 1921 and made it one of the three top brokers of the Roaring 20s. However, the ﬁrm gradually declined, was acquired by Travellers Corporation (which was then run by Jerry Tsai, the ex-Fidelity number two) and by the 1990s it had become a large-ish boutique, part owned by Barings and by its partners. SBC bought it for $600 m in May 1997 – thus violating the Law of (Non-)Acquisition on page 100 – and merged it with SG Warburg which became SBC Warburg Dillon Reed.

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In June 1998 the new UBS came into being. Mathis Cabiallavetta was Chairman and Marcel Ospel was CEO, and there were four divisions: private and corporate clients; asset management; private banking; investment banking; and private equity. But in October that year Cabiallavetta resigned after heavy losses, including a $690 m exposure to a hedge fund exquisitely misnamed Long-Term Capital Management (LTCM)107 and Alex Krauer, a Vice-Chairman of UBS who was Chairman of Novartis, took the chair. Far worse than its ﬁnancial impact, the LTCM episode dealt a crushing blow to the ﬂedgeling ﬁrm’s image and conﬁdence. An air of pessimism pervaded most divisions, leading to significant employee disaffection and client losses.108 In 1999 UBS acquired Global Asset Management (GAM) for its private banking division. This was founded in 1983 to give private clients access to great investment talent and was mainly a hedge fund manager and fund-of-funds provider, domiciled in Bermuda with branches in major world financial centres and with assets under management of $13.9 bn – although it did also provide equity and bond funds. However, during 1999 it became increasingly clear that there was a fundamental problem with the asset management division of UBS. This was still called UBS Brinson but had a number of independent ﬁefdoms: the Phillips and Drew business in the UK was run pretty well independently. Gary Brinson was Chairman of the business but in late 1998 Peter Wufﬂi, a former McKinsey partner who had joined SBC as CFO in 1994 and became CFO of UBS, was appointed CEO of UBS asset management. In mid-1999 he was made Chairman and CEO with Gary Brinson continuing as CIO. At that time it was possible for the Chairman and the CEO of UBS to write: While investment performance within the UBS Brinson area remains generally good, US equity portfolios and certain balanced portfolios have under-performed relevant benchmarks on a short-term basis.

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This fund, run by John Merriweather, took enormous punts on ﬁnancial markets based on ﬁnancial theory and trading cunning. Merriweather had been head of ﬁxed income trading at Salomon Brothers but was forced to leave in the wake of a scandal (see Lewis 1989 for a sense of the atmosphere there). However, LTCM had two Nobel Laureates (Merton and Scholes) on the payroll and a lot of ‘smart’ traders. Their customers and investors were a Who’s Who of the global ﬁnancial establishment: even the Bank of Italy had some $100 m invested, reportedly not realizing that LTCM was a hedge fund, and many individuals in Wall Street had a stake. But UBS’s exposure was greater than anyone. When things went wrong LTCM was found to have balance sheet assets of $125 bn on a capital base of $4 bn, which had then been leveraged up with derivatives trades to a notional value of c. $1000 bn. The US Federal Reserve decided that LTCM was too big to fail and organized a $4 bn rescue, in which the LTCM partners were given a $400 m stake (an offer from Warren Buffett to buy the book for $250 m was refused!). Eventually the LTCM positions were unwound and the investors in the rescue got their money back. There were accusations of ‘crony capitalism’ as Wall Street ﬁrms undertook to bail out, with shareholders’ money, a ﬁrm in which their ofﬁcers had invested, or were thought to have invested, part of their personal wealth. The COO, the chief risk ofﬁcer, and the head of ﬁxed income at UBS were also dismissed. These two sentences are from the searingly honest UBS publication The Making of UBS.

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However, by the end of 1999 profits had declined from CHF448 m to CHF333 m partly due to a decline in institutional assets under management ‘as gains from performance and currency were offset by client attrition and performance issues in certain mandate types’. Indeed Phillips & Drew had suffered net client withdrawals of $12 bn and Brinson’s US ﬂagship equity fund for institutional investors had declined 3.8 per cent. This was partly due to the value investing style being unfashionable at the time – a fact which contributed to underperformance during the TMT boom but avoided losses during the crash. But there were two other problems. According to UBS sources, the execution of their strategy was poor, and the risk proﬁles were poorly differentiated: a mutual fund would get the same risk proﬁle as an institutional client. A reduction in proﬁtability is never pleasant but the real problem was that the poor performance of the asset management division had serious repercussions for the highly proﬁtable private banking part of UBS: people who use private banking do not want their investments to underperform. Gary Brinson retired in 2000 and the process of integrating the asset management division effectively began. The collapse of TMT stocks helped validate value investing styles and Phillips & Drew was the topperforming pension fund manager in Britain in 2000. Meanwhile in July 2000 UBS agreed to merge with Paine Webber, a US broker dating from the 1880s which had $452 billion in assets and 8500 brokers, thus enhancing UBS’s US distribution network and adding some top-ranked research analysts to help boost its US stock underwriting business, without much overlap in investment banking.109 It was announced that Marcel Ospel would become Chairman and Luqman Arnold would be President and CEO. This happened at the AGM in 2001. However, Luqman Arnold left after a dispute about the role of the Chairman110 in December and Peter Wuffli became President. Interestingly his father had been president of Credit Suisse in the 1970s. The new boss of Asset Management was John Fraser, an Australian former civil servant who had joined UBS in Australia in 1993 and became head of Asia Pacific for the UBS Asset Management in 1998. He had been President and COO of UBS Asset Management since 2000 and had been a major player in integrating the disparate elements of the business. However, this work continued apace in 2002 and 2003 – costs were cut, quality upgraded and new investment 109

110

This was reportedly the reason why merger talks with Merrill Lynch had broken down in 1999. Paine Webber had bought Kidder Peabody from GE which had divested following the Joseph Jett scandal – a rare example of an unsuccessful GE acquisition (although another instance of Beale’s law of (non-) acqusition!). In September 2001, Swissair Group needed an emergency bailout and the Marcel Ospel as Chairman committed c. CHF700 m. Though he involved the chief credit ofﬁcer, the Vice-Chairman of the Supervisory Board and the chief legal counsel, the group executive board only later ratiﬁed the decision to commit the funds.

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processes and products developed. By 2003 UBS Global Asset Management was named Best Overall Group at the European Fund Awards 2003 in Luxembourg and UBS was named Best Asset Management Bank by Global Finance Magazine. In 2003 revenue and proﬁt were up 5 per cent and 52 per cent respectively from their low point in 2002, and in 2004 they grew again by 16 per cent and 64 per cent, so that profits reached an all-time high of CHF544 m.111 Net new money inflows in the institutional business stood at CHF23.7bn, almost doubling from CHF12.7 bn a year earlier. The business now has four platforms: the core investment management business has a clear price/value investment philosophy that emphasizes fundamental analysis when assessing securities; the alternative and quantitative investments business; the real estate business invests in properties in the US, UK, Continental Europe and Japan and in publicly traded real estate equities globally; and the fund services business is a global fund administration unit delivering professional services to an internal and, increasingly, an external client base. As at 31 December 2004 they had $527 bn under management and 620 investment professionals worldwide.

UBS GAM'S APPROACH TO SHAREHOLDER/NED CONTACT John Fraser is somewhat unusual amongst CEOs of investment management business in having experience as an NED.112 He was on the Board of ASX – the Australian Stock Exchange, from 1997 to 2003 and served on their audit, nomination and remuneration committees. This makes him more aware than most of the value and the practical realities of Boards, and what NEDs can add. His view is that corporate governance or ethics should not be too prescriptive. The key to good corporate governance is the Non-Executive Chairman, rather than the NEDs. The focus should be on the Chairman, as they have the power to do something. Chairmen should have integrity and robustness. It can be a mistake to be too purist about independence in NEDs. Successful business people with relevant expertise may well have some conflicts of interest in respect of a particular company, but if they are people of integrity this can be managed and it should not disqualify them from serving as NEDs. However, the Chairman may have to be robust in suggesting that they absent themselves from particular discussions. The focus on Boards should be on their behaviour rather than being over-concerned with composition. See how they act. For example David Scholey was rightly deemed by Vodafone to be an independent director despite his link with UBS because everyone who knew David knew that he would act independently and not use his Vodafone Board position to advance the interests of UBS. It is important that we don’t proscribe a large set of highly competent and successful people from 111 112

This is after CHF130 m of goodwill write-off and the transfer of some lines of business to the wealth management side. Though as noted in Chapter 7 Patricia Dunn who was Chairman and CEO of BGI was an NED of HP.

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sitting on Boards. He also believes that for small and medium firms it is hard to have four independent directors: ‘It is sensible to differentiate as we do not want to discourage ﬁrms from listing.’113 Effective governance and engagement has become increasingly important to them, and their approach has evolved: initially they gave lead responsibility for governance in the UK to one of their experienced fund managers, Ian Pitﬁeld, who had previously had responsibility for £18 bn of funds under management, but he has now become global corporate governance director with an international remit, especially within Europe. This extends through the core investment platform, working with colleagues in the other major ﬁnancial centres. They try to avoid press comment, and have clear guidelines for their engagement which are meant to be adapted sensibly to the country in question: so for example they would engage with a Japanese company in a very different way from a UK company, but with the same overall guiding principles. Ian was an important player in constructive engagement with Shell, the details of which I discuss in the next chapter.

UBS GAM'S APPROACH TO DIRECTOR DEVELOPMENT UBS is an active participant in initiatives such as the investor/Chairman dinners and the NEDX masterclasses run by Sciteb. In addition to helping to build the next generation of NEDs and improve the communication and understanding between industrialists and investors, they find that it is helpful to their work to gain a deeper understanding of how Boards work and how chairmen react. On one occasion it was possible to have quite a frank debrief with a respected Chairman on a high-profile episode of investor engagement quite a while after the dust had settled – which was certainly considered helpful in terms of making further interventions even more constructive, as well as fascinating for the other directors who were part of the conversation.

UBS GAM'S APPROACH TO THE POLICEMAN'S LOT John Fraser profoundly disagrees with people who suggest that shareholders should not do corporate governance but only buy or sell, because of the free rider problem. Major investors have a duty to be involved in the governance of the companies in which they invest. This is partly because there are strong public policy implications – ultimately the government stands behind pension obligations because they have to 113

FT Business November 2002.

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provide if pensions schemes fail. It would be irresponsible for investors not to take whatever steps they reasonably can to ensure that the companies in which they invest perform well. It is also a reflection of the fact that, whereas small investors can trade out of a company without moving the share price, if you have a substantial stake you may have take a signiﬁcant discount if you sell it. Nevertheless investors need to approach this with a large degree of humility. We should also look at our own corporate governance – recent McKinsey and BCG studies have shown that most European asset managers are unprofitable or marginally profitable. There needs to be transparency with companies and with the investment businesses. Hedge funds are increasingly involved in governance issues. They are not shy of sending a strong email to a CEO if they disagree with a policy. This may be a healthy trend. UBS’s hedge funds are involved in governance issues as well. Equally, they cannot help suspecting that, if NEDs did the job they were supposed to do, there might be more NED resignations. How often to NEDs decide to go quietly when their term is up, even when they strongly disagree with a Board decision?

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CHAPTER 10

Constructive Engagement in Action: Royal Dutch Shell A LONG PILGRIMAGE In 1833 Marcus Samuel opened a small shop in London, selling sea shells to Victorian natural history enthusiasts. It soon became a thriving import–export business: Marcus Samuel & Company. On a visit to the Caspian Sea coast, Marcus’s son recognized a huge opportunity to export oil for lamps and cooking to the Far East. He commissioned the first special oil tanker in 1892, and subsequently delivered 4000 tonnes of Russian kerosene to Singapore and Bangkok, under the trade mark ‘Shell’. In 1897 The ‘Shell’ Transport and Trading Company Ltd was formed, and in 1904 they adopted the scallop shell as their logo.114 Meanwhile, the Royal Dutch Petroleum Company had been formed in the Netherlands to develop oil fields in Asia. By 1896 they had their own tanker fleet to compete with the British, but in 1907 they combined their worldwide operations into the Royal Dutch/Shell Group of companies. This had a curious structure.115 There were two publicly traded companies, The Royal Dutch Petroleum Company NV and Shell Transport and Trading Company plc (Shell T&T). These had a 60 per cent and 40 per cent stake, respectively, in both Shell Petroleum NV (SPNV) and the Shell Petroleum Company Ltd (SPCo) and these then owned the service and operating companies that made up the Royal Dutch/Shell Group. Royal Dutch and Shell T&T were legally separate companies with separate Boards, operating under Dutch and English law respectively. Of the group managing directors who provided the executive management of the group, two were EDs of Shell T&T and three were members of the Management Board of Royal Dutch:116 collectively these formed the Committee of Managing Directors (CMD). All the members of the three top Boards – the Royal Dutch 114

115 116

Possibly at the instigation of a Mr Graham who sold their oil in India, became a director of the company and whose family coat of arms incorporated a scallop shell as a symbol of a pilgrimage to Santiago di Compostella. I am describing the structure as it existed in 2004 – I believe this is essentially how it was in 1907 although the exact names, and some of the details, had changed. Dutch companies have a management board led by a President responsible for running the business and a separate Supervisory Board with its own ‘non-executive’ Chairman. Supervisory Board members are less involved in their businesses than UK NEDs, though the Dutch businessman who was asked how he found the time to be on a dozen Supervisory Boards and replied that it wasn’t a problem because he only chaired six of them may be an extreme case.

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Supervisory Board and Management board and the directors of Shell T&T – met together about eight times a year in a gathering called Conference. These meetings were chaired by the Chairman of the CMD who was thus the nearest thing Shell had to a Chairman and CEO. This position normally alternated between an Englishman and a Dutchman. Conference had no legal powers: brief formal Board meetings of the two holding companies were held immediately afterwards. Throughout the early twentieth century, the group expanded with acquisitions in Europe, Africa and the Americas. Mass production of cars had opened up a vast new market. The First World War saw many of Shell’s operations closed or conﬁscated; but others were added or expanded, particularly in North America. Shell expanded in the 1920s and 1930s , but during the Second World War, Shell once again lost businesses, tankers and properties. Following the Second World War, an enormous effort began to replace and expand Shell’s facilities for production, transport and reﬁning to meet the new pressures on demand. Throughout the 1950s and 1960s, Shell’s oil output and sales increased dramatically, to the point where Shell supplied almost one-seventh of the world’s oil products. The major oil companies of the day (Exxon, Shell, BP, Mobil, Chevron, Texaco and Gulf to give them their modern names) were known as the Seven Sisters and epitomized global capitalism. In the 1970s, Shell made major oil and gas discoveries in the North Sea. At the same time, an economic recession combined with a steep rise in the price of crude oil had a serious impact on the oil business. Shell had pioneered and developed the concept of scenario planning, so that instead of basing a business plan on a single view of the future, a number of different scenarios were considered, and this served them well in adjusting to the unexpected rises in the oil price. It also contributed further to the rise in their reputation in the business community. By the end of the decade, gas accounted for about 15 per cent of Europe’s energy consumption, with Shell and its partners supplying about half. Liqueﬁed natural gas – which Shell helped to pioneer – also performed well, breaking the tyranny of the pipeline. Meanwhile, Shell was developing its long-term interests in coal and metals. In the 1980s, Shell companies installed advanced technology, launched new products and services, and explored solutions to environmental concerns. Shell began to sell unleaded petrol, and subsequently gained a worldwide leadership position. With the 1990s came lower oil prices, and a concentration on Shell’s core businesses – mainly oil, gas and chemicals. Shell was regularly voted one of the most admired companies in the world. Internally there were elaborate checks and balances, partly to avoid individual hubris. The Chairman of the CMD was more of a primus inter pares than was the case in other oil majors. The top functional managers were called ‘coordinators’, so the head of R&D was the R&D coordinator and again had far less executive authority. Things were done by consensus, in the Shell way, and it is fair to say that it was pretty successful. However, it was increasingly inward-looking and

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convinced of its superiority. Shell got a nasty shock when their plans to sink a surplus oil rig (the Brent Spa) in the North Sea, chosen after careful consideration as the most environmentally friendly option, were derailed by a high-profile PR campaign by Greenpeace. It made them realize that they needed to be more responsive to the outside world, but also showed that the outside world was, in many respects, a highly ‘irrational’ place.117 Sir Mark Moody-Stuart became Chairman of the CMD in 1997. He determined to make Shell rather more entrepreneurial, and encouraged value creation teams to study the problems. One conclusion was that Shell was more conservative than their major competitors in booking proven reserves, so in 1998 they revised their internal guidelines accordingly. The MD of exploration and production (EP) at the time was Phil Watts. When Moody-Stuart retired, instead of his job going to a Dutchman Phil Watts became Chairman in June 2001, and Sir Philip in 2003. Within the group and the market, there was a perception that this success could be attributed, in part, to his ability to meet or exceed reserve expectations. A very bright Dutchman called Walter van der Vijver became MD of EP. Shell sat out the consolidation in the oil industry initiated by BP, partly because the dual company structure made it very difﬁcult to do a big takeover or merger by issuing shares.118 But Shell continued to prosper, and remained one of the world’s most admired companies.

THE CRISIS ‘I am becoming sick and tired about lying about the extent of our reserves issues and the downward revisions that need to be done because of far too aggressive/optimistic bookings,’ said Walter van der Vijver to Phil Watts in an astonishing email sent on 9 November 2003. This was an escalation of the serious dispute that had been going on between the two men for over two years. As described by van der Vijver:119 Soon after coming to ofﬁce as head of EP in June 2001, I observed that the health of the EP business was not as robust as the company-determined performance targets set under the former EP CEO. In fact, EP was in a far worse state in mid-2001 than was ever portrayed by my predecessor to senior management or the Conference.

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Greenpeace was acting very irrationally in that it was opposing, on environmental grounds, the best environmental option for disposal of the rig. They were acting very rationally in that by doing so they boosted their membership and proﬁle, and demonstrated that they could take on one of the world’s most admired multinationals and win. Shell did buy a small company called Enterprise Oil, for cash. In a letter dated 22 March 2004. The details of this crisis are laid out in the executive summary of a report commissioned by Shell from the US law ﬁrm Davis Polk & Wardwell which is on the Shell website, and from which most of the subsequent quotations and references are drawn.

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The value of an oil company depends to a large extent on the state of its oil reserves. There are many uncertainties in oil production: geological, political and economic, so it is a complex matter of judgement to estimate how much oil there is in the ground and how much will be economically recoverable. In outline, reserves are divided into proved and merely probable, and the idea is that reserves are not proved if there are potential environmental, political or commercial showstoppers or if there is a risk that the oil will not be extracted before the end of the licence period. The SEC lays down guidelines for when companies can claim proved reserves: as with many other disclosure methodologies these are somewhat arbitrary with a number of manifest absurdities120 but US ﬁlings must abide by SEC rules, even if you use different numbers for your own internal purposes. Issuers may not disclose in SEC ﬁlings estimates of oil and gas reserves other than proved reserves unless such disclosure is required under state law or the law of a non-US jurisdiction. Shell operated a decentralized system for estimating reserves, reviewed by a group reserves auditor, a lone retired Shell petroleum engineer who worked only part-time and was provided limited resources and no staff. He lacked authority to require operating unit compliance with either SEC rules or group reserves guidelines. He reported to EP management, meaning he was answerable to the same people he audited, and made brief visits to a handful of operating units per year. Nevertheless, as early as February 2000 he had raised concerns about the appropriateness of booking up to 600 m boe of proved reserves in Nigeria and repeated these concerns, without EP taking any steps to de-book non-compliant reserves, in each of his next two annual reports.121 Meanwhile the SEC issued guidance on the application of their regulations in 2001 – what was perhaps arguably OK in 1999 was clearly non-compliant by 2001. On 11 February 2002, van der Vijver had forwarded to the CMD a Note for Information122 which warned that proved reserve exposures could be as high as 2.3 bn barrels of oil equivalent because of non-compliance with SEC guidelines. The note identified seven areas where these issues applied. The note raised issues of sufficient concern that a further presentation be made to CMD. But before this second presentation was made, Sir Philip directed him by email to leave no stone unturned to achieve more than 100 per cent replacement of (proved) reserves for 2002, a result inconsistent with signiﬁcant de-booking of reserves already claimed. Instead the plan 120

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In particular seismographic techniques for estimating reserves that were widely used in the industry could not be used, except in the Gulf of Mexico, which said more about the lobbying power of the US companies that owned ﬁelds there than about the unique geological conditions of that admittedly interesting region. But then US GAAP has absurdities which too numerous to mention exhaustively, anyone unfamiliar with them should ask a suitable qualiﬁed and candid accountant about the treatment of Pensions and Options, and there are many more. See the SEC Consent Decree at http://www.sec.gov/litigation/admin/34-50233.pdf and the FSA Decision Letter at www.fsa.gov.uk/pubs/ﬁnal/shell_24aug04.pdf. The group reserves auditor also raised concerns about some of the other inappropriate bookings. There were three kinds of notes, a Note for Information, a Note for Discussion, and a Note to the CMD.

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became to manage the totality of the reserve position over time, in hopes that problematic reserve bookings could be rendered immaterial by project maturation, license extensions, exploration successes and/or strategic activity. On 2 September van der Vijver submitted a further note to the CMD (with a copy to Judith Boynton, the CFO who had joined in June 2001)123 describing the dilemmas facing EP and the uncomfortable situation EP was in: Given the external visibility of our issues (lean organic development portfolio funnel, RRR low, F&D unit costs rising), the market can only be ‘fooled’ if 1) credibility of the company is high, 2) medium and long-term portfolio refreshment is real and/or 3) positive trends can be shown on key indicators.’ [He added that] ‘unfortunately … we are struggling on all key criteria. On 22 October 2002 he emailed Sir Philip: I must admit that I become sick and tired about arguing about the hard facts and also cannot perform miracles given where we are today. If I was interpreting the disclosure requirements literally [SarbOx etc] we would have a real problem. This dialogue continued into 2003 and it became increasingly clear that the plan to manage the exposure would not work. The Group Audit Committee (GAC) had raised the issue of whether Shell’s ﬁgures were in accordance with the SEC guidelines in 2003 and had been told that much if not all, of the potential exposure was offset by Shell’s practice of not disclosing reserves in relation to gas production that is consumed onsite as fuel or (incidental) flaring and venting.124 In November 2003 van der Vijver had lunch with the Chairman of the Supervisory Board (who also chaired the GAC) and mentioned to him ‘there was an imminent problem about the oil reserves’. He was advised to discuss it with his colleagues on the CMD.125 Following external legal advice, a project began to review the reserves. In December 2003 EP staff produced a draft script for Walter stating that: 123

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Judith Boynton, an American, had been with Amoco 1978–98, rising to be VP and Controller in 1996. She joined Polaroid as CFO in 1998 but resigned in December 1999 – presumably concerned about the ﬁnancial position (Polaroid ﬁled for bankruptcy protection in October 2001). Although she attended Conference as of right, she was not on the CMD. This was in a note dated 26 August 2003, which was sent to the GAC for their meeting on 21 October. However, on 30 September the group reserves auditor issued an ‘unsatisfactory’ audit report in relation to the Shell company where most of the Nigerian over-booking occurred and by 20 October 2003, a note to the CEO of EP reported that, for reasons EP did not yet understand, the potential offset from fuel and ﬂare gas would be only approximately 300 million boe rather than the 1 billion boe previously believed. The GAC was not informed of either of these at the time. When questioned about this at the AGM the Chairman pointed out that this lunch had been repeatedly cancelled by Mr van der Vijver and that this subject was only mentioned brieﬂy, in a way that ‘it didn’t come over as a big problem’.

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If and from the time onwards that it is accepted or acknowledged … that, when applying the SEC rules, the 2002 proved reserves as reported in the Form 20-F are materially wrong, [we] are under a legal obligation to disclose that information to all investors at the same time and without delay. Astonishingly, on the same day this script was provided to Walter van der Vijver, he immediately emailed one of its authors: ‘This is absolute dynamite, not at all what I expected and needs to be destroyed.’ Because of prompt interdiction by internal counsel, the document was retained. There are many extraordinary aspects of this which I do not understand. Naturally I have not spoken to the people who sent these emails, and I am aware that emails taken out of context can be highly misleading. Both Sir Philip Watts and Walter van der Vijver are very able but apparently rather complex characters, who come across at least to some observers as rather arrogant and as not having great communications skills. One of them was described as giving the impression that ‘he considered the rest of the human race in general and his fellow-MDs in particular as intellectual pygmies’. A director of Shell, when we were discussing this later, pointed out that Sir Philip had never been an NED of another company and suggested that such service might have helped give a more rounded outlook. Judith Boynton was also apparently very bright and able but not great at external communications. Although she did attend Conference as of right, her position was also weakened internally by not being on the CMD and by the fact that the CFOs of the businesses reported to their respective MDs and not to her, as well as the notorious difﬁculty of an outsider making an impact in a company which is run almost entirely by people who have spent 20 or more years there. But it is still hard to understand a post-Enron CFO apparently not taking more vigorous steps when in receipt of emails from a group MD suggesting that there may be disclosure irregularities, if only for motives of self-preservation. And it is amazing if indeed, as would appear, neither the internal nor the external auditors sought or found the reports of the group reserves auditor. At the end of December an emergency meeting of the GAC was called for early January, which was so sensitive that no agenda papers were sent out. On the 9 January 2004 Shell shocked the market with the following announcement: Following internal reviews, some proved hydrocarbon reserves will be recategorised. The total non recurring recategorisation, relative to the proved reserves as stated at December 31st 2002, represents 3.9 billion barrels of oil equivalent (‘boe’) of proved reserves, or 20% of proved reserves at that date. Over 90% of the total change is a reduction in the proved undeveloped category; the balance is a reduction in the proved developed category.

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They added that: There is no material effect on ﬁnancial statements for any year up to and including 2003. The recategorisation of proved reserves does not materially change the estimated total volume of hydrocarbons in place, nor the volumes that are expected ultimately to be recovered. It is anticipated that most of these reserves will be re-booked in the proved category over time as ﬁeld developments mature. The market sensed trouble126 and the shares fell 7.5 per cent that day, reducing the group’s market capitalization by over £7 bn. Shareholders were further exasperated when Sir Philip Watts was not available to take questions from the investors at the conference call that followed. An internal investigation led by their general counsel recommended that Shell adopt full, proactive disclosure to the SEC and the FSA, and authorize a full independent review by an outside law ﬁrm. Davis Polk and Wardwell were engaged by the Group Audit Committee, and submitted an interim report on the 1 March. Two days later, Sir Philip Watts and Walter van der Vijver were asked to resign and Judith Boynton was moved from her position as CFO.127 Jeroen van der Veer was appointed President of Royal Dutch and Chairman of the CMD. But, in view of the unprecedented situation, Conference decided to appoint an NED as Chairman. Ron Oxburgh is an academic geologist by background, who taught at Oxford and Cambridge and became head of a Cambridge college. He joined the UK Ministry of Defence as Chief Scientific Adviser in 1988 and on his retirement in 1993 became Rector (that is, effectively Vice-Chancellor) of Imperial College. He retired from this position in 2001 and was made Lord Oxburgh. In 1996 he had joined the Board of Shell as the boffin on the Board and moved up to become SID. Then suddenly on 3 March everything changed – he was asked to be interim Chairman, both of Shell T&T and of Conference. Rigorous, intellectually disciplined, honest and independent, he was clearly the man for the job.

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When they said ‘there is no material effect on the ﬁnancial statements’ they meant the audited ﬁnancial statements – reserves information was in an unaudited supplementary information section of the annual report and 20F. The SEC’s standardized measure of future cashﬂows was overstated by $6.5–7.2 bn. Ironically, had they been using the SEC methodology properly, their one-year and three-year reserves replacement ratios would have been higher in 2002, but the total proven reserves would of course have been lower. Philip Nichol, global sector director for oil at ABN Amro, was quoted in Financial Director June 2004 as saying, somewhat harshly: ‘What we now discover is that, where we all thought Shell was a great company, the company has basically been in decline for a decade. Management have been focusing on proﬁtability and allowing the reserves to wind down without that fact becoming visible to the market.’ She remained an employee for a few months until her replacement was found, and then left the company.

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THE TEAM The Boards of Shell T&T and of Royal Dutch contained a diverse galaxy of talent, though it was never envisaged that they would have to play the roles for which they were now being cast. The directors of Shell T&T and Royal Dutch were a diverse group of talented people, though they were not used to working as a real Board. Firstly Conference was simply too big for any real Board discussion. Secondly it had no legal powers: MDs of Royal Dutch could only be ﬁred by the Royal Dutch Supervisory Board and MD of Shell T&T by that Board: the operational management of the group was legally the province of the two top subsidiaries (SPNV and SPCo) of which only the EDs were directors. Thirdly the way in which Conference was chaired by the Chairman of the CMD made it very difﬁcult to hold him to account, and in practice Conference was a sounding board nodding through decisions that had already been taken in the CMD. All this was about to change, rapidly. In addition to Ron Oxburgh the NEDs of Shell T&T128 were:

128

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Teymour Alireza A Saudi businessman, appointed in 1997.

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Sir Peter Burt appointed 2002. Former CEO of the Bank of Scotland, he was appointed Chairman of ITV plc in February 2004. He became SID when Ron Oxburgh was made Chairman.

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Dr Eileen Buttle Appointed in 1998 following a career of public scientific appointments.

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Luis Giusti A Venezuelan oil man, appointed 2000.

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Mary (Nina) Henderson A US national, appointed in 2001. Previously VP of Bestfoods.

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Sir Peter Job Appointed in 2001. Previously CEO of Reuters, an NED of Schroders and GSK, and on Supervisory Boards of Deutsche Bank and Bertelsmann. A former journalist, admired by chairmen for his ability to ask tough and pertinent questions.

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Sir John Kerr Appointed in 2002. Previously Head of the UK Diplomatic Service, who had been UK permanent representative to the EU and ambassador to the USA. From 2000 to 2003 he was Secretary of the European Convention that wrote the draft EU constitution. He is a NED of Rio Tinto (since 2003) which has a famously well-run Board and dual-company structure. During 2004 he was awarded a life peerage and became Lord Kerr of Kinlochard.

For brevity, unless stated otherwise the NEDs of Shell are UK nationals and the members of the Supervisory Board of Royal Dutch are Dutch nationals.

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Sir Mark Moody-Stuart Appointed a NED in 2001. Chairman of the CMD 1997–2001 having been on the CMD since 1991. Since 2002 Chairman of Anglo American, an NED of HSBC and Accenture.

And the Supervisory Board of Royal Dutch comprised: ●

Aad Jacobs Appointed a member in 1998 and Chairman in 2002. On six other Supervisory Boards, including ING. Chairman of the GAC.

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Maarten van den Bergh Appointed 2000 when he retired as a MD of Royal Dutch after 33 years with the group, including eight years on the CMD and two years as President. Based mainly in the UK, he is Chairman of Lloyds TSB and an NED of BT and British Airways.

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Wim Kok Appointed in 2003. A former Dutch PM, on the Supervisory Boards of ING, KLM and TPG.

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Jonkheer Aarnout Loudon Appointed in 1997. Member of the Board of management of Akzo/Akzo Nobel 1977–94 and its Chairman 1982–94. He chairs the Supervisory Boards of ABN AMRO and Akzo Nobel and is a member of the International Advisory Board of Allianz.129

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Prof. Hubert Markl A German national, appointed 2002. On three other Supervisory Boards including Aventis and BMW.

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Lawrence Ricciardi A US national, appointed in 2001. Previously General Counsel of IBM.130

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Henny de Ruiter Appointed in 1994. MD of Royal Dutch 1983–94. On four other Supervisory Boards, he had been Chairman of the Supervisory Board of Royal Ahold when it was engulfed in accounting scandals. During 2004 he was replaced by:

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Christine Morin-Postel A French national, who had been CEO Societé Générale de Belgique. She is currently a NED of Alcan, Pilkington and 3i.

With this replacement, three of the seven members of the Royal Dutch Supervisory Board were non-Dutch. Thus of the 16, three were former members of the CMD and initially only five (rising to six) had experience of serving as an NED on a UK Board , where the levels of engagement expected from NEDs are considerably higher than in other jurisdictions. 129

130

Jonkheer is roughly the equivalent of ‘Count’ and Aarnout Loudon is at the pinnacle of the Dutch business aristocracy. He is grandson of a former Chairman of Royal Dutch, and his family is connected by marriage to the van den Berghs. Lodewijk van Wachem, who was Chairman of the CMD until 1992 and then Chairman of the Royal Dutch Supervisory Board until 2002, served on the Board of IBM and knew Mr Ricciardi there.

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However all of these people were highly intelligent with considerable experience of dealing with difficult business situations. By the time this work finished, they had plenty more. The executive directors at 4 March were: ●

Jeroen van der Veer who became Chairman of the CMD. He was President of Royal Dutch since 2000, having been a MD since 1997. He had joined the group in 1971 in process design and held management positions around the world. He was also a member of the Supervisory Board of De Nederlandsche Bank and had served as an advisory director131 of Unilever since May 2002.

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Rob Routs ED Downstream. Joined the CMD July 2003. Joined the group in 1971 and held various positions in the Netherlands, Canada and the USA. Previously head of Shell in the USA.

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Malcolm Brinded Appointed ED of exploration and production in March 2004 (in succession to van der Vijver) and an MD of Shell T&T, having been an MD of Royal Dutch since 2002.

They were later joined by two colleagues: ●

Linda Cook A US national was appointed an MD of Royal Dutch in August 2004. CEO for Shell Gas & Power. She became an NED of Boeing in December 2003.

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Peter Voser Appointed group CFO and an MD of Shell T&T on 4 October 2004. A Swiss national, he had worked for Royal Dutch/Shell since 1982 in a variety of finance and business roles (including group chief internal auditor 1997–99), but in March 2002 he left to become CFO of ABB. He became an NED of Aegon in April 2004 (and joined the Supervisory Board of UBS in 2005).

ENGAGEMENT BEGINS Even before the reserves problems, investors had talked to Shell about Board structure. Sir Philip Watts would certainly have been aware of investor concerns. However, they had not yet reached the stage of having a serious and immediate impact on the share price. As one of them put it, ‘With hindsight perhaps the investors should have pressed harder sooner, but the reality is that we’d probably not have been listened to.’ When the reserves issue broke it was clear that serious investor engagement was needed. Two investor bodies took action. The Association of British Insurers (ABI) 131

Unilever’s NEDs were called advisory directors, but increasingly took the role of NEDs which they now formally are.

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formed a special committee to address the questions. And the National Association of Pension Funds (NAPF) formed a case committee – a mechanism which had been recently revived. Of these two bodies the NAPF in this case worked more behind the scenes, and on balance, as will be seen, it was quite effective, having a variety of investor voices, all saying much the same thing but in somewhat different ways. As is suggested by their names, these bodies have somewhat different but overlapping memberships. Equally there are many important investors in Shell and Royal Dutch who were non-British and therefore not members of either. NAPF has a JV with Institutional Shareholder Services which advises on voting issues and many US investors take advice from ISS on voting or even outsource their voting to them, so the NAPF at least inﬂuences the votes of US investors as well. On 2 February 2004 about a dozen institutional investors met a Shell delegation led by Lord Oxburgh (then the SID) at the ABI’s ofﬁces. The issues raised included reserves replacement, communications generally, the structure of the company, credibility of the senior management team, and SEC methods. In particular the Shell team was able to explain some of the anomalies and complexities of the SEC’s definition of proven reserves and the fact that there is a considerable element of judgement in making such estimates. The point was also reinforced that the amount of oil in the ground had not changed. It was made clear that Royal Dutch had a veto on structure, and that UK investors had to be very diplomatic and tactful. A few days later the Financial Times carried an article ‘NAPF and ABI urge investor reticence’ which stated that: This year has started with a row at Royal Dutch/Shell, Europe’s second largest energy group. Sir Philip Watts, chairman of Shell, is under pressure to unify the group’s dual shareholding structure, which has made UK investors frustrated about the way the Dutch side of the business controls 60 per cent of the group. Investors want the structure unified, partly because Watts is being distracted by his twin role as chairman of the UK company and chairman of the overall operation’s management committee. Watts is under pressure as a result of share price underperformance and Shell’s admission that it had overestimated its proven oil reserves by 20 per cent. The ABI said its members were ‘extremely concerned’ and had embarked on ‘close discussions with the company’. This was true.132 When Sir Philip was having investor meetings he was questioned about lack of independent and objective leadership, the role of NEDs, internal controls 132

Although the issue wasn’t really about chairing Shell T&T but chairing Conference.

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and reporting lines and investors wanted to know more clearly how decisions were made. There was some discomfort about the fact that the existence of discussions was being reported in the press, but this needs to be seen against a background of strong pressure on the institutional investors to be seen to be acting as responsible owners. In the words of another long-time investor in Shell133 We had held meetings with Shell management over many years. After the shock announcement about reserves in January, we organised another meeting with the Chairman, Sir Philip Watts. This took place on 13 February and was a very unsatisfactory meeting. Following that, we wrote to the Senior Independent Director of Shell, Lord Oxburgh, expressing our concerns. On 3 March Watts was sacked and Lord Oxburgh became interim Chairman. In our letter, we gave our views about Shell’s structure, but nobody in F&C can tell Shell how to organise itself. We can’t run companies or decide how much people should get paid but we can and do express views based on our experience as investors. Meanwhile a voluble activist investor called Eric Knight burst on the scene. Backed in part by the now late Edouard Stern, Knight ran a hedge fund which, according to Business Week, had $200 m on tap from the California Public Employees’ Retirement System (CalPERS) and $100 m more from other investors. They had about $70 m invested in Royal Dutch/Shell. According to Knight134 Shell’s investor relations department initially refused to talk to us. It emailed CalPERS asking, ‘Who are these people? Do you support them?’ CalPERS said, ‘Yes, we do.’ We then had a meeting with Sir Philip Watts just before he was fired and CalPERS came with us. Shell didn’t take us very seriously. It had enough problems on its mind and was already talking to the bigger shareholders. The issue then was how many shares we own – which is irrelevant, because it’s how much time and effort we’re prepared to spend [on this campaign] that is important. So we circulated a white paper and managed to get a lot of media attention. After the dramatic departure of Sir Philip the pace of engagement accelerated further. Knight had contacted the ABI and had given the ABI a copy of their research – a 14-page document which was described by one investor as ‘quite impressive’. By this time the investor view in the UK was that ‘we wanted to see a streamlined structure – how they did it was up to them but we wanted at least a unified Board if not a unified company’. However, UK investors received the impression that ‘the Dutch will think 133 134

Foreign & Colonial, which had held Shell shares since 1925. Quotes from Eric Knight and John Kerr are based on press comments, especially Business Week 24 January 2005, Corporate Board Member March/April 2005 and IR Magazine January 2005.

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that the departure of Phil Watts will sufﬁce’. Investors wrote to Lord Oxburgh and there was a further meeting at the ABI on 22 March. This went well, with investors seeing ‘a no-nonsense approach’ and the NEDs being ‘pretty open about the problems’. That day the London Evening Standard published a article headlined ‘Shell braced as investors get chance to vent anger’: Furious major investors will today call for an unprecedented shake-up at scandal-hit Shell and push the company to abandon its century-old dual-listed corporate structure. The [ABI] wants answers from the Anglo-Dutch giant after it stunned investors last week with a further downgrade to its sprawling reserves base. It is leading a meeting with Lord Oxburgh, the non-executive director appointed head of Shell’s UKlisted arm after Sir Philip Watts’ resignation three weeks ago. ABI members control up to a quarter of the shares in Shell’s UK-listed arm … and are stunned over the way the group has handled the crisis. Shell’s reputation has taken a battering ever since it alarmed the City two months ago by cutting 3.9 billion barrels of its proven reserves off its books – some 20 per cent of its total … Shell said: ‘We are listening to shareholders and will continue to do so through to our annual general meetings. When that is completed both boards will then decide what, if anything, should be done. The following day the FT had an article ‘Shell UK arm hails “helpful” talks with angry investors’: Board members of Shell … yesterday described their first meeting with shareholders since last week’s new cut to reserves as ‘helpful and constructive’ … ‘When we said we were “deeply upset”, that reflected a real sense of frustration,’ said Peter Montagnon, ABI’s head of investment affairs. He added: ‘The dialogue is not over and it will continue.’ … Lord Oxburgh called it ‘an excellent meeting’, and said: ‘A whole range of matters was discussed. Nothing [was] ruled in, nothing [was] ruled out.’ … Many investors have advocated a unified board, with more independent and active members. Some have sought the end of Shell’s century-old dual structure, while others continue to push for further changes among top managers … Dutch investors continue to focus on the outcome of Royal Dutch/Shell’s review of its reserves accounting policy, and have refrained from commenting on wider issues, including management reform. The NAPF Case Committee met with Shell the following day 24 March. Understandably they requested that this meeting should not be publicized: indeed it is

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a basic rule of NAPF Case Committees that they should be wholly confidential while they are in existence, and any statement should only be made at the end of the engagement – the NAPF has kindly given permission for us to use the material to deepen understanding of the real process of constructive engagement. At this meeting the investors got a very frank and accurate picture of many of the governance issues. An important complication was that Shell T&T was very much the junior partner in the JV with Royal Dutch, a situation that was magnified by the existence of priority shares in Royal Dutch. Amazingly, the holders of these 1500 priority shares had effective control of the entire group: they had the right to draw up a binding nomination consisting of two persons for ﬁlling vacancies on the Supervisory Board and the Board of Management of Royal Dutch, as well as the right to block any changes to the articles of Royal Dutch or to the number of members of the Management or Supervisory Boards. The priority shares were controlled by a foundation whose members were all the members of the Royal Dutch Management and Supervisory Boards.135 Therefore any changes had to be with their consent – it was legally impossible for shareholders to force a change. Diplomacy and persuasion were necessary. If it appeared that ST&T were ganging up with shareholders to cause structural change, this would be counter-productive. There were also tax advantages of the dual structure which needed to be considered. Generally investors were impressed with the openness and willingness to listen of the NEDs, but they were also concerned that the company was controlled by the bureaucracy and not by the Boards, and that the culture was deeply entrenched. ‘The body language was fascinating and the behaviour was also remarkable,’ one of the attendees dryly remarked. There was a sense by early April that the Shell T&T NEDs had got the message but it was less clear whether the Dutch and the executives were on side. The general feeling was the Dutch investors also wanted greater accountability but were much more cautious about an Anglo-Saxon business model. They were also very unwilling to make public representations. At least one leading Dutch investor expressed the view that the reserves story was about technical issues and not about governance, and basically sent a message that no change was needed. Eventually some ABI people were able to meet Aad Jacobs in the Hague on the 17 May, accompanied by Roderick Munsters who is one of the Netherlands’ most inﬂuential investors. The Royal Dutch side emphasized that signiﬁcant changes had been made to the Board, that Dutch Government and the Queen were signiﬁcant stakeholders/shareholders in this and that the responsibilities of the ﬁve MDs had already been redeﬁned. They also made the point that Conference 135

This membership was not public knowledge at the time, but was no surprise. In normal Dutch companies nominations have to be made by the Supervisory Board but this can be overturned by a qualiﬁed majority of the shareholders.

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was now chaired by an independent director. There was a school of thought that these changes would be sufﬁcient – how inﬂuential this view was remained to be seen.

EFFECTIVE TRACTION It was clear to everybody that the governance issue would not go away. On 27 April conference set up a steering group consisting of Sir John Kerr, Maarten van den Bergh, Sir Peter Job, Jonkheer Aarnout Loudon and Jeroen van der Veer. Their terms of reference were to review: ●

the possible simpliﬁcation of Board/group management structures,

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improving decision making processes and accountability, and

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enhancing effective leadership for the group as a whole.

This team was carefully selected by conference as a whole. There was a 60:40 balance. Any solution with Jonkheer Aamout Loudon’s support would be likely to be acceptable in highly influential Dutch circles. Maarten van den Bergh also hails from a famous Dutch family and has a long career with Shell: being based mainly in the UK and on various UK Boards he is well versed in UK governance. Sir Peter Job combines business acumen and Board experience with a background in international media, and Sir John Kerr is a consummate diplomat. He was elected by the Steering Group to be its Chairman – this was not a case of picking the Chairman and then his packing the committee. However, diplomacy, listening, respecting national and other sensitivities, intelligent use of time and building consensus were key skills that were needed, and deployed by a master. The Steering Group was also supported by a working group of some bright Shell people, three ﬁrms of lawyers (UK, Dutch and US) and, from July, by bankers from Citigroup and Rothschilds. Shell announced the existence of the Steering Group but initially would not disclose the members or the terms of reference. This met a barrage of criticism. When Shell NEDs met the ABI on the 14 June they were pressed on this, and meeting the NAPF on the same day, the Shell NEDs remarked that ‘initially it had not been appreciated how much interest there would be in the group. It had always been intended to name them at the AGM but perhaps this might be done sooner.’ They explained that the working party had begun with 21 different corporate models and had whittled them down to six by that stage. There was useful discussion of the most intelligent way for investors to vote, and the natural inclination of some investors to register their disapproval of (for example) the auditors was curbed by a greater desire to achieve beneﬁcial change. A fierce letter from Eric Knight and Ted White (director, corporate governance, at CalPERS) was published in the FT on the 16 June, ‘if the process is to be at all credible,

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the directors must disclose publicly the terms of reference of this review – namely: the specific issues to be considered; the composition of the body conducting it; and a timetable, involving further shareholder consultation before formal approval of any changes is sought,’ they thundered. On the 17 June Shell released an update on structure and governance which disclosed the membership and terms of reference of the Steering Group, that it was: assisted by a working group of senior group executives, which includes the Legal Director, the Head of Group Taxation, the Group Treasurer and the corporate secretaries. Outside advisors, such as law and tax ﬁrms and investment bankers, are and will be consulted as appropriate … [and that] It is the intention that results emerging from this review will be made public by the Boards in November 2004, after which a round of further and more focussed consultation with shareholders will be undertaken, so that the entire process is concluded in the shareholders meeting of 2005, for implementation immediately thereafter. A number of possible structures, and improvements to decisionmaking, accountability and enhancement of effective leadership, are under active consideration. Amongst other alternatives, forms of uniﬁed Boards, to which a CEO would report, are being studied. Nothing is ruled out at this stage. An update was promised for the AGM on 28 June. It is just possible that the letter on the 16th might have influenced this announcement, but it seems unlikely in view of the time required to gain consensus on such an issue. On the 28 June both Shell T&T and Royal Dutch held their AGMs, in London and The Hague respectively. Publication of the accounts and the AGMs had been delayed because the proven reserves had needed thorough checking. It had also emerged that there were a number of other relatively minor irregularities which meant that the 2003 financial accounts needed re-stating. There were many changes in the internal operation of the group (listed in Shell’s 20F ﬁlings) which are beyond the scope of this chapter – but it’s worth remembering that there was a lot going on in terms of internal governance as well as the structure review and the normal business of running one of the world’s biggest and most proﬁtable companies. Shell’s share price had gone from a high of 415p in January just before the reserves debacle to a low of 349p (representing roughly a £16 bn loss of value) and by the time of the AGM had climbed back to 412p, greatly assisted by a rising oil price. Shell was also under investigation by the SEC and the FSA and threatened by the usual raft of class actions, so it was understandable that they were cautious. There was also some investor concern at the compensation paid to

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Sir Philip Watts on loss of ofﬁce, although the general view of UK institutions was that this was a secondary issue. At the Shell T&T AGM Lord Oxburgh began by ‘offering a sincere apology for the failures that led to the significant restatement of the Group’s proved reserves earlier this year’. He told the shareholders that his other main task was: to lead your company in its work with Royal Dutch on a review of governance and possible new structures. The two boards continue to work together in a collegial and effective way. Nevertheless you have told us and both Boards agree that the time has come to look at alternatives. In an interesting slight contrast Aad Jacobs told the Royal Dutch AGM that: The Supervisory Board deeply regrets the issue of the reserves recategorisation that has affected the reputation of the company in recent months [and that] We have decided to re-visit the governance structure of the Group, as well as Royal Dutch itself, and to see whether we can make it more effective, with better accountability and not least more intelligible to the outside world. Although, as the report of the independent working group and external auditors have also conﬁrmed, we do not believe that there is a correlation between the reserves recategorisation and the governance of Royal Dutch and the Group, it is in any event a good enough reason to review the structure of the Group and governance of both particularly when shareholders have expressed their keen interest and concerns in that respect. Jeroen van der Verr and Malcolm Brinded delivered a remarkable speech136 where they each said: I would like to add a personal note. These recent months have felt simply dreadful. People everywhere ask What is going on at Shell? And I agree that such a crisis should never have happened. But it has. And I sincerely regret this. [and disclosed that] in May, we met with the top 400 leaders in Shell and asked some searching questions. Do we understand the word humility? Do we always put the enterprise ﬁrst? This undoubtedly won some hearts and minds. The AGMs proved to be a turning point. The Shell AGM took four hours. Major investors attended and although they generally voted for the resolutions the NEDs 136

They used the same agreed text at both the AGMs.

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were in no doubt as to their concerns. There was considerable criticism from the private investors. But the Royal Dutch AGM went on for six hours. A shareholder demanded an apology from Jeroen van der Veer to the shareholders (which was immediately given) and many shareholders found ‘Mr Watt’s platinum handshake’ unacceptable. There was criticism of having separate Boards and separate AGMs. A representative of the major Dutch state pension fund (ABP) publicly complained about the governance, as did other shareholders, and Jeroen van der Veer admitted that there were significant deficiencies in the information flows to the Board. The resolutions to discharge the directors for 2003, usually a formality, was nearly defeated with a 39 per cent vote against.137 Roderick Munsters, the CIO of one of Holland’s largest investors, concluded by saying that: we have … €700 m invested in the company. And we do that working from a long-term perspective, that proceeds from the trust that Royal will offer a good return in the long term … That trust took a knock in the last year, trust in the management and trust in the company. And I want to ask you in the next few months … to take very seriously the 40% vote against … I don’t have any doubt about this but I nevertheless call you once more because I think that, at this moment, Royal must go from the ‘trust me’-phase and come into the ‘show me’-phase.138 You have to show what your plans are. I would like to call on you to continue dialogue with the shareholders and on that basis come forward with good proposals on which we as shareholders afterwards can make any decisions. The Chairman replied ‘thank you very much for your words. We will certainly take them to heart’. It was clear that the idea of leaving the governance more or less unchanged was unsustainable. Jeroen van der Veer was winning many friends amongst the investors. They found him ‘business-like, friendly and relaxed’. He said he was aware of the concerns – very quickly, and that ‘we are doing something about it.’ When told that investors wanted an efficient, effective, transparent and accountable decision-making process his response was ‘No problem.’ 137

138

These votes – essentially approving the reports of the Management Board and the Supervisory Board, have teeth in Holland because directors cannot be sued by the company or the shareholders for anything that was disclosed in the report. Some shareholders were particularly concerned about this in relation to Walter van der Vijver, and there was a suggestion that the votes be delayed. On a poll the motions were both carried on proxies but of the votes cast at the meeting 40 m were against and 14 m for. The vote to discharge the supervisory board was marginally worse. They also approved the appointments of Christine Morin-Postel and Linda Cook to their respective Boards. Want ik denk dat, op dit moment, de Koninklijke uit de ‘trust me’-fase moet gaan en in de ‘show me’-fase komt.

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John Kerr’s experience of diplomacy helped him to structure the complex internal and external processes on the governance review. There were three parts to the operation: listening to people inside Shell, liaising with investors and addressing the structural and governance issues. When meeting investors he would take careful notes, and then be able to refer specifically to their words in follow-up meetings. Eventually he and colleagues had seen investors representing over 50 per cent of the equity of the group, and in some cases met them three or more times. He could go back and say, ‘When we last met you said X, can you explain a bit more why?’ He was also at an advantage in that he really was listening, and learning things from the investors. This increased his leverage within the company – he was the only person on the Board who had really listened to so many investors, ever. It also enhanced his credibility with the investors. The other crucial decision was to leave the most difficult issues till last. This meant that they started with governance issues, developing detailed documents to define the roles of the Chairman, Board, CEO, Executive Committee and Company Secretary, very much as BP had done after Horton (see Chapter 4) and deferring the difficult questions about corporate structure. This is an excellent general principle, because it builds up trust and momentum towards an agreement and by the end the parties are keen to resolve the difficult questions since the alternative is to lose everything that they previously agreed. It also sometimes turns out the that difficult questions are not so difficult after all when agreement on other matters has been reached. Members of the Steering Group met investors in July and made it clear that they were open to radical constructive ideas but that both a unitary Board and, if necessary, duplicated Boards were being considered. They were also considering the possibility of moving from the 60:40 ownership split to 50:50. There had been some concern in the Dutch press that the governance issues were being raised by Anglo-Saxons as a means of changing the 60:40 settlement and those investor representatives who spoke to journalists were clear that this was not an Anglo-Saxon agenda but a desire to make Shell more successful. The point was strongly made to the Steering Group that the priority must be to come up with a long-lasting solution, even if it meant missing the November dateline. For long-term shareholders ‘the worst result would be a hastily reached solution that required changing in five years time’. Shell received similar feedback from Dutch investors – take your time (if necessary) and help make the group more successful. It was also very helpful that the Royal Dutch Supervisory Board announced that they would give up the priority shares.139

139

The reforms of Dutch governance (the Tabaksblat Report) would have required any retention of these to be justiﬁed to the 2005 AGM.

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DECISIVE ACTIONS In August Shell settled with the SEC and the FSA, paying $120 m to the SEC and £17 m to the FSA. The SEC emphasized that Shell had provided full cooperation and undertaken many remedial actions, including the separation of Chairman and CEO. Shell was still subject to criticism and the idea was even floated in the press of a takeover by either BP or Total. Although this felt a bit like a combination of silly season and some fantasies about mouthwatering fees for underemployed investment bankers, the fact that reputable papers like The Economist could ﬂoat such suggestions indicated how things had changed since 2003. The Steering Group, met in all 21 times:140 many of these were all-day meetings. In addition to the ABI and NAPF members the investors consulted included the major Dutch investors, Capital (who is one of the largest shareholders in both companies) and Fidelity: both of these firms maintained their own dialogue rather than going through the ABI or the NAPF. Thinking began to coalesce around some preferred reforms. It concluded that there should be a proper CEO accountable to a unified Board with a majority of outside directors and a non-executive Chairman. The governance documents defining the roles of the key parties were discussed in detail and accepted at a long meeting of conference on 20 September 2004. Everyone was very keen to avoid a US-style Chairman and CEO and they were also concerned about having a ‘heroic’ CEO . However, the detailed checks and balances in the documents, which had been developed after studying the BP arrangements amongst others, helped avoid this. Conference also received the recommendation that the Board should initially have ten NEDs and five EDs. From September, ABN AMRO and Deutsche Bank were retained to give independent advice to the Boards of Royal Dutch and Shell T&T respectively. Meanwhile the structural options, and their legal and tax implications, were being studied by the Steering Group and even more by the working group. The review focused down to two options:

140 141

1.

A best-in-class dual company structure, drawn from experience with such companies as Carnival and Rio Tinto, which have a unified Board but are legally two companies.141

2.

Uniﬁcation into a single company.

Not counting the celebratory dinner for the Steering Group and the Working Group after everything was over. So technically there are two Boards, one for each company, but these Boards have identical membership. The fact that the legal duties of directors are broadly the same in the UK, US and Australia makes this easier: under Dutch law it is theoretically possible to have a situation where the legal duties of a Dutch Board conﬂict with those of a UK Board in identical circumstances.

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The two options were carefully kept open, so that the difficult and highly emotive issues of national control could be dealt with last. But this had other advantages. Once the roles of the Board, the Chairman and the CEO were defined, the question of structure become largely technical: what structure best supports the efficient performance of these roles – both in terms of decision making and in terms of any tax and financial implications? Thus the Steering Group could ask for technical studies from the working group and the advisers. Furthermore the definition of roles and the nature of the process placed the onus on those who wanted a dual company to justify the increased complexity. This was particularly important because several years earlier a unification proposal had been rejected by the Board and ‘we looked at this years ago and rejected it’ always sounds like a powerful argument. Eventually these two options were put to conference on 8 October. The expectation was that Conference would go for (1). There was a view that this was a matter for which the EDs should retire, since they were interested parties. But, backed by the Chairman, they insisted in being in the room, and when it was their turn to speak they astonished many of those present by all coming down in favour of unification. This view carried the day with Conference and with both Boards.142 The details were approved unanimously at a final meeting on 27 October. They involved creation of a new company, Royal Dutch Shell plc, listed in the UK but headquartered in Holland. Royal Dutch shareholders will have 60 per cent of the issued share capital and Shell T&T shareholders 40 per cent. To preserve the current tax treatment of dividends for all shareholders, Royal Dutch Shell has ‘A’ and ‘B’ shares. Royal Dutch shareholders received ‘A’ shares and Dutch-sourced dividends while Shell T&T shareholders received ‘B’ shares and UK-sourced dividends. These ‘A’ and ‘B’ shares are otherwise identical,143 and vote together as a single class on all matters and have dividends of the same amount declared, in euros and pounds respectively. The Board shrank to ten NEDs and ﬁve EDs and new NEDs will be rotated in. Aad Jacobs became Chairman but will step down in 2006 in favour of a new Chairman from outside the Group. As John Kerr put it ‘we surprised ourselves by going much further than we thought we would’. On 28 October 2004 Shell announced their structure change. ‘It caught us all by surprise’ a key investor recalls ‘we switched on our PCs and there it was. “What, Shell 142

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However, some of the Royal Dutch Supervisory Board wanted an alternate plan considered: keeping the two listed companies but with uniﬁed holding company underneath them (instead of SPNV and SPCo as described above). The Supervisory Board considered this carefully on the 27 October and identiﬁed seven main advantages in full uniﬁcation: (i) Removing the risk of a conﬂict between the Boards of Royal Dutch and Shell T&T; (ii) Simplifying the raising of capital in the future; (iii) Reducing regulatory burdens resulting from having two publicly traded companies; (iv) Clarity and simplicity in both management and corporate structure; (v) Improved efﬁciency with clear lines of authority and an empowered CEO; (vi) Accountability through improved clarity of governance; (vii) Financial and strategic ﬂexibility. However, if the prices of the ‘A’ and ‘B’ shares diverge then RDS may buy back whichever is cheaper in any share buyback programme.

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have done it!” And they sort-of over-delivered. The shares went up despite the fact that they also announced yet another downgrade of reserves. Also there were no leaks, which was most impressive.’ The fact that it was attacked by ‘nationalist’ elements in both the English and the Dutch press was, in a strange way, mildly encouraging. But it clearly had the support of the investors and of powerful establishment ﬁgures in both the UK and Holland, including the former Prime Minister Wim Kok. The following day five Royal Dutch/Shell directors (Lord Kerr, Lord Oxburgh, Marten van den Bergh, Jeroen van der Veer and the newly appointed CFO, Peter Voser) met the NAPF Case Committee, whose Chairman congratulated the Shell team on their achievements and for meeting all the committee’s aspirations. There were some interesting questions on governance. The Shell team explained that they were phasing in recruitment of new NEDs over three years, partly because Shell is a large and complex business and it is important to have a Board with people who know the company. They stated that they now see themselves as neither Dutch nor British but as a major global company and the nationality of key people will be a matter of chance deriving from ability rather than turn-and-turn-about.144 The new articles of Royal Dutch Shell plc would be in complete compliance with the Combined Code. Peter Voser made it clear that he would not have accepted the role of CFO if he did not have total functional control, and Jeroen van der Veer again impressed investors with his honest assessment of the culture that had existed and the need to change. All in all there was a consensus, both with the NAPF and with the other major investors, that the engagement had worked very well. Simon Fraser of Fidelity summed it up as follows: Shell seemed to go well. The discussions with investors were good. They did seem to listen. They got on the front foot and they over-delivered: announcing the changes a bit sooner than they had promised and changing more than the investors had expected.

REFLECTIONS AND LESSONS LEARNED There were some remarkable special features about the Royal Dutch/Shell engagement which complicated matters: the dual company structure, the national sensitivities and the priority shares. However, arrogance, personality conflicts, reluctance to admit mistakes, cultural differences and power struggles exist in all companies to some extent. I have been pressing the people I have spoken to about the lessons learned. Here are some of the conclusions offered:

144

As an outsider I feel compelled to remark that how easy it will be to convince people of this given the choice of company name remains to be seen.

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(a)

‘If you are aware of governance problems don’t forget them just because there are no immediate issues. Just because there is no crisis you shouldn’t let it go. That is not to say that we could have done anything because they might well not have been willing to change, but a real Non-Executive Chairman could well have prevented this crisis from happening.’

(b)

‘We had so many shareholders concentrating on this because Shell is so big. You couldn’t probably get this for smaller companies.’

(c)

‘It was very helpful to have someone … coordinating. It meant that we could develop a common line [as investors] and we had a 30 minute premeeting on each occasion.’ [This view was echoed by people from Shell to whom I spoke for this book.]

(d)

‘Internal controls and audit issues are important. There is a lot of work going on at present on how companies can make these transparent to shareholders.’

(e)

‘This was a good one, there was good engagement and I think the NEDs were already on our side. They took a bit of persuading, but they understood. If you have a consensus behind you the shareholders get more power. And sometimes you do get what you want.’

(f)

‘It’s very important that companies listen to the concerns of their shareholders. The NEDs/Supervisory Board members need to listen as well as executive management.’

(g)

‘Major shareholders don’t form committees and write asking for meetings lightly – if things get to that stage there are very serious issues.’

(h)

‘The supervisory elements of the Board need to be in touch with what is going on in the business. Two-tier boards are really problematic in that respect.’

(i)

‘It is much easier to coordinate the response of London-based managers because there is so much concentration. It’s not clear that this would work so well in New York.’

(j)

‘Of course you don’t want a Chairman and CEO at loggerheads, but you must have a Chairman who offers real accountability. The Chairman’s main job is to ensure that the CEO is running the company properly [that is, not to run the business but to provide accountability] and in a way that the NEDs can justify to the shareholders.’

(k)

‘The SID is useful if you have problems with the Chairman and the CEO.’

(l)

‘Having the same person as Chairman of CMD and Chairman of the Conference allowed him to dominate the agenda and thus suppress real scrutiny.’

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(m) ‘You need multiple sources of power in a company – checks and balances.’ (n)

‘You ideally need a Chairman and a CEO who are prepared to resign.’

(o)

‘Any Board that has to vote has serious problems – decisions should be taken by consensus.’

(p)

‘You need very clear lines of responsibility in the reporting organization.’

(q)

‘It is the job of the Chairman to talk to the investors/owners about governance issues and to carry their feelings to the Board. The executives should be the ones that deal with analysts – they both must meet some of the investors.’

(r)

‘A company the size of Shell is much bigger than a normal FTSE 100. It is very difﬁcult even for the Board to judge what is going on in all parts of it – let alone analysts and investors. It is an open question whether the Combined Code is really suitable for businesses of this size, even if it is right for smaller FTSE 100 companies. In particular, the norm of six years with a maximum of nine seems silly, especially if you want to get people from non-City backgrounds. It takes too long to learn what is going on.’

(s)

‘Engagement works well when it is consistent over a period of time. We had lots of meetings over six months – one every few weeks. In the process positive relationships formed and continued to be built.’

(t)

‘In all this to some extent there was a good cop/bad cop situation. Eric Knight played the bad cop – CalPERS was publicly associated with him but other institutions were a bit nervous about the confrontational approach. The multiple track approach, with some investors wanting change but not agitating at all, others actively engaging to a greater or lesser extent behind the scenes and Knight making a lot of noise, was positive in this case.’

(u)

‘It worked because Shell gave themselves the most appalling shock. This was a company that thought of itself as rock-solid, a Rolls-Royce operation, and it was suddenly shaken to the core. i. The impact on morale throughout the organization must have been huge. ii. Consequently (c/f the light bulb!) they really wanted to change. iii. It’s quite different from a situation where the company sees no need to change.’

I would add the following: 1.

This kind of engagement is a complex iterated multiparty negotiation, and in any such situation it is well worth listening, taking careful notes, and

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building agreement on the easier questions before you tackle the difficult issues. 2.

Remember that Boards and companies are collections of individual people, usually pretty strong-willed and generally with a surprising diversity of views and agendas. It is often not a question of persuading the Board but of helping some people on the Board persuade their colleagues. Therefore in engagement you always need to consider the absent parties as well as those that are present.

3.

Investors are, of course, people too. There was an interesting discussion (counterfactual for reasons discussed in Chapter 4) on what would have happened if this kind of problem had occurred at BP. The view of my wellinformed interlocutor is that someone who had built up a lot of credibility and trust with investors, such as John Browne, would almost certainly have retained the support of the investors and his Board. At Shell blunders of substance were compounded with blunders of style – investors had a negative view of Phil Watts already, and the fact that he did not personally take the Conference call to discuss the reserves issue was a further black mark. To a signiﬁcant extent the major investors are the CEO’s customers: it is essential to take them seriously.

4.

AGMs can matter. It is often stated that these have become rather irrelevant, with the major investors making their points privately. Nevertheless at the Royal Dutch AGM the comments from major Dutch investors were remarkably forthright and although they had been making similar points to Royal Dutch in private, the public criticism made matters very clear.

5.

Timing is very important. For example, if Shell had reviewed their reserves booking when the SEC had announced their revised guidance in 2001 it would have caused problems but not a scandal. Equally, Shell generated an enormous amount of goodwill by delivering the structure review a few days earlier than promised: an elegant demonstration of show-me phase.

6.

The quality of relationships is enormously important. It was difﬁcult for the NEDs to see the specifics of the reserves problem but they must have realized that there were strains in the relationship between Phil Watts and Walter van der Vijver. Certainly the special factors at Shell made this difﬁcult, but in a normal business the NEDs should think hard about how to address relationship problems. They might be a symptom of trouble: they will certainly make any trouble that does come much worse. Equally the relationships built within the Board and between the NEDs and the investors were crucial in redeeming the situation. Relationships are not a

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substitute for effective action: investors don’t just want warm words and are highly sceptical of spin. But they do provide a context in which decisions can be made more wisely and actions interpreted in a positive way. It could well be in the best long-term interests of Shell that the reserves problem, which might have been a minor embarrassment if nipped in the bud, became a catastrophe. Without something like this it is unlikely that the governance reforms would have happened. Many great companies can trace their greatness to a nasty shock. A highly successful company whose governance embodies global best practice and whose management is prepared to agonize publicly about whether ‘we understand the word “humility”’ is going to be an increasingly formidable force. With Shell, to borrow a slogan of BP’s, there is every reason to hope that the best is yet to come. Let us leave the last word to two investors: I think this was a quality dialogue. It was a good engagement and outcome – so far. In a way it is not over – they have arrived at a new structure – now they have to make it work. There is always a difficulty of translating strategy into specifics. But so far so good.

PART THREE

Notes of Experience Hear the voice of the Bard Who Present, Past and Future sees! (Blake, 1794) ‘They are my favourite investor.’ Other chairmen concurred. ‘Why?’ asked the CEO of one of the investor’s competitors. ‘They are very focused, ask excellent questions and bring a global perspective. They are long-termist and help you see the investors’ point of view. Their level of detailed understanding is enormous, and you come away from discussions with them having learned a lot and having had your thinking challenged constructively.’ When I was on an early Board I had very little idea what was really going on until I became Chairman of the Audit Committee. I’m sorry to say that the NEDs know absolutely nothing about the business. This section consists of some of the insights gleaned from the chairmen, directors, investors and others who participated in our masterclasses and our investor/ Chairman dinners. In each case I made rather detailed notes of the discussions, which were then sanitized and sent to the participants (only) in draft for comments. Once these had been received I aggregated them and currently have some 210 pages of these detailed notes. I have tried to classify the comments by theme and extracted about 20 per cent of them for this section. About 65 per cent of the other comments are given in Volume II (which can be ordered through www.constructiveengagement.com and will be updated). About 15 per cent of the comments have been discarded either because they have little content when taken out of context or because they make somewhat sensitive remarks that we’d prefer not to repeat. The categorization is a bit arbitrary, many comments touch on several aspects. The aim is to give a feel of some of the discussions. I have also resisted the temptation to make this look more ‘intellectual’ by performing a statistical analysis, which would interest academics more than practitioners. This section is divided into four chapters:

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●

Chapter 11 – Chairmanship and Board Effectiveness – covers topics such as the role of the Chairman, the relationship with the CEO, building Board effectiveness and Board evaluation.

●

Chapter 12 covers independent and executive directors, including the role of independent directors, NED appointment and the often thorny matter of remuneration.

●

In Chapter 13 I focus on the investor industry, investor engagement and activism.

●

Chapter 14 offers perspectives on the governance landscape, considering the aims of governance, lessons from failures such as Marconi and Enron, and the impact of Higgs and SarbOx.

Although I don’t identify the individuals who have made these comments, I do indicate the category into which they fall: ●

Investors (either the Chairman, CEO, CIO, or occasionally a senior director from an investor/Chairman dinner) or the investors who participated in the masterclasses (who tend to be head of governance in their firms) are preceded with I.

●

Chairmen are preceded with C; often they are NEDs as well.

●

Main Board Directors of listed plcs are shown by D. They are generally NEDs who are also EDs but about half of the NEDX nominees are Main Board directors without NED experience, and some of the NEDs are no longer EDs.

●

Other contributors preceded by O. These would include NEDX nominees who were not yet on their own Main Boards, and other people (such as senior civil servants) who occasionally attended such discussions.

At which point my authorial voice falls silent, and I invite you to eavesdrop on parts of some interesting conversations.

CHAPTER 11

Chairmanship and Board Effectiveness THE ROLE OF THE CHAIRMAN WHAT MAKES A GOOD CHAIRMAN D:

That [balancing the Board] reinforces the role of the chairman as the most important key. When I was looking for my ﬁrst Board roles I looked for a Chairman: 1. I could trust, 2. who took it seriously, 3. who had the right attitude towards the role of the Board in providing challenge to the executive, and 4. who had a good relationship with the CEO. It’s so important to get the right Chairman if the NEDs and the Board are to work properly. The lack of an independent Chairman is why there are huge problems in the US, and I see it as a problem in a non-UK company I know: the Chairman is very sound but his dual role as CEO means that the Board operates in a very different way.

C:

As Chairman I have had in mind four guiding principles: 1. accountability 2. transparency 3. objectivity 4. continuity (since CEOs come and go). The character of the Chairman is very important. Key questions for any Chairman are: ● Can you make decisions – allowing proper consultation and debate? ● What’s your track record? ● Do you allow proper questioning? ● Did you do what you said you’d do? What are the actions that you have taken? Investors need to then join up the dots and form a clear picture.

RESPONSIBILITIES OF THE CHAIRMAN I:

Sometimes companies seem to think that ditching their Chairman and looking for a new one will appease the shareholders, and the Chairman becomes a fall guy. Often this is not really what the investors want.

C:

I’d accept that as far as it goes. There is a difference in accountability and the Chairman could be the fallguy in certain circumstances. After all, he or she does have ultimate responsibility for the conduct of the Board.

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C1: C2:

C: I:

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The role of the Chairman is absolutely critical in the proper functioning of a Board. I’m so glad you raised this point. It was an area which Sciteb’s response to the Higgs consultation did not emphasize sufficiently. What the NonExecutive [NE] Chairman does is utterly critical to the Board working. I have been NE Chairman for many years and the number of my CEOs is now in double ﬁgures. The role of the Chairman is very important. Ultimately governance is their responsibility. I am not sure that this fundamental point is properly understood or clariﬁed.

O:

It’s interesting that no one has stated categorically that it’s the Chairman who’s responsible for the overall quality and governance of the Board.

I:

We are very clear that the Board’s job is to run the company – if we don’t believe that the Board is doing its job then the Chairman should be held to account. We do not think that it is our job as investors to run the business! We also recognize that Boards are human beings – we do not expect them to act like a machine and we don’t expect no mistakes, but a balance of risk and reward.

C:

I am absolutely convinced that the value and contribution that a Board gets from its NEDs is hugely dependent on the Chairman. Indeed one of my concerns is that the Higgs enquiry will not sufﬁciently cover this point. A good chairman can hugely influence the selection of NEDs, their involvement, the information provided to them, the relevance of Board agendas, the relationship of the NEDs with the Executives, strategic awareness, succession planning, and many other very important issues. A good Chairman will put a lot of his own time into working at these various issues. A less good one will not.

WORKLOAD INVOLVED C:

I spend 3–4 days per week on my main company’s business, with a particular focus on succession planning. But I very deliberately don’t have an ofﬁce on the company premises. You can, of course, be part-time but you are Chairman.

C1:

Based on your experience, what kind of information flow and time commitment is involved as a Chairman? When I was Chairman of one company, in a steady state I had a threehour, one-to-one meeting with the CEO once a month. We would talk about anything and everything – one minute a product issue, then the next moment international strategy.

C2:

CHAIRMAN AND CEO – SEPARATION OF ROLES C1: C2:

Are you in favour of the idea of a Non-Executive Chairman? Yes. I fired my CEO and have appointed a new one. This took far longer than I had intended. During this time I have been the Acting CEO, and I

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can say with authority that it is very hard to combine these roles. Indeed on two or three occasions I know I got it wrong – I was too pushy on my own Board in favour of a particular course of action. To be fair, I realized the CEO had to go a few weeks after I became Chairman. The independence of the Chairman is most important – however, although it may be important, there are instances where you just have to be Acting CEO. No course of action in business is without risks. D:

There does seem to be a strong view in the US that the Chairman and CEO should be split. This is tempered by suggestions that it cannot be done for serving chairmen and CEOs, because it would be perceived as a demotion. Given the vastly inflated sums paid to most US CEOs, you might have thought that they could take such issues on the chin.

I: D:

What do executives think about the CEO becoming the Chairman? We think that it is something that needs a good explanation, but can be done. We don’t think companies should be run to placate PIRC.

C:

I heard an interesting comment from a CEO who became a NE Chairman. He had heard of some development within the company and walked out of his ofﬁce to sort it out, but then stopped and walked right back in. This emphasizes that you need to be able to step back and not get so involved as a chairman.

C:

Some years ago I looked into the (then) nine companies worldwide that had a market cap of over $100 bn and they all had a combined chairman and CEO. So are we sure the separation is a good idea? There is much more separation of Chairman and CEO now.145

O: I: C:

I: C1:

How did you ﬁnd it making the transition from CEO to Chairman? At ﬁrst I thought that the prohibition against this was a nonsense, but my experience has rather won me over to the view that it is not normally a good idea. I would make an exception in the case when a CEO moves up to Chairman and the COO becomes CEO because then you have a fundamentally similar relationship. There is always the explain option. It is important not to overemphasize what governance can do. I have been an NED for many years and I am still not convinced that the Chairman/CEO split is absolutely right. In the US it is very rare, to the point of hardly existing, and yet on average US companies have been very successful indeed – the odd scandal should not detract from the great success of other major US businesses. Accountability may be clearer and decision making quicker under the US model.

RELATIONSHIPS WITH OTHER BOARD MEMBERS C:

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[As Chairman] you have to run an open process. You must ensure people are included. I never want to take decisions unless they can be unanimous In June 2004, 27 companies had a market cap greater than $100 bn.Thirteen (48 per cent) clearly separate Chairman and CEO, another two have a President/COO. Of the top nine, ﬁve (56 per cent) separate and one has a President COO. Six of the top ten do.

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– even if one NED is holding out you should listen, and I have has known signiﬁcant improvements to a decision come from this. C:

You need a good sense about the people in the group. The succession planning side of the job greatly interests me. We also need to make sure the Board gets the information it needs. But equally it is important that the Chairman does not get under the CEO’s feet or vice versa.

C:

Meet the NEDs informally, without the executives, occasionally.

I:

Personally, and from my company’s perspective, I don’t see the move towards the SNED as terribly worthwhile; however, I can see where they could sometimes be useful if the Chairman is conflicted. And it is sometimes difficult from the outside to judge independence. There is definitely a desire to know the NEDs more, and the audit and remuneration committees are natural areas of interest.

C:

As a Chairman I must say I’m against too much spontaneous discussion – NEDs and EDs need some notice of points coming up. If it’s a big strategic issue, there are pros and cons to collective chatting with other NEDs. It’s always interesting to have an open debate and to hear the input NEDs bring, but equally one doesn’t want unprepared views.

THE NATURE OF INDEPENDENCE I: C:

Can the Chairman be independent as an NED? There is no such thing as the truly Non-Executive Chairman.

OTHER COMMENTS I:

The quality of the Chairman is crucial to the effectiveness of the Board. But it’s generally very very hard for outsiders to judge this.

D:

Although the US Board on which I sit has all its major posts filled with excellent people, whenever the Chairman goes to Europe he makes a point of trying to meet the heads of European competitors to benchmark their calibre against that of his people. By contrast, UK and European companies tend to be much less knowledgeable about the calibre of people at their major global competitors.

THE CHAIRMAN'S RELATIONSHIP WITH THE CEO THE INGREDIENTS OF A GOOD RELATIONSHIP I: C:

But you don’t have two CEOs and sometimes we suspect that the CEO is really to blame. Absolutely not. But governance is adding a signiﬁcant additional load on companies, and to some extent it is part of the role of the Chairman to shield the CEO from this so that they can get on with running the business. Dealing with the business, customers and suppliers should be

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the CEO’s focus. Investors should not try to get involved in the particulars of relationships between the Chairman and CEO. They should look to the chairman for independence and real focus on shareholder interests. All of this is a one and a half person job. C:

CEOs need more counselling from a Chairman than is often appreciated.

C:

You can have people that meet all the criteria for excellence, team membership and so on, but they lack the X-factor. Also good Number 2s often don’t make good Number 1s. Having a good Number 2 who doesn’t want to be Number 1 but can be relied upon for loyal support and advice is of inestimable value. I have had a number of these, and being able to come in and say ‘I think I may have got this wrong – I’m not sure what I should do’ in confidence and trust is great. Hence Maggie’s famous dictum – ‘Every PM needs a Willie.’

I:

O: C:

One of my rules of engagement with my CEOs is that there are no secrets between us. I talk to my CEOs at least once a week.

C:

I am very clear that any instructions I give are only to the CEO. If people come to me with information, then my ﬁrst questions are: ‘Does the CEO know? What does he suggest?’ You can’t be a great Chairman without a great CEO. Conversely, if the CEO has to leave, then usually the Chairman will have to go too in due course. This is a real dilemma.

THE CHAIRMAN AS ACTING CEO C:

I have worked hard to explain the relationships and roles between the chairman and the CEO. As well as the CEO, I have regular access to the CFO, the head of investor relations and the head of external communications.

C:

Succession planning is an issue as well [as to whether there should be a non-executive chairman]. In a small company there may well not be a CEO-in-waiting so it goes with the territory that the Chairman may have to step in if the CEO falls under a bus or has to go. But it should not be for too long, and it inevitably will not be done well. I have done it twice and I admit I quite enjoyed it – being Acting CEO gave me a chance to fix a number of problems that I had noticed but as chairman had not been able to deal with directly.

C1: C2:

Do you allow the Board to modify a recommendation from the CEO? Yes – but we would all take it back and think about it, it would not be done wantonly on the ﬂy. I will never allow this – the Board can only send it back for reconsideration. We could have a debate in the Board and all agree to change a recommendation – if we all felt comfortable with the result that would be ﬁne.

C1: C2:

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CHECKS AND BALANCES D:

C:

C:

How difﬁcult is it for the Chairman to develop the right relationship with the CEO, when on the one hand you are there as coach, but on the other to act as a check and balance? I’ve worked with 13 CEOs, all of whom were very different. The answer is, it’s different in every case. There are riveting problems in personal relationships. I can think of one leading Chairman and his CEO who are both good friends. They are very different. It was difficult for me with one CEO who had a penchant for a US show-and-tell style and his attitude was that the Board is a necessary evil, and I had to get him from that position to see the sense of explaining things to the Board and accepting that his performance was judged by the Board and by meaningful criteria. The NEDs can be very helpful in this regard and ours were terrific. I was deeply and unswervingly supported by them. The company would have broken if they had not kept with me, but the NEDs were wonderful in saying to the executives. ‘This is the way things are’, and if nobody loses their nerve eventually the executives come round. It’s big stakes because in the long run, companies owe their longevity to the quality of their Boards. I joined the Board of a company and went from Non-Executive Chairman to executive chairman to CEO and then back to Non-Executive Chairman. I found it was very difﬁcult to let the CEO get on with it. The withdrawal symptoms were quite marked and it took some time to adjust. All too often in the past people have moved from CEO to chairman automatically, and without making the necessary adjustments in behaviour.

COACHING AND DEVELOPING EXECUTIVES AND HOLDING THEM TO ACCOUNT C:

Based on over 30 years’ experience of Boards, relationships must be based on trust. We have had rogues on boardrooms and you have got to catch them, but tying people up in rules is not the best way to do it.

C:

As a nominating Chairman I use NEDX because the NEDX process puts time and effort into finding the right appointments for nominees that would not be spent by a traditional supplier. This is a helpful part of the overall solution. NEDX takes particular care to understand the individuals and see where they might ﬁt, and then it works harder to see where they should go and sell them to potential recipients.

C:

I think the NEDX process is a great initiative. I was lucky to have the experience, in my 30s when I was a CEO, of a Chairman who encouraged me to serve as an NED – it was the best development experience I have had. That was the experience I would try for, but it is a very different role from that of an executive.

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STEERING THE BOARD AGENDA SETTING THE AGENDA D:

I agree the agenda needs to be set at low level and technical because you need to get to the choices. For example, ‘Do we go for the X or the Y market?’ But because most of us don’t have the technical/scientific background you need ﬁrst to raise the level of the discussion to consider, what will happen in the external environment, how is it going to change in next five years, and have a structured way of crossing over subtle internal boundaries. You can often give it a different perspective.

C:

It’s the job of the Chairman to ensure that everyone gets the information early and that, through early discussion, there is proper buy-in.

C:

The Chairman owns the agenda with the Company Secretary. I find it helpful to circulate a rolling agenda 15 months in advance. This helps the Board get a medium-term perspective on what they will be doing, and it is also a useful tool for the executive management because they can schedule their XCo agenda in the light of Board topics. Any of the NEDs can of course suggest modifications of the agenda to the Company Secretary.

LENGTH OF AGENDA AND PAPERS D:

I once had some Board papers which had a clear discussion of the issues and then ended up recommending the opposite decision to that which the evidence pointed. I remember telephoning the FD to ask if I was missing something. I got the impression that the CEO wanted one decision and his colleagues felt that the evidence pointed the other way.

C1: C2:

The weight of paperwork in Board papers is terrifying. The Chairman should manage that. One hundred pages of Board papers are excessive.

I:

If you can distil the future of heart surgery into two pages then you should be able to do the same to key business issues. We all have too much information. Reduction is essential.

O:

How many additional issues can be added to the Board agenda? What are the top priorities? What has gone off the agenda? Nothing has gone off the agenda: the additions are coped with to some extent by pushing things down to sub-committees. The key is to establish, for example, a safety culture throughout the company and to have the processes in place to cope with the other seemingly more peripheral issues. We are spending very much more time on environment, health and safety and social responsibility. These issues can get 15 pages in the annual report and there are another ten pages on remuneration, so this is about 25 per cent of the total. But do investors really want such weight given to these issues, as opposed to the CEO’s statement on strategy and the Chairman’s statement on outlook? HS&E is good for business (and neglecting it is bad) but the load is very much greater and issues like products, marketing and R&D tend to get superseded.

C1:

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DISCUSSION D:

I have seen issues being bungled because the Board has to rush out.

C1:

When the executives respect the NEDs you can have a true open debate, and modiﬁcation of a proposal can then happen. But you don’t want the CEO backed into a corner.

C2: C:

Too much ‘process’ on the Board can act as a damper to proper discussion of the strategic business issues.

D:

I would like to differentiate between open and closed items. A good Board leaves enough time for the open items. If the Board only goes to closed items, these can be crowded out. I agree. Two or three times a year I have direct Chairman discussions on occasions when the CEO is not there and we’ll discuss the CEO’s performance. On other occasions, I’ll discuss with the CEO how he feels his executive are performing.

C:

OTHER C:

Board meetings once a month is too often. Six to eight times a year is about right, though if there is a crisis you just have to meet when you need to. There is a danger of Boards being cluttered up with governance. One tries to keep the Board clear of it, but the committees do tend to be.

C1: C2:

I run Boards by consensus and never have a formal vote. I agree. We never have a vote – in all my time I don’t recall having one.

I:

It has been suggested to us that some Boards spend at least 80 per cent of the time on governance issues. Surely not! It should be a minor part of the discussion, integrated into good business practice. There are perhaps two Board meetings a year where we focus a bit on governance issues: the one were we approve the annual accounts and the one where we approve the interims.

BALANCING THE BOARD MANAGING BALANCE D:

What do people think about the balance between the executives and the NEDs? I don’t believe that the numerical balance is so important. It is the responsibility of the Board to ensure that the NEDs are listened to, in my view. But if you have a fair number of EDs and you then add more NED members just to keep up the numbers, you end up with a US-style Board. You need to get the balance right on a Board between action and challenge, and between continuity of people and re-invigoration with new people and perspectives.

C:

If you are the Chairman of the NomCo you also need to be sure that you have the right balance on your Board. And the population of diverse, broad-based business talent in the UK is much less than in the US.

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I:

It’s quite difﬁcult to engage people and to get them to do it well. I had a debate with Lord Young once where he suggested that institutional shareholders should directly appoint Board representatives. But I’m not sure about fund managers serving as NEDs – it would be very beneficial to the fund managers, but not necessarily so good for the companies.

C:

For good reasons many NEDs are no longer full-time execs – it is helpful in addition to appoint someone who is an executive today.

D:

From the outset the CEO and I recognized that we had a great rapport and tended to think along similar lines – but that we have completely different backgrounds and come from different industries. The Chairman said, ‘That mix is ideal, trust me, I have done this before.’

ESSENTIAL QUALITIES OF AN NED C:

There are serious grounds for concern about what would become of UK corporate governance if people didn’t take this line [that it is worth being an NED as well as an ED]. The supply of suitable people for NEDs will otherwise, in the long run, dry up. It is particularly important that it should be recognized as being in the interests of UK plc to have an expectation of one or two younger NEDs on your Board so that people can be trained. You need a spread of age and experience on any Board. Not enough people have thought it through. It is up to the shareholders (and members of the Chairmen’s peer group) to encourage Chairmen to take this line. It is the Chairmen who inﬂuence the Board rather than the NEDs.

C:

It’s good to have a variety of talents, but too much variety can be a big problem. You need business nous. Professionals (for example, solicitors, bankers) don’t make very good directors because no one goes in to these professions to manage, so they are poor managers. You are no good as a NED unless you can read human situations. The pool is wider than is commonly perceived. I know one highly regarded Board director who came to business at Board level from an academic background, and made a signiﬁcant contribution.

O:

C:

As well as courage, I like women on Boards (although may be that’s a fashion for now that may change), and people who are cheerful and inject a bit of fun. Lastly, and critically, you need to have people you can go into the jungle with.

C:

I have never been a Chairman or a CEO of a business where we did not have in-depth strength on the Board in terms of industry experience, with people with at least 10–15 years experience of the relevant industry. Such people can probe sub-Board level and point out areas from their personal experience of the business which need to be considered further. This creates a healthy relationship between the CEO and the Board.

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EXPERTS AND SPECIALISMS D:

You can see the need on an Audit Committee for someone to challenge the FD. But there is still a risk if you have a ‘designated expert’ that they are out of date. It really depends on how the Chairman uses them. If the Chairman can manage deployment of the expert’s skills in the Boardroom, then you can get a balance.

C:

Coming back to the specialist skills point: you need common sense, but specialist skills in some instances, for example, retailing, helps. We had someone who was given supply chain and spent a weekend in a warehouse picking out clothes. He noticed that there was a problem: 96 per cent of the decisions were right, but remaining 4 per cent was not. There was an issue with the size of the whiteboard they were drawing up their needs on. It was that attention to detail that made him so valuable. As a non-executive, I was pretty impressed.

SIZE OF BOARD C:

It is hard to make a Board function effectively if it is too big. This is one of the downsides of having numerical balance on the Board and lots of INEDs as Higgs proposed. The SID has an important role here in helping to ensure that the Chairman focuses on these issues.

I: C: I:

Any comments on the size of Boards? Not more than 12 people. I’m amazed it is so many. On a Board where I am an NED we went from 15 people to seven and the quality got much better.

OTHER C1:

C:

I:

Although the AGM has become somewhat farcical in many respects, I have heard of bad decisions being avoided in a Board by someone asking, ‘But how would we defend that at the AGM?’ This can be useful for the Chairman. ‘I have to be cautious in view of the likely criticism at the AGM,’ is perhaps a more polite way of turning down an unreasonable request from a colleague. We have a similar standard in the ‘Wall Street Journal Test’ – that is, how would you feel if what you were thinking of doing became published in the WSJ? It’s an interesting way of avoiding temptation.

BUILDING BOARD EFFECTIVENESS PROCESSES AND STRUCTURES C:

The most productive Board meetings are away days when we have a chance to think about strategy. They are longer than normal Boards and we can get to know each other.

C:

The Board is the highest consultative and decision-making body in the company. The executive directors need to have their functional

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responsibilities but also be aware of their wider role as directors of the company. They should be challenged, but in a constructive way – not confrontationally. The chairman should ensure that people are stretched, again constructively. No one is endowed with divine wisdom. C:

If a vote is being taken, you’ve got a big problem; the Chairman needs to sort that out. If a Board is all about politics you need to decide as an NED if you’re comfy with that. If it’s all politics, then the Chairman has to do something about it and stop the nonsense. Chairing a Board is a management task, it’s what you all do in your daily lives. It’s exactly the same process of applying good management principles. It’s important that Boards should not be removed from good management practice. For example, what’s wrong with Board evaluation?

C:

I have had experience of the three styles: American, Unitary and Continental. In my view the Unitary is the best. I don’t like the US model. It’s not really a Board – you can see the CEO but you can’t see the whites of the eyes of the executive team. How can you be a good NED if you can’t get close to the thinking that’s going on in the business? I’m not so strong on having functional heads like personnel/HR on the Board. Ideally you’d have one ED for each major managed business, but not more than three or so.

I:

From a fund manager’s point of view, the process of enhancing Board performance is encouraging. With companies based on real assets it is much harder to have large-scale deceptions as happened in Enron when everything was supposedly virtualized. Ten-year track records are much more reassuring.

PERSONALITIES C:

Body language on Boards is very important. I am astonished that more directors don’t pay attention to this, and it is very rarely discussed. EDs really do roll their eyes and signal disagreement with the CEO – which is very helpful to the NEDs.

ADDING VALUE D: C: I: O:

What constitutes success for the Board? Results at bottom line, share price of the day, consolidating of earnings. Great people on the Board? Long-term value for shareholders.

C1:

The company before I joined had made one very bad decision, a large acquisition that had to be sold shortly afterwards at a substantial loss. I came to the depressing conclusion that, on balance, the Board would have been more effective if it had never met. You are not alone in wondering sometimes if a Board is truly adding value.

C2: C1:

[Executives. who are ready for NED roles, but may not be on their own boards yet] are the chairman and CEOs of the future.

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CONSTRUCTIVE ENGAGEMENT

Now I have an exec. from a FTSE 100 on my Board, and he is not yet on his company’s Board. Not only do we get really valuable insights from this, but he often says how the perspective of being on our Board helps him in his day job.

DYSFUNCTIONAL BOARDS I:

Have you ever been on a dysfunctional Board? I have, and they are very hard indeed to fix. You get factions, excessive politics and it’s very difﬁcult. Especially when it is the Chairman that’s the problem.

C:

The most dysfunctional Board I ever experienced had two directors who had been there over 15 years and were unwilling to retire. The Board had to call an EGM to remove them.

KNOWING THE BUSINESS I:

The number of times I have had a call from a Chairman about an issue in a year, is about ﬁve. There is effectively no relationship! This is a bad thing. Chairmen sometimes talk to the corporate governance officers which is ﬁne but not the same. I attribute this to three causes: ● Higgs undoubtedly de-emphasized the role of the Chairman compared to the SID. ● There is some dialogue between the CEO and the CIOs and the chairmen are not quite clear on their appropriate levels and role. ● We just haven’t been clear enough about what we expect from chairmen.

C:

At another company, they were having a change of CEO and the Chairman wrote a letter to 15 shareholders. The letter hit the desk before they announced their change of CEO. Not one investor was interested in seeing the Chairman.

I:

Some chairmen seem to have the attitude that shareholders are a nuisance and have nothing to contribute. By contrast others come across as ready to listen and have an open dialogue. This may be partly a question of self-awareness.

C:

One Chairman designate got too close to the shareholders and went around the City defending his CEO’s strategy. Whether in fact the strategy was right and the execution was poor, or the timing very unfortunate, is not an issue. The problem was that he was too closely identiﬁed with it. The Chairman must leave enough space to replace the CEO if everything else fails.

C:

It would be really good to try to get near to telling it as it is. In the 1980s I was involved with a defence company, and we decided that we should regularly announce contract wins. So we started putting out a regular stream of announcements and the price went up, even though the rate of contract wins remained the same. It’s bound to make a positive impression. Shareholders and investors tend to be very sceptical about what we are told. It is not helpful if we think

I:

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we are being spun. There is one CEO though who always tells it straight – Warren Buffett at Berkshire Hathaway. His annual reports are excellent and a very very funny read.

BALANCING MULTIPLE CHAIRMANSHIPS C:

I have just been asked to chair another FTSE 250 – it would seem that there is no limit to the number of these smaller companies you are allowed to chair at one time.

I:

We think multiple chairmanship is another example of box-ticking. It completely depends on the circumstances, whether the person really has the time to do both jobs well.146 I applaud that attitude. It applies to independence as well. For example one director has been on the Board of a major company I know well for over 14 years, which the NAPF think makes him non-independent. But he is in fact very independent and it is of great value to have one NED who represents something of a corporate memory.

C:

BOARD EVALUATION BOARD APPRAISALS D: C1:

C2:

C:

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Should someone other than the Chairman do it [Board appraisal]? Yes probably, but it’s the process that’s important. Boards aren’t mechanistic, they’re a handful of individuals and it’s a function of time working together. An external consultant that doesn’t think much about past history tends to be doctrinaire, with theories of their own about how boards should work, and you will worry about the broken glass. It may be better to involve the SID, and the Chairman, with maybe an outside consultant if necessary. You should probably ring the changes. However, you may need to be brave; people find it difficult to say unpalatable things to others. Nevertheless, however much support there is from NomCo for a director to be asked to leave, it is always up to the Chairman to give the bad news of: ‘I think you should go.’ I have added a section on governance to his directors’ report where the SNED and the NEDs write on: 1. The quality of the relationship between the chairman and the CEO. 2. The role of the CEO and the Board. 3. The visibility of the checks and balances. This has already caused us to do things differently and has made it clear that corporate governance is not just a NED thing but for the Board as a whole. In fairness to Higgs he says that having two FTSE 100 chairmanships is something that should be explained if it occurs. But all this discussion is in the general context that the Higgs requirements are likely to be come increasingly seen as obligations rather than suggestions, with an explanation if you don’t follow.

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C:

I would encourage annual evaluation both ways. I am doing it in-house at a company I chair (next year it will be probably be outsourced). There will be a three-point agenda: 1. How effective has the Board been? Has it looked at a range of strategic issues, also views on the balance of the Board? 2. The performance of each individual NED – I tell them what I’d like more of and what less of. 3. Feedback from them to me, what they feel has been good and what has been less effective. I feel it’s important to go through the checklist and do it one on one.

C:

Higgs has one really positive recommendation, that Boards should review their effectiveness. I am a convert to this: ten years ago I would have been against it. I wish he’d stopped there.

C:

Instead there’s a long comet’s tail of Higgsery which is lecturing, not wisdom.

C:

We have been doing Board evaluation every two to three years since 1998. Each director (NED and ED) gets 47 questions (scale of 1–10). They also have a 360o evaluation of each director including the CEO and the Chairman. This is collated and the results fed back – including comments. Each director gets their own feedback with the median of the others. I get them all and the comments. I am seldom if ever surprised by the results. I will then give each director one to two items of feedback.

EVALUATION OF INDIVIDUAL NEDs C1: C2: C1:

D: C2:

Can a person survive and make a useful contribution on the Board when their colleagues know that they are going? Yes in this case, which I regard as a major tribute to the maturity of the other directors. Following the Combined Code, each of the NEDs need evaluation and feedback. This gives you an opportunity to discuss with them how they are doing. Three-year reappointments are good but you must do the evaluation one year beforehand if possible. The last thing one needs is to have to tell a director ‘get off now’. It may be good to phone the Chairman of NomCo for a frank discussion on the performance of the NED. Does this become some form of execution? No, one can encourage the NED who may perform better elsewhere.

CHAIRMANSHIP AND BOARD EFFECTIVENESS

O:

C:

165

I’m told of a US company where each NED is given a 33-page questionnaire about Board effectiveness, and there is a commitment to shed NEDs who measure below standard. This is a bit much for the UK. But the three-year review of NEDs’ reappointment now increasingly has real teeth, and is not just a formality.

C:

I tell them, you can either be evaluated by me or externally – what do you want? They say, by me. I then think about it and give them their evaluation in the round – so that the other directors can each chip in. Sometimes useful, but humorous comments from the other NEDs can be very helpful. Finally, they give me their feedback on me.

C:

I am more positive on the Combined Code. Evaluation is a good thing. It is really helpful to have the discipline of performance evaluation on NEDs, especially when coming up to their three-year reappointment. This should not be automatic. Possibly a year before re-election there should be a hard-headed assessment and if re-election is not appropriate then the NED in question should be encouraged to stand down gracefully to avoid the embarrassment of not being proposed for re-election. Doing it shortly before the dateline is a bit late.

EXTERNAL EVALUATION OF BOARDS C:

One leading Chairman said he plans to alternate, with one year the Chairman doing the evaluation and one year an outsider.

THE CITY PERSPECTIVE I:

When I came into fund management in the late 1960s, we were just starting to perform financial analysis on companies. I remember an old codger who was on the point of retiring saying to me, ‘Never mind all that rubbish. What you need to do is get the annual report, look at the photos of the Board and the profiles of the directors, and ask yourself – do I trust them? Are they competent and do they have integrity?’ I’m now coming round to the view, as I approach retirement myself, that he wasn’t wrong: Board calibre is key – the ﬁnancials ﬂow from that.

C:

From a fund management point of view, do fund managers take into account the reliability of individual chairmen and CEOs to deliver? Do they back long-term horses? This is a bedrock issue. Since the leadership of the industry in question will be dispersed geographically, between cities and countries, the management will be known by different analysts, and it may be very difﬁcult for a ﬁrm to come to a coherent judgement. However, based on my business experience I fully agree with you – the determining factor in performance is people!

I:

OTHER C:

Is CEO performance properly judged? This is a very central issue covering a lot of things. If the CEO is judged on inappropriate targets then it can inﬂuence decisions throughout the company.

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CONSTRUCTIVE ENGAGEMENT

C:

Many years ago we had a US subsidiary where we had the majority of shares but a minority on the Board. Because both the Chairman and the President were incompetent, we decided not to pursue legal devices (recommended by our lawyers) but gave them letters explaining why they should be ﬁred with a copy to all the NEDs on the subsidiary’s Board. This direct, reasoned approach proved effective.

C:

A focus on directors’ responsibilities and corporate governance has helped to some extent, but I welcome the shift in focus to Board effectiveness, which is a much better way of thinking about these issues. It gets governance away from box-ticking. Box-ticking has a bad reputation – you can have a very ineffective Board which appears to tick all the right boxes.

APPOINTMENT OF CHAIRMEN D: C: D: C:

How do you find enough chairmen and CEOs? You are effectively doubling the number of top jobs at FTSE 100 companies. There is an issue about this in the UK, and it will take a while to settle down. BAE, for example, seem to have found it difﬁcult. BAE also offered some examples of the difficulties of a combined Chairman and CEO, and of having an Executive Chairman.

OTHER I:

The key is to lengthen timeframes. This should not be too difﬁcult, since the main investors in UK Equities are pension funds and insurance funds who likewise have very long underlying time horizons. Nominal growth at 8 per cent is very good. People should not chase unsustainable doubledigit growth. You have got to run businesses for the long term, and be clear about this.

C:

There are four arguments that generally drive international expansion: 1. The shareholders demand growth, the home market is saturated but look at the high growth that is happening in country X. 2. We’re better at running our core business than they are – we can transfer our skills. 3. Unless we go to country X we will be left behind; this is the future. 4. I fancy myself as an international businessman and like the idea of going to Beijing (often the real reason).

C:

I was very pleased to get some outstanding people whom I knew and trusted onto the Board. But one investor and the ABI said they were concerned that I knew too many of the NEDs. I replied that the NEDs are there to scrutinize the executive management. They said, ‘But you run the company.’ ‘Not any more,’ I replied. ‘I hold the executives to account.’

I:

It is important that Boards are not fooled by short-term market reaction. If the share price goes up, that may mean that the market thinks it’s a

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good deal at present – but it is no substitute for having a clearly considered strategic rationale. NEDs should all be thinking about the real business issues. C1:

C2: C1:

I chair a small company, which I like very much. The shares were driven sky-high by investors and are now down to a fraction of their peak value, but it is a much better company now than it was then. The large institutions pushed the shares up and it was something of a feeding frenzy. Did you make it clear that you thought the shares were too high? We tried to profit from it – by expanding the base. It’s very hard to stop people from liking your shares (in an appropriate way). How should directors act if they don’t believe that the shares are worth what the market is paying for them? We weren’t entirely sure what to do: we didn’t want to talk the shares down, but we tried hard not to talk them up. It’s a really super company, and eventually it will be worth what it was at the top. We’re on the way to doing it – and the fact that the shares were so high allowed us to do the right thing and build the base with a products business whose profits can underpin the development of the bio-tech part of the business.

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CHAPTER 12

The Independent Directors and Executive Directors THE ROLES OF INDEPENDENT DIRECTORS, BEYOND THE STATUTORY PERSONAL QUALITIES I:

As an investor, you hope that NEDs will have a positive inﬂuence on deals where there is a need to supplement and support management, investment bankers and consultants. NEDs with the right experience can do this. I think that NEDs can contribute: ● expertise ● objectivity ● knowledge – both of people and industries/situations ● the ability to dig down.

D:

The greater danger is not fraud, but incompetence. Yes, the NED can be useful there. The CEO or Chairman may not be inclined to say ‘This NED can’t do their job.’ The CEO can keep delaying but the NED needs to face it. I agree. You don’t even have to see people in this situation to take action. On the whole with negative scenarios it’s better to act sooner rather than later.

C:

C:

I:

C:

I believe that even good NEDs take three years to become really useful, because your leverage doesn’t depend on having an empire: it depends on brains, personal relationships, character, determination and interest. You may be able to free-wheel on the back of the Chairman, but if your Chairman is any good, he will be sucking out of the NEDs what he wants as a task. I can get almost missionary zeal on this because, as a Chairman for 25 years, I believe passionately in Board quality. It’s about the quality of Boards and the improvement of Board quality from the NED point of view. Next to the Chairman it’s the most important factor. Have no illusions, the NED is very important. The NED role is not often done very well but when it is well done it adds a great deal of value. And six and a half out of ten is a high average. Can I clarify when you spoke about three years for an NED, does that mean an NED would then reach their ‘sell by date’ and become less efﬁcient? I really was referring to a ﬁrst-time NED – if people are experienced NEDs it can be quicker.

170

C:

CONSTRUCTIVE ENGAGEMENT

The Board is not there to run the business but to support, constructively challenge and (if necessary) change the management. NEDs can do more than investors in that they have good access to information about the company, but they don’t have all the knowledge of the business. Most of the time the challenge simply becomes – pick bloody good people.

RESPONSIBILITIES OF THE INDEPENDENT DIRECTOR I: D: I:

The role of the NED is to protect the interest of the shareholders. This is the ‘hand in the till’ perception? No, it’s from a positive perspective. We, as institutional investors generally, want to have some sense that you have some people in that role (that of protecting shareholders’ interests). So we have to get to know them in general.

I:

A lot of what I do involves getting information together about the role of governance and the attitudes to it. I’ve asked my principal analysts what they want to see in an NED and their views on Higgs. I was very interested to learn that not many have views. Nevertheless we seem to be able to bring together a view that NEDs should: ● Add value. ● Be able to step into the shareholders’ shoes, especially on issues where there is a potential conflict of interest. Have the stature and inﬂuence to be able to address a situation when things go wrong and be listened to – an air of gravitas, which doesn’t have to be age. In my company some of the people who carry the most weight by their stature are in fact rather young, but well-respected for their achievements. ● Those are the two things I’ve got specific and uniform feedback on. The nitty gritty analysts are not as in tune with governance issues. I myself have those ideas on governance, but other members of my firm are often too busy or lack a governance focus. There’s a long way to go and I’m not sure that the investment community really knows NEDs or is interested in them. They’re much more driven by speciﬁcs.

C1:

I dislike the talk of NEDs vs EDs. What do people think the most important part of the NED role is? To ensure that the executive management of the company is working in the interests of shareholders and creating value. Constructive challenge is needed, and with the ultimate responsibility to replace the CEO. I agree, and to be additive, the governance role is really important. This needs to be seen widely because it touches on many things. They need to protect shareholders’ interests but also bring something different in terms of outlook and (non)traditional lines of thinking. Legally all directors have the same duties – to create value for the shareholders. Good NEDs can really bring something to the business. (1) To provide internal challenge and (2) new ideas. They have to have certain skills and be able to see the big picture as well as ask detailed questions.

C2:

D:

D: I:

THE INDEPENDENT DIRECTORS AND EXECUTIVE DIRECTORS

C:

D: C: C:

171

Governance is number 1. They must act in the interests of shareholders. This is not just a question of access to accounts: it includes compensation, reputation, relations with shareholders, meeting plans and performance targets and three-year objectives. Within this there are roles for NEDs, the CEO and the Chairman who needs to cope with the non-executive. ● Testing, challenging and eventually owning and supporting the strategy and major developments. ● Adding personal value – for example, on each of his Boards there is an NED who understands IT. As a NED you are holding the executive to account for what happens. You must try not to get involved in the how. Surely if the strategy fails it is relevant why? Most strategies fail. The job of the CEO is to ensure that, even if one part of the strategy fails, overall the outcome is satisfactory. ●

There are often only around three really major decisions for a Board to make in a year. Most of the time you’re in monitoring/encouraging/ mentoring mode. It’s a difficult time to be a NED. The trick is to both challenge and support at the same time. Be upbeat when morale flags. Then you have to play quite a role. In some senses it’s contra-cyclical: you need to be there to support the CEO when it turns out he’s made a wrong decision, but you also need to help him to depersonalize it and move it forward.

TIME COMMITMENT I:

There is no ﬁxed institutional view on how many NEDships a person could hold; it depends on the individual. Institutions accept that it’s good to bring experience of other companies, so are very happy for NEDs to have two or three directorships, but more than four or ﬁve is a problem.

C:

You need 15 days per year to be an NED. Ten meetings a year with dinner the night before and directors’ visits, works out at about 15. Fifteen days a year seems a bit low? It remains mine and my house’s view that to have sufficient time to get to know the major divisions of a company and its senior management outside of Board-level attendance, to undertake training where necessary, and to properly prepare for and attend Board meetings, runs to a ﬁgure of closer to 30 days.

I:

C:

If you have a merger under discussion of something similar it can take ages. There is one thing I would like to achieve in the debate, which is to dispel the idea that an NED commitment is 20 days a year. This is rubbish! I had Boards which were meeting seven times a year going up to ten, and these could be five-hour meetings with pre-meetings and reading the paperwork.

OTHER I:

I’m sceptical of NEDs that don’t hold the shares in the company whose Boards they’re on.

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CONSTRUCTIVE ENGAGEMENT

C:

There is deﬁnitely more for NEDs to do. In a three-hour meeting you can have a load of persiﬂage.

I:

I remember talking to an NED of X [a company where technology was very important] and asking ‘What steps do you take to understand X’s technology?’ and being disappointed with the reply ‘I don’t need to understand X’s technology.’

D:

Having opted now for a career as NED on various Boards, it has become clear to me that I am now Chairman and MD and major shareholder in my own ‘brand’ and I have to be a careful custodian of this. It’s only considered to be valuable as long as I am valuable to the Boards on which I sit. You should only go somewhere insofar as that will be valuable to your brand and reciprocally, if you feel you can add value to that Board over time. It only takes one mistake to ruin this.

C:

I have been NED on a number of Boards over the years and two things stick in my mind: The sheer complexity of how a company actually works, which is not at all obvious at ﬁrst. The number of times you can compare what is said on the Board where you are NED with what is done in your own company. Going back to your own company with a fresh perspective is very salutary, beneﬁcial and rewarding.

D:

Here are the key points I have noticed, as an ED who is also an NED, about the transition: (a) The shift from operations to looking at the interests of the shareholders (b) … from governance rules being a constraint on the EDs to being considered by the NEDs as a protection to the company and its shareholders – from constraining and disciplining to protecting and channelling (c) … from detail to key indicators. Often on a Board people tend to get into detail and the NEDs can usefully shift them up to discussing the key indicators (d) … from schemes to themes – if from knowledge to achieving the vision and the strategy (e) Always being willing to ask ‘Why?’ – executives are often preoccupied by the what. (f) Clearing hurdles for executives and empowering them. Be careful that your questions are not seen as offensive (causing defensive behaviour in the executives) – not criticisms but helpful. You need to think about why you are asking a question – to be helpful – or to score points – if it is the latter, you probably want to can it – you are here to help. (g) Clarity of messages left behind. Be careful how you phrase your questions. I find it helpful at the end of a meeting to clarify the message and make sure it isn’t seen as negative. (h) Executives can get excessively immersed in detail – make sure that they see the bigger picture. Show independence when execs get carried away by elegance of technology or their cleverness and lose sight of what the customer thinks.

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THE NATURE OF INDEPENDENCE D: C:

How do NEDs manage conﬂicts of interest? The NED appointment has to be tailored to avoid big ones. In more minor situations where there is a conﬂict, the conﬂicted individual will leave the room – and it is almost always the person concerned who draws attention to the conﬂict and leaves.

I:

People get confused between independence and NEDs. The institutions have no objection to people being NEDs who are not independent, as long as there are enough independent NEDs. What do you think about the bar on independence after nine years? My Board has an ex-executive as an NED and he is the most independentminded on the Board. We explained to our top 20 shareholders and they have not objected.

C:

C:

The length of time someone serves on Board is not a sound test of independence. There is no formula that would work for everyone. It must be considered on a case-by-case basis.

O:

It might be helpful if people talked about ‘formal’ independence. Real independence is a state of mind and will depend on the individual. But investors are accountable to their clients and the ultimate beneficiaries, and need some straightforward guidelines they can use.147

O:

It may well be that a more relevant question would be to look at the average tenure of the Board, rather than the Higgs focus on maximum tenure. Is that the case? Does there come a point when NEDs go native, rather than cease to be the contributing people you want on a board? In some cases, but you can never generalize. It depends also on what the Chairman wants, and how much share of mind you need to devote.

I: C: D: O:

C: I:

All:

147

One previous masterclass attendee was a leading Chairman who had been obliged to retire from UK Boards at 70 and had thus gone onto two major foreign enterprises. There is no requirement to retire at 70. It may be because age is an issue for independence. The argument suggests that you are less likely to take an independent view as you get older. No! The length of service on one Board might influence independence, but age couldn’t possibly!

Post-meeting note: the Higgs review of course gave a more speciﬁc deﬁnition of independence, and does not adduce age as a factor as mentioned in the following comments – rather length of service on the Board.

174

CONSTRUCTIVE ENGAGEMENT

INFLUENCE THROUGH WISDOM, LISTENING AND QUESTIONS C:

Pick your interventions. Make sure how you make your intervention when you speak.

C:

One of the things you most need as an NED is courage. Of course the Chairman should ensure that questions get answered, but in my experience an NED needs to be deeply suspicious about executives who won’t answer questions. The Nick Leeson scandal that broke Barings involved a business apparently doing very well that was not properly understood. Joe Jett at Kidder Peabody also refused to answer questions. The report on Equitable Life highlighted the reluctance of the CEO to respond to questions. You need to beware of such an attitude and not tolerate it.

D:

When I left the company on which I served as ED, I had a farewell do for my investors because about 25 per cent of my time was spent talking with them. As an NED, I now want to be an ‘active listener’ and I’ll be happy to ‘be talked to’ by investors about their concerns and ideas, without me saying anything specific about the company or in any way undermining the management.

C:

At Boards you spend a lot of time monitoring, so you need good reporting and the ability to bring threads together. You say, you’re a bit puzzled, it’s not about scratching through the detail, you’re looking at the big decisions involving allocation of capital and people, strategic direction and/or, as is the case with utilities, their relationships with the regulators, then the infrastructure and relations with suppliers and customers.

D:

It’s all about influencing and not decision making. You’re not there to make the decision happen. When you become an NED you operate by advising, suggesting, persuading and inﬂuencing.

C:

It takes a very long time to get to understand what the business is really about, and how you can best make a contribution round the Boardroom table. And the style of your interaction in the Board is as important as what you say. Yes, a good NED knows how to say things. Very often it is best to speak outside the formal meeting.

I: O:

THE ART OF ASKING C:

C1: C2:

Even on the most effective Board, it is unlikely that at every Board meeting the NEDs are sufficiently informed about all the decisions they are expected to take. How easy is it to ask questions with bite and edge as an NED? When I came on the Board it became clear that my initial contributions were too sharp, and more appropriate for an executive than an NED. It is

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an essential skill of cultural sensitivity to find other ways of getting the right results and to be subtle. I now ﬁnd that some conversations are quite formulaic – but then they become quite open and they get to the point. C1:

C2:

There is coming to be far too much emphasis on structure and process. The key is to have the right people on the Board. I have been on several boards over the last 30 years and I have only seen two votes on issues taken at the Board. There is a danger of focusing on the wrong things. By contrast, two questions I like to ask and which give useful insights are: When was someone last fired for an ethical violation? If this doesn’t happen it might mean that no one does anything seriously wrong, but it could also mean that violations are not detected or not taken seriously. What is the safety record of the company? Companies with integrity take great care of their people. I strongly agree.

THE SID C:

I’m not convinced by the SID. If you don’t have an independent Chairman then a SID is very much a second prize. I would be interested to know how valuable the investors ﬁnd the ability to call the SID?

O:

The SID is meant to help. One of the nice innovations from Richard Lapthorne is to have the SID write part of the annual report on the way the Board functions. I’m not so keen on that idea. Is he going to write a bad report? It’s about the integrity of people and no amount of governance could prevent a Maxwell. An enormous amount of time and effort can be wasted if you focus on process and not on substance. Governance came about more as a result of the delinquent phases. The rush to ISO10000 had many of the same characteristics. We can all improve the quality of UK plc by running our businesses better, but processes will not necessarily get rid of Maxwells.

I: D:

O:

When the Chairman has a dysfunctional Board and is basically not up to the job then surely this is where the SID comes in – as we have recently seen.

CHECKS AND BALANCES: VISIBLE BUT NOT INTRUSIVE O:

I:

Which is really more important, strategy or governance? If you have good governance with a really competent and well-functioning Board, then the business should be able to find sensible strategies and implement them. Whereas if you don’t, you can have a plausible CEO presenting nice-sounding strategies but they may not be implemented well or fall prey to avoidable risks or information may be distorted (or even falsiﬁed) to make it appear that the strategy is working. Ideally you would cover both. In practice, we like to focus on the strategy and then judge over time from results whether it is being executed effectively.

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CONSTRUCTIVE ENGAGEMENT

C:

A number of plcs in which I have been involved have the wrong controls and incentives because they haven’t considered the risks they run in a systematic way. For example bonuses are often paid simply for bringing in business rather than for its profitable completion, which is crazy.

D:

I am of the view that only the NEDs can really perform a monitoring role because the EDs have potential conﬂicts of interest.

O:

There is a serious problem created by the prevalence of transactionoriented fee structures in deal-making. Perhaps investors should insist on a second opinion from a firm whose fee was not contingent. The accounting convention whereby the bid costs do not go through the P&L makes it worse. Is there anything wrong with fees being contingent? The implications of the fees being added to the purchase price in an acquisition could be distortive, though. It would be more interesting if they went through the P&L immediately.

I:

MAKING A REAL CONTRIBUTION D:

As an ED, who has impressed you most as an effective NED, and what is it that makes them effective? One of our NEDs is a US academic, a professor and expert in regulation – a world authority. With his specialist expertise, and his set of relationships round the world he could be perceived as just a regulatory expert. But this is not so – he’s highly numerate, knows the whole industry and has an ability to engage and a willingness to commit the time, which makes him extraordinary. It’s just that combination of personal attributes. Would he be a good NED in any company? Not necessarily – having a passion for an industry and a deep understanding really helps.

D:

I’ve noticed something very interesting. At one company we had someone leave recently who’d been on the Board a long time, and now in Board discussions I hear remarks like ‘If X were here, then he’d have thought such and such.’ So Board members can continue to have an inﬂuence after they have left (without any contact or interference).

C:

When I worked for [a large respected US company] I never was aware of the Board or Board input or any contribution from NEDs, even when I was working directly with a Vice-Chairman on developing their international expansion strategy. I had no idea when the Board meetings were and didn’t care.

D1:

The stress for an NED is how do you answer the question, ‘What value have I added?’ I agree with this comment. As an ED there are a team of people around you who constantly remind you of where you are, if you are on target, how you are performing and so on. It’s a patchy kind of value calculation. But as an NED you can look at things from a slightly different perspective, from a more informal point of view.

D2:

D1:

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D:

In the annual report, rather than just explaining how many Board meetings someone attended, it would be much better to explain what each NED was expected to do.

O:

I have seen a few Boards and worked with a few. I observe two different types of behaviour by the executives. ● Those who will genuinely debate at the Board – ‘this is a tricky issue’ – want input by NEDs and want to thrash issues out. ● Those who say, ‘This is the executive opinion – there you are.’ I think the latter adds most value. Both are right in appropriate circumstances. There are instances where you’d expect the executive to come with a view. Other times it’s more difficult and you don’t know the answer and you need to have the courage to do that. At the end of the day, the executives should make those views, and the diversity of views, known. They’ve got to do it. On some decisions, such as an acquisition, if the executives don’t really want to do it, forget it.

C:

D1:

C:

You can’t make a contribution if you don’t have a clue of what the business is about. I believe it’s wrong, taking money under false pretences. You also need to be sufficiently like-minded with the management to be on their wavelength. NEDs can add value. My advice is: Get to know the main executives well: it’s an investment of time. The Board should know the next layer down. Every NED should get to know as many executives as possible. You’re then able to judge better. The usual complaint from executives is that the NEDs don’t know what it’s like. Generally, if they do have a meeting with an NED they’re highly welcome. For example, one NED whom we lost due to a conflict of interest is now back again. I feel this NED really understands our business and the people in it, and is hugely valuable on the Board as a consequence. So get to know the executives well. ● Try and visit the company away from Board days. When I was in the US recently, I went to visit one of my other company’s operations. It was a colossal facility in the desert. I was able to satisfy myself for real about, for example, safety issues, and so on. The worst that could happen to my main company would be an insurance claim; the worst at this one is death. You get a real feel for what’s going on. Of course you get the red carpet treatment to some extent (which could get in the way of being able to make a proper assessment) but you will get a sense of how things are and get a feel for what makes things tick. Get away from the dry numbers. ●

EFFECTIVE MENTORING C:

Mentoring is absolutely vital. CEOs have a lot of pressure on them and it is essential that they can talk to their chairman with conﬁdence. I was lucky to have learned chairmanship from a mentor. Mentoring is very important.

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CONSTRUCTIVE ENGAGEMENT

D:

The Chairman also has an important mentoring role, both for the CEO and for other EDs.

D:

Our NEDs don’t hold back, either themselves or on forcing opinion out of the EDs. We had a system of pairing whereby each NED pairs with an ED originally for mentoring. Now it’s more informal but it’s normal for an NED to spend 15 minutes to 30 minutes in an ED’s ofﬁce one on one just before a Board meeting. Typically it’s about particular issues, but it does enable EDs to be quite open in communication. This is an admirable practice, but in my experience extremely rare!

C:

COMMITTEES: TIPS AND PITFALLS C:

Be ruthless about the number of major committees on which you will serve but recognize that the minor committees also need servicing.

D:

Committees are important and valuable so long as they supplement the work of the Board and do not detract from it.

C:

I agree the committee is an extension of business. The Audit Committee can take a load off the board, but they are doing it on behalf of the Board. There is a skill and type of experience [needed] to be on the Audit Committee. God bless them?! Terrible work! I am on the Audit Committee at one of my companies.

BOARD VISITS, FORMAL AND INFORMAL C:

If an NED is not in a position to consider Board visits two times per year, they should not be an NED. Bear in mind that all NEDs don’t have to be there at exactly the same time – some may visit before the meeting and some afterwards. NEDs are legally responsible for so much, and the value of paper is limited. Come and see!

THE FUN ELEMENT C:

D:

Why would you want to combine your experience as an ED with the additional workload and responsibilities of an NED? Is the learning experience worth the sacriﬁce? I am here on the assumption that it is. I believe that it should be possible to manage my time effectively and to delegate enough to free up the time required. It should give a greater breadth of experience.

C:

An NED role is currently 25 per cent policing versus 75 per cent positive contributions – that’s just about OK, but going much higher would act as a further deterrent to good people serving on Boards.

C:

Serving as an NED is one of the best development experiences you can have, far better than most of the business school stuff. When you put yourself in live business situations you’ve never been in, and you rise to

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meet challenges you’ve never encountered before, you’ll learn more in one hour than in a whole year of business school. O: I:

You also need to have fun on a Board, otherwise you might as well resign. It’s not just about doing it for fun, but because you are able to make a contribution.

O:

In the 1980s my company diverged into new ventures area. I was director of the ventures business, and I discovered you could have fun with the smaller businesses – but different skills were required. I now question the validity of big companies taking existing people and training them for new areas where sometimes what you need is a person with a specialist knowledge or background.

C:

Do you not ﬁnd life as a front-line executive a high-octane, very stressful life? Not really. I found working as an accountant more stressful – balancing the priorities between different clients. Now I feel more in control and you have more freedom to control it – you could never say to your client as an accountant, ‘That’s not important on my list of priorities!’

D:

NED APPOINTMENT C:

You will have to have good people on Boards and this will be difficult. The idea of placing nominees below Main Board level from FTSE 100 companies is a good one.

C:

I think it may become particularly difficult to get good NEDs. This is not because there isn’t a talent pool – there are plenty of good people – but training up the right cadre, and persuading people to serve, will take time.

D:

We need to hone in on the quality of people as NEDs. You can’t just walk off the street and do this job. Investors don’t come forward enough to do or say anything to contribute. They should be more forthright. They invariably abstain rather than vote against. I agree. We need a closer relationship between the shareholders and the NomCo. In an emergency we will call a meeting to ask a director to step down and suggest another person in their place but I don’t believe that’s at all ideal. The NomCo knows their board and is a better vehicle to make appointments.

I:

C:

I have been a recipient of an NEDX nominee, although he has not yet joined my Board due to clash of dates. The essence of my reason for looking at NEDX nominees alongside suggestions from an appointed search firm was that, in filling the Board, I needed to look for the best person: how I found them is not an issue. We interviewed him rigorously, he ﬁtted well, the chemistry was good so we decided to appoint him. It’s about ﬁnding the right individual.

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CONSTRUCTIVE ENGAGEMENT

CASTING THE NET C:

I:

How will the institutional shareholders react to companies not using head hunters to ﬁll vacancies? Around the Board table we probably know most of the people that we would want to consider. After all, you can only tell what people are really like when you have seen them in action. I can’t speak for all investors but at my company we are totally pragmatic. If we have conﬁdence in the company’s management then we will almost invariably accept their judgement – you do have to be tolerant of speciﬁc circumstances. We have a totally pragmatic approach.

O:

I was recently asked by a Chairman to assist in a strategic succession issue at the behest of some of their largest shareholders. By efficient confidential liaison with the appropriate people at some of the major shareholders, we were able to facilitate a more orderly transition with a more transparent process.

D: C:

What exactly do you look for re. passion in an NED? I like to see passion in an NED about the company on which they serve. You’ve got to believe it, not just look at it.

C:

Has Sciteb noticed a restriction in the supply of NEDs coming forward post-Higgs? They’re more cautious about the positions they take up. One outstanding NED was asked to join the Board of a leading FTSE 100 firm and did the due diligence but was ultimately dissuaded because of the sector, and also by his wife, who was concerned about the level of reputational risk involved. Another person turned down two much bigger Boards in favour of a Board where he really liked and respected the Chairman and CEO.

O:

C:

We have recently hired a director from the USA where we found 30 wellqualified female candidates from a wide range of companies. There is a whole extra dimension of talent there whereas, in the UK, of the 1200 or so FTSE 100 directors, only about 30 are women.

C:

I told the headhunters I did not want the ‘usual suspects’ and I wanted at least one female nomination. They came up with an all-male shortlist. So I asked again. They came up with a female candidate who might have been very good but was far too busy. She said, ‘Have you thought about X?’ So I called X and she joined the Board instead, where she has made a major contribution. I still had to pay the headhunters.

REMUNERATION OF NEDs A FAIR REWARD C1: C2:

How much time do you think it is necessary to spend as an NED? The load is definitely increasing. We would not be comfortable with people doing ﬁve or six NEDships: one or two is of course OK. We pay well because we expect a lot of work: £70 k plus extra for committee chairs.

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I:

We have no problem with NEDs being paid more; it’s a reasonable reﬂection of their increased workload.

C:

One reason we have had so many fewer scandals is that even for £10 m no one good will, willingly mess up their career – but for £100–200 m it would become more tempting.

All:

The effective per diems of NEDs are too low and should be comparable to those of good strategic consultants (c. £6 k per day) – the extra kudos, status and security of a major plc NEDship being at least balanced by the risk and exposure. If people are paid realistic per diems, they are not compromising independence.

C:

By comparison, a middle-ranking consultant from an accounting firm costs £3 k per day. So directors are getting a substantially lower per diem and they have the legal liability. Although the consultant does not personally receive all the fee charged by their employer.

O: I:

I quite agree that companies will have to pay more for NEDs – finding excellent or good people is very important. The amounts paid to NEDs are chicken-feed in relation to the value contributed by good ones – or destroyed by bad ones.

C:

If it gets to a level where NEDs are signiﬁcantly dependent on the income from one NEDship then you have a problem.

I:

You have to be careful that the remuneration for an NED is appropriate. It should reasonably reflect the work and risk involved, but not compromise independence. The problem is that remuneration which may be easy to walk away from for a successful person in the commercial world could be doubling the salary of a professor. I have had quite a few academics approach me about whether they can find NED roles and I suspect that most of them would be unable to make an appropriate contribution. There are some exceptions to this. Of course they are not ‘mere’ academics but heads of major institutions in their own right.

O: C:

I would make far more money from my smallish private equity buy-out than from the other things I chair.

C:

NED fees are a nonsense – they don’t remotely compensate for the risk and the effort involved. We’d be happy to see them double. We applaud GSK for raising theirs. But we do expect in return a very professional job. They should spend an extra day a month at least.

I:

C:

Directors need increased expertise. This will require extra time and remuneration. The understanding is also a function of the amount of time you have spent with the company, both in terms of things like site visits and induction days and in terms of years on the Board. The days of taking 14–15 NEDships are long gone. At most you can do ﬁve, preferably fewer. So why not pay NEDs £100 k and make it a proper career, making it clear that they are expected to put in the time and have the experience?

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FEEDBACK FROM INVESTORS C:

The attitude of some investors to make sensible and innovative arrangements for NED remuneration is inappropriate. If NEDs do their best to demonstrate confidence in the business by buying shares, the institutions should applaud. My predecessor made essentially no money from his time as Chairman. When I came in, I bought a signiﬁcant number of shares with my own money, and I persuaded my friends who were joining the Board to commit to buy a signiﬁcant number a year at the price when they joined. This was a demonstration of faith in the business and a real alignment of interest with that of the shareholders. This did not stop certain institutions from complaining that I was giving the NEDs options and objecting. Surely shareholders should know the difference between an option and a contract to buy shares at a ﬁxed price in the future.

OTHER C:

The net effect of all of this is that there is too much reputation risk and hassle in being on the Board of a public company. Why not go on the Board of a private equity business? You get at least as much (up to £105 k pa) in fees, and an equity upside that can make you serious money.

REMCO AND ED REMUNERATION THE REMUNERATION COMMITTEE AND POLICY I: C:

We should join forces to try to sort out the complexity of remuneration packages! Yes, we should!

I: C:

How far down does the RemCo of a Board go? It covers the EDs speciﬁcally, and then approves policy on the next level.

O:

The importance of the RemCo generally lies not in the absolute sums but more in the signals it gives.

I:

Who should be covered by the RemCo? How far down should it go? I approve of the idea that it should be independent of the executive.

O:

I think it’s mainly score-keeping. Maybe if RemCos simply announced that ‘X is worth every penny of £20 m pa but has generously agreed to be paid only £1 m’ it would be helpful.

I:

Remuneration schemes are very difficult to assess – they have tended to become highly complex. The new accounting rules will mean that shares are the preferred form of incentive, and not share options. Remuneration consultancy is an industry out of control – they are appointed by the company (in practice the executive management) and this is totally wrong – they should be appointed by the RemCo. There also needs to be a clearer consensus amongst investors on appropriate guidelines for remuneration.

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C:

In another company where I was an ED, RemCo worried about the bonuses to, and options held by, directors and we all said, ‘OK we’d be happy to resign from the Main Board so that this difficulty could be overcome.’

C:

The whole thing is now taking up far too much time. I’d rather be Chairman of the Audit Committee than chair a Remuneration Committee these days.

O:

The chair of RemCo should be agreeing the best possible deal for the shareholders with the executives, not vice versa.

C:

I had a surreal experience when I was briefly on the Board of one US company. The CEO came to the RemCo saying, ‘I need $123 m,’ in a combination of cashing options, bonus and so on, explaining that he wanted to buy a sports team. The RemCo just rolled over. The CEO of one of the major shareholders was a good man but he spoke of this company’s CEO in almost messianic terms. I was there because my company had invested a nine-ﬁgure sum. I thought, ‘I’m out of here’; and although it took some time to exit, eventually my company sold its stake for a substantial profit which proved astute. RemCos are where all the action is on a US Board.

C:

You should look at people flow in and out, and not at theoretical comparisons. In exceptional cases it makes sense to get people in with special packages, for example, relocating a top scientist from the US, but this does not have to set a precedent.

CEO PAY C:

I remember a discussion with an investor when I suggested that CEOs should be moved up to the middle point in their peer-group remuneration after three years, and the investor said, ‘What’s the point? They’ll probably be gone in two years.’ The mean lifetime of a FTSE 100 CEO is about three and a half years, and that is far too short.

C:

I will not join Boards where the CEO is paid far more than the second highest paid director, because you can see at once that there is a big ego factor.

C1:

Sometimes you see a CEO arguing on the Board how exceptional his people are and how they all need big increases to stop them from being poached, and you strongly suspect that he is really positioning himself for a pay rise. Why not call his bluff, and be prepared to give his subordinates more than him?

C2: C:

Greedy management is a serious problem. Rewards should be reasonable but not excessive. If you enjoy the job and are cut out for it, then being CEO of a large global concern can be a wonderful job. There needs to be a sensible work-life balance.

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ED REMUNERATION C:

In a Board I was on in 1974 the Chairman got together with the key executives for a debate twice a year. There was a discussion on whether to give the executives share options. The executives said no – this will merely give us a ﬁnancial incentive to do things that beneﬁt the short term.

C:

Promoting to the Board is the cheapest remuneration you can give.

C:

It would be interesting to see what would happen if an organization were up-front about having a policy of paying over the odds for exceptionally talented people. At present, there is a tendency for everyone to pay above the median – a built-in recipe for inﬂation.

C:

There’s not just one measure of success. It can differ widely over 20 years. Also, the metrics are different for different skills. One of my EDs is a specialist in a particular area we have to compete with other specialists in that area so he ends up being paid a lot more than more generalist directors. Trying to square it all up in a tidy way is not easy.

I:

There is not a big issue to solve in terms of the quantum of executive remuneration. The general issue is that there may be a risk of the management being too focused on the share scheme and there can therefore be less of a focus on the long term. This can percolate down the organization.

I:

What is really needed may be ten-year long term bonuses, which are then paid over the long term.

C:

We have a scheme where executives are given the opportunity to buy shares with their own money and then the company will match them up to ten-fold depending on the three-year TSR [total shreholder return] relative to their peer group. The executives then have to hold these shares for three more years. This does give the possibility that executives get big bonuses (at least in shares) even if the share price goes down, provided that they go down less than their peer group.

C:

There are real issues around complexity. Although it is possible to link bonuses simply to total shareholder return there is general agreement that this goes through peaks and troughs which are unrelated to real performance. Therefore most companies have a mix of schemes: ● long term ● short term ● company savings/restricted share schemes.

FEEDBACK FROM INVESTORS I:

UK investors are being pushed by the media and government to focus on CEO pay. It’s one area fuelled by the media who get over-reactive in terms of focus and overstep the boundaries. As investors we have always been more interested in the structure of remuneration packages than in the quantum.

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I:

Remuneration isn’t a very big issue for the investors – except in exceptional cases.

I:

I’m nervous about using TSR as a performance measure because there is a self-fulfilling element in this. Ideally there should be a greater focus on measure that did not depend on market sentiment – although this is a minority view amongst Investors who are judged by quarterly performance. And I also accept the logic that simplicity in targets is a good thing.

C:

On remuneration policy, you have to decide what is the right thing to do and then explain it to the investors. We have recently made big changes to our remuneration policy and then went to the key investors and talked them through it. It was approved without a murmur.

C1:

In large companies, do you see people being unwilling to serve on the Main Board because then their pay will have to be disclosed and subject to control of the shareholders? Yes, there are such examples but I believe they are exceptional.

C2: C1: C2:

Is this going to be a growing issue? We have to be aware of the need to compete for talent in global companies. My company has the largest part of its sales in the US and we have to remain sufficiently competitive with US levels of remuneration.

C:

Why can’t investors publish sensible [remuneration] guidelines and say, ‘If you stay within these guidelines, we should be happy,’ saving a lot of rather unproductive discussion? I’m trying to persuade colleagues to do this. Unless sensible guidelines are produced, the time spent will keep going up and up. This has to impact the ability of companies to create wealth and run the business.

I: C:

INTERNATIONAL COMPARISONS C:

I feel strongly that you should not quote international pay in remuneration discussions. If people want to go and live in the US – that’s up to them. The UK levels of remuneration are much more reasonable.

C:

UK benchmarking is all very well, but what if 85 per cent of your sales are outside the UK?

C:

The culture of remuneration in the US is posing a problem for UK companies – it may lead to great recruitment difficulties. Our US staff were astonished that we attached performance conditions to their LTIPs; this is pretty well unheard of in the US. Surely, though, we are right, and they will eventually have serious problems with executive remuneration so out of hand. You may have remuneration issues as well, with people going into hedge funds.

I: D: I:

Well, if people decide to leave to join hedge funds that is their prerogative.

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I:

There’s a fundamental problem in the different approaches to remuneration in the US and in the UK. It may be that this problem is unsolvable, in which case the future for large multinationals headquartered in the UK is bleak.

OTHER I:

How do you set expectations when you set budgets? This has signiﬁcant implications when substantial bonuses are at stake.

C:

I resent the idea that directors will not work properly unless they are given huge financial incentives. Good people will do their best to do an excellent job in any event. To pretend otherwise is arrant nonsense, and self-serving greed.

O:

One of the strongest psychological motivators is the desire to do right.148 One reason why people seemed ridiculously motivated to ‘earn’ excessive sums of money is that, in a society which has lost its values, earning money becomes a way of ‘keeping score’ which is simplistic and does not require serious thought. I agree. This business of ‘keeping score’ is far too important in people’s minds.

C: C:

Senior civil servants, prime ministers, bishops and so on, don’t get enormous bonuses. Why is it only in business that you are thought to need to be bribed to do a good job?

AUDIT, AUDIT COMMITTEES AND FINANCIAL EXPERTS AUDIT C:

There is a serious problem now in that the large accounting ﬁrms cannot afford to lose a major client. In the old days you would have say three to four key people on an account, if you lost it maybe a couple could be retired and the others moved on. Now you have a very substantial team. As a result the mere threat by the CFO that they might want to put the audit out to tender creates a serious problem, and the accounting ﬁrm is likely to fall in to line.

O:

I had an interesting discussion with a senior partner of one of the big four who was responsible for our internal audit work. He said he was not at all sure that he wanted to pitch for the audit since it would mean giving up internal audit, and he thought that this probably positioned him at least as well to pick up additional business – especially since it did not have to be disclosed in the way that consulting business to your auditors does. Nevertheless $2–3 m is a lot to walk away from, and I suspect this factor may have played an important role in the reluctance of US auditors to speak out.

148

This is not widely discussed, but almost certainly true. See Three Seductive Ideas by Prof Jerome Kagan, Harvard University Press, 1999.

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AUDIT COMMITTEES C:

I wish people understood that audit committees are now really hard work. I have committees where the members expect them to be over in two hours and non-verbally complain when I chair them and they go over three. But it is essential to explore the key issues.

I:

Audit Committee Chairmen can have a profound inﬂuence.

I:

There is something to be said for having all the directors on the Audit Committee since they are all legally responsible.

O:

You practically have to be a serving FD to be able to meet the requirements [for chairing an Audit Committee]. Not necessarily. Indeed it is very hard for a serving FD to make the time available needed to chair an Audit Committee.

C: D:

In the US discussions are minuted in the most anodyne terms. This is a particular problem on audit committees, where fear of litigation means that the minutes suggest that there was no serious discussion of any issues. The problem of course is that any Audit Committee that did not consider alternative treatments would not be doing their job, but if they did consider them and were minuted as having done so it could lay the company open to litigation from (rapacious lawyers allegedly acting on behalf of) disgruntled shareholders.

C:

I rather enjoyed being Chairman of an Audit Committee because you really had the power to insist on things happening, and get to grips with what is going on.

C:

The chairman of the audit committee does not need to be an accountant, it can be helpful to have someone of wider experience, with the ‘ﬁnancial expert’ serving on the committee but not chairing it.

C:

My attitude on an Audit Committee is that I want to be told of all areas where there are differences of interpretation. It is important that the Audit Committee makes/reaffirms the judgements on different treatments, understands their implications and can defend them. I also tell auditors ‘I don’t want to hear about materiality.’ Small problems can be signs of larger ones – especially if there is an integrity issue.

FINANCIAL EXPERTS C:

D: C: C:

I have had one issue recently where I am now required to have a ‘ﬁnancial expert’ on the Board. The qualiﬁcations for this are very stringent, that is, the person needs to be a recent partner or FD. In the old days one could be more of a generalist; now there is a move towards being much more specialized. Is this regarding the financial expert qualification for the Audit Committee? Yes. Lapsed accountants, such as me, don’t qualify. I would be very reluctant to identify myself as a ‘financial expert’ even though I have chaired businesses and audit committees for 16 years. Just

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keeping up with the International Accounting Standards is a mammoth task. D:

A serving FD of a large corporate may ﬁnd it hard to ﬁnd the time to do everything the NED ‘financial expert’ is expected to do. Sarbanes-Oxley and the Smith Review presuppose a larger pool of candidates than is actually there.

I:

What has been the effect of Sarbanes-Oxley and the requirement to designate a ﬁnancial expert? The requirement is very onerous. We are very lucky to have a retired FD of a major company on our Board who has the time and the expertise.

C:

OTHER C1: C2:

At present accountants are not, in reality, independent. This is one reason why the Chairman and the CEO should not be on the Audit Committee.

THE COMPANY SECRETARY I: C:

Often as investors we see FDs who are also the Company Secretary. I think this is a very bad idea. Although the routine admin of the company secretariat functions can be subsumed into the FD’s work, the strategic and governance roles are separate.

C:

If the General Counsel is also a member of the Executive Committee then you can sometimes have a conﬂict if the executive is strongly advocating something to the Board where counsel may have.

D:

The separation of roles is key for integrity. Often the real discussion for the executives is, ‘How can we get this past the Board?’ At the company at which I am Chairman we now have a separate General Counsel and Company Secretary, but the role can be combined with the right calibre of person. I know of a number of companies where they currently combine the roles because of the person, but plan to separate them when this person leaves.

C:

D:

POINTS TO CONSIDER BEFORE ACCEPTING A NEDSHIP C:

You need to meet the people when you are doing your due diligence. Meet the Chairman and CEO and ask the CEO how the Chairman runs meetings. Chat to a couple of NEDs about how it feels to attend Board meetings. Style affects things.

C:

Don’t have an over-specific idea of your own value. There will be useful contributions outside your narrow expertise.

D:

It takes a year to learn a business, so don’t take on more than one NEDship in any 12-month period.

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C:

My advice is to ‘choose your parents wisely, and really do your due diligence’. Is this a well-run company? Get a feel for the company; its culture, its approach to governance and so on.

D:

Ask for three sets of old Board papers. They may well not be the most recent – but looking at them will give you a feel for what the Board discusses and how it operates.

C1:

I think it’s extremely valuable to know something of the history of a company and where it came from. The history of a company so often shapes what is happening now.

D:

It’s the Warren Buffet advice: ‘If you don’t understand the business then don’t invest.’ Also the geography of business meetings, where the businesses are and their attitude to visits – all these issues need to be explored and taken in to account.

D:

When I was considering joining a large pharmaceutical company, the CEO specifically invited me to visit any site I wanted to – unannounced – and to ask any questions I wanted.

D:

I’ve been offered several NED positions and had half a dozen discussions, but have turned them down because of who’s already on the Board.

I:

As a Chairman, how many NEDships do you think are suitable for one person to hold? In my view, it depends on the experience of the NED and their ability to absorb and interpret facts. I have reached a stage in life when I am still happy to work a very full week.

C:

I: C:

As an investor, I’d like to know how you select an NEDship. You need a Board and a Chairman who will allow real discussion with all the relevant facts able to be discussed where necessary.

O: C:

How did you choose your NEDship? Primarily because of the Chairman. Irrespective of other things, for example, sector, you have to be comfortable with the style of the Chairman, know the other NEDs and be aware of how they work.

D:

Do you think you needed to be on a particular Board because of a speciﬁc element you could contribute, or do you subscribe to it being a more holistic activity? I Chair the Audit Committee, which is my primary way of adding value, but you also need to have a good grasp of the other issues.

C: C:

O:

I was on the Board of a US company some years ago and it was a farce – typical of US Boards. The only NEDs who spoke up were the directors appointed by a major shareholder. The rest were CEOs of large corporates and would not rock the boat at all. Perhaps for fear that someone would then rock the boat on their Boards.

C:

Pick your CEO carefully.

I:

May I ask a related question? What sort of due diligence do you do before taking on a NEDship?

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D:

I: D:

C1: C2:

CONSTRUCTIVE ENGAGEMENT

I did a lot of ringing round. Of course with the bigger companies there’s plenty of information in the public domain, but I also asked myself, does the board really engage, is the board well qualiﬁed and is the Chairman someone you can really trust and respect? If you know the Chairman it helps a lot. There is a lot of focus on the Chairman, but what about others on the board? I looked at V at one point. I love the industry, but I looked at the Board and I thought I’d be really exposed there. That’s the last thing you want. I wanted to make a real difference and that can be difﬁcult depending on the other Board members. There’s also a question of how long a time people have been on a Board, it can be too long. What due diligence should one do on a company before joining as an NED? I had 10–12 hours of discussion with the CEO, the FD, the Chairman and the Chairman of the Audit Committee. I also went through the accounts. The quality of the other NEDs was a very important consideration and I really felt that I could learn from these people. I was interviewed by two NEDs but did not meet everyone.

C:

It’s very important for NEDs to understand that they are no longer involved in process. Thus, whatever people’s professional background, as NEDs they are paid for business judgement: only 9 per cent of the time is their speciality required. HR people on Boards can be disappointing – especially if they don’t understand this.

C:

Get enough finance training so that you can fluently read the figures – you don’t have to be a ﬁnancial expert but you mustn’t be ﬂoundering.

C:

The role is very different from that of an ED. You need to be tolerably certain that you will add value. The amount of work is rising with greater emphasis on corporate governance. The business may be different and business behaviour is different.

I:

One needs to consider one’s reputation.

D:

I would like to add two things. Is this a company you’d be embarrassed by being on the Board of? I agree you should talk around as part of due diligence. Another criterion for me is discovering where they want their NEDs to add value. You should listen and note if the Chairman and the CEO support this and value debate. If the company question your wanting to know, don’t go there.

C:

I am an NED as well as a Chairman. You want to be in the best company you can, and you want to see the Chairman in action. I sometimes ask myself in this instance, ‘Am I adding any value at all?’ You need to ask yourself, ‘Is it a well-run company?’ If you’re not sure of the answers, don’t join.

C:

There are two overriding things when choosing to join a Board: ethical standards and behaviour. You can tell from the Chairman when you talk to them. Does the Chairman have real integrity? It’s very easy to focus on

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the CEO, who is of course very important, but there is a change in corporate governance terms, and you need to think how the NEDs interact with the company and CEO. You need to consider this, not when you’ve got problems, but before. I: C: I: C1:

C2: O: C1: I:

What are the danger signals on Boards? Is it an over-dominant CEO? I think this is overplayed. Companies work in teams. Fund managers overfocus on the CEO and make him a hero. (Probably because the CEO is the only person they regularly see.) I have just turned down an offer to serve on a major plc Board as an NED. This is an excellent business run by people for whom I have a high regard. The people in the company are first-rate. However, I don’t have any direct experience of the ﬁeld, and the guts of the business would be, for me, a black box. My family sees the publicity about the former directors of Equitable Life, and they say to me, ‘Why do it?’ It’s really important to me that there is no black box at the heart of a business on which I am on the Board. Yes, you have got to be able to ﬁgure it out. This was not a business about which there were any concerns on the quality of the business or the people. Yes. If you have any doubts about the business, it is better not to join the Board.

ED DEVELOPMENT C:

There are interesting issues in the way in which people’s perspectives develop from executive committee to Main Board to CEO.

C:

When I was at one large company we used to regard ourselves as a closed world – you did not need experience outside to grow – people were almost apparatchiks. That attitude began to change as I was leaving.

C:

One has to accept that there is some pretty poor management around. But a big issue for the future is: where do we find good management who are prepared to withstand the pressures that are put upon them today, and will be to a greater degree in the future? I find the speed of change of CEO/MDs alarming. Lots quit because they just get tired of all that pressure. As a modern CEO you pretty well have to dedicate your life to the company – it’s hard to have outside interests.

C:

The NEDX process has gone very well for us.

D:

My company encourages all EDs to have an NED position, primarily because it is good experience and contributes to our performance as directors. My view is that you should only have an NED position with a business where you can genuinely contribute and, ideally, where you have some relevant industry knowledge. My professional background, for example, was in ﬁnance, but because of my management experience I

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am more drawn to engineering businesses. Although executives are directors, I tend to take the view that they are primarily motivated (understandably) by their personal ambition. The primary duty of NEDs is to ensure that this is channelled in the best interests of the shareholders. As an NED of an engineering company, the executives know that I am both interested in and understand the business activities; they therefore tend to give more care and thought to what they say, particularly where capital projects and major commercial decisions are to be made. I like to think that the executives are now more thoughtful and prepared for interrogation from the NEDs than before. I personally derive great satisfaction from participating in the executive issues and hopefully contributing to the progress of the business. Equally, I have gained from being an NED of a global business with specialist technologies, particularly from first-hand knowledge of international markets. There should be a benefit for both the NED and the company, and I think identifying with the company is crucial if you are to give your best.

NED DEVELOPMENT I:

We have no problem contacting NEDs. We are also quite happy about the idea of an NED coming along to a meeting with analysts to hear the types of questions raised and answers given.

O:

One of the modest objectives we have in the NEDX process is to help get to a situation where every FTSE 100 company has at least one NED with experience of a well-run business. You might have thought this was a precondition for a board, but it doesn’t seem to be.

O:

One highly respected plc Chairman started out by chairing a company well below the FTSE 100 and learned his trade there. Now he chairs a company that is well up the FTSE 100, much larger scale but with the same sound principles.

I:

People will have to pay more for NEDs – and surely the NEDX initiative of getting executives to serve on other Boards is valuable. I don’t think there are lots of people willing to do this job.

C:

There is also an important aspect of apprenticeship in Boards. Do you have all your NEDs on your Audit Committee? [Other chairmen: no.] Well I do have all the NEDs on the Audit Committee, and for two reasons: ● They all have to sign off the accounts and are collectively responsible, so they ought to have the opportunity to scrutinize them. ● It helps develop the less ﬁnancially oriented NEDs.

OTHER C:

It might be better for people to have served as an NED before becoming CEO.

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C:

Should Boards be exposed to strategic options? One of the frustrations as an NED is you always get proposals and never alternatives.

C:

If you are on a Board with very different values to yours, you should be happy to resign.

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CHAPTER 13

Reﬂections on the Investment Industry GENERAL REFLECTIONS ON INVESTOR ENGAGEMENT POSITIVE ENGAGEMENT I:

Our view is that we need to put the companies in the best possible position to do well for you. The strategic point of interaction is at the Board, and you need to make sure you have a good Board. Having significant investments in a few hundred companies, this requires an appreciable amount of engagement. Hence the prime objectives are to get the best people working in the right way. Now the world’s an imperfect place and sometimes you only have one or two shots at getting this right with informal interaction. Then you may have to vote against the Chairman or something. But we will always try to engage, and we use our voting rights.

I:

Feedback from NEDs on the fact that they [investors] have raised an issue with them ‘really gives it status’ when they raise it at the Board. This shouldn’t be so – NEDs should be taken seriously in any case – but alas it is.

I:

Contacting NEDs seems a very big step. It is better if we have met beforehand. That’s a very good point.

C: All:

It would be good to see the odd NED coming to an investor meeting as an observer with the management, and also NEDs attending the results presentation where you get a good indication of what may be on analysts’ minds.

I:

The feedback to the NEDs can be duplicated. There can be some merit in this, especially in situations where there may be a conflict of interest [between the shareholders and some of the executives].

C:

What are the mechanisms whereby you engage? A lot of investors don’t really do it. It starts with the standard investor visits. If they are still concerned, we will call the CEO or the SNED or the Chairman. We typically have about 5 per cent in a company we are invested in so this is enough to be noticed. We notice the views of even a 2 per cent shareholder!

I:

C: I:

The key issues we ﬁnd ourselves dealing with are: remuneration, people, strategy. The most challenging issues are people – where the problem is

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compounded by the fact that the people you need to talk to at the company are often part of the problem. C:

What galvanizes opinion more in the City is the relationship between management and shareholders. We typically have 40-minute meetings with institutional shareholders and although there are opportunities for them to raise issues about Board composition and so on, these are rarely mentioned. This seems to be the pattern throughout most of the City: the Board discusses and spends lots of time before the meetings, but then there is either no discussion from the shareholders or only the briefest of discussions.

D:

Which people do institutions see and particularly evaluate? CEO, Chairman, NEDs? We investors mainly see the FD and CEO, sometimes the Chairman and in certain circumstances the SNED, but normally we don’t go beyond that.

I: C: I:

What is the missing piece of this discussion for investors? It’s so easy to get your shareholders in to talk to them. Don’t have a public debate.

I:

What kinds of questions should the shareholders ask?

C:

One good example is ‘Why are you doing this when all your competitors are doing something different?’

I:

There is no way the institutions can meet all the NEDS – they don’t have the resources. They can meet the Chairman or the Remuneration Committee when there is an issue with remuneration. It’s also useful to meet NEDs when they have a problem, and having a designated SNED means they know who to contact when they need to go to someone other than the Chairman. It’s also useful to have had some background contact with NEDs so they’re not calling people they don’t know at all.

I:

At the end of the day, investors realize they have huge power (and so do Boards), but they cannot exercise day-to-day supervision, and they want Boards to go for effectiveness.

C1:

It would be really helpful if investors said things like, ‘We would like NEDs to accompany CEOs to investor presentations, say four times a year.’ This would increase the level of knowledge around the Boardroom table of what the investors really thought. It would be a great waste of your time in respect of investors because they don’t ask that many questions. It might tell you a great deal about the CEO though, and his ability to explain strategy.

C2:

I:

We do speak to the NEDs on occasion but it tends to be a bit of a last resort. It would be much better if we could have an open dialogue. Occasionally meeting the NEDs, possibly without the CEO, might work well. So might a system where an NED occasionally accompanied the CEO to a presentation. It would make it, in human terms, much easier for investors to ring up and chat about something if they were concerned.

REFLECTIONS ON THE INVESTMENT INDUSTRY

C: I: C:

I:

197

What do companies need to do better when we come to shareholders to discuss their investments? The key point is the dialogue about strategy. That this the key issue. Why not allow these differences of view [about governance issues] to be discussed [at a meeting with a company when there are a number of people from the investor with these different views]? Surely a major ﬁrm of your stature should not be afraid of admitting the reality that people will have different perceptions? This would be very difﬁcult. Our clients expect a continuity of investment decisions. We would get hammered if we exposed our internal disagreements.

O:

Maybe we need the concept of a Lead Investor, roughly along the lines of a SID, so that companies have a preferred point of contact on complex governance issues. This would help to address the problem that intelligent engagement is expensive (and the investors customers seem very reluctant to pay the costs – with the exception of Hermes as far as I know no investor is expressly paid for engagement) and that if the top 10–20 shareholders have to engage in each company the costs are multiplied by 10–20.

C:

If you are a shareholder with 1 per cent or under you can, readily enough, vote with your feet. But if you have a larger stake, and sometimes we have shareholders with 10 per cent or more, then it is very expensive to sell your shares and engagement is usually the only viable option.

O:

Seems to me there are three options, to vote for, against, or abstain. Some believe an abstention vote can be used as a warning shot but in our company we hold that timely engagement between shareholder and company makes this unnecessary.

C:

A ‘hobbyhorse’ of mine (that I’ve been mooting over the years but with no success) is that senior fund managers should, as much as possible, have one NED role. Then they’d really learn about what actually happens around a Boardroom table. I feel it would be salutary and sobering. I’ve never bought the idea that there’d be a conflict of interest. I really feel it’s the missing link.

C:

Over the past few months I’ve been asking a cross-section of CEOs and chairmen if they’ve ever had a useful, productive idea from a meeting with an investor. To date there has been only one person who has. Maybe that was because they misunderstood the nature of a fund manager. Most fund managers trade shares; they don’t see themselves as owners. Therefore the sort of ‘productive’ meeting managers want doesn’t take place.

I:

I:

We want to be told this stuff. In discussions with corporates I say that we want to avoid a row by mistake. If we have genuine disagreements then they need to be discussed properly, but I am concerned that some of the potential bones of contention are based on misunderstandings of the others’ positions. This can be due to poor communications and ho-hum presentations.

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GOVERNANCE ISSUES I:

The quality of work on governance causes us concern. There is a lot of box-ticking. A more proactive shareholder base is here to stay, but we must beware of trying to separate the governance issue from all others. Relationships on both sides need to be more professional, and we need to give lots of warning, where possible, of concerns we have. It’s not good enough to ring up and say ‘By the way, at your AGM in ten days time I plan to vote against.’ Six months warning is much better. This is not happening as it should, but things will improve.

C:

The assessment of the quality of a company’s governance should be built into the investment process. It should not be simply a question for the governance department.

OTHER C: I: O: I: C:

I:

I can see pressure mounting for institutions to have a website which records all their votes. I have no problem with that. There is a huge push towards transparency and this is the one principle that works in all jurisdictions. Would investors trust accounts more if they were from a firm that had proper insurance? Probably not, unless the partners had their assets on the line. In particular, it’s all very well to say that NEDs should spend one day per week in the business, but who do they learn from – the CEO. Consequently if you have six NEDs the CEO could be spending all their time teaching the NEDs and no time doing the real CEO job. Is this what the investors want? Very definitely not. The fund management industry is responding to pressure from the government and felt they had to do something in order to stave off legislation.

FRUSTRATIONS D:

It is quite useful to companies when the investors do form a collective forum. For example, I’m becoming RemCo chair at Z, and it is helpful to meet the investors collectively. There were leaks in the newspapers. The ABI get blamed very often, but investors are more likely to be guilty than the ABI.

D:

I was CFO of my company for six very interesting years. During that time they did some very big M&A deals. When a large investment bank did one of these deals, they then went worked for a major competitor on a similar deal. They did not think this was enough of a conﬂict of interest. My company were (understandably) furious – as far as they could see it was a case of ‘same slides, different titles and numbers’ – but there was nothing they could do other than stop using the investment bank completely. As a result the investment bank lost out on many billions of dollars of disposals.

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All:

There was concern that some had had similar experiences. A common complaint was that the off-limits rule was not being abided by, even within the large headhunters.

I: D:

Are shareholders unreasonable in their demands? Yes. There are cases where decisions have been made, but they’re not given enough time to do it.

C:

At one company the share price fell from 400 to 50 which was a very painful experience. Not one shareholder got in touch with the Chairman.

C:

Getting the real views of the institutions can be very frustrating. The financial press sometimes reports that investors are unhappy (either naming them or more often not). You ring round and there is no consistency of reaction from fund managers. In one company where I was SNED I rang round, with the agreement of the Chairman and of the CEO, the 15 largest shareholders and got wholly confused reactions. Various people felt very strongly on the particular issue but in different ways.

I:

It is very difficult to find the right people who can credibly question the CEO. We suspect that CEOs are actually not that comfortable with such questioning. CEOs should be – they get detailed questioning on Boards and good Chairmen will coach them on the need to be able to give a simple and clear account. It’s really important that the shareholders raise their game in this respect.

C:

I: C:

We went to one of our large investors and talked through our strategy – they were apparently OK. Two months later we made an acquisition in line with the strategy and the investor sold their large percentage of the company. This was very frustrating. Of course investors must be free to apply their commercial judgement to their shareholdings, but it illustrates the limitations of the dialogue process.

C:

Being a good shareholder and giving thought to each shareholder resolution is hard work. It costs time and money. A formulaic approach no doubt seems attractive, because it is easier, but it is not a good solution.

C:

I wrote to our top 20 shareholders about a set of issues and only five bothered to reply. The institutions must get their acts together. The shareholders were probably pleased you wrote to them and felt that there was no need for a meeting. Leading shareholders can take three to four months to respond before raising corporate governance issues. Probably if they had an issue they would have replied. I hope we replied.

I: C: I: C:

There is an element of distrust that comes into the thinking of major companies in talking to the fund managers. For example, on one Board of a company in difficulties, some of the directors had a confidential meeting with representatives of three fund managers and it was in the Evening Standard that night.

C:

If investors do not approve the remuneration report but vote to re-elect all the NEDs they are presumably saying: you solve the problem. Consider

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the owl and the fieldmouse: the fieldmouse asks the owl how to escape from predators. The owl says the best way is to be able to fly. ‘But,’ says the ﬁeldmouse, ‘how can I ﬂy?’ ‘I don’t do implementation’, says the owl. O:

I don’t think investors realize how much bad feeling their lack of replies creates amongst chairmen. It is a consistent complaint. Even a simple form letter would be helpful.149

I:

Manners are a problem. But post-Higgs, investors are inundated with post. We have companies asking about NEDs and RemCo issues with huge reports from remuneration consultants. Until recently we only had two reasonably senior staff and they look after 700 companies. That’s part of the reason. It’s more about managing the resourcing, not an indication of lack of interest. The load has increased considerably over the last two years and staffing has gone up but there’s a time lag. It’s due to resources.

O:

Absence of reply is a problem. I’ve been urging investors to have a standard letter of acknowledgement – they may think it obvious that they aren’t replying because they are broadly happy, but chairmen have worked hard on their letters and it is dispiriting and breeds mistrust if there is no response.

I:

I regret that the institutions don’t consult very well – they would far rather compete than collaborate.

I:

We had some experience of this [shareholders damaging the interests of the company] when we won some management contracts for an investment trust. Some of the other houses who lost the contract, and who were big shareholders in the investment trust, went public with questions about whether the fund would perform so well under our management – despite the fact that they were talking down the value of their own shareholdings!

O:

Some chairmen have complained that the ABI is not really representative of their members on governance issues. The ABI provided an excellent forum for us to discuss some of our major governance issues. I agree that it can be useful. But the NAPF has a tendency to leak. Unfortunately the IMA has not proved as successful as we had hoped in providing a uniﬁed forum.

C1: C2: I:

149

Perhaps something like this? Dear X, thank you for your letter of the Yth. We really do appreciate you taking the trouble to write to us. As you know we have shareholdings in approximately Z000 companies and therefore must focus our governance resources carefully on those where we have particular concerns. As far as I am aware we do not have any particular strong concerns about the governance of W plc, and so it seems unlikely that we will have any speciﬁc comments or wish for a meeting at this stage. Should I become aware of any particular concerns from any of my colleagues that suggest a different response I will of course let you know. We continue to rely on the Board, under your leadership, to take decisions in the interests of all the shareholders. Investors may imagine that all this goes without saying, but we really think chairmen would appreciate some kind of feedback or acknowledgement – since a considerable amount of effort goes in to these attempts to consult investors.

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C:

In one of my companies, we had a large US investor. We went to them to explain why we were doing something in a non-standard way and they were happy. But when the proxies came in we found they were voting against. Their representative explained that this was because they outsourced their voting to a third party, which makes a nonsense of the consultation. The investor was very embarrassed about this, but all he could do was pull his proxy, so that the vote against would not count. He was unable to change it.

C:

We wrote letters to all our major shareholders inviting them to meet the Chairman and the SID. Twelve out of 18 accepted the invitation, and I went to see one other. Nearly all the attendees had responsibility for corporate governance. We were initially urged by one of our brokers not to do this, because another client did and a number said they’d come but only two showed up. I made it clear that I would not talk about profits and short-term issues at the meeting. They wanted to talk about corporate governance and the relationship between the NEDs and management. We also talked about the RemCo report, and concluded that there will in future always be some who will vote against the report and 80 per cent + acceptance will be the norm. There was discussion about fund managers disclosure of their remuneration and the probability that disclosure of this will be a requirement soon.

C:

I was at the dinner where chairmen of various companies met leading investors. It was supposed to be a pretty confidential discussion, but it quickly found its way into The Sunday Times! There were two main messages that emerged for me [of which the main one was]: a plea that the investment firms should speak with one voice: at present we talk to the corporate governance people in the ﬁrms and to the actual investors and can get two quite different messages.

C:

Thanks to the Combined Code all institutions are encouraged to engage. But there is confusion about who talks to whom about what within institutional shareholders.

C:

In a long history of talking to investors I have never ﬁelded any questions re. governance. It may be that they are exceptionally happy with mine. But I would have liked to be asked about at least the nominations committee and succession planning.

C:

A typical meeting with an investor lasts one to one and a half hours. They will ask about strategy and markets but not governance – it drops off their agenda. It’s true, we very rarely ask. Frankly it’s a function of time. We go for things that affect our investment. We are not interested in running companies or in taking extreme positions in companies.

I:

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INVESTOR ACTIVISM IN PRACTICE GENERAL PRINCIPLES I:

Selling is a stupid response to corporate governance issues. At my ﬁrm we believe that skilled fund managers can add value. Generally, we can’t afford to sell, because we have big enough stakes that putting them on the market will drive the price down. We have lots of in-house analysts and rely on the sell-side less and less. They’re only useful to the extent that they can tell us what other people already think and understand, which may have an influence on whether the current price incorporates all the relevant information.

I:

You need to be absolutely clear in your explanations. PIRC and Manifest can be problematic, but you have to deal with them. The ABI and the NAPF are pretty well essential to get on board. Research organizations will be relied on more and more. This is the danger.

C:

Nevertheless, if investors want a change of Chairman, should we not give it to them?

I:

In considering corporate governance I like to think of what would happen if you were a very rich individual who decided to put some money into funding say ﬁve to six businesses for fun. You would appoint managers, agree the strategy, expect transparency about the state of the businesses, make sure you understood what each of them did, and expect a discussion about any major changes. You would probably be very receptive if one of the managers told you that they needed to organize their business in a somewhat different way for particular reasons provided they were reasonably well explained. You would be pragmatic and ﬂexible in the details. This is the attitude that investors should take in listed companies.

C:

Put in plain terms, how do the investors make sensible assessments of the chairman, the calibre of the Boards, and the quality of the governance? Do they have the necessary skills and experience to make such assessments, and how are these integrated into the investment decisions? These are very important questions. We are clear that we should be applying business judgement and having intelligent dialogue, rather than box-ticking. The institutions don’t want to run people’s businesses for them, and they do want to try to understand the true strategy of the businesses in which they invest. The Pru used to see the management and ask them about this on a regular basis.

I:

C:

Investors make their judgements on bad communication and attitude. If the company comes to them and there’s a feeling of arrogance or complacency then it’s not really consulting.

O:

Maybe you should have asked the investor for an indemnity against the consequences of sacking him. Interesting idea – we didn’t think of that.

C:

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I: O:

Surely no investor would give such an indemnity. Well it might concentrate everyone’s minds if it were made clear that the activist shareholder was urging a course of action for which they did not have to carry the can if it went wrong.

C:

I was at a recent seminar where they had e-voting from the audience. There were about 150 people, mostly fund managers. When asked whether they thought institutions should engage with companies, 90 per cent said yes. But when asked whether institutions had the qualities required to engage with companies effectively, 90 per cent said no. How then are the institutions to acquire these qualities? There is likely to be a shift in the skills of fund managers over time. There will be a greater emphasis on business judgement and not just on shortterm investment performance.

O: I:

SPECIFIC CASES C:

Joint MDs don’t work when companies merge – you need one CEO. However, in this recent case, the deal might not have been done at all to merge the two companies if both CEOs hadn’t thought that they would get a top job. This is what’s known as the ‘social issues’. These had to be taken care of.

I:

At least some of the NEDs on the uniﬁed Board may believe that the fund managers who raised objections were doing them a favour. They knew that changes were necessary, but they didn’t feel in a position to push them through. It is a widely shared perception that the track records of companies where there has been shared power without a clear CEO is abysmal.

C:

Do you think this case [of intervention to force Board change] was putting a stake in the ground by the investors? The general attitude of the investors is that management should manage, although we want them to listen to investors. The results from this recent case are speciﬁc to that situation, and are not intended as an example to others.

I:

O: I: C:

What would have happened if the Board had said, ‘OK then, if that’s how you will behave, we’ll all resign’? I think the investor in question would have followed through. They probably had a contingency Board in mind. They were entirely serious. Investors should be very careful about taking this kind of attitude.

VOTING POLICIES AND PRACTICE I:

We have a policy of voting on all our stock anyway. We have a clear voting strategy which we discuss with our customers.

D:

I was in a discussion group. One Chairman said it’s all very well meeting major investors but instanced one occasion when there was one such meeting: five people were in attendance and there was a warm feeling; the Broker called afterwards and confirmed that all the feedback was

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good. But at the AGM there was a proxy vote, and every resolution – including the re-election of the CEO – was voted against by the investor. When the Chairman rang the investor they said, ‘Oh, we outsource the voting’! That’s scary. C: I: C: I:

I:

O:

I:

O: I:

Does your governance team make all the voting decisions, and how do you actually exercise your votes? We use a voting service to cast our votes. But the mechanism of voting at present is a quagmire. I agree. The development of voting recommendations has an escalation procedure which can go all the way up to the CIO if necessary. The governance team, the fund managers and the analysts will all have a view, and they will generally all interview the top management. When a company comes in to see us, there will generally be someone asking about governance and ethical issues as well as people with a more traditional investor focus. We try to be open about the process that we use for voting. We think transparency is important, and if the client wants to know how we have voted on an issue we will tell them. We think it’s unfortunate that some funds won’t do this. I think part of the concern is that if fund managers published their voting information this would open them up further to activist pressure and lawsuits. Ill-founded lawsuits are highly annoying, but they are a cost of doing business in the US. Despite this, the information should be publicly available. Who is responsible for exercising the voting rights? We have a clear process for this. Starting at the highest level, there is a voting template signed off by our Main Board. We then have to report how we exercise these rules, in the sense of how many times we have exercised each rule. The Main Board does not decide on specific voting issues.

THE EVOLVING CHALLENGES OF MANAGING AN INVESTMENT MANAGEMENT COMPANY DEVELOPMENTS IN THE MARKET I:

Consolidation in investment management is likely to enter a third phase. There are still 24 000 fund managers in Europe compared to 8000 in the US.

I:

If we are in a world with c. 6 per cent returns then there is an increasing tendency for fund management to bifurcate into index tracking and high alpha. High alpha requires you to add value in some way, and clearly one way is to help improve the performance of business by sensible governance and top-management changes. The costs of selling are also a

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more visible drag on performance in a lower returns world. Even if you are an index tracker you have some incentive to try and improve performance, and none to sell (you can’t). So, increasingly, companies and investors will have to work together. The difﬁculty is that we are in a complex environment. We need to work through together to ﬁnd better ways of engaging effectively, where the value is very much greater than the costs. I:

C: I:

The first time [the market timing abuses in mutual funds] sprang to prominence, I asked for an internal review to ensure that we were not involved in such practices in any way. My people replied, ‘Where have you been for the last two years? You told us then to make sure that we didn’t do any business with suspect firms, and so we have been consistently turning away such offers.’ This sounds like a nice example of ethical policies, that may have cost some money in the short term, giving big beneﬁts in the medium term. Turning away business with which you are uncomfortable – even though it is (at least apparently) perfectly legal – is a cost of doing business, but you won’t retain the best people, or your reputation, if you don’t.

REMUNERATION C:

There is an area of trust which is really difficult. One problem is that everybody in industry assumes that investment managers are paid a fortune and that it is a bit hypocritical having them clamp down on the pay of industrialists. Maybe the investment management industry should come clean about what it pays its people (possibly anonymized through the associations)?

I:

I am worried that the lessons of the last three years are not being learned, and that the returning bull market will cause firms to revert to their old habits of excessive remuneration.

ETHICS AND GOVERNANCE I:

At university you are taught about some of the issues around the separation of ownership and control. The theory is that the fund managers help address this problem. Then you get people like [a former investor and current professor] who come to talk to us and say, ‘Fund managers should not be active in corporate governance’ because of the free rider problem. But if fund managers take that attitude then the system will collapse. Leading investors need to take responsibility. They are also thereby adding value for their clients, and giving their clients additional reasons to want to entrust them with their funds. This can be especially important for pension fund trustees in the public sector, for example. The fund management industry is remiss if it does not realize the need to be accountable.

C:

Would you take the management of a pension fund from a company that does not comply with governance guidelines? Yes – there should be a complete separation of these two sides of the business.

I:

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PEOPLE C: I:

C:

How do you evaluate fund managers and ensure that they get a balanced perspective of their abilities and successes? When I was directly running a fund I would encourage people at the end of the year to do a ‘how could I have been so stupid’ exercise. This involved looking back over the year and identifying your most important actions and mistakes. It seems that 90 per cent of what we do in fund management is a waste of time. In my view it takes one year to see a tracking error of c. 1 per cent and thus seven to ten years to know whether you have a significant out-performance. There is a tendency to over-track to try to get to the short-term numbers. A lot of fund managers in fact trade volatility. Do they do it with much understanding of the business?

ESCAPE! PRIVATE EQUITY C:

3i is inundated with people wanting to be NEDs of their investees. The fees are just as good at plcs, there is a tremendous equity upside – a Chairman can personally make £5 m on the back of one outstanding CEO who will make £35 m in a relatively small company. Naturally you want to have a diversified portfolio. I am continually amazed at the calibre of people I meet who are interested in this – it’s almost a case of, ‘not you as well!’

HEDGE FUNDS I:

There is a sort of fuzziness or meeting in the middle of the hedge funds and long only investors. But the world in which we are now operating (6–8 per cent returns) means that management fees are a bigger issue than they were when people imagined that much larger returns were sustainable. There is a sign of a shift with major players like ourselves moving to develop high alpha products. It will be logical for diversified ﬁnancial business to move in that direction.

I:

Hedge funds are becoming increasingly signiﬁcant players. Anyone who owns a big hedge fund, however well run, who says they don’t worry about that is a liar. But hedge funds are becoming very big with leading pension funds investing in them, and in the Middle East the very high net worth individuals are sophisticated investors and very interested in hedge funds.

I:

There has been some leakage of talent to hedge funds, but I think hedge funds are past their high water mark. Why? Fees too high and opacity creates a bubble effect. Also they profit from exploiting market anomalies and these tend to be ironed out, especially where there is a greater weight of money in hedge funds. They also aim to proﬁt from turnover. Finally there is a big survivor

C: O: I:

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bias in the numbers – hedge funds that succeed do well but a lot of them fail altogether. Paying fees [to hedge fund managers] of 2 per cent + 20 per cent of out-performance is ridiculous. C:

Corporate governance feels rather different when 10–20 per cent of your stock is held by hedge funds.

ANALYSTS AND ANALYSIS ENGAGEMENT WITH AND BY ANALYSTS I:

We do study directors’ transactions but understand that there can be legitimate reasons for selling – we accord far more weight to directors’ buys than their sells.

I:

My focus is to try to give our investment analysts a framework within which they can think intelligently about the value and risk implications of corporate governance issues. How can we be comfortable that the remuneration practices are aligned with shareholders interests, for example? Are the motivations right? Corporate governance professionals can’t do it because they don’t understand the business drivers and culture of particular companies. Analysts can do it, at least in principle, but they need to become more familiar with the issues.

D:

We try and keep away from individual briefings with analysts, as it’s dangerous ground. Some firms would insist on one-to-one meetings though – they’d question the seriousness of such players. I though it was generally the case that investors are allowed to ask long-term questions because they are not deemed price-sensitive, whereas short-term earnings-related questions are off the menu – although that is a nonsense if a company is on a P:E signiﬁcantly greater than one. I am surprised by this. In the US, you are allowed to talk about the future but it’s suitably qualiﬁed.

C: D:

FRUSTRATIONS C:

Analysts don’t focus on the underlying business sufﬁciently. They tend to look at detailed points, and not focus on strategy.

C1:

At one of my companies, there was an analyst at a major bank who printed negative, false rubbish about us – despite the fact that this bank was one of our main bankers and led the syndication of a major loan. I said to their MD, ‘I won’t give you banking business if your analyst keeps saying things like that.’ The MD ﬁred the analyst. I did the same years ago – but I would never do it now. Banks are very keen to demonstrate the independence of their analysts. They might say, ‘I agree, he is wrong, but I can’t ﬁre him.’

C2:

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THE INFLUENCE OF ANALYSTS D:

Investors and analysts have a range of insights about the industry that are well worth considering, not least because they have an access to your competitors and compensation budgets that companies cannot match. Although they are not always right, to dismiss them as ‘teenage scribblers’ is immature.

OTHER C:

How do you judge a company and whether to invest in it? There’s the story of the parson who assiduously read the Chairman’s letters and only invested in those he could set to ‘Brother James’s Air’. He was singularly successful at it.

INTERNATIONAL PERSPECTIVE I:

The UK does corporate governance well on the whole. But we do have an issue with the corporate governance movement and we are worried that there will be a tendency to box-tick. Already this is causing problems. A Chairman of a telecoms company I know has said that, given their time again, they would prefer it to be a private company. If we clobber public companies in the UK too much then the entrepreneurial ones will delist by going private or moving to the US.

C: I:

Does any other country do it [corporate governance] better? I’m not convinced that they do.

DIFFICULT AREAS I1:

C: C:

I1: I2: I:

Company visits [that is, visits by the company to the institutions] can be a charade. For example a company comes, with the CEO and the FD – they give a 40-minute spiel most of which we know already. What’s the value in this? There is no real dialogue or information. But remember we have to do six to eight per day – and we have to be very careful not to fall foul of rules against selective disclosure. How do you deal with investors who, under the pretext of engagement, seem really to be after inside information? It is difficult to give engagement and keep it on all fours in terms of information. A lot of the engagement can come if you listen to us. You don’t necessarily have to tell us things. Some companies treat it like football and try to slip you insider information so that you can’t trade, like an offside play. There is also quite a major issue about the ABI and NAPF. The ABI feels it is on a mission to improve governance and hence justify its subscriptions. This encourages it to act in a high-profile way which is by no means always helpful. The NAPF does not have a lot of investor representatives

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any more (that is, I think they are more on the marketing side). The IMA has chosen to work much more behind the scenes. O:

All:

I:

Chairmen often complain about institutions not voting but it seems that there are significant technical problems, especially in companies with ADRs. [A leading Company Secretary] says that they have identiﬁed up to seven levels that can exist from the registered owner of the share to the ultimate beneficiary, and in some jurisdictions it is not merely difficult, but illegal, for them to get involved in the communication up these levels. They can of course ask under the Companies Act for a statement of who the ultimate beneﬁcial owner is. People expressed surprise at the notion that there might be as many as seven levels. But all who knew [this Company Secretary] agreed that if this was [their] view, it was probably right. From my experience of executive committees, I have been saddened by how focused the management can be on spin. I have seen excessive focus on, ‘Shall we put it this way?’ and ‘How should we tell people things?’

PENSIONS THE PENSIONS CRISIS I:

Much of the concern over pension funds and falling asset prices is misplaced. Other things being equal, a fall in share prices increases the health of a pension scheme because the contributions are buying a higher dividend yield. [I think in fact this does depend on the maturity of the fund. If for example you are in fact liquidating the fund then capital values do matter.] In particular, if the market risk premium goes up for psychological reasons then the dividend streams remain the same and the viability of pension funds is unaffected.

D:

A significant part of the present pensions crisis was created by the pension holidays that companies took in the late 1980s and 1990s. If only they had been able to put their contributions in escrow – accounting for them as a contingent liability, then the funds would be there to draw on. But the problem is caused in part by the increased benefits that were agreed. Yes, and these increased benefits were agreed as a quid pro quo for a pensions holiday.

C: D: D:

O: C:

We looked at putting money in escrow into our pension fund – the worry is that we repair the damage and then the markets go up and we didn’t need to, and the money is then lost to the company – but we were advised by the lawyers that there was no proper way to this. This might be worth drawing to the attention of HM Treasury. The pension system is selling an unsustainable dream. When it was introduced the retiring age was 65 and life expectancy was about 67.

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Now the retiring age is 60 and life expectancy is 75 – moreover if you live to 65 then your life expectancy is 80–85. Furthermore, old men are marrying younger women, so the fund may be paying out a widow’s pension 70 years after retirement.

THE CITY D:

I:

It would be interesting to get the investor perspective on the controversy over pensions. Responsibility ultimately lies somewhere between the Board and audit committee. It is an issue the investor community will need to take a tough stance on. What’s your perspective, how do you deal with that? I must declare myself as an actuary before beginning to answer that question. It’s probably best for me to try and interpret where the analyst would be coming from. If you look at the FRS17 – the fact that one takes the spotlight in participation is positioned on mark-to-market value that you really can’t determine the trend until you see two to three years of reports. There has been a high correlation to recent equity markets performance.

TRUSTEES C:

I:

In complex situations with pensions, you may have to go back to the trust deeds to ﬁnd out exactly how they are set up. When I did so, to my great surprise I found that they were all very different, even in the same company. Trustees are in an uncertain position and there seem to be no standard forms. Pension fund trustees generally express very little interest in corporate governance. The investors are berated by the government to do something, but in general the customers show little interest and are not prepared to pay for it. The exception is that many local authority pension funds are very keen on governance issues with a major focus on pay. Trustees in general have to worry about other matters, such as FRS17, defined contributions, deficits, allocation to bonds and so on. So inevitably governance won’t be that high on their agenda.

OTHER C:

Top management pensions are absurd. No one needs a pension of £500 k pa. Some companies may be competing with Americans for top management but most are not.

OTHER O:

It used to be true that plcs could follow longer-term objectives than private equity companies who were looking for a three-year exit. But some plcs focus on three-month timeframes!

I:

Let’s look at the consequences of the change in time horizons. When I was at a major investor in the 1970s, we were clearly long-term

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shareholders. With the life fund we were essentially cashflow investors. We sent out a clear message to companies which was along the lines of: ● We like companies to pay us dividends which are broadly equal to their sustainable free cash ﬂow. ● If you need capital for expansion or acquisition or other investment, then come to us and we will be minded to support a rights issue. ● The actuaries value our investments on the basis of income stream and not the current share price. On that basis the dividend policy sends a very powerful signal. The net result was a very long-term focus.

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CHAPTER 14

Perspective on the Governance Landscape and Trends AIMS OF CORPORATE GOVERNANCE C:

I was on the Hampel Committee and during this we had 500–600 written representations made to us. I think it was unfortunate that Adrian Cadbury placed the focus and the terminology on corporate governance. This inevitably tilted the emphasis onto systems. The focus should be on effective and appropriate leadership. If there were more emphasis on proper leadership then there would be more progress. This would be a development path for the shareholders to go down. We’ve learned a lot in the last few years about what works and what does not.

I:

From a shareholder’s point of view, we really want to get the focus shifted somewhat from shareholder activism (as discussed by Paul Myners) to shareholder interest. This should be a focus for the ISC. We want the institutional shareholders to be clearly seen as being appropriately interested in the companies in which we invest – not interfering but acting as responsible owners. We don’t want to be, or be seen to be, a load of box-tickers. If you have an issue, then talk early to us. Very often problems arise because issues are surfaced too late.

C:

What’s the aim? What ideally would be the position in ten years’ time? Will you need more expertise, costs and effort to allow the institutions to act on corporate governance? I greatly hope that the right governance/Board effectiveness considerations will be integrated into the investment process, and that corporate governance and fund managers will become assimilated in ﬁve to ten years’ time. Of course, this will cost money.

I:

I:

The shareholders can get too absorbed in RemCo issues. I want to move the focus on to real Board effectiveness. [In my roles in industry bodies] I hope I will be able to contribute to this. It is not that remuneration is unimportant but there should not be too much focus on it.

O:

We need a different name for corporate governance. Board effectiveness is surely what it should be about.

O:

The focus should be Board quality not corporate governance.

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C:

I do think that the pendulum of corporate governance is swinging and that the drama will shift to the investors. We need to create an architecture to enable them to be accountable and transparent.

C:

There needs to be a balance of powers. I’m sure you are right – there needs to be a more even balance of power. For five years, some behaviour by Boards has needed constraining. The irony is that the total power of the shareholders to re-jig Boards has not been exercised for so long. Provided we can correct the balance and not have extremism, things will go well. But there is a real worry that the pendulum will swing too far. The corporate governance pendulum does risk going too far. Maybe we as industrialists have a responsibility to resist it?

I: C: C:

I: C: I:

Is there a concerted response from the fund management industry to the pressures that this government is putting you under regarding corporate governance? This is changing rapidly. The institutions feel that they have to raise their game and attempt to work together better. It is deﬁnitely changing. Is the collaboration formal or informal? The NAPF have matters well in hand; the ABI is also active; the IMA (recently formed by a merger) is getting better at representing the views of professional investment managers, and the institutional shareholders committee, meets quarterly and tries to bring the viewpoints together.

I:

It’s important not to jump on the corporate governance bandwagon. We have one very experienced person who deals with corporate finance issues, not particularly corporate governance. We don’t want teams of box-tickers. Where we invest, we want to ﬁnd out what is right and do it. We need to focus help on the two or three situations where it is most needed.

C:

The question to financial intermediaries is, ‘What is the governance process that you use?’ There needs to be more transparency. I have just been on your website and there is no statement about the process, nothing on corporate governance. Actually we do have a document – we should put it up.

I:

SOME LESSONS FROM BIG FAILURES C:

A corrupt CEO will always lead to serious problems, especially if you have an FD who is on the take as well. FDs need to be properly qualified and have enough independence to understand their fiduciary duties to the company and the Board as a whole.

MARCONI C1: C2: C1:

The Marconi saga provides interesting lessons. The City has lots to answer for. Personal circumstances led certain members of the Board to stay on longer than perhaps they should have. When the Board decided to

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C2:

215

refocus the business on telecoms equipment, they should have recruited people who understood that business. The NEDs should have been more outspoken. One wonders about the NEDs letting Marconi acquire these two companies in the USA.

C:

[on Marconi] There but for the grace of God.

O:

At Marconi, one of the NEDs there had a whole file of unanswered questions.

I:

The government keeps saying, ‘We must avoid another situation like Marconi,’ but the specific problem at that company was that the management was egged on by investors and the press in what proved to be a disastrous strategy.

ENRON C:

Enron was a testing time for advocates of a regulation-based approach. They had an (apparently) very high-powered Audit Committee, with a former Dean of Stanford Business School. The problems were not that the functions did not exist, but in the way that they were performed. Yes I do remember when the Board was able to do pretty much what it liked, before there were corporate codes of conduct, but most serious Boards acted with restraint. We also looked with respect at any representations from a shareholder with 3 per cent or more.

C:

I spoke to an Enron director and asked him, ‘How did it happen?’ He replied, ‘We did all that an Audit Committee could do.’ The auditors assured us that everything was being done properly.

SHELL O: D: C: I: D:

What could a good NED do about [something like Shell’s reserves problems]? You need a process that allows the NEDs to interrogate the process, give a chap a chance to explain and discuss the way. It’s very unlikely that would be done at Board level, much more likely to be at the Audit Committee, that’s the place to pick things up. Do two tier Boards work, for example, Shell with their supervisory board? In Shell there there were two Boards. But in my personal view is that the Board operated OK in certain ways. The problem was not directly related to the two Boards. Five years ago they reorganized Shell and removed a lot of the internal checks and balances in order to speed decision making and focus accountability onto individuals. This made it a lot easier for the ﬁgures to be manipulated.

COMPLY/CONFORM OR EXPLAIN C:

The problem is that when companies take the explain route, the institutions must apply judgement and this requires a level of insight into

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how companies work which is not common amongst professional investors. O:

We discussed the point that apparently Higgs has accepted that ‘comply or explain’ should be ‘apply or explain’ and my suggestion that it should be explicitly defined that you are compliant if you have either applied the provision [post-meeting note: perhaps conformed would be a better word] or have given an explanation unless the explanation is regarded by the shareholders as clearly unacceptable. This would explicitly place the onus on dissatisﬁed shareholders to demonstrate why the explanation is no good, rather than at present leaving the feeling that the onus is on the company to demonstrate that the explanation is good.

I:

We are strong supporters of the ‘comply or explain’ principle, and I think it is particularly important that companies do feel free to explain when this is the appropriate choice. However, it seems highly probable that there will be pressure on investors from their clients (especially local authority pension funds) to agree to be ‘Higgs compliant’.

C:

The onus in public discussion of governance is becoming increasingly on policing, and having people say what you can’t do. This is not supportive of the main job of wealth creation. The dice are weighted against management who want to do things differently, and I am concerned that over ten years or so the prevailing wisdom will become entirely comply – it will be too problematic to explain. Governance in the UK won’t be effective if this happens.

I: C:

Why does it [a governance issue] get to that stage [when it is clear that the company is going to be defeated]? I see no problem at all in departing from best practice if you explain. But when you start to depart you expect to go to the shareholders in the first place and talk to them about how things are.

GOVERNMENT I:

As investors we are also being egged on by the government to demonstrate our activism.

C:

Politicians love to get their teeth into things. They cannot resist interfering.

C:

Do you think there will be legislation in this area?

I:

I believe that the government is desperate not to legislate – they realize that additional laws could be counter-productive, but they are on our backs all the time. We may need more people in our organizations and some fund managers will have to change the way they look at things.

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HIGGS All:

It was really important that Derek Higgs understood that we don’t need more rules. It is far from clear what the problem is that Higgs is supposed to be addressing. There has been incompetence in UK Boardrooms but nothing really dodgy since Maxwell. The problem is not that the current rules don’t allow good performance, but that not enough companies do it right under the current rules.

I:

Companies should communicate and focus on what is right – not with the niceties of Higgs and so on.

C:

I liked the idea in the Sciteb response to Higgs that you could get a vote of shareholders to endorse a different model and then be deemed Higgs-compliant. For example, I would never allow the EDs to outvote the NEDs, and on one occasion in a company which was 3+3+1, I voted against the EDs (on a relatively small matter, not a resigning issue) when the EDs wanted to do something and the NEDs didn’t, even though I thought the EDs were probably right. A sensible company should never act against the unanimous view of the NEDs. I like the idea of maybe having extra votes for the NEDs. There is a real danger that D&O insurance will be compromised if you are not Higgscompliant.

SARBANES-OXLEY I:

Sarbanes-Oxley also requires the Audit Committee to be independent – this means, ‘no contact with the company for two years before’. This is a very tight definition and potentially highly misleading. For example, someone now running a major (non-UK) company has hired a former minister as an NED. Tests proclaim him independent but in fact the two people have been very close indeed for 20 years.

I:

Oxley was heavily focused on the Audit Committee issues, and on a feeling that the SEC had not done a good enough job in this area. The legislation is very prescriptive and, although the Audit Committee is undoubtedly important, we don’t think it is the real heart of governance. We need to encourage a culture where Boards do the right thing. This would of course lead to audit committees doing the right thing as well. Of course, Sarbannes-Oxley also focuses on areas other than the Audit Committee, such as executive responsibility.

C:

The UK is fine – all it requires is a sensible, organized approach. But it’s feeling the hand of the US market, and aspects of it, which are horrible. We decided this year to combine the UK report and accounts with the US ﬁlings; the result was a tome. Do we need all these problems? Sarbanes-Oxley and the SEC are imposing great burdens. It’d be better to see UK rules emanating from the UK. Ideally, UK firms would be protected from excessive interference by the US governance lobby.

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WIDER ECONOMIC ISSUES UK I:

Capitalism is the only way in which wealth creation can happen properly, and it is essential for the economic good of the country. Not enough people in political decision-making roles understand this.

I:

Investors are getting very frustrated with this government. There is huge scope for the UK to gain lots of fund management and investment business from Continental Europe given the impending savings and pensions crisis, and to create/build a really world-beating position. But the government takes a very parochial attitude and doesn’t seem to understand that it could be ten times better. Luxembourg has ﬁve times the mutual funds based there that the UK does. There is a lot they could do to reduce costs and red tape.

C:

I am also working as an adviser to a government department. This is mainly because I am concerned that we are moving towards a compensation and class action culture in the UK which is so damaging. The devastating ingredients in the US are: ● class actions ● contingent fees ● derivative suits.

I:

Taken together, are you optimistic about the UK? Or are there trends of decline – such as driving out medical research through animal rights activists and the Huntington Life Sciences debacle? Depends a bit on who wins the next election. The UK is a great place but in 10–15 years’ time if present trends continue it is hard to see how we can keep up a sustainable edge.

C:

OTHER NATIONAL I:

The Japanese have recently discovered corporate governance and have got very enthusiastic about it. The Japan Pension Fund Organization, which is both a fund and a trade body for the other funds, has advised voting against about one-third of the resolutions that have come up.

C:

In Sweden when you put the accounts to the AGM and they are accepted, this absolves the directors of any further liability to the shareholders. Even if the accounts are fraudulent? Yes, the view is that the shareholders should have asked sufficient questions at the AGM.

D: C:

INTERNATIONAL O: I:

Are we ahead in the UK compared to other countries? This is a complex question. The status of corporate governance in the UK is pretty good – well ahead of the US. There was a recent survey of institutional investors which indicated that governance should be

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important for their investment processes, but was not yet in practice. The push for improved governance goes back to the excesses of the 1990s. CEOs became loaded with options to ridiculous levels, and became obsessed with their share prices. This was seen to be about beating expectations, on a quarterly basis. There was a slippery slope between: ● taking sensible business measures to meet expectations; ● using accounting devices which, although legal, were questionable; and ● illegal manipulation. All of these were made worse by the rules-based accounting culture in the US which meant that if it was legal it was OK – there was not a concept of a true and fair view. C: I:

What about the situation overseas compared to the UK? It’s very different in the US – very legalistic. You have to vote because if you don’t vote you can be sued. There is little, or no, real dialogue. In London people are very concentrated geographically and can talk to each other. In the US it’s much more diffused.

O:

In the US there is no equivalent to London, with an overwhelming concentration of corporate and investor HQs.

OTHER I:

A decision not to do something is always safer.

C:

I sit on the Board of a company that writes D&O insurance policies. We have started providing D&O insurance for individual directors that would be valid across all their companies. The premium for decent cover works out as $100–200 k which is considerably more than UK NED fees.

I:

It’s a big issue: should shareholders sue a company? It happens in the US but it’s illogical because, if they win, they are recovering money from the company which they already own, less the 20–40 per cent for lawyers. The lawyers are enriched at the expense of the shareholders. Nevertheless, my Deputy Chairman has convinced himself that, at least in the US, litigation is the most effective way to change behaviour, and has teamed up with a US law ﬁrm. We must instead develop a closer relationship with companies and engage in more constructive ways.

C:

Will there be an attempt by investors to exercise some control over subMain Board pay? I hope not. This is a matter for the Boards, the CEO and the RemCo. Further interference by investors in the detail is unlikely.

I:

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PART FOUR

Unscientiﬁc Postscript

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CHAPTER 15

From Governance to Stewardship BOARD BEHAVIOUR MATTERS MORE THAN PROCESSES Great businesses are built by teams that turn visions into realities. A spinout from a provincial electronics company becomes the world’s most valuable mobile telephone business. BP goes from a troubled company that had to be rescued by the government to the world’s largest publicly listed oil producer. Tate & Lyle drops out of the FTSE 100 as a troubled sugar producer and powers back seven years later as the world’s leading renewable ingredients company. We could tell similar stories about many UK companies. For example Zeneca, Amersham and ARM (respectively) span out from an underperforming chemicals company, a UK Government research lab and a marginal educational computer maker, and become (respectively) a leading global pharmaceutical company, the core of GE’s $20 bn global healthcare business and an intellectual property company whose ubiquitous microprocessor designs lie at the heart of the digital world. The CEO is the pivot and in each case outstanding CEOs have indeed been pivotal in these achievements. But the behaviour of the board as a whole has been signiﬁcant, and the chairmen have played a substantial role. Knowing that your key ideas will be scrutinized by rigorous, informed, fair-minded and independent colleagues sharpens the CEO’s thinking; confidence that they have been so scrutinized is an important element for investor support. A belief in the competence of the Board is really essential for the whole management team – especially in critical issues such as the selection of the CEO. Few talented people wish to work for Napoleon, and probably the most important skills for investors who are bold enough to back a Napoleonic company is timely constructive engagement or an ability to make a timely exit. In the companies on which we have focused, and in others which have been consistently successful with a balanced Board model, great attention is paid to appropriate behaviour, relationships and information, with structures and procedures seen as a means to an end and not an end in themselves. In particular, good Boards focus attention on: 1.

Developing outstanding leadership teams that sustainably generate competitive advantage for the company and wealth for the shareholders, with a clear and viable strategy.

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2.

The quality of relationships, especially those between the Chairman and the CEO and between the executives and the independent directors. The goal is not to be ‘cosy’ but to achieve the right mixture of stimulus, encouragement, challenge and mutual learning.

3.

Checks and balances and their visibility.

4.

The access to information by the Board and Board members, and in particular the extent to which questions are promptly and effectively answered.

None of these are really about structures or procedures, though clearly some make it easier than others. Think about what went wrong at Shell, in terms of quality of relationships and access to information. It is more difﬁcult for outsiders to form a view on these than on the more tangible aspects such as committee structure and attendance. Some companies are at least explicitly focusing investor attention on these issues. However, evaluating a Board, or indeed a company, is a matter of judgement and is inevitably subjective. It is better that the information on which shareholders are invited to make these judgements should be answers (albeit imprecise) to the right questions rather than precise answers to the wrong questions.

EVOLVING RELATIONSHIPS WITH INVESTORS The relationships between the Boards and investors are also evolving. Experience and personal contact are helping to change these and open up the possibility of real constructive engagement, but there are quite serious issues: ●

Companies and NEDs need to become more aware of the different types of investor and the different levels of engagement that each can appropriately offer. The deeply research-based investors, such as Capital, Fidelity and UBS, have a cost structure and business model which permits a deeper level of engagement and understanding than an index-tracker. Hedge funds often have their own priorities, in some cases buying into a company in a difficult situation and actively pushing for a bid.150

● ‘Clients think what we are doing in terms of engagement is great – they are

just not willing to pay a premium for it,’ remarked one investor ruefully. There is a risk that a desire for low costs amongst their clients will inhibit Investors from deploying the resources needed to engage properly with companies. This desire is pretty rational within the terms of the incentive 150

Press reports suggested that the surprise bid by BAE SYSTEMS for Alvis was catalysed at least in part by hedge funds.

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structures in which trustees operate. There should be some clear economic incentive for investors to engage rather than leave the work to others: and at the least the economic disincentives should be minimized. ●

A political desire for visible activism can be seriously counter-productive. Politicians and civil servants, egged on by the media interest groups and all with minimal experience of business, run the risk of making matters worse by imposing half-baked solutions. For example one idea floating around is to push responsibility for governance and engagement back to the trustees of pension funds. It is difficult enough to find the right staff for constructive engagement for the 20 largest fund managers: the idea that the hard-pressed trustees of thousands of pension funds would be able to engage effectively is ludicrous. In practice, it would simply encourage them to outsource engagement and voting to some of the specialist agencies, whose agendas and incentives are not primarily around making money for their clients. It is already a major complaint of chairmen that governance and investment decisions can become de-coupled – this would make matters much worse.

●

There is a danger of ‘the lunatics taking over the asylum.’151 Although the extremes of shareholder activism represent few votes, they can make quite a lot of noise in the media, and both governments and trustees can be seduced by the simplicity of ‘of course you should conform to best practice’. If ‘comply or explain’ comes to mean ‘comply or write a long note of explanation, crawled over by lawyers, on which you may be personally sued if any aspect of it is retrospectively alleged to be marginally misleading’ then Boards may comply for a quiet life even if this is not in the best interests of the company. There is already some acceptance of the idea that ‘comply or explain’ may be an unfortunate choice of words: ‘conform or explain’ would be better.

●

Investors don’t yet fully understand the difﬁculties and resentments created by having separate corporate governance departments that appear to be disconnected with the investment process and by failing to reply to communications over which chairmen have sweated blood. Such irritations can signiﬁcantly erode effective dialogue.

SUGGESTIONS TO CHAIRMEN In many parts of this book I feel presumptuous in advising people who do their jobs far better than I could ever do them – and in this chapter I feel this most acutely. To the 151

Paul Myners, in FTfm , 9 May 2004 speciﬁcally re. proposals to vote against Warren Buffett serving on a Board.

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extent that there is anything of value in what I am about to say to experienced and successful practitioners it is based on a synthesis of the advice from other experienced and successful practitioners whom I have been privileged to listen to, question and reflect on. I take full responsibility for the mistakes and oversimplifications. I apologize also for the direct tone of this advice. Chairmen don’t often get straight advice and although the best rather enjoy being stood up to, I would not in fact address any of my chairmen friends or clients in this way – certainly not in writing. However, to apply the usual packaging would make the prose excessively turgid and indirect, especially for the readers in other categories who are eavesdropping. If you like, please read this as advice offered to some other Chairman. You probably know all this already. With this apologia, here goes … Your role is to ensure that the company has the best Board possible – an excellent team of people working together well, providing the right mixture of support and challenge for the CEO and the executive team. Remember, you are there to run the Board, not to run the company. Don’t worry if the CEO takes decisions with which you disagree – unless they are truly life-threatening. Getting this balance right is not easy. Remember the Chairman who heard there was a problem in the company, got out of his ofﬁce, started walking down the corridor, turned around and went back to his ofﬁce to wait. But be careful: the Chairman of one of the most spectacular corporate failures was described by his CEO as, ‘he’s great, he just sits in his office reading The Economist’. By contrast, many of the most successful chairmen make a point of not being based at the main company they chair. It makes it clear to everyone that they are not there to get involved in the day-to-day. It is also easier to hold the management to account if you are not continually present. Your primary focus within the company should be: Do we have the right team of people on the Board making decisions in sensible ways? This is actually more important than whether they make the right decision on a particular issue, because a well-functioning team will recover from a bad decision and will work well together in a crisis, whereas a badly functioning team will probably not, even if it makes a number of good decisions. There is more to a good team than a bunch of individual stars, but remember that you are accountable for the quality of the Board and you should make every effort to get the best people: use headhunters by all means but don’t allow them (or employees) to slant the process in favour of their candidates. Recall also that making decisions in sensible ways emphatically does not mean making decisions that cannot be criticised given 20:20 hindsight. Investors are after the right balance of risk and return. It is important that the Board does not become inward looking and inbred. It’s a really good idea to have at least one NED, and preferably two, with a current role in a business that is more successful than yours. If they are smart they will not keep saying,

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‘At X we do things like this’, but the fact that they are in a position to do so may help signiﬁcantly. It’s also important to bring new people in to the Board. The great virtue of an expectation that people will serve for six years is that it implies that one-sixth of your Board will be new every year. Fresh perspectives are vital in any business. You should be prepared to lose the services of some excellent people after six years in order to keep the Board fresh. However, there is a lot to be said for having one veteran on the board who has been there for eight to ten years: especially in a business with long investment cycles. Don’t be afraid of explaining why you are differing from corporate governance orthodoxy on points where you really think your Board should be run differently. No sensible investor is going to invest just because you conform with all the recommendations: where comply or explain is an option, as it is in the UK with the Combined Code, then feel free to explain if there is a good business reason for doing something differently. But don’t start from the assumption that the way things have always been done is necessarily the best. Be very careful when everybody – press, analysts, investors – is convinced that you are doing the right thing. They may be right, but this attitude can breed complacency and lead to a situation where decisions are not scrutinized effectively. Recall the plaintive words of an NED of a major corporate crash: ‘Every time the management did something that I was worried about, the share price went up. How could we argue effectively with that?’ As in sailing, having the wind with and sea behind you may be fast but can be dangerous. The practice of one of the world’s most successful businesses is always to have the board hear a buy and a sell voice in the analyst/ investor community. Success tends to breed arrogance and arrogance is extremely dangerous: remember Shell.152 Arguably your most important job is to help keep the CEO’s feet on the ground. Aim for continual improvement in the way you and your colleagues work. Don’t lean on consultants to achieve this: focus the collective wisdom and experience around the Boardroom table. From time to time, ask: How can we work together better? How can I be a more effective Chairman? What skills might we be lacking? Boards are moving into uncharted territory and smart people will be encouraged by a willingness to learn and question. Encourage succession planning, including your own. Encourage your EDs to contribute as real Board members and not just as functional managers. Support and 152

Of course arrogance is a common thread through most corporate disasters: Marconi, Enron and Worldcom had it in spades. But these all suffered ﬁnancial collapse, in the latter two cases involving serious accounting irregularities.

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mentor your CEO and encourage them to look forward to the day when an even more able successor takes over. And, after a sensible break, they can share their wisdom as chairman of another company or two.

SUGGESTIONS TO NEDs There is nothing quite like the role of an independent NED. For many purposes, in almost all legal respects, you and your fellow-directors are one team, working together for the good of the company. Yet you must also be in evaluation mode quite often. Occasionally you have to work with your colleagues to remove the Chairman or the CEO. In business you can generally, at least as a last resort, dismiss your subordinates, but you can seldom sack your boss. Even though such changes are rare, the latent possibility of them has interesting implications for the dynamics of working together. Another great difference between the normal business world and the world of the NED is the nature and scope of decision-making. In a senior executive role you are asked to make decisions many times a day, for which you will be held personally accountable. But as an NED the only decision you have to make really frequently is whether to oppose or seriously question the emerging consensus of the Board. Boards very seldom vote, but the wise Chairman is highly reluctant to push forward a decision with which an NED is visibly uncomfortable, so you have a pretty effective power of veto.153 But in practice this should be used rarely. Most of the decisions the Board makes will be collective. This implies that the traditional ratio of listening to talking (two ears to one mouth) needs to be substantially increased. If there are six NEDs, then you have effectively twelve ears to one usable mouth. It also brings into strong focus the value of your eyes. These should be used in the boardroom not primarily for reading papers or looking at PowerPoint presentations, and certainly not for checking your emails on your Blackberry, but for reading the body language especially of the people who are not speaking.

153

When a well-respected company was proposing an innovative venture with Enron which was then at the height of its power and adulation, an NED astonished his colleagues by declaring ‘if we do a deal with those bastards, I shall resign’. This completely killed the deal – a narrow escape.

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This is one of the major reasons for having executive directors on the Board. EDs (as you will know if you are, or have been, one) have an interesting dual role. Outside the Board they are executives of the company reporting to the CEO, with clearly defined functional responsibilities. But inside the Board they are directors of the company with the same collective responsibility for the whole of the business as the other Board members. It is remarkably difficult for them to voice openly in the Boardroom doubts and concerns that they may have about proposals that have been agreed by the Executive and are presented to the Board. But you will often be able to judge their real attitudes by observing their body language when the CEO is speaking.154 Your main contribution within the Board meetings will be to ask questions and these need to be quite carefully judged. One NED who was also an ED related how, having asked their ﬁrst question carefully toned down to be much more gentle than the question they would have asked of one of their subordinates in a similar situation, they were taken aside afterwards by the Chairman and told that it was a very good question, but could it be asked in a less direct and aggressive manner. Asking good questions is really important, and having a reputation for doing so is a major asset on a Board. However, as we have discussed earlier, your relationships outside the formal Board meetings are probably more important than your contributions within the meetings. It is important that you should be able to pick up where you have left off with the CEO and with the Chairman, and preferably with all your colleagues. This is one of the major values of Board visits – travelling together on an uncomfortable bus to a remote facility is an excellent bonding experience. Try very hard to make these trips, especially in your ﬁrst few years on the Board. They are difﬁcult to combine with the day job but you learn more from them than from papers and meetings, and they build up your social capital, which is essential to your effectiveness. If you are on a well-run Board there will be some areas where you have specific relevant expertise to the development of the business, and you will probably be encouraged to take a deeper interest in these aspects of the business. For example, as 154

I have heard a female NED suggest that this focus on body language is a female thing. It is true that males, especially those who are unusually driven, competitive and numbers- or systems-oriented, as many EDs are, generally have a lower empathy quotient than females (see Baron-Cohen 2003). However, at least one highly successful Chairman quotes the body language point as a major reason for having EDs on the Board. It has also been suggested to me that the idea that EDs would betray their reservations by body language on the Board is naïve because they would take care to conceal them. But, ﬁrstly, people (unless they are highly successful poker players or professional negotiators) are not as skilled in concealing their views in body language as they think they are, and secondly, it is not clear why EDs should want to conceal their views in this way. If they do have reservations about a proposal their boss is presenting, it is important that the Board should be aware of it, without the CEO being able to pick on any speciﬁc action that might be seen as disloyal. Provided the most blatant non-verbal actions are avoided (I have heard of one director who would habitually roll his eyes at proposals, but he was an NED) the CEO is unlikely to notice since (s)he will usually be speaking and looking at the NEDs.

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we have seen, on the Vodafone Board Penny Hughes, Alec Broers and John Buchanan have specific interests in marketing, technology and finance. This can sensibly be combined with a degree of mentoring of a few of the executives in the organization who have responsibility for these key functions. It’s important that this mentoring is done with the right level of professionalism and detachment: we don’t want the NEDs to have baronies as well as the EDs. But it’s really helpful in terms of building the team and of building your understanding of the business and what is really going on in it. If you have become ‘plural’ it’s really important not to take on too much. At the start allow at least a year to go by between accepting any offers – and six months even if you are a very experienced NED. You need plenty of spare capacity when things are going well because you have to be able to cope if two of your companies hit problems simultaneously. Finally, do not be afraid of evaluation and of moving on. After six years, however much fun it has been, it’s usually a good idea to ﬁnd a new challenge.155 You will have made an important contribution of which you can be justly proud, and you will have learned a lot. Not least, you will have a better idea of the kind of Board where you can add most value.

SUGGESTIONS TO PEOPLE CONSIDERING AN NED ROLE The right NEDship, although a huge time commitment and responsibility, is an unrivalled opportunity to learn and to contribute. Select your appointments, especially your ﬁrst one or two, with some care. Worries about whether the company is big or prestigious can be misplaced.156 It is also worth considering the downside of joining a very well-run company with few strategic problems: one NED lamented accepting a role in such a company because they were not able to add much value, when they could have joined a more difficult business that had many strategic challenges! Having said all this, difﬁcult companies are problematic as your ﬁrst NEDship, especially combined with an executive role. Here are some points to consider when considering joining a Board as an NED, culled from my many discussions with experienced NEDs and Chairmen: 155

156

It’s useful to have one NED who acts as corporate memory on the Board, and in very large and complex businesses it may be helpful to have a couple of NEDs with long tenure. But too many and the board may get stale, even if the NEDs don’t. ‘Prestigious’ is a word whose meaning has shifted completely in the last few decades. The SOED (third edition 1944, reprinted with corrections 1973) gives ‘Practising juggling or legerdemain; cheating; deceptive, illusory’ and Webster’s (1996, 1998) gives ‘Practicing tricks; juggling. [Obs.]’ but The American Heritage Dictionary of the English Language, Fourth Edition gives ‘Having prestige; esteemed.’ A prospective NED should worry greatly about whether a company is ‘prestigious’ in the original sense, but not in the ‘modern’ one. Enron was, of course, truly a prestigious company.

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GENERAL 1.

‘You must choose your company so carefully.’

2.

‘Having opted now for a career as NED on various Boards, it has become clear to me that I am now Chairman/MD/major shareholder in my own brand, and I have to be a careful custodian of this. It’s only considered to be valuable as long as I am valuable to the Boards on which I sit. You should only go somewhere insofar as that will be valuable to your brand and reciprocally, if you feel you can add value to that Board over time. It only takes one mistake to ruin this.’

3.

‘Do not be in a hurry. Make sure you find a group of people you respect and a place where you can add value.’

PEOPLE 4.

‘A lot is to do with chemistry, and the need to connect with people.’

5.

‘Visit the company and form a judgement of its people.’

6.

‘As due diligence, listen to the response of the company and their approach to life. Is it solid with a good reputation? You can learn a lot from reading the annual report and you can also talk to the auditors. The Audit Chairman may say, “Are we not good enough for you?” – particularly now they’re pushed to the hilt. You can do a lot by asking around the brokers. All of this can be very helpful. Informal rather than formal. Higgs has a list, some of which is right, but informal due diligence is very important.’

7.

‘Your relationship with the CEO is very important. I don’t talk to the CEO every day or even every week but it’s essential that you can pick up where you left off.’

8.

‘I’ve been offered several NED positions and had half a dozen discussions, but have turned them down because of who’s already on the Board.’

9.

‘Choose your parents wisely, and really do your due diligence. Is this a well-run company? Get a feel for the company: its culture, its approach to governance and so on.’

10.

‘When I was considering joining one Board, the CEO specifically invited me to visit any site I wanted to – unannounced –and to ask any questions I wanted.’

11.

‘In discussions on joining a Board I remarked to the Chairman that the accounts looked very complex; as a result I was invited to spend half a day with the external auditors. I was able to go through with them the scenarios of writing down their intangibles. The Chairman had basically said, “Feel free”.’

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12.

‘You want to be in the best company you can, you want to see the chairman in action. I sometimes ask myself as NED of a particular company, “Am I adding any value at all?”, because it is so well run. You need to ask yourself, “Is it a well-run company?” If you’re not sure of the answers, don’t join.’

ADDING VALUE 13.

‘Another criterion for me is discovering where they want their NEDs to add value. You should listen and note if the Chairman and the CEO support this and value debate. If the company question your wanting to know, don’t go there.’

14.

‘My view is that you should only have an NED position with a business where you can genuinely contribute and ideally where you have some relevant industry knowledge. My professional background was in ﬁnance, but because of my management experience I am more drawn to engineering businesses. As an NED of an engineering company, the EDs know that I am interested in and understand the business activities and therefore they tend to give more care and thought to what they say, particularly where capital projects and major commercial decisions have to be made. I like to think that over the years I have been an NED, the executives are now more thoughtful and prepared for interrogation from the NEDs than before. I get great satisfaction from participating in the executive issues and hopefully contributing to the progress of the business. Equally, I have gained from being an NED of a global business with specialist technologies, particularly from first-hand knowledge of markets such as China, Korea, South America, and so on. There should be a beneﬁt for both the NED and the company and I think identifying with the company is crucial if you are to give your best.’

15.

‘Don’t be afraid to join a company whose business is different to your specific experience. I was appointed as NED to the Board of a major company in a sector of which I knew little. It was a great time for me to join. They have a new CEO who is himself new to the company’s business. It was a great opportunity for the company to rethink strategy and direction. It gave rise to a very open mindset. What I really like to do is to join companies who are capable of asking questions like “What are we here for?” and “What’s our competitive edge?”. This company is now in a good position, one of the leaders in terms of market cap. What experience do I bring to the industry? I had some experience while working within other industries which overlapped, so I’ve always had a window on that world. Fundamentally it’s a service business.’

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16.

233

‘The first rule is to understand what the company does. I once turned down a prospective NEDship for a biotech company because I didn’t understand what it was they did. For high-ﬂying executives it’s sensible to avoid getting into the ﬁrst thing that comes along. You need to make sure you can contribute something.’

OTHER PRACTICAL TIPS 17.

‘It’s the Warren Buffet advice: “If you don’t understand the business then don’t invest.” Also the geography of business meetings, where the businesses are and their attitude to visits – all these issues need to be explored and taken in to account.’

18.

‘Is the Higgs rule of only one NEDship is a good one? Not totally. The ﬁxed nature of the commitment and fitting that into the schedule is probably more important. There needs to be an understanding up-front as to availability.’

19.

‘Another issue of course is conflict of Board meetings, and year-ends. If you take on too much, you won’t do the job so well.’

20.

‘It takes a year to learn a business so don’t take on more than one NEDship in any 12-month period.’

21.

‘I think it’s extremely valuable to know something of the history of a company and where it came from. The history of a company so often shapes what is happening now.’

22.

‘Ask for three sets of old Board papers. They may well not be the most recent – but looking at them will give you a feel for what the Board discusses and how it operates.’

23.

‘When you’re first asked, it’s all very flashy, but you need to treble the time, multiply the risk, and proceed with caution.’

24.

‘Here are the key points I have noticed, as an ED who is also a NED, about the transition: – The shift from operations to looking at the interests of the shareholders – … from governance rules being a constraint on the EDs to being considered by the NEDs as a protection to the company and its shareholders – from constraining and disciplining to protecting and channelling – … from detail to key indicators. Often on a Board people tend to get into detail and the NEDs can usefully shift them up to discussing the key indicators

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– … from schemes to themes – if from knowledge to achieving the vision and the strategy – Always being willing to ask why – executives are often preoccupied by the what – Clearing hurdles for executives and empowering them. Be careful that your questions are not seen as offensive (causing defensive behaviour in the executives) – not criticisms but helpful. You need to think about why you are asking a question: to be helpful or to score points? If it is the latter, you probably want to can it, you are here to help – Clarity of messages left behind. Be careful how you phrase your questions. I ﬁnd it helpful at the end of a meeting to clarify the message and make sure it isn’t seen as negative – Executives can get excessively immersed in detail – make sure that they see the bigger picture. Show independence when execs get carried away by elegance of technology or their cleverness and lose sight of what the customer thinks.’

SUGGESTIONS TO EXECUTIVE DIRECTORS Yours is the primary responsibility for making the business work. The NEDs have a lot of influence and experience but little direct power and limited understanding of how the business works.

BUILD TRUST AND UNDERSTANDING WITH THE NEDs One senior executive of a large multinational told me ‘I’m afraid to say that the NEDs know absolutely nothing about the business’ and although this represents a somewhat extreme position, for various reasons the degree of real knowledge and understanding by the NEDs varies enormously. It is very much in your interests to ensure that you have the best NEDs possible and that they understand as much about the parts of the business for which you are responsible as reasonably possible. Some EDs may ask, why? Isn’t it better to get on with as little interference as possible? I think the answer is only if you’re always right (both in terms of the decisions you take and the way you implement them), and if you’ll never need support from the Board in difﬁcult resource allocation decisions. I’ll add that people who think they are always right are a menace in the Boardroom. Good NEDs will only back investments in areas they feel they understand sufﬁciently, run by people that they trust. Relationships with NEDs have to be managed quite carefully if you are not the CEO. Some CEOs feel threatened by any such dialogue and it’s important to ensure that an atmosphere of trust and mutual understanding prevails to avoid this being a

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problem. You can expect mentoring and advice from NEDs but you must not expect them to act as your champion in the boardroom, nor must you in any way use relationships with them to undercut the authority of the CEO. Smart NEDs are well aware of the pitfalls. One of them recalls: At one company where I was on the Board, the managers had lots of access to the then Chairman and they played a great deal of highly destructive politics. Avoid this like the plague. And remember that the NEDs are indeed non-executive: with the exception of the Chairman talking to the CEO anything else they say is, like the proverbial Italian trafﬁc lights, not a command, but a suggestion.

BE A DIRECTOR, NOT JUST A FUNCTIONAL MANAGER As you know, being on the Board is not simply a promotion – it entails a legal responsibility to act as a director in the interests of the company as a whole. Within the Board you have, for most purposes, the same rights and responsibilities as any other director. The responsibilities are a given, but the rights must, as always in such situations, be marked with a big ‘Handle with Care’. Questions to the FD from one of their colleagues may have a different impact from the same questions from an NED. But it’s really important that you understand the numbers and the other key information that goes to the Board – so it’s worth being prepared to ask questions ofﬂine, preﬁxed if necessary with such handles as: ‘I think it might clarify things for the NEDs if we explained X a bit more – indeed I don’t really follow it myself’, ‘Can you educate me about how we treat this?’ A number of NEDs have expressed concerns to us about how, even in very successful companies, the EDs tend to stick rigidly to their allotted areas and don’t speak about the wider business, even (in some cases) when asked a direct question about it. By contrast, a highly successful Chairman remarks how: Discussion on the executive committee is useful, but it is really helpful to have an open discussion on the Board between the executives. When we got a [difficult situation requiring Board judgement] our CEO was able to ask each ED openly for their opinion … This was much more persuasive than a uniﬁed line would have been. Broaden your view, and remember the eyes and ears points made to NEDs above. Be wary of ‘us and them’ attitudes. These are fundamental to human nature, and no doubt very necessary in hunter-gatherer societies. But the company, rather than the group executive, is ‘us’ and the competition, rather than the NEDs, are

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‘them’. It is only by working effectively together as a team that the Board can deal with the unexpected difficulties where it really comes into its own, and can make the sustained progress that can turn fairly boring companies into highly successful ones. From this point of view, having an NED role of your own really helps. Combining the ED and NED perspectives helps you understand the processes on the Board much better. And there is no other way of gaining such a deep insight into the realities of another business.

SUGGESTIONS TO INVESTORS For most investors, the nature of your business is changing. There was a time when, in the memorable words of one investor, ‘A trained chimpanzee could have made money in investment management.’ It is debatable whether clients are actually more sophisticated but they are surely more demanding. There are also societal pressures on investors in a way that there were not previously. One of these pressures is to be more engaged as an owner. It seems to me that there are good reasons why fund management should increasingly polarize into three classes: 1.

Index trackers which aim to match closely the performance of a particular index that is appropriate to the requirements of the client.

2.

Long-term stock-pickers which make positive judgements about particular companies and industry sectors, and back them with concentrated investment.

3.

Hedge funds which attempt to exploit mispricing of financial instruments in order to deliver absolute returns, using short selling and other unconventional strategies.

With closet index trackers generally fading away, although there are interesting business models like BGI’s which straddle these categories. The issues for each class of investor are somewhat different, so let’s address each in sequence, although much of what is said to one class of investor is also relevant to the others. In particular, what is said about Lead Investors, although perhaps applying most sharply to index trackers, is relevant to all classes of investor and offered as a suggestion to try to improve the system as a whole.

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INDEX TRACKERS To the extent that you hold the index you are perceived as ideal long-term investors. Unless the company falls out of the index you are seen as not being liable to sell.157 This means that management obsessed with share prices can afford to ignore you, but you and your like-minded colleagues will increasingly represent the largest classes of shareholder in most companies, and thus when votes matter your views are really important. Although the performance of speciﬁc stocks does not directly concern you, you have an overall interest in the success and reputation of the listed sector, since if listed companies perform well and have a good reputation, people will be keen to invest in them through index funds, whereas in the contrary state people will tend to shun them so your funds under management will decline. You also have a strong interest in the reputation of the investment management industry, since if this is perceived as untrustworthy and not adding value, people (and trustees) will tend to shun equities. However, this creates a series of unpleasant dilemmas. If you don’t vote you give the impression of apathy, if you vote unintelligently then your votes may actually damage the companies and their long-term prospects, but voting intelligently and, even more, engaging intelligently, requires time and understanding which is expensive. To the extent that index-tracking is a commodity business, another competitor may come forward without the overhead of people capable of effective engagement and undercut your charges. Meanwhile, your costs of engagement and understanding beneﬁt all the market participants. The worry about costs is mitigated to some extent by the fact that the investment management side of indexing is quite readily scalable, and for a large index tracker the costs of having some high-quality engagement effort is not huge. Even if the additional costs won’t make much difference to the client they will make more difference to the profitability of the investment firm. But one excellent person who leads on engagement issues and who wins the respect and trust of chairmen is a very valuable investment in your firm’s reputation and effectiveness. Chairmen respect good engagement professionals the way they respect good analysts – even if they give them a hard time.

EXPLORING THE LEAD INVESTOR CONCEPT In Appendix A I tentatively advance the concept of a Lead Investor for public companies. This might save a lot of time for companies and investors and help focus constructive engagement. Rather in the same way that companies designate a SID as a preferred point of contact on the Board, companies could designate a Lead Investor 157

Even though this may not be strictly true, since you can track an index without holding all the stocks in it.

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who could act as a primary focal point for dialogue on governance and remuneration issues. This could improve the efficiency of constructive engagement both in economic terms and in terms of the time that EDs, NEDs and investors spend in having the same meetings, with relatively small variations, time and time again.

POINTS TO CONSIDER ON VOTING AND ENGAGEMENT PROCEDURES Whether or not there is formal Lead Investor status, it makes sense to pool resources in some way with like-minded investors. It is also highly desirable to have a well thought through set of procedures on voting and engagement, which focus resources where there are important and difficult issues, and which ensure that the management of companies is not needlessly irritated and distracted. In particular it is well worth making sure that: 1.

Communications from chairmen get a timely and polite answer. There are a number of occasions when chairmen write to their top 20 investors, offering a meeting. These include on appointment, on a shape-changing deal or on a major Board change such as the sacking of a CEO. Investors are notorious amongst chairmen for not responding to such letters. ‘I wrote to the 20 major investors as incoming Chairman asking if they wanted to see me. One said yes the rest no (or more accurately, most didn’t reply!).’ Chairmen don’t much mind being told that the investor doesn’t want to see them – after all it is, in a sense, a vote of conﬁdence. But having usually put a lot of work and thought into composing such letters it is galling in the extreme to have them ignored. At the minimum an elegant form letter should be sent!

2.

Dialogue with fund managers and voting are properly connected. It is understandably infuriating for companies to find that, after they have talked to a fund manager and got their agreement on a controversial matter, the shares held by the house are voted against, on the grounds that it is another department or ‘we outsource our voting’. It is confusing when the votes on the shares held by a house are split, as increasingly happens. A leading investor explained, ‘We will quite often have three votes – some of our shares will be voted FOR a resolution because that is what we believe, but other shareholders will be voted on the clients’ instructions AGAINST or ABSTAIN.’ It is important that the companies understand this, otherwise perplexity and ill-feeling are likely to result. It is desirable that trustees use this provision very sparingly, since it militates against informed engagement.

3.

There is a sensible escalation procedure. Negative votes are not always unwelcome or unacceptable to chairmen. Sometimes they are useful

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opportunities to push through a change that the Board is resisting. One Chairman memorably compared a no vote to ‘hitting a mule on the head with a stick and saying – now that I have your attention …’. But sometimes a company may feel very strongly that an intended vote by an investor is misguided. There should then be a clearly understood and efficient approach to appropriate escalation, so that matters can be considered properly and efﬁciently, with companies feeling that they have a fair hearing. Before the escalation goes too far it would be wise to have the company’s NEDs (possibly the SID or the Chairman of the relevant committee) involved, so that the escalation is not a routine tactic by the management. It is also very important that outsiders, such as government and the media, do not equate engagement with voting against the company. The objective of constructive engagement with a company is to achieve beneficial change, not to make a noise to look good for the media. Just because investors do not vote against proposals at an AGM does not mean that they are not actively engaged in dialogue with the company to change aspects that they consider unacceptable.

LONG-TERM STOCK PICKERS You make your money by having sound judgements about the long-term value of a business and ideally by being able to enhance the value of the business through intelligent ownership. This is widely seen as the noblest calling in investment. Spoilsports suggest that this is a zero-sum game because, if institutional investment as a whole matches the index158 then stock-pickers on aggregate must do so too. This is not the place to wade fully into the Efﬁcient Market Hypothesis debate. Four remarks must sufﬁce:

158

1.

The herd psychology of the retail investor and of low-grade fund managers, who tend to over-react to enthusiasms and distortions, provides the possibility of rich pickings for those who are better informed. Not for nothing does Warren Buffett talk about ‘being in partnership with Mr Market, a manic-depressive’.

2.

Chess, poker and bridge are also zero-sum games. They can, nevertheless, be highly proﬁtable for players who are signiﬁcantly better than average.

3.

For large shareholders, transaction costs are far from negligible. Putting a significant block of shares on the market can depress the price. Consequently making sound judgements which allow you to lengthen your average holding periods will of itself, other things being equal, improve performance.

Begging the complex question of which index.

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4.

If an investor can add value by being an intelligent owner in a stock in which they are signiﬁcantly overweight, then this gain accrues disproportionately to the investor in question as opposed to the market as a whole.

If you are a long-term stock-picker, any opportunity to understand the company better and to enhance its value is potentially useful. It is therefore a very good idea to engage effectively with the management and to integrate the insights this gives into their strategy and character within the overall investment process. If you don’t have the time and resources to do this then you are probably investing in too many stocks. And since in practice companies focus their dialogue on their top 20 investors, and particularly on their top ten, you should consider a portfolio in which you only hold shares in companies where you are in their top ten or 20. One of Capital’s legendary investors suggested that they should only own shares in a company if they would be happy to be its largest shareholder.159 The points to consider on voting and engagement procedures are even more relevant to you. But it may well also be worth having a couple of specialists who can provide detailed support to the fund managers and analysts on difficult or technical questions, such as remuneration packages which went through a phase of Byzantine obscurity. Some investors, such as Fidelity, have a senior manager who can be consulted on key issues in conﬁdence, and who can be ‘Chinese-walled’ away from the fund managers when necessary. Try to ensure, by effective dialogue and spending time with the people before crises develop, that you have some understanding of what goes on around a Boardroom table, and that the companies in which you have major investments also understand the realities of the investment world. You don’t want the Chairman ringing up a few days before a vote to ask you to vary your published voting policy, unaware that to do so would require the consent of hundreds of clients!

HEDGE FUNDS Hedge funds have for a few years been something of a sweet spot in the market. Faced with bear markets and various scandals affecting the mainstream fund management industry, some investors have poured into hedge funds, attracted by the mouthwatering returns, the argument that index + hedge allows you to pick any point on the risk/reward spectrum you wish, and the fact that absolute returns strategies offer the prospect of making money in falling markets and of designing portfolios which match projected liabilities more accurately. There is also the argument that the most talented fund managers are more likely to be working for hedge funds with the high personal rewards and light regulation, rather than in the heavily regulated traditional investment management sector. 159

Ellis (2004) p. 281.

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Against this, there are several notes of caution. High returns may be associated with high risks that may be poorly understood.160 If you have a portfolio of hedge funds and only need to disclose the performance of some of them, it is conceptually straightforward to achieve high returns on your best performers. A world in which even professional fund managers are prepared to say to a hedge fund manager ‘I have my money in your fund – I don’t know what your fund does but it’s great’ sounds depressingly like bubbleland. And the combination of high fees and in most cases rapid turnover of stock (generating plenty of commission for investment banks) makes it hard to see how sustainable risk-adjusted returns can really be available for the investors in the long run. Nevertheless, if there are huge rewards available for investment managers with superior skill and judgement in this industry, it would be surprising if there were not at least a few of them running hedge funds – and the rest of this section is addressed to you – with the other readers eavesdropping. You probably don’t need telling that chairmen and directors generally don’t rate hedge funds very highly. There is considerable debate as to whether you should be regarded as shareholders at all: the point of view is that if hedge funds make money out of short-term pricing anomalies, so they should be ignored as shareholders – directors should concentrate on developing the long-run value of your business. Since your value depends on understanding, which depends on information and effective dialogue, try to be as transparent and open with your Investee companies as possible. (And if hedge funds hold CFDs and not shares then they are not in fact shareholders.) Consider adopting some of the best engagement practices of more conventional investors. And act on the assumption that it is in your long-run interests for hedge funds, or at least your sort of hedge fund, to be acting to high ethical and professional standards. There are some special issues about those hedge funds which are aggressive governance activists. It is very tempting to go public with your governance concerns; after all you must be much smarter than the people running these companies because you make far more money than they do, right? However, governance is about inﬂuencing the way that people behave, for the long and medium term. Except with tiny companies you will need real support from the major institutions: do not confuse this with acquiescence or a willingness to listen. For real change you must convince the Boards, not try to bludgeon them. Meeting arrogance with arrogance is not usually the best way.

STEWARDSHIP The scary thing about Enron is not just that it ticked many of the right governance boxes, but it had blue chip advisers doing lots of business with it and that said many of the right things. The statement by Kenneth Lay about the role of directors 160

Beale’s ﬁrst Law of Derivatives Trading is ‘If you think you are making very high risk-adjusted returns on derivatives trading, you probably haven’t really understood the risks you have been taking.’

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Strength of character, an inquiring and independent mind, practical wisdom … we must have directors who start with what is right ... we look ﬁrst and foremost for principle-centred directors ... we want board members whose active participation improves the quality of our decisions161 said alarmingly many of the right things. In the Senate hearings the non-executive directors contended that they were doing the right things but had been misled by management.162 But people knew there were problems. It is not just the ‘Red Flag’ accounting issues that have been well-discussed. The NED whom I mentioned earlier referred to Enron as ‘those bastards’. One of my business acquaintances, hired into Enron from a major investment bank, left in disgust when she queried the legality of a proposed action and nobody seemed to care. There were some very able people at Enron but a deplorable culture of breathtaking arrogance. To some extent this is the old problem of organizations saying something virtuous and, under this mask, consciously and intentionally doing the opposite. This used to be called hypocrisy163 but since this word has been somewhat hijacked and over-used we can instead talk, following Argyris, about espoused values vs values in use. Fundamentally, companies are about people and the way people behave. Systems, procedures and legislation clearly have some influence on behaviour, but less than one might imagine from much of the literature. This is why an attitude of stewardship164 on the part of the Board and the executive management is so important. Stewards have got a bit of a bad press. An unjust steward features the most famous tale of falsiﬁcation of accounts in history: There was a rich man whose steward was accused of wasting his possessions. So he called him in and asked him, ‘What is this I hear about you? Give an account of your stewardship, because you cannot be steward any longer.’ The steward said to himself, ‘What shall I do now? I’m losing my job. I’m not strong enough to dig, and I’m ashamed to beg – I know what I’ll do so that, when I lose my job here, people will welcome me into their houses.’ So he called in each one of his employer’s debtors. He asked the ﬁrst, ‘How much do you owe my employer?’ 161 162 163

164

Quoted in Monks & Minow (2004) p.5. Conclusions of Blake: ‘We were told by the Chief Accounting Ofﬁcer that Arthur Andersen was “ﬁne with it’’.’ Winokur: ‘lack of candor with respect to information for us’. A word that has been dangerously hijacked to mean ‘any case where behaviour falls short of the moral code at which someone is aiming’. Since the only way of avoiding this is to have no demanding moral code at all, the practical effect of this hijacking has been to discourage all forms of moral values: it was originally intended by the hijackers simply to discourage traditional sexual morality. Interestingly this term is not found in the index of Monks and Minnow!

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‘Eight hundred gallons of olive oil,’ he replied. The steward told him, ‘Take your bill, sit down quickly, and make it four hundred.’ Then he asked the second, ‘And how much do you owe?’ ‘A thousand bushels of wheat,’ he replied. He told him, ‘Take your bill and make it eight hundred.’165 Malvolio in Twelfth Night does not enhance the reputation of the profession, though in this case he is the victim, rather than the perpetrator, of falsified documentation.166 However, the idea of stewardship provides an excellent model of what can be expected of the best investors, managers and Boards. I was headhunting a top manager of a major multinational to join the Board of a famous, but significantly smaller, company. He was very impressed by the Chairman and by his attitude to the business. The Chairman described it to us thus: ‘We think of ourselves as the current guardians of this business – we like to think that we embody some of its best traditions and values, and that we will be able to hand it on to the successors who will pick it up from us.’ This is not to say that the directors are complacent or resistant to change – in fact the business has been a significant innovator and is appreciably reshaping its portfolio. But the attitude is fundamentally different from the attitude of ‘We run this business and we’ll do what we want to – provided the shareholders can be kept on-side’. Firms like Fidelity, Capital and McKinsey have a similar attitude of stewardship. At Capital the status of being one of the shareholders in firm ‘is seen as a passing phenomenon … ownership is really stewardship, endowed with more responsibilities than rights.’167 Not coincidentally, Fidelity and Capital have a similar attitude of stewardship to investing, which it shares with other responsible and ethical investors. This comes down to how you regard other people’s money (OPM). For the archetypal investment banker of the 1990s, other people’s money was something that you would use to leverage up your own, and you would take more risks with OPM – hoping that you would gain the major beneﬁts but if money was lost, most of it would be OPM. Share options are an excellent example of this kind of attitude: if I invest OPM in a company at (say) $5/share and obtain options for myself at $5/share then I am in a ‘heads I win, tails I don’t lose’ situation. If the project does well I get a payout at the expense of the real investors (a payout craftily disguised, under the US GAAP rules prevalent until 2004, so that it 165 166

167

Luke (62), Chapter 16. It is very tempting to speculate who the steward’s auditors were. Shakespeare (1623). Maria indeed gulls him into a nayword and his complaint that they have ‘kept me in darkness, and do all they can to face me out of my wits’ sounds a bit like the protestations of a frustrated NED. There is a delicious suggestion in Simon and Brahms (1941) that Malvolio is a satire on Francis Bacon, who muses ‘some dark revenge, something deep and literary to obscure Will’s name to all posterity. Bacon should deface the name of Shakespeare! But how?’ Ellis (2004) p.262.

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did not go through the P&L).168 and if it does badly I lose nothing. By contrast, when Richard Lapthorne became Chairman of the then highly troubled Cable & Wireless plc, he invested £500 000 of his own money in the shares at the then-prevailing price, and made a contractual commitment to invest a substantial sum each year at the same price. Furthermore he encouraged other directors who joined to do likewise. Similarly, the attitude of stewardship to OPM is that you should look after it at least as carefully as you look after your own. Indeed the shareholders in Capital regularly sell their shares to other more junior associates at a fraction of what they are worth – something that they would never do to shares in their clients’ portfolios. Of course this is not to suggest that people with an attitude of stewardship are saints, or that they are acting against their own real economic interests. In the short term, it may pay financially to be greedy, but in the long term people are unlikely to entrust you with money. You are unlikely to attract and retain the most talented colleagues and successors if you are likely to be cashing out at their expense. And you are unlikely to have many real friends or a contented life if you have made your money by cheating other people. How is this attitude developed and protected, and how can investors and others detect its presence? Being about attitudes and behaviour, there are no simple formulaic answers. But there are seven characteristics that are well worth looking for: 1.

humility

2.

ethical conduct

3.

long-termism

4.

professionalism

5.

educating the next generation

6.

relationships

7.

servant leadership.

Let’s take each in turn.

168

This attitude possibly reached its most extreme expression when an article appeared in the Harvard Business Review in the ﬁnal months of the editorship of Suzy Wetlaufer, claiming that greedy executives with excessive remuneration and share options were not the problem for US industry; it was shareholders who in aggregate received more in dividends than they put in in new capital, and thus had a deplorable ‘entitlement mentality’.

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HUMILITY There is a dangerous trap that surrounds success. Goethe apparently remarked169 that whenever anyone does something truly remarkable the world lionizes them and makes a fuss of them and generally does all it can to … stop them from ever doing anything remarkable again. Certainly, you want directors, CEOs and investors who are successful, but you don’t want success to have gone to their heads. The reason why excessive CEO remuneration was, and is, a serious problem is not primarily for its direct effect on the ‘bottom line’ but because of the arrogance and envy that it can breed, with corrosive effects on teamwork and ability to listen. One wise NED advised ‘I look at the ratio of the remuneration of the CEO and his number two – if it’s more than 200 per cent then you have trouble.’ What is humility? The OED offers ‘the quality of being humble ... opposite of pride or haughtiness.’ Humble comes from humilis (low or lowly, mean or base) which comes from humus which means ground or earth. It is really about being grounded – having your feet on the ground and your ear close to the ground. Arrogance, pride and haughtiness prevent this. It is a willingness to listen and to genuinely believe that you can learn something useful from the encounter. It is a real understanding that, just because you are in a position of power, authority or responsibility, does not mean that you are in any ultimate sense above anyone else. It has been memorably described as ‘a state of mind in which [a person] could design the best cathedral in the world, and know it to be the best, and rejoice in the fact without being any more (or less) or otherwise glad at having done it than [they] would be if it had been done by another.’170 Humility enables people to listen, learn, encourage others. It’s worth investing in, personally and corporately. Remember Jeroen van der Veer’s penetrating question: ‘Do we understand the word “humility”?’

ETHICAL CONDUCT Note that I do not say ‘ethical codes’. This is a big subject, and to explore it fully is far beyond the scope of this book or the abilities of this author. It includes not telling lies, doing what you say you will do, generally being trustworthy. This is also not the same as consistently delivering the numbers quarter by quarter, which sometimes has as much to do with creative accounting and the manipulation of expectations as with integrity. One experienced NED advised that a good due diligence question was ‘When was the last person fired for an ethical violation and what were the circumstances?’ That tells you a great deal about the organization’s real commitment. 169 170

But I am unable to ﬁnd a reference. I don’t want to perpetrate a ﬁctitious quote like the one routinely ascribed to ‘Petronius Arbiter’. Lewis (1941) Chapter 14.

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A climate of small ethical violations, such as seems to have prevailed at Enron, is clearly a danger signal. There are, of course, difficult issues here: the distinction between being a strong competitor and being an unethical one is a fine one, and certain ‘ethical’ issues like ‘animal rights’ and offshoring171 are decidedly moot. The personal conduct of top management is also relevant. One CEO was well known amongst senior figures in his industry for a string of affairs, facilitated by private jets, hotel suites and so forth. He was forced to resign after a violation of business ethics by some people who reported to him caused the loss of major contracts and various other resignations. It is nevertheless hard to imagine that his lurid private life was not sending an unhelpful message to his subordinates.

LONG-TERMISM With a few important exceptions, companies should be managed for the long term: indeed any company with a P:E significantly greater than one is being valued on the basis of a number of years’ future earnings. Major investments made now may not come to fruition until after the CEO has left. An attitude of stewardship precludes worrying about such artiﬁcial time horizons: companies need to invest for the medium and long term, and the management as stewards need to be able to hand over to their successors. Like the other indicators of stewardship, intelligent long-termism is the best policy; after all, investors generally want to invest in businesses that have a viable future. But pretending you have a viable future seems, in many ways, easier than achieving one. On the basis of published ﬁgures it may be difﬁcult to tell the difference. But it is possible to ask intelligent questions and assess whether a company has a genuinely long-termist attitude or not.

PROFESSIONALISM There are two aspects to this, which need to be distinguished. There is a tendency to see a profession as a money-earning white-collar activity which requires paper qualiﬁcations. Hence marketeers look with envy at their ﬁnancial colleagues with their FCAs and so on. This is not what I mean: having an MBA or any other paper qualification is neither necessary nor sufficient to the professionalism I am talking about. A profession is originally the vow made by a monk or nun on entering a religious order. The professionalism I would associate with stewardship is an attitude: we are here to do a demanding job requiring judgement and integrity, and we will seriously try not to allow our personal prejudices and foibles to interfere with this. We will look at issues objectively and work to find the best solutions. Effective leaders, like other effective 171

Some see this as unethically depriving US or UK workers of jobs. But providing much-needed employment and trade in developing countries is arguably an ethical imperative.

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professionals, are not machines. A human touch, real commitment and going beyond the numbers and reports are all vital. But there is an important difference between using all the faculties you have to do the job in the best way possible, and confusing your role with your self.

EDUCATING THE NEXT GENERATION Developing talent in the organization is a really essential aspect of stewardship. The attitude is the polar opposite of the proverbial CEO whose first job is to identify his successor – and then fire the blighter. It is true that first rate people hire first rate people, and perhaps even more so that first rate people hire and develop first rate people. Both Andy Grove at Intel and Jack Welch at GE emphasized how they put a great deal of their personal effort into training and developing the next generation of their leaders.172 One aspect of this education is, of course, to encourage people who may not yet be on their own Main Boards, to serve as non-executive directors on other companies; and, conversely, to be willing to have at least one person on your Board who is still developing, and possibly not yet on their own Main Board – although clearly they need to be of the requisite calibre.

RELATIONSHIPS The quality of relationships is absolutely fundamental to the idea of effective stewardship. In the context of a Board with stewardship of a substantial company there are three critical sets of relationships: 1.

Relationships with the owners of the business and with their representatives.

2.

Relationships between members of the Board.

3.

Relationships between the Board and the employees and other stakeholders in the company.

If these relationships are healthy then the business will be likely to be operating according to sound principles. If not, it is reasonable to expect that serious problems will ensue. Let us try to characterise the desirable qualities of these relationships.

172

There was, I recall, an extra chapter about training for Grove (1998) which he wished he had written and which was published in a US business magazine. Welch (2001) (From the Gut in the US, Jack in the UK) has Chapter 12 entirely devoted to remaking Crotonville (their training centre) to remake GE.

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Relationships

Stewardship

As opposed to – for example

Owners and representatives

Recognition of stewardship. Professionalism and objectivity. Honesty and integrity. Appropriate levels of openness.

Shareholders are dumb and insolent. Why should we listen – we know best. Give the City whatever it wants. Do what we can get away with – throwing things to the wolves where necessary.

Within the Board

Openness. Recognition of stewardship. Professionalism and objectivity. Honesty and integrity. Teamwork but not groupthink.

If the NEDs know more, they’ll interfere more. Face it, we are the company, really. Now I’ve really made it! How much were these other guys getting in share options? This is crazy, but no one else has objected, so I’d better stay quiet. Don’t rock the boat.

With employees and other stakeholders

Recognition of stewardship. Professionalism and objectivity. Honesty and integrity. Teamwork.

They are there to do what we tell them. I’ll stick up for my people. Tell them what we want them to hear. Them and us.

It’s worth touching on appropriate levels of openness. It is sometimes suggested in the governance literature that the more information given to shareholders the better, since as the owners of the business they have a right to know. But this is not true. Directors have a right to know, but there are many facts about the business and about strategy which are genuinely commercially sensitive. Disclosure of any information is only in the shareholders interests if the benefits to them of having this information disclosed exceed the costs, and these costs include not only the time spent obtaining this information and checking it, but also the economic advantage competitors and other parties in commercial relationships, such as suppliers and customers, would gain from having this information disclosed. For example, knowing the exact profitability and stage payment profiles by contract in a major defence contractor would be very interesting to the analysts, but might make it harder to negotiate sensible prices from the customers. Equally, some organizations are instinctively secretive, withholding information that is plainly relevant for shareholders. Shell famously launched a review of its structure and governance, in response to strong shareholder pressure, and then refused for a few weeks to say who was conducting it. Independent directors may be better placed than long-serving executives to weigh the balance between the costs and beneﬁts of disclosure.

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However, it is worth repeating that, whereas companies should be run in accordance with the interests of the shareholders as a whole, that is not to say that they should necessarily be run in accordance with their wishes. The judgement to discern the difference is sometimes very difficult, but it is an essential part of the duties of directors, especially if they take their stewardship seriously.

SERVANT LEADERS The key and final attribute of stewardship is a sense amongst leaders who take their stewardship seriously that theirs is a role of service, where the privileges of leadership entail grave responsibilities. Great organizations are awesome things to lead. Whether or not the portraits of your illustrious predecessors actually stare down at you from the walls, it is important that people should feel, as they work in positions of great power and leadership, the weight of responsibility and the feeling that their successors will be looking back at them. This feeling is by no means conﬁned to CEOs: someone working in the room in a laboratory where someone won their second Nobel prize is bound to feel a little challenged and humble. There is a beautiful picture in Charles and Elizabeth Handy’s book A Journey Through Tea of a tea garden manager at his desk, with the names and dates of service of his predecessors on a roll of honour on the wall behind him. This man knows he has received an important trust and has to hand it on. Servant leaders are also aware of the dangers of inaction. Allowing the weight of your responsibilities to paralyse you into inaction or excessive caution is not the attitude. Whether or not people are within the Christian tradition, another story involving stewardship rings down through the centuries in Western literature. A man going abroad called his servants and entrusted his capital to them; to one he gave five million, to another two million, to another one million, to each according to his ability. Then he went away. The one who had received five million went at once and put them to work, and he made ﬁve more. So also, the one who had two made two more. But the one who had received the one million went and dug in the ground and hid his master’s money. Now after a long time the master of those servants came and settled accounts with them. And he who had received the ﬁve million came forward, bringing five million more, saying, ‘Sir, you delivered to me five million; here I have made five million more.’ His master said to him, ‘Well done, good and faithful servant; you have proved trustworthy in a small matter, so I will put you in charge of something big; come and share the joy of your master.’ And he also who had the two million came forward, saying, ‘Sir, you delivered to me two million; here I have made two million more.’ His master said to him, ‘Well done, good and faithful servant; you have proved trustworthy in a small matter, so I will put you in charge of something big; come and share the joy of your master.’ He

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also who had received the one million came forward, saying, ‘Master, I knew you to be a hard man … so I was afraid, and I went and hid your million in the ground. Look – you have what is yours.’ But his master answered him, ‘You wicked and lazy servant! …’ (Matthew 40: 25) No doubt there are similar stories in other traditions. There is, as always, a balance that needs to be struck. There are temptations to pride and to excessive conservatism in dwelling too much on the past of an organisation. But steering the right course between obstacles on either side is a fundamental part of the leader’s art. And the attitude of servant leadership is not confined to organizations with a long past: Capital and McKinsey have had it from their early days.173

CONCLUSION During these pages we have toured a strange and interesting archipelago: five remarkable companies, ﬁve remarkable investors, three central issues of governance, and insights from over 150 chairmen, directors and investors. I have not tried to impose a tight theoretical structure because, at least at this stage of development of governance and stewardship, we are at the natural history stage of understanding: there is no Darwin and certainly no molecular genetics. In the end, companies are about the way people behave. While this can be influenced by legislation and litigation, it is really a question of attitude and understanding. After all, legislation only affects behaviour if people chose to modify their behaviour in response to it: people always have the choice with rules as to whether to try to ignore them, obey them, disobey them or get round them, and it is only concern about litigation that can alter behaviour before the event litigation is designed to stop. I’ve offered some suggestions to investors, chairmen, NEDs, people considering an NED role, EDs and investors, and tried to outline an attitude of stewardship which should lie at the heart of wise Board behaviour. Whichever of these positions you occupy, or if, like me, you are just an interested observer, I hope that amongst the views that you have seen on this journey, some will stick with you and resonate. In terms of governance, stewardship and constructive engagement we certainly live in interesting times. I hope that, by sharing the perspectives of many people who are doing this successfully, this book can make a contribution to these interesting times being ones of opportunity and hope, for us and for the next generation. 173

But such an attitude may be important for any organization that wants to have a long future. By far the longest-established large global organization in the world calls its CEO (amongst other things) ‘servant of the servants’ (beginning with Pope John III in 570 and much loved by Gregory the Great, see www.newadvent.org/cathen/13737a.htm) and although this has perhaps not always been as much of a ‘value in use’ as it might have been, it is at least a clear statement of intent.

APPENDIX A

Outline of Lead Investor Idea LEAD INVESTORS – A SID IN REVERSE? Constructive engagement with a company benefits all the shareholders, so it seems logical on the face of it that the costs should be covered by all the shareholders, rather than by the institutions that take a lead in a particular area. Rather as the Board designates a SID so that there is a focal point of contact amongst the INEDs for investors, it would be possible for a company and its shareholders to designate a Lead Investor. How could this be achieved without the obvious drawbacks? Perhaps something along the following lines: ●

An investor could be designated the Lead Investor for a particular company by a vote at the general meeting if it is one of the ten largest shareholders. This would normally be done on the recommendation of the Board, but would not have to be. It would be best if the vote required was 75 per cent in favour, rather than 50 per cent, with shares connected with the management or with a controlling shareholder excluded from voting.

●

The Lead Investor would perform a role amongst investors analogous to that of the senior independent director amongst the directors. He or she would keep a particularly close eye on the business and would normally be the ﬁrst point of contact if the company was concerned about investor issues or if fellow-investors were concerned about an issue and felt they were not getting an adequate response from the company or the SID or the company’s brokers.

●

The Lead Investor would be entitled to reimbursement of its reasonable engagement costs from the company.

●

The Lead Investor would explicitly not have any legal liability to the other investors or to the company. However, the reputation of the Lead Investor would clearly be at risk if they allowed an avoidable debacle in a company for which they were lead investor, or if they performed in other unsatisfactory ways.

To some extent this is re-inventing the role of the corporate broker, who in the good old days provided a signiﬁcant governance input and whose independence and reputation were clear. To what extent brokers in these good old days truly behaved in the way in which they were ideally expected is beside the present point. However, now that corporate brokers have become parts of investment banks it is widely believed, with

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some justiﬁcation, that the primary goal of these ﬁrms is winning substantial fees from the companies and, with maybe one or two exceptions, they are not seen as impartial. The Lead Investor, by contrast, should have no incentives other than to do a good job of engaging with the company and helping to enhance its governance and hence its value. The engagement activity in itself would be neither proﬁtable nor loss-making, so a sensible investor will do it only to the extent that it adds value. I would expect that being elected Lead Investor on a company would be a signiﬁcant marketing plus for the investor concerned, and thus lead to increased business from its clients. This would provide the economic incentive for investors to act in this way – otherwise why should they do something which by deﬁnition can only break even? But it would also solve one of the fundamental problems at the heart of the institutional investor capitalist model: who pays for engagement, which is a public good and a private cost? There is an argument that Lead Investors should receive tax and other legal privileges, but tax incentives almost invariably have perverse consequences, and are subject to change at the whims of government. If a goal can be achieved by purely economic means without involving governments then it should be so achieved. The Lead Investor concept would also help deal with the serious problems of meeting fatigue that affects companies and investors alike. At present, companies put a great deal of effort into seeing, and consulting with, their top 20 shareholders. Much of the discussion is very similar in each meeting – indeed if substantially the same information were not communicated on each occasion by the company they might be accused of giving inside information. As a result you have a large number of expensive people on both sides spending time on repetitious meetings which add little value – indeed in some cases important messages can get lost or diluted in the blur of back-toback meetings. If, instead of 20 one-hour meetings every quarter, companies had a two-and-a-half-hour meeting with their Lead Investor, a transcript of which was made available on the web, followed by 30-minute meetings with the other 19 investors who could assume what was said to the Lead Investor and only have supplementary discussions, approximately eight hours of meetings would have been saved per company. Given that each meeting will typically have two to ﬁve expensive attendees from each side, this is a saving of four to ten person days per quarter per company. To the extent that the CEO and CFO, who typically attend these meetings, add value to their companies, this should add about 1 per cent. More to the point, it should allow these ‘roadshows’ to be concluded with one to two days’ less time away from the ofﬁce. I have some concerns about the situation in which a top manager in a highly successful international business can describe his job before he joined the Board as ‘essentially running the day-to-day business, whilst our CEO, COO and CFO concentrated on external communications and shareholder relations crucial for us … as a public company. In that time my responsibility was to deliver quarterly numbers.’

OUTLINE OF LEAD INVESTOR IDEA

253

IMPLEMENTATION ISSUES FOR THE LEAD INVESTOR CONCEPT There seems no need for a change in the law to implement the idea of Lead Investors. All that would be needed is for a model contract to be drawn up, ideally under the auspices of one or more bodies representing investors and ideally companies (for example in the UK, the IMA and the CBI) and for a company to propose at its AGM that X be designated as lead investor in accordance with the model lead investor contract. Companies in any case bear the costs of investor relations consultants and corporate brokers, and in some cases pay ﬁrms simply to survey investors and analysts on their views on the company. In other cases companies also pay more explicitly for engagement costs of intermediaries. For example when we are asked to assist a company with difﬁcult strategic succession issues (such as the need to appoint a new chairman in situations where Investors have been very critical of performance) the company pays our costs, even though a considerable proportion of our work is in liaison with the institutional investors who are the major shareholders. In private equity there is generally a Lead Investor in a company, who undertakes the most intensive monitoring and engagement role, with other investors being rather more passive. Although the role of the Lead Investor in a publicly listed company would be far less dominant, we hope it would offer some of the same advantages to the system. To some extent the ABI and the NAPF play a Lead Investor-like role when a company gets into a crisis. However, the aim of constructive engagement is to avoid crises. Constructive engagement also depends on relationships, trust and understanding, which are best established in calmer times.

INCENTIVES FOR CONSTRUCTIVE ENGAGEMENT RATHER THAN NOISE In addition to tackling the costs side of the problems of constructive engagement, the Lead Investor concept offers some hope to deal with another problem: changing the balance of incentives between constructive engagement and noisy engagement. Except for the most bull-headed and obstinate companies,174 the most constructive way in which investors can engage effectively with management is through focused, behind-the-scenes dialogue. However, they generally get no credit for this with their 174

A charming but remarkably ‘tone-deaf’ Chairman springs to mind, who was convinced he could deal with the deafening wave of investor disquiet by employing one of his cronies to do investor surveys, and refused even to call the Chairman of a major investor who had offered to explain to him why it would be helpful to use our more specialist services. He was eventually sacked by the Board to head off a major shareholder revolt.

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customers – the pension fund trustees or the buyers of mutual funds/unit trusts. By contrast, a confrontational approach, with leaks to the press and all the trimmings, is highly visible and, even if unconstructive, gets a firm noticed so that at least some customers will be inclined towards it.175 Since Lead Investor status would be proposed by Boards and approved by investors it would be a reasonable proxy for judgement by one’s peers. A Board which picked a dozy or complacent Lead Investor would have a lot of explaining to do, and would risk the embarrassment of their choice being voted down. Investors who were good lead Investors would probably want to allude to it in their marketing material and trustees might well take note, since lead investors would generally be better informed about the business without placing the cost burden of thus on their customers, because their engagement costs are covered. Trustees who feel that something must be done will also feel that their money and votes are doing something useful and wellinformed.

175

There is an analogous problem when low-ranked analysts make outlandish suggestions in reports to get noticed, hoping to be right occasionally. The most extreme example of ill-founded governance noise I have heard is of a voting advisory service which advised a vote against the re-election of an independent director on the grounds that he worked for HP EMEA and one of the EDs used to work for Motorola EMEA and thus they were former colleagues at EMEA! The Chairman who told me this assures me that it is not a ﬁctitious example.

APPENDIX B

Royal Dutch Shell Corporate Governance Arrangements Schedule 2 of the Implementation Agreement for the establishment of Royal Dutch Shell (RDS) explicitly deﬁnes the roles of: ● ● ● ● ●

the CEO the executive management and especially the executive committee (ExCo) the Board the Chairman the Deputy Chairman.

In addition this document implicitly defines aspects of the roles of the CFO and the Company Secretary. The roles of the four Board committees: ● ● ● ●

audit remuneration (RemCo) nomination and succession (NomCo), and social responsibility.

are described further in the listing particulars. The summary that follows is closely based on these sources with the occasional ellipsis and paraphrase, all the abbreviations are mine. Comments from me are in italics.

THE CEO The appointment of the CEO is made by the Board as a whole: the process is led by NomCo. The CEO can be removed by the Board (normally acting through the chairman) or by shareholder resolution. The CEO chairs ExCo and sets its agenda. The CEO is responsible for the effective functioning of ExCo and leads the individual EDs and the ExCo as a team. The CEO will provide the Board through the Chairman with the information needed to evaluate the performance of individual EDs and the ExCo as a whole each year; and fulﬁls a leading role in the development of individual EDs.

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Note that the CEO provides this information through the Chairman and that it is the Board’s responsibility to evaluate individual EDs. The CEO bears overall responsibility for the implementation by ExCo of overall strategy agreed by the Board, the operational management of RDS and the business enterprise connected with it. The CEO with the Chairman is responsible for ensuring effective two-way communication with shareholders and other stakeholders and for maintaining the corporate reputation of RDS. In general the CEO will be the chief spokesman for RDS. The CEO determines the assignment of executive roles amongst the EDs, subject to approval of the Board. Pending consideration by the Board the CEO may change an ED’s executive role with immediate effect. The CEO has oversight responsibility (subject to the views of the Board) for the appointment, proper functioning, and, if necessary, dismissal of individual EDs as employees. It is clear both here and below that RDS is keen to avoid the possibility of an ‘imperial’ CEO and is striking a careful balance between giving the CEO authority and having collective accountability. The CEO is accountable to the Chairman and to the Board for the performance of ExCo and the individual EDs. They are accountable to the CEO and the Board. The CEO, with the Chairman, ensures that the Board receives accurate, timely and clear information. The CEO is authorized to give general directions to each individual ED in relation to the exercise of the operational responsibilities assigned to the respective ED.

EXECUTIVE MANAGEMENT The Board delegates the executive management of RDS to the CEO and, under the CEO’s direction, to the other members of ExCo. Accordingly ExCo shall be responsible for RDS’s overall business and affairs and have the final authority in all matters of management that are not within the duties and authorities of the Board or the shareholders’ meeting. It shall implement all Board resolutions and supervise all management levels in RDS. Note that ExCo is in some respects like a management board. In theory the CEO could be ‘outvoted’ by colleagues on ExCo – in practice this is vanishingly unlikely but it does mean that the members of ExCo are collectively responsible for its decisions. In BP by contrast delegation is always to individuals.

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Without limiting the generality of the foregoing, ExCo’s areas of responsibility in particular include (subject to Board or audit committee approval where required): 1.

RDS’s strategic aims, as approved by the Board; and its basic organization, policies plans and performance, against these strategic aims, and in respect of the values and standards set by the Board, including RDS’s business principles and policies forming the basis of its culture and identity, and its risk and internal control policies.

2.

RDS’s accounting framework and its financial control, planning and disclosure procedures.

3.

Compliance with RDS’s lending and borrowing limits, as determined by the Board, and its procedures and approval processes for new investments.

4.

The annual operational and capital budget and appraisal and the consolidated quarterly, half-yearly and annual ﬁnancial statements.

5.

Acquisitions, divestitures, liquidations, restructurings and other transactions in accordance with established limits, procedures and approval processes.

6.

Appointment and dismissal of senior executives below ExCo level, and staff development.

7.

Monitoring of performance against determined goals.

8.

On all matters which are for Board decision or approval, appropriate preparatory and follow-up action.

ExCo shall consist of: ●

The CEO, who shall report directly to the Board.

●

The CFO and other EDs, who shall direct and supervise the major organizational units; the CFO and the other EDs shall report directly to the CEO in such a manner as the CEO shall determine, and they shall be accountable both to the CEO and to the Board.

●

Such additional members as the Board, in consultation with the CEO, shall determine, and who shall report directly to the CEO.

ExCo shall meet as often as business requires. Proceedings and decisions shall be recorded in minutes. ExCo shall be assisted by a secretary not the Company Secretary, whose role and obligations shall be determined by ExCo. In principle ExCo meetings shall take place in the Netherlands. Exceptionally, on particular occasions, ExCo may meet in other countries. Meetings will be conducted in English.

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The executive management shall also comprise an extended executive leadership group, the membership of which shall vary over time. Such membership and the duties and authorities of the members, shall be set forth under the principles of RDS’s basic organization, as determined by ExCo. Note again the rather careful checks and balances: the CEO cannot pack ExCo.

THE BOARD The Board is collectively responsible for the success of RDS. It should meet as often as necessary to discharge its duties effectively. The Board role is to: ●

provide entrepreneurial leadership of RDS within a framework of prudent and effective controls;

●

consider and, if appropriate, approve RDS’s strategic aims and business principles, and review management performance against these aims; and

●

set RDS’s values and standards and ensure that its obligations to the shareholders and others are understood and met.

The Board will comprise: up to ten NEDs, including the Chairman and the Deputy Chairman, with appropriate business and professional experience and together having a suitable balance; and the CEO, CFO and up to three other EDs. There shall always be at least two more NEDs than EDs. It is agreed that, in respect of all Board appointments, the governing principle shall be the choice of the best person for the job, irrespective of nationality. NomCo shall have due regard to the international nature of RDS and to its Dutch/British heritage. An elegant compromise. As noted earlier, I think it will be an important challenge to convince outstanding people who are neither Dutch nor British that they are really on a completely equal footing. However, it is fair to point out that the ExCo of RDS has Dutch, British, US and Swiss members which makes it significantly more diverse in terms of nationality than its major competitors. The Board will annually: ●

review its own performance and that of its committees and individual directors; and

●

review RDS’s system of internal controls.

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NEDs should: (a) constructively challenge and help develop proposals on strategy; (b) scrutinize the performance of management in meeting agreed goals and objectives and monitor the reporting of performance; (c)

satisfy themselves of the integrity of financial information and that ﬁnancial controls and risk management are robust and defensible;

(d) be responsible for determining appropriate levels of remuneration of EDs; (e) appoint and where necessary remove EDs and plan succession; (f)

keep RDS’s business principles under review;

(g) meet at least annually without the Chairman being present, to review the performance of the Chairman; (h) meet routinely without the EDs being present, to discuss, amongst other things, corporate strategy, RDS’s system of internal controls and the performance of individual directors. Note that (c),(d) and (e) are the primary focus of audit, RemCo and NomCo but this is emphasizing that these are the responsibilities of the NEDs as a whole. The Board shall establish from among the NEDs an Audit Committee, NomCo, RemCo and Social Responsibilty Committee. The Chairman will chair NomCo but will not be a member of audit or RemCo. The Board will appoint other committee chairmen from among their members. Committees shall comprise at least three directors. Any NED shall be entitled to attend any committee of which he or she is not a member (other than ExCo): a committee Chairman may invite any ED to attend any meeting when appropriate. Audit, NomCo and RemCo will comprise NEDs exclusively. In principle Board and committee meetings shall take place in the Netherlands. Exceptionally, on particular occasions, they may meet in other countries. Meetings will be conducted in English. The Company Secretary shall be the secretary of the Board.

BOARD CHAIRMAN The Chairman is responsible for the leadership of the Board. The appointment of the Chairman (who shall not be a former member of ExCo) shall be made by the Board as a whole. The process is led by NomCo.

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The Chairman is responsible for ensuring that the Board and its committees function effectively. With the CEO, the Chairman shall ensure that the members of the Board receive accurate, timely and clear information. To this end the Chairman shall see to it that: ●

There is an adequate induction and training programme that all directors follow.

●

The development needs of individual directors are identiﬁed and met.

●

All directors receive in good time all information which is necessary for the proper performance of their duties and have sufﬁcient time to take decisions.

●

The performance of the CEO, the other EDs and the NEDs is assessed at least once a year.

●

The Board elects a Deputy Chairman.

●

The Board has proper contact with the CEO and the ExCo.

It is interesting that the Chairman is responsible for ensuring that the development needs of all the directors – including the EDs other than the CEO – are met, although of course the CEO ‘fulﬁls a leading role in the development of individual EDs’. The Chairman will from time to time convene meetings of the NEDs without the EDs present. The Chairman shall ensure the orderly and efficient conduct of general meetings of shareholders. The Chairman with the CEO is responsible for ensuring effective two-way communication with shareholders and other stakeholders and for maintaining the corporate reputation of RDS.

DEPUTY CHAIRMAN The NEDs shall choose a Deputy Chairman (not a former member of ExCo) from amongst their number, who will: ●

chair meetings in the absence of the Chairman;

●

provide such assistance to the Chairman and the CEO as they may require;

●

facilitate the self-evaluation of the Board and its committees and its evaluation of the Chairman; and

●

fulﬁl the other functions of ‘senior independent director’.

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BOARD COMMITTEES NOMINATION AND SUCCESSION COMMITTEE (NOMCO) NomCo makes recommendations to the Board on all Board appointments and reappointments. It regularly reviews the structure, size and composition (including the required skills, knowledge and experience) of the Board and makes recommendations with regard to any adjustment deemed necessary. It evaluates, prior to an appointment being made, the skills, knowledge and experience on the Board and defines the role and the capabilities required for a particular appointment. It is responsible for identifying and nominating suitable candidates for the approval of the Board to ﬁll vacancies as and when they arise. NomCo keeps under review the leadership needs of RDS. It also makes recommendations to the Board concerning the succession plans for both EDs and NEDs, on the reappointment of any NED at the conclusion of the specified term of ofﬁce and on any matters relating to the continuation in ofﬁce of any director. NomCo also makes recommendations on the appointment of the Chairman of each of the Audit Committee, RemCo and the Social Responsibility Committee and, in consultation with the Chairman of the relevant committee, the membership of those committees. It also makes recommendations in respect of corporate governance guidelines for RDS and monitors compliance with corporate governance requirements and makes recommendations in respect of disclosures relating to corporate governance and its appointment processes. The initial members of NomCo are Aad Jacobs (Chairman), Lord Kerr of Kinlochard and Jonkheer Aarnout Loudon.

AUDIT COMMITTEE The Audit Committee assists the Board in fulfilling its responsibilities in relation to internal control and ﬁnancial reporting, and carries out certain oversight functions on behalf of the Board. It is charged with monitoring the effectiveness of the RDS Group’s risk based internal control system. It monitors compliance with applicable external legal and regulatory requirements, the Shell Statement of General Business Principles and Code of Ethics. It has a duty to discuss with the RDS Group CFO, the RDS Group controller and the external auditors issues regarding accounting policies and practices. It reviews and discusses the integrity of the financial statements with management and the external auditors. It reviews, in conjunction with management, the policies of RDS with respect to earnings releases, ﬁnancial performance information and earnings guidance, reserves accounting and reporting and signiﬁcant ﬁnancial reporting issues. It establishes and

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monitors the implementation of procedures for the receipt, retention and treatment of complaints regarding accounting, internal accounting controls or auditing or other matters, including mechanisms for the confidential or anonymous submission of related concerns by employees, ensuring that these procedures provide for proportionate and independent investigation of such matters and appropriate follow up action. It monitors the effectiveness of the procedures of RDS for internal control over ﬁnancial reporting. The Audit Committee reviews and assesses the internal audit function’s remit, the appropriateness of internal audit strategies and the annual internal audit plan. It monitors the execution and results of the audit plan. It reviews and assesses management’s response to audit findings and recommendations. It discusses the adequacy of the risk management and internal control system of RDS and any significant matters arising from the internal audit with the chief internal auditor, management and the external auditors. It monitors the qualifications, expertise, resources and work structure of the internal audit function. It considers the standards employed by the internal audit function, quality assurance procedures and auditor competence. It assesses annually the performance of the chief internal auditor, including the role and effectiveness of internal audit in the overall context of the risk management and internal control systems of the RDS Group. The Audit Committee makes recommendations to the Board for it to put to the shareholders for approval in general meeting, in relation to the appointment, reappointment and removal of the external auditors. It investigates the issues giving rise to any resignation of the external auditors and considers whether any action is required. It reviews and approves the engagement letter for the external auditors. It monitors the execution and results of the audit. It also monitors the qualifications, expertise, resources and independence of the external auditors and assesses annually the performance and effectiveness of the external auditors. It establishes and monitors policies for, and external disclosures in respect of, the pre-approval of all audit services and permissible non-audit services to be provided by the external auditors and the hiring of employees or former employees of the external auditors. It obtains annually a report from the external auditors describing all relationships between the external auditors and RDS and material issues raised by internal quality control reviews or by any external inquiry or investigation. The Audit Committee updates the Board about its activities after each Audit Committee meeting. Where the Audit Committee is not satisfied with any aspect of risk management and internal control, ﬁnancial reporting or audit-related activities, it reports to the Board. The Audit Committee is also responsible for bringing to the attention of the Board material issues regarding accounting, internal accounting controls or auditing. It is responsible for describing in the annual report how it has

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discharged its responsibilities and how auditor objectivity and independence has been safeguarded. The initial members are Lawrence Ricciardi (Chairman), Sir Peter Burt, Mary (Nina) Henderson and Christine Morin-Postel.

REMUNERATION COMMITTEE RemCo determines and agrees with the Board the remuneration policy and individual remuneration packages for the Chairman, the CEO and the EDs. It monitors the remuneration for other senior executives and makes recommendations if appropriate. RemCo determines and agrees with the Board the framework remuneration policy for the Chairman, the CEO and the other EDs, ensuring that remuneration is adequate to attract, retain and motivate high calibre individuals. Within the terms of the agreed framework remuneration policy, it determines individual remuneration packages for the chairman and the CEO, and, in consultation with them, for other EDs. It monitors the structures and levels of remuneration for other senior executives and makes recommendations if appropriate. It determines and agrees with the Board a performance framework and endorses its application in setting performance targets for the remuneration of the CEO and other EDs and, assessing their performance against such targets, determines resultant annual remuneration levels. RemCo also approves employee share plans and other incentive plans for executive directors. It considers and advises on the terms of any contract to be offered to a director. It approves pension arrangements for executive directors and any major changes to employee beneﬁt arrangements applicable to them. It reviews and endorses the policy for authorizing claims for expenses from the CEO and the Chairman. RemCo prepares an annual remuneration report and ensures that all necessary disclosures within its remit are properly made. The initial members are Jonkheer Aarnout Loudon (Chairman), Lord Kerr of Kinlochard and Sir Peter Job.

SOCIAL RESPONSIBILITY COMMITTEE Under its terms of reference, the Social Responsibility Committee reviews the policies and conduct of the Group with respect to the Shell Statement of General Business Principles as well as the Group’s health, safety and environment policy, other relevant Group policies and standards and major issues of public concern, making recommendations to the Board accordingly. It also oversees the design of internal control procedures relating to the Shell Statement of General Business Principles and health, safety and environment policy, and makes recommendations to the Board accordingly.

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The initial members are Wim Kok (Chairman), Maarten van den Bergh and Mary (Nina) Henderson. It is worth re-emphasizing that the governance arrangements were written and agreed before the decision on structure was made, and could in principle have been implemented with two companies having a common Board. However, it is also clear that the additional complexity of a dual-headed arrangement would have had few, if any, advantages in terms of making RDS more competitive.

Glossary ABI Association of British Insurers ADR American Depository Receipt AUM Assets under management Black-Scholes A theoretical framework for pricing options, used in trading and applied (somewhat contentiously) to valuing share options granted to directors boe Barrels of oil equivalent CAGR Cumulative annual growth rate CalPERS The Californian Public Employees Recruitment System – a large activist investor CEO Chief executive ofﬁcer CFD Contracts for Differences – a financial instrument (often a hedge fund which allows an investor) to have an economic interest in a share without owning one (or paying stamp duty) CFO Chief ﬁnancial ofﬁcer CMD (Shell’s) Committee of Managing Directors CIO Chief investment ofﬁcer Combined Code The Combined Code on corporate governance was updated in the light of the Higgs Review (qv) and the Smith Review (qv). It consists of principles and provisions to which companies should ‘comply’; if they do not, they should ‘explain’ their decision CSR Corporate social responsibility ED Executive director ExCo Executive Committee FIL Fidelity International Ltd, the ‘overseas’ arm of Fidelity FSA The UK Financial Services Authority – regulator of almost all UR ﬁnancial services GAAP Generally Accepted Accounting Principles GAC (Royal Dutch/Shell) Group Audit Committee Higgs Review A government-initiated, independent review of the role and effectiveness of NEDs (qv) led by Derek Higgs (now Sir Derek) in 2002–2003 IMA Investment Management Association INED Independent non-executive director NAPF National Association of Pension Funds NED Non-executive director NomCo Nominations Committee of the Board PIRC Pensions Investment Research Consultants – a private company that advises Investors (especially local authority pension funds) on governance issues.

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RemCo Remuneration committee of the Board Sarbanes-Oxley (SarbOx) US law of 2002 passed in the wake of the Enron scandal; it concerns corporate governance, ﬁnancial disclosure and public accounting SID Senior independent director SEC The (US) Securities and Exchanges Commission Smith Review A review of audit committees led by Sir Robert Smith SNED Senior non-executive director – now called the SID TMT Telecoms, media and technology TSR Total shareholder return that is, the total gains made by shareholders from an investment per share, including dividends, share buy-backs and any increase in the value of the shares

Partial bibliography Anderson, Anthony (1982) The Man who was HM Bateman. Webb & Bower. An illustrated biography of one of the great comic artists of the twentieth century. Bennis, W.G. and O’Toole, James (2005) ‘How Business Schools Lost their Way’ Harvard Business Review, May, pp. 96–104. This suggests that business schools are hiring professors with limited real-world experience, suffering from ‘physics envy’ and graduating students who are illequipped to wrangle with real management problems: They describe ‘complex unquantifiable issues’ as ‘the stuff of management’ which is true as far as it goes, but issues of attitudes and relating to people also seem relevant. Blake, W (1794) Songs of Experience. The attitude of The Bard is highly dangerous in NEDs, or CEOs. Block, Peter (1996) Stewardship: Choosing Service Over Self Interest. Berrett-Koehler. An earlier book advocating the idea of stewardship, although not in exactly the same sense that I do. Brahms, C. and Simon, S.J. (1941) No Bed for Bacon Michael Joseph, republished by Black Swan, 1999. Brahms and Simon (real names Abrahams and Skidelsky) wrote this delicious romp through late Elizabethan England, in which a Lady Viola disguises herself as a boy player and falls in love with Will, while on fire-watching duty in 1941. If only someone could be as funny about a modern CEO and their advisers and hangerson. Cadbury, Adrian (2002) Corporate Governance and Chairmanship: A Personal View. OUP. A delightful book by a wise and experienced former Chairman whose Cadbury Report got the whole governance movement going in the UK to such good effect. Carter, C. and Lorsch, J. (2003) Back to the Drawing Board: Designing Corporate Boards for a Complex World. HBSP. I agree with much of this book. The authors’ main focus is where ‘Chairman & CEO’

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is the norm174, and although they advocate splitting the roles or having a lead director they raise ‘can two jockeys ride one horse?’ questions. There are distinctions not made in this book that I try to explore further: for example between the wishes and interests of shareholders and between director remuneration in stocks and by options. I’m also wary of the idea that all boards need to be redesigned, firstly because most of what they advocate is actually practised in the successful Boards I study and partly because there are dangers in a ‘Year Zero’ approach. Climacus (1846) Johannes Climacus, ed. S. Kierkegaard. Concluding Unscientific Postscript to Philosophical Fragments: A Mimical-Pathetical-Dialectical Compilation, An Existential Contribution. As far as I know the real Johannes Climacus, a sixth-century abbot on Mount Sinai who wrote The Ladder of Paradise, had no connection with Denmark. This postscript is, rather like Lear’s young bird, about five times as long as the book Philosophical Fragments. Davis, Adrian (1999) A Strategic Approach to Corporate Governance. Gower. This gives rather a nice view of the UK scene around 1998. It is interesting how little attention, relatively, is paid to the role of investors in such books at that time. The focus is much wider than the UK plc and the case study on Equitable Life has a considerable poignancy today, as does that of BT. Davis, Jonathan (2004) Investing with Anthony Bolton. Harriman House. This is a very useful proﬁle with a longish essay by Anthony Bolton, giving valuable public-domain insights into how Fidelity International operates. Ellis, Charles D. and Vertin, James R. (2001) Wall Street People. Wiley. A series of biographies of various investment legends (not all US: Warburg and Maxwell both get a mention) usually culled from earlier published proﬁles. Ellis, Charles D. (2004) Capital. Wiley. This is a super book. But he says little on governance: a bit on the governance of Capital’s own mutual funds and the sustained long-termism of Capital’s own governance, although he does refer to a campaign by a capital analyst to remove a CEO.

174

For example, the story (p. 20) about the two-day Board retreat at 9000ft where the directors found great difﬁculty in focusing, or even keeping awake, during an intensive brieﬁng session organized by the chairman and CEO, would be read by many as another argument for separating the roles, rather than a story about bad design. The claim that combining chairman and CEO has proved successful perhaps deserves more scrutiny in the light of the massive disguised wealth transfers from shareholders to management through the granting of excessive stock options and hiding their true costs, with heavy lobbying to prevent the cost of options being offset against reported earnings.

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Garrett, R. (2003) Thin on Top: Why Corporate Governance Matters and How to Measure, Manage, and Improve Board Performance. Nicholas Brealey. Nobody’s perfect, but I have not met many ‘unelected, incompetent and irresponsible Directors’ nor encountered a ‘conspiracy of silence’. This may be due to our difference in focus and to the fact that my fieldwork is post-Enron and largely post-SarbOx/Higgs. The existence of CEOs and NEDs are now facts of business life recognised by the FSA, the government and the Combined Code. Gerstner, Louis (2002) Who Says Elephants Can’t Dance? HarperCollins. A delicious and instructive story of the turnround of IBM. But it’s remarkable how small a role in the investors and NEDs seem to play in this. Gilbert, W.S. (1879) The Pirates of Penzance. Grisham, J. (2003) The King of Torts. Arrow. One of my Chairman friends sends this to anyone who imagines that Class Actions are about justice. An enjoyable and salutary read. Grove, Andrew (1998) Only the Paranoid Survive. Proﬁle Business. A fascinating story of building a major corporation. Haffner, Sebastian (2003) Defying Hitler. Orion. This memoir, originally written in 1939 by a German journalist who fled to England, gives a remarkable account of the pressures that led to Hitler’s rise to power. Obviously this is not about corporate governance but it is still well worth reading. Handy, Charles (1995) The Age of Unreason. Random House. My ﬁrst introduction to Charles was at a seminar by Tom Peters who said, ‘There is one book I beg you all to read, on bended knee.’ Long pause – but it was of course The Age of Unreason, which is still seminal, with its lucid exposition of the portfolio lifestyle and many other key concepts. Handy, Charles (1997) The Hungry Spirit. Hutchinson. Obviously I am a huge fan of Charles and all his books are to be read with humility and profit. I hope, and think, that he’s a bit too pessimistic about Anglo-Saxon companies and investors (both management and investors seem to have learned something about sustainability and ethical behaviour, not least from reading Handy and other authors) and about organized religion. Handy, Charles (2001) The Elephant and the Flea. Hutchinson. Continued masterly reﬂections on the relationships between large enterprises and portfolio living.

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Handy, Elizabeth (1997) Journey Through Tea. Elizabeth Handy. A photographic journey through the tea gardens of Duncan Brothers in Bangladesh and those of the Goodricke Group in India. The photographs are remarkable (I refer to the one on p.67 of the manager in his ofﬁce under a roll of honour going back to 1892) and the commentary from Charles is thought provoking. It takes ‘four pruning cycles, or 16 years, really to understand the management of a tea garden. Not for the tea manager a quickie MBA followed by a highly paid consultancy assignment.’ Jones, Edgar (1987) A History of GKN, Volume One: Innovation and Enterprise17591918. Macmillan. This and its companion volumes trace the history of a remarkable company (also chaired by Sir David Lees for many years) and has inter alia the story of Lady Guest. Kagan, Jerome (1998) Three Seductive Ideas. Harvard University Press. Kagan, Professor of Psychology at Harvard, powerfully attacks three fallacious ideas common in the social and psychological sciences: a passion for abstraction, the lure of infant determinism and the pleasure principle – the idea that humans arre simply motivated to seek pleasure and avoid pain. Kendall, N. and Kendall A. (1998) Real-World Corporate Governance: A Programme for Proﬁt-Enhancing Stewardship. FT Pitman Publishing. Unlike the Kendalls I do not offer a comprehensive approach such that, ‘If we try and implement this concept, we are inevitably heading towards the ideal scenario.’ Their focus is on UK business ranging from mutuals to ‘a large insurer with a value in excess of £1.5 bn’. I agree with some of their observations, but not others. Lewis, C.S. (1941) The Screwtape Letters. HarperCollins. Dedicated to JRR Tolkien. Lewis, M. (1989) Liar’s Poker. W.W. Norton. A scary account of the decadent days when bond traders thought themselves masters of the universe. Longhurst, Henry (1959) Adventure in Oil: The story of British Petroleum. Sidgwick and Jackson. This remarkable book (which belonged to my grandfather who had worked for Anglo-Iranian in Persia before the Second World War) gives a perspective on the early years of BP. Luke (62) Gospel, conventionally supposed to be written c. 80 but see e.g. Wenham (1991) Redating Matthew, Mark and Luke Hodder & Stoughton; c/f John Robinson’s Redating the New Testament.

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MacAvoy, P. and Millstein, I. (2004) The Recurrent Crisis in Corporate Governance. Palgrave Macmillan. They argue against the traditional US-style board and against many of the excesses of the Enron/Worldcom era, present evidence that adopting stronger corporate governance does lead to better economic performance, and argue for a number of reforms including especially a deeper involvement of the Board, the separation of Chairman and CEO, with an interim step of appointing a Lead Director who carries out many of the Board-related functions of the Chairman so that existing Chairman and CEOs do not appear to be demoted(!). They suggest that the Chairman should be ‘full-time’, which UK experience indicates is undesirable, and do not engage with the value of having EDs other than the CEO and the CFO on the Board. Perhaps because they led the charge towards stock options they are insufﬁciently critical of some of the excesses created by them. Mallin, C. (2004) Corporate Governance. OUP. This is a rather nice textbook giving an overview to undergraduates and graduate students. Matthew (40) Gospel, conventionally supposed to be written c. 80 but see e.g. Wenham op. cit. – also the Syriac Orthodox have a continuous tradition of Matthew’s original Aramaic version. The word I translate as ‘million’ is talanton (talent) in the original which was worth 10 000 denarii and a denarius was a day’s wage. Monks, R. and Minnow, N. (2004) Corporate Governance – Third Edition. Blackwells. I aim to complement this magisterial tome. My narrower focus perhaps allows me more detail. I also try to focus mainly on good practice within outstandingly successful companies, which complements the war stories whereby heroic shareholders force or persuade underperforming businesses to mend their ways. In common with most of the UK, I am considerably more sceptical about the value of litigation than Monks is – after all shareholders suing the company they own are at best getting damages with their own money, and in practice the legal fees and costs are considerable. Munro, H.H. (1914) Beast and SuperBeasts. The complete works are published by Penguin in the UK. The immortal Saki – who enlisted as a Private in 1914 and was killed in 1916. The quotation is from ‘The Schwartz-Mettercheme Method’ – a gem even by Saki’s standards, which is also in The Best of Saki. Rodger, N.A.M. (2004) The Command of the Ocean. Penguin. The Royal Navy from 1679 to 1815 became arguably the second most significant and large-scale global enterprise that the world had ever seen. This fascinating book looks at governance and operations.

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Roe, Mark (2003) Political Determinants of Corporate Governance. OUP. This is a rather nice comparison of the political influences on corporate governance in various countries. It works at a very macro level and in concerned with inter-country comparison the big issues of relative power of shareholders and other stakeholders, and doesn’t really get into governance at the level discussed in this book. Schwed, Fred (1940) Where are the Customers’ Yachts? Simon & Schuster, republished in 1995 by John Wiley with a foreword by Michael Lewis. A real gem, with Peter Arno cartoons. Shakespeare, W. (1600) Much Ado about Nothing The quotation is from Act 3 Scene 3. Shakespeare, W. (1623) Twelfth Night First performed in 1601 but not published till the First Folio. Shapiro, Ellen (1995) Fad Surﬁng in the Boardroom. Addison-Wesley. This deliciously-titled book is an enjoyable romp through some of the Board absurdities. There is also a ‘dictionary of business basics’ which goes from accountability (‘… everyone else in the organization needs far more. Not to be confused with authority, which is what I need more of’) to war (‘A metaphor for business from which the customer is unaccountably left out’). Smith, Terry (1992) Accounting for Growth. Random House. This was the first book really to explain some of the ways in which accounts mislead. It is alarmingly topical 13 years later. Stiles, P. and Taylor, B. (2001) Boards at Work: How Directors View their Roles and Responsibilities. OUP. This is a very sensible book based, like mine, on extensive interviews with real directors. I go beyond Stiles and Taylor in explicitly studying the investors and how they interact with Boards, in focusing on some speciﬁc world-class companies and investors, and of course have the advantage of five eventful years in the development of governance frameworks. On the other hand I focus more specifically on non-executive directors and do not attempt to review or engage with the academic theories about Boards. Vives, X. (ed.) (2001) Corporate Governance, Theoretical and Empirical Perspectives. CUP. This is an intriguing selection of fairly academic essays from a variety of authors, devoted to a signiﬁcant extent to theoretical or cross-country empirical studies.

PARTIAL BIBLIOGRAPHY

273

Welch, Jack (2001) Jack. Headline. One has to be careful about the ‘hero Chairman’ and CEO, but this is still a very interesting read. The chapter on training is particularly interesting. It’s a pretty safe bet that GE will split the role at some stage and that Jeff Immelt’s successor will not combine both.

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Index Note: footnotes are cited by page number, not note number. academics, as NEDs 181 accountants, independence 187, 188 accounting culture, rules-based 219 activism, political desire for 225 AGMs 19 importance 147 AirTouch 84–5, 90 Alireza, Teymour 130 Allen, Charles 43 Amersham International 28, 223 Amoco 57 Amylum 74, 75 analysts 207–8 Anglo-Iranian Oil Company 52 Anglo-Persian Oil Company 52 Arcadia plc 20 ARM 223 Arnold, Luqman 118 arrogance 227, n.227, 241, 242, 245 Ashburton, Lord 55, 56 Association of British Insurers see ABI AT&T Wireless 88–9, n.89 Atlantic Richﬁeld Company (ARCO) 58 Attlee, Clement 73 audit 187 Audit Committee 12, 21–2, 178, 187–8 chairmanship 187, 188 ﬁnancial experts on 12, 188 independence 217 minutes 187 NEDs on 192 policing role 33 auditors, and INEDs 21–2 Austen, Jane n.51

Bacon, Francis n.243 BAE (British Aerospace) 28, 85, 166, n.224 Bamford, Peter 88 Barclay, James 99 Barclays 99–100 see also BGI; BZW Baric Computer Services 83 Barings 174 Bass 67 Bell Atlantic 84, 85 Bellsouth 89 BGI 99–104 business model 236 history 99–103 NED appointment and development approach 104 policeman’s lot approach 104 shareholder/NED contact approach 103–4 Blair, Tony 57 board behaviour 223–4 checks and balances 224 dysfunctional 162 evolving relationships with investors 224–5 exposure to strategic options 193 information access 224 relationships 224, 247, 248 size 160 board agenda 157–8 board balancing 158–60 board effectiveness building 160–3

276

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focus on 213 reviewing 163–4 board evaluation 163–6 appraisals 14, 163–5 CEO performance 165–6 City perspective 165 external 165 individual NEDs 164–5 board quality accountability of chairman for 41, 226 measures 17 board visits 178, 229 body language, on boards 161, 228–9, n.229 Bolton, Anthony 43, 110, 111, 112, n.112 investment style n.112 quote 113 Bond, Sir John 90 Boskin, Michael 90 Boynton, Judith 127, n.127, 128 BP 51–71 AGM 60, 68 Audit Committee 65, 71 board-executive linkage policy 63, 64 board operation and function 63–6 CFO appointments n.57, n.90 Chairman’s Committee 65 code of conduct 62, n.62 Company Secretary 56, 61, 63, 66 delegation to individuals 256 dialogue with directors 60 diversiﬁcation programme 53 employee concerns programme 62, 71 Ethics and Environment Assurance Committee 65, 70–71 executive limitations policy 63, 64 governance model 56, 58–66 governance report (2004) 58–60 Group Values 61–2 history 51–8 management framework 61–2 NED appointment and development

approach 68–70 Nominations Committee 65 performance contracts 60–61 policeman’s lot approach 70–71 Remuneration Committee 65, 66–7 reporting 60 share performance 54, n.54 shareholder/NED contact approach 66–8 succession planning 68–9 voting 60 website 63, n.63, 68 BP Amoco 57–8 BP Solar n.54 Brandes 20 Brinded, Malcolm 132, 139 Brinson, Gary 116, 117, 118 Brinson Partners Inc. 116 British Aerospace (BAE) 28, 85, 166 Britoil 54, 56 Broers, Sir Alec (Lord Broers) 90, n.90, 230 Browne, John 25, 53, 57, 64, 66–7, n.67 Buchanan, Dr John 90, 230 Buffett, Warren 163, n.225 quotes 113, 189, 233, 239 BUPA 46 Burmah Castrol plc 58, 64 Burmah Oil Company 52, 53, 58, n.58 Burt, Sir Peter 130, 263 Buttle, Dr Eileen 130 BZW n.99, 100, 101 Cabiallavetta, Mathis 116, 117 Cable & Wireless (C&W) 42, 84, 244 Cadbury, Sir Adrian 55, n.55, 213 Cadbury Schweppes 46 CalPERS 134, 137, 146 Capital 142, 240, 243, 244, 250 capitalism, need for 218 Carlton, merger with Granada 18, 43–4 Carnival 142, n.142 take-over of P&O 18

INDEX

Castell, Sir Bill 27, 28 CEO and INEDs 14–15, 231 performance evaluation 165 pivotal role 223 prior NED service 192–3 relationship with chairman 154–6 remuneration 184, 185, 245 separation of chairman role from 152–3 of top companies 26 chairman 151–67 accountability for Board quality 41, 226 as acting CEO 155–6 appointment 166–7 balancing multiple chairmanships 163 board agenda steering 157–8 board balancing 158–60 board effectiveness building 160–3 in board evaluation see board evaluation change in role 4 executive development by 156 independence 154 and INEDs 13–14 integrity 190 interaction with investors 44–5 mentoring role 177–8 primary focus 226 qualities needed 151 relationship with CEO 154–6 relationships with other board members 153–4 responsibilities 151–2 separation of role from CEO 154 suggestions to 225–8 workload 152 Chase Investors 116 Churchill, Lord Randolph 51–2 Churchill, Sir Winston 52 Cingular 89, n.89 class actions 218

277

Coca-Cola 78, 90 COLT Telecom 107, 109 Combined Code 265 applicability to largest companies 146 on independence of NEDs 47 on leadership of board 41 on NED evaluation 164–5 on Nominations Committee 12, 42 on third three-year term 80 committees, tips and pitfalls 178 Company Secretary 188 and INEDs 21 role 21 Compaq, merger with HP 37, 101–2 compensation culture 218 ‘comply or explain’ regime 37–8, 216, 225, 227 conﬂicts of interest among directors 8 among fund managers 8 among shareholders 8 between business and directors 9 between business and fund managers 9 between business and shareholders 9 between directors and fund managers 9 between directors and shareholders 9–10 between fund managers and shareholders 10 dealing with 8–11 within business 8 contingent fees 218 Cook, Linda 132, n.136 corporate brokers 251–2 corporate governance see governance Cox, Vivienne 27 Crocker National Bank 54, 100 Curvey, Jim 107 D&O insurance 217, 219

278

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D’Arcy, William Francis n.51 D’Arcy, William Knox 51, n.51, 52 de Ruiter, Henny 131 Delaware Delusion n.4 Delbridge, Richard 75, 77, 79 derivatives trading n.241 Deutsche Asset Management (DeAM) 37 Deutsche Borse 44, n.44 Deutsche Telecom (DT) 40–41 Diamond, Bob 102 Dillon Read 116, n.116 directing 5–6 directors duties 4, n.4 remuneration 9 see also EDs; INEDS; NEDs; SID disclosure, costs and beneﬁts 248 due diligence 189, 190–91, 231 Dunn, Pattie 101–2, n.119 EDs acting as directors 235–6 body language 228 development 192 and INEDs 15, 176–7, 234–5 remuneration 9, 184–7 suggestions to 234–6 education, of next generation 247 Efﬁcient Markets Hypothesis 7, 239 Empathy Quotient n.229 engagement, axes of 3 Enron 215, n.227, n.228, 241–2, 246 entitlement mentality n.244 Equitable Life 24, 174, 191 equity, private 206 ethical conduct 245–6 Evans, Dick 28 executive directors see EDs Exxon 53, 58, 70 Exxon Mobil 58, 88 Exxon Valdez tanker disaster 70

Fargo, William 99 FDs, ﬁduciary duties 214 Ferguson, Iain 76, 78 Fidelity 105–13 attitude to stewardship 243 and Carlton/Granada merger 43–4 director of corporate ﬁnance 108 director development approach 111–12 history 105–7 policeman’s lot approach 112–13 Principles of Ownership 108, 109, 110 and Royal Dutch/Shell 142, 144 shareholder/NED contact approach 107–11 specialist consultant 240 telecommunications interests 107 Fidelity International (FIL) 106, 108–11 Fidelity Management and Research Co (FMR) 105, 106 ﬁnance directors see FDs ﬁnancial experts, on audit committee 12, 188 Fiorina, Carly 103, n.100 Fish, David 77 Flint, Douglas n.57, n.67, 68 France Telecom (FT) 40–41, 85–6, n.86, 88 Fraser, John 118, 119, 120 Fraser, Simon 110–11, 112–13, 144 Freame, John 99 free rider problem 205 fund management, classes 236 fund managers conﬂicts of interest with shareholders 8 ethics and governance 205 evaluation 206 evolving challenges 204–6 and INEDs 16–19 as NEDs 197 numbers 204 remuneration 10, 201, 205

INDEX

skills shift 203 Garnier, JP 25 GE 223, 247, n.247 GEC 23 General Counsel 21, 188 Gent, Sir Christopher 25, 83, n.83, 84, 85, 87 and investors 91–2 Ginn, Sam 84 Giusti, Luis 130 GlaxoSmithKline, remuneration policy 19–20, 67–8 Global Asset Management (GAM) 117 Goethe, Johann von 245 Gould, Thomas 99 governance 213–19 aggressive activism 241 aims 213–14 ‘comply or explain’ regime 37–8, 216, 225, 227 government pressure 216 international perspective 208 investor concerns 198 lessons from big failures 214–15 versus strategy 175–6 wider economic issues 218–19 Granada, merger with Carlton 18, 43–4 ‘Greater Fool’ theory 39–40 Green, Michael 43–4 Green, Philip 9, 20 Green, Stephen 25, n.25 Greenpeace 125, n.125 Grossman, Blake 103 Grove, Andy 247, n.247 GTE 85 Guest, Lady Charlotte n.4 Halford, Andy 89 Hampel Committee 213 Hanratty, Judith 55–6 HATT 83

279

Hawthorne, Nathaniel 105, 113, n.113 Hayward, Tony 27 Hazen, Paul 90, 91, 100 headhunters and INEDs 22, 180, 181 use by BP 69 hedge funds 206–7, 224, n.224, 236, 240–41 in governance issues 121 Long-Term Capital Management 117 remuneration issues 185–6 Henderson, Mary (Nina) 130, 263, 264 Henkes, Evert 77 herd psychology 239 Hermes 108 Higgs, Sir Derek 217 Higgs Review 12, 217, 265 on board appraisal 14 on ‘comply or explain’ 216 on due diligence 231 on independence n.173 on multiple chairmanships n.163 on NEDships 233 high alpha 204–5, 206 Hoffer, Eric 105 Hogg, Sir Christopher 19–20 Hogg, Sarah (Baroness Hogg of Kettlethorpe) 18 Hopkins, Keith 77 Horn-Smith, Sir Julian 83, 88 Horton, Bob 53, 54–5, 56 Hovey, Charles Fox 105 HP, merger with Compaq 37, 101–2 HR people, on Boards 190 HSBC n.54, n.67, 90 Hughes, Penny 18–19, 90, n.90, 91, 92, 230 humility 139, 245 Hurn, Sir Roger 23, 44 Hutchison Wampoa 85 Hydon, Ken 88 hypocrisy 242, n.242

280

CONSTRUCTIVE ENGAGEMENT

ICL 83, n.83 IMA 200, 209, 214 independence ‘formal’ 173 nature of 173 independent non-executice directors see INEDs index trackers 100–101, 205, 224, 236, 237 INEDs 10–11, 169–82 appointment 179–80 asking questions 174, 175, 229 and auditors 21–2 Board visits 178, 229 and the business 16 career development motivation 24–5 and CEO 14–15, 231 and chairman 13–14 checks and balances 175–6 committees 178 community duty motivation 27–8 and Company Secretary 21 and executive directors 15, 177, 234–5 fun element 179 and fund managers 16–19 and headhunters 22, 180, 181 inﬂuence 174 and investment bankers 22 making a real contribution 176–8 mentoring by 230 mentoring of 178 nature of independence 173 and non-independent NEDs 15–16 personal qualities 169–70 perspective broadening motivation 25–7 relationships between 11–13 remuneration 181–2 responsibilities 170–71 roles beyond statutory 159–63 searching for 180 and shareholders 19–20

soft landing motivation 28–9 suggestions to 228–30 tenure 230, n.230 time commitment 171 transition from ED 172 see also NEDs; SID Institutional Shareholder Services (ISS) 133 institutional shareholders committee (ISC) 213 insurance 56 integrity, of chairman 190–91 Intel 247 international expansion, drivers 166 investment bankers and INEDs 22 primary goal 251–2 investor engagement difﬁcult areas 208–9 escalation procedure 238–9 frustrations 198–202 general principles 202–3 governance issues 198 positive 195–7 speciﬁc cases 203 voting policies and practice 203–4, 238–9 investors conﬂicts of interest 36–7 and ED remuneration 184 evolving relationships with 224–5 exceptional involvement in new Chairman 43–4 how to decide if happy 38–41 interaction with NEDs 195–6 interaction with newly appointed Chairman 44–5 involvement in selection of new Chairman 41–3 lead see lead investors letters of acknowledgment 200, 238 and NED remuneration 182

INDEX

pensions controversy perspective 209–10 as policemen 35–6 reaction to ‘explain’s 45–7 suggestions to 236–41 time horizons 210–11 types 224 what to do if not happy 41–4 ITV plc 18, 43–4, 109–11 Jacobi, Mary Jo 75, 77 Jacobs, Aad 131, 136, 139, 143, 261 Japan Pension Fund Organization 218 Jett, Joe 174 Job, Sir Peter 130, 137, 263 Johnson, Abigail 107 Johnson, Edward C. Jr 105 Johnson, Edward C. III (Ned) 106–7, n.106 Johnson, Samuel 105 Johnson & Johnson 74 Kerr, Sir John (Lord Kerr of Kinlochard) 130, 137, 141, 143, 144 Royal Dutch Shell board committees 261, 263 Kidder Peabody 174 Knight, Eric 134, 137–8, 146 Kok, Wim 131, 144, 264 Krauer, Alex 117 Kuwait Investment Ofﬁce (KIO) 54, 56 Kuwait Oil Company 52 Lapthorne, Richard 28, 42, 244 Lay, Kenneth 241–2 Lead Director 102 see also SID Lead Investors 197, 237–8, 251–4 concept implementation issues 253 incentive for constructive engagement 253 Lees, Sir David 74–5, 78, 79, 80

281

AGM quotes 76, 77 Leeson, Nick 174 liqueﬁed natural gas (LNG) 124 litigation 250 local authority pension funds 210, 216 long-term stock-pickers 236, 239–40 long-termism 246 Loudon, Jonkheer Aarnout 131, n.131, 137, 261, 263 Lyle, Abram 73 Lynch, Peter 106 MacLaurin, Lord (Ian) 18–19, n.83, 84, 89, 91 and investors 91–3 Magellan Fund 106 Manifest 202 Mannesmann 85, 90 acquisition by Vodafone 7, 18–19, 40–41, 85–6 Marconi 23, 27, 214–15, n.227 Markl, Prof. Hubert 131 Marks & Spencer 9, 20–21, 34, 90, n. 90 Massey, Dr Walter n.67, 70 McKinsey 243, 250 Mead, Scott 84 meeting fatigue 252 mentoring 177–8, 230 mergers, social issues 203 Merriweather, John n.117 Messier, Jean Marie n.57 Midland Bank 54, n.54, 100 Millicom 83 Mobil 58 mobile telephony, licences 83, 86 Montagnon, Peter 135 Moody-Stuart, Sir Mark 125, 131 Morehouse College 70 Morin-Postel, Christine 131, n.140, 263 motivators 186, n.186 INEDs 24–9 Mr Cube 73

282

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Munsters, Roderick 136, 140 Musesengwa, Stanley n.75, 76 Myners, Paul 20, 213, n.225 NAPF 133, 200, 208, 214 Lead Investor-like role 253 need for 202 and Royal Dutch/Shell 133, 135–6, 142, 144 Nargolwala, Kai 77, 80 National Association of Pension Funds see NAPF nationalization 73 NED appointment and development approaches BGI 104 BP 68–70 Fidelity 111–12 Tate & Lyle 79–80 UBS Global Asset Management 120 Vodafone 93–4 NEDs adding value 232–3 on Audit Committee 192 choice of company 231 considerations before accepting NEDship 188–91 courses 80 development 192 due diligence 189, 190–91, 231 evaluation 165 independent see INEDs interaction with investors 195–6 non-independent 15–16, 173 practical tips 233–4 qualities needed 159–60 suggestions to people considering role 230–34 NEDX 102, 111, 120, 156, 192 need for ABI 202 blame for newspaper leaks 198 on governance issues 201, 209, 214

lead investor-like role 253 and Royal Dutch/Shell 132–3, 134–5, 136, 142 Nicholson, Sir Robin 67 Nikko Securities 100 Nominations Committee 12 non-executive directors see NEDs notes of experience, categorization of contributors 150 Nycomed 28 offshoring 246, n.246 oil companies major 124 share prices and price of oil 40, 41 oil reserves, estimation 126 openness 248 OpenTalk 62, 71 Orange 85–6, n.86, 88 Ospel, Marcel 116, 117, 118 other people’s money (OPM) 243–4 overvaluation factor 6–7 ownership, separation from control 205 Oxburgh, Lord (Ron) 129 at 2004 AGM 139 as interim chairman 129, 130, 134 and investors 135, 144 as SID 129, 133, 134 P&O, take-over by Carnival 18 Paine Webber 118, n.118 Parker, Sir John 18 pensions 209–10 crisis 209–10 trustees 210 pensions holidays 209 Phadnis, Shashikant 74 Phillips and Drew 116, 118 Pilkington, Sir Alistair n.67 Pilkington’s 67, n.67 Pillard, Larry 76 PIRC 202, 265

INDEX

Pitﬁeld, Ian 120 Piwnica, Carole 75, 76, 77 policeman’s lot approaches BGI 102 BP 70–71 Fidelity 112–13 Tate & Lyle 81–2 UBS Global Asset Management 120–21 Vodafone 95–7 policemen conﬂicts of interest 36–7 investors as 35–6 in performing arts 31–2 practical issues surrounding role for investors 37–44 portfolio approach, to NED roles 28–9 private equity 206 professionalism 246–7 Prossor, Sir Ian n.57, 67, n.67 quantitative funds 101 Queen Elizabeth College 74, n.74 Racal 83, 84 Redpath Sugars 74 relationships, importance 147–8, 247–9 remuneration CEO 184, 185, 245 EDs 9, 184–7 fund managers 10, 201, 205 INEDs 181–2 international comparisons 185–6 investor concerns 205 Remuneration Committee (RemCo) 12, 182–3 remuneration consultancy 182 Rentokil Initial 34 Reuter, Baron de 51 Ricciardi, Lawrence 131, 263 Robbins, Sir Ralph 42 Rose, Stuart 20 Routs, Rob 132

283

Royal Dutch Petroleum Company 123 2004 AGM 138–40 priority shares 136, 141 Supervisory Board 131 Royal Dutch/Shell 123–48, 224 arrogance 227 boards 130–3 Brent Spar disposal controversy 70, 125 Committee of Managing Directors (CMD) 123–4 conclusions 144–8 Conference 124, 130, 136–7, 143 crisis over disclosure of reserves 41, 125–9, 215 executive directors 132 governance review 137–41, 248 history 123–5 investor engagement 132–7 in Nigeria 70 share performance n.54 Steering Group 137–8, 141, 142–3 uniﬁcation 142–4 see also Shell Transport and Trading Company Royal Dutch Shell corporate governance arrangements 255–64 Audit Committee 261–3 Board 258–9 CEO 255–6 Chairman 259–60 Deputy Chairman 260 executive management 256–8 NEDs 259 Nomination and Succession Committee (NomCo) 261 Remuneration Committee (RemCo) 263 Social Responsibility Committee 263–4 Rumsfeld, Donald n.22 Sainsbury’s 13–14, 18, 34–5, 67 and Cadbury Schweppes 46 Samuel, Marcus 123

284

CONSTRUCTIVE ENGAGEMENT

Sarbanes-Oxley (SarbOx) 217, 266 on Audit Committee independence 217 code of ethics 95 on ﬁnancial experts 12, 188 Sarin, Arun 25–6, 84–5, 87, 88, 90 and investors 93 on Nominations and Governance Committee 93 SBC 89, 115–16 Scholey, Sir David 88, 89–90, 116, 119 Schrempp, Jürgen 90 Schwabe, Leopold 105, 113 Sciteb n.55, 102, 152, 217 SEC 217 guidelines on oil reserves 126 sector overvaluation 7 senior independent director see SID servant leaders 249–50 Seven Sisters 124 SFR 88 shareholder/NED contact approaches BGI 101–2 BP 66–8 Fidelity 107–11 Tate & Lyle 78–9 UBS Global Asset Management 119–20 Vodafone 91–3 shareholder value creation 86–7 shareholders activism 225 conﬂicts of interest with fund managers 8, 10 and INEDs 19–20 interests 6 litigation against company 219 relationship with management 196, 248 Shell see Royal Dutch/Shell Shell Transport and Trading Company (Shell T&T) 123 2004 AGM 138–40

NEDs 130–31 SID 175 role in removal of chairman 34–5 Simon, David (Lord Simon of Highbury) 54, 55, 56–7, 58 site visits 16 Six Continents Group 67 Skirton, Andrew 103 Smith Review 12, 188, 266 SNED see SID social issues, of mergers 203 specialist skills, of board members 160 spin 209 AE Staley Manufacturing 74, 75 Standard Chartered 46, n.46, 77 Standard Oil Company of Ohio (Sohio) 52–4, 56, 57 State Street 107 Stern, Edouard 134 Stern Stewart 86–7 steward, unjust 242–3 stewardship 241–50 characteristics 244 educating next generation 247 ethical conduct 245 humility 139, 245 long-termism 246 parables 242–3, 249–50 professionalism 246–7 relationships 247–9 servant leaders 249–50 strategic options, exposure of board to 193 strategy, versus governance 175 Strathcona, Lord 52 succession planning BP 68–9 encouraging 227–8 Vodafone 91 Sucralose 74, 78, 80 Sullivan, Brian 103 Sutherland, Peter 57

INDEX

Sweden, acceptance of accounts 218 Swiss Bank Corporation (SBC) 115 The Tanker Insurance Company 56 Tate, Henry 73 Tate & Lyle 73–82 Audit Committee 79, 81–2 Board evaluation 77–8, 79–80 Chairman’s Committee 75 Company Secretary 78, 81 Corporate Affairs Committee 75 history 73–8 NED appointment and development approach 79–80 Nominations Committee 75, 79 performance evaluation 78 policeman’s lot approach 81–2 Remuneration and Appointments Committee 75 Remuneration Committee 75, 77 share performance 77, 78 shareholder/NED contact approach 78–9 SID 76, 77, 79, 82 whistleblowers programme 81 Tate Gallery 73 Tesco 89 Thatcher, Denis n.58 Thatcher, Margaret n.58 Thompson-CSF 84 timeframes, lengthening 166 Tomlinson, Lindsay 102 total shareholder return see TSR transparency 198, 202, 204, 214 Tsai, Jerry 105–6, n.116 TSR 266 bonuses linked to 184 maximization 6–7 UBS AG 116 UBS Brinson 117 UBS Global Asset Management 115–21 director development approach 120

285

global corporate governance director 120 history 115–19 Long-Term Capital Management fund 117, n.117 policeman’s lot approach 120–21 shareholder/NED contact approach 119–20 Union Bank (of Switzerland) 115–16 see also UBS Global Asset Management Utopia Limited 34 values, espoused versus in use 242 van den Bergh, Maarten 131, 137, 144, 264 van der Veer, Jeroen 132 at 2004 AGM 139, 140 as chairman of CMD 129, 132 and investors 144 on steering group 137 van der Vijver, Walter 125, n.140 in dispute over reserves 125–9 Vandevelde, Luc 90, n.90 Verizon Communications 85, 88–9 Verizon Wireless 85, 88, 89, n.96 Vivendi 87, n.87, 88 Vizzavi 87, n.87 Vodafone 83–97 acquisition of Mannesmann 7, 18–19, 40–41, 85–6 AGMs 92 Audit Committee 91, 95, 96–7 business principles 95–6 challenges 97 code of ethics 95 governance model 89–91 history 83–9 investor/director dialogue approach 91–3 NED appointment and development approach 93–4

286

CONSTRUCTIVE ENGAGEMENT

Nominations and Governance Committee 91, 93–4 ofﬁces 89, n.89 performance evaluation 91, n.91, 93 policeman’s lot approach 95–7 Remuneration Committee 88, 91, 92 remuneration policy 92 shareholder value creation 86–7 speciﬁc interests of board members 230 succession planning 91 Voser, Peter 132, 144 voting, investor policies 204, 238–9 Walker, John 76 Wall Street Walk 109 Walters, Sir Peter 53, 54, n.54 Warburg, Siegmund 116 SG Warburg plc 116 Watts, Sir Philip (Phil) 125 compensation 138–9

departure from Royal Dutch/Shell 134 in dispute over reserves 125–9 investors’ view 147 Welch, Jack 247, n.247 Wells, Henry 99 Wells Fargo 54, 99, 100 Whent, Sir Gerry 83, 84 whistleblowers programme, Tate & Lyle 81 White, Ted 137–8 Williams, Phil 92 Williams, Trelawny 108, 110 Wilson, LR 75 Wolff, Sir Henry Drummond 51–2 women directors 180 Worldcom n.227 Wufﬂi, Peter 117, 118 Zeneca 223 Zoumas, Prof. Barry 78