Retirement fund trustees can play a key role in promoting good corporate governance by incorporating shareholder activism into their investment strategies and demanding this from their asset managers, says Michael Leeman, a consultant to Frater Asset Management. South African investors are lagging behind their global peers, but they have the potential to catch up rapidly.
The era of global corporate complacency, self-enrichment, and disregard for shareholders, let alone other stakeholders, is rapidly coming to a close. The collapse of world giant Enron marked the end of an era of corporate abuse that was aided by complacent regulators, stockbrokers with conflicts of interest and passive asset managers, Michael Leeman says.
Leeman, who is a consultant to Frater Asset Management in the field of shareholder activism and corporate citizenship, was a speaker at the annual conference of the Institute of Retirement Funds in Johannesburg this week.
Shareholder activism is sweeping the world, he says. New regulations are being formulated, activism funds are being established and corporate codes of conduct are being rewritten.
Even before the Enron collapse, one in eight dollars invested in the United States in their domestic markets was subject to some form of shareholder activism. Yet in South Africa, with no shortage of corporate governance disasters and maltreatment of shareholders, activism is in its infancy.
The basic principle of shareholder activism is recognition of the power that investors, the owners of capital, have to influence not only financial markets but also corporate practice in the real economy, Leeman says.
Shareholder activism is particularly relevant to the retirement fund industry in South Africa because its asset base, which is in excess of R600 billion, is a major source of capital in the economy.
Since the primary objective of retirement funds is to provide optimum returns for the fund's beneficiaries, trustees should actively use the power and influence at their disposal to satisfy this objective. A key way in which trustees can achieve this is through shareholder activism, which in turn promotes good corporate governance.
Retirement funds should look to invest in a socially responsible manner. Shareholder activism is the way to enhance performance of the fund's assets as well as to promote good corporate governance.
Corporate citizenship
Shareholder activism can be used to promote good corporate citizenship practices within the companies in a retirement fund's portfolio, ensuring that these engage with their stakeholders in a responsible and sustainable manner. Engagement is done both reactively, through proxy voting, and proactively, through meetings with management and shareholder resolutions.
Why is corporate citizenship important?
The promotion of good corporate citizenship enhances the performance of a company and feeds through into share price performance and can assist in reducing corporate failures.
Promoting and enforcing good corporate governance helps enhance shareholder value by, for example, preventing overgenerous option plans. Good governance will also minimise risk to shareholders by, for example, ensuring the election of sufficient and suitably qualified independent and non-executive directors, an appropriate composition of the audit and remuneration committees and proper risk management.
Many recent corporate failures, both in South Africa (Leisurenet, Macmed, Saambou, Regal) and overseas (Enron, Global Crossing, WorldCom) can be linked to poor corporate governance, Leeman says.
International research by McKinsey & Company (The Global Investor Opinion Survey, 2002) found that the majority of investors are willing to pay a premium for companies exhibiting high governance standards. In North America and Western Europe, investors are prepared to pay a premium from 12 to 14 percent, in Eastern Europe and Africa, investors are prepared to pay a 30 percent premium, and in South Africa investors indicated that they are happy to pay a premium of 22 percent.
Domestic research done by Deutsche Bank Securities (Valuing Corporate Governance in South Africa, 2002) found that investors rewarded companies displaying better corporate governance with significantly higher valuation multiples and that these companies also outperformed the lower ranked companies over one-, three- and five-year periods.
Empowerment
The government has adopted a more rigorous policy on empowerment in 2002. Enlightened empowerment policies in accordance with government's proposed framework are thus essential to ensure companies' access to government licences, contracts and procurement. This will in turn enhance a company's long-term financial performance given the role the government plays in the economy.
Other factors
Other aspects of corporate citizenship also contribute to financial performance.
- Good environmental and occupational health and safety management reduce possible litigation and legal costs. The recent international examples of asbestosis claims are an indication of the potential risks.
- Approaching the HIV/AIDS pandemic through treatment and education programmes is increasingly proving to be an optimal business decision, as highlighted in the gold mining industry where the pandemic will significantly increase production costs unless adequately tackled.
- Developed countries are setting higher social and environmental benchmarks for their suppliers, as consumers in these countries are becoming more socially aware and active. These benchmarks will have to be met by South African producers aiming to export into these markets.
- Research indicates that good corporate citizenship practices are an indicator of management competence and good employee relations, and enhance brand value (UBS Warburg, The Merits of Socially Responsible Investing, 2001).
Fiduciary responsibility
There is an growing body of opinion which maintains that, since the pursuit of corporate citizenship through shareholder activism is associated with improved financial performance, it is a fiduciary responsibility of retirement fund trustees to adopt these approaches.
In the United States, legislative guidance makes it clear that activism is a part of the fiduciary responsibility of an investment manager.
The British government is proposing to impose, on all those involved in pension fund management, an express statutory duty to use shareholder powers to intervene in investee companies where this is in a pension scheme's best interests.
In South Africa, the release of the King II report in March echoed the call for greater shareholder activism. King II calls for institutional investors to vote on shareholder resolutions and be accountable to their constituencies. It further recommends that institutional investors and pension fund managers should adopt positions on governance and develop voting policies - and make these available to their constituencies and the public.
However, King II remains a voluntary code (although JSE-listed companies must state their degree of compliance with it) and the relevant statutory regulation, Regulation 28 of the Pension Funds Act, has yet to specifically address governance issues, Leeman says.
Corporate citizenship in South Africa
Shareholder activism has not taken off in South Africa as asset managers are not convinced that the benefits of comprehensive shareholder activism outweigh the costs involved.
Secondly, as with all relatively efficient markets, there is a lack of demand for shareholder activism, Leeman says. There is thus little incentive for asset managers to invest the additional time, and the human and financial resources to establish a comprehensive shareholder activism programme, if they do not believe this approach will enhance their performance and if their ultimate clients - individuals and retirement funds - are not demanding the service.
Impediments in South Africa
Leeman says there is no clear obligation on retirement fund trustees to undertake basic shareholder activism nor to disclose their policies in this regard to their members. Both of these measures are in place in the United Kingdom where they have generated significant impetus for shareholder activism. In South Africa, suitable measures can be easily incorporated into Regulation 28 that is currently under revision.
To date, retirement funds have not shown any significant interest in shareholder activism, although some are beginning to do so, particularly within the government sector, as government itself has been quite vocal on the need for better corporate governance.
There is also a lack of demand from retail investors. The fact that most individual investments are sold and not purchased, has resulted in the absence of shareholder activism funds from most retail distributor product offerings. Also, South Africa lacks a consumer activism movement along the lines of those in many developed countries.
Another problem is that shareholder activism is both time and resource intensive. In both the US and the UK, a number of intermediaries provide corporate citizenship research and proxy voting services. Both countries also have active, well-organised social investment forums, credible screened indices and extensive research into the linkages between shareholder activism and share price performance.
How to promoting good corporate citizenship
There are two investment approaches that trustees can use to exercise good corporate citizenship, Leeman says.
- Screened approach
Under the screened approach, companies are expected to maintain minimum standards of corporate citizenship and are rated accordingly. If they do not meet the required standard, they are excluded from the investment list.
- Overlay approach
The alternative approach is one where the portfolio manager does not limit itself to investing in certain companies, but rather interacts with the company to influence it corporate citizenship practices, for instance by proxy voting, direct meetings with management and shareholder resolutions.
What is corporate citizenship?
Corporate citizenship refers to the way in which companies interact with their stakeholders including:
- Shareowners, through transparent corporate governance;
- Employees, through fair labour practices and employment equity;
- The environment, through the responsible use of natural resources;
- Broader society, through participation in social and economic development;
- Customers, through the provision of safe and healthy goods and services;
- Suppliers, through dialogue on the above issues and through the targeting of empowerment companies; and
- Government, by adhering to laws, regulations and other non-statutory objectives.