The Foundations and Anatomy of Shareholder Activism 9781472560797, 9781841136585

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1 Introduction to Shareholder Activism in the UK 1. MEANING AND NATURE OF SHAREHOLDER ACTIVISM

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HAREHOLDER ACTIVISM TODAY may mean ‘... the way in which shareholders can assert their power as owners of the company to influence its behaviour’1 or as readily understood by some others, ‘the intervention by shareholders in the running of the company’.2 Activism as an incident of share ownership is now accepted as mainstream, and this may be attributed to the general acceptance of the special position of shareholders in relation to the corporation.3 There may of course be various motivations driving shareholder activism, and activism may take place in a variety of ways. However, a dominant theoretical paradigm in which shareholder activism is understood is the principalagent paradigm4 that perceives shareholder activism as mitigating the tendency of self-dealing that management could engage in. This book intends to take stock of how shareholder activism has developed in the UK in the last 15–20 years. Contemporary shareholder activism has developed along certain patterns, and is being developed against the backdrop of two main streams of thought in corporate theory: shareholder value and social responsibility. The book suggests that it is timely to consider the position of shareholder activism within these theories of the company and the legal framework surrounding shareholders and their rights. 1 As defined by the European Corporate Governance Institute, see . 2 , accessed Dec 2008. 3 Even if such acceptance is not characterised as a pure form of shareholder primacy, which is often seen as the opposite of a more inclusive stakeholder perspective of the corporation, see S Worthington, ‘Shareholders: Property, Power and Entitlement: Parts 1 and 2’ (2001) 22 Company Lawyer 258 and 307; A Etzioni, ‘A Communitarian Note on Stakeholder Theory’ (1998) 8 Business Ethics Quarterly 679. 4 MC Jensen and WH Meckling, ‘Theory of the Firm: Managerial Behaviour, Agency Costs and Ownership Structure’ (1976) 3 Journal of Financial Economics 305. However, some contemporary management literature has criticised this paradigm as unconstructive as the paradigm itself perpetuates the agency problem by making directors ‘individualised’ and defensive, see JD Roberts, ‘Trust and Control in Anglo-American Corporations’ (2001) 54 Human Relations 1547.

2 Introduction to Shareholder Activism in the UK This allows us not only to consider shareholder activism as a practical phenomenon, but takes us back to foundational roots and perspectives in order to locate the place of shareholder activism in theory and law. Some recurring questions in the book would be: (a) What is the nature of shareholder activism—is it part of the greater landscape of corporate governance and responsibility or is it an investment approach? (b) What are the consequences/effects of shareholder activism, and do they matter? (c) Are shareholders acting as self-interested utility maximisers in activism, and can this produce a countervailing force against self-interested management as assumed in the principal-agent paradigm? Shareholder activism is not a novel phenomenon. As Lauren Talner argues, all forms of shareholder engagement and discussion with companies, questioning or complaining against company policies, could be regarded as early forms of shareholder activism.5 In the UK, family controlled companies only started unwinding during the post-war period, largely due to tax incentives favouring diversification, the rise of the portfolio theory and the rise of the managerial revolution.6 Although institutions rose to become the main owners of publicly issued equity in the UK by the 1980s, they were largely ‘sleeping giants’, relying on the active market for corporate control to exert discipline on management, or they could exit from the company by selling out.7 Systematic forms of shareholder activism arguably only emerged in the 1980s in the United States,8 and had taken a slow start in the UK in the 1990s. By referring to ‘systematic forms’ of shareholder activism, this book means the perspective taken by some shareholders who regard activism as an inherent part of their investment management; that engaging with their investee companies is part and parcel of ongoing investment, and not as an ad hoc occurrence. Early shareholder activism described in Talner’s book such as the ‘gadflies’ questioning of the sale of oil by the Board of Standard Oil to the Axis Powers in the 1930s, is a form of activism that is triggered by specific events, and is thus ad hoc, event-led and ex post in nature. Contemporary

5 L Talner, The Origins of Shareholder Activism (Investor Responsibility Research Center 1993), now out of print, quoted in RF Balotti, JA Finkelstein, GP Williams, Meetings of Stockholders (Aspen Publishers Online, 1996) at para 5.4. 6 See BR Cheffins, Corporate Ownership and Control: British Businesses Transformed (Oxford, Oxford University Press, 2009) at chapters 2, 3 and 4. 7 Ibid, Cheffins, 373ff. 8 Notably as carried out by CalPERS and TIAA-CREF, major public pension funds in the US. More on CalPERS’ approach will be discussed in chapter 2, as context and comparison for the purposes of examining shareholder activism in the UK.

Meaning and Nature of Shareholder Activism 3 shareholder activism may still be event-led, but it is observed that ‘relational investing’9 has become a significant development, characterised by relatively more persistent engagement with companies. Such engagement may be carried out in order to safeguard investment value when issues arise that may threaten investment value. Some engagement may even be carried out with a view to influencing management on an ex ante basis. The latter may include regular and not merely ad hoc participation in general meetings, but also includes informal types of engagement outside of the general meeting. Contemporary shareholder activism also potentially includes the joining in any litigation in enforcing shareholders’ rights, although the book will not focus on the exercise of legal rights as a feature of shareholder activism, as there is copious existing literature dealing with derivative actions and minority shareholder litigation. This book will focus on contemporary shareholder activism as an investment approach, and the location of such an approach in theory and law, in order to offer come critical perspectives. Nevertheless, for the sake of completeness, this chapter will briefly discuss shareholder activism which is concerned with other issues unrelated to investment value in the company. Shareholder activism as examined in this book will be confined to publicly listed companies in the UK, as shareholder involvement in private companies may be based on different considerations, such as those in the realm of ‘quasi-partnerships’10 that deserve separate discussion. Some consideration will however be given to private equity involvement in the management of some companies, as the activities of the private equity sector have been seen as being important to how shareholder activism is perceived and practised in publicly listed companies.11 In terms of why this book has chosen to discuss shareholder activism in the last 15–20 years, it could be argued that these years are key in the development of contemporary shareholder activism in the forms commonly seen today. The acceptance of shareholder activism in both policy and industry sectors had emerged by the 1990s, especially by 1992 with the Cadbury Committee’s Report,12 which is subsequently affirmed in

9 Relational investing is frequently characterised by significant stakes held over a long period of time, with the shareholder committed to exerting internal discipline on managers, see I Ayres and P Cramton, ‘Relational Investing and Agency Theory’ (1994) 15 Cardozo Law Review 1033. 10 Lord Hoffmann, in O’Neill v Phillips [1999] 1 WLR 1092, refers to ‘quasi-partnerships’ as a form of private company where member-managers have made commitments of mutual understanding vis-a-vis one another. 11 Chapter 3. 12 Sir Adrian Cadbury, Report of the Committee on the Financial Aspects of Corporate Governance (Dec 1992) (hereinafter known as the Cadbury Report).

4 Introduction to Shareholder Activism in the UK other independent Committee Reports.13 The Annual Surveys carried out by the Investment Management Association (‘IMA’) documents a marked increase in institutional outsourcing of investment management, which is followed by an increase in engagement with investee companies and the carrying out of activist campaigns.14 This also coincides with the increase in hedge fund investment in UK companies and the carrying out of novel forms of aggressive activism.15 Hence, where the UK is concerned, systematic forms of shareholder activism carried out by some shareholders in publicly listed companies are a recent phenomenon, and it is arguably timely to take stock of the drivers and patterns of such activism and relate them to the foundations of theory and company law.16 Overview of the Range of Shareholders in the UK This book will focus mainly on shareholder activism in relation to investment value, ie the activism of institutional shareholders and shareholders such as hedge funds, as these represent the dominant patterns of shareholder activism in the UK. Although a significant amount of shareholder activism in the US is in relation to social responsibility matters and stakeholder concerns such as employment matters, such activism is less significant in the UK. The breakdown of beneficial ownership of shares in UK PLCs as at December 2008 (latest figures on the website of the Office of National Statistics)17 is as follows: foreign shareholders (41.5%, from 10–11% in 1990), insurance companies (13.4%, from 20% in 1990s), pension funds (12.8 % from 30% in the 1990s), unit trusts (2% from 6% in 1990s), investment trusts (1.9 % from 1–1.5% in the 1990s), individuals (10.2% down from 20% in the 1990s), alternative financial institutions (10% from 1% in the 1990s), charities (about 1%), corporations (2–3%), the state (0.1% as at 2006 but has risen to 1% with bank bailouts following the global financial crisis in 2008/9), and banks (3% from 0.7% in the 1990s). Institutional shareholders collectively own about 26 per cent of UK PLCs, foreign 13

As will be discussed in greater detail shortly. Investment Management Association, Survey of Fund Managers’ Engagement with Companies for the Year Ending 2005, . 15 See J Plender, ‘Our Punt Went Wrong, Now Help Us’, Financial Times (17 Jul 2005) on how Elliot Associates, a US hedge fund started actively campaigning for asset stripping or earnings improvement by Woolworths after a share price decline. See also C Hughes, ‘Hedge Funds Home in on UK Targets’, Financial Times (5 Nov 2007) reporting on a survey by Thomson Financials that hedge funds view investments in the UK as fertile territory for shareholder activism for the purpose of improving share price. 16 Hedge funds, see example ibid. 17 . 14

Meaning and Nature of Shareholder Activism 5 shareholders own 41.5 per cent, alternative financial institutions such as hedge funds own 10 per cent with the remainder dispersed amongst individuals, charities and non-financial corporations. Foreign shareholders are thus the largest significant group of shareholders in the UK. Such foreign shareholders may be individuals, corporations, institutional or alternative investors, and sovereign wealth funds. In particular, foreign institutional investors such as CalPERS’ investment in the UK Hermes Funds will be discussed in chapter 3, and foreign hedge funds and private equity fund activities will be discussed in the same chapter. Sovereign wealth funds have existed since the 1960s and 1970s, as oil producing nations such as Norway, Saudi Arabia and the United Arab Emirates. These funds have been formed to manage trade surpluses from sales of crude. Countries with huge trade surpluses also manage their wealth through sovereign wealth funds, and China for example has formed a few of the richest sovereign wealth funds in the world to invest in foreign assets. Increasing concern has been raised over the role of sovereign wealth funds in general, and questions are being asked as to the motivations of sovereign wealth funds in taking stakes in foreign public companies. Although such high levels of foreign share ownership exist in the UK, it is however observed that sovereign wealth funds have engaged in little or no shareholder activism. A similar pattern is observed in the US.18 There is only one reported instance of sovereign wealth fund involvement in supporting American hedge fund Trian’s activism against Cadbury Schweppes, which will be discussed in chapter 3. Other than that, sovereign wealth funds have been extremely quiet, whether on corporate governance issues (which is actually largely led by UK institutions), or on issues relating to extracting value from the company (which is largely led by hedge funds, whether UK or foreign).19 This observation is at odds with the literature that evinces suspicions and fears over sovereign wealth funds.20 Some academics have even called for

18 RA Epstein and AM Rose, ‘The Regulation of Sovereign Wealth Funds: The Virtues of Going Slow’ (2009) 76 University of Chicago Law Review 111. The article further explores the advantages of sovereign wealth investing and argues that there is no necessity as yet to seize on paranoia and fears regarding sovereign wealth funds to reform corporate legislation. 19 It is also reported in the US that sovereign wealth funds are largely too long term, passive and cautious to be activist, see P Rose, ‘Sovereigns as Shareholders’ (2008) 87 North Carolina Law Review 83. 20 G Lyons, ‘State Capitalism: The Rise of Sovereign Wealth Funds’ (2008) 4 Law and Business Review of the Americas 179; RJ Gilson and C Milhaupt, ‘Sovereign Wealth Funds And Corporate Governance: A Minimalist Response To The New Mercantilism’ (2008) 60 Stanford Law Review 1345; all write of the fears and suspicions regarding the motivations for sovereign wealth fund investments and whether any political reasons may exist to use the investments as political levers or as learning platforms to better domestic industries. These suspicions are increased where the fund is operated by countries whose political motivations may be unclear, and whose social values differ greatly from the social values

6 Introduction to Shareholder Activism in the UK sovereign wealth funds to be disabled from voting, so that they will be unable to exercise any form of activism that may be motivated by political aims.21 However, the reality is that sovereign wealth funds appear to make highly diversified and small investments in different industry sectors all over the world,22 are long term investors in nature23 and do not appear to initiate or carry out activism, having a primary concern for investment value rather than other political concerns.24 Further, the Santiago Principles mapped out in early 2008 are likely to be adhered to by large sovereign wealth funds such as Abu Dhabi’s and Singapore’s wealth funds, committing to greater transparency and disclosure of their structures, objectives and accountability.25 The book will not devote much discussion to sovereign wealth funds as there is no significant activist activity led by them in the UK. There is also no significant pattern of shareholder activism emerging from the individual shareholders’ quarter, and this is perhaps to be expected as individuals are possibly too dispersed and unmotivated to take a lead on activism. The only noteworthy movement of individual activism is the collective action taken by former Northern Rock shareholders whose shares have been expropriated after the nationalisation of the bank in early 2008.26 Such activism is thus driven by highly unusual events, and is not even targeted at the company.27 It is thus not representative of individual shareholder activism against target companies in the UK. Individuals may however be an important force to be reckoned with when it comes to voting, as will be discussed in chapter 2 in relation

of the jurisdictions where the investments are made, L Badian and G Harrington, ‘The Politics of Sovereign Wealth’ (Winter 2008) International Economy 5. AH Monk, ‘Recasting the Sovereign Wealth Fund Debate: Organizational Legitimacy, Institutional Governance and Geopolitics’ 2008, at writes of fears surrounding the operations and lack of disclosure by sovereign wealth funds, affecting their legitimacy, see also EM Truman, ‘Sovereign Wealth Funds: The Need for Greater Transparency and Accountability’ Policy Brief, Peterson Institute for International Economics, Aug 2007. 21 Ibid, Gilson and Milhaupt, ‘Sovereign Wealth Funds and Corporate Governance’ (2008). 22 C Balding, ‘A Portfolio Analysis of Sovereign Wealth Funds’ (2008) at ; C Portman, ‘The Economic Significance of Sovereign Wealth Funds’ Economic Outlook, Oxford Economics 2008 24. 23 V Fotak, B Bertolotti, W Megginson and William Miracky ‘Soveriegn Wealth Fund Investment Patterns and Performance’ (2009) at . 24 J-F Seznec, ‘The Gulf Sovereign Wealth Funds: Myths And Reality’ (2008) 15 Middle East Policy 97. 25 Rose, ‘Sovereigns as Shareholders’, above at n 19. 26 Northern Rock Shareholders Action Group, see , that is involved in campaigning for fair compensation for the expropriation of their shares upon nationalisation. 27 The main action taken is the filing of a judicial review suit against the legislation for nationalising Northern Rock.

Paradigms and Characteristics of Shareholder Activism 7 to Marks and Spencer. As individual shareholders are likely to ride on shareholder activism initiated by institutions or alternative investors such as hedge funds, their activities will not be separately discussed. 2. PARADIGMS AND CHARACTERISTICS OF SHAREHOLDER ACTIVISM

As Cheffins argues, the dominant ownership structure of most publicly listed companies today is dispersed ownership.28 The erstwhile issue in dispersed ownership is the agency problem first identified in Berle and Means’ locus classicus.29 Bratton argues that ‘[the] book’s continued vitality (after more than 70 years) results from its identification and discussion of problems left untreated both then and now’,30 such problems referring mainly to issues arising out of the agency problem. Jensen and Meckling’s seminal article has attempted to show how the separation of ownership from control would result in the divergence between managers’ self-serving interests and shareholders’ interest in the maximisation of corporate wealth.31 This paradigm has come to dominate perspectives in corporate governance, hence, much of mainstream corporate governance focuses on how managers as agents may be incentivised, governed or controlled, so that the effects of the agency problem may be mitigated.32 In general, shareholder activism is seen as a necessary countervailing force to combat the agency problem in widely dispersed companies. This perspective allows us to locate shareholder activism within the fabric of corporate governance in general. It also allows us to frame the perspective that shareholder activism is a form of market-based governance intended to ‘monitor’ management. The fundamental rationale for shareholder activism is arguably a means of ‘defence’ against managerial deviations. There could be two expressions of shareholder defence against the agency problem—exit, ie by selling shares and hence removing the exposure to the problem altogether, or voice, ie the taking of a positive form of action or intervention that moves away from reliance on the market.33 The book’s

28 See Cheffins, Corporate Ownership and Control, above at n 6, which discusses the historical development of the ownership structure in UK public companies and the factors contributing to the dominance of the dispersed ownership structure. 29 AA Berle and GC Means, The Modern Corporation and Private Property 2nd edn (New Jersey, Transaction Publishers, 1991). 30 W Bratton, ‘Berle and Means Reconsidered at the Century’s Turn’ (2001) Journal of Corporation Law 737, at 739. 31 Jensen and Meckling, ‘Theory of the Firm’ (1976) n 4. 32 EF Fama and MC Jensen, ‘Separation of Ownership and Control’ (1983) 26 Journal of Law and Economics 301. 33 AO Hirschmann, Exit, Voice and Loyalty: Responses to Decline in Firms, Organizations, and States (Cambridge, MA, Harvard University Press, 1970).

8 Introduction to Shareholder Activism in the UK discussion is on shareholder activism as the use of voice. Jansson further develops shareholder activism as the use of voice into two categories: defensive and offensive shareholder activism.

Defensive and Offensive Shareholder Activism Jansson’s paper discusses two paradigms of shareholder activism in exercising ‘voice’, the offensive and defensive forms of activism.34 This typology is derived from two representative case studies in the paper, and is also used to explain more generally why shareholder activism does not always lead to abnormal returns in share prices. Jansson is of the view that where share prices do not dramatically increase as a result of the shareholder activism, the activism could be explained as a defensive type, where shareholders see the need to safeguard their investment in the company, but are not prepared to sell. Defensive shareholder activism is defined as ‘a defensive safeguarding of invested capital, which is exposed to hazards because of increasing costs of exit’. Defensive activism is thus aimed at maintaining the value of the share price as far as possible and not seeking abnormal returns. Hence, the defensive type of activism also takes on a characteristic of seeking to rectify certain management failures which are observed that threaten the viability of the investment, in particular governance failures. Chapter 2 will argue that elements of defensive shareholder activism can be seen in institutional shareholder activism in the UK, as the activism is carried out on the basis of a pre-existing stake, and is largely related to issues of governance in the company, which could have implications for long term value. However, institutional shareholder activism in the UK is closely connected with policy exhortations with regard to the institutions’ roles, as chapter 2 will argue. Hence, the exercise of voice or exit by institutions may not only be related to investment value, or whether the institution has too large a stake to sell. The book refrains from characterising institutions as being ‘defensive’ on all fours with Jansson’s typology, although significant elements of defensiveness can be found. Where abnormal returns on share price result, Jansson characterises such activism as ‘offensive’ activism. Offensive activism is described as action taken to seize an opportunity, often in an aggressive manner, in the

34 A Jansson, ‘Types of Shareholder Activism: Offensive Opportunity Seizure or Defensive Safeguarding of the Investment?’, paper presented at EAA (2007), Lisbon. Armour and Cheffins have a more limited definition, classifying ‘defensive’ activism as activism carried out by a minority shareholder who has a pre-existing stake in a company, and ‘offensive’ activism as the building up of a minority stake by an activist in an opportunistic manner in order to realise abnormal returns from the stake, J Armour and B Cheffins, ‘Offensive Shareholder Activism’, paper delivered at the Department of Management, King’s College London, 7 Oct 2009.

Paradigms and Characteristics of Shareholder Activism 9 expectation of generating abnormal returns on share price.35 This type of shareholder activism is characterised as ex ante in nature, and stakes are taken in a company in order to seek gains. This is opposed to seeking to rectify a concern as is the case with defensive activism. The offensive type of shareholder activism characterised by hedge funds will be discussed in greater detail in chapter 3. In the 1980s when shareholder activism emerged on a systematic basis in the United States, led by major public pension funds such as CalPERS,36 the agency problem was the chief driver of such activism. However, what started as a defensive mechanism in investment rather quickly developed into a quest for abnormal share price returns. Hence, the motivations for defensive activism became fused with the objective to seek returns, turning into a form of offensive activism. This allowed shareholder activism not only to become an investment approach in the corporate governance landscape, but also an investment strategy. Hence, Jansson’s typology draws the distinction between defensive and offensive shareholder activism too starkly, although it is useful to note some of the differences between defensive and offensive forms of activism when looking at the practice in the UK. Even if shareholder activism may be driven by defensive concerns, a corollary aim may be to make ‘offensive gains’ at the same time. This is not only because shareholders realise that defensive activism could become an investment strategy, but because defensive activism also entails cost which needs to be made up for by the gains in share price returns that could result from activism. Jansson’s case study where shareholder activism does not result in ‘offensive’ gains, in the case of Pricer in Sweden, is possibly unintended rather than intended. In this author’s view, the failure to realise any abnormal gains in share price by Pricer shareholders could possibly be due to the fact that the shareholders involved were not prepared to take a systematic and persistent approach to activism, and engaged in a one-off protest until the Chairman and CEO were replaced. Contemporary shareholder activism on a systematic and persistent basis features both defensive and offensive elements, and this book argues that the distinction between the two is possibly not as neat as Jansson suggests, although the typology is still very useful in explaining the drivers and evolution of shareholder activism in the UK. It is necessary to take a look at CalPERS in the United States as the groundwork laid by CalPERS in shareholder activism is essential to the understanding of contemporary shareholder activism generally, and in

35

Cheffins also describes such activism as being ‘offensive’, see above n 6, at p392. The California Public Employees’ Retirement System, see . 36

10 Introduction to Shareholder Activism in the UK relation to the UK. In the 1980s, CalPERS was managing a large pension portfolio, and like all other pension funds, the investment approach was one of selling if the equity did not perform, or waiting for an acquirer to purchase an underperforming company and hopefully improve the share price thereafter. Performance was passively tracked against an index which was an aggregate of significant equities. From 1986–88, CalPERS saw that companies were passing poison pills against takeovers without the matter being approved by shareholders, and hence it would be increasingly difficult to rely on the market for corporate control to provide discipline for poorly managed companies in the portfolio. CalPERS commenced a form of activism in putting forth shareholder proposals to combat takeover defences. This investment approach could arguably be categorised as a defensive type, responding to an unfavourable trend that could threaten the safeguarding of the value of certain portfolio assets. It was documented in empirical research that such activism did not produce any significant changes in the share price of the companies concerned, and Smith explained this as being characteristic of a defensive approach where the value of the stock was maintained rather than improved.37 CalPERS changed this investment approach in 1989 when the beginnings of a systematic approach appeared in their targeting of companies whose share price had been underperforming. The activism was aimed at improving the performance of these companies and making gains on share price. This later evolved into the Focus List (from 1992) where CalPERS would publish annually the companies they regarded as underperforming. The investments made by CalPERS in these companies would be for the objective of performance improvement, as opposed to merely changing policies such as anti-takeovers or corporate governance.38 After conducting a form of defensive investment management in 1987–88, CalPERS has very quickly moved beyond the combating of the agency problem. Purely defensive activism motivated by the desire to combat the agency problem is rather short lived and CalPERS seems to view the defensive and offensive approaches to shareholder activism as two sides of the same coin: that the investment approach to safeguard assets by engaging with investee companies is also an investment strategy that seizes the opportunities offered by underperforming companies, allowing engagement in a systematic way in order to influence management to improve abnormal returns on share price. This has paid off in long term share price improvement as documented in empirical evidence

37 MP Smith, ‘Shareholder Activism by Institutional Investors: Evidence from CalPERS’ (1996) 51 Journal of Finance 227. 38 Also see CE Crutchley, CD Hudson and MR Jensen, ‘The Shareholder Wealth Effects of CalPERS’ Activism’ (1998) 7 Financial Services Review, available at .

Paradigms and Characteristics of Shareholder Activism 11 conducted on the results of CalPERS’ activism from 1989–1994,39 and till today.40 It may also be argued that the move into offensive activism by CalPERS is necessary as a simple balancing exercise in cost-benefit for carrying out any activism; that the costs incurred in the activism campaign has to be more than offset by the benefits gained in abnormal share price returns, especially since such activist efforts are often free-ridden upon by other investment managers. CalPERS’ investment approach cum strategy in shareholder activism has inspired other funds to follow suit in the US, and notable efforts in shareholder activism have been undertaken by the TIAA-CREF41 and the LENS Fund founded by Robert Monks.42 The influence of the CalPERS strategy is arguably important to the development of contemporary institutional shareholder activism in the UK, as well as more aggressive forms of offensive shareholder activism today, especially as conducted by hedge funds. CalPERS’ strategy has filtered through to a major investment manager in the UK, Hermes, which has formed a Focus Fund to target small to medium cap underperforming companies. Investors in the Hermes Focus Fund include the British Telecom Pension Scheme and the LENS Fund.43 From 2003, we have started to witness novel forms of activist campaigns in the UK.44 Such campaigns bear the characteristics of being predominantly offensive, and are overtly for the purpose of maximising the activist shareholder’s returns. Such offensive forms of shareholder activism are largely carried out by hedge funds, whether foreign (mainly US hedge funds) or those managed in the UK. For example, American hedge fund Trian Fund Management led by Nelson Peltz campaigned against Cadbury Schweppes to split its non-core food business from its core

39 S Nesbitt, ‘Long-term Rewards from Shareholder Activism: A Study of the CalPERS Effect’ (1994) 6 Journal of Applied Corporate Finance 75–80. 40 Crutchley et al, ‘The Shareholder Wealth Effects’ (1998) above n 38, and PC English II, TI Smythe and CR MacNeil, ‘The “CalPERS Effect” Revisited’ (2004) 10 Journal of Corporate Finance 157. 41 See for example, WT Carleton, JM Nelson and MS Weisbach, ‘The Influence of Institutions on Corporate Governance through Private Negotiations: Evidence from TIAACREF’ (1998) 53 Journal of Finance 1335 documenting the activism carried out by the TIAACREF, a public pension fund managing the retirement savings of school teachers. 42 Monks discusses the activities of the LENS Fund in his books The New Global Investors (Oxford, Capstone Publishing, 2001) and The Emperor’s Nightingale (New York, Basic Books 1999). 43 Recent empirical research documented that the Hermes Focus Fund investment strategy in shareholder activism has generated significant abnormal share price returns, see M Becht, J Franks, C Mayer and S Rossi, ‘Returns to Shareholder Activism: Evidence from a Clinical Study of the Hermes UK Focus Fund’ (2008) Review of Financial Studies 10. 44 Armour and Cheffins also argue that offensive activism in the 2000s, notably from 2003 onwards could be seen as a new genre, and different from the type of corporate raiding in the 1980s, as such activists are not interested in corporate control, but in ‘corporate influence’ with a minority stake, ‘Offensive Shareholder Activism’, paper delivered at the Department of Management, King’s College London, 7 Oct 2009.

12 Introduction to Shareholder Activism in the UK beverage business, which succeeded in 2007. Cadbury Schweppes gave in to Trian’s demands although Peltz only owned a 3 per cent stake in the company. Such offensive activism fits closely with the characteristics identified by Jansson—an aggressive seizing of opportunities motivated by a desire to generate abnormal returns on share price. Such activism may also arguably be unrelated to the governance driver of shareholder activism, as there is often no relation to the agency problem. Chapter 3 will discuss the activities of offensive shareholder activism, largely in the hedge funds quarter, and it is arguable that such activism may contribute to the corporate governance landscape. This book will argue that there are two dominant types of shareholder activism in the UK, viz institutional shareholder activism, bearing some defensive characteristics, and offensive shareholder activism, led largely by hedge funds. In the institutional shareholders’ quarter, there is arguably a strong acceptance for shareholder activism motivated primarily by the agency problem and corporate governance concerns. This is borne out not only by discussions led by policy-makers and industry leaders but is also reflected in much industry practice. However, these activist institutional shareholders are also justifying their actions by producing evidence45 of improved share prices, suggesting that share price gains are essential to their activism. As such, institutional shareholder activism is not that “defensive” going by Jansson’s typology, but the desire to gain abnormal returns may be balanced by other concerns, such as good governance in companies. Chapter 3 then deals with novel practices carried out by offensive shareholder activists that regard activism as more of an investment strategy in order to generate investment returns. Such offensive activism is introduced primarily by hedge funds. The Hermes Focus Fund however raises some issues of interest being an institutional investor with a strategy that is closer to offensive activism. Hence the book will compare and contrast the various trends of shareholder activism in the UK, and discuss the contextual forces and factors shaping shareholder activism conducted by different quarters of investors. Further, some discussion will be made of private equity, although these funds are strictly speaking in the market for corporate control and not the market for ‘corporate influence’.46 With the onset of the financial crisis in late 2008/early 2009 and the subsequent economic recession, the corporate and financial sector may arguably have entered into another watershed. The financial crisis that hit many high street banks in the UK in the third quarter of 2008 has exposed

45 For example, M Selvaggi, and J Upton, Governance and Performance in Corporate Britain: Evidence from the IVIS Colour-coding System (ABI Research Paper 7, 2008). 46 Armour and Cheffins, ‘Offensive Shareholder Activism’ (2009), above n 44.

Paradigms and Characteristics of Shareholder Activism 13 shortcomings in the top management of large banks in the UK,47 and has now entailed scepticism as to the quality and competence of the Boards of many large, widely-held public listed companies. We have witnessed the fall of publicly listed companies such as Woolworths in December 2008 and many other businesses. More regulation and self-regulation are being considered at the same time,48 with significant banks overhauling compensation schemes to improve risk management and governance.49 It is reported that employees’ faith in managers to lead them out of the financial crisis is particularly low.50 The change in times opens up the opportunity to take stock of the role of shareholders in UK public listed companies.51

Shareholder Activism for Social Responsibility and Stakeholder Concerns Besides shareholder activism that is centred on investment value, shareholder activism may also be based on campaigns designed to put pressure on companies to make policy changes especially with respect to social responsibility, environmental or community concerns. It is reported that in the US, a significant number of shareholder proposals relate to social issues raised by religious groups,52 and unions in both the US53 and Australia54 have also used their shareholding to bolster their bargaining power with employers in an era of declining union power or governmental support. Further, Romano’s research on pension fund activism in the US also shows that some public pension funds engage in activism for

47 E Knight and G Suarez, ‘Lenders should have to Pay a Price for Taking Risks’, Financial Times (1 Oct 2008), D Walker, ‘Boards must be Made Fitter for their Purpose’, Financial Times (23 Dec 2008). 48 For example, see Financial Services Authority, The Turner Review: A Regulatory Response to the Global Banking Crisis (Mar 2009). 49 ‘Credit Suisse Ties Pay to Illiquid Assets’, Financial Times (19 Dec 2008). 50 B Masters, ‘Managers give Chief Executives the Thumbs Down’, Financial Times (10 Dec 2008). 51 ‘Activists Rise from the Ashes’, Financial Times (13 Nov 2008). 52 E Sjöström, ‘Shareholder Activism for Corporate Social Responsibility: What do We Know?’ (2008) 16 Sustainable Development 141; JM Logsdon and HJ van Bulen III, ‘Justice and Large Corporations: What do Activist Shareholders Want?’ (2008) 47 Business and Society 523. 53 R Marens, ‘Going to War With the Army You Have: Labor’s Shareholder Activism in an Era of Financial Hegemony’ (2008) 47 Business and Society 312; SJ Schwab and RS Thomas, ‘Realigning Corporate Governance: Shareholder Activism By Labor Unions’ (1997–98) 96 Michigan Law Review 1025. 54 K Anderson, I Ramsay, S Marshall and R Mitchell, ‘Union Shareholder Activism in the Context of Declining Labour Law Protection: Four Australian Case Studies’ (2007) 15 Corporate Governance 45.

14 Introduction to Shareholder Activism in the UK other political reasons such as augmenting its profile.55 It is also reported in the US that shareholders with overt environmental or social agendas are also on the rise,56 and all of these groups generally garner institutional investor support for their proposals. Institutional investors especially in the US have been forthcoming in supporting corporate social responsibility concerns, as they often support these issues themselves,57 or perceive these issues to be able to enhance long term investment value, and to improve the legitimacy of the shareholder activism itself.58 In the UK, it is observed that activism based on social, ethical or environmental issues is relatively insignificant. Groups such as Greenpeace hold stakes in BP and Royal Dutch Shell in order to influence various environmental policy concerns,59 but such is not the mainstay of shareholder resolutions. The question is whether institutional investors are also concerned with and support or table such resolutions. It is observed that a number of institutional investors have on their engagement policies an item on ethical or social responsibility,60 and Hermes for example has dedicated socially responsible funds which invest only in companies perceived as socially responsible. However, it is also reported that institutional investors are concerned with such issues only to the extent that investment value may be perceived to be affected,61 and institutional investors’ concern for corporate governance does not necessarily import concern for social

55 R Romano, ‘Public Pension Fund Activism in Corporate Governance Reconsidered’ (1993) 93 Columbia Law Review 795. 56 R Monks, A Miller and J Cook, ‘Shareholder Activism on Environmental Issues: A Study of Proposals at Large US Corporations (2000–2003)’ (2004) 28 Natural Resources Forum 317; A O’Rourke, ‘A New Politics of Engagement: Shareholder Activism for Corporate Social Responsibility’ (2003) 12 Business Strategy and the Environment 227. 57 IB Lee, ‘Corporate Law, Profit-Maximisation and the Responsible Shareholder’ (2005) 10 Stanford Journal of Law, Business and Finance 31. 58 B Rogers, ‘The Complexities of Shareholder Primacy—A Response to Sanford Jacoby’ (2008) 30 Comparative Labour Law and Policy Journal 95; WT Proffitt Jr and A Spicer, ‘Shaping the Shareholder Activism Agenda: Institutional Investors and Global Social Issues’ (2006) 4 Strategic Organisation 165; E Sjöström, ‘Shareholder Activism for Corporate Social Responsibility’ (2008) n 52. 59 See . 60 For example, Fidelity International Ltd, Principles of Ownership (Sep 2007) at 6 refers to importance being placed on a company’s corporate social responsibility and the perceived link to long term business sense; Hermes, Corporate Governance Principles (as of Jan 2009) at p13 also contains the investment manager’s endorsement of social, ethical and environmental responsibility. However the Association of Investment Companies’ Code of Corporate Governance (May 2007) does not refer to corporate social responsibility and other investment managers such as Aberdeen do not explicitly state its importance. The Combined Code of Corporate Governance in the UK is silent on this issue. 61 GL Clark and ER Knight, ‘Institutional Investors, The Political Economy of Corporate Disclosure, and the Market for Corporate Environmental and Social Responsibility: Implications from the UK Companies Act’ (Paper Presented at Sloan Industry Conference, Boston, 2008).

The Book’s Approach 15 responsibility. Moreover, the key issues motivating institutional investors to activism, as will be discussed in chapter 2, generally deal with corporate governance as such, and activists with ‘offensive motivations’, as will be discussed in chapter 3, are largely concerned with short to medium term investment value. 3. THE BOOK’S APPROACH

Shareholder activism may be an investment approach, or may be an investment strategy. It may be regarded as part of the wider corporate governance landscape, or it may be self-serving in nature. This book focuses on shareholder activism centred on investment value, whether for defensive or offensive motives or a mixture of these purposes, as these are the most prevalent forms of shareholder activism in the UK today. The book intends to examine the development of two dominant patterns of contemporary shareholder activism in the UK, as well as the theoretical foundations of such activism and how theory and law may provide a framework for understanding how such shareholder activism should be located and practised. Chapter 2 discusses the evolution of institutional shareholder activism, the characteristics of institutional shareholder activism, and the outcomes and the challenges facing such activism. Chapter 3 discusses the development of more offensive forms of shareholder activism particularly in the alternative investment quarter, and the impact of their activities on the shareholder activism landscape. The rest of the book is as follows. Chapter 4 takes a step back to discuss shareholder activism in the context of theoretical frameworks of the company and company law, in order to locate activism within the general rubric of the shareholder’s normative role. This chapter will critically discuss the legitimacy of institutional and offensive forms of shareholder activism in the UK. Chapter 5 then looks at the issue of whether concerns arising out of shareholder activism need to be addressed by regulatory controls and critically discusses existing literature on the role of law and regulation. Chapter 6 concludes.

2 Shareholder Activism Unveiled: Institutional Shareholder Activism in the UK 1. INTRODUCTION TO INSTITUTIONAL SHAREHOLDER ACTIVISM IN THE UK

T

HE APPROACH TO governing businesses in the UK has been described as ‘negotiated regulation’. This means that businesses in the UK are not imposed with regulatory intervention unless necessary, and such regulatory intervention is shaped largely by bottom-up influences from the industry itself. Much trust is reposed in self-regulation by businesses, conditioned by market forces. Even if regulation were to be introduced, it is usually preceded by a process of consultation with the industry in constructing a framework that reflects the needs of business, a type of ‘arm’s length’ regulation based on the accommodation of and mutual respect for the industry.1 In this landscape, corporate governance based on the agency paradigm may arguably be regarded as a largely internal matter for companies, and the involvement of policymakers would be facilitative rather than prescriptive.2 As Cheffins documents, the dispersion of ownership in UK public companies only started in the post-war period, and by the 1970s–80s, institutions such as pension funds and insurance companies became the dominant owners of publicly issued equity in the UK. These institutional investors had been content to accept managerial dominance in the investee companies, largely due to the Chandlerian exhortation to respect

1 S Wilks, ‘The Amoral Corporation and British Utility Regulation’ (1997) 2 New Political Economy 280, quoted in A Dignam, ‘Exporting Corporate Governance: UK Regulatory Systems in a Global Economy’ (2000) Company Lawyer 70, and this concept is also again extensively discussed in A Dignam, ‘Capturing Corporate Governance: The End of the UK Self-regulating System’ (2007) 4 International Journal of Disclosure and Governance 24. 2 The soft law nature of corporate governance continues to be affirmed after the nearcollapses of several large British banks in 2008/9, see D Walker, A Review of Corporate Governance in UK Banks and Other Entities in the Financial Services Industry (Nov 2009) (hereinafter ‘Walker Review Final Report’).

Introduction to Institutional Shareholder Activism in the UK 17 the managerial revolution.3 Institutional shareholders arguably saw their main objectives as receiving dividends and allowing the market for corporate control, which had become very active in the 1980s, to exert discipline on companies.4 Institutional shareholders were rarely concerned with corporate governance, as seen in the lack of any collective exercise of voice, and the rarity of executive turnover.5 Corporate governance became a concern in the 1990s as a result of corporate scandals. Management fraud in the BCCI and Polly Peck had caused two large public companies with significant operations in the UK to collapse and these scandals engaged policy-makers with the reality of the agency problem. The increasing skepticism surrounding the selfserving tendencies of Board and executive officers is key to driving policy changes to corporate governance in the UK. However, in the tradition of negotiated regulation, the UK approach to corporate governance is incremental and heavily coordinated with industry leadership. Policy-makers have initiated the discourse on corporate governance in the UK, and government-commissioned reviews starting from the Cadbury report, are discussed in Part 3 of this chapter which has led to the framing and development of corporate governance in the UK. In the discourse on corporate governance, the role of institutional shareholders as a market force for discipline is frequently put forward. As the majority of publicly listed UK equity has been held by institutional shareholders since the 1990s, the conception of the role of shareholders is largely based on the institutional shareholder. The role of active institutional shareholders would complement the soft law nature of corporate governance, which exists primarily in the form of a Code of best practice, the UK Corporate Governance Code.6 The Corporate Governance Code (“hereinafter the “Code”) is subject to a comply-or-explain regime which relies on institutional shareholders calling the management of companies to account. It is however debatable whether the role of institutional shareholders calling management to account is a matter of market discipline or increasingly, public interest. If the Code is a platform upon which market practices and discipline should develop, then it should be shaped by market forces. MacNeil and Li, in surveying the market response in the form of share price changes to non-compliance with the then

3 AD Chandler, The Visible Hand: The Management Revolution in American Business (1977), quoted in B Cheffins, Corporate Ownership and Control: British Businesses Transformed (Oxford, OUP, 2009). 4 P Clyde, ‘Do Institutional Shareholders Police Management?’ (1997) 18 Managerial and Decision Economics 1 argues that institutional investor discipline comes from the willingness to back takeover bids. 5 Cheffins, above, n 3, 370–77. 6 The UK Corporate Governance Code 2010, http://www.frc.org.uk/corporate/ukcgcode. cfm and all its antecedent versions.

18 Institutional Shareholder Activism in the UK UK Combined Code of Corporate Governance, reports that market participants and shareholders do not exert any market discipline on firms that do not comply or explain adequately.7 Faure-Grimaud et al also agree that non-compliant UK firms do not generally produce good explanations for deviation, if explanations are given at all, and shareholders have been agnostic about the quality of explanations given.8 If the Code is merely a platform for market discipline, then the market seems to have indicated that corporate governance is not exactly essential to the market’s investment concerns. However, policy-makers have persisted in exhorting that institutional shareholders hold management to account according to the terms of the Code. This chapter will discuss the nature of institutional shareholder activism in the UK, and in particular, the part played by policy-makers in shaping the nature of such activism. This chapter will argue that although institutional shareholder activism in the UK is driven by investmentcentric forces that look for the reconciliation between activism and investment gains, the stronger impetus for institutional activism in the UK arguably comes from the policy emphasis on institutional shareholders being part of the governance landscape or ‘regulatory space’. Policymakers arguably see institutional shareholder activism as being part of good corporate governance for the public interest and not merely for the institutions’ investment objectives. The policy emphasis has become more important since the global financial crisis of 2008/9. In particular, corporate governance issues such as remuneration policies at banks may be issues of public interest, as failed governance may result in externalities of a scale that exceed those from corporate collapses in other industries.9 This is now increasingly being accepted by policy-makers. For example, the French government has tightened bonuses that could be paid to bank executives where the bank is receiving government support,10 and the UK Financial Services Authority has published A Code of Remuneration Practices for banks and financial institutions.11 However, corporate governance straddles the internal-external and public-private paradigms.

7 I MacNeil and X Li, ‘“Comply or Explain”: Market Discipline and Non-compliance with the Combined Code’ (2006) 14 Corporate Governance 286. 8 A Faure-Grimaud, S Arcot and V Bruno, ‘Corporate Governance in the UK: Is the Comply or Explain Approach Working?’ (2005) at . 9 Ch7, Second Banking Supervision and Regulation Report, Economic Affairs Committee, House of Lords (19 May 2009); M Becht, ‘Corporate Governance and the Credit Crisis, Financial Regulation and Macroeconomic Stability—Key issues for the G20’ (2009) Centre for Economic Policy Research; also D Walker, Review of Corporate Governance in UK Banks and Financial Institutions – Final Report (Nov 2009) at para 1.5, London, 31 January 2009. 10 ‘Sarkozy Tightens Bank Bonus Rules’, Financial Times (25 May 2009). 11 March 2009, at .

Introduction to Institutional Shareholder Activism in the UK 19 It is on the one hand concerned with internal policies, culture, governance, risk management and accountability to shareholders, but on the other hand, failures of governance may contribute to corporate failures having wide social effects.12 There is arguably an aspect of a desirable social or public good that may be delivered by compliance with the Code, and policy-makers are looking to the partnership of the investment industry in enforcing the delivery of the public good. However, this is equivalent to looking to institutional shareholder activism to provide a form of governance that is nevertheless ‘market-based’. Donahue13 asks ‘[g]overnance and markets... tend to be tangled with each other....’, but ‘does engaging the market offer the most promising blueprint for accountability in the pursuit of particular public goals?’ Donahue argues that ‘governance’ is based on a form of ‘extensive accountability’ to a variety of stakeholders, in furthering a variety of different ‘mandates’.14 This is different from ‘intensive accountability’ represented by market-based governance which rather single-mindedly seeks market efficiency and individual wealth creation. Further, it is arguable whether or not sound corporate governance is to be regarded as a public good although corporate failure generates externalities and social consequences.15 Hence, the role of institutional shareholder activism in the UK is situated within two wider issues: whether sound corporate governance as a proxy for mitigating social losses upon corporate failure is itself a public good, and whether market-based governance in the form of institutional shareholder activism can deliver the public good. The chapter will discuss the nature of institutional shareholder activism in the UK and in particular the dilemmas that entail from the expectation that institutional shareholder activism plays a role in the regulatory space for the purposes of public good. The next Part will address the forces that motivate or impede institutional shareholder activism, and the relationship between institutional activism and investment gains. It will be suggested that the role of institutional shareholder activism in the UK

12 L Van den Berghe, ‘To What Extent is the Financial Crisis a Governance Crisis? From Diagnosis to Possible Remedies’ (2009) at . 13 JD Donahue, ‘Market-based Governance and the Architecture of Accountability’ in JD Donahue and JS Nye eds, Market-based Governance (Mass, Brookings Institution Press, 2002) at 1 and 4. 14 Ibid, Donahue, ‘Market-based Governance’ (2002), 5–8. 15 For example, with the fallout from the financial crisis in late 2008, the FSA is planning to make prescriptive inroads into the determination of remuneration in banks and building societies, an area usually left for corporate governance. See FSA, Reforming Remuneration Practices in Financial Services (Mar 2009). The financial crisis has generally raised many fundamental questions regarding the effectiveness and externalities of self-regulatory processes and the role of regulation.

20 Institutional Shareholder Activism in the UK is predominantly shaped by policy leadership that co-opts institutional shareholders into the ‘regulatory space’, rather than by reliance on institutional shareholders’ own incentives such as investment concerns.16 2. INSTITUTIONAL SHAREHOLDER ACTIVISM AS MARKET DISCIPLINE?

The nature of shareholder monitoring is based on the ‘agency problem’ of managerial control espoused in the classic work by Jensen and Meckling.17 Self-interested management may deviate from the wealth maximisation for shareholders and hence shareholders have a monitoring role against management deviation and shirking. The agency problem places shareholder activism within the internal governance framework of a corporation, and shareholder activism could be characterised as a form of market-based discipline. According to empirical research, management is often key to the failure of a corporation. Research undertaken by Ooghe and Prijcker,18 points out that the underlying reason for all corporate failures is management, although not all management failures19 would necessarily be a breach of directors’ duties in law. As the law will only offer remedies against some but not all aspects of management failure, there is room to consider if shareholder activism may be able to exert monitoring influences to prevent investor loss. Ooghe and Prijcker opine that management errors are made in the context of management personality characteristics and difficulties in the

16

See ch5, Walker Review Final Report. MC Jensen and WH Meckling, ‘Theory of the Firm: Managerial Behaviour, Agency Costs and Ownership Structure’ (1976) 3 Journal of Financial Economics 305. 18 H Ooghe and S de Prijcker, ‘Failure Processes and Causes of Company Bankruptcy: A Typology’ (2008) 46 Management Decision 223. 19 Ooghe and Prijcker explain that there are four main types of corporate failures, one, the start up company which does not thrive as inexperienced entrepreneurs/managers lack financial and corporate expertise to drive the company to success. The company’s failure is attributed to errors of judgment and hence the failure of the company to attract customers or capture market share. Second, a young ambitious company that fails, as management overestimates demand and takes on excessive risks that are not properly managed. Third, a mature company that fails for similar reasons as the young and overly ambitious company in the second category. Such a company may have management that is dazzled by the earlier growth of the company and have become complacent in assuming optimistic prospects, taking the company into excessive leverage and commitments, making it difficult for the company to survive if circumstances change for the company. Fourth, an established company whose management has lost touch with reality and have become apathetic, sticking to rigid practices that lack innovation, causing the company to gradually lose market share and lose touch with its customers. By the time the company has lost enough financial strength to force management to seek finance, the company is no longer an attractive entity to be supported. 17

Institutional Shareholder Activism as Market Discipline? 21 company’s environment, and often it is a question of competence, skill and poor judgment. As a matter of law, errors of business judgment are unlikely to be regarded as a breach of directors’ duties as such unless a breach of fiduciary duty or negligence can be established.20 Hence, the reality for shareholders is that there may not be any legal remedies that could be taken against certain management errors in business decisions. 21 The quality of management remains shareholders’ risk, and it is up to shareholders to mitigate for themselves by actively participating in general meetings, considering appointments to the Board and using voice where necessary. Where an issue of a breach of directors’ duties arises, shareholders can rely on the statutory derivative action or minority shareholder litigation to seek redress. Hence, is there a need for shareholder activism in monitoring agency problems and potential management weaknesses before any real issues of concern arise? There are two main concerns that make ex post litigation an unattractive option. First, procedural difficulties still surround the mounting of a derivative claim by shareholders on behalf of the company against management wrong-doing, and the statutory derivative action under the Companies Act 2006 has not made it much simpler. Second, the cost of litigation is often prohibitive. The unfair prejudice petition for minority shareholders under section 994 of the Companies Act 2006 is often more appropriate for smaller private companies where issues of grievance relate to matters outside of pure investment, and after O’Neill v Phillips,22 it would arguably be rare for investors in public listed companies to find redress in taking an unfair prejudice petition.

20 Re Smith & Fawcett, Ltd [1942] Ch 304, Re Barings Plc (No.5) [1999] 1 BCLC 433 but see Re Brian D Pierson Contractors Ltd [1999] BCC 903 where certain objective expectations were also set as to a director’s competency, such as being able to understand the company’s financial position from statements. Also see s 172, Companies Act, see A Keay, ‘Formulating a Framework for Directors’ Duties to Creditors: an Entity Maximisation Approach’ (2005) 64 Cambridge Law Journal 614 who argues that implicit in the court’s approach to directors’ duty is an endorsement of the business judgment rule that the courts will not second guess what management should have done. However see D Arsalidou, ‘Objectivity vs Flexibility in Civil Law Jurisdictions and the Possible Introduction of the Business Judgment Rule in English Law’ (2003) 24 Company Lawyer 228 who thinks there might still be room for an explicit business judgment rule. The Company Law Review did not think an explicit rule was necessary. 21 Also note that shareholders are unlikely to be able to claim for ‘reflective loss’, ie loss in the value of the company reflected in their investments as such, unless special circumstances give rise to a personal claim. Johnson v Gore Wood [2001] 2 WLR 72, and see Giles v Rhind [2002] 4 All ER 977. 22 [1999] 1 WLR 1092. The case provides that the unfair prejudice petition may be brought only if there is a breach of express provisions in the company’s constitution, or where there is a breach of mutual understanding and abuse of rules in an inequitable manner in a ‘quasipartnership’, hence limiting the instances where shareholders of public widely dispersed companies may take such an action in court. See also Cobden Investments Ltd v RWM Langport Ltd & Ors [2008] EWHC 2810 (Ch).

22 Institutional Shareholder Activism in the UK The Limitations of Legal Redress Although it could be argued that shareholders could seek redress for breach of directors’ duties in law and that is a form of ex post redress for the agency problem, the Equitable Life scandal is perhaps a useful illustration to look at in considering the limitations of the litigation option for shareholders. Equitable Life is a mutual and hence does not have shareholders as such. Policy-holders who are also members do not have the equivalent shareholder protections under the Companies Act in terms of information disclosure and reporting. Although Equitable Life is not a publicly listed company and hence the analogy is limited, it could be argued that a publicly listed company with dispersed and indifferent shareholders may also be in a similar position. Although there is much theoretical literature that deals with managers behaving as stewards23 or mediators of a range of interests,24 there is substantial empirical evidence that shows how the agency problem actually plays out in corporations. In Equitable Life, Barings and even in the financial crisis of 2008/9, management incompetence, ignorance and negligence have been unchecked and caused grave investor losses. In BCCI, Polly Peck, Enron in the US and Parmalat in Italy, management fraud has also gone undetected until the companies have collapsed. In fact, a report that surveyed corporate failures across Europe notes that 40 per cent of all corporate failures in Europe are due to management fraud.25 The Penrose report26 into the Equitable Life saga showed how Equitable Life, one of the largest mutual insurers in the UK, came close to collapse when it became unable to pay guaranteed bonuses to policy-holders, and had to ask the Courts to allow it to cut its guaranteed rates.27 After the House of Lords rejected Equitable Life’s case to alter its constitution and fundamentally change the nature of guaranteed policies to variable-rate policies, Equitable Life put itself up for sale in order to rescue

23 JH Davis, FD Schoorman and L Donaldson, ‘Toward a Stewardship Theory of Management’ in T Clarke, Theories of Corporate Governance (London, Routledge, 2004), ch 9. 24 MM Blair and L Stout, ‘A Team Production Theory of Corporate Law’ (1999) 85 Virginia. Law Review 247; S Bainbridge, ‘Shareholder Activism and Institutional Investors’ (2005) University of California at Los Angeles Law and Economics Research Paper, at ; TL Fort, ‘Goldilocks And Business Ethics: A Paradigm That Fits “Just Right”’ (1998) 23 Journal of Corporation Law 245. 25 MARC and RSM, Classification and Analysis of Major European Business Failures (Research Project Commissioned by the European Contact Group), Oct 2005, discussed in IH-Y Chiu, ‘The Role of Securities Disclosure Regulation in Investor Protection Relating to Corporate Insolvency? Some Observations of the US, EU and UK Regulatory Frameworks’ (2008) Company Lawyer 35. 26 See , where the report is available in full (accessed Dec 2008). 27 Equitable Life Assurance Society v Hyman [2000] 3 ALL ER 961.

Institutional Shareholder Activism as Market Discipline? 23 the business. Significant portions of its business were eventually sold to Canada Life, Reliance Mutual, Halifax and Prudential. An enquiry into the mutual was carried out under the leadership of Lord Penrose, who identified management complacency and poor corporate governance as key to Equitable Life’s failings in not being able to understand the real financial position and commitments of the company. The Penrose report identified significant corporate governance failings such as an overly powerful Chief Executive Officer who was not effectively monitored by the Board, ignorance on the part of the Board as to how the business was run and managed, and cursory adoption of recommendations of the Combined Code such as instituting independent committees of the Board. Lord Penrose documented in some detail how the audit committee was formed with very reluctant support from Ranson the then Chief Executive, and how information was not systematically given to the committee to allow it to perform its review function. The Penrose report also highlighted significant failings in risk management such as an overreliance on one department and the lack of an internal audit, such internal failings not being remedied although the audit committee expressed some concerns. In 2004, aggrieved policy-holders commenced an action against 15 Equitable Life directors, but the prohibitive cost of litigation caused the proceedings to be eventually dropped in 2005 at a loss of £10m.28 The abandoned Equitable Life litigation possibly illustrates the practical difficulties in seeking legal remedies for massive corporate governance failures and errors of judgment which could amount to legal breaches of directors’ duties. Reisberg argues that the derivative action for minority shareholders is prohibitively costly, and only if the policy-makers are willing to regard it as serving a public interest of deterrence and compensation can the action be reformed.29 The reliance on shareholders to take such private actions at their own expense is arguably not an attractive option when the result would be the provision of a collective good for the benefit of all shareholders.30 However, at least for the purposes

28 A sum of settlement was reached with 407 annuitants in 2008, but that did not prevent campaigning policy-holders from alleging mis-selling and a violation of financial services regulation on the part of Equitable Life, the case pending at the time of writing of this book. 29 A Reisberg, Derivative Actions and Corporate Governance (Oxford, OUP, 2007). 30 H Hirt, ‘In what Circumstances Should Breaches of Directors’ Duties Give Rise to a Remedy under ss 459–461 of the Companies Act 1985?’ (2003) 24 Company Lawyer 100, see also Clark v Cutland [2003] EWCA Civ 810; [2003] 4 All ER 733, which allows the derivative action to be consolidated with the minority shareholder action under then s 459, now s 994 of the Companies Act 2006, effectively circumventing some of the procedural difficulties of the derivative action by ‘delegating’ the action to a minority shareholder who also has an issue of personal remedy, see J Payne, ‘Shareholder Remedies Reassessed’ (2004) 67 Modern Law Review 500.

24 Institutional Shareholder Activism in the UK of facilitating a strong and robust equity market,31 it arguably remains important that there is a legal framework for redress in derivative actions and shareholder remedies. Although the derivative action has been reformed under the Companies Act 2006, the Act has not made it that much easier for derivative actions to be mounted against directors. The Law Commission identified in 1998 that the derivative action was complex and confusing for shareholders to use, and embarked on recommending a simpler and more flexible legal procedure.32 The Commission recommended that there should be procedural steps taken in order to satisfy the court that the company is not taking an action, and there should be a list of factors for the court to consider in deciding whether to grant leave to the minority shareholder bringing the action on behalf of the company. These steps and criteria were intended to replace the common law position on derivative actions.33 Under the common law, the derivative action could only arise under specific circumstances such as where the company had committed to an ultra vires transaction or there was ‘fraud on the minority’.34 ‘Fraud on the minority’, in particular, had been difficult to diagnose, and could involve directors’ breaches of duty or oppressive conduct by majority shareholders35 and not directors. However, the resulting provisions in the Companies Act 2006 still left a number of questions unanswered. First, there seems to be a two-stage approach36 where courts have to reject the leave application if certain factors are present, such as whether the litigant is acting in the best interests of the company, and whether the company has authorised or ratified the act. After the first stage, the court would then consider various factors to decide whether to grant leave. The same factors appear in the first and second stages of consideration, and hence, this may cause confusion as to whether the first stage is actually an ‘absolute bar’ as such, and whether the two-stage interpretation is indeed correct. Further, the Law Commission recommends that ‘effective ratification’ could be a bar to a derivative action, such ‘effective ratification’ taking into account whether the ratification has been procured under circumstances of ‘fraud on the minority’.37 The provisions relating to stage

31 R La Porta et al, ‘What Works in Securities Laws?’ (2003) at . 32 Paras 6.4–6.12, Law Commission, Shareholder Remedies (1998), endorsed largely in the White Paper. 33 Foss v Harbottle (1843) 2 Hare 461. 34 Edwards v Halliwell [1950] 2 All ER 1064; Prudential Assurance Co Ltd v Newman Industries Ltd (No 2) [1982] Ch 204. 35 Estmanco (Kilner House) Ltd v Greater London Council [1982] 1 WLR 2. 36 Section 263(2) and (3) respectively. 37 Paras 6.81–6.87, Law Commission, Shareholders Remedies (1998).

Institutional Shareholder Activism as Market Discipline? 25 one and two do not refer to ‘effective’ ratification but merely ratification, although the Act also provides that ratification may only be carried out if affected directors who are also members are not counted for the purposes of the vote.38 Next, although the Law Commission would like to see old case law on derivative actions put to rest,39 recent case law interpreting the statutory derivative action has affirmed the preservation of old case law in relation to the interpretation of ‘fraud on the minority’ as a condition for derivative actions to take place, in the context where the wrongdoing had been ratified by the company.40 Hence, it remains to be seen how clarity is to emerge in case law dealing with the factors the court will look into in order to decide whether to grant leave. One is also not certain as to what extent courts may still require extensive proof of the merits of the case at the stage of granting leave. Section 261 of the Companies Act requires claimants to prove a prima facie case in order for the derivative action to proceed, and it remains unclear to what extent the substantive case itself would have to be proved even at such a preliminary stage.41 That said, legal remedies are not necessarily a white elephant. In 1995, the state managed to procure the disqualification of the directors at the collapsed Barings Plc which also had problems in risk management and effective corporate governance. Investigations into the collapse of Barings Plc in 1995 uncovered a situation of persistent Board indifference to and lack of awareness of sub-optimal risk management practices and operational actualities in the company.42 Such management negligence allowed a rogue trader, Nick Leeson, in Barings’ Singapore office to bet excessively on currency futures contracts, sustaining a loss of £1.4bn, causing the bank to collapse. Three directors were sought to be disqualified by the Secretary of State for Trade and Industry43 First, the deputy group chairman, while chair of the bank’s management committee, had delegated his management functions to others, without retaining any monitoring function. He also failed to acquire any understanding of the business being carried out by Leeson in Singapore. Next, the product manager, who also served as head of the bank’s financial products group and a member of its risk committee, had been excessively tolerant of Leeson and did not enforce any risk limits

38

S 238, Companies Act 2008. Paras 6.51–6.54, ibid. 40 Franbar Holdings Ltd v Patel and Others [2008] EWHC 1534 (Ch); [2008] WLR (D) 220. 41 This was the difficult question in Prudential Assurance v Newman, above, n 34. This question is not quite answered in the case of Kiani v Cooper [2010] B.C.C. 463, decided after the Companies Act 2006. This case allowed an action to proceed on the basis that there is a need to look into further evidence at the full trial. 42 J Gapper and N Denton, All That Glitters: The Fall of Barings (London, Penguin Books, 1997). 43 Re Barings plc (No.5) [1999] 1 BCLC 433. 39

26 Institutional Shareholder Activism in the UK on Leeson’s trading. Moreover, he was responsible for a simple failure of risk management, in failing to separate front and back offices, and to ensure that trading adhered to compliance requirements and regulations. Finally, the bank’s head of settlements was aware of the lack of proper risk management in the Singapore office and unreconciled funding remitted to that office, and did not call Leeson to explain such anomalies. The judge held that the directors had been in breach of their duties of care and skill as they failed to acquire an adequate knowledge and understanding of the business (although it could be argued that Leeson’s activities were operational as well as strategic); and to adequately monitor the discharge of functions by their delegates in the business. The judge however did not go on to provide a general legal test to determine how a residual duty to monitor may be satisfied, and preferred to leave it to the facts of the case, the nature of the company and the role of management in the company to determine the scope of the residual monitoring duty and whether it has been breached. Excessive delegation of duties to professional managers by the Board, and the Board’s increasing alienation from understanding the complexities and risks in the business, were present in the Barings Plc case as were also present in the Equitable Life saga. It is arguable that the same deficiencies have also been present in the Royal Bank of Scotland and the Halifax Bank of Scotland, two of the UK banks that needed rescue in the global financial crisis of 2008/9. However, private litigation in Equitable Life exacted a prohibitive cost before the courts could provide jurisprudence on the issues raised. The Barings case did not result in any private compensation but a form of punishment was meted out by the successful mounting of a public action by the state. Hence, shareholder litigation is arguably prohibitive after the fact, and is not the most attractive option for shareholders to safeguard their investments or gain compensation for loss in investments. State actions in disqualification orders provide the public good of developing jurisprudence and meting out punishment to the errant directors, but they do not achieve the effects of redress for shareholders and stakeholders. With this backdrop, it is arguably understandable why policy-makers are keen that shareholders should take preventive actions in activism on an ongoing basis rather than to rely on ex post legal redress. The limitations of the law in safeguarding investors against management failures lie in that: (a) the law’s definition of breaches of legal duties may be limited and may not encompass certain errors of judgment which could be fatal to the company; and (b) the law provides private shareholder actions to redress defined wrongs but such actions may bring cold comfort to investors as they are ex post and prohibitively costly.

Institutional Shareholder Activism as Market Discipline? 27 In light of the limitations of legal protection for shareholders’ investment losses, shareholder activism could be perceived to be a natural marketbased instinct or self-help measure for institutional shareholders, much like what has been discussed regarding CalPERS in chapter 1. However, the book doubts that institutional shareholder activism in the UK is a form of market-based discipline, and will argue that the impetus for institutional shareholder activism has come more dominantly from policy exhortation than market-based needs. Institutional Activism Inertia A natural driver for institutional shareholder activism is the impracticability44 of using ‘exit’ instead of voice when shareholders are not entirely happy with corporate performance. The Myners Report identifies various factors that may make ‘exit’ an unattractive choice—where the exit may involve a not insignificant stake that may drive market prices lower for the company stock, or where the holding is significant enough such that exit at a loss is not a favoured option, or where certain pension funds may be servicing the investee company’s pension savings and hence are reluctant to sell the investee companies’ shares.45 These factors should drive investors towards choosing to use ‘voice’ where issues of concern arise for them. The Myners Report in 2001 documents a systematic unwillingness on the part of institutional shareholders to use voice. The systematic unwillingness on the part of institutional shareholders to engage in activism may be due to the free-riding concerns that such activism would cost the activist while benefits are being reaped by other shareholders.46 This produces a classic dilemma known as the collective action dilemma. However, Admati et al’s research47 shows that even under circumstances where free-riding is predicted, it could still be economically rational for individual action to be taken that benefits the collective group. Admati et al looks at shareholder activism in the face of free-riding tendencies and concludes that the size of holding is key to the taking of activist actions. Admati et al describes shareholder 44 Also see JP Hawley and AT Williams, The Rise of Fiduciary Capitalism: How Institutional Investors Can Make Corporate America More Democratic (Pennsylvania, University of Pennsylvania Press, 2000). 45 P Myners, Institutional Investment in the UK: A Review (2001) (hereinafter known as the Myners Report) at para 5.80, 5.85. Also discussed in JC Coffee, ‘Liquidity versus Control: The Institutional Investor as Corporate Monitor’ (1991) 91 Columbia Law Review 1278. 46 AM Clearfield, ‘“With Friends Like These, Who Needs Enemies?” The Structure of the Investment Industry and Its Reluctance to Exercise Governance Oversight’ (2005) 13 Corporate Governance 114. 47 AR Admati, P Pfleiderer and J Zechner, ‘Large Shareholder Activism, Risk Sharing, and Financial Market Equilibrium’ (1994) 102 Journal of Political Economy 1097–130.

28 Institutional Shareholder Activism in the UK activism and monitoring as a ‘tax’ upon the holding of the shares, and hence, where the stake is large and payoffs from activism are significant, these payoffs would outweigh the ‘tax’, and activism would still occur despite free-riding by other shareholders. Von Thadden48 also builds on this research and suggests that the payoffs for activism would also be more likely realised over the long term. These pieces of research provide some rational support for institutional shareholder activism. Hence, the twin factors of large holding and long term commitment could still make economic sense for meaningful activism. It may be arguable that UK institutional shareholders perhaps do not have the large enough stakes required for activism to be activated, as Admati et al’s paper envisages the largest number of actions to be taken by concentrated to sole owners. Further, some empirical research has pointed out that UK institutional shareholders have a short term investment horizon.49 Although pension funds’ obligations are long term and do not mature for a long time, allowing them to commit to equity investments over the long term, they frequently outsource to investment managers who are assessed regularly and hence these investment managers may take a short term perspective of the investments. The Tenets of Investment Management Institutions such as pension funds manage investments by outsourcing for investment value, relying on the skills and aptitude of investment managers rather than by looking into how shareholder value in any particular investee company could be enhanced.50 The competition between asset managers for the management mandate of pension funds allows pension funds to regularly hire and fire asset managers, and commentators have found that such ‘manager tournaments’ entail regular replacement51 of asset managers, mainly due to performance reasons, although other reasons also exist.52 Hence, asset

48 E Ludwig von Thadden, ‘Long-Term Contracts, Short-Term Investment and Monitoring’ (1995) 62 Review of Economic Studies 557. 49 A Jackson, ‘Towards A Mutual Understanding of Objectives? Attitudes of Institutional Investors and Listed Companies to Corporate Governance Reforms’ (2001) 9 Corporate Governance 196; J Hendry, P Sanderson, R Barker and J Roberts, ‘Responsible Ownership, Shareholder Value and New Shareholder Activism’ ESRC Centre for Business Research Working Paper 297, University of Cambridge (Dec 2004). 50 A van Nunen, Fiduciary Management: Blue Print for Pension Fund Excellence (New Jersey, Wiley Finance, 2008). 51 P Cox, S Brammer and A Millington, ‘Pension Fund Manager Tournaments and Attitudes Towards Corporate Characteristics’ (2007) 34 Journal of Business Finance and Accounting 1307. 52 A Goyal and S Wahal, ‘The Selection and Termination of Investment Management Firms by Plan Sponsors’ (2008) 63 Journal of Finance 1805.

Institutional Shareholder Activism as Market Discipline? 29 managers have little incentive to engage in shareholder activism to improve the longer term value of investee companies. Further, a pervasive emphasis on numbers exists in the pension fund industry, and this has given rise to a general scepticism regarding unquantifiable matters such as good corporate governance. Mitchell53 also argues that the modern investment economy has fundamentally changed from one that holds stock for the longer term, in order to gain dividends based on actual operating profit of companies, to one that holds stock in order to make quick capital gains relying on market movements. Shareholder gains according to Mitchell are divorced from the actual operations, products and services provided by the businesses of investee companies and hence shareholders are not incentivised to behave as owners. Hence, there is the question of whether shareholders see themselves as monitoring the agency problem any longer, if their incentives are entirely market-based. Further, the lack of incentives to monitor may mean that difficulties such as having insufficient information or resources to carry out the monitoring role would only become entrenched as shareholders may not be motivated to address or overcome them. Hence, asset managers have found a middle way to respond to the policy call to be active—engagement is based on the blueprint of the Code, and any shortfalls from the Code would be highlighted by the proxy advisory and voting services in the corporate governance industry. However, this is not necessarily equivalent to intelligent and insightful monitoring of companies.

Regulatory and Legal Constraints Institutional shareholders may also be concerned as to whether activist activities may trigger market abuse liability as activism may entail privity to inside information, and any trading carried out by such shareholders could be regarded as insider dealing. There are also concerns as to whether institutional shareholders acting together in an activist pursuit may be regarded as ‘concert parties’ in takeover regulation, triggering a mandatory bid should the combined shareholding exceed the relevant threshold.54

53 LE Mitchell, ‘The Legitimate Rights of Public Shareholders’ (2009) 66 Washington and Lee Review 1635. 54 See also para 5.81–5.82, Myners Report. These concerns are now however rather robustly addressed by the Walker Review in coordination with the FSA and Takeover Panel, that safe harbours would be provided for shareholder activism for the purposes of corporate governance, although shareholders have to monitor any conflict of interest in their activism, see para 5.44, Walker Review Final Report.

30 Institutional Shareholder Activism in the UK The Relationship between Corporate Governance and Value for Institutional Shareholders Despite some of the factors mentioned above that may be impediments to institutional shareholder activism, there is some empirical evidence that suggests a positive link between activism and investment performance. First, empirical evidence suggests that sound corporate governance may be key to averting corporate disasters and losses in shareholder value. A number of commentators suggest, albeit with hindsight, that corporate disasters such as Enron and Royal Ahold could have been averted if better corporate governance were in place earlier.55 Although such ex post analyses do not positively prove that sound corporate governance would likely contribute to corporate survival, these studies suggest that sound corporate governance should be advocated for the possible prevention of corporate disasters. Another study suggests that sound corporate governance is likely correlated with fewer instances of shareholder litigation, which is used as an indicator of impending corporate disaster.56 Sound corporate governance is highly relevant to purely ‘defensive’ concerns, to prevent the loss of shareholder value. But there also seems to be some empirical evidence to support the correlation between shareholder activism, corporate governance and investment gains, although these gains are more discernible over the longer term. Some empirical research has shown a correlation between corporate governance and performance. A study in the US which uses an aggregate of 39 different corporate governance variables such as independent committees of boards, executive remuneration, blockholding, existence of debt, institutional ownership, activism and so on finds that at least 14 of those variables are highly correlated with share price returns and operating performance of the firm.57 However, there is also empirical evidence that contradicts any supposed correlation between governance and performance.58 In sum, the results seem to indicate that: (a) Different governance practices may affect different firms to different extents, and a one-size-fits-all approach according to one set of best

55 A De Jong, DV De Jong, P Roosenboom and G Mertens, ‘Royal Ahold: A Failure of Corporate Governance’ (2005) at ; Robert Rosen, ‘Risk Management and Corporate Governance: The Case of Enron’ (2003) 35 University of Connecticut Law Review 1157. 56 G Kaltchev, ‘Corporate Governance and Shareholder Litigation’ (2008) at . 57 DF Larcker, SA Richardson and I Tuna, ‘How Important is Corporate Governance’ (2005) available at . 58 L Bebchuk, A Cohen and A Ferrell, ‘What Matters in Corporate Governance?’ (2009) 22 Review of Financial Studies 783.

Institutional Shareholder Activism as Market Discipline? 31 practices need not be optimal.59 In fact, some firms that have not complied with all of the Code and have explained the deviations have performed well.60 (b) The imposition of governance change upon a firm alone has not significantly improved a firm’s performance, and this is consistent with earlier empirical research.61 Although based on US firms, research that has been conducted into institutional shareholder activism seems to suggest that institutional activism based on corporate governance concerns has little or no impact on generating abnormal returns on share value in the short term.62 That said, studies carried out by proxy advisory and voting agencies generally support a correlation between governance and performance, and it is not hard to see that such evidence benefits the proxy advisory and voting services industry. Empirical research from the ABI63 also shows that where companies have been served with red top alerts for governance breaches by the ABI’s in-house institutional investor voting service, these companies have performed worse in both absolute and relative terms over the five years thereafter. Where companies have been well-governed, the ABI reports that such companies see less volatility in their share price over the five years in the research period from 2002–2007, and further, an average increase of 13–18 percentage points on its share price is gained in absolute terms. Further, a number of institutional investors64 believe in the link between good corporate governance and corporate performance over the longer term such as the time period of five years the ABI has looked at. There is also empirical evidence that suggests that companies

59 DF Larcker et al, ‘How Important is Corporate Governance?’ (2005) n 57; LD Brown and ML Caylor, ‘Corporate Governance and Firm Performance’ (2004) (unpublished manuscript), available at ; S Bhagat and B Bolton, ‘Corporate Governance and Firm Performance’ (2006) at . 60 SR Arcot and VG Bruno, ‘One Size Does Not Fit After All: Evidence from Corporate Governance’ (2006) (unpublished manuscript), available at . 61 NK Chidambaran et al, ‘Corporate Governance and Firm Performance: Evidence from Large Governance Changes’ (2008) (unpublished manuscript), available at . 62 S Wahal, ‘Pension Fund Activism and Firm Performance’ (1996) 31 Journal of Financial and Quantitative Analysis 1; JM Karpoff, ‘The Impact of Shareholder Activism in Target Companies: A Survey of Empirical Findings’ (2001) at . 63 M Selvaggi and J Upton, Governance and Performance in Corporate Britain: Evidence from the IVIS Colour-coding System (ABI Research Paper 7, 2008). Earlier empirical evidence applicable to other countries may be found in C Alves and V Mendes, ‘Corporate Governance Policy and Company Performance: The Portuguese Case’ (2004) 12(3) Corporate Governance 290. 64 McKinsey and Co, Global Investor Opinion Surveys: Key Findings (London, 2002), at http://www.mckinsey.com/clientservice/organizationleadership/service/corpgovernance/pdf/globalinvestoropinionsurvey2002.pdf.

32 Institutional Shareholder Activism in the UK with better perceived corporate governance, such as by compliance with the Combined Code are valued higher in the market over the medium term (four years) than those that do not report consistent compliance.65 Such evidence provides support for the link between good governance and ultimate corporate performance, therefore generating medium to long term investment value not only for the activist shareholders but for all shareholders.66 If long term gains are consistent with most institutional shareholders’ investment horizons, the expected increase in value could motivate institutional activism. However, many commentators have discussed the predominantly short term focus of the fund managers for institutional shareholders, and doubt that voice will be preferred to exit.67 Moreover, Mitchell has argued that at least in the US, the investment economy is of such a nature that shareholders no longer see their gains as being derived from investing in companies and sharing in the profits of real businesses. Shareholders have become more and more reliant on market movements to provide capital gains, and hence, turning the tide backwards to expect shareholders to become concerned again for their investee companies and expect longer time horizons for gains to be made is extremely unlikely.68 This book is of the view that investment-centric concerns have not appeared to drive institutional shareholder activism. The lack of overwhelming evidence linking activism, governance and performance, especially short term performance, may be able to account for the still significant level of institutional inertia in empirical evidence.69

65 C Padgett and A Shabir, ‘The UK Code of Corporate Governance: Link between Compliance and Performance’ (2005) ICMA Centre Discussion Paper. 66 However, one has to bear in mind other academic research that has documented no significant relationship between various aspects of corporate governance and corporate performance, see discussion and review of the literature in L Heracleous, ‘What is the Impact of Corporate Governance on Organisational Performance?’ (2001) 9 Corporate Goverance 166, which reviews empirical literature showing no significant relationship between board composition and corporate performance or no significant relationship between the duality or otherwise of the CEO and Chairman, and corporate performance. 67 For example, see Lord Myners’ views on institutional shareholders being long term investors, Interview with Robert Peston (BBC, 4 August 2009), although this view may not be held by some who argue that institutional shareholders turn over their portfolios regularly and do not necessarily see themselves as long term owners of corporations, see H Short and K Keasey, ‘Institutional Shareholders and Corporate Governance in the UK’ in Keasey et al eds, Corporate Governance: Enterprise and International Comparisons (John Wiley & Sons 2005) at 61; M Goergen, L Renneboog and C Zhang, ‘Do UK Institutional Shareholders Monitor Their Investee Firms?’ (2008) at ; A Rappaport, ‘The Economics of Short-Term Performance Obsession’, (2005) 61 Financial Analysts 65; D Young, and P Scott, Having their Cake … How the City and Big Bosses are Consuming UK Business (London, Kogan Page, 2004), cited in C Mallin, ‘Institutional Shareholders: Their Role in the Shaping of Corporate Governance’ (2008) 1 International Journal of Corporate Governance 97 at 102. 68 Mitchell, ‘The Legitimate Rights’ (2009), n 53 above. 69 Renneboog and Zhang, ‘Do UK Institutional Shareholders Monitor Their Investee Firms?’ (2008), n 57 above.

Institutional Shareholder Activism in the Public Interest 33 The more significant developments in institutional shareholder activism in the UK may arguably be policy-led, that compel institutional shareholders to play their part as ‘owners’ and not merely ‘investors’ in the ‘regulatory space’. 3. INSTITUTIONAL SHAREHOLDER ACTIVISM IN THE PUBLIC INTEREST

Although agency problems could motivate institutional shareholders to monitor their investee companies, Part 2 of this chapter has also pointed out many reasons for institutional inertia or indifference. Although institutional shareholder activism has been on the rise since the latter part of this decade, this part of the chapter will argue that the development of institutional shareholder activism in the UK is predominantly policy led. The following part of the chapter will discuss the consistent policy encouragement for contemporary institutional shareholder activism, since the Cadbury report in 1992, and through a succession of other reports culminating in the Walker Review of 2009. Although the Walker Review focuses on banks and financial institutions, it contains some general perspectives of institutional shareholders’ role. The perception from policy is important in shaping how institutional shareholders conceive of their role and responsibility. Such a role will be described later as being part of the ‘regulatory space’. As the Walker Review states: The potentially highly influential position of significant holders of stock in listed companies is a major ingredient in the market-based capitalist system which needs to earn and to be accorded an at least implicit social legitimacy. As counterpart to the obligation of the board to the shareholders, this implicit legitimacy can be acquired by at least the larger fund manager through assumption of a reciprocal obligation involving attentiveness to the performance of investee companies over a long as well as a short-term horizon. On this view, those who have significant rights of ownership and enjoy the very material advantage of limited liability should see these as complemented by a duty of stewardship. This is a view that would be shared by the public, as well as those employees and suppliers who are less well-placed than an institutional shareholder to diversify their exposure to the management and performance risk of a limited liability company.70

Cadbury Report 1992—The Foundation for Policy-Led Activism The fall of BCCI and Polly Peck due to management fraud in 1991 triggered a thorough examination of honest financial reporting by companies

70

Para 5.7, Walker Review Final Report.

34 Institutional Shareholder Activism in the UK and Sir Adrian Cadbury was asked to lead a committee to look into that issue. The Cadbury committee however rightly identified that the governance of the company was integral to a sound financial reporting process, and that internal governance and controls had to be in place before integrity in the output of financial reporting could be secured. Hence, much of the Cadbury Report dealt with a model of good governance for companies, including Board effectiveness, Board composition including non-executive directors, the formation of independent committees of the Board, the appointment of auditors and how audit services should be provided, and the role of shareholders. The Cadbury Code has since been subject to a number of rounds of amendments and updating, but what the Code represents for the UK is the first explicit acceptance of the importance of ‘corporate governance’ in companies. These best practices are based on a comply-or-explain regime, and they are adopted into the Listing Rules which require explanation for deviation if the standards in the Code are not complied with. Although some commentators71 opine that ‘comply-or-explain’ is not effective as a means of incentivising companies to comply with these best practice standards, the Cadbury Code has set a milestone in making observeable the internal governance of companies. The watchdogs of compliance are however not intended to be the Listing Authority or the London Stock Exchange. The Cadbury committee views shareholders as the key watchdogs for ensuring compliance with the Cadbury Code, and generally calling the company to account for its internal governance and structures. Shareholders have delegated many of their responsibilities as owners to the directors who act as their stewards. It is for the shareholders to call the directors to book if they appear to be failing in their stewardship and they should use this power. While they cannot be involved in the direction and management of their company, they can insist on a high standard of corporate governance and good governance (at para 6.6, Cadbury Report). Institutional shareholders are also especially admonished: ...the way in which institutional shareholders use their power to influence the standards of corporate governance is of fundamental importance. Their readiness to do this turns on the degree to which they see it as their responsibility as owners, and in the interest of those whose money they are investing, to bring about changes in companies when necessary, rather than selling their shares (para 6.10, Cadbury Report). We look to the institutions in particular, with the backing of the Institutional Shareholders’ Committee, to use their influence as owners to ensure that the

71 JG Parkinson and G Kelly, ‘The Combined Code on Corporate Governance’ (1999) The Political Quarterly 101; MacNeil and Li, ‘Comply or Explain’ (2006) n 7 above.

Institutional Shareholder Activism in the Public Interest 35 companies in which they have invested comply with the Code. The widespread adoption of our recommendations will turn in large measure on the support which all shareholders give to them. The obligation on companies to state how far they comply with the Code provides institutional and individual shareholders with a ready-made agenda for their representations to boards. It is up to them to put it to good use (at para 6.16, Cadbury Report, emphasis added by the author).

The Cadbury Report encourages shareholders, especially institutional shareholders, to be actively engaged with their investee companies not only in terms of voting at the general meetings, but also in terms of dialogue and communication with the companies.72 Finch also commented that ‘[h]eavy reliance is placed on institutional shareholders to take a newly active role in enforcing good governance’.73 It may be argued that this foundational report on contemporary corporate governance actively encourages shareholder activism, but it frames such activism in the language of ‘responsibility’ and ‘accountability’. The role envisaged for shareholders is one of monitoring, that shareholders, as owners, should be interested in ensuring that directors behave as stewards, consistent with the role of shareholders in the agency paradigm. The recommended best practices would institute mechanisms such as having independent elements on the Board that may mitigate the agency problem, and provide controls on management behaviour which are key to safeguarding the value of institutional investment in the companies concerned. The ‘ready-made’ agenda in the Code would be a blueprint for shareholder engagement in companies, and such engagement would be based on good corporate governance as set out in the Code. The connection is thus drawn between ownership, corporate governance and the eventual safeguarding of institutional shareholders’ investments in companies. However, in the context of public concern over the collapse of significant enterprises, it cannot be said that the Cadbury Code is merely geared towards the protection of shareholder investments. There is arguably a sense of public interest that could be protected if shareholders lever on their capacity to call management to account. The Cadbury Report also does not arguably see shareholder activism as an investment strategy that could realise abnormal share price returns. The Cadbury Report however does not address the issue of how successful engagement may be paid for, since commentators have often referred to shareholder activism for the purposes of changing governance

72

Paras 6.8, 6.13ff, Cadbury Report. V Finch, ‘Corporate Governance and Cadbury: Self Regulation and Alternatives’ (1994) Journal of Business Law 51, at 58. 73

36 Institutional Shareholder Activism in the UK in a company as a ‘public good’,74 that may not be provided voluntarily due to the free-riding tendencies of other shareholders. In expecting shareholders to take on the role of activism for the purposes of ensuring sound corporate governance, the Cadbury Report arguably expects shareholders to be able to surmount the inertia of collective action dilemmas and not only provide a private good for their investors, but also to provide a public good for the benefit of other shareholders.

Successive Corporate Governance Reports and the Development of Institutional Shareholder Activism The engagement of shareholders is regarded as key to improving corporate governance in companies by the Cadbury Code, and this perception is fundamental to the design of policy in relation to corporate governance in the UK. It may be argued that the 1990s is a decade where policy-makers and even the industry have persistently encouraged shareholder activism to become staple: to move from mere ‘investors’ to being ‘owners’. At its peak, institutional shareholders have been reported to hold about 60–80 per cent of publicly listed equity in the UK.75 The proportion has now decreased to about 30 per cent, as more foreign shareholders and hedge funds have entered the fray,76 and institutional holdings have diversified to include investments in bonds, foreign investments and alternative investments.77 Institutional shareholders however remain a significant group of investors in UK publicly listed equity. The call to institutional shareholders to become more active is largely directed towards their neglect in attending general meetings and using their vote. Hence, much academic literature in the 1990s focus on documenting levels of attendance at general meetings78 and calling for voting to be taken on as a form

74 Admati, Pfleiderer and Zechner, ‘Large Shareholder Activism’ (1994). 1097–1130 n 47 above. 75 The peak of 80% holdings in publicly listed UK equity was reached around 1997–8, see R Morck, ‘A History of Corporate Governance and of the Oddity of the British’ at . 76 See Morck, ibid; also see National Association of Pension Funds (NAPF), Institutional Investment in the UK Six Years On (2007) at para 53 where it was reported that pension funds were also divested of holdings of UK equity to diversify into bonds and holdings of international equities. 77 Paras 20 and 53, National Pension Fund Association, Institutional Investment Six Years On (2007), in its review of the application of the Myners Report’s principles on institutional investment (see n 45 above), reports changes in the asset allocation carried out by pension funds over the 6 years from the Myners Report. 78 BS Black and JC Coffee, ‘Institutional Investor Behaviour in the UK’ (1993–4) 92 Michigan Law Review 1999; EB Rock, ‘The Logic and (Uncertain) Significance of Institutional Shareholder Activism’ (1990–91) 91 Georgetown Law Journal 445; C Mallin, ‘Institutional Investors and Voting Practices: An International Comparison’ (2001) 9 Corporate Governance 118.

Institutional Shareholder Activism in the Public Interest 37 of ‘responsibility’.79 The UK, and most of the world, has not followed the American example of legislating to create a fiduciary duty to use the vote in relation to pension funds. In 1995 the governance issue in the spotlight was executive remuneration, as a public outcry mounted against excessive executive remuneration in privatised utilities companies, while witnessing staff reductions and pay restraints for staff in such companies.80 The Committee led by Sir Richard Greenbury to look into this issue produced a Report which recommended more robust guidelines for the structure and operation of independent remuneration committees on the Board, and also advocated greater shareholder engagement with remuneration issues. The Report recommended the disclosure of remuneration policies and packages in the annual report to shareholders, as well as share option schemes and pension entitlements. However, the Report did not go as far as to suggest that shareholder approval should be obtained annually for the remuneration reports, but that shareholders ‘have the option of speaking at the AGM to make their concerns known, or putting down their own resolutions for the AGM ...or voting against remuneration committee members standing for re-election...’,81 leaving only long term incentive schemes to be approved by shareholders. In line with the perception of the role of the shareholders laid down in the Cadbury Report, the Greenbury Report specifically saw a role for shareholder engagement in the issue of executive remuneration which could have governance implications. Once again, disclosure and accountability to shareholders are seen as key to the way towards ameliorating the issue of excessive executive remuneration, rectifying agency problems, and possibly addressing public concerns over pay gaps and social disparity. Just as in the Cadbury Report, shareholders are expected to put to good reflection the corporate disclosure that is made to them, and register their concerns at the annual general meeting or by voting. Although the Directors’ Remuneration Report Regulations 2000 have since made the disclosure of remuneration packages and policies mandatory, and the annual advisory voting82 on the packages and policies mandatory as well (as opposed to the Greenbury Report’s initial suggestion), shareholders could only respond to the Board in one of two ways: voice or exit. The Cadbury Code clearly expects shareholders to use their voice to register influence with their investee companies, especially at general meetings, and 18 years on this same expectation is expressed in the Walker Review of corporate governance in banks.

79

Ibid, Mallin, ‘Institutional Investors’ (2001). Paras 1.6–1.7, Richard Greenbury, Report: Directors’ Remuneration (17 July 1995) (hereinafter known as the Greenbury Report). 81 Paras 5.28–5.33, Greenbury Report. 82 The Board is not necessarily bound by an advisory vote. 80

38 Institutional Shareholder Activism in the UK The use of voice is explained by the Hampel Committee Report, which reviewed the Cadbury Code of 1992, to be the use of the vote at general meetings.83 The Hampel Committee is wary of the exercise of voice through private dialogue and negotiation between investors and the Board, as this may result in the inequality of access to information between different shareholders. The Committee is also wary of private engagement resulting in the passing of price-sensitive information to an inquiring investor who is then unable to trade due to insider trading constraints under the law.84 The Hampel Committee is also of the view that private forms of communication between shareholders and the Board are not indispensable to the effective exercise of voice and investors should have the freedom to abstain from such dialogue.85 The Committee recommends the active use of the vote, better presentations of the company’s business at general meetings, and the unbundling of proposals for investors to better consider how to vote on each proposal.86 It is arguable that the Hampel Committee has been rather non-committal to the improvement of informal communication and does not recognise dialogue between shareholders and the Board as being intrinsic to shareholder activism and corporate governance. A commentator suggests87 that the Committee could have provided clearer guidelines for ‘safe harbours’ of investor relations if it is perceived that there are such concerns for the potential triggering of insider trading prohibitions. Policy support for shareholder activism by institutions has thus focussed on participation at the general meeting and the use of voice through the exercise of the vote. The use of voice, as Hirschmann explains in his classic exit-voice paradigm,88 is a union of economic and political action, and has a social dimension beyond the force of the invisible hand which is manifested by exit. The call to institutional shareholders to use voice, is arguably a mandate to adopt an investment attitude that is beyond mere economic calculation. In the US, Hawley and Williams89 also observe that the use of voice will increasingly become indispensable as institutional shareholders such as pension funds take stakes that are too large to liquidate. As pension funds are also compelled by law to use their vote as an exercise

83 Para 5.13ff, Ronnie Hampel, Committee on Corporate Governance: Report (Jan 1998) (hereinafter referred to as the Hampel Report). 84 Para 5.12, Hampel Report. 85 Para 5.11, Hampel Report. 86 Paras 5.14, 5.17, Hampel Report. 87 A Dignam, ‘A Principled Approach to Self Regulation? The Report of the Hampel Committee on Corporate Governance’ (1998) 19 Company Lawyer 140 at 149. 88 AO Hirschmann, Exit, Voice and Loyalty: Responses to Decline in Firms, Organizations, and States (Cambridge, MA, Harvard University Press, 1970). 89 JP Hawley and AT Williams, The Rise of Fiduciary Capitalism: How Institutional Investors Can Make Corporate America More Democratic (Pennsylvania, University of Pennsylvania Press, 2000).

Institutional Shareholder Activism in the Public Interest 39 of fiduciary duties to beneficiaries, institutional shareholder activism will be characterised as a form of ‘fiduciary capitalism’ that is based on ownership, and is also public spirited in nature, providing a public good alongside retirement savings for the aging population. Pension funds are not subject to the same explicit fiduciary duty in the UK, but as will be discussed later, the role of institutional shareholders is increasingly being framed in public interest terms such as ‘stewardship’.90 Nevertheless, has the exercise of shareholder activism through voice, primarily by the use of the vote at general meetings become significant or effective? By 1998, PIRC’s survey of proxy voting by institutional investors shows such voting levels to be low—less than 50 per cent of institutional shareholders would turn up or vote at investee companies’ general meetings.91 This record has improved significantly by the millennium, as the annual surveys by the Investment Management Association points out. By 2008, over 95 per cent of investment managers managing institutional funds would exercise their votes at general meetings.92 The Myners Report93 on how institutional investment is managed in the UK indicates policy support for shareholder activism involving the private exercise of voice, and seeing shareholder activism as an investment strategy and not just an investment approach. Myners strongly encourages investors to meet privately with executive officers and to register their concerns in a persistent manner with ‘thick skin’ until their concerns are addressed.94 This is because institutional investors should be ‘adding value for clients through improved corporate performance leading to improved investment performance’.95 Myners specifically refers to investment funds in the US which have targeted underperforming companies and engaged in activism to influence better performance by these companies and hence bringing about improved share values.96 Myners also doubts that private shareholder engagement would result in triggering insider trading prohibitions or takeover rules on concert parties,97 identifying the real excuse made by institutional investors as being down to conflicts of interest, where institutional investors also manage the

90

Discussed in Part 4. PIRC, Survey of Voting Trends (1998) cited in Mallin, CA, “Institutional Investors and Voting Practices: an international comparison” (2001) 9 Corporate Governance 118. See also discussion in Rebecca Stratling, ‘General Meetings: A Dispensable Tool for Corporate Governance of Listed Companies?’ (2003) 11 Corporate Governance 74. 92 Investment Management Association, Annual Survey of Engagement for Years Ending 2008 (2008). 93 See Myners Report, n 45 above. 94 Para 5.79, Myners Report. 95 Para 5.75–5.76, Myners Report. 96 Para 5.74, Myners Report. 97 Para 5.81–5.82, Myners Report. 91

40 Institutional Shareholder Activism in the UK investee company’s pension savings.98 Myners also advocates Chinese walls to be used in institutional investors’ organisational structures in order to allow the investment management arm to carry out effective activism in investee companies.99 Myners recommends in general that the duty of investment funds as trustees should expressly include shareholder activism in order not only to vote their proxies but to routinely intervene in order to add value to their clients’ investments.100 The Department of Work and Pensions has since consulted on whether shareholder activism as described by Myners should be included as part of investment funds’ fiduciary duties,101 although it has not been in favour of enacting an explicit legal duty as such. Policy-makers have however been consistent in their strong support for institutional shareholders taking steps to intervene in their investee companies whether through voting or informally, as may be necessary.102 In 2003 Sir Derek Higgs was asked to review the effectiveness of non-executive directors in companies, 10 years on from the Cadbury Report. The Higgs Report103 also deals with the Board’s relations with shareholders, and sets out more explicit avenues of communication and dialogue between shareholders and executive and non-executive directors, and affirms the rationale for shareholder activism as opined in Myners’ Report, ie that shareholder activism may generate value for shareholders and prevent loss in share values.104 The Higgs Report specifically recommends that non-executive directors should attend general meetings in order to be accountable to shareholders, and that shareholders could have access to the Senior Independent Director (leader of non-executive directors) in order for the latter to take on board the concerns and issues shareholders wished to raise.105 Higgs also recommends that non-executive directors other than the Senior Independent Director should attend a sufficient number of meetings with shareholders to understand shareholder views and concerns.106 Shareholders should also be given access to non-executive directors through the company secretary at all times.107 These mechanisms may be

98

Para 5.85, Myners Report. Para 5.87, Myners Report. 100 Para 5.90, Myners Report. 101 Department of Work and Pensions, Encouraging Shareholder Activism (Consultation Paper, 2002) at . (hereinafter referred to as the DWP Paper). 102 Paras 8, 10, 14–16, DWP Paper, ibid. 103 D Higgs, Review on the Role and Effectiveness of Non-executive Directors (Jan 2003), hereinafter referred to as the Higgs Report. 104 Para 15.22, Higgs Report. 105 Para 15.15, Higgs Report. 106 Para 15.16, Higgs Report. 107 Para 15.19, Higgs Report. 99

Institutional Shareholder Activism in the Public Interest 41 supplemental to other forms of dialogue that shareholders would have with the executive members of the Board including the Chairman. Hence, by 2003, institutional shareholder activism has been given firm policy endorsement and the policy position on activism has moved from encouragement to vote, to more informal use of dialogue and communication with investee companies. In 2009, another important review of corporate governance has taken place. Sir David Walker has been asked to look into the corporate governance at banks in order to determine the part played by governance issues in the banks’ crises in late 2008/9. The Walker Review108 on the corporate governance in banks recommends that shareholders should be encouraged to be more active as ‘stewards’ of the corporation in monitoring management, and suggests that principles of engagement which have been formulated under the auspices of the Institutional Shareholders Committee be given greater status as a Code in order to facilitate informal engagement. The Walker Review also recommends that collective engagement be permitted in order for institutional shareholders to join efforts in their activism, and that safe harbours be provided for such activism from legal restraints in concert parties and market abuse.109 Hence, institutional shareholder activism has been encouraged not only to be carried out at general meetings but beyond general meetings. The role of corporate governance is not merely an internal matter but is regarded to have implications for corporate well-being and survival, issues in political, social and public interest. This reflects Myners’ view that institutional investors should engage in activism as a public good, as ‘...[freeriding] is not a problem for their clients, and as such should be irrelevant: a manager’s duty is to do the best for their clients. If others benefit too, this is not a reason for inaction’.110 The Walker Review has also frowned upon the use of exit without voice by institutions and stated that this is ‘a relatively blunt means of communication between owner and board’.111 However it has refrained from putting forward an earlier suggestion that the FSA be allowed to engage with institutions as to the motivations for selling, although the latter would compel institutions that prefer exit to voice to provide explanations to the FSA.112 It is observed that the Walker Report now refers to institutional shareholders as ‘stewards’,113 themselves to be accountable for their

108

D Walker, Review of Corporate Governance in Banks and Financial Institutions (Nov 2009). See para 5.46, Walker Review Final Report. This has been adopted by the Financial Services Authority’s clarification on shareholder activism, see FSA, ‘FSA Provides Clarity for Activist Shareholders’, 19 Aug 2009, at . 110 Para 5.88. Myners Report. 111 Para 5.21, Walker Review Final Report. 112 Paras 5.24–5.25, Walker Review Final Report. 113 Para 5.7, Walker Review Final Report. 109

42 Institutional Shareholder Activism in the UK engagement, moving away from Cadbury’s reference to directors as ‘stewards’ accountable to owners, where owners have a certain amount of freedom to determine how that accountability should be delivered. The Walker Report has clearly articulated that institutional shareholder activism is moving beyond a form of market-based discipline, which is up to the freedom of institutions’ will to exercise or otherwise, to a form of market-based governance, where institutions are part of a larger governance framework for public interest purposes, and they are not only exercisers of discipline but may themselves be subject to discipline in the ways of their engagement. From 2003, voluntary trade associations of pension funds and their investment managers, the NAPF (National Association of Pension Funds) and the IMA (Investment Management Association) have been conducting annual surveys to discern the level of engagement by institutional investors in investee companies, both in informal avenues and in voting at general meetings. Investment managers who have been outsourced with managing parts of institutional investors’ portfolios are also surveyed on whether they have transparent policies of engagement in place. There is still a strong emphasis on voting and attendance at general meetings, but informal forms of engagement such as contact and engagement outside of general meetings also take place. Although anecdotal evidence suggests that some effective activism takes place on an informal level,114 there is a general lack of publicly available information on the effectiveness of private dialogue, and that makes it difficult to evaluate the effectiveness of informal engagement. However the IMA Annual Survey for the years 2007 and 2008 have taken pains to provide examples of private engagement, especially collective engagement by institutions and hence a rare insight is obtained into the level of informal engagement.115 These examples are however not exhaustive and there continue to be great potential in research into information regarding the nature, frequency and effectiveness of institutions’ private engagement. Publicly available information is however able to showcase visible and powerful forms of institutional shareholder activism publicly witnessed at general meetings.

114 JC Coffee, ‘Liquidity versus Control’ n 45 above, but the IMA and NAPF surveys show that the majority of their members do not regularly engage with companies on an informal basis. 115 IMA, Annual Survey of Engagement (2008), giving examples of how private and collective engagement took place in respect of RBS and Bradford and Bingley for issues in performance, in respect of SportDirect and Marks and Spencer for governance issues, in respect of Marks and Spencer, BP and GSK for remuneration issues and in respect of Lonmin for issues of health and safety, and social responsibility for its overseas suppliers.

Institutional Shareholder Activism in the Public Interest 43 As opposed to the situation in the US where shareholder activism has arisen from the bottom-up, as a self-help measure,116 in the UK, policymakers have been chiefly responsible for urging institutional shareholders to adopt activism not only as a self-help measure but as as a means of playing a role in wider corporate governance concerns and social good. It is arguable that the twin motivations of self and public interest have not played an equal part in driving institutional shareholder activism, as concerns for investment value have not per se motivated institutional shareholder activism. Although there is a public good aspect to institutional shareholder activism, there has been hitherto restraint in imposing regulation to deliver the public good.117 Lord Myners has also spoken out to encourage institutions to behave as owners, and suggested they should be given greater voting rights as long term owners.118 This Part has so far argued that the major force shaping institutional shareholder activism in the UK is policy leadership in partnership with the industry. This is arguably because institutional shareholders are a dominant group of shareholders in public listed companies in the UK and are hence naturally placed to exert market-based discipline, and policymakers also hope to leverage such market-based discipline as a form of market-based governance, which is the achievement of public good through private means and objectives.119

Institutional Shareholders in the ‘Regulatory Space’ The ‘regulatory space’ is a metaphor used to describe the idea that resources and information are often dispersed and fragmented among a group of constituents that are interested in an area of governance, and hence the exercise of powers of governance or regulation may actually be dispersed rather than concentrated in the hands of the government.120

116 See especially Robert Monks’ depiction of shareholder activism in The Emperor’s Nightingale: Restoring the Integrity of the Corporation in the Age of Shareholder Activism (New York, Basic Books, 1999). 117 The Company Law Review and the Department of Trade and Industry arguably see company law and corporate governance as 2 distinct regimes, see pages 8, 10 and 268 of DTI, Company Law Reform (Marc 2005) (hereinafter referred to as the White Paper). Corporate governance is referred to as a regime developed in conjunction with the industry producing the Combined Code of Corporate Governance, and this regime is not regarded as part of the company law regime for the purposes of reviewing the Companies Act 1985 and enacting the Companies Act 2006. 118 See ‘Opposition grows to “two-tier” share plan’, Financial Times (2 Aug 2009). 119 Ch 1, Donahue and Nye, Market Based Governance (2002) n 13 above. 120 C Scott, ‘Analysing Regulatory Space: Fragmented Resources and Institutional Design’ (2001) Public Law 329, also see J Black, ‘Enrolling Actors in Regulatory Processes: Examples from UK Financial Services Regulation’ (2003) Public Law 63.

44 Institutional Shareholder Activism in the UK The recognition of the fragmentation of resources and hence the fragmentation of governance or power is compatible with the observed tradition of negotiated regulation in the UK. Hence, in the area of ensuring sound corporate governance in companies, policy-makers do not see themselves as being the only ones responsible for the prescription of top-down rules. The UK Corporate Governance Code is a product derived from consultation with the industry itself and continues to set a benchmark for best practice, not as a matter of legal obligation. The Cadbury, Greenbury, Hampel, Myners, Higgs and Walker Reports consistently identify shareholders as key players in the regulatory space who can use the Code as a benchmark in assessing and evaluating if companies are being governed and perform in a satisfactory manner. The role of the Code is to provide more information disclosure to shareholders, and to provide mechanisms and a blueprint for shareholder engagement with companies. Whether shareholders are driven or not, both policy-makers and the industry see shareholders as a key participant in the regulatory space, able to affect the governance of companies through voice or the withdrawal of capital (exit). Pension funds in particular are custodians of retirement savings of the working population in the UK, and providers of retirement income to the majority of the population. Insurance companies also provide long term savings for the working population through their insurance-linked products. Hence, the interest in safeguarding investment value in pension funds or insurance companies is not merely a private capitalist interest for these entities as shareholders, but a public interest for all savers and beneficiaries.121 The bodies representing institutional shareholders, namely the NAPF, IMA and the Association of British Insurers (ABI) have responded to such policy admonitions by encouraging their members to take activist stances where necessary, and to survey their members annually. For example, the ABI issues coloured top warnings on general meeting proposals such as amber or the more serious red-top warnings, where it discerns that the proposals violate sound corporate governance principles. The regulatory space for corporate governance features the government leveraging on the industry’s knowledge and resources to provide a set of best practices for themselves, and on shareholders’ investment interests and resources to provide the ‘enforcement or sanction’ aspect of corporate governance. Scott and Black rightly opine that ‘[i]ndeed regulatory enforcement has been characterised as “a matter of continual interpretation, adjustment and discussion”,’122 as the role of shareholders in the negotiative landscape between shareholders and management is not to mete out 121 Myners Report, n 45, and RH Kraakman and H Hansmann, ‘The End of History for Corporate Law’ (1994) 82 Georgetown Law Review 1733. 122 Scott, ‘Analysing Regulatory Space’ (2001), n 120 above at 343, J Black, Rules and Regulators (Oxford, Clarendon Press, 1998).

Institutional Shareholder Activism in the Public Interest 45 top-down sanctions, but to evaluate, discuss and adjust expectations and outcomes relating to the governance of the company. However, would this admonition to institutional shareholders suffer from a collective action dilemma, known as the ‘free-rider’ problem? The free-rider problem occurs when no one acts for fear that someone else would benefit from one’s actions. Empirical research into social psychology suggests that where there is a social dilemma in collective action, possibly caused by the perception that one’s efforts would be free-ridden upon by others in the same situation, such social dilemma can be overcome by social campaigns aimed at influencing entities to change their beliefs and attitudes.123 These campaigns may be particularly effective if undertaken at peer level, using the power of the social norm to drive behaviour.124 The persistent policy admonition coupled with industry support towards shareholder activism may be responsible for persuading institutional shareholders to take activist efforts even if free-riding by others will occur. As Scott opines, ‘[g]ood institutional design might seek to harness and develop the dispersed resources which would be likely to support the public policy objectives of the regulatory regime’.125 The regulatory space analysis is clearly at work in UK corporate governance where policy-makers enrol the investment industry to take responsibility for the development and evaluation of corporate governance, and have persistently put in place a norm of shareholder activism for both shareholders’ own and collective interests. Institutional Shareholder Activism as Market-based Governance In perceiving institutional shareholders as both defenders of their own investment value and providers of a form of market-based governance, policy-makers have arguably framed the ‘Enlightened Shareholder’ as a theoretical and legal construct to encapsulate the role of shareholders. The ‘Enlightened Shareholder’ model will be discussed below, followed by the recent efforts to intensify market-based governance in institutional shareholder activism in the wake of the global financial crisis. 123 DM Messick, MB Brewer et al, ‘Individual Adaptations and Structural Change as Solutions to Social Dilemmas’ (1983) 44 Journal of Personal Socio Psychology 294 discussed in M van Vugt, ‘Concerns about the Privatization of Public Goods: A Social Dilemma Analysis’ (1997) 60 Social Psychology Quarterly 355. 124 KG Carman, ‘Social Influences and the Private Provision of Public Goods: Evidence from Charitable Contributions in the Workplace’ (Stanford Institute of Economic Policy Research 2003), SIEPR Discussion Paper No. 02-13, at , discusses how social influences drive voluntary charitable giving and generally altruism, and such social influences are especially powerful when peers engage in similar activity. 125 Scott, ‘Analysing Regulatory Space’ (2001), n 120 at 331.

46 Institutional Shareholder Activism in the UK Company Law Reform and the Enlightened Shareholder From Cadbury to Higgs and the Company Law Review, both policy-makers and the industry consider shareholders to be key players in the realm of corporate governance. The Company Law Review’s conception of the ‘Enlightened Shareholder’ arguably reinforces the expectation that shareholders are part of the ‘regulatory space’ exerting discipline over management to mitigate the agency problem. Shareholders are regarded as the primary market players in the regulatory space as the UK does not subscribe to a more communitarian perspective of corporate governance.126 The Company Law Review’s earlier output suggests that the Review is keen on reforming the law in the UK so as to include a more pluralist perspective of the company.127 However, by the later papers and the enactment of the Act, the position is supportive of shareholder engagement and shareholder value in particular. The purely pluralist approach has been rejected128 for fear that it imposes on directors an impossible burden of mediating various stakeholder interests, and the White Paper in 2005 set out that the legal reforms are geared towards: …effective communication and engagement between directors and shareholders, and ... efficient mechanisms for taking decisions critical to the running of the company.

The Government’s proposals in this area, which are based upon the CLR’s analysis, therefore aim to ensure greater transparency and accountability within the company’s operations, and greater opportunity for all shareholders to play an informed part in company business (ch 3, White Paper). Policy-makers see shareholders not only as drivers of their own investment interests, but that the promotion of shareholder value in general provides public goods such as long term economic prosperity and efficient allocation in capital markets.129 Hence, shareholders are seen as crucial in driving the long term performance of companies and accountability to them is seen as also facilitative of general ‘economic prosperity’.130 The paradigm of shareholder value is seen as being able

126 Such as stakeholder models discussed in RE Freeman, ‘A Stakeholder Theory of the Modern Corporation’ reproduced in MB Clarkson ed, The Corporation and Its Stakeholders (Toronto, University of Toronto Press, 1998) at 125 on how stakeholders may be defined and how a corporate nexus of contracts could include them. 127 DTI, Modern Company Law for a Competitive Economy: Developing the Framework (2000) at para 7. 128 Para 3.5, DTI, Modern Company Law, above n 127. 129 R Martin, P Casson and T Nisar, Investor Engagement (Oxford, OUP, 2008) at 1 explains that corporate governance in the UK is driven by shareholder value, and that the contextual and global factors leading to the rise in shareholder value is a key tenet underlying corporate governance. 130 Para 3.1, White Paper.

Institutional Shareholder Activism in the Public Interest 47 to serve collective interest and to generate the public good as mentioned above.131 Hence, the Company Law Review proposed the ‘Enlightened Shareholder Value’ model132 as underlying corporate governance and directors’ legal duties. This seems to be a compromise between the communitarian view of corporate governance which allows pluralism and stakeholders’ interests to be defined within the company law framework, and the shareholder centric view of shareholder primacy in corporate governance. The Enlightened Shareholder Value model adopts a profile of shareholders as being concerned with the long term well-being of the company, and hence, directors, in serving such shareholders’ interests, ought to have regard for certain stakeholder interests that are naturally aligned with the goal of long term well-being. It has also been argued that stakeholders’ interests are in essence no different from shareholders’ interests in the long run,133 and the Enlightened Shareholder Value model would be able to take care of relevant stakeholders’ interests although it is preponderantly geared towards shareholder value. The overwhelming concern is for shareholder wealth maximisation in the long run, as Dame Mary Arden puts it, ‘[i]n the end [the Company Law Review] settled for the view that a company existed ultimately for the benefit of shareholders, but that directors ought in running companies to take a balanced view of the long term and the short term, and to take into account its need to foster relationships with its various stakeholders’.134 Institutional shareholder activism based on an Enlightened Shareholder Value model is further supported by enhanced transparency and disclosure to shareholders. First, enhanced disclosure was introduced in the now defunct Operating and Financial Review which has been re-enacted

131 This is referred to as the Third Way by American commentators Cynthia Williams and John Conley who see the Enlightened Shareholder Value model as a compromise between shareholder centric models that could encourage myopic and short term behaviour and pluralist models, see ‘An Emerging Third Way?: The Erosion of the Anglo-American Shareholder Value Construct’ (2005) 38 Cornell International Law Journal 493. 132 M Hodge MP, ‘Companies Act 2006: Intention, Interpretation, Implementation’ (27 Feb 2007) at . 133 P Goldenberg, ‘Shareholders vs Stakeholders: The Bogus Argument’ (1998) 19 Company Lawyer 34. 134 M Arden, ‘Reforming the Companies Act: The Way Ahead’ (2002) Journal of Business Law 579. Paul Davies also argues that shareholder primacy is key to the Enlightened Shareholder Value model, see P Davies, ‘The Enlightened Shareholder Value and New Responsibilities of Directors’ at at pp 1–9.

48 Institutional Shareholder Activism in the UK as the Directors’ Annual Business Review.135 Second, reforms have also been made as to how general meetings are conducted. The Company Law Review saw the role of law in providing more mandatory disclosure and hence information for shareholders to act upon. It was proposed that public and significantly large companies be required to produce an Operating and Financial Review (‘OFR’) attached to the annual report, to provide directors’ assessment of the risks, prospects and direction of the company, in order to shed light upon what may affect business performance prospectively. The purpose of the OFR was also to ‘account for and demonstrate stewardship of a wide range of relationships and resources’.136 The OFR was also seen as an important source of information for shareholders, and possibly as evidence of directors having complied with their legal duty to promote success of the company in the interests of the collective enlightened shareholders.137 The OFR was in line with the initiatives taken at the EU level, particularly in the Transparency Directive, which required Member States to ensure that non-financial reports were issued by publicly traded companies which described the position of the business and factors that had affected performance of the business. Such non-financial reports were known as ‘Interim Management Reports’ to be issued twice yearly, but the contents of such reports are left to be decided upon by Member States.138 However, the OFR was ultimately regarded as going beyond what was required at the EU level and hence a form of ‘gold-plating’. Although the Company Law Review reported support for the OFR during its consultation, after the OFR was enacted in the form of Regulations in 2005, complaints from the industry entailed its quick repeal in late 2005, replaced by the obligation to prepare a directors’ business review attached to the annual report.139 The business review still required directors’ to review and assess the material factors and principal risks that the company faced in the year before, and also adopted the repealed OFR’s requirement to assess the likely future position of the company, essentially a forward-looking statement. Like the OFR, the business review also preserved the obligation imposed on directors to disclose how they have considered stakeholders’ interests. There is arguably no real substantive difference between the OFR and the business review,140 and hence, the spirit of enhanced disclosure has been preserved in order to facilitate greater shareholder knowledge of management stewardship. 135

s 417, Companies Act 2006. Para 3.4, DTI, Completing the Structure (2000), n 128. 137 Davies, ‘The Enlightened Shareholder Value’ (2005), n 134 above. 138 Article 6, Transparency Directive. 139 s 417, Companies Act 2006. 140 T Burns and J Paterson, ‘Gold Plating, Gold Standard or Base Metal? Making Sense of Narrative Reporting after the Repeal of the Operating and Financial Review Regulations’ (2007) 26 International Company and Commercial Law Review 247. 136

Institutional Shareholder Activism in the Public Interest 49 The Companies Act 2006 also made reforms to certain procedures surrounding general meetings to improve shareholder engagement. Public companies are now required to hold a general meeting within six months of issuing the annual general report,141 to allow shareholders to be able to engage investee companies on information in the annual report in a timely manner. The right of shareholders to appoint proxies is also provided, and funds voting as proxies also have a right to demand a poll.142 Companies are now required to post poll results on their websites143 and to make use of electronic means to send documents to members in a timely manner.144 The ‘Enlightened Shareholder’ is a legal construct, the object of directors’ accountability, and also a policy construct: what shareholders should be and do. The ‘Enlightened Shareholder’ in the UK is arguably different from the starting agency paradigm that perceives shareholders as a form of market-based discipline in monitoring corporations. The ‘Enlightened Shareholder’ straddles the private sphere of market-based discipline and the sphere of public interest that is served by sound corporate governance, and hence the behaviour to be expected of shareholders is no longer left to market forces and instincts, but somewhat led by policy expectations. The long term Enlightened Shareholder is thus one that is encouraged to use voice to engage with investee companies, in a form of relational investing and not by prompt exit. The yearly NAPF and IMA surveys of their members’ engagement with companies, and the ABI’s in-house corporate governance service that provides advice to members, have documented a steady rise in the investing industry’s efforts to answer the call to use voice. This is largely manifested in the case studies discussed below pertaining to voting at general meetings. It will be argued that the case studies show that institutional shareholder activism in the ‘enlightened’ construct is concerned with the blueprint of the Code, focussing on using the vote at general meetings and is supported by the research and analyses done by the corporate governance industry, ie proxy voting and advisory agencies such as PIRC and RiskMetrics. However, there is also a steady rise in informal engagement as surveyed of 2008 although such informal engagement remains opaque. Compliance with the UK Corporate Governance Code One of the key characteristics of institutional shareholder activism in the UK is its overt support for compliance with the Code. Institutional 141 142 143 144

s 336, Companies Act 2006. ss 324, 329, Companies Act 2006. ss 341, 353, Companies Act 2006. s 333, Companies Act 2006.

50 Institutional Shareholder Activism in the UK shareholders in the UK generally engage in significant activism in threatening to vote no where investee companies deviate from the Code. It will be argued shortly that this is perhaps the least costly and challenging approach for institutions as the Code is a ready-made agenda and the work of the corporate governance industry focuses on it. This Part will discuss a few cases of notable institutional shareholder activism. However, as the first decade of the millennium passes, this form of activism would still be insufficient for the delivery of public interest goods, as manifested in the global financial crisis. This Part will discuss how policymakers intend to intensify the market-based governance by institutional shareholder activism. A number of institutional shareholders have taken the lead in several cases to revolt at general meetings in order to ensure that the Code is adhered to. Such investment managers include Fidelity Investments International Ltd which services a number of pension funds, Legal and General, Aviva Investors, Schroders Asset Management and more. A good number of investment managers also have transparent policies on their engagement and the corporate governance issues that matter to them, and these are closely aligned with the Code.145 The Association of British Insurers (ABI) also takes proactive efforts to help members flag up questionable resolutions at general meetings by issuing coloured top warnings in advance of general meetings. However the pattern of institutional shareholder activism in the UK is reactive in nature, ie that institutional shareholders react to actions taken by the company and consider how to use their votes, rather than call extra-ordinary general meetings or table proposals. This is quite different from institutional shareholder activism in the US. In the US, rule 14a-8 of the Securities Exchange Act 1983 allows a holder of $2,000 in market value or 1 per cent in equity to submit a single proposal to be voted on at the general meeting. In the UK, a member in a public company can ask for circulation of a proposal if he holds at least 5 per cent of the company’s equity or the proposal is supported by at least 100 members each having an equity value of not less than £100.146 However, members’ proposals for resolutions must be received by the company at least six weeks147 before the general meeting, but as companies are entitled to give a minimum

145 Aberdeen Asset Management, Aberdeen Corporate Governance Principles at ; Fidelity Investments, Principles of Ownership, at ; Aviva Investors, Corporate Governance, at ; Lazard Ltd, Corporate Governance Guidelines at . 146 s 338, Companies Act 2006. 147 Ibid.

Institutional Shareholder Activism in the Public Interest 51 of 21 days’ notice148 for the general meeting (or 28 days if the removal of a director is proposed)149, members may be unable to send proposals to a company in time, including for the removal of directors. This may however arguably be made up for by the power of members to call an extra-ordinary general meeting, and hence, members are not limited by the directors’ power to call a general meeting. In the US, empirical evidence shows that member’s proposals for resolutions are increasingly successful as they attract fellow shareholders’ support and although not binding in nature, could practically change the direction that the company has been taking.150 The proposal process is also helped by rules allowing for solicitation of proxies.151 However, the proxy process may sometimes be fraught with difficulties in terms of communication, coordination and cost.152 That said, the threat of putting up a proposal for a resolution may itself be an influence for management to be reckoned with, whether or not the proposal is in fact put through and the proxy solicitation efforts are undertaken.153 Other indirect forms of activism that leverage on the power to vote are in the form of ‘just vote no’ to appointments and re-elections of directors, as a form of protest in order for management to register other specific shareholder demands, and empirical evidence shows that such campaigns are being noticed by

148

s 307(2)(a), Companies Act 2006. ss 168, 312, Companies Act 2006. 150 R Thomas and JF Cotter, ‘Shareholder Proposals in the New Millennium: Shareholder Support, Board Response, and Market Reaction’ (2007) at ; SL Gillan and LT Sparks, ‘The Evolution of Shareholder Activism in the US’ (2007) at ; Cindy.Alexander, Mark Chen, D Seppi, and C Spatt, ‘The Role of Advisory Services in Proxy Voting’ (2006) University of Maryland working paper; EG Maug and K Rydqvist, ‘Do Shareholders Vote Strategically?’ (2006) ECGI— Finance Working Paper No. 31/2003. 151 Rule 14-a of the Securities Exchange Act 1934. 152 Shareholders may be passive due to the collective action free-rider problem, or their behaviour may largely depend on private motivations and whether they face conflicts of interest managing the funds of their investee companies, see BS Black, ‘Shareholder Passivity Re-examined’ (1990) 89 Michigan Law Review 520; GF Davis and E Han Kim, ‘Would Mutual Funds Bite the Hand that Feeds Them? Business Ties and Proxy Voting’ (2005) at , P Ye, ‘On Investors’ Ownership and Voting Decisions: Evidence from Mutual Funds’ (2008) at ; R Ashraf and N Jayaraman, ‘Determinants and Consequences of Proxy Voting by Mutual Funds on Shareholder Proposals’ at . Shareholders may also face communication costs problems, see JN Gordon, ‘Proxy Contests in an Era of Increasing Shareholder Power: Forget Issuer Proxy Access and Focus on E-Proxy’ (2008) ECGI—Law Working Paper No. 92/2008, or are subject to distortions and manipulations introduced by management, see JE Bethel and SL Gillan, ‘Corporate Voting and the Proxy Process: Managerial Control Versus Shareholder Oversight’ (2005) at . 153 NK Chidambaran and T Woidtke, ‘The Role of Negotiations in Corporate Governance: Evidence From Withdrawn Shareholder-Initiated Proposals’ (1999), EFA 0458; WP EFMA Athens 2000 and NYU, Centre for Law and Business Research Paper No. 99-12, also found on the ssrn at . 149

52 Institutional Shareholder Activism in the UK management and could lead to a change in corporate policy and even CEO turnover.154 Institutional shareholders in the US also engage investee companies on an informal basis, usually to effect governance changes, to successful results.155 The proposal and solicitation process are less likely to be relied on in the UK as a means of activism, as the IMA surveys have revealed very few instances of shareholders calling for extra-ordinary general meetings156 or tabling proposals.157 Shareholders have sometimes exercised the power to vote against director appointments in order to register a protest against the company’s performance or governance, but this is rare.158 Institutional shareholders have up to 2007 not carried out frequent dialogue informally with the company, many reporting meeting the company once or twice a year.159 However, with the onset of the credit crunch, many institutions have stepped up their informal meetings with the Board and Senior

154 D Del Guercio, L Seery and T Woidtke, ‘Do Boards Pay Attention when Institutional Investor Activists Just Vote NO?’ (2008) at . 155 R Romano, ‘Less is More: Making Shareholder Activism a Valued Mechanism in Corporate Governance’ (2000) at ; JM Karpoff, ‘The Impact of Shareholder Activism in Target Companies: A Survey of Empirical Findings’ (2001) at , whose survey of a range of other studies shows that private negotiations are more effective in inducing change than shareholder proposals; WT Carleton, JM Nelson and MS Weisbach, ‘The Influence of Institutions on Corporate Governance through Private Negotiations: Evidence from TIAA-CREF’ (1998) 53 Journal of Finance 1335; Becht et al, ‘Corporate Governance and the Credit Crisis’ (2008), n 9 above. 156 In 2003, the IMA Survey of Fund Managers’ Engagement with Companies reports that most investment managers do not see putting general meeting resolutions forward, requisitioning extra-ordinary general meetings and putting out public statements ahead of general meetings as being desirable forms of engagement. The figures for such activity remain virtually nil for the years after. In 2006, the Survey reports 2 extra-ordinary general meetings requisitioned and 5 proposals put forward by institutional shareholders. These relatively low numbers show that proactive and public forms of engagement relating to meetings and voting are not preferred. One of the EGMs relates to SkyePharma Plc in 2006, discussed in Martin, Casson and Nisar, Investor Engagement (Oxford, OUP, 2008) at 72ff, where an extraordinary general meeting has been convened to remove the executive Chairman in light of the Board’s decision to sell the company as a whole after disappointing results for several preceding years. Compared to the UK, the tabling of proxy resolutions by institutional investors in the US may be more frequent, and may be used as a strategy to force the Board to accede to demands for changes. However, many researchers doubt that proxy tabling has been particularly successful in the US, especially if measured in terms of performance, see Romano, ‘Less is More’ (2000) n 155 above. However, such proxy proposals often exert governance pressures on the company, see KJ Martin and RS Thomas, ‘The Effect of Shareholder Proposals on Executive Compensation’ (1999) 67 University of Cincinnati Law Review 1021; R Ashraf and N Jayaraman, ‘Determinants and Consequences of Proxy Voting’ (2007) n 152. The frequency and regularity with which this tactic is being used may be due to the lack of shareholder power to convene extra-ordinary general meetings in the US. 157 IMA, Annual Survey of Engagement (2004, 2005, 2006). 158 ‘All Bark and No Bite: When Snarling Shareholders Become Docile Poodles’, The Independent (16 Jun 2002), and compare ITV episode with Marks and Spencer, below. 159 Ibid.

Institutional Shareholder Activism in the Public Interest 53 Independent Directors of investee companies,160 although such meetings are also reactive to bad news from the investee companies. Hermes, the rather unique institutional fund discussed in chapter 3 however, regards private forms of engagement that are ex ante in nature to be more effective.161 The dominant picture of institutional shareholder activism in the UK is still one of reacting to issues presented by the company. Institutions also decide on their reactive positions by placing significant reliance upon voting and advisory services in respect of governance issues. The exercise of voice and the vote at general meetings is targeted towards specific issues raised by the voting and advisory service agencies. These issues usually centre on rights issues, executive remuneration, and the appointment of an executive Chairman for example. The manner of exercise of institutional shareholder activism is to date primarily through the collective forum of the general meeting, giving such activism respectable characteristics of being collective, transparent, highly visible and in sync with regulatory and perhaps social expectations. The case studies that will be discussed shortly show that institutional shareholders take activist actions not only to ‘defend’ their investment interests but to extend the benefits of such ‘defence’ to shareholders collectively upon the platform of general good corporate governance. This following will discuss the shareholder revolt in ITV Plc in 2003, in Marks and Spencer Plc in 2008 and in Barclays Plc in 2008 to highlight the institutional shareholders’ emphasis on the Code as forming the basis for their activism. Institutional activism is characterised by reliance on voting and advice in evaluating resolution proposals, and in exercising the vote at general meetings.

ITV Plc 2003 ITV Plc is the merger of two companies Carlton and Granada in 2003. Carlton was a broadcasting company, owned largely by Michael Green, that first started making headway when it acquired a franchise in 1991 to broadcast to audiences in London on weekdays under an ITV licence. Carlton became more ambitious and acquired key companies, expanding the coverage of its broadcasting territory across the UK. Granada and Carlton competed to merge with United News and Media in 2000, and both companies ultimately acquired different parts of United’s business.

160

IMA, Annual Survey of Engagement (2008). M Becht, J Franks, C Mayer and S Rossi, ‘Returns to Shareholder Activism: Evidence from a Clinical Study of the Hermes UK Focus Fund’ (2008) 10 Review of Financial Studies 1093. 161

54 Institutional Shareholder Activism in the UK In late 2002, Carlton and Granada discussed a possible merger, which would see a single entity owning all of the franchise rights to broadcast under the ITV licence. The matter was referred to the European Competition Commission which gave the go ahead in 2003. The new entity was to be renamed ITV Plc. It was proposed that Michael Green of Carlton was to be Chairman of the new ITV Plc, a post which he refused to pigeonhole as ‘executive’ or ‘non-executive’. The Chief Executive of Granada Charles Allen was to be deputy Chairman. Before shareholders were due to vote on this issue, institutional shareholders of Carlton led by Fidelity Investments Ltd signalled that up to 35 per cent of shareholders were opposed to the appointment of Michael Green as Chairman. Institutional shareholders insisted that it would be according to best practice under the then Combined Code of Corporate Governance that the Chairman of ITV Plc be non-executive, and the move of Michael Green as former chief executive of Carlton to the position of Chairman of the Board of ITV Plc was not in line with best practice.162 Further, Michael Green had a reputation for being domineering and had a volatile temper, and shareholders were not convinced that he would bring balance to the Board. Institutional shareholders ultimately succeeded in ousting Michael Green, as Green decided not to put himself up for the vote. However, was this episode all about institutional shareholders enforcing good corporate governance in line with the public interest underlying their activist role, and did it have anything to do with financial performance? It was argued that shareholders were disgruntled with a major £1bn loss due to Michael Green’s mistaken judgement regarding the profitability of digital television in 2001, and hence the removal of Green could also be seen as a penalty for not delivering corporate performance.163 Even if the removal of Green may have been done in order to safeguard institutional investors’ investment in ITV Plc, the vocal support for adherence to the Code, and the visible threat to vote no to Green’s potential appointment showed that institutional shareholders stepped up to enforce the best practices under the Code.

Marks and Spencer Plc 2008 The Marks and Spencer institutional shareholder revolt however did not achieve the effect of securing compliance with the then Combined Code of Corporate Governance as the institutional shareholders were outvoted

162 163

‘Why Michael Green had to Go’, BBC News (21 Oct 2003). Ibid.

Institutional Shareholder Activism in the Public Interest 55 by the majority of small individual shareholders. The key issue at the 2008 general meeting was whether Sir Stuart Rose, Chief Executive of Marks and Spencer since 2004 should be moved up to be the Chairman of the Board. Marks and Spencer Plc explained that although this move was not in line with the recommendation of the Code, an exception could be made so that Marks and Spencer could achieve continuity during the transition when a successor would be looked for to replace Rose in due course. Legal and General, which owned 5 per cent of Marks and Spencer, and Schroders Investment Management which owned 2 per cent signalled that they would not support this as this was in contravention of the Code. The ABI also issued a red top warning to members holding Marks and Spencer equity that this was not in line with best practice. Marks and Spencer was reported not to have welcomed private and informal engagement with any particular shareholder, although it issued a letter to all shareholders equally to explain its position. Although institutional shareholders mounted pressure on Rose to step down, the resolution was still put forward at the general meeting on 10 July 2008. 22 per cent of shareholders, mainly institutional investors abstained or voted no at the appointment of Rose as Chairman, and hence, although Rose was still successfully elected as Chairman, the sizeable lack of support was very noteworthy.164 Rose’s success mainly rested with many small, individual shareholders, who despite being disappointed with Marks and Spencer’s products and sales, still believed in Rose as the right person to lead the company, having successfully fended off a hostile bid in 2004 from the Arcadia Group led by Philip Green and led the company’s share price to almost double Green’s bid in the years after. However, institutional shareholders were affected by a shock profit warning that brought down share price just a week before the general meeting. In spite of the fact that the institutional shareholder revolt at the Marks and Spencer meeting did not bring about an outcome that secured compliance with the Code, institutional shareholders had exercised their loud voices and their vote was in support of continued and unwavering adherence to the Code. One may argue, as was argued in the case of ITV above, that perhaps institutional shareholders wanted to remove Rose for the dismal performance of Marks and Spencer the preceding year, and hence, the vote could also have been motivated by defensive concerns other than to safeguard the more public and collective interest in securing compliance with the Code. It is arguable, from the pattern that has emerged in these two cases, as well as a number of other cases dealing with shareholder revolt on

164 ‘Marks and Spencer Shareholders Stage Large Protest at Election of Stuart Rose’, Thomson Financial (10 Jul 2008).

56 Institutional Shareholder Activism in the UK excessive executive remuneration, that institutional shareholders have responded to the policy call to ‘enforce’ the then Combined Code, and such ‘enforcement’ has been most pronounced in issues to be voted on at the general meeting. The Walker Review of 2009 now raises the question of whether institutional shareholders have been adhering excessively to the letter of the Code, and encourages a more intelligent and considered engagement of companies where it concerns adherence to the Code.165

Ensuring Sound Executive Remuneration Packages Institutional shareholders have also been vocal against excessive executive remuneration, an issue that remains thorny in the corporate governance landscape of the UK. This is especially evidenced in the persistence of institutional shareholders in raising the issue over and over again despite the stubborn resistance of companies and many instances of failure to pass a negative resolution. MyTravel.com is an online company providing holiday services. Between 2002 and 2007, although its financial performance had been dismal, it repeatedly paid enormous sums in golden handshakes to departing executives. The ABI issued a red top warning alert on MyTravel.com’s proposed remuneration packages. In 2003, after making 700 employees redundant and with the company close to financial collapse, three departing executives, Tim Byrne, former Chief Executive, David Jardine and Richard Garrick, were each paid £1.2m, £840,000 and £630,000 respectively in golden handshakes.166 By 2004, MyTravel.com’s shares plunged 37 per cent, and its Chairman left the Board with a payoff of £240,000.167 In 2006, after posting a pre-tax loss of £18.3m, shareholders due to vote on Chief Executive Peter McHugh’s £3.5m remuneration package were understandably ruffled,168 and the ABI issued a red top alert over this. Although 57 per cent of shareholders voted against the remuneration package and 43 per cent passed it, as the nature of the shareholders’ vote on remuneration was only advisory under the Directors Remuneration Report Regulations 2000, the vote was not binding on the company and McHugh still received his bumper package. MyTravel.com was ultimately acquired, forming part of the Thomas Cook companies. Successful shareholder revolt was also carried out in GlaxoSmithKline

165

Para 2.23ff, Walker Review Consultation Paper, Jul 2009. ‘MyTravel Trio Walk Out with Large Pay-Offs as Group Limps on’, The Independent (21 Mar 2003). 167 ‘MyTravel Shares Slump but Boardroom Pay Doubles’, The Independent (24 Mar 2004). 168 ‘ABI Serves MyTravel with “Red Top” Alert’, The Independent (26 Feb 2006). 166

Institutional Shareholder Activism in the Public Interest 57 in 2003,169 where over 50 per cent of institutional shareholders including Standard Life, and members of the NAPF such as Schroders voted down a golden parachute for Chief Executive Jean Pierre Garnier after the company posted weak results. However, as the vote was not binding on the company, Garnier’s salary remained unchanged, except that the award of shares and options became deferred. In other cases, institutional shareholder revolt on pay was loud and clear although a majority advisory vote in the negative was not obtained. Institutional shareholders such as ABI members owning 6 per cent of Cable and Wireless revolted on a departing executive’s £5m payout in 2003 after a weak performance the preceding year. However, only a third of votes cast did not support the remuneration package,170 and shareholders did not manage to register a majority vote of discontent even if such an advisory vote was not binding. Similarly, JS Sainsbury Plc also saw a shareholder revolt on its proposed remuneration package to award most of the shares in executive stock options held by departing Chairman Sir Peter Davis in 2004. Institutional shareholders were unhappy about the soft evaluation of Sir Peter’s performance by the remuneration committee after the group posted weak results. PIRC and ABI both issued alerts to institutional shareholders to scrutinise the award carefully. The award was ultimately supported by the majority largely consisting of Sainsbury family members, and by the abstention of a trustee who held 23 per cent. Although the award passed in the face of institutional shareholder criticism, JS Sainsbury Plc seemed to have taken this unhappy episode on board and brought in a new team by 2006. By 2008, it has posted remarkable profits.171 Institutional shareholders and the corporate governance industry have been relentless in flagging up excessive remuneration as an important agency problem. By 2007, the concerted efforts of major institutional shareholders’ groups such as the NAPF and ABI are unequivocal about their efforts to curb fat cat pay.172 As the financial crisis continues through 2008 to 2009, executive pay has come under the spotlight for greater scrutiny than ever. A number of banks in the UK and in jurisdictions such as the US and elsewhere in Europe have received government bailouts to stave off solvency and liquidity crises. Hence public outcry has followed where executives have been rewarded amidst job losses inflicted upon others.173 The Royal Bank of Scotland’s pension agreement with departed

169

‘Glaxo Defeated by Shareholders’, BBC News (19 May 2003). ‘Cable & Wireless Shareholders Revolt on Pay’, The Independent (26 Jul 2003). 171 Discussed in greater detail in Martin, Casson and Nisar, Investor Engagement (2008) n 129 at 78–81. 172 ‘Curbs for Fat Cat Pay-Offs’, Mail on Sunday (11 Nov 2007). 173 ‘Fear of Falling’, Financial Times (5 Jan 2009); and see below on public outcry against the Goodwin pension. 170

58 Institutional Shareholder Activism in the UK Chief Executive Sir Fred Goodwin, for example, has come under severe criticism by even the public.174 Other companies are also being scrutinised to see if directors are taking bloated pay packages in spite of an economic downturn.175 In May 2009, shareholders have been advised by leading governance advisory services provider RickMetrics as well as the ABI to vote against a number of remuneration packages176 so as not to reward for failure. Such investor revolts have taken place at Xstrata, BP and Shell, to name a few.177 By early 2010, shareholder revolt at HSBC Plc also threatens to derail a generous compensation package proposed for the Chief Executive Officer.178 The Walker Review of 2009 has now recommended that where pay revolts are significant enough to involve at least 75 per cent of the shareholders, the Chairman should put himself up for re-election the following year.179 This has however to date not been taken up in the revised UK Corporate Governance Code of 2010. Shareholder activism in the area of remuneration packages has been heavily supported by the work of the corporate governance industry. PIRC in particular devotes a significant amount of research effort to watching pay trends, and is delivering more intensive scrutiny and advice to investors especially in the economic downturn since late 2008.180 However, this is one area where although institutions have been active and vocal, they have not always been able to overturn bloated remuneration awards. The area of remuneration has now moved onto the regulatory radar screens of jurisdictions such as France, and the UK Financial Services Authority would have quasi-regulatory oversight of remuneration packages in financial institutions.181 The next discussion deals with Barclays’ shareholders’ revolt in 2008, involving the disapplication of pre-emption rights in raising capital to meet capital adequacy requirements after the onset of the financial crisis. Defensive Shareholder Activism at Work in Barclays Plc The third quarter of 2008 is a significant time in financial history as many financial institutions have had to write off billions from assets held by them. 174 ‘£650,000 Pension for Former RBS Chief Sir Fred Goodwin’, The Times Online (26 Feb 2009). 175 ‘Activist Shareholders Get Tough over Directors’ Pay’, The Guardian (12 Jan 2009) reporting shareholder revolt in Bellway and Debenhams. 176 ‘Investors Turn Militant over Director Pay’, Financial Times (5 May 2009). 177 ‘Shell at Risk of Investor Pay Revolt’, Financial Times (5 May 2009). 178 ‘HSBC Retreats on Chief’s Pay Award’, Financial Times (23 Feb 2010). 179 Recommendation 36, Walker Review Final Report. 180 . 181 Code of Practice in Remuneration (Aug 2009) at .

Institutional Shareholder Activism in the Public Interest 59 Such assets are based on collaterised debt obligations and they have largely been held by investment and retail banks. The severe devaluation of these assets followed defaults on subprime mortgages in the US which made up substantial chunks of these assets. Consequently, banks have fallen short of regulatory requirements in capital adequacy. All major UK high street banks have had to engage in capital raising, including HSBC Holdings Plc, Barclays Plc, Lloyds TSB Plc, Royal Bank of Scotland Plc and Halifax Bank of Scotland which has now been merged with Lloyds to prevent collapse. In order to ensure the continued viability and stability of major banks, the Treasury has offered a £37bn package to inject capital into struggling banks in return for preference shares paying an annual dividend of 12 per cent. This offer has been accepted by Lloyds and Royal Bank of Scotland. The Treasury’s investment offshoot, the UK Financial Investments has provided £17bn into the merged Lloyds-HBOS entity, resulting in government ownership of 40 per cent of the merged banking giant; and £20bn into the Royal Bank of Scotland, resulting in government ownership of 60 per cent of the bank.182 By late February, RBS has received a further £25bn injection and the government’s stake had risen to almost 90 per cent with voting capped at 75 per cent. HSBC and Barclays however have rejected the government’s offer to inject capital. HSBC has found £750m from its own resources in overseas holdings, and a rights issue of £12bn in early April 2009, while Barclays has made a rights issue to raise capital earlier in the beginning of the financial crisis. On 31 October 2008, Barclays announced to investors how this would be done. Barclays would issue £2.8bn of mandatorily convertible notes (MCNs), which would be converted into ordinary shares by 30 June 2009. The notes would carry a 9.75 per cent annual dividend. Qatar Holding, an investment company representing the interest of Sheikh Mansour Bin Zayed Al Nahyan, a member of the Abu Dhabi Royal Family in Qatar, agreed to subscribe for £500m of MCNs. Challenger, the sovereign wealth funds of the state of Qatar agreed to subscribe for £300m of MCNs. Sheikh Mansour Bin Zayed Al Nahyan further agreed to subscribe for £2bn of MCNs. Next, Barclays also issued £3bn worth of Reserve Capital Instruments, which were preference shares carrying an annual dividend of 14 per cent. These preference shares could be redeemable from June 2019 by Barclays. The Reserve Capital Instruments were equally subscribed by Qatar Holding and HH Sheikh Mansour Bin Zayed Al Nahyan in £1.5bn each.183

182

‘UK Banks Receive £37bn Bailout’, BBC News (13 Oct 2008). See Barclays’ announcement to investors, at (accessed Dec 2008). 184 See ‘PIRC Shareholder Group Urges Vote Against Barclays Deal’ (2008) Financial News—Dow Jones Newswires at . 185 See Barclays’ announcement to investors at < http://group.barclays.com/cs/Satellite? blobcol=urldata&blobheader=application%2Fpdf&blobheadername1=Content-Disposition& blobheadername2=MDT-Type&blobheadervalue1=inline%3B+filename%3D18-Nov--Barclays-announces-update-to-Capital-Raising.pdf&blobheadervalue2=abinary%3B+charset% 3DUTF-8&blobkey=id&blobtable=MungoBlobs&blobwhere=1231864045160&ssbinary=true > (accessed Dec 2008).

Institutional Shareholder Activism in the Public Interest 61 be responsible for a wider failure in the UK banking system. In that sense support for the resolution does not mean approval of the way the company has handled the issue’.186 The Barclays capital raising episode shows that institutional investors are motivated to exercise voice and to make known their discontent primarily with respect to governance issues and where shareholders have not been treated fairly. These efforts are however heavily supported by the corporate governance industry. However, public interest concerns with regard to the stability of UK banks were also at stake and these were ultimately perceived to be overriding. The Barclays episode shows quite clearly institutional shareholders’ sensitivity to public interest issues surrounding their activism, and perhaps this is a manifestation of the nature of institutional shareholder activism which is not merely a market-based discipline for private investment interests, but a form of market-based governance. Up until the financial crisis of 2008, it is arguable that significant institutional shareholder activism has been carried out largely around the issues at the general meeting and based on the Combined Code of Corporate Governance. Besides the fact that data on informal engagement is opaque and generally not publicly accessible, it may also be true that informal engagement is infrequent, as the NAPF and IMA annual surveys documents at least 90 per cent of their members meeting the Board or Senior Independent Director only once or twice in a year. The Marks and Spencer episode in 2008 has been reported to involve very little informal engagement before the vote, and it also does not seem that the Barclays episode has been preceded by informal meetings. It is suggested that the approach taken by institutional shareholders to focus activism on meetings is because such an approach is supported by the work of the corporate governance industry, and is a least challenging approach. Further, activism at meetings is highly visible and is able to be perceived as answering policy-makers’ call. The global financial crisis has however challenged the efficacy of this approach, as being superficial, box-ticking in nature and lacking in intelligent monitoring, which is the essence of the agency problem. The Walker Review of 2009 now clearly exhorts institutional shareholder activism to become an enhanced form of market-based governance, in intelligently engaging with investee companies and carrying out much more private engagement. The IMA has started to document a rise in informal engagement as a response to the global financial crisis, and it remains to be seen how the nature of institutional shareholder activism may evolve from here.

186 ‘Barclays Fundraising Gets Investor Support but not Approval’, The Guardian (25 Nov 2008).

62 Institutional Shareholder Activism in the UK Chapter 4 will further discuss some of the theoretical and legal implications going forward.

The Influence of the Corporate Governance Industry The corporate governance industry helps not only to overcome the institutional inertia in voting at general meetings, their work also helps to overcome the collective action dilemma that institutional shareholders may otherwise face. Most of the institutional shareholders in the UK rely on the market leaders PIRC187 and RiskMetrics,188 which provide voting advice and arrange for proxy votes to be cast by institutional shareholders. RiskMetrics also provides evaluation of companies’ governance according to its own metrics and provides a governance rating service (the Corporate Governance Quotient).189 In the UK, the Code not only provides a ready-made agenda for institutional shareholders’ engagement, it is also largely the basis for advisory and voting services’ recommendations for voting at general meetings. Hence, the corporate governance industry supports the ‘enforcement’ of the Code by institutional shareholders. It is arguable that institutional shareholders are willing to engage in such activism as it is less challenging for institutional shareholders to add on to their predominant focus on investment management. In 2004, researchers still find many institutional investors primarily concerned with short term value and sceptical of relational investing as such.190 Further, the Unilever Superannuation Fund famously sued Mercury Asset Management in 1999 when the outsourced fund underperformed by the benchmark index by 10.5 per cent.191 The book is sceptical that institutional shareholder activism in the UK is only based on perceptions of investment value, and it is of the view that institutional shareholders’ reliance on the corporate governance industry, the dogged focus on the Code and the nature of activism centring around general meetings are all features that seem to point towards a pattern of institutional shareholder activism that attempts to balance activism as a response to policy call and as delivering improvement in investment

187

See PIRC Services . See RiskMetrics . 189 , see critique in LD Brown and ML Caylor, ‘Corporate Governance and Firm Performance’ (2004) (unpublished manuscript), available at . 190 J Hendry, P Sanderson, R Barker and J Roberts, ‘Responsible Ownership, Shareholder Value and New Shareholder Activism’ ESRC Centre for Business Research Working Paper 297, University of Cambridge (Dec 2004). 191 The case was eventually settled and hence a judicial opportunity to articulate on the standards of care of investment managers was missed. 188

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value. Institutions’ reliance on the corporate governance industry may however not entail a form of intelligent and individualised monitoring appropriate for each investee company. Rose warns that the corporate governance industry may be too zealous in adopting one-size-fits-all metrics and ratings, and wonders if their recommendations are made on a truly discerning basis.192 On the other hand, an optimal approach should not be to allow companies to merely explain away all non-compliance with the Code.193 Whether or not institutions are intelligently engaging with their investee companies may be manifest in their attitude to explanations for deviation from the Code. Faure-Grimaud et al have found that in the UK, non-compliant firms are seriously lacking in terms of their explanations for deviation if explanations are given at all, and the quality of explanations do not seem to bother institutional investors much.194 This may show that institutions are unwilling to take on more challenging forms of activism beyond compliance with the letter of the Code. In the 1990s, it was even difficult to convince institutions to vote and the rise of the corporate governance industry has been key to mitigate that inertia. Perhaps institutions have now been willing to engage in a form of visible activism in voting largely because that is the least costly and challenging mode of action, the analysis having been done by the corporate governance industry and the required action of returning a vote (as recommended by proxy voting agencies) is sufficiently simple. Hence, to require institutional shareholder activism in the future to be based on intelligent monitoring and ‘stewardship’ would be a rather challenging step forward. 4. THE FUTURE OF INSTITUTIONAL SHAREHOLDER ACTIVISM AS A FORM OF MARKET-BASED GOVERNANCE

Institutional shareholder activism has been criticised as an insufficiently effective form of market-based governance in the wake of the UK banking crisis. In the UK banking crisis, two large UK banks, Halifax Bank of Scotland (HBOS) and the Royal Bank of Scotland (RBS) have received significant government aid in order to stave off insolvency. In terms of the corporate governance arrangements in these banks, both banks have complied with the requirements of the then Combined Code of Corporate Governance. Both banks have independent non-executive directors in the Nomination, Audit and Remuneration Committees of the Board, the

192 193 194

P Rose, ‘The Corporate Governance Industry’ (2007) Journal of Corporation Law 101. I MacNeil and X Li, ‘Comply or Explain’’ (2006) n 7. Faure-Grimaud et al, ‘Corporate Governance in the UK’ (2005), n 8 above.

64 Institutional Shareholder Activism in the UK separation of the Chairman from the Chief Executive, and have largely enjoyed shareholder support. When the financial crisis hit HBOS, it surfaced that HBOS had pursued an aggressive lending policy that had made it excessively reliant on interbank lending. Hence, it seems that the lack of rigorous risk management may have been critical to HBOS’ downfall. For RBS, the excessive premium RBS paid for the ambitious acquisition of ABN-AMRO, a Dutch commercial bank whose books contained many toxic collaterised debt assets, has been blamed for its current problems. Both banks, as in the case of many other banks, have many toxic collaterised debt assets on their books whose values, although uncertain, have been written down to reflect the poor quality of their inherent value. Could the flawed business decisions of these banks have been mitigated by more robust corporate governance? Although weak corporate governance has not caused the above named UK banks to fail, it could have exacerbated the making and perpetuating of poor business and risk decisions.195 A number of commentators have criticised the application of the corporate governance principles in the UK as not being rigorous enough. Independent non-executive directors tend to be drawn from the limited pool of a ‘self-perpetuating oligarchy, with the same social, educational, business and economic backgrounds as the executives’.196 It has therefore been questioned if these directors are likely to be sufficiently critical in order to unearth business and management problems. Further, it has also surfaced that members of the Boards of banks may not have sufficient banking knowledge or experience to contribute to an adequate understanding of such a complex business and this may have been important in the lack of strategic direction in risk management.197 More specifically, banks with apparently independent remuneration committees have not refrained from excessively generous remuneration packages awarded to directors and executives, which have been fuelling short term risk taking in the banks, a contributing factor to the banking crisis. Hence, the apparent compliance with requirements of the Code could not guarantee that independent non-executive directors would be either competent or vigilant enough to successfully challenge poor Board decisions, or prevent

195 M Brunnermeier, A Crockett, C Goodhart, AD Persaud and H Shin, ‘The Fundamental Principles of Financial Regulation’ Geneva Reports on the World Economy (2009). 196 S Kiarie, ‘Non-executive Directors in UK Listed Companies: Are they Effective?’ (2007) 18 International Company and Commercial Law Review 17. 197 This seems to be consistent with empirical evidence that suggests that non-executive directors on UK listed companies are not sufficiently involved or critical to be effective, see T Long, V Dulewiscz and K Gay, ‘The Role of the Non-executive Director: Findings of an Empirical Investigation into the Differences between Listed and Unlisted UK Boards’ (2005) 13 Corporate Governance 667.

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business errors from being made, and to ensure that the agency problem involving remuneration has been mitigated. The financial crisis has thus exposed one of the key weaknesses of the type of market-based governance institutional shareholders have been practising: the lack of individual and considered monitoring which is the old problem in agency. However, it is also queried as to what extent intensive scrutiny could have been possible, or would really have made a difference, as shareholders could never be in the same position as Boards in evaluating the business models of companies. An argument that supports increasing the intensity of shareholder monitoring would lie in the faith in institutional shareholders being competent and proximate enough to monitor their investee companies intelligently. As CalPERS in the US and Hermes in the UK (as will be discussed in chapter 3) have led by example, it is possible for institutional shareholders to adopt individualised and considered activism in their investment approach. Policy-makers still arguably see this form of market-based governance as ideal as there are limits to what is regulable in corporate governance.

Back to the Agency Problem This Part will argue that insight into recent research on Boards show that Board sub-optimalities are pervasive not necessarily because of deliberate ‘shirking’ from maximising shareholder interests, but as a matter of the difficulties in achieving an optimal behavioural balance. Hence, it may be difficult to set regulatory standards in a one-size-fits-all manner to prescribe how Boards should act in order to prevent shareholder and social losses. Perhaps shareholders could have a role in monitoring the ‘agency problem’ in terms of understanding and forming an objective perspective of the behavioural balance of the Board rather than in specific business issues. Recent research into how Boards work through the lens of behavioural theories shed light on the imperfection and sub-optimalities of Boards in general. These sub-optimalities may arguably be pervasive and not deliberately calculated. This perspective allows us to see the ‘agency’ problem as a wider paradigm, not merely as deviation from shareholders’ interests in a calculated way, but as a natural consequence of the team dynamics of the Board as a collective group. Huse198 provides a detailed study into the working of the Board, the emphasis being on how Boards actually work. Huse looks into the two

198 M Huse, Boards, Governance and Value Creation: The Human Side of Corporate Governance (Cambridge, Cambridge University Press, 2007).

66 Institutional Shareholder Activism in the UK sets of conditions that affect how Boards work, one, internal factors, such as the bounded rationality and behavioural tendencies of human beings faced with the tasks of the Board, the issues of power, influence and trust that affect intra Board dynamics, the issues of leadership and personality that may impact on decision-making, and the actual demands of tasks such as strategy, controls and networking which may involve the exercise of personal cognitive capacities such as in advice, information, evaluation and judgment. The external factors Huse identifies are the paradigms of corporate governance such as the agency issue that dominates corporate governance discussions, the range of stakeholders, the regulatory framework for companies and industry-specific regulation, the supply and demand for directors, ownership structures, the firm’s size, point in its life cycle, position in the industry and firm resources. Together these two sets of factors interact to influence the working of a Board, and Huse identifies that Boards can generally be classified into one of four types. First, the Aunt Board, which trusts and is dominated by senior executive officers, is largely passive but law-abiding and only rises to the occasion to provide strategy if the company is under challenge. Second, the Barbarian Board which complies with contemporary corporate governance codes and has a good representation of independent directors. Such a Board may over-emphasise its monitoring role and be unduly critical of executive officers, without necessarily being constructive. Third, there are Clan Boards who see their primary role as a networking club keen to maintain good relations within the Board, whether between independents or executives. Such a Board nevertheless may provide mentoring and expertise to senior executive officers, but is largely insular and indisposed to making suggestions that may challenge and disturb the dynamics of the Board. Finally, Huse envisages a value-creating Board that is able to provide both monitoring and constructive value to the strategy and operations of the company. However, value-creation is a difficult outcome as it requires Boards to be able to balance the following contradictory forces: trust and critical challenge, monitoring and involvement, collaboration and independence. A value-creating Board would be able to balance these paradoxes to achieve an overall beneficial effect. Huse’s study seems to suggest that most Boards are not operating in an optimal manner as it is difficult to achieve a balance of internal and external factors to facilitate a value-creating Board. Empirical research carried out by London Business School and the McKinsey Institute199 also suggest that Boards in PLCs focus too much on box-ticking governance

199 VV Acharya, C Kehoe and M Reyner, ‘Private Equity vs Plc Boards: A Comparison of Practices and Effectiveness’ (London Business School Aug 2008) at http://papers.ssrn. com/sol3/papers.cfm?abstract_id=1324019.

The Future of Institutional Shareholder Activism

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and compliance matters, and do very little in terms of leading the strategic direction of the company, hence, not delivering optimal value creation for the company. The delicate balance of internal and external factors affecting Board behavioural dynamics would mean that most of the time, Boards could likely be ‘behaviourally’ sub-optimal. Viewed in this light, agency is not merely a problem of calculated managerial deviation from shareholders’ interests or a breach of fiduciary duties or negligence in law. ‘Agency’ is arguably a paradigm that refers to all the sub-optimalities that may entail from how the Board works and the consequential effects on business and governance decisions. ‘Agency’ could arguably be a wide and unpredictable range of issues working in different ways in different corporations, and possibly entailing different forms of externalities and social consequences as well. Shareholder monitoring in such a context requires dedicated monitoring, meeting with Board members and understanding the hints of Board dynamics and forming a bird’s eye view of what is needed to achieve efficacy in both business and governance. This is a form of tailor-made monitoring akin to continuous Board evaluation that requires both dedication of resources and access to information. Institutions as Stewards in Market-based Governance? Institutional shareholders have been accused of being ‘asleep’ in the wake of the banking crisis in the UK.200 Reforms proposed in the UK Treasury White Paper, the Walker Review and Lord Myners’ remarks all hope for and expect an increase in the intensity and quality of institutional shareholder activism in the UK. Following the Walker Review, the revised Code now requires greater efficacy in the leadership of the Chairman of the Board,201 and a separate Code of Stewardship for shareholder engagement which would be instituted on a comply-or-explain basis. The Walker Review has defined the future of institutional shareholder activism as an exercise in stewardship. This articulation challenges the fundamental conception of investment management as a private activity. Would investment management become a quasi-public activity? The arguments that support this approach may be the social legitimacy of limited liability as mentioned above, and that institutional shareholders are trustees for beneficiaries who are the social community anyway.202

200 ‘FSA Chief Lambasts Uncritical Investors’, Financial Times (11 Mar 2009) and ‘Myners Lashes out at Landlord Shareholders’, Financial Times (21 Apr 2009). Also ‘Institutional Shareholders Admit Oversight Failure on Banks’, The Daily Telegraph (27 Jan 2009). 201 A.1.1, A.3, UK Corporate Governance Code (Jun 2010). 202 See Hansmann and Kraakman, ‘The End of History for Corporate Law’ (2001) n 121 above, 439–68.

68 Institutional Shareholder Activism in the UK However, there could be a conflict between the interest to maximise returns for those particular beneficiaries who are saving through the institutions and the wider social community which would include other stakeholders such as employees, suppliers and customers. Further, if institutional shareholder activism is to be a form of continuous Board evaluation, what extent of resources needs to be devoted and what extent of expertise needs to be developed on the part of institutions and their investment managers? How will the cost of engagement be paid for and would beneficiaries of funds benefit from improvements in investment value? It may be argued that relying on institutional shareholder activism in the regulatory space may mean delegating a form of public interest governance to them, and framing institutional shareholders as ‘enlightened’ does not answer the question as to how they would be able to discharge the burden of governance. Hence, if we recognise that institutional shareholder activism is not merely asked to deliver defensive protection for themselves but a form of governance that benefits the public good, then to what extent could institutional resources be put to use to engage with companies beyond what the Financial Times terms as ‘the basket case?’203 How is the ‘duty’ of institutions framed? Is it a duty to engage and improve investee companies for the benefit of all concerned, or a duty to engage and improve investee companies according to the individual manager’s investment objectives? Institutions are now called upon to move away from standardised ‘monitoring’ based on the Code and general meetings into more individualised forms of monitoring for investee companies.204 It is arguable that unless institutions adopt a hands-on approach such as CalPERS and Hermes (as will be discussed in chapter 3) have taken, institutions are likely to pass the responsibility along to investment managers, who may require the corporate governance industry and perhaps Board evaluation service providers to offer solutions to meet this need. An immediate consequence would be the cost in fund management which would ultimately be borne by beneficiaries. It is imperative that empirical research be undertaken to chart the evolution of institutional shareholder activism in the ‘stewardship’ era, to compare the cost entailing from the discharge of ‘stewardship’ and more individualised and intelligent monitoring, and the benefits not only to investment value but also to the long term performance of companies, benefits to stakeholders and the community in general. One of the implications of the Walker Review is to create layers of accountability that ultimately channel into a form of public accountability 203 ‘Shareholder Rights’, Financial Times (29 Nov 2009) arguing that shareholders should be allowed to exit a ‘basket case’ and ‘stewardship’ may be unduly prescriptive for shareholders as investors. 204 ‘Myners Hits Out at Governance Specialists’, Financial Times (5 Dec 2007).

Some Concluding Remarks 69 ie the accountability of investee companies to institutional shareholders and the accountability of institutions as ‘stewards’, presumably to their beneficiaries. It is arguable that this may be no different from the desire to make companies directly accountable for aspects of public interest. There could be two alternative ways, not mutually exclusive, in pursuing this. One is to determine what aspects of corporate governance may be regulable and to impose standards by law, such as the move towards regulating bankers’ remuneration. For example, countries such as France have passed legislation to curb bankers’ bonuses where the bank has received government funds, and the UK Financial Services Authority has introduced a Code of Best Practice in Remuneration that regards remuneration as essential to the regulation of risk management. Earlier discussion has also pointed out that institutional ‘enforcement’ against bloated remuneration awards has not been practically effective.205 The other may be to overtly accept a more communitarian model of the corporation, moving away from a shareholder centred model, so that stakeholders may be able to exert monitoring or enforcement against corporations.206 Policy-makers do not accept shareholder primacy in its pure form anyway in championing the ‘Enlightened Shareholder’. It could be argued that viewed from the perspective of what policy-makers are trying to achieve in the public interest in corporate governance, it may not be appropriate to rely excessively on the market-based governance of institutional shareholders whose investment interests are not always aligned with the interests of public good. 5. SOME CONCLUDING REMARKS

This chapter has discussed the nature and developments in institutional shareholder activism in the UK in the last 15–20 years. Although there exists investment-centric concerns that could motivate institutional shareholders in the UK to engage in activism, the major factor leading developments in institutional shareholder activism in the UK is policy leadership. This is linked to the wider question of whether corporate governance is perceived to be able to deliver public goods such as the prevention of social losses from corporate failure, and the role of institutions in the ‘regulatory space’. The global financial crisis has further 205

As discussed in Part 3 above. It may be argued that corporations are already affected by other stakeholders’ influence in areas of corporate social responsibility, see N Finch, ‘Sustainability Reporting Frameworks’ (2005) at . However, many stakeholders may still not have a position in the legal framework for corporate decision-making or regulatory accountability, as compared to employee representation on supervisory boards, or where creditor or related company influence may be significant, as in Germany and Japan. 206

70 Institutional Shareholder Activism in the UK convinced policy-makers of the social importance of corporate governance and not just the private importance of corporate governance to investors. For example, the UK Financial Services Authority has published A Code of Remuneration Practices for banks and financial institutions,207 moving into regulatory soft law to govern this aspect of financial institutions’ internal governance. Although the principle of ‘stewardship’ intends to enrol institutions more intensively into the regulatory space, it is queried to what extent this may push institutions’ erstwhile investment management philosophy into disequilibrium, and the consequences this may entail for the beneficiaries of those institutions. Further, the intensive enrolment of institutions in the regulatory space may ignore the potential power of the wider community and stakeholders whose empowerment can bring balance against excessive reliance on institutions. This would however require a major change in the theoretical and legal perspectives of the shareholder-centred corporation. The next chapter will discuss offensive forms of shareholder activism as practised by alternative investment groups such as hedge funds.

207

Mar 2009, at .

3 Shareholder Activism Unveiled: Offensive Shareholder Activism in the UK 1. INTRODUCTION TO OFFENSIVE SHAREHOLDER ACTIVISM

D

EFENSIVE AND OFFENSIVE motivations driving shareholder activism are not mutually exclusive phenomena. It did not take long for CalPERS to realise, after having started defensive forms of activist campaigns in 1986, that by the end of 1987, shareholder activism could also be the means to generate abnormal returns on share price. This potential was overtly referred to in both the Myners Report and Higgs Report in the UK.1 Offensive shareholder activism is characterised by the motivation of profit-seeking, and more often than not, is followed by prompt exit from the company when the returns have been generated, or if the campaign has not resulted in the expected returns. If the expected returns have not been generated, the exit is made to reduce any investment loss. Offensive activists may be existing shareholders, or may be entities that deliberately take stakes in a company and become shareholders in order to exploit an opportunity for share price gains.2 Offensive activism is carried out largely by shareholders in a different camp from institutional shareholders, and the methodology of engagement is also different in that much more reliance is placed on informal and regular engagement outside of the general meetings, such informal engagement sometimes becoming a publicised form of aggression. However, it is arguable whether such informal engagement may be properly characterised as ‘relational’. Although the engagement may be rather intensive, exit is often the ultimate objective for the offensive activist.

1 Para 5.74, Myners Report see P Myners, Institutional Investment in the UK: A Review (2001); para 15.22, Higgs Report, see D Higgs, Review on the Role and Effectiveness of Nonexecutive Directors (Jan 2003). 2 J Armour and B Cheffins, ‘Offensive Shareholder Activism’, paper delivered at the Department of Management, King’s College London, 7 Oct 2009.

72 Shareholder Activism Unveiled Strictly speaking in relational investing, exit may not be a top priority and engagement for long term value is often the norm. The offensive, even ‘predatory’3 form of profit-seeking activism is primarily an investment strategy, arguably for the short term, and it has gradually become more overt in the UK from 2000. The main examples in offensive activism are as follows: (a) The rise of hedge funds have brought in their practices of offensive shareholder activism to generate abnormal returns; (b) The activities in the private equity sector that have generated enormous abnormal returns on their investments provide an example for how informal and hands-on activism may pay off. Private equity activities have come under media spotlight after certain large public companies in the UK have been delisted and taken private by some groups in order to generate profitability; (c) Targetting under-performing companies, which is the investment mantra of the Hermes Focus Funds, part of Hermes, the investment manager that manages one of the largest UK pension funds. Hermes Focus Funds adopt a form of offensive shareholder activism with the purpose of engaging perceived underperforming companies to generate abnormal returns on share price.

2. HEDGE FUND ACTIVISM

Rise of Hedge Funds, Absolute Returns and Aggressive Activism Hedge funds have been in existence since the 1940s4 and although hedge funds have seen increases in the investment managed by them steadily through the 1990s, boutique hedge funds had risen in meteoric proportions by the end of 2001.5 The eyes of the world started to turn on hedge funds only in the millennium. By 2004, the UK Financial Services Authority (FSA) felt the need to take stock of hedge funds operating in the UK, as fund managers in the UK, although regulated by the FSA, are regulated lightly in view of their dedicated service to sophisticated

3 Memorandum from Martin Lipton, Partner, Wachtell, Lipton, Rosen and Katz, to Clients, Be Prepared for Attacks by Hedge Funds (21 Dec 2005), available at . 4 Started in the US by Alfred Winslow Jones, see Hedge Funds Standards Board, What is a Hedge Fund? At . 5 The amount of investment managed by hedge funds jumped by 100% from over a US$100bn to over US$200bn, see The Conference Board, Hedge Fund Activism: Findings and Recommendations for Corporations and Investors (2008), at 12 .

Hedge Fund Activism 73 investors.6 Further, most funds managed by UK fund managers are based off-shore for tax advantages. The estimate provided by the FSA is that there are approximately 8000 hedge funds worldwide,7 and a few hundred of them operating from the UK, representing three-quarters of all European hedge fund operations. Two-thirds of the world’s hedge funds operate from the US.8 Hedge funds operate on an agenda of absolute returns, which means that they seek to generate returns on their investment whatever the conditions of the market. They maximise upsides and minimise downsides using a variety of strategies, including hedging, leveraging and short selling, and are not benchmarked passively to an index.9 Light regulation for hedge fund managers in the UK has allowed hedge fund managers to use nonconventional strategies in managing the funds. One such non-conventional strategy that is the focus of this book, is the carrying out of shareholder activism in order to make absolute gains on equity holdings. Although it is estimated that only about 5 per cent of hedge funds’ resources (about US$50bn is available for shareholder activism) the activism is nevertheless significantly felt by target companies and has changed the activism landscape.10 It may be arguable that activism started against UK companies by hedge funds from the US such as Polygon, which targeted British Energy in 2004, then Sainsburys in 2007, and inspired other hedge funds, whether US-based or operated from the UK, to take similar strategies. Characteristics of Hedge Fund Activism This chapter will detail some examples of shareholder activism carried out by hedge funds in the UK, and present an analysis of the nature of such activism and the differences between such activism and institutional shareholder activism. Certain characteristics may now be briefly described. One is that hedge funds target companies and engage in shareholder activism with a list of precise demands, to generate value in a certain timeframe. According to empirical research, the hedge fund

6 This remains the case under the European Markets in Financial Instruments Directive, 2004/39/EC, OJ L145, 30 April 2004, where sophisticated investors are given less mandatory protection under its conduct of business regime. 7 FSA, Hedge Funds: A Discussion of Risk and Regulatory Engagement (2004) (hereinafter known as the FSA Paper). 8 Conference Board, Hedge Fund Activism, n 5 above. 9 Alternative Investment Market Association (AIMA), Roadmap to Hedge Funds (2008) at 101, FS L’Habitant, Handbook on Hedge Funds (Chichester, John Wiley and Sons, 2006) generally. 10 According to research by JP Morgan, as reported in the OECD Steering Group, The Implications of Alternative Investment Vehicles for Corporate Governance: A Synthesis of Research about Private Equity Firms and Activist Hedge Funds (2007) at para 3.1, p22.

74 Shareholder Activism Unveiled investment horizon is relatively near-term.11 The relatively near-term horizon also feeds into hedge funds’ aggression and impatience in extracting the value of their investments, and hence a similar style in their activism.12 Of course it is acknowledged that many pension funds are also investing in hedge funds,13 which seems to indicate endorsement of the style of hedge fund activism. However, there are differences in terms of the drivers for and motivations of hedge fund activism and institutional shareholder activism, which is seen as a form of market-based governance. Empirical research report that hedge funds carry out shareholder activism in order to generate abnormal returns, and hence, it is arguable that they see activism as purely an investment strategy,14 rather than as a corporate governance concern, as perceived by institutional shareholders. It is also reported that hedge funds often target well-performing companies,15 with certain characteristics that may allow them to boost their investment returns. It is quite clear that hedge funds see shareholder activism primarily as an investment strategy focussing on the returns for the fund, and this is arguably different from institutional shareholder activism in the regulatory space which is related to monitoring the agency problem, and safeguarding beneficiaries’ investment while providing a collective public good.16 Chapter 4 will further discuss a theoretical framework for examining the activism led by institutions and the activism led by hedge funds, and will argue that offensive shareholder activism may not be well supported in theory and law, and may also entail adverse consequences for the company and other investors and stakeholders.

11 W Bratton, ‘Hedge Funds and Governance Targets’ (2007) available at which at p10 argues that hedge funds generally hold their equity positions for about 2 years, whereas A Brav, W Jiang, RS Thomas and F Partnoy, ‘Hedge Fund Activism, Corporate Governance and Firm Performance’ (2007) at report that the median term of hedge fund holding is one year. 12 As argued by Bratton, ibid. 13 In 2004, it was reported that about 12% of pension funds were allocating about 5% of their portfolios to hedge funds, see para 2.10, FSA Paper (2004), n 7 above. 14 M Kahan and EB Rock, ‘Hedge Funds in Corporate Governance and Corporate Control’ (2007) 155 University of Pennsylvania Law Review 5. 15 The Conference Board, Hedge Fund Activism, n 5 above, argues that hedge funds typically choose well-performing companies with large amounts of cash, little debt and R&D expenditure so as to campaign for share buybacks or extraordinary dividends to boost their returns, see pp 25–27. Bratton’s paper ‘Hedge Funds and Governance Targets’, n 11 above also shows the hedge funds target well-performing companies at least half the time of reported activism in his sample. 16 Although Bratton tends to support some benign effects hedge funds may leave for corporate governance, such as alerting managers to investors who monitor the agency problem, or to leave complacency and improve performance, by referring to Pershing Square’s activism against McDonalds. The OECD Steering Group, The Implications of Alternative Investment Vehicles, n 10, also shares a similar view with regard to hedge funds’ positive impact on a target’s corporate governance.

Hedge Fund Activism 75 Hedge funds have been reported to carry out dedicated shareholder activism with not insignificant stakes in some companies. In the US for example, the first indication of hedge fund activism comes through when hedge funds take a 5 per cent stake in companies and make a Schedule 13D filing to the SEC to notify of its ownership. As the market expects hedge funds to actively change performance at the targeted company, abnormal returns on share price are generated around the filing date even before the process of engagement is underway. Such abnormal returns could be as high as 10 per cent.17 In the UK, the minimum threshold for disclosure is at 3 per cent, and such disclosure extends to the acquisition of any financial instrument, including derivative instruments such as options, swaps or futures, and contracts for differences, if the instrument may entitle the further acquisition of the underlying equity and voting rights.18 In the UK, hedge fund activists have used shareholdings of less than 1 per cent19 to 5 per cent in carrying out activism, and it has been observed20 that a disclosure of threshold shareholding by activists usually generates abnormal returns on share price per se as well. Most empirical research on the results of offensive activism by hedge funds report not insignificant absolute returns on share price, and where returns may not be forthcoming, hedge funds usually wind out or dispose of the position in order to move on. In 2007, an empirical report suggests that hedge funds make absolute returns of at least 5–7 per cent on share prices after commencing activism in the US,21 and by 2008, another piece of empirical research suggests that hedge funds make absolute returns of up to 12 per cent for 2–3 years in running after the commencement of activism.22 Although these reports deal largely with US companies, it is arguable that similar results may have arguably been replicated in the UK, such as seen in the performance of HSBC shares after Knight Vinke targeted HSBC Holdings in 2007.23 However, where hedge fund

17 A Klein and E Zur, ‘Entrepreneurial Shareholder Activism: Hedge Funds and Other Private Investors’ (2006) at , but Brav et al, n 11 above, suggests that abnormal returns are generally at about 5–7%. However, the broad picture is that significant abnormal returns are generated by the market being aware of the Schedule 13D filing alone, in expectation of activism to be carried out. 18 FSA Handbook, DTR 5.2 and DTR 5.3. Contracts for differences have been included since Sep 2008. 19 Eg Knight Vinke against HSBC in mid 2007 onwards with less than a 1% holding, Polygon against British Energy in 2003/4 with a 5.6% holding, these events will be discussed in greater detail shortly. 20 Remarks by Robert Prugue, Lazards Asset Management, Australia, at the ICGN Conference, Globalisation of Capital Markets: Impact of Corporate Governance (18–20 Jun 2008, Seoul) at Hot Topic Workshop (Moderator: S Wong). 21 See Brav et al, ‘Hedge Fund Activism’ (2007) n 11. 22 See Klein and Zur, ‘Entrepreneurial Shareholder Activism’ n 17. 23 HSBC was targeted towards the end of Nov 2007 and by May 2008, Knight Vinke had gained a slightly over 5% increase in the ordinary share price. Results obtained from HSBC’s

76 Shareholder Activism Unveiled activists perceive that the gains on share price may not be forthcoming after all, they would generally tend to wind down their positions and move on.24 Activist Campaigns Offensive activist campaigns led by hedge funds are generally of a different character from the institutional shareholder activism discussed in chapter 2. As hedge funds seek to generate abnormal returns to share price and to boost the value of the funds, their activism has frequently been carried out to persuade companies to take certain actions that could result in a generation of cash for hedge funds, although a brazen process of ‘cash-stripping’ is generally not found.25 The Conference Board reports that typical targets for hedge funds would be companies: (a) with excess cash capacity and no investment or innovation plans and hence are vulnerable to requests for redistribution or dividends (such as J-Power which was targeted by the UK Children’s Investment Fund in 2008); (b) with low expenditures in R&D or repayments of debt; (c) with significant asset diversification, hence giving activists the opportunity to call for sales of non-core assets that may result in a generation of cash for shareholders in terms of redistribution; and (d) with high institutional ownership, and takeover defences or corporate governance practices that are sub-optimal and not yet challenged, allowing hedge funds to bundle up a few issues appealing to institutional investors, to garner support for its activism package (such as in the case of Knight Vinke and HSBC).26 Brav et al provide further supporting evidence that hedge funds tend to target firms with ‘low market value relative to book value, are profitable with sound operating cash flows and tend not to be technology companies (as [those have] high R&D expenditures). Targeted companies have more takeover defenses than average firms and historic data repository, at . 24 Polygon wound down its larger than 1% stake in Sainsburys after a failed speculation that the retailer would be taken over at a premium in 2007, and The Children’s Investment Fund wound down its stake in J-Power after failing to persuade the company to distribute capital and cash back to shareholders in 2008. 25 C Clifford, ‘Value Creation or Destruction? Hedge Funds as Shareholder Activists’ (2007) at . 26 Conference Board, Hedge Fund Activism (2008), n 5 above.

Hedge Fund Activism 77 enjoy higher trading liquidity than companies of comparable size and book-to market’.27 Hedge fund activists generally pursue strategies that seek to change the capital structure of the company, such as demanding the repurchase of shares or expanding leverage, or they may request redistribution to shareholders, or demand that companies make operational and strategic changes such as disposing of assets, selling itself or imposing cost-saving measures.28 Bratton also reports that a number of patterns in hedge fund activism emerge. The activist may get the target firm to sell itself at a premium to another firm; or it gets the target to sell or spin off a significant asset; or it gets the target to pay out any spare cash. Sometimes, an activist engages the target for the longer term, by getting the target to change its long term business plan for the better. Bratton collects information on 130 firms from 2002 identified by the press as being targeted by activist hedge funds in the US, and finds that in a third of the cases, hedge fund activists have pressed for the firm to be sold in order to gain from the takeover premium. In another third of the cases, hedge funds have contended that the targets should sell or spin off assets, as diversification generally puts a 15 per cent discount on the firm’s market value and in the last third of the cases, the targets are generally cash rich, and although the hedge fund activists have not specifically pressed for a sale of assets or merger to make quick cash, they have alleged that the firm is underperforming. These funds then engage in corporate governance and anti-takeover issues to change the long term strategy or operations of the business in order to generate higher returns, and they would ask for a share repurchase or dividends thereafter.29 Although much of the evidence is produced by American commentators, hedge fund activism in the UK is arguably a rather international industry as American hedge funds such as Polygon and Monaco-based Knight Vinke have been active in the UK Plc landscape. UK hedge funds such as The Children’s Investment Fund operate in a similar way although its targets have largely been companies in Europe and Japan. Hence, the observations made about how hedge funds select targets and the type of campaigns they launch could arguably apply to hedge fund activism in the UK as well. As will be discussed in relation to Trian and Knight Vinke’s activism in the UK, hedge fund activism is offensive in nature—driven by profit-seeking motivations and the types of campaign launched against their respective targets fit in well with the empirical observations made above.

27 28 29

See Brav et al, ‘Hedge Fund Activism’ (2007), n 11. Conference Board, Hedge Fund Activism (2008), n 5. See Bratton, ‘Hedge Funds and Governance Targets’ (2007) n 11.

78 Shareholder Activism Unveiled The Process of Activist Engagement The starting point for any hedge fund activism would be the amassment of a stake within the company. In the US, many hedge funds with activist intent tend to amass at least 5 per cent of the shareholding, triggering a schedule 13D filing to notify of their ownership. As mentioned earlier, the filing alone usually helps share price to move upwards in the market’s anticipation of activist behaviour by the funds.30 The Schedule 13D filing helps hedge funds achieve visibility and pave the way for the next step, which is usually informal engagement. Further, the visibility of the hedge fund activist sends a signal to other funds so that they may take positions in the target company to bolster the ‘wolf pack’ behaviour against the target. In the UK, activist hedge funds have carried out their activities with as little as less than 1 per cent of the shareholding (Knight Vinke/HSBC) but many activists have amassed a sufficient stake to cross the reporting threshold of 3 per cent (such as Polygon in British Energy, Trian in Cadbury Schweppes). Activist hedge funds in the UK also tend to reach out for support from other activist funds, and even institutional shareholders.31 It has been commented that such informal linkages and ‘coalitions’ may add up to a substantial amount of shareholder influence against the management.32 Hedge fund activists usually initiate informal contact with the company in order to generate dialogue with investor relations and executive officers. Such contact is non-confrontational to begin with.33 In nearly a fifth of cases, concessions may be made by the target company without any public attention drawn to the activism.34 However, as this book relies on press publications in the UK to supply empirical information on hedge fund activism, discussion will be made of the type of activism that has gone past merely informal engagement, into varying degrees of publicised engagement. Hedge funds may employ a variety of pressure strategies against the target company. The most common tactic is a letter to management setting out various deficiencies as observed by the hedge fund activist and various changes and concessions sought to be made. The Conference Board reports this first step is almost universally taken in all cases in 30 Brav et al, ‘Hedge Fund Optimism’, n 11, NM Boyson and RM Mooradian, ‘Hedge Funds as Shareholder Activists from 1994–2005’ (2007) at . 31 For example, Knight Vinke in its campaign against HSBC had the support of CalPERS and institutional investors. 32 Y Millo and R Wearing, ‘Activist Investors: Some Implications for Corporate Governance’ (2008) at . 33 Reported in the Conference Board, Hedge Fund Activism (2008), n 5. 34 Bratton, ‘Hedge Fund Activism’ (2007), n 11.

Hedge Fund Activism 79 the US where some public attention is given to the activism. Next, the hedge fund activist may publicise the contents of the letter in order to draw attention to the activism. In the UK, Trian’s letter to Cadbury Schweppes, although addressed to the management, was posted on a website set up by Trian specifically for the activist campaign.35 Knight Vinke takes this further by publishing an open letter to all shareholders regarding their observations on deficiencies in the target company and their recommendations for changes to be made by the target company. Such open letters are frequently published in major newspapers in the jurisdiction of the target company.36 These public or semi-public communications generally exert pressure upon the Board of the target company to meet with and try to resolve the activist demands, although such meetings need not necessarily result in concessions being given by the target. In the US, the failure to obtain concessions from the target company after an extent of publicising the activism may result in a threat to or an actual carrying out of a proxy contest by the hedge fund activist. The indication of a hedge fund activist’s ‘intent to solicit’ proxies or actual commencement of the campaign of solicitation of proxies generally result in the target company’s climb-down from resistance against the hedge fund activist. Settlements could occur based on major concessions or minor concessions agreeable to the activist. This happened after Icahn Partners threatened to engage in a proxy contest against Yahoo Inc in 2008, and after Harbinger Partners and Firebrand Partners did the same with the New York Times in the same year. In the UK, the escalation of conflict between an activist and target has been seen in Polygon’s campaign against British Energy in 2004 which resulted in an extra-ordinary general meeting requisitioned by Polygon. However, such steps are rarely taken in the UK. Hedge fund activists have not been shy of increasing confrontational and aggressive tactics against the target in their escalation of activism, if initial efforts do not entail a response from the target. On the whole, they have been observed to be less concerned with collective action inertia than institutional shareholders. In fact, institutional shareholders may free-ride upon a hedge fund activist’s campaign, as is observed in the Knight Vinke campaign against HSBC. It has been suggested that the lack of conflicts of interests (such as where pension funds may be providing pension management to the investee company as well) and the ability to make the funds rather illiquid by limiting redemptions from the funds

35

. This was done in relation to HSBC in the UK, as well as Suez SA in Belgium and VNU the media group in the Netherlands. 36

80 Shareholder Activism Unveiled have allowed hedge funds to commit resources to activism and to persist with such activism until results are achieved.37 In terms of what the hedge fund activists have achieved, only in a small minority of cases would the target be completely unaffected by the activist demands and the fund would wind down its position and sell off its stake.38 In most cases the target would make concessions to some extent to adopt the hedge fund recommendations, or settle with the fund by making certain concessions and then repurchase the shares (such as in Mylan Laboratories and Icahn Partners, for example). In some cases, the fund may be awarded a Board seat and such a position allows the fund to continue to influence the longer term value of the target company. In the US where funds have gone on a full proxy fight, success in proxy solicitation generally occurs with other investors giving support to the hedge fund activist and this would result in target concessions (Trian in its campaign against Heinz for example, resulted in two Board seats for the successful activist fund). Proxy withdrawals or failures are relatively rare where the hedge fund has gone on a full proxy fight.39 In the UK, the landscape is a mixture of target concessions and target resistance. In the arguably most dramatic case of target resistance, Trian against British Energy as will be discussed below, strong and reasoned target resistance could prevail, and this also seems to be the case as HSBC holds out against Knight Vinke, who has called a cease-fire on HSBC after 14 months of engagement since September 2007. However, concessions have also been made by target companies without the matter escalating to a highly publicised conflict, such as in Cadbury Schweppes’ concession to Trian. Several significant instances of hedge fund activism in the UK will now be discussed. The funds discussed have taken positions of leading particular activist campaigns, although in some of the campaigns, the leading activist fund is supported by other shareholders. Polygon Global Opportunities Master Fund The Polygon Global Opportunities Master Fund is described as a global multi-strategy arbitrage fund with approximately $4.5bn under management. It is organised as a Cayman Islands exempted company and it engages in and ‘seeks to maximise fund value through merger and event

37 Bratton, ‘Hedge Fund Activism’ (2007), n 11. See also K-W Chueh, ‘Is Hedge Fund Activism New Hope for the Market?’ (2008) Columbia Business Law Review 724 providing a succinct discussion of the structure and regulatory context of hedge funds and the fund remuneration structure that all contribute towards giving hedge fund managers incentives to be activist. 38 2–3%, as observed in the findings in the Conference Board, Hedge Fund Activism (2008), n 5. 39 Ibid.

Hedge Fund Activism 81 arbitrage’.40 It is primarily operated out of the US, and from 2004, its UK arm Polygon Investments has been actively pursuing strategies in the UK that may maximise the value of the fund. Polygon’s dramatic engagement with British Energy in 2004 will be discussed. British Energy is an electricity provider in the UK privatised in 1996. It used to be listed on the London Stock Exchange, and from 2002, its share price had been performing weakly due to falling electricity prices. In mid 2004, British Energy had to propose a restructuring of the company’s capital in order to stave off administration. It proposed to accept a government bailout which would allow the government to take a majority stake in the company, and to convert bondholders’ rights into equity. This would result in existing shareholders being diluted to about 2.5 per cent of the equity holding in the company.41 Polygon which held 5.6 per cent of British Energy opposed the restructuring as it was a raw deal for shareholders. It threatened to take a derivative action against the management of British Energy claiming breaches of fiduciary duties, and requisitioned an extra-ordinary general meeting in order to obtain a resolution opposing the restructuring.42 In retaliation, British Energy decided to delist from the London Stock Exchange a day before the extra-ordinary general meeting and such delisting was permitted to be carried out without the need for shareholder approval.43 British Energy and its creditors also launched a series of legal actions against Polygon. Hence, three months after the activist campaign started, Polygon backed down and agreed to vote against its own proposals at the extra-ordinary general meeting. British Energy and its creditors then withdrew the legal action against Polygon. Polygon subsequently unwound its position in British Energy and exited the company.44 Shortly after the approval of the restructuring, British Energy relisted its shares on the London Stock Exchange in January 2005. The episode surrounding British Energy and Polygon is one of the earlier instances of offensive shareholder activism in the UK, however, being an early episode, it also features certain unique and atypical characteristics. First, Polygon’s activism is arguably driven by defensive considerations as British Energy’s restructuring would significantly affect the value of the Polygon holding, and hence, this is quite different from

40 Description provided by VC Lamb, in Polygon Global Opportunities Master Fund v West Corporation (Delaware Court of Chancery, Nov 2006), at http://www.delawarelitigation. com/polygon.pdf. 41 ‘Rebel Investors Attack British Energy Rescue’, The Independent (26 Jul 2004). 42 ‘Polygon Calls in Lawyers to Halt British Energy Restructuring’, The Independent (1 Aug 2004). 43 ‘British Energy Pre-empts Polygon by Delisting Shares’, The Independent (24 Sep 2004). 44 ‘Polygon Backs Down over British Energy’, The Independent (1 Oct 2004).

82 Shareholder Activism Unveiled the more recent forms of shareholder activism where well-performing companies may be targeted in order to generate abnormal returns to hedge fund holdings. However, Polygon’s aggression in terms of threatening a legal action and requisitioning an extra-ordinary general meeting is more typical of offensive forms of activism. The dramatic aggression returned on the part of British Energy is also rarely seen in the corporate landscape, and is atypical of the more subdued resistance put up by publicly listed companies in the UK if such resistance is put up at all. Polygon’s ultimate exit however is typical of hedge fund activism, where closures are made rather promptly when it is discerned that the investment strategy has paid off or otherwise. Polygon’s activism in British Energy is completely investment-centred, and this again is consistent with the other offensive forms of activism seen in more recent years. Knight Vinke and HSBC Knight Vinke Asset Management is a Monaco-based hedge fund that specialises in shareholder activism. Its mission statement states that it invests in underperforming large-cap companies in order to actively engage the company to adopt changes in structure, strategy or corporate governance in order to create value for shareholders. Knight Vinke has been formed since May 2003 with seed capital from CalPERS.45 Prior to its campaign against HSBC, it has already carried out campaigns famously on Suez SA in Belgium and VNU in the Netherlands. Eric Knight’s elucidation46 on the campaign against Suez SA shows how over a two-year period, Knight Vinke had targeted Suez, the French energy giant to sell off its stake in Belgium nuclear energy company Electrabel. The hedge fund activist first uncovers structural and governance inefficiencies that have entailed from Suez’s 50 per cent stake in Electrabel. In this process, Knight Vinke has also had recourse to court review of Suez’s conduct in Electrabel to pressurise Suez to resolve its position vis-a-vis Electrabel. Although Suez has not sold Electrabel and thereafter goes on to acquire 100 per cent in Electrabel in mid 2005, Knight Vinke continues to carry on the campaign of asking Suez to dispose of non-core minority holdings and to dispose of its water business.47 In 2006 when Gaz de France approaches to bid for Suez, Knight Vinke dedicates itself to this major campaign in combing all relevant financial statements of Suez and all of its subsidiaries and related companies, uncovering hidden value of several important contracts that a subsidiary of Electrabel (now 100

45 46 47

See . Eric Knight, remarks at Shareholder Activism in the UK Conference (London, 16 Oct 2008). Ibid.

Hedge Fund Activism 83 per cent owned by Suez), holds over the long term. Knight Vinke hence argues that Suez is undervalued in the market and its sale to the Gaz de France should be valued substantially higher. Knight Vinke’s campaign has garnered 15 per cent of investor support by late 2006, but it has surprisingly sold its stake to a large investor in Suez for a handsome profit almost double of the value it has paid for Suez’s shares. Suez and Gaz de France ultimately merged in September 2007. Although in Knight Vinke’s campaigns, no direct concessions have actually been made by Suez, the group has nevertheless been pressured to consider its strategy and position, and the activist process itself may have been perceived by the market to have added value to the group. This may explain the high price Knight Vinke has fetched for its holding in Suez even before the merger has taken place. In relation to Knight Vinke’s campaign against HSBC, a similar pattern emerges. In September 2007, Knight Vinke acquired a close to 1 per cent stake in HSBC and supported by CalPERS, it started a campaign against HSBC urging HSBC to review: (a) Its highly diversified business consisting of many non-majority stakes in institutions worldwide; and (b) Its insufficient focus on emerging markets where it actually has comparative advantages.48 Knight Vinke took the view that the above failures in strategy had caused the group to underperform over the previous years.49 HSBC responded by arranging a meeting between Senior Independent Director Simon Robertson and Knight Vinke, but Knight Vinke’s request for an independent review of the group’s strategy was turned down.50 On 16 October 2007, Knight Vinke wrote an open letter to all shareholders explaining its perception of HSBC’s deficiencies and underperformance, and took out large advertisements in leading newspapers to draw shareholders’ attention to the matter.51 Several institutional investors also voiced support for Knight Vinke’s recommendations for HSBC which included the disposition of non-core minority stakes in companies around the world and focussing on emerging markets where HSBC’s revenue growth had been the highest. Although HSBC did not concede to Knight Vinke, the

48 Knight Vinke’s letter to Stephen Green, 30 Nov 2007, at . Other letters are available to see at . 49 ‘Knight Vinke Goes for Jugular in New HSBC Attack’, The Observer (11 Sep 2007). 50 ‘HSBC Rebuffs Attempt by Activist Knight Vinke to Force Shake-Up’, The Independent (20 Sep 2007). 51 Eric Knight, at the Shareholder Activism in the UK Conference, n 46, however explains this as a way to evade insider dealing prohibitions.

84 Shareholder Activism Unveiled activist stepped up its campaign by highlighting further corporate governance issues such as generous share plans to be awarded to executives in November 2007.52 Further from March 2008 to May 2008, Knight Vinke further called specifically for HSBC to sell its consumer credit subsidiary in the US which specialised in sub-prime lending, in order to minimise losses for the group.53 Although HSBC had not met any of Knight Vinke’s demands after 14 months of activism carried out by Knight Vinke, in the light of the extraordinary financial and banking crisis that started in late 2008, Knight Vinke temporarily eased its position on HSBC. However, by mid 2009, Knight Vinke observes that HSBC’s sale of its US sub-prime business,54 and the relocation of its Group Chief Executive to Hong Kong55 have both vindicated Knight Vinke’s engagement which has to date lasted over two years. This highly visible episode has also entailed favourable publicity for Knight Vinke which saw assets under its management soar by 600 per cent.56 Knight Vinke’s activist campaigns fit within the pattern of offensive hedge fund activism observed in the US, centring mainly on issues of asset disposal and changes in business strategy in a bid to revamp the valuation of the target company. Its tactics, like those observed in the US too, follow a pattern of private engagement which could escalate to public criticism and confrontation. Unlike proxy fights in the US, even high profile activism in the UK such as carried out by Knight Vinke has not culminated in the requisitioning of extra-ordinary general meetings although recourse to the court has been had in the case of Suez. Further, the sale of the Knight Vinke stake in Suez before the Suez-Gaz de France merger also arguably shows that the hedge fund activist is driven largely by profit motivations, and the activism is an investment strategy rather than an engagement for governance ends as such. Knight Vinke’s investment horizons have also averaged 2–3 years, consistent with the median time horizons reported in empirical evidence from the US. . It may also be argued that Knight Vinke’s assertions that HSBC has been underperforming, and the attack on executive share plans are slight deviations from its core proposal to HSBC to dispose of non-core assets and boost cash as well as to change strategy in the group. It is queried whether the activist’s assertions of underperformance may actually refer to ‘under-valuation’, which may not necessarily be a measure of longer term performance. However,

52

‘Knight Vinke Attacks HSBC over Bonuses’, Financial Times (23 Nov 2007). ‘Knight Vinke Tells HSBC to Shed US Loan Arm’, The Daily Telegraph (13 May 2008). 54 25 Sep 2009, see . 55 25 Sep 2009. 56 ‘Best Year for Knight Vinke’, The Daily Telegraph (9 Nov 2008). 53

Hedge Fund Activism 85 CalPERS’ use of ‘underperformance’ as its criterion for intervention has given ‘underperformance’ a nuance of legitimacy and the framing of activist campaigns in the name of under-performance may be taking advantage of the more acceptable impressions connected with such activism. As has been mentioned earlier, hedge fund activists have not been concerned per se about underperformance or corporate governance as the relational investors in the tradition of CalPERS have been.57 As Knight Vinke continues to hold onto the stake in HSBC, it remains to be seen how this episode of offensive activism may evolve and whether such activism may adopt characteristics of collective concern for corporate governance issues and monitoring in the agency paradigm,58 or whether an exit in the near term is on the cards. Trian Fund Management and Cadbury Schweppes Trian Fund Management is a US hedge fund founded in 2005 by billionaire Nelson Peltz and two other partners. In 2006, Trian built up a 5.5 per cent stake in Heinz in the US, and led a rebellion to force Heinz to cut costs and revamp strategy in order to deliver greater investment value. This led to a full proxy fight and resulted in success for Trian in that two of its partners were appointed to the Heinz Board. In the wake of the success at Heinz, Trian targeted UK confectionery and beverage giant Cadbury Schweppes. Cadbury Schweppes which is a conglomerate of beverage and confectionery businesses, had been considering the possibility of spinning off the beverage arm and concentrating on the core confectionery business. In March 2007, Trian amassed a close to 3 per cent stake in Cadbury Schweppes and vocally called for the split of the beverage business to take place as soon as possible in order to boost investment value. Two days after the announcement of Trian’s close to 3 per cent stake, Cadbury Schweppes announced the decision to split its beverage business, apparently accelerating its decision due to Trian’s exertion of

57 The Conference Board report, Hedge Fund Activism, n5, shows that although hedge fund activists talk about under performance, it is often by the way and supplementary to the main activist demand of value generation through cash generation. Further, Bratton, ‘Hedge Fund Activism’, n 11 also shows that activist cases involve good performers and underperformers equally and this characteristic is not key to the activist decision. 58 Conference Board, Hedge Fund Activism (2008), n 5, and see critique levied in AM Kulpa and B Long, ‘The Wolf in Shareholder’s Clothing: Hedge Fund Use of Cooperative Game Theory and Voting Structures to Exploit Corporate Control and Governance’ (2005) 6 UC Davis Business Law Journal 4. The critique may also be contrasted with those who argue that hedge fund activism still nevertheless produces the by-product of necessary monitoring of corporations and mitigation of the agency problem, see Chueh, ‘Is Hedge Fund Activism New Hope for the Market?’ (2008) n 37; RC Illig, ‘What Hedge Funds can Teach Corporate America: A Roadmap for Achieving Institutional Investor Oversight’ (2007) 57 American University Law Review 225.

86 Shareholder Activism Unveiled pressure.59 This decision resulted in investors owning two shares for one, and increased Cadbury’s cash by a massive amount. Trian however did not wind down its position. In the nine months after the announcement of the Cadbury split, Trian continued to engage its Board in informal dialogue. It then built up a 4.5 per cent stake in Cadbury after teaming up with Qatar Investment Holdings, a sovereign wealth fund. Its demands, made public finally on 18 December 2007 included: (a) Asking the Board to set specific margin targets for improvement in corporate performance in the short, medium and long terms; (b) Asking the Board to carry out cost reduction exercises including extracting supplier and manufacturing efficiencies; (c) Asking the Board to recapitalise the balance sheet by paying a special dividend to shareholders or make a share repurchase and finance the business by increasing debt levels which are believed to be sustainable given the company’s cash flow; (d) Asking the Board to consider accepting Trian nominated candidates for the Board.60 Trian’s demands arguably fit in well with the typical pattern of hedge fund activism observed in the Conference Board report, where extraction of value is sought by demands for share repurchases or dividends. The Cadbury Board has publicly refused to meet these demands. Although Trian in its letter has warned that it would become more active in evaluating Cadbury if the demands are not met, the Cadbury Board continues to resist the demands. The Cadbury Board proceeded to divest its drinks business worldwide including selling off its Australian Schweppes business near the end of 2008. Trian has become quieter in 2008, and seems to have moved on to other activist ventures, particularly in Kraft Foods in the US which has bowed to Trian’s pressure and appointed two Board members out of the hedge fund. However, the old ghost of Trian lurks as Kraft makes a successful hostile bid for Cadbury in late 2009.61 Trian’s episode at Cadbury is arguably typical of the observed patterns of hedge fund engagement. First, a sizeable enough stake that usually crosses reporting thresholds is built up, and the activist then becomes visible in targeting the company. The activist campaign between March and December 2007 has been carried out with the objective of generating cash and quick returns for shareholders, a process of value-extraction.

59

‘Cadbury Confirms Plans to Split’, BBC News (15 Mar 2007). This was available at http://www.triancadbury.com/FinalCadburyLetter121807.pdf (accessed Dec 2008) and still at http://www.guardian.co.uk/business/2007/dec/19/ cadburyschweppesbusiness. 61 ‘Kraft-Cadbury’, Financial Times (12 Jan 2010). 60

Hedge Fund Activism 87 Although Trian’s public letter put some pressure on Cadbury, the resistance of the company has not been followed by further aggressive tactics by Trian including requisitioning extra-ordinary general meetings or threatening to go to court. It is observed that Trian’s demands are not exactly related to underperformance or corporate governance, as the letter from Trian shows a single-minded pursuit of investment value that may be extracted from Cadbury. Although Trian has not achieved the share repurchase or dividend campaigned for, Trian has become quiet, and this may arguably be attributable to the fact that the shares have risen in value due to Cadbury’s split of its beverage businesses, and hence, there could have been no further pressing necessity for Trian to compel more extraction of value from Cadbury. This nevertheless brings to question the integrity of Trian’s initial claims against Cadbury and whether these claims are merely instrumental to the ultimate gain in share value Trian seeks. Since Trian has made a profit on its shares after the disposal of Cadbury’s drinks business, the quiet abandonment of the campaign may suggest that the demands in Trian’s letter may not be entirely credible after all.62 The above three examples which the book has chosen to discuss raise certain important points regarding hedge fund activism in the UK, which are different from the results achieved in the US. The similarities though, are that hedge fund activism in the UK is also achieved through amassing a sufficiently significant stake, the activism relates to specific objectives that often could result in value extraction or generating cash for shareholders, or increases in share price. Such activism is also offensive in nature—seizing an unexplored opportunity in the company, and is therefore ex ante, and not reactive and defensive in nature, as institutional shareholder activism is characterised. Kahan and Rock describe hedge fund activism as ‘a profit-making strategy, [hedge funds] take economic positions in portfolio companies that enable them to engage in, and make profits from, activism’.63 Hence such activism is motivated by exploiting opportunities to achieve revaluation of shares or generation of cash. It is arguable that such activism is not truly concerned with ‘underperformance’ in the CalPERS tradition, as empirical research has found that hedge funds do not systematically target underperforming companies.64 It is perhaps even more arguable whether hedge funds are concerned with

62 Further, Trian has disposed of a significant amount of shares in Cadbury Schweppes bringing the holding to less than 3% on 25 Nov 2009, see . 63 See Kahan and Rock, ‘Hedge Funds in Corporate Governance and Corporate Control’ (2007) n 14. 64 Brav et al, n 11.

88 Shareholder Activism Unveiled governance issues as such, as fights for Board representation are often not justified in terms of improving Board balance or diversity, and could even be overtly for the purposes of putting in place the hedge funds’ strategic proposals.65 These characteristics are seen in both hedge fund activism in the US and the UK. It is also arguable that even UK based hedge funds such as The Children’s Investment Fund have been heavily influenced by these patterns that first emerged in the US, and the Fund has carried out a similar form of activism against companies outside of the UK.66 Hedge fund activism against companies in the UK is however arguably more muted than in the US. Full proxy fights and threats to litigate are often used in the US as compared to the restraint seen in the UK. Public letters and critique are dominant in hedge fund activism in the UK. In terms of differences, the main difference that can be observed between US and UK hedge fund activism is that hedge funds may meet with successful Board resistance in the UK more often, and funds do not necessarily press for an all-out opposition. The Conference Board reports that in the US, two-thirds of the companies targeted by hedge funds buckle even at the initial stages of engagement, and this could arguably be due to management awareness that hedge funds would be quite happy to carry out a full proxy fight, particularly for the purposes of securing Board seats,67 or threaten to carry out derivative class litigation.68 In the UK however, hedge funds have seldom resorted to requisitioning extra-ordinary general meetings or threatening litigation, and Polygon’s dramatic move in

65

See Trian’s letter to Cadbury, 18 Dec 2007, n 60. The Children’s Investment Fund in February 2007 publicly criticised Dutch bank ABN-AMRO for not improving shareholder value and suggested the break-up of the bank in disposal of assets. The TCI had 1% in ABN-AMRO then. See http://uk.reuters.com/article/ hedgeFundsNews/idUKNOA14320220070221, the letter from the TCI to ABN-AMRO. By March 2007, Barclays had entered into merger talks with ABN-AMRO, and in April 2007, TCI led a shareholder revolt to disapprove of the merger which would see shareholders receiving less than a rival bid from the Royal Bank of Scotland. TCI then worked with Atticus Capital, a US hedge fund which owns about 1% in Barclays to disapprove of the Barclays bid and by June 2007, Atticus’ disapproval had been made public and clear. By Oct 2007, Barclays finally conceded the takeover battle, leaving the Royal Bank of Scotland to acquire ABN-AMRO at a higher price. Also, TCI tried to intervene in J-Power in Japan asking for dividends and share repurchases to be made from the energy giant’s cash hoard. This was rebuffed and TCI had to walk away and wind down its stake in 2008. 67 Ibid. 68 Although in terms of carrying out class litigation, the evidence favouring hedge funds is mixed. Choi et al report that hedge funds are well-placed to be lead plaintiffs as they are sophisticated and have significant stakes, but the courts have also demonstrated that they would not readily endorse hedge funds as lead plaintiffs. In In re Bank One Shareholders Class Actions, 96 F. Supp. 2d 780, 784 (N.D. Ill. 2000), the court refused to appoint a hedge fund as lead plaintiff as it had also shortsold the stocks of the company concerned. See SJ Choi, JE Fisch and AC Pritchard, ‘Do Institutions Matter? The Impact of the Lead Plaintiff Provision of the Private Securities Litigation Reform Act’ (2005) 83 Washington University Law Quarterly 869 at 881. 66

Hedge Fund Activism 89 2004 perhaps have set an example of how such polarised public moves could actually backfire. It is arguable that hedge funds’ easier successes in the US could have been due to a greater certainty of institutional support for hedge fund actions,69 whereas institutional support for hedge funds in the UK is much more mixed. In Polygon’s engagement with British Energy, government and creditor support prevailed over Polygon’s dissidence which was supported by other shareholders. In Trian’s engagement with Cadbury, no institutional support was reported, and Board resistance prevailed. Even in Knight Vinke’s engagement with HSBC, institutional support did not overcome the Board’s resistance although the onset of the financial crisis may have been key to mitigating the activism. Given institutional pre-occupation with corporate governance standards and compliance with the Corporate Governance Code, it could be argued that institutions would consider rather carefully whether to jump on the bandwagon with hedge fund activists. Further, given the policy endorsement of ‘Enlightened Shareholder Value’, institutions may arguably not wish to be seen as short to medium term extractors of corporate value in asking companies to dispose of assets and return cash. Next, the chapter will discuss the activism carried out by the Hermes Focus Funds, a set of funds established by the institutional investment manager Hermes that targets underperforming small and medium sized public companies. The Focus Funds engage in a type of activism that is somewhat different from the reactive and defensive engagement which is typical of UK institutional investors. However, is it the same type of offensive activism that hedge funds have been carrying out? This chapter will argue that the Hermes activism, which follows in the tradition of CalPERS is a hybrid of the purely offensive activism practised by hedge funds, and the defensive, reactive type of activism that most UK institutions are used to. Hermes Focus Funds The Hermes Focus Funds were first set up in 1998, as a partnership between Hermes and the US based LENS Fund. Subsequently, other investors including pension funds in the UK, a Canadian and a Japanese pension fund joined in. The Focus Funds are run rather autonomously

69 The Conference Board reports that institutional investors tend to go along with hedge fund activism, see Hedge Fund Activism, n 5, and commentators also report that institutional investors see hedge funds as providing a useful monitoring service on their behalf as they have often been plagued by collective action problems, regulatory burdens or conflicts of interest. See JW Verret, ‘Economics Makes Strange Bedfellows: Pensions, Trusts, and Hedge Funds in an Era of Financial Re-Intermediation’ (2003) 10 University of Pennsylvania Journal of Business and Employment Law 63; Kahan and Rock, ‘Hedge Funds in Corporate Governance’ (2007), n 14.

90 Shareholder Activism Unveiled from the main investments under Hermes. Becht et al have made a major study into the investment decisions and shareholder activism carried out by the Hermes Focus Funds from 1998–2004 and have provided important insights into this set of iconic pension funds.70 The Hermes Focus Funds target under-performing companies and seek to engage the companies in order to bring about an improvement in shareholder value. The target improvement in share price sought to be achieved is 20 per cent.71 In terms of what motivates the activism, the Focus Funds clearly adopt an offensive approach, attempting to seize opportunities in under-performing companies in order to engage them for future value enhancement. Such an approach is akin to the profitseeking approach adopted by hedge funds that treats activism as an investment strategy. This approach may be reflected in the types of activist campaigns mounted by Hermes in the 30 cases studied by Becht et al. In over half of the cases the Focus Funds have sought to limit company capital expenditure or acquisitions,72 and have demanded companies to make cash payouts to shareholders either in terms of dividends or share repurchases. However, where extraction of cash from the company is concerned, Hermes has often sought to couple it with a general restructuring of the company, and hence it seems that cash is not pursued as an end in itself.73 In many cases, the Focus Funds seek to replace the CEO with a candidate likely to agree with the carrying out of the Funds’ recommendations.74 The Focus Funds’ concerns are however not all financial, as in at least a third of the cases the Funds seek to strengthen the independent element on the Board by asking for more non-executive directors to be appointed. The Funds’ engagement has also included issues such as improving customer and investor relations, and treating shareholders fairly, especially on rights issues.75 In terms of the activist process, the Focus Funds also adopt a rather different approach from hedge funds. Becht et al report private negotiations as being the mainstay in the Focus Funds’ engagement approach, and the Funds rarely put an item on the agenda for the general meeting or requisition a general meeting. No instances of public critique has been reported, unlike in the case of hedge funds where public critique

70 M Becht, J Franks, C Mayer and S Rossi, ‘Returns to Shareholder Activism: Evidence from a Clinical Study of the Hermes UK Focus Fund’ (2008) 10 Review of Financial Studies 1093. 71 Remarks by Hermes Focus Fund representative, Shareholder Activism in the UK Conference (London, 16 Oct 2008). 72 Eg Hermes’ engagement with Smith and Nephew, causing the latter to dispose of its non-core businesses. 73 Hermes engagement with Six Continents aimed not only at cash extraction but at refocussing the business on its core as well. 74 Eg Hermes’ engagement with Brazit saw the entire Board replaced. 75 Becht et al, ‘Returns to Shareholder Activism’ (2008), n 70.

Hedge Fund Activism 91 is often issued, perhaps to tactical advantage as share prices have often responded positively to news of hedge fund engagement (as discussed earlier). The private negotiations between the Focus Funds and their targets have however been reported to be very constructive as the Focus Funds achieve their objectives in a majority of cases. In issues such as limitation of capital expenditure, Becht et al report a success rate of 80–90 per cent, and in issues such as the appointment of non-executive directors, a success rate of 60 per cent has been achieved. The returns to the Focus Funds in terms of share price changes are often due to public awareness of the implementation of change, and not the engagement of the Fund as such. The Focus Funds tend to make their exit after the valuation of the company improves following from the implementation of the changes proposed during the engagement. Becht et al report a continuing salutary effect upon the company’s performance in the two years thereafter. The company’s returns on assets generally improve up to 8 per cent. However, it is also noted that many of the targeted companies have shed employment of up to 40 per cent. The Hermes Focus Funds arguably follow the approach taken in the CalPERS Focus List and is offensive in nature, being profit-seeking. However, the approach to profit-seeking is also affected by longer term concerns for the company, and concerns for the governance of the company, although governance concerns do not per se drive the activism, unlike the typical institutional shareholder activism discussed in chapter 2. This broader range of concerns appears to differentiate the Focus Funds’ offensive activism from that carried out by hedge funds, which is heavily motivated by value extraction or the creation of events that would drive abnormal returns to share price, whether or not the target company in question has governance concerns or underperformance. Further, the Focus Funds’ primarily private approach and emphasis on dialogue may be more collaborative with the target company than the more aggressive and ready-to-publicise approach taken by many hedge funds. Many studies76 that report how hedge funds generate shareholder value focus heavily on the publicising of hedge fund stakes as such, and share prices rise as the market expects engagement by hedge funds which disclose a significant stake. Such studies do not actually inform us as to the continuing value of the hedge fund engagement and what such engagement has done for the company after exit. Becht et al’s study has carried out a thorough analysis of the after effects of Focus Fund engagement in target companies, and the sustainability of the increased valuation of the

76 See eg Klein and Zur, ‘Entrepreneurial Shareholder Activism’ (2007), n 17 and Brav et al, ‘Hedge Fund Activism’ (2007), n 11.

92 Shareholder Activism Unveiled company after exit may suggest that the Focus Fund engagement could have had the company’s longer term well-being in mind. A caveat however is to be noted in relation to stakeholder losses especially in terms of employment. The Hermes Focus Funds hence represent a type of hybrid approach between offensive and defensive forms of shareholder activism in the UK which is being driven by offensive motivations but takes on board certain longer term ‘enlightened’ concerns and certain governance concerns. Would this approach be ideal for companies, investors, the market and regulators? Further, this approach also engages in individualised activism vis-a-vis selected investee companies, and hence could be a form of informed and intelligent monitoring. However, it is uncertain as to how this rather “boutique” approach could be adopted as a general investment approach by institutions. The Walker Review’s perception of stewardship for institutions could arguably amount to such activism, but the Focus Funds clearly do not invest in many investee companies as intensive scrutiny and engagement require effort and cost. Next, this chapter will discuss how offensive forms of shareholder activism are received and perceived, and the issues and concerns regarded to be arising out of this phenomenon. Chapter 4 will then discuss the theoretical and legal support for all types of shareholder activism identified and discussed so far. 3. POLICY AND CONCERNS RELATING TO OFFENSIVE SHAREHOLDER ACTIVISM

The novel and offensive forms of activism carried out by hedge funds have not only come under scrutiny in the US,77 and UK78 but also internationally.79 In terms of market response to hedge funds, it is arguable that institutional shareholders regard hedge fund activism with interest and many also invest in hedge funds, taking advantage of the shareholder activism carried out by hedge funds.80 However, the institutional shareholders themselves do not seem to be switching into adoption of the

77

The Conference Board, Hedge Fund Activism, n 5. FSA Paper, and Hedge Funds Standards Board (led by Sir Andrew Large), Hedge Fund Standards: Final Report (Jan 2008) (The Large Report). 79 OECD Steering Group, The Implications of Alternative Investment Vehicles (2007), n 10. 80 In 2004, it was reported that about 12% of pension funds were allocating about 5% of their portfolios to hedge funds, see para 2.10, FSA Paper (2004), n 78. By 2007, the NAPF survey of institutional investment reports that about 40% pension funds are allocating up to 25% of assets in hedge funds, bringing the total institutional investment in hedge funds up to about 7% of the institutional investment landscape, see paras 54–55, NAPF, Institutional Investment 6 Years On (2007). 78

Policy and Concerns Relating to Offensive Shareholder Activism 93 hedge fund objectives or tactics in shareholder activism as such. What the market and regulators are concerned about areas follows: (a) Do hedge funds improve corporate performance not just in terms of share valuation but in terms of longer operating performance, or are they merely value or cash extractors? (b) Does hedge fund activism contribute to the regulatory space in terms of monitoring the investee companies for agency problems that may manifest in governance problems? Many empirical studies, particularly those that focus on hedge fund activism in the US, report that hedge fund activism generate abnormal returns on share price, particularly around the event of notifying a significant stake.81 However evidence is more mixed where longer term operating performance of the company is evaluated post hedge fund activism. Boyson and Mooradian report82 that although hedge funds may extract cash from target companies, such companies generally have idle free cash flow that is not put to efficient use. Hence, hedge fund activism provides a form of discipline against the agency problems of free cash flow. Such discipline can provide a lasting effect on the targets, and targets generally improve their returns on assets by an average of 7 per cent in the year after the hedge fund exit has been made. Hence, hedge funds may be able to achieve not only their investment objective of profiting from their activism, but also to create longer term value for the company as a result of helping to monitor and reduce agency costs. This may be corroborated by Becht et al’s study into the Hermes Focus Funds, but one should note that these findings of benign after-effects are based on both reports pointing out that the activist funds have provided input as to the long term restructuring of the company, as well as discipline in terms of improving governance. Hence, it remains to be discerned if offensive forms of activism only entail sustainable benign effects on targets where agency cost concerns are also addressed. These findings may be compared to a number of other reports that find that although hedge funds have not raided target companies’ cash, the evidence for value-adding by hedge funds for longer term operating performance is not strong.83 Hence, hedge fund activism may not contribute to the longer term improvement of corporate performance in target companies. It seems that only where the hedge fund activism has provided a ‘monitoring’ function that beneficial effects may also accrue

81 Eg Klein and Zur, ‘Entrepreneurial Shareholder Activism’ (2007), n 17 and Brav et al, ‘Hedge Fund Activism’ (2007), n 11. 82 See Boyson and Mooradian, ‘Hedge Funds’ (2007), n 30. 83 See Klein and Zur, (2007), n 17; Clifford, ‘Value Creation or Destruction?’ (2007) n 25.

94 Shareholder Activism Unveiled to the target company and a wider set of constituencies. In other words, hedge fund activism is not always likely to entail the type of ‘public good’ effects following from the governance efforts of institutional shareholders. However, we need to discern if hedge funds provide a monitoring function whether deliberately or incidentally. It has been argued that hedge fund activism may provide an incidental but powerful form of monitoring as the aggressive engagement, where it culminates in the replacement of Board members, could serve as a warning to complacent management in other companies.84 These commentators see that hedge fund activists fill in a gap of monitoring that they argue, has never been filled by institutional shareholders in the US.85 However, replacement of Board members by hedge fund partners need not necessarily be for a company’s good if Board dynamics may be adversely affected. In the UK context, institutional shareholders have been stepping up to the engagement challenge particularly at general meetings and over governance issues, but that seems to still fall short of meaningful monitoring as “stewards”. Hence, can monitoring only be effectively carried out if the activism is intense and individualised? Further, hedge fund and Hermes Focus Funds’ hybrid activism have shown us that individualised and intense activism is usually costly and hence may only be undertaken where there is profit-making for the activist concerned. The type of intensive monitoring envisaged in shareholder activism as a form of market-based governance may only be carried out if there is also significant private gain. On a higher level, can there be a win-win reconciliation between interests in private gain and the provision of governance for collective and public good? In the US, Vice-Chancellor Leo Strine of the Delaware Chancery Court has openly voiced his reservations regarding shareholder activism as ‘concern over the potential adverse effects of giving shareholders more influence over corporate governance, fearing that it is an overreactive and poorly designed means to generate better corporate performance’,86 especially if such shareholders are ‘transients on short term visas—’.87

84 TW Briggs, ‘Corporate Governance and the New Hedge Fund Activism: An Empirical Analysis’ (2007) 32 Journal of Corporation Law 681; Illig, ‘What Hedge Funds Can Teach Corporate America’ (2007) n 58. 85 Illig, ibid, and see SJ Choi and JE Fisch, ‘On Beyond CalPERS: Survey Evidence on the Developing Role of Public Pension Funds in Corporate Governance’ (2008) 61 Vanderbilt Law Review 315, who argue in their latest empirical survey that institutional shareholders in the US are still not active enough. 86 L Strine Jr, ‘Towards a True Corporate Republic: A Traditionalist Response to Lucian’s Solution for Improving Corporate America’ (2006) at at 9. 87 Referring to short term investors such as hedge funds, see ‘Toward Common Sense and Common Ground? Reflections on the Shared Interests of Managers and Labor’ (Lecture at William Mitchell College of Law, Minnesota, 2007) at , at 12.

Policy and Concerns Relating to Offensive Shareholder Activism 95 In the UK, the response to hedge fund activism from policy quarters is still rather tentative. Although the report on hedge funds led by Sir Andrew Large88 recognises that hedge funds engage in activism,89 the report only deals with a small number of issues raised by hedge fund activism. The Report deals at length with the possibility of market abuse— particularly insider dealing carried out by hedge funds which may be privy to inside information in the activism process. The Large Report sets out at length preventive procedural measures in the operation of the hedge fund in order to minimise market abuse and non-compliance with the FSA’s rules on market conduct, such procedures including the appointment of compliance officers familiar with the rules against market abuse, instituting Chinese walls between different hedge fund departments, having employees on registers depending on their level of exposure to inside information and having regular dialogue with the regulators on compliance with market conduct rules.90 Next, the Report deals with voting conduct by hedge funds, and recommends that hedge funds set out clear guidelines on how hedge funds vote their proxies, under what circumstances and how they may engage with investee companies, and how they may join other investors in activism. The Report also recommends that such guidelines and policies should be available to fund investors on request.91 However, it is queried as to what extent such information may be available to a wider scope of persons, for example, other funds, and the investee company itself, or to the public at large, having an interest in hedge fund activism policies, as there are companies who could become hedge fund targets. It is noted that as most hedge funds do not have websites or have websites that only allow access by fund investors, there is very little public knowledge as to hedge fund policies in activism. The Association of Investment Companies, a trade association for closeended investment funds among whose membership are hedge funds, has produced its own code92 of corporate governance, but its code is largely a one-way document, stating investors’ expectations of how the Board should manage the company, offer disclosure and communicate with investors, but not on how investors may engage or vote, unlike the level of transparency93 seen in the policies issued by investment companies of institutional investors. Finally, the Large Report recognises that borrowing

88

Hedge Fund Standards (2008), n 78. Para 6.5, Large Report. 90 Pages 93–94, Large Report. 91 Pages 95–96, Large Report. 92 The AIC Code of Corporate Governance (2007). 93 Referred to in Investment Management Association, Survey of Fund Managers’ Engagement with Companies For the Year Ending 2005, , see also for example, Fidelity Investments International Ltd, Principles of Ownership. 89

96 Shareholder Activism Unveiled stock to vote may be opportunistic in character,94 and recommends a ban on borrowing stock to vote. The relatively minimalist approach to corporate governance issues taken in the Large Report may be compared to the American Conference Board report95 which provides detailed guidelines to management as to how to respond if they are targeted by hedge funds,96 and how to engage other investors and gatekeepers in order to garner support for Board decisions in the face of activist pressure from hedge funds.97 The Conference Board report arguably sees the offensive activism carried out by hedge funds as not always being desirable and advocates not only that management be vigilant regarding hedge funds, but that institutional investors who invest in hedge funds should also monitor and discipline their investee hedge funds in the matter of their activism.98 The UK position in this respect seems to be a little more ‘wait and see—, but this may be because hedge funds have had only mixed success in their activism efforts in the UK,99 whereas in the US, there are many more reports of management buckling under hedge fund pressure.100 The Large Report guidelines have only attracted a fraction of hedge fund managers as signatories in the UK, and all the hedge fund activists earlier discussed in this chapter are not signatories. That said, the minimalist approach to hedge fund activism taken in the Report leaves lots of room for this area to be examined. The approach taken in the Large Report may be superseded by regulatory control if the EU Proposal for a Directive to Regulate Alternative Investment Fund Managers is passed as legislation.101 The Proposal has been drafted in the wake of the global financial crisis as a reaction to close off as many avenues of unchecked self-regulation as possible that may pose systemic risk. The Proposal deals largely with mandatory disclosure to investors and to regulators to enable both to monitor the risks of hedge funds. However, there are a number of provisions that may affect hedge fund activism. For example, Article 12 of the Proposal requires hedge funds to maintain a liquidity profile and to stress test its liquidity positions. Would this affect the resources hedge funds can set aside in offensive activism, especially since offensive activism is usually initiated

94 HT Hu and B Black, ‘The New Vote Buying: Empty Voting and Hidden (Morphable) Ownership’ (2006) 76 Southern California Law Review 811 and ‘Equity and Debt Decoupling and Empty Voting II’ (2008) 156 University of Pennsylvania Law Review 625. 95 Conference Board, Hedge Fund Activism (2008), n 5. 96 Ibid, 16–39. 97 Ibid, Principle V. 98 Ibid, 40–51. 99 As discussed earlier in this chapter. 100 Conference Board, Hedge Fund Activism, n 5, 12. 101 http://ec.europa.eu/internal_market/investment/alternative_investments_ en.htm#proposal (as of Jun 2010).

The Inspiration from Private Equity Funds in the UK 97 upon the acquisition of a sufficiently notable stake? Further it is uncertain to what extent hedge fund activism may be scrutinised by regulators as being part of the fund’s risk profile and it remains uncertain if regulators can intervene in such activism on that basis. Offensive activism raises certain empirical and normative questions regarding shareholder activism. In terms of empirical questions, markets, the industry and regulators would like to know to what extent offensive activism generates not only investment returns but sustainable corporate wealth over the longer term. To what extent also does offensive activism improve decision-making or governance or both at a company? Is there a relationship between governance changes and corporate performance, not only in terms of share valuation but also operating performance? In terms of normative questions, should shareholders seek to overtly and unabashedly engage with companies to generate abnormal returns for themselves? Are shareholders entitled to challenge management on any issue that may result in the generation of abnormal share price returns? Should shareholder engagement be carried out for the short term or for the longer term? This book has attempted to present an overview of hedge funds’ offensive activism in the UK, but the above questions show that there are still information gaps to be filled although the book will take issue with some of the normative questions in chapters 4 and 5. Next, the chapter will turn to the activities of private equity funds to describe how they have also provided inspiration for offensive and involved forms of shareholder activism in the UK.

4. THE INSPIRATION FROM PRIVATE EQUITY FUNDS IN THE UK

Private equity has been invested in private companies in the UK for a number of years but since the 1990s and the millennium more public awareness and media attention have been generated regarding these activities. This is partly due to the recognition that private equity funds have been generating returns for investors that are at least equivalent to if not better than publicly listed equity, and hence the promotion of private equity as an ‘asset class’ to appeal to a broader base of investors is seen as appropriate, particularly to institutional investors. The other reason for the increased public awareness of private equity is that some private equity groups have become ambitious enough to take large listed companies in the UK private sector, such as the AA, Boots and Debenhams, and such actions have caused the public in general to be wary of alternative investment groups such as private equity which are not regulated to the same degree as those in the publicly listed corporate sector. Further, several private equity groups have also floated their fund management

98 Shareholder Activism Unveiled outfits on the London Stock Exchange and Euronext, inviting more public attention in relation to their activities.102 The Myners Report on institutional investing first issued the call to institutional investors to consider being more open to investing in private equity and regarding it as an asset class.103 The British Venture Capital Association (BVCA) has also eagerly sold the idea to institutional investors by commissioning research104 which shows that private equity funds are capable of delivering slightly higher returns overall to investors, with some spectacular years.105 By 2007, it is reported that about 20 per cent of pension funds invest in private equity, up from 5 per cent in 2005.106 This reflects a broad-based recognition of the strong returns private equity has generated for investors,107 as well as the contribution to GDP, employment and economic well-being of the UK generally.108 At the heart of private equity’s success is arguably the governance provided by private equity involvement in the businesses invested to achieve ‘value creation’. The general partners (also fund managers) of the private equity fund that has invested in a business are often reported to be heavily involved in the management of the business.109 This may include Board representation, often by one or more of the general partners themselves. Both private equity testimony110 and empirical research111 show that private equity managers adopt a hands-on approach from due diligence before the acquisition, to the creation of a 100-day blueprint to articulate the company’s strategy and general operational direction. Ineffective management is replaced early on, and existing management own significant amounts of the company’s equity to incentivise towards value creation. Private equity managers spend considerable amounts of

102 Kohlberg Kravis Roberts floated one of its arms on the Euronext but was announcing a likely float on the New York Stock Exchange in Aug 2008. Fortress and Blackstone are listed on the New York Stock Exchange, 3i Quoted Private Equity is floated on the London Stock Exchange. 103 Myners Report at ch 12. 104 O Burgel, ‘UK Venture Capital and Private Equity as an Asset Class for Institutional Investors’ Research Report for the BVCA, 2000. 105 Averaging out to over 14% over 10 years but some years may see record returns of over 30%. 106 David Paterson, Head of Corporate Governance, National Pension Funds Association, in his contribution to the BVCA, Private Equity in the UK: The First 25 Years (2007), available at . 107 See for example, the average of 17.8% returns for investors in 2007, reported by the BVCA, in Private Equity and Venture Capital Performance Measurement Survey 2007. 108 J Hart, ‘Transforming the UK Economy’ in BVCA, Private Equity in the UK: The First 25 Years, n 106 above. 109 VV Acharya and C Kehoe, ‘Corporate Governance and Value Creation: Evidence from Private Equity’ (London Business School 2008) at http://www.london.edu/assets/documents/PDF/Acharya_Kehoe_v6.pdf. 110 BVCA, The First 25 Years, n 106 above. 111 Acharya and Kehoe, ‘Corporate Governance’ (2008), n 109 above.

The Inspiration from Private Equity Funds in the UK 99 time in informal communication with the other executive officers of the company and seek external help within their network to support the company. One private equity partner describes private equity investment as ‘single minded in its pursuit of cash flow improvement—the ultimate measure of business success—and incentivises management teams accordingly, through both the equity ownership and annual cash bonus schemes. Where public companies often use a balanced business score card, seeking to take numerous complex metrics into account when measuring managements’ performance, a buyout-backed business has a very short list of key performance indicators, all closely monitored, but with the focus on generating cash’.112 The active engagement of private equity in its portfolio company and hands-on management approach have been described as key to private equity’s success.113 Private equity groups point to how the taking private of Halfords and Homebase,114 Gala Coral115 and Alliance Medical116 have provided new strategic direction and resulted in more sales and higher operating performance at these companies. Empirical evidence in academic studies also seems to support the correlation between governance changes brought about by private equity involvement (usually increased monitoring or management self-monitoring and hence decreased agency costs) and improved operating performance and higher financial returns.117 This phenomenon is arguably tested in some high profile public-to-private deals where a few large UK public listed companies have been acquired by private equity. Did governance changes brought by private equity improve Boots’ performance? Boots was dramatically taken private in mid 2007 by private equity group Kohlberg Kravis Roberts, one of the most prominent American private equity groups. Today, although not much disclosure regarding Boots’ performance is readily available, there is a public report of its improved financial performance.118 This may not

112

Robert Easton, Carlyle Group, remarks in BVCA, The First 25 Years, n 106. Acharya and Kehoe, ‘Corporate Governance’ (2008), n 106, argue that financial engineering and leverage are important tools but not key to the abnormal returns on private equity investments. The returns are largely generated by improved operating performance, which is driven by private equity’s hands-on management approach towards value creation. 114 Andrew Cornelius, RHM, remarks in BVCA, The First 25 Years, op cit, on how Homebase redefined its appeal to the female market and how Halfords brought in products in a change of business direction, that allowed these companies to become profitable again. 115 Sarah Butler and Philip Hoult, remarks in BVCA, The First 25 Years, n 106. 116 Helen Dunne, remarks in BVCA, The First 25 Years, above. 117 E Nikoskelainen and M Wright, ‘The Impact of Corporate Governance Mechanisms on Value Increase in Leveraged Buyouts’ (2005) at ; and D Cumming, D Siegel and M Wright, ‘Private Equity, Leveraged Buyouts and Governance’ (2008) 13 Journal of Corporate Finance 439. 118 Boots reported a 7% rise in sales growth and a rise in profits at close to 5% in Jan 2008, half a year after being delisted, see ‘Health and Beauty Drive Boots Turnaround’, The Guardian (17 Jan 2008). 113

100 Shareholder Activism Unveiled be the case with Debenhams which was taken private in 2003, and floated back on the stock exchange in 2006,119 generating over £6m in profit for its private equity owners. Debenhams was not an attractive flotation however as it was laden with a £1bn debt,120 courtesy of restructuring made by its private equity owners.121 In March 2007, it issued a profit warning and lost half of its share price after reflotation.122 The apparent failure of Debenhams to thrive after being brought back to market after the exit of private equity has caused public anxiety over private equity’s operations and its economic impact. Further, there is public anxiety over the frequent shedding of jobs after private equity takes over, a point acknowledged by the BVCA.123 Private equity has been openly committed to shareholder value, and it is intensively involved in leading and advising its portfolio companies on all aspects of strategy and management. These are seen as key reasons for private equity’s success in generating shareholder wealth.124 Private equity is driven by the motivation to exit with profit,125 and hence, it is arguable that private equity’s ‘offensively’ motivated governance may be an inspiration to shareholders in publicly listed companies. If private equity’s success shows analogically how greater involvement and active approaches could improve returns and corporate performance, then offensive activism as discussed earlier is merely transposing the methodology of involvedness and intensity into the public listed sector. However, the key difference between activism in private companies owned by private equity funds and publicly listed companies is that private companies are less subject to regulation and more subject to private contracting arrangements, principally because publicly listed companies are regulated in order to meet certain public objectives. Hence, how activism works in private equity owned companies may not necessarily be appropriate for publicly listed companies.126 Further, many private equity funds hold their investments for a median period of 5–7 years 119 ‘Private Equity Group Puts £3bn Price Tag On Debenhams As It Floats For Third Time’, The Guardian (21 Apr 2006). 120 ‘Debenhams Forced To Float At Bottom Of Price Range’, The Independent (4 May 2006). 121 Nikoskelainen and Wright argue that leverage may not help private equity held firms to perform better in all cases, and this may explain the phenomenon at Debenhams, above at n 119. 122 ‘Debenhams Falls out of Fashion’, The Independent (28 Sep 2007). 123 Andrew Cornelius, remarks in BVCA, The First 25 Years, n 106. 124 See case studies in R Martin, P Casson and T Nisar, Investor Engagement (Oxford, OUP, 2008) at 84ff. 125 Acharya and Kenoe, ‘Corporate Governance and Value Creation’ (2008), n 109 at 55, reporting that private equity managers spend 59% of their management time planning their exit. 126 Paul Myners, remarks in The First 25 Years, n 106, but see caution urged by Richard Lambert, remarks in the same volume.

The Inspiration from Private Equity Funds in the UK 101 which is much longer than the hedge fund median.127 In order to better understand the lessons private equity may contribute to corporate governance and performance, policy-makers in the UK commissioned Sir David Walker to chair a working group to recommend as to how private equity funds may make themselves more transparent. The Final Report issued by the Working Group recommends that private equity should as a matter of best practice report on its funds as well as portfolio firms where portfolio firms are either a) acquired by private equity firms in a public to private transaction where the market capitalisation of the firm is in excess of £300m, more than 50 per cent of revenues are generated in the UK and UK employees total in excess of 1,000 full-time equivalents; or b) where the portfolio firm is acquired by private equity firms in a secondary or non-market transaction where enterprise value at the time of the transaction is in excess of £500m, more than 50 per cent of revenues are generated in the UK and UK employees total in excess of 1,000 full-time equivalents.128 Such portfolio firms have to produce an annual review similar to the business review for public companies under the Companies Act,129 and should report as part of its risk management, the level of leverage and how the firm manages it, as well as issues relevant to stakeholders especially employees. The report on the portfolio company is recommended to be available to the public via the company’s website. The private equity fund should also report on the structure of the fund, identity of partners, its investment management and valuation of investments, to increase transparency and accountability to its investors.130 Further, the Report urges the BVCA to expand its intelligence role and to actively gather data in the private equity sector in order to fully assess private equity’s contribution to the UK economy and corporate landscape. The Report also encourages private equity firms and portfolio firms to participate in data provision in order to build up a more comprehensive picture of private equity in the UK.131 These measures may be overtaken if the EU Proposal for a Directive to Regulate Alternative Investment Fund Managers is legislated.132 The Proposal is particularly concerned about stakeholder effects from private equity acquisitions and Articles 27 and 28 require private equity funds

127 This is also supported by empirical evidence that suggests that greater returns may be generated over a longer horizon, over an average of 10 years, see A Ljungqvist and MP Richardson, ‘The Cash Flow, Return and Risk Characteristics of Private Equity’ (2003) at . 128 Walker Working Group, Guidelines for Disclosure and Transparency in Private Equity (Nov 2007) (Walker Report). 129 Section 417, Companies Act 2006. 130 See ch 5, 24–28, Walker Report. 131 See ch 6, 29–32, Walker Report. 132 See n 130 above.

102 Shareholder Activism Unveiled that have taken a stake of 30 per cent or more in a non-listed company to put in place policies for communication with and concern for stakeholders such as employees. Article 29 also requires private equity funds to make annual reports setting out how employees may have been affected by the acquisition, in terms of turnover, recruitment and termination and whether the fund has orchestrated significant divestment of assets. Mandatory disclosure as provided above will increase general intelligence into private equity activities and the benefits and costs of private equity operations. Such empirical information will likely assist to some extent the answering of some of the questions in relation to offensive activism generally, as posed earlier. 5. THE FUTURE OF OFFENSIVE SHAREHOLDER ACTIVISM

The influx of hedge funds as owners of publicly listed equity in the UK since the early 2000s and the media attention on significant private equity deals in the same period have brought about a sea-change in the perception of how shareholder activism should be conducted. Hedge funds show how aggressive persistence and proposals that may be unrelated to governance may be pushed towards management in order to generate ‘absolute’ returns. Private equity shows how the ‘closeness’ between management and ownership and the single-minded emphasis on value creation could change Board behaviour to pursue cash flow improvement and shareholder wealth. Institutional investment in these two sectors since the Myners Report has opened up institutional shareholders to the world of value creation driven by alternative investment, and may also inspire these investors to critically consider the role of shareholder activism in generating shareholder value. Pension funds now report more awareness of the principles of engagement,133 or have formulated their own policies of engagement, and do engage in more regular intervention and voting. Investment managers to whom pension funds outsource some portfolios also report that the pension funds are demanding more regular and comprehensive reports from their managers on engagement and voting.134 Would offensive shareholder activism provide a template for the kind of engaged monitoring envisaged in the stewardship era for institutional shareholders? It may be surmised that the stewardship objective may not

133 Such as formulated by the Institutional Shareholders Committee, see . 134 Information obtained from NAPF, Pension Funds’ Engagement with Companies (Aug 2007).

The Future of Offensive Shareholder Activism 103 be easily reconciled with the overtly profit-seeking motivation driving offensive shareholder activism. Further, we could argue that institutions could regard alternative investment funds that undertake offensive shareholder activism as their surrogates. The Myners Report has started the policy reform of unshackling explicit limitations on pension trustees’ investment discretion by abolishing the ‘Minimum Funding Requirement’.135 Policy-makers have watered down the spirit of minimum funding to a ‘statutory funding objective’, obliging pensions trustees to ensure that they can meet the liabilities of the fund and make appropriate disclosure to members as to how they may do so.136 Further, legal harmonisation on how collective investment schemes could be run in the EU have also tended to liberalise the range of investments collective schemes could make137 subject to certain limitations on exposure.138 Investment liberalisation has encouraged institutions to be more openminded towards alternative asset classes, and it could be argued that institutions investing in these asset classes are engaged through offensive hedge fund activists as surrogates. Institutions such as pension funds serve a semi-public purpose of safeguarding and providing savings for retirement and old age, hence, the motivations that drive pension funds would still be different from the pursuit of self-interest and ‘absolute returns’ that hedge funds focus on. Collective investment schemes are also heavily regulated by the Financial Services Authority in the interests of investor protection, and are subject to rules similar to the statutory funding objective for pension funds.139 Public interest and regulatory objectives will continue to influence the stewardship of institutional investors and this will affect how they perceive shareholder activism as a driver to create shareholder wealth. Moreover, it is arguable that the UK policy-makers’ approach to ‘value creation’ or ‘absolute returns’, in the case of hedge funds, is a cautious one. This is evidenced in the commissioning of the Large and Walker Reports in 2007 and the continued call for disclosure and transparency to be made by hedge funds and private equity, so that intelligence gathering regarding the operation and impact of hedge funds and private equity may be more

135 Pensions Act 1995, and see Myners Report at 114ff. The Minimum Funding Requirement requires pensions trustees to ensure that assets in the fund always exceed liabilities, and Myners reports that hence trustees allocate investments according to how they measure up to reference assets such as quoted equities and gilts, in order to meet the Requirement. 136 Sections 222–223, Pensions Act 2004. 137 Directive 2001/108/EC of the European Parliament and of the Council of 21 Jan 2002 amending Council Directive 85/611/EEC on the coordination of laws, regulations and administrative provisions relating to undertakings for collective investment in transferable securities (UCITS), with regard to investments of UCITS, OJ L 41, 13.2.2002. 138 See UK FSA’s Handbook on Collective Investment Schemes COLL5.2 in particular. 139 COLL 5.2.24, FSA Handbook.

104 Shareholder Activism Unveiled comprehensive. Hence, it may be too early to say that the policy-makers are drawn to the activist lessons from hedge funds and private equity. Policy-makers and regulators are arguably tentative about more offensive forms of activism carried out by these alternative investment groups, especially since it has to be discerned how ‘value creation’ by alternative investment may coincide with the vision of the ‘Enlightened Shareholder’ who ought to take a long term interest in the company including its stakeholders. By the end of 2008 the corporate and financial landscape has seen massive changes flowing from the financial crisis that hit banks. There are opposing predictions regarding shareholder activism in the UK. One is that there may be less activism, especially offensive activism such as activism carried out by hedge funds, as the corporate sector is suffering from the effects of the credit crunch/freeze and the financial fallout of banks, and hence value extraction would be difficult to mount.140 Proposals such as asking companies to restructure their capital and take on more debt and return capital to shareholders, would likely be illsuited for these times. On the other hand, the relative ignorance of risk management and questionable competence of Boards at banks hit by the financial crisis of 2008 may prompt more shareholders to respond to the reality of having to monitor their ‘agents’, and hence becoming more willing to be actively engaged. Such activism may refocus on governance issues and the quality of the Board, instead of brazen and purely offensive activism that treats activism as an investment strategy to extract value.141 Further, the fraud of Bernard Madoff142 and Allen Stanford who ran large hedge funds based in the US with many UK and European banks significantly exposed to them in terms of investments and loans, may trigger a more aggressive review of international hedge fund regulation, as is underway in the EU. On the private equity front, it may also be argued that the falling value of shares of floated private equity managers143 may prompt regulators and exchanges to look into the risk management and governance of private equity funds, and hence it is too early to unreservedly acclaim the governance example led by private equity.

140

‘Long Live Activism’, Financial Times (4 Nov 2008). ‘Activists Rise from the Ashes’, Financial Times (16 Nov 2008). 142 Uncovered in mid Dec 2008, see ‘Madoff Fall-out Spreads World-wide’, Financial Times (15 Dec 2008). 143 ‘Shares in 3i Crash as Private Equity Group Falls into the Red’, The Daily Telegraph (15 Nov 2008); KKR’s Euronext listed arm also saw share price falling until the decision was made to merge the Euronext listed arm with the US arm to be delisted from Amsterdam and listed on the New York Stock Exchange, and Blackstone’s shares on the New York Stock Exchange have by Dec 2008 lost 45% of their initial listed value. 141

Conclusion 105 6. CONCLUSION

This chapter discusses the rise of offensive shareholder activism in the UK, largely driven by the perception that shareholder activism may be carried out in an ex ante way to exploit an opportunity in a company that could deliver value in abnormal share price returns. Such activism is primarily driven as an investment strategy. The US public pension fund CalPERS has explicitly practiced such activism in the 1980s, and has influenced Hermes, one of the most activist managers of pension funds in the UK. However, Hermes and CalPERS’ activism, which often also considers the longer term value and governance of a company, is different in nature from hedge fund activism which has emerged since the millennium. Hedge fund motivations and tactics in shareholder activism may cause some concern, and there is some way before it may be said that hedge fund activism is a legitimate investment strategy well-accepted in the UK. The model of close alignment and involvement between ownership and control seen in private equity, which has also generated enormous returns in the 2000s, also raise the question as to whether more offensive forms of shareholder activism including greater shareholder involvement with management may work to unlock value in publicly listed companies in the UK. To date, the shareholder activism landscape in the UK is influenced by governance and public interest concerns and self-interested, offensive motivations. Besides, the financial crisis of 2008 will usher in an era calling for a return to ‘monitoring’, although it remains uncertain what extent of monitoring is efficacious, what cost this entails, and how this would change the investment approaches of institutions and hedge funds. The next chapter will embark on a different journey. As chapters 2 and 3 have taken stock of the empirical developments of shareholder activism in the UK, the next chapter will discuss the normative role of shareholder activism. What is the role of shareholder activism within the theoretical framework of the company and the legal framework of company law? The chapter will discuss whether shareholder activism may be theoretically supported and whether it is consistent with the legal framework and principles on shareholders’ roles and rights. Chapter 5 then discusses the concerns and issues that may arise out of shareholder activism and how these issues and concerns may be addressed. Chapter 6 concludes.

4 Theoretical Foundations and Critical Perspectives 1. SHAREHOLDERS AS OWNERS?

A

S DISCUSSED IN the previous chapters, institutional shareholder activism and offensive forms of activism practised by some hedge funds are the two dominant patterns of contemporary shareholder activism observed in the UK. Shareholder activism is often perceived as a legitimate exercise of ownership rights.1 The concept of owners as ‘principals’2 allows corporate governance to be defined partly in terms of instituting accountability to shareholders.3 Hence, shareholder activism may be

1 The UK government even considered shareholders as possibly owing a fiduciary duty to engage in appropriate activism in their investee companies, see Department of Work and Pensions, Encouraging Shareholder Activism (Consultation Paper, 2002) at , as many institutional shareholders have been known to be passive and insufficiently attentive to their investee companies’ internal governance. See H Short and K Keasey, ‘Institutional Shareholders and Corporate Governance in the UK’ in Keasey et al eds, Corporate Governance (Chicester, John Wiley and Sons) at 61–92; R Stratling, ‘General Meetings: A Dispensable Tool for Corporate Governance of Listed Companies?’ (2003) 11 Corporate Governance 74. 2 M Jensen and W Meckling, ‘Theory of the Firm: Managerial Behavior, Agency Costs and Ownership Structure’ (1976) 3 Journal of Financial Economics 305. 3 No doubt this view of corporate governance is based on the importance of the finance perspective, principally espoused as the agency problem, where owners are regarded as bearing the residual risk of corporate failure and hence having the best incentives to ensure accountability of management to them, Jensen and Meckling, ‘Theory of the Firm’ (1976) ibid; this theory is often seen as being too narrow by stakeholder theorists, but Jensen and others have argued that the ultimate accountability of the managers to owners entails managerial goals to maximise the value of the corporation and that would also create social welfare to a certain extent, see M Jensen, ‘Value Maximisation, Stakeholder Theory and the Corporate Objective Function’ reproduced in DH Chew and S Gillan eds, Corporate Governance at the Crossroads (Irwin, McGraw-Hill, 2005); FH Easterbrook and DR Fischel, The Economic Structure of Corporate Law (Cambridge, Mass, Harvard University Press, 1991) at ch 1. For generally opposing views see Margaret Blair who argues that stakeholders such as employees are also residual risk bearers, Ownership and Control (Washington DC, Brookings Institution Press, 1995); and the late John Parkinson who made prolific arguments in theory and ideology against adopting shareholder primacy as the dominant model of corporate accountability, see Corporate Power and Responsibility (Oxford, Clarendon Press, 1993) 262–71.

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legitimated in the name of protecting shareholders’ residual interests.4 This chapter intends first to make a brief but critical examination of the theoretical underpinnings of shareholder activism as an incident of ‘ownership’. Thereafter, the chapter intends to critically discuss how the practice, trends and developments in shareholder activism examined in earlier chapters may be accounted for and accommodated within the theoretical framework of the company and the legal frameworks providing for shareholder involvement. The objective of this chapter is to locate the theoretical and foundational support (or otherwise) for shareholder activism. 2. THE FABRICATION OF SHARE OWNERSHIP IN THE UK

The Legal Nature of Share Ownership A classic starting point to describe the nature of share ownership in a company is as follows: A share is the interest of a shareholder in the company measured by a sum of money, for the purpose of liability in the first place, and of interest in the second, but also consisting of a series of mutual covenants entered into by all the shareholders inter se...5

The above quotation does not actually describe the share as being an ownership interest, but a more limited interest entailing certain rights and liabilities; in fact ‘of interest in the second’ is vague as no mention is made of the nature of the interest, and where the interest specifically lies. Many commentators6 agree that the ownership label attached to share ownership begs definition, as shares represent a bundle of interests and liabilities7 that differ somewhat from a conventional understanding of ownership.8 Property theorists have often pointed out that a key feature of an ownership interest is the ability to exclude others from any use or enjoyment of the subject matter over which the ownership right is

4 See for example, LA Bebchuk, ‘The Case for Increasing Shareholder Power’ (2005) 118 Harvard Law Review 833, which will also be discussed later. Also see RA Monks, The New Global Investors (Oxford, Capstone Publishing, 2001) where the importance of investors is posited as being crucial to the sustainability of corporations and their practices. 5 Borland’s Bank v Steel Brothers & Co. Ltd [1901] 1 Ch 279. 6 J Hill, ‘Visions and Revisions of the Shareholder’ (1998) 48 American Journal of Comparative Law 39; H Bird, ‘A Critique of the Proprietary Nature of Share Rights in Australian Publicly Listed Corporations’ (1998) 22 Melbourne University Law Review 131; S Worthington, ‘Shareholders: Property, Power and Entitlement’ Parts 1 and 2 (2001) 22 Company Lawyer 258 and 307. 7 Some of the notions will be teased out shortly. 8 See R Goode, Commercial Law (London, Penguin Books, 2004) at 31–35 where ownership is defined as an absolute interest in the residual rights in property, and such interest is indefeasible.

108 Theoretical Foundations and Critical Perspectives exercised.9 One of the key characteristics that flow from the private exclusivity analysis is that property subject to an ownership right is indefeasible.10 However, shares are not indefeasible, and the private ‘ownership’ right to a share can be eclipsed by the occurrence of squeeze-outs11 either under the Companies Act12 or by provisions in the company’s Articles of Association.13 Further, it has been argued that it is perhaps inaccurate to describe proprietary rights over fungible items such as shares as ‘ownership’, as no distinction can be made between fungible assets to identify which asset is owned by a particular owner. When such assets are transferred, it is more accurate to refer to such transactions as an extinguishment of certain rights and liabilities held hitherto by a particular person, and the giving rise of a bundle of rights and liabilities to another. In short, such transfers are contractual rather than ‘property transfers’.14 A commentator has also opined that proprietary rights (or rights in rem) are no different in substance from other personal rights such as contractual rights. All rights in relation to things also define the parameters of rights and correlative duties, just like rights in relation to persons. The argument goes that maintaining a distinction between personal and proprietary rights is not substantively meaningful,15 and perhaps labelling a bundle of rights and interests as ‘proprietary’ may artificially create an aura of superiority for those rights and interests. Therefore, we are left with the perspective that share ownership gives rise to a bundle of rights and liabilities, but such a bundle sits debatably between the realm of personal and proprietary rights. As Lord Millett opined in Her Majesty’s Commissioners of Inland Revenue v Laird Group Plc: ‘It is customary to describe [a share] as “a bundle of rights and liabilities”, and this is probably the nearest that one can get to its character, provided that it is appreciated that it is more than a bundle of contractual rights. ...These rights, however, are not purely personal rights. They confer proprietary

9 HE Smith, ‘Property and Property Rules’ (2004) 79 New York University Law Review 1719; OL Reed, ‘What is Property?’ (2004) 41 American Business Law Journal 459, both arguing that private exclusivity is the hallmark of a proprietary right, and not a positive bundle of rights. 10 H Bird, ‘Proprietary Nature of Share Rights’ (1998), n 6 above. Such indefeasibility may however be subject to certain property rules in sales of goods transactions, eg Kwei Tek Chao v British Traders and Shippers Ltd [1954] 2 QB 459 or by governmental acquisition and compensation legislation. 11 Referring to majority buy-outs of minority shares under certain circumstances. 12 Section 979 on squeeze-outs in a takeover situation. 13 Such provisions in the company’s Articles, if secured by amendment, may also be reviewed by the court, see especially in Australia, Gambotto & Anor v WCP Limited & Anor (1995) 182 CLR 432 HCA. 14 JS Rogers, ‘Negotiability, Property and Identity’ (1990–91) 12 Cardozo Law Review 471. 15 P Ereftheriadis, ‘The Analysis of Property Rights’ (1996) 16 Oxford Journal of Legal Studies 31.

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rights in the company though not in its property’.16 The nature of share ownership is thus judicially affirmed to be superior to merely personal or contractual rights, but is not quite akin to fully-fledged proprietary rights. This chapter argues that the proprietary label attached to shares is perhaps derived from its external dimension, ie in relation to its transferability, although that does not relate precisely to a share in corporate assets ie the internal dimension (both aspects to be discussed shortly). The fabrication of share ownership, as a proprietary rather than personal notion, has been important for the following reasons: (a) shares need to be regarded as tradeable assets; (b) private property notions such as ownership rights attached to equity investments in companies are important to the development of investment capitalism. The growth of the modern corporation very much depends on investment capitalism. In an earlier paper, this author has argued that business growth requires investment in the form of equity and there is a limit to the roles of debt and retained earnings as sources of corporate finance.17 Equity investment is arguably only attractive if investment securities are able to pass good title to the holder, and are tradeable so that the holder can then freely transfer such securities. Easy transferability could be further supported by liquid stock markets in those securities.18 Hence, the aspect of a share as an investment asset that could be held or transferred is fundamentally important to both the issuing corporation and the shareholder. This is the external dimension of the share, ie the proprietary nature of the share as an asset recognised by the issuing corporation, and the market. The proprietary notion attached to a share is fundamental in ensuring that there is no doubt as to its asset quality. The nature of investment instruments as assets then allows them to be fabricated in terms of economic resources that may be allocated and protected from arbitrary expropriation19 viz ‘Protecting private property rights [in share ownership] is vital for preventing coercion, securing liberty and enhancing personal welfare. The recognition of equity as asset is hence arguably crucial to the development of an investment economy. Empirical work also demonstrates a strong positive association between

16

[2003] UKHL 54 at para 35. IH-Y Chiu, ‘Can UK Small Businesses Obtain Growth Capital in the Public Equity Markets? An Overview of the Shortcomings in the UK and European Securities Regulation and Considerations for Reform’ (2004) 28 Delaware Journal of Corporate Law 933. 18 R Goode, Commercial Law, n 8 at 570. 19 H Demsetz, ‘Toward A Theory of Property Rights II: The Competition between Private and Collective Ownership’ (2002) 31 Journal of Legal Studies 653; R Coase, ‘The Problem of Social Cost’ (1960) 3 Journal of Law and Economics 1. 17

110 Theoretical Foundations and Critical Perspectives the advancement in economic development in any country and the degree to which the country protects private property rights’.20 The legal protection of the share asset as private property is key to stimulating economic activity in relation to the investment market.21 However, what is not completely and clearly defined, is the internal dimension of the share. In other words, the share is clearly identified as a proprietary asset in its external dimension. Such a proprietary fabrication of the share allows the share to be a commodity supplied to and demanded for by the market and hence bought and sold. But what other enjoyment can be derived from the share as an incident of property, as regards the holder of the share? Does the holder of a share own any part of the issuing corporation? This refers to the internal dimension of the share, and it is the internal dimension that this chapter focuses on to determine if and to what extent the enjoyment of ownership (other than in transferability) in a share may form the basis to support the different forms of contemporary shareholder activism. The external dimension of a share, which is supported by proprietary notions of ownership, serves the purpose of facilitating the acceptance of equity as an asset, and the free transferability of shares. However, the external dimension of the share should arguably not be borrowed to fabricate the internal dimension of a share. The bundle of rights in the internal dimension of a share may still be argued to be ‘proprietary’ in nature, as these rights allocate control over certain corporate decisions to shareholders, such as decisions to be made by the general meeting.22 Recent judicial opinion such as Lord Millett’s view in Her Majesty’s Commissioners of Inland Revenue v Laird Group Plc,23 accepts that there is a proprietary character attaching to the rights in shares, although not attaching to any corporate property as such. However, where precisely may we say that the proprietary rights lie? In Henry Smith’s conceptualisation of ownership property rights,24 which is distinguished from

20 R Levine, ‘Law, Endowments and Property Rights’ (2005) 19 Journal of Economic Perspectives 61. 21 See Weber’s exposition explained in R Collins, ‘Weber’s Last Theory of Capitalism’ (1980) 45 American Sociological Review 925 on how private property rights in general are indispensable to the economic use of assets towards maximum efficiency. WC Mitchell, ‘Commons on the Legal Foundations of Capitalism’ (1924) 14 The American Economic Review 24; S Bowles and H Gintis, Democracy and Capitalism: Property, Community, and the Contradictions of Modern Social Thought (NY, Basic Books, 1998). 22 S-O Collin, ‘Governance Strategy: A Property Right Approach Turning Governance into Action’ (2007) 11 Journal of Managerial Governance 215; M Whincop and JA Armour, ‘The Proprietary Foundations of Corporate Law’ (2007) 27 Oxford Journal of Legal Studies 42; CJ Milhaupt, ‘Property Rights in Firms’ (1998) 84 Virginia Law Review 1145. 23 [2003] UKHL 54 at para 35, as discussed shortly before. 24 Smith, ‘Property and Property Rules’ (2004) n 9 above; HE Smith, ‘Exclusion and Governance: Two Strategies for Delineating Property Rights’ (2002) 31 Journal of Legal Studies 453.

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what he terms as ‘governance rights’, Smith describes governance rights as existing in the rules of liability permitting defined actions and treating certain other actions as forms of encroachment. As rules of liability define each permitted action vis-a-vis the property concerned, they are different from ownership rights. Ownership rights are defined in the ability to exclude others so there is therefore no need to define a bundle of rights ie governance rights over the property. In Smith’s conceptualisation, a bundle of rights representing certain extents of control would merely be a form of governance, and is not to be regarded as ownership. Many would acknowledge that a stronger case may be made for saying that proprietary rights in the firm actually lie with management as management has the power to make decisions directly regarding the use and allocation of corporate assets (although subject also to mandatory duties in law). Although the legal fiction of the corporation actually owns the assets, the bundle of proprietary rights over the assets is in reality exercised by management.25 The right of the Board to manage is defined as ‘general authority’ and a right to exercise ‘all the powers of the company’.26 This is consistent with Smith’s conceptualisation of ownership as having an unspecified bundle of powers. It may be argued that the Board is but an agent of the shareholders, as finance economists suggest. However, ‘agency’ as understood in finance economics is rather different from under the law. An agent in law derives the remit of powers from the principal under a contractual arrangement (and even in apparent authority, such authority is derived from the principal’s representation27 to begin with). However, the powers of the Board and shareholders are not only determined by contract but also by law. The relationship between the Board and shareholders is often seen in a paradigm of ‘division’ of roles, and the law has also frequently regarded the proper principal of the Board to be the real entity, the company. Division of Powers and Director Primacy under the Law? The ‘‘division of powers” paradigm is arguably the dominant legal paradigm that defines the relationship between management and shareholders, as the law does not seem to subscribe to a pure conception of ‘agency’, regarding directors as merely agents for shareholders. This is arguably indicated in the case of Breckland Group Holdings Ltd v London & Suffolk Properties Ltd & Ors28 where a majority shareholder’s usurpation of the power to 25 J McDermott, Corporate Society: Class, Property and Contemporary Capitalism (Boulder, West View Press, 1991) 80–91. 26 Art 2, Model Articles for Private Companies Limited by Shares, and Model Articles for Public Companies. Such a position is similar to the predecessor to the Model Articles, Art 70, Table A of the Companies Act 1985. 27 Freeman and Lockyer v Buckhurst Park Properties [1964] 2 QB 480. 28 (1988) 4 BCC. 542.

112 Theoretical Foundations and Critical Perspectives institute proceedings against a minority shareholder was set aside as the decision had to be taken by the Board. Where the Board is to have general management authority, English law has quite firmly held that shareholders do not have the arbitrary power to intervene. It could be argued that this is a ‘default’ and not ‘mandatory’ position in UK company law as the Board’s powers and authority are derived from the Articles of the company, and the Model Articles conferring power generally on management would apply only in default of the company’s specific constitutional provisions on the matter. Hence, it is arguable that members in a company could set out Articles to limit what the Board may do and augment the discretion of the general meeting. However, in reality, the division of powers is very entrenched, especially in public and listed companies. In practice, it is more likely than not that the Board’s powers are not derived from a conscious contractual formulation drawn up by shareholders. The default position on management powers provided by the Model Articles defines the accountability paradigm of the Board as to the real entity, the company. Worthington has argued that the evolution of the company is characterised by a form of depersonification from its membership,29 and the law has also frequently affirmed that Boards serve the interests of the company and not the interests of shareholders as such.30 In Howard Smith v Ampol Petroleum,31 the directors recommended a higher takeover offer over the lower takeover offer tendered by an existing shareholder. This was contrary to the majority shareholders’ wishes. The first instance and appeal courts opined that the directors had not acted wrongly, as they acted in accordance with the company’s best interests. In the House of Lords, the decision went in favour of the shareholders as the results of allotment to the higher bidder adversely affected the balance of shareholding and this was held to be ‘improper’. But Lord Wilberforce stated in agreement with the submissions on behalf of the company, that ‘[it] is established that directors, within their management powers, may take decisions against the wishes of the majority of shareholders, and indeed that the majority of shareholders cannot control them in the exercise of these powers while they remain in office (Automatic Self-Cleansing Filter Syndicate Co. Ltd v Cuninghame [1906] 2 Ch 34).32 Further, a series of cases dealing with the nature of the directors’ employment contracts may also highlight that the

29

Worthington, ‘Shareholders: Property, Power and Entitlement’ (2001) n 6. Ashburton Oil NL v Alpha Minerals NL, (1971) 123 CLR 614 at 620; Long Acre Press Ltd v Odhams Press Ltd [1930] 2 Ch 196 also affirms that where directors have the discretion to set aside certain profits to be retained by the company before paying interest or dividends, such a decision made in the best interests of the company could not be challenged by even majority shareholders. 31 Howard Smith Ltd Appellant v Ampol Petroleum Ltd and Others Respondents [1974] AC 821. 32 Ibid at 837. 30

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law treats members of the company as distinct from the company as a real entity. In many small companies, the terms of directors’ employment with the company could be spelt out in the Articles of the company. As the Articles are a contractual document representing the relationship between members inter se,33 only members acting in the capacity of members are able to enforce the Articles in court.34 Terms benefitting or relating to directors are often not enforceable as directors are regarded not to have a contract with members of the company as such.35 If the law upholds the agency model of corporate governance and directors are treated as agents of shareholders, then surely shareholders can embody in a document that represents their collective agreement, the terms of the agency. However, the court regards directors as being contractually employed by the company as a real entity, and the provisions of the Articles dealing with directors may not be enforced as such, but may to some extent be implied into the employment contract.36 Hence, the legal framework is heavily based on the ‘real entity’ theory as the company’s interest, as discussed above, is regarded as distinguished from shareholders’ interests.37 That is why a shareholder’s nominee director on the Board should serve the company’s interests first and foremost and it would be a breach of duty if such director does not consider the company’s interests and only considers the appointing shareholder’s interests.38 Even where shareholders engage in the activity of voting to amend Articles, the ‘real entity’ theory is arguably at work as the vote must be exercised bona fides for the benefit of the company as a whole.39 Finally, in the case of Short v Treasury Commissioners, it is stated

33

Hickman v Kent or Romney Marsh Sheepbreeders Association [1915] 1 Ch 881. Eley v Positive Government Security Life Assurance Co. (1876) 1 Ex.D. 88. 35 See Read v Astoria Garage (Streatham) Ltd [1952] Ch 637; Southern Foundries v Shirlaw [1940] AC 743. 36 Read v Astoria, ibid. Also arguably, the old cases of Swabey v Port Darwin Gold Mining Co (1889) 1 Meg 385 and Shuttleworth v Cox Bros & Co (Maidenhead) Ltd [1927] 2 KB 9 allow such a contract itself to be inferred from the Articles, but this inferred approach still confirms for us the difficulty for the court in treating the members’ document, the Articles as an agreement itself between members and management. Directors are firmly regarded to be employed by the real entity, the company. 37 s 170(1), Companies Act 2006. 38 Scottish Co-operative Wholesale Society Ltd v Meyer [1959] AC 324; Kuwait Asia Bank E.C. v National Mutual Life [1990] 3 All ER 404. It is however arguable that Cobden Investments Ltd v RMW Langport Ltd & Ors [2008] EWHC 2810 may have now relaxed the position a little by allowing express and ex ante modification of a nominee director’s duty. 39 Allen v Gold Reefs of West Africa, Ltd [1900] 1 Ch 656, although this position has been somewhat changed by the interpretation given in the later case of Greenhalgh v Ardene Cinemas Ltd [1951] Ch 286 where the benefit for the company as a whole is to be determined by the ‘reasonable corporator’. This arguably links shareholders’ interest to be the same as what benefits the company, and such a presupposition may be questioned. However, the ‘reasonable corporator’ is itself a fiction and hence it could be argued that there is no difference between the two expositions. 34

114 Theoretical Foundations and Critical Perspectives that ‘shareholders are not, in the eye of the law, part owners of the undertaking’.40 Shareholders do not have a proprietary stake in the assets of the company, the ‘real entity’, as has been affirmed in the much more recent case of Her Majesty’s Commissioners of Inland Revenue v Laird Group Plc41. But why do many commentators and the judiciary accept that shareholders’ powers have a ‘proprietary character?’ This may be partly attributed to the legal position that shareholders have certain powers of control in the company. For example, shareholders may exercise a reserve power42 to direct management if shareholders procure a special resolution to do so, and hence, the enabling framework in company law may allow shareholders in exceptional circumstances to override management. English law has always accorded a special provision to the equity capital suppliers of the firm, and this may be due to the fact that companies evolved out of partnership law, and until 1855, members of a company did not have limited liability.43 Equity providers were not seen as a collective mass of anonymous persons but often as participants in the company. Reserve Power, Reversion of Power and Ratification The recognition of the reserve power is explained in the seminal case of Quin & Axtens v Salmon.44 In that case, a company with two directors was supposed to comply with an Article providing that all decisions with respect to acquiring or letting of property required the consent of both directors. One director dissented and the other procured a general meeting where the resolution of securing a lease was passed by simple majority. It was held that only if the resolution were passed by a special majority would the resolution be binding on the company. Hence, the case reserved residual management power to the general meeting only if the general meeting exercised such power with a three-fourths majority. This position has now been adopted in the Model Articles under the Companies Act which form the default constitution for companies.45 The UK legal regime has provided for a generous regime of governance for shareholders through the reserve power, which is not available in the US. The exercise of the reserve power may arguably be regarded as an acceptance of proprietary notions in the concept of share ownership, as the exercise of the reserve power could deal with corporate assets. 40

Short v Treasury Commissioners [1948] 1 KB 116. n 16 above. 42 Art 3, ibid, codifying the position in Quin & Axtens v Salmon [1909] AC 442. 43 R Grantham, ‘The Doctrinal Basis of the Rights of Company Shareholders’ (1998) Cambridge Law Journal 554. 44 Quin & Axtens v Salmon, n 42 above. 45 Art 4. 41

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Further, case law allows for a reversion of power from the Board to the general meeting in limited cases that feature management deadlocks.46 Today, in publicly listed companies where shareholding is heavily dispersed, it is arguable if the reserve power could be called upon. However, the regime of the reserve power or reversion of power may support an ‘ownership’ fabrication of shareholders’ rights. Today, the theoretical support of such a fabrication lies in the ‘residual claimant’ theory in institutional economics, which has evolved to favour shareholders as a key entity in the company. This will be shortly discussed. The law acknowledges the special nature of shareholders’ bundle of interests, and the reserve power goes fairly close to a fabrication of ownership. Shareholders are also endowed with a general power of ratification in such a way that shareholders are treated as the only organ of the company that can decide whether to forgive or enforce against irregularities committed against the company. In case law47 and now under the Companies Act 2006,48 shareholders have the power to ratify any breaches of duty or default committed against the company by directors. The exclusive power of ratification means that other constituents do not have a say in this.49 It is also to be noted that shareholders’ power of ratification may be exercised according to their freedom to vote50 and the Allen v Gold Reefs51 limitation arguably does not apply. Mandatory law also confers on shareholders specific governance rights to which we shall turn and these arguably reinforce the perception that shareholders are ‘residual owners’. However, it is arguable that the legal regime does not unequivocally support shareholder primacy, such as the aspects of law supporting director primacy as discussed above. Changes made to the law of directors’ duties under the Companies Act 2006 may also arguably shape our perception of the internal dimension of share ownership. The chapter now turns to examine the contesting aspects of the legal regime in framing shareholders’ governance and rights in a company.

46 Eg Re Opera Photographic [1989] BCLC 763; Union Music Ltd v Watson Arias Ltd v Blacknight Ltd [2004] BCC 37, these cases concerned whether a shareholder could ask the court to order the convention of a general meeting in order to resolve any deadlock in management, but the court has used such power carefully so that reversion is granted only when it is necessary for the general meeting to make a management decision that otherwise would not be made. The court has refrained from aiding the calling of general meeting with an often amended quorum if doing so will override minority and class rights that were sought to be protected, see Ross v Telford [1997] BCC 945. 47 Bamford v Bamford [1970] Ch 202. 48 s 239. 49 Foss v Harbottle (1843) 2 Hare 461; Bamford v Bamford [1970] Ch 202, now see s 239 for a statutory codification. 50 Northern Counties Securities Ltd v Jackson & Steeple Ltd [1974] 2 All ER 625. 51 Allen v Gold Reefs of West Africa Limited n 39.

116 Theoretical Foundations and Critical Perspectives Governance and Control Rights: The Nature of Share Ownership Nature of the Right to Vote The key governance right derived from share ownership is the right to vote. Shareholders are entitled to vote on their shares ‘as an incident of property’,52 and so the legal framework recognises voting as the main control mechanism for shareholders to participate in the governance of a company. A vote allows an expression of preference between given options, but the nature of the vote is such that only the collective aggregation of votes into a majority matters for the outcome,53 and hence, the allocation of an individual right to vote does not per se entail the exercise of strong powers such as those inherent in the exclusionary nature of ownership rights. But it is nevertheless a right of participation and hence judicial acceptance of this right as an ‘incident of property’.54 That said, the right to vote may translate into stronger forms of control and exercise of ownership rights under certain situations. This would be the case in companies with a concentrated large blockholding where shareholders are in the position to vote themselves or trusted persons onto the Board, and the right to vote becomes a strong control right that can ultimately translate into decisions directly affecting corporate assets. Commentators have observed how concentrated large blockholding held particularly by families affect the management expertise, and decisions of the company,55 as well as the use, acquisition or disposal of corporate assets.56 This is also the case where the right to vote may be weighted, so that significant control can be achieved in spite of a small stake.57 Further,

52 Northern Counties v Jackson & Steeple [1974] 1 WLR 1133; North-West Transportation Co Ltd v Beatty (1887) 12 App Cas 589. 53 KJ Arrow, Social Choice and Individual Values 2nd ed (Conn, Yale University Press, 1970), also argues that the social choice aggregated from the voting decisions need not provide the most optimal outcome for all participants. 54 Northern Counties v Jackson & Steeple, n 52. 55 Collin, ‘Governance Strategy’ (2007) n 22; RH Carlsson, Ownership and Value Creation (Chicester, John Wiley and Sons, 2001) on how Swedish owners who are also in management bring various forms of input and motivational impetus to the corporation. 56 DL Kang and AB Sorensen, ‘Ownership, Organisation and Firm Performance’ (1999) 25 Annual Review of Sociology 121. Reports of tunnelling and extraction of corporate value for private interest are also rife, see R Gilson, ‘Controlling Shareholders and Corporate Governance’ An ECGI Working Paper 49/2005, available at ; M Ararat, B Sener and E Taboglu, ‘v-Net: a Case of Family Owned Conglomerates’ in C Mallin ed, International Corporate Governance: A Case Study Approach (Cheltenham, Edward Elgar, 2006) ch 11, 269–83. 57 Bushell v Faith [1970] AC 1099. Also the weighted voting structures frequently used in family-founded firms even where the founding family shareholders are no longer in the majority, see J Agnblad, E Berglof, P Hogfeldt and H Svancar, ‘Ownership and Control in Sweden: Strong Owners, Weak Minorities and Social Control’ in F Barca and M Becht eds, The Control of Corporate Europe (Oxford, OUP, 2002) 250–55.

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the majority vote at a general meeting may indicate the general meeting’s advice to management, and where the majority vote is a super-majority, the special resolution could direct management to be bound to take certain courses of action,58 which is earlier described as the shareholders’ reserve power. Where the right to vote is concentrated, sufficiently collective or sufficiently weighted, it can be used to further the exercise of exclusionary rights over corporate assets and decisions, and hence, depending on how the voting structures are constructed, the ownership of shares could practically translate into ownership rights over the company itself. Shareholders’ Role under Mandatory Law The mandatory framework in company law has arguably played a key role in reinforcing the ownership notion underlying the holding of shares. This is because the mandatory framework in company law has co-opted shareholders into a governing role vis-a-vis management, especially in situations where directors may face conflicts of interest involving corporate resources. Such a co-option seems to be based on the perspective that sees shareholders as the ultimate residual claimants of a company. The Companies Act 2006, like its predecessors, reserves certain decisions to shareholder meetings, or prohibits certain executive decisions to be made unless shareholders approve. Provisions dealing with the appointment and removal of directors are examples of the former.59 Such powers may translate into the direct or indirect exercise of ownership rights in the firm, as may often be the case in concentrated blockheld companies. Further, directors or their connected persons are not allowed to enter into substantial property transactions with the company,60 or to benefit from a company loan or quasi-loan61 or other credit transaction,62 without the approval of shareholders by an ordinary resolution. These provisions co-opt shareholders into monitoring the prospects of selfdealing by management, and in turn allow the exercise of a form of proprietary control for shareholders. Further, directors acting in conflicts of interest and duty may seek shareholder approval for the transactions and shareholder approval hence takes on a gatekeeping function to ensure that directors are allowed to proceed without running the risk of a breach of fiduciary duties.63 Mandatory law has also provided for shareholders

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Quin & Axtens v Salmon [1909] AC 442, now codified in Art 3, Model Articles, n 42. Sections 160, 168–9, Companies Act 2006, and s 188 in respect of long-service contracts exceeding two years with the company. Appointments may however be made just by the Board under the Model Articles, although this may be modified by companies. 60 ss 190–196. 61 ss 197–200, 213–214. 62 ss 201–214. 63 s 175(4), s 180. 59

118 Theoretical Foundations and Critical Perspectives to have the right of ratification or otherwise of breaches, negligence or omissions committed by directors.64 The right of shareholder ratification seems particularly based on the perspective of shareholders as residual risk bearers and hence the exclusive right to act as assessors of whether or not it is appropriate to accept irregularities committed by management. Are Shareholders Residual Claimants or Owners? The residual claimant theory was developed from economic theory on the organisation of a firm. Coase’s famous theorem65 argued that firms were organised in order to internalise certain contractual arrangements on a revolving basis, such arrangements would otherwise have to be sourced on the market. Williamson took Coase’s theorem one step further by showing how internalisation minimised opportunity costs (or transaction costs) that took place with repeated on-market arrangements. The organisation of a firm was based on the efficiency of economic arrangements minimising transaction costs that would otherwise have been incurred on the market.66 However, the internalisation of a firm as a nexus of contracts would feature some long term open-ended contracts as specific rights that are unlikely to be completely spelt out in an ongoing relationship where myriad possibilities exist. These open-ended long term contracts include shareholder’s investments in a company or long term employees’ service in the firm.67 Such open-ended contracts would result in continuous negotiations and arrangements over time, and hence it is argued that ‘[the] Board of directors thus arises endogenously, as a means by which to safeguard the investments of those who face a diffuse but significant risk of expropriation because the assets in question are numerous and ill-defined and cannot be protected in a well-focussed, transaction-specific way’.68 But who are these residual risk bearers whose investments are long term and ill-defined? Alchian and Demsetz69 argue that the internalisation of a nexus of contracts within a firm must be subject to a centralised contractual agent that organises the input into the team production process of the firm. The ‘investments’ made by different entities in the nexus would be the different inputs made by investors, employees and other stakeholders as part of a ‘team’. The centralised contractual agent that organises the inputs would be the directors. They should however be monitored

64 Foss v Harbottle (1843) 2 Hare 461, now enshrined with modification in s 239, Companies Act 2006. 65 RH Coase, ‘The Nature of the Firm’ (1937) 4 Economica 386. 66 OE Williamson, The Economic Institutions of Capitalism (NY, Free Press, 1985) at 15ff. 67 Ibid at 306. 68 Ibid. 69 AA Alchian and H Demsetz, ‘Production, Information Costs and Economic Organisation’ (1972) 62 The American Economic Review 777.

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in order that they do not shirk the responsibility in overseeing the due deployment of inputs into the team production process. In order for the monitor to be incentivised to carry out monitoring of the contractual agent, s/he could be designated a residual owner of the net earnings of the firm so that s/he would not likely shirk the monitoring responsibility. This gives rise to the paradigm of the firm as being organised by management and management would be monitored by residual owners. However, it is not necessary, from this thesis, to deduce that shareholders must be the residual owners. Constituents who fall within this category arguably include shareholders, long term creditors and employees. Another group of economists took the contractual relationships constituting the firm to another level: the level of property rights. Grossman and Hart70 argue that in order for the contractual relationships in the firm to be sustained, contractual relationships must spell out either specific rights or residual rights. Where specific rights cannot be spelt out and the rights are long term, unspecific and residual, the holder of residual rights in effect holds proprietary rights over the net assets of firm. Hart71 argues that as the organisation of the firm is centred around the use of the nonhuman assets of the firm, the residual rights should then be structured as residual ownership rights over those assets.72 Hence, the residual claim over the firm’s net assets as a ‘proprietary right’ is an efficient means to achieve the monitoring essential to a diffuse team of constituents in the nexus of contracts. If so, such proprietary rights are based on notions of efficiency and not fundamental or moral rights.73

70 SJ Grossman and OD Hart, ‘The Costs and Benefits of Ownership: A Theory of Vertical and Lateral Integration’ (1986) 94 Journal of Political Economy 691. 71 OD Hart, ‘An Economist’s Perspective on the Theory of the Firm’ (1989) 89 Columbia Law Review 1757. 72 This view may arguably become outdated as suggested in CF Sabel and JE Prokop, ‘Stabilisation through Reorganisation’ in R Frydman et al eds, Corporate Governance in Central Europe and Russia (Budapest, London, NY, Central European University Press, 1996) at 151. Frydman et al argue that new economies need not be built upon capitalistic notions of residual ownership of corporate assets and decisions made by the pricing mechanism of the free market. This is because production is getting harder and more product runs are short, making work organisation less based on product-specific property but on more flexible forms of property that can be used for all sorts of production. This means that suppliers, firms and customers should combine with each other at different points to produce a collaborative network that may always be changing. In this context, to make residual owners who also have diversified portfolios as economic owners and responsibility for firm decisions may not be optimal. Alternative forms of defining ownership of residual assets that are decoupled from control is necessary, and that will allow more collaborative frameworks to arise so that governance may be provided by different actors who have different incentives to drive production as may be necessary. 73 For example, proprietary rights derived from one’s labour as opined by Locke. Locke’s theories, as well as Kant’s ‘will theory’ are discussed in J Riedinger, ‘Property Rights and Democracy: Philosophical and Economic Considerations’ (1993) 22 Capital Unviersity Law Review 893.

120 Theoretical Foundations and Critical Perspectives The ‘finance perspective’ of the firm introduced by Jensen and Meckling is crucial to our recognition of shareholders as the residual claimants in the firm with property rights. The ‘finance’ perspective places emphasis on the role of the capital providers to the firm ie shareholders and creditors. Jensen and Meckling assume a model of separation of capital provision from managerial control, and opine that the capital providers would be interested in maximising the cash flow rights and residual value of the firm while managers may be interested in maximising their private utility and job satisfaction. The relationship between owners, managers and creditors would entail agency costs.74 The structure of the firm would then depend on the monitoring and bonding activities undertaken by creditors and shareholders to reduce management expropriation of private benefit in their position of control.75 They also opine that although capital will always be a mixture of debt and equity, debt produces enormous agency costs for creditors and costs for both the manager and the firm itself in being constrained by various covenants, and hence debt is not a preferred source of finance. From a finance perspective, the separation of ownership from control creates conflicts of objectives between shareholders and management, and management may direct the firm into transactions that need not necessarily maximise the net cash flow for shareholders. This represents agency costs for shareholders, and hence they bear the residual risk of the value outcome of the firm.76 The finance perspective is arguably responsible for identifying the shareholder as the residual claimant/owner developed in organisational economic theory. Agency costs is therefore seen as the dominant factor affecting the risk borne by shareholders, but is a necessary evil, as Fama and Jensen argue that from an organisational perspective, the separation of professional managers from diverse shareholders is still most likely to be efficient.77 However, the antidote to the power of control would be to subject management to the interests of the residual risk bearers, and hence shareholder primacy. The development of shareholder primacy is founded both on the perspectives of shareholders as ‘principals’ or controlling agents, and as residual claimants/owners in the firm. These perspectives accept shareholders as residual claimants with rights of a proprietary nature. These perspectives also allow shareholder primacy to develop as a governing norm in

74 Although Berle has earlier described directors as trustees of power in managing the corporation, it is finance literature that has brought out the negative self-dealing incentives of the ‘trustees’ to the forefront, see AA Berle, ‘Corporation Powers as Powers in Trust’ (1931) 44 Harvard Law Review 1049. 75 M Jensen and W Meckling, ‘Theory of the Firm’ (1976) n 2. 76 EF Fama and MC Jensen, ‘Separation of Ownership from Control’ (1983) 26 Journal of Law and Economics 1. 77 Ibid.

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corporate governance. Shareholder primacy would define management’s role to be the maximisation of cash flow rights and shareholders’ wealth.78 These theoretical perspectives lend support to the fabrication of ‘ownership’ of the firm by shareholders, and corporate governance theories based on shareholder primacy. It is even arguable that mandatory law such as shareholder controls on director expropriation (which, as earlier discussed, are imposed under mandatory law since the Companies Act 1985), are derived from this perspective of shareholders as ‘owners’.79 However, the legal framework on the whole is still arguably ambivalent in recognising shareholders as the only residual owners, as will be discussed below. The finance perspective, supporting shareholders as residual owners and shareholder primacy, has been criticised by a number of leading proponents. Margaret Blair has criticised the shareholder primacy model for being based on an erroneous assumption that only shareholders are residual risk bearers. Blair argues that employees are also a class of residual risk bearers as they acquire firm specific expertise and the longer they work for the firm, the less likely they will be able to move freely to another job. Long service employees hence make a firm-specific investment and are residual risk bearers of a firm’s insolvency.80 Blair together with Lynn Stout have developed a director primacy theory in which they argue that directors must maintain their primary roles in managing the different inputs into a firm, including those of shareholders, employees and creditors, and allowing shareholder primacy to dictate the objectives of the firm is misplaced.81 This augments Dodd’s early model that managers are trustees for the corporation as a real entity.82 This school of thought

78 F Easterbrook and D Fischel, The Economic Structure of Corporate Law (Mass, Harvard University Press, 1986). 79 The Companies Act 1948 contains significantly fewer and less detailed provisions controlling director expropriation, than later Companies Acts. The provisions controlling directors’ transactions with the company were first introduced in Part IV of the Companies Act 1980, thereafter consolidated as Part X of the Companies Act 1985, and now retained in the 2006 Act. The 1980 Act’s provisions may be attributable to the explosion of awareness of the agency problem developed in finance literature in the 1970s and 80s. 80 M Blair, Ownership and Control (Washington DC, Brookings Institution Press, 1995) 223–45. 81 M Blair and L Stout, ‘A Team Production Theory of Corporate Law’ (1999) 85 Virginia Law Review 248; M Blair and L Stout, ‘Specific Investment: Explaining Anomalies in Corporate Law’ (2006) 31 Journal of Corporation Law 719 seems in accord also with theorists who view labour as another form of capital and hence refuse to accord primacy only to cash capital suppliers, see A Alchian and D Woodward, ‘The Firm Is Dead; Long Live The Firm. A Review of Oliver E. Williamson’s The Economic Institutions of Capitalism’ (1988) 26 Journal of Economic Literature 65. Also see L Stout, ‘The Mythical Benefits of Shareholder Control’ (2007) 93 Virginia Law Review 789 and Worthington, ‘Shareholders: Property, Power and Entitlement’ (2001) n 6 where an ‘ownership’ fabrication of shareholdership is rejected and it is also argued that there is no entitlement on the part of shareholders to require firms to be run for their primary interests. 82 EM Dodd, ‘For Whom are Corporate Managers Trustees?’ (1932) 45 Harvard Law Review 1057.

122 Theoretical Foundations and Critical Perspectives that endorses director primacy is arguably in line with the Model Articles and Breckland Holdings, and is wary of shareholders taking advantage of their position to interfere with management in order to satisfy their private interests.83 The economists Alchian and Woodward also argue that the view that treats shareholders as residual claimants over non-specific firm value and hence superior to the other constituents in the firm is erroneous. They argue that managers invest firm-specific input not only in terms of expertise, but frequently in terms of investment capital too, and similarly for employees of the firm. That is why many professional firms are labour-owned and not capital-owned, as the input by labour is regarded as specific and not-time limited to the firm, and there is no reason why labour should not be responsible for administering the proprietary decisions over the firm and share in the residual claims.84 In their words, ‘First, the leader of a team (management) is the member with the comparative advantage in deciding what the team and its members should do, and this manager need not be an owner or even part-owner in the firm; second, ownership of the team is the residual claimancy on the most team-specific resources, which may be labor or capital. To start an analysis of firms by assuming the presence of “capital” or that capital hires labor is to beg the question of the basis for the existence of a firm’. Further, modern perspectives of the firm see the firm not as an organisation built around assets that are used towards a production of the same outputs, but as networks of resources that can be combined, collapsed and re-combined to produce a variety of outputs for competitive markets. Such a view allows a network of interacting and flexible relationships to be organised. This organisation is less based on pools of stable property, hence even diminishing the stature of the capital provider as a ‘residual claimant’.85 This perspective sees resource providers as being

83 These concerns are voiced by M Lipton and PK Rowe, ‘The Inconvenient Truth about Corporate Governance: Some Thoughts on Vice-Chancellor Strine’s Essay’ (2007) 33 Journal of Corporate Law 63; JN Gordon, ‘Shareholder Initiative and Delegation: A Social Choice and Game Theoretic Approach to Corporate Law’ (1991) 60 University of Cincinnati Law Review. 347; L Stout, ‘Shareholders Unplugged’, LEGAL AFF., Mar–Apr 2006, at 21, available at ; TN Mirvis, PK Rowe and W Savitt, ‘Bebchuk’s Case for Increasing Shareholder Power: An Opposition’ (2005) at ; SM Bainbridge, ‘Director Primacy and Shareholder Disempowerment’ (2006) 119 Harvard Law Review 1735; I Anabtawi, ‘Some Skepticism about Increasing Shareholder Power’ (2006) 53 UCLA Law Review 561. Further, it is also argued that stronger regimes of director primacy arose in the law in the US precisely because shareholders could and have engaged in selfish extraction of corporate value and giving them primacy could cause serious instability for the corporation and many externalities to stakeholders, see AD Boyer, ‘Activist Shareholders, Corporate Directors, and Institutional Investment: Some Lessons From The Robber Barons’ (1993) 50 Washington and Lee Review 977. 84 Alchian and Woodward, ‘The Firm Is Dead’ (1988) n 81. 85 Sabel and Prokop, ‘Stabilisation through Reorganisation’ n 72 at 151.

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able to move freely and flexibly with less committal to particular economic arrangements in order to meet changing production objectives, and directly challenges the model of the long term residual claimant and shareholder primacy. Another school of thought that disagrees with shareholder primacy approaches from the social welfare stance. Parkinson86 argues that the emphasis on wealth maximisation may be misplaced when looked at in the context of social or moral welfare. In considering these other priorities, he advocates a model that includes other stakeholders such as employees, arguing that employees need to have a right to democratic self-government in an organisation, and such rights should not be sidelined by conventional efficiency and ‘capital as property’ perspectives. This school of thought is echoed in many other ‘stakeholder’ theories87 that reject the analysis of shareholder primacy from the finance perspective. Modern developments may also undermine the finance perspective. The finance perspective is based on recognising that shareholders bear the greatest amount of residual risk in the firm due to agency costs. The assumption made by all institutional economists is that the residual claimant is subject to a long term, undefined and open-ended risk of expropriation of the firm’s assets, hence, the residual claimant is placed in a passive risk-bearing position. If shareholders’ risk is gradually being mitigated or dissipated by other means outside of the boundaries of the firm, then they may be less affected by agency costs within the firm, and according them primacy for being the most vulnerable residual risk bearers may then become misplaced. For example, many modern shareholders of firms are institutions such as pension funds, mutual funds and hedge funds. These funds, being professionally managed, are diversified, or are able to hedge their investments in order to mitigate risk. Next, some shareholders are able to enter into arrangements where they do not bear the risk of cash flow rights but only have ‘naked’ voting rights. In situations where the cash flow rights have been decoupled from voting rights, can we really say that the holder of the voting rights bears a residual risk in the firm?88 Partnoy and Martin discuss how the

86

JE Parkinson, Corporate Power and Responsibility (Oxford, OUP, 1993). S Turnbull, ‘Stakeholder Governance: A Cybernetic and Property Rights Analysis’ (1997) 5 Scholarly Research and Theory Papers 11; TI Nwanji and K Howell, ‘The Stakeholder Theory in the Modern Global Business Environment’ (2008) 1 International Journal of Applied Institutional Governance at ; CA Williams, ‘Corporate Social Responsibility in an Era of Economic Globalization’ (2002) 35 UC Davis Law Review 705. 88 HT Hu and B Black, ‘The New Vote Buying: Empty Voting and Hidden (Morphable) Ownership’ (2006) 76 Southern California Law Review 811 and ‘Equity and Debt Decoupling and Empty Voting II’ (2008) 156 University of Pennsylvania Law Review 625. 87

124 Theoretical Foundations and Critical Perspectives decoupling of rights in shares affects the propensity to vote, and point out the perversity of allowing certain technical ‘holders’ of shares to vote who may have economic interests adverse to the firm.89 It is also documented that many joint venture shareholders have complex arrangements where cash flow rights, voting rights, liquidation rights and Board representation rights may all be separated, and hence, it may be too simplistic to hold on to a perception of the ‘shareholder as a vulnerable residual risk bearer’ in the firm.90 Further, one needs to query if the residual claimant is premised on an assumption of risk exposure over the long term. If so, should a short term shareholder necessarily be treated as a residual claimant? (Although arguably it may be difficult to say when a shareholder may dispose of his stake, but hedge funds for example have been known to move on from an investment after 2–3 years91 and hence it is arguable that there could be some empirical support to regard them as having certain predictable investment horizons). However, how do we explain the favourable treatment mandatory law gives to shareholders, by co-opting shareholders to participate and make certain exclusive decisions in the company? It is arguable that the co-option of shareholders to exercise strong governance rights over potentially conflicting transactions involving directors is a means of affirming the special proprietary nature of the shareholders’ rights as residual claimants. On the other hand, it can equally be argued that co-opting shareholders to gatekeep director abuse of the company in transactions where conflicts of interests occur need not be based on the shareholders’ proprietary claim to the company or a fabrication of ‘ownership’ in the company. Regulatory theory92 argues that the complexities of modern regulation often make it difficult for regulators to have comprehensive oversight or control over all forms of wrong-doing. Regulators therefore co-opt other actors in the market as these have their own resources, and natural incentives to perform certain roles that would achieve a regulatory effect. This is the idea of the ‘regulatory space’ as discussed in chapter 2. Hence, the role that mandatory law has given to shareholders may arguably be read no more than in that light, and may not represent the law’s endorsement of a fabrication of ‘ownership’. Further, as discussed

89 F Partnoy and S Martin, ‘Encumbered Shares’ (2004) at . 90 H Takizowa, ‘New Institutional Arrangements for Product Innovation in Silicon Valley’ in L Sun ed, Ownership and Governance of Enterprises: Recent Innovative Developments (Basingstoke, Palgrave Macmillan, 2003) at 69. 91 See chapter 3. 92 C Scott, ‘Analysing Regulatory Space: Fragmented Resources and Institutional Design’ (2001) Public Law 32; J Black, ‘Decentring Regulation’ (2001) Current Legal Problems 103; J Black, ‘Enrolling Actors in Regulatory Systems: Examples from UK Financial Services Regulation’ (2003) Public Law 63.

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earlier, the legal framework is largely supportive of the perspective of the company as ‘a real entity’, and has often made distinctions between the ‘real entity’s interest’ and the interest of shareholders, not unequivocally supporting shareholder primacy. Although shareholders have ‘reserve powers’ that can intervene specifically in a management decision, and can contract for powers of control in a company under the enabling framework of company law, there are aspects in company law that do not accord shareholders with primacy. Worthington93 has argued that whether we view the company as a ‘nexus of contracts’ or as a ‘real entity’, the legal framework does not support any assertion that shareholders are entitled to have directors run the company for the purpose of shareholder wealth maximisation. The ‘nexus’ perspective allows companies to be seen as a web of interactions among constituents, but the theory itself does not give primacy to shareholders. It is only if we accept the finance economists’ attribution of importance to the shareholder as a special residual risk bearer (at least in terms of financial capital) that a primary position can be accorded to shareholders. The law recognises that shareholders risk their capital in the company for the long term without easy prospects of withdrawing the capital.94 But shareholders are ameliorated by the rule on limited liability, and the prospect that their shares can ordinarily (subject to contractual restrictions in Articles) be sold in a liquid market or privately. Further, there are countervailing aspects in mandatory law that do not seem to support a pure form of shareholder primacy. Rules on transaction avoidance,95 directors’ duties to creditors during the twilight of a company,96 and provisions protecting creditors at a voluntary liquidation,97 are examples in company law that clearly allow others’ concerns to be given priority over shareholders under certain circumstances. Further, the Companies Act 2006 requires directors to consider a wide range of stakeholders’ interests in the discharge of directors’ duties,98 and the need for shareholders to consider stakeholders’ interests is reiterated in provisions dealing with how derivative actions99 are to be pursued. These are examples of when shareholder primacy does not rule. It is however arguable that although section 170 of the Companies Act 2006 sets out that directors’ duties are owed to the company, s172 may arguably contradict that position by saying that ‘[a] director of a company

93

Worthington, ‘Shareholders: Property, Power and Entitlement’ (2001) n 6. Trevor v Whitworth (1887) 12 App Cas 409, and modern day limitations in the rules on maintenance of capital. 95 ss 238, 239 and 245, Insolvency Act 1986. 96 The Liquidator of West Mercia Safetyware Ltd v Dodd [1988] 4 BCC 30. 97 Eg s 84, 89 of the Insolvency Act 1986 (consolidated version). 98 s 172, Companies Act 2006. 99 ss 263(2) and (3), Companies Act 2006. 94

126 Theoretical Foundations and Critical Perspectives must act in the way he considers, in good faith, would be most likely to promote the success of the company for the benefit of its members as a whole…’. Section 172 may arguably define the best interests of the company to be the benefit of its members as a whole, hence giving a position of primacy to shareholders.100 Even if s172 requires directors to also consider stakeholders’ interests, these are arguably subordinate. However, as s172 has been enacted against the backdrop of ‘Enlightened Shareholder Value’, it is arguably unlikely that s172 would be used to support pure forms of shareholder primacy. The White Paper to the review of the Companies Act 2006 states: The statement of [directors’] duties will be drafted in a way which reflects modern business needs and wider expectations of responsible business behaviour. The CLR proposed that the basic goal for directors should be the success of the company for the benefit of its members as a whole; but that, to reach this goal, directors would need to take a properly balanced view of the implications of decisions over time and foster effective relationships with employees, customers and suppliers, and in the community more widely.101

The duties of directors are geared towards the hypothetical long term shareholder with a view to sustaining the benefit of the members as a whole and considering the balance of stakeholders’ interests. A pure perspective of shareholder primacy is arguably not supported,102 although commentators wonder how the hypothetical long term and balanced interests of the company may actually be enforced and by whom.103 The legal framework in the UK arguably has the following features: (a) Unless otherwise modified, the enabling legal framework provides for director primacy; (b) Shareholders have a reserve power to direct management in a specific resolution passed by special majority, but not a general power of interference; (c) Shareholders are empowered under general mandatory law to have exclusive governance over various areas such as appointment and removal of directors, approval of certain transactions and in ratification;

100 P Davies, ‘The Enlightened Shareholder Value and New Responsibilities of Directors’ also at 1–9. 101 Para 3.3, DTI, Company Law Reform (2005) Cmnd.6456. 102 D Attenborough, ‘The Company Law Reform Bill: An Analysis of Directors’ Duties and the Objective of the Company’ [2006] Company Lawyer 162. 103 See A Keay, ‘Section 172(1) of the Companies Act 2006: An Interpretation and Assessment’ (2007) Company Lawyer 106 who affirms the legislative effort to include stakeholders’ interests in a statement on directors’ duties but wonders how such a statement may be enforced.

The Theoretical and Legal Foundations of Shareholder Activism 127 (d) But directors are allowed to consider other constituents’ interests and above all, the interests of the ‘real entity’, the company, above shareholders. The above analyses show that the fabrication of shareholders as ‘owners’ has come largely from a finance perspective whose dominance may not be completely warranted. However, there are aspects of enabling and mandatory company law that seem to support this fabrication—viz (a) the enabling framework of company law can allow shareholders to contract for substantial control over corporate decisions and assets, making their power more ‘proprietary’ in nature, although this is rarely the approach taken in public and listed companies that uphold the division of powers in the default Model Articles; (b) mandatory law tends to co-opt shareholders as the exclusive group in monitoring directors’ actions and transactions, and in formally participating in the governance of the company. This seems to reinforce the conception of the shareholder as residual owner, although the co-option of institutional shareholders in particular is, as discussed in chapter 2, increasingly for the purpose of providing a form of governance in the ‘regulatory space’. In sum, the law does not unequivocally support shareholder primacy, but it does provide a special place of influence and even control for shareholders. Against this backdrop, this chapter will go on to critically discuss the practice of shareholder activism in widely held publicly listed companies in the UK. 3. THE THEORETICAL AND LEGAL FOUNDATIONS OF SHAREHOLDER ACTIVISM

In Tsuk Mitchell’s insightful article,104 shareholders in the US are conceptualised as ‘investors’ whose primary right is to sell out if unhappy with the investment, rather than as participants in the internal reform of companies. This conceptualisation is supported by the federal law’s emphasis on securities market regulation and transparency, over prescriptive corporate governance. Such an approach underlies the political antagonism against concentrated power, favouring dispersal of corporate ownership amongst dispersed investors.105 Although the same political culture is absent in the UK, it is arguable that the UK and

104 D Tsuk Mitchell, ‘Shareholders as Proxies: The Contours of Shareholder Democracy’ (2006) 65 Washington and Lee Law Review 4. 105 M Roe, Strong Managers, Weak Owners (NJ, Princeton University Press, 1996).

128 Theoretical Foundations and Critical Perspectives the US have converged106 in the ownership structure of firms since the dispersal of ownership and the rise of institutional shareholders have been the dominant feature in publicly listed companies in the UK. Although there is no deliberate ideological movement towards dispersal of shareholding, the evolution of investment capitalism and pension saving in the UK has led to a similar shareholding structure in most of the public listed companies in the UK. Dispersal of ownership and the rise of the managerial class are the key features of corporate governance and company law in the UK. The following will now relate the practice of shareholder activism in the UK to the theoretical and legal conceptions of share ownership earlier discussed. This is intended to critically locate the foundations of shareholder activism.

Two Paradigms of Shareholder Activism Shareholder Activism as a Bargaining Process Shareholders are given a role in law to exercise certain governance and control rights, and the theoretical paradigm of agency and residual claimants point to shareholders as key entities in the internal framework of the company. As the firm is characterised as a nexus of contracts, shareholder activism could be viewed as part of the bargaining process between shareholders and companies. In the basic paradigm of contractual bargaining, actors in the bargaining process rationally bargain to maximise their respective interests. The offensive forms of shareholder activism discussed in chapter 3 reflect that type of bargaining behaviour. What about institutional shareholder activism in the UK? It is arguable whether institutional shareholder activism in the UK is directly aimed at bargaining for their investment interests. The ABI in the UK,107 and early shareholder activists such as CalPERS in the US and other US public pension funds such as TIAA-CREF, and investment managers such as Hermes in the UK, seem to believe in the relationship between governance and performance. Campaigns that have surrounded issues such as making executive compensation linked to performance,108 removal of anti-takeover

106 H Hansmann and R Kraakman, ‘The End of History for Corporate Law’ (2001) 89 Georgetown Law Journal 439–68. 107 M Selvaggi and J Upton, Governance and Performance in Corporate Britain: Evidence from the IVIS Colour-coding System (ABI Research Paper 7, 2008). 108 KJ Martin and RS Thomas, ‘The Effect of Shareholder Proposals on Executive Compensation’ (1999) 67 University of Cincinnati Law Review 1021, discussing shareholder activism against excessive remuneration for CEOs of underperforming companies.

The Theoretical and Legal Foundations of Shareholder Activism 129 defences109 and changing Board composition to include independent directors, and other stakeholder concerns such as employment and environment,110 are all seen as measures that could be linked to improvement in share values. However, the link between governance and performance is not unequivocal.111 Chapter 2 has also argued that UK institutional shareholder activism is motivated more clearly by policy leadership than pure investment concerns. The recent articulation of shareholders as ‘stewards’ also challenges the basic theoretical paradigm of characterising shareholder activism as a ‘bargaining process’ in the nexus of contracts. This chapter intends to start by looking at the theoretical paradigm of shareholder activism first as a bargaining process, an outworking of the internal contracting in the nexus of contracts, and then to discuss the implications of perceiving shareholder activism as beyond bargaining, and in furtherance of public good. In sum, the book will consider the competing schools of theory underlying the company and company law ie the contractarian and communitarian perspectives, and discuss how shareholder activism may be accommodated and legitimated, or otherwise, within those frameworks. The contractarian perspective sees the company as a nexus of contracts entered into by constituents in order to internalise transactions within the structure of a firm that may otherwise be costlier to achieve in the market (the Coasean view). Hence, the constituents with long term, openended commitments to the nexus need freedom to bargain and adjust their contracts to meet their changing needs. A significant role for the

109 Particularly in the US, as the UK has always had a friendly regime supporting takeovers and discouraging the use of anti-takeover defences such as the poison pill. 110 K Rehbein, S Waddock and SB Graves, ‘Understanding Shareholder Activism: Which Corporations are Targeted?’ (2004) 43 Business and Society 239. 111 This is also consistent with empirical findings on the financial impact of shareholder activism. Most literature argues that the financial impact on share prices may be mildly significant in the short run, but long term impact on operating performance is almost nonexistent, see M Smith, ‘Shareholder Activism by Institutional Investors: Evidence from CalPERS’ (1996) 51 Journal of Finance 227; JM Karpoff, ‘The Impact of Shareholder Activism in Target Companies: A Survey of Empirical Findings’ (2001) available at ; S Wahal, ‘Pension Fund Activism and Firm Performance’ (1996) 31 Journal of Financial and Quantitative Analysis 1. See Becht et al, ‘The Control of Corporate Europe’ (2008) n 57 on the discussion of returns to shareholders in the form of increased share prices after activism. Where hedge funds is concerned, similar findings of short term share price abnormal returns are recorded after activism, see NM Boyson and RM Mooradian, ‘Hedge Funds as Shareholder Activists from 1994–2005’ (2007) at ; C Clifford, ‘Value Creation or Destruction? Hedge Funds as Shareholder Activists’ (2007) at ; A Brav, W Jiang, RS Thomas and F Partnoy, ‘Hedge Fund Activism, Corporate Governance and Firm Performance’ (2007) at . But see adverse findings on hedge fund activism on long term operating performance of the firm, Y Allaire and M Firsirotu, ‘Hedge Funds as “Activist Shareholders”: Passing Phenomenon or Grave-Diggers of Public Corporations?’ (2007) at .

130 Theoretical Foundations and Critical Perspectives law is to facilitate the effective realisation of the contracting process. The communitarian view of the company sees the company as a real entity in itself and as a social institution that affects and impacts on society and the community. Its actions should therefore be governed by notions of wider responsibility and redistributive fairness.112 The book will critically locate the dominant patterns of shareholder activism in the UK in both theoretical points of view, and will seek to discuss shareholder activism with reference to two issues: (a) the legitimation of shareholder activism as part of the open-ended contracting process in the nexus, and (b) secondly, the legitmation of shareholder activism in its contribution or otherwise to social benefit as a whole. Even if communitarian perspectives of the company may not be dominant especially in AngloAmerican jurisdictions, the existence of social benefit may arguably provide a form of legitimacy for shareholder activism. Further, as chapter 2 has discussed, recent articulations of shareholders as ‘stewards’ may now bring us closer to adopting a more communitarian model of the company and company law. In sum, shareholder activism in the UK may be represented in the paradigm as follows: Target Company

Offensive Activists Investment value Social Benefit?

Target Company

Institutions

Investment Value? Social Benefit

112 M Bradley, C Schipani, AK Sundaram and JP Walsh, ‘The Purposes and Accountability of the Corporation in Contemporary Society: Corporate Governance at a Crossroads’ (2000) 62 Law and Contemporary Problems 9 discusses the competition between the two perspectives and although the article contends that the contractarian perspective would find itself the winner at the end of the day, the article acknowledges the flaws of the contractarian model, many of which would be resolved by taking a communitarian approach to some aspects of company theory and law.

Institutional Shareholder Activism as Open-Ended Contracting 131 The diagram above encapsulates the main arguments in this chapter, viz offensive activism may be seen as a bargaining process between shareholder activists who aim at profit-making for themselves from such activism. The book is more sceptical of the social benefit aspect of such activism, as will be discussed below in Part 5 of this chapter. As for institutional shareholder activism, the multiple arrows emanating from the institutions to the target represent the complexity in the institutions’ representative capacity. The policy drivers for such activism may motivate institutions to engage in an issue that has wider ramifications beyond self-interest, and hence such activism may not merely be self-interested bargaining but also representative bargaining for other constituents even if this representation is not intentionally undertaken. Although short term investment value is not necessarily achieved through institutional shareholder activism, much more consensus is found for long term value and socially beneficial implications such as better stakeholder management and relations. The contractarian perspective allows this chapter to discuss the nature and legitimacy of the bargaining process in shareholder activism. The communitarian perspective allows this chapter to examine the ‘output legitimacy’ of shareholder activism, in terms of what is achieved, whether in terms of investment value gains or social benefit. It is this book’s view that empirical literature dealing with the link between activism and corporate performance alone is inadequate in itself to legitimate the practice of shareholder activism. Taking theoretical perspectives allows us to locate the foundational legitimacy of shareholder activism, as well as its consequences and wider implications.

4. INSTITUTIONAL SHAREHOLDER ACTIVISM AS OPEN-ENDED CONTRACTING

Turning first to institutional shareholder activism, this part of the chapter will explore such activism as a bargaining process in the nexus of contracts, and will argue that institutional shareholder activism is well situated within the theoretical and legal framework of the company, and in particular, two features are essential to reinforce the theoretical support: (a) the representative nature of institutional shareholder activism in the nexus of contracts; and (b) the legitimacy gained by the social benefit that ensues from the activism. In the open-ended contracting process, shareholder activism could be carried out to meet any contractual intentions. However, institutional

132 Theoretical Foundations and Critical Perspectives shareholders in the UK have focussed on issues that are governancecentric, and within the enabling framework of company law. For example, shareholder activism in relation to the appointment or removal of directors, or in relation to the composition of the Board, are matters falling within the enabling framework of company law, as shareholders are by default under the Model Articles and statute given a role in matters of appointment and removal. Perceived as such, shareholder activism may be regarded as part of the natural contractual outworking of the nexus of contracts, refining and giving certainty to terms that have been left open for the outworking of the contractual process in the company. This type of shareholder activism is termed as ‘open-ended contracting’ in this book. Shareholder activism of the ‘open-ended contracting’ type is arguably prima facie a legitimate outworking of the bargaining process in the nexus of contracts. Further, matters of governance enshrined under the Corporate Governance Code, as soft law, are also matters that are intended to be worked out between shareholders and the company in the open-ended contracting process. The Cadbury Report stated: ‘[t]he obligation on companies to state how far they comply with the Code provides institutional and individual shareholders with a ready-made agenda for their representations to boards. It is up to them to put it to good use’ (at para 6.16, Cadbury Report, emphasis mine). I have elsewhere argued113 that the soft law nature of the Code is consistent with the enabling framework in company law, and perhaps should even be elevated into the enabling framework of company law. Corporate governance deals with Board responsibility, composition, the independent institutions and relations with shareholders. These matters in the Code also form a template for the open-ended contracting process, similar to the outworking of the enabling framework in company law.114 As institutional shareholder activism (discussed in chapter 2) is heavily concerned with corporate governance issues, shareholder rights and compliance with the Code, institutions engaging on these issues prima facie fall within the open-ended contracting process within the nexus of contracts. The position on executive remuneration is however arguably less clear, as the law merely gives shareholders an advisory vote on executive remuneration,115 and executive remuneration may be seen as an issue of allocation of resources by the company (which is a role for management under the general mandate to manage the company). Executive remuneration

113 IH-Y Chiu, ‘The Role of a Company’s Constitution in Corporate Governance’ (2009) Journal of Business Law 697. 114 R Nolan, ‘The Continuing Evolution of Shareholder Governance’ (2006) Cambridge Law Journal 92. 115 Directors’ Remuneration Report Regulations (2000).

Institutional Shareholder Activism as Open-Ended Contracting 133 may be regarded as an area that does not fall squarely within the enabling framework of company law that facilitates the open-ended contracting process, and this may explain why institutional shareholder activism has had little success in challenging the bloated awards that companies make. However, executive remuneration is by its nature a key agency problem where managerial self-interests are at stake, and hence it is puzzling as to why shareholders do not have governance over this issue as they would have under mandatory law in respect of matters such as directors’ transactions with the company. At present, executive remuneration has now been recognised to entail issues affecting social benefit,116 and it has been placed on the regulatory radar screen in order that issues of public interest may be addressed in the public sphere of governance. The future of governance in executive remuneration issues is likely to provide some insight as to how corporate governance issues of a public interest may be dealt with and to what extent shareholder activism as an essentially contractual process of bargaining is able to provide private and social governance. Turning back to institutional shareholder activism in the UK as a form of ‘open-ended contracting’, it is argued that theoretical and legal support for such activism may be particularly derived from the representative nature of such activism. The acceptance of institutional shareholder activism as being situated within the enabling framework of company law does not per se mean that such activism is legitimate. A concern that could arise would be: could institutional shareholder activism be a form of improper pressure in contracting, and is activism unfair to other constituents in the nexus of contracts within the firm? If we accept the finance perspective of the special position of shareholders as ‘residual claimants’, it may be argued that activism is not an improper form of pressure because shareholders as ‘residual owners’ have the right117 to bargain over an open-ended range of matters. However, as discussed above, any proprietary notion attached to share ownership is limited and not absolute, hence, it remains relevant to consider if the process of activism may be regarded as legitimate in the nexus of contracts. Even if a shareholder activist campaigns for an issue that is unregulated or within the enabling framework of company law, it may be possible that the activist is pushing for an agenda that would not be accepted

116 D Walker, A Review of Corporate Governance in UK Banks and Other Entities in the Financial Services Industry (Nov 2009) at ch7, also para 1.5. 117 What one has a right to carry out may not be regarded as a form of improper pressure or coercion upon another, see A Wertheimer, Coercion (Princeton NJ, Princeton University Press, 1987), commented on by T Honore, ‘A Theory of Coercion’ (1990) Oxford Journal of Legal Studies 94.

134 Theoretical Foundations and Critical Perspectives by other shareholders. If such a campaign is tabled as a resolution and put to a vote, then the general meeting is allowed to decide. However, as the law only allows a shareholder with at least 10 per centof the shareholding to call an extra-ordinary general meeting to vote on proposals, it may be argued that the law closes the door to an activist that cannot meet that threshold. Hence, such an activist may go informally to the Board. If the Board succumbs to that pressure, without the matter going to a vote, the activist would arguably have excluded other shareholders from the bargaining process in the nexus of contracts. This would be ironic given that a minority shareholder with less than 10 per cent shareholding is conferred less power under the law. The law has frequently been involved in striking a balance between allowing an individual shareholder to pursue his grievances,118 and not allowing certain individual grievances to undermine the collective outworking of all shareholders’ interests in a company.119 Hence, it is imperative that shareholder activism in the extra-legal realm be examined carefully to discern to what extent the legal framework that protects other shareholders’ interests may be undermined. If we accept an ‘ownership’ and the proprietary fabrication of shareholders’ rights in a company, the danger of that being combined with shareholder activism is that: proprietary notions often give rise to and justify self-interested behaviour to the exclusion of others, that is the essence of property,120 and this may be used to justify activists’ informal engagement to the exclusion of others, or even the extraction of private benefits for themselves. Proprietary notions underlie the phenomenon of allowing concentrated shareholders of a company who are also in management to expropriate private benefits through their position in the company, often at the expense of minority shareholders.121 Since there is broad consensus122 that majority extraction of private benefit needs to be controlled, and regulated, would there not be a case for examining the extent of private benefit extraction by minority activists which did not involve other shareholders? If activists could influence direct implementation of changes they propose without going to a vote, and/or extract private benefit for themselves in the process, then the minority shareholding of an activist shareholder may be regarded as in disproportion to its

118

s 994, Companies Act 2006. For example, enforcement of personal rights in the Articles may be trumped by collective ratification, see MacDougall v Gardiner (1875) 1 Ch 13 , or that a shareholder’s campaign to amend the company’s constitution has to be subject to the collective benefit of the company, Allen v Gold Reefs of West Africa, n 39. 120 OL Reed, ‘What is Property?’ (2004) n 9 above. 121 RJ Gilsson, ‘Controlling Shareholders and Corporate Governance: Complicating the Comparative Taxonomy’ (2005) ECGI Working Paper. 122 World Bank, Minority Shareholders (Aug 2003) at http://rru.worldbank.org/documents/publicpolicyjournal/265Capau-082003.pdf. 119

Institutional Shareholder Activism as Open-Ended Contracting 135 power, and the exercise of such power, in the extraction of private benefit must be examined carefully.123 It could be argued that where an activist exercises informal pressure on the Board without taking into account collective opinion in the general body of shareholders and stakeholders, a Board bowing to such an activist may be in breach of directors’ duty in failing to take the course of action that best benefits the real entity, the company itself.124 However, such a course of action does not address the real concern, if it were remotely to succeed. Penalising the Board for taking on board certain activists’ demands may affect the value of the company for the other shareholders and stakeholders, especially if the activists have already extracted their private benefits. The activist could also be regarded as a shadow director under UK law if the Board is accustomed to listening to and acting on his wishes,125 but if an activist merely engages in an intensive short term campaign the necessary pattern of Board obeisance over a significant period of time, as required under the law, may not be established. Hence, it is argued that even if an activist is acting consistently with the open-ended contractual process within the nexus of contracts, the appropriation of private power through activism and its impact on other shareholders and stakeholders needs to be considered carefully as to its desirability. The legal framework at present arguably does not address this issue, since minority shareholder remedies in the UK126 may not be applicable against a minority activist shareholder, and legal controls over directors’ duties or shadow directors may not sufficiently address the concern. As the dominant type of institutional shareholder activism in the UK relates mainly to voting and exercising voice at meetings, the issues raised above are unlikely to become a grave concern. The majority of institutional shareholder activism is carried out in such a way that is usually inclusive of the collective body of shareholders and is sufficiently public. However, institutional activism may also be carried out in private via informal engagement with the company, and the Code of Stewardship proposed in the Walker Review now envisages increased informal engagement as a matter of best practice.127 Hence it is important that a balance should be found between such informal engagement pursuant to the perceived social good, and the concerns of undermining

123 RJ Gilsson and JN Gordon, ‘Controlling Controlling Shareholders’ ECGI Working Paper (2001) at ; I Anabtawi and L Stout, ‘Fiduciary Duties for Activist Shareholders’ (2008) 60 Stanford Law Review 1255. 124 s 172, Companies Act 2006; Re Smith v Fawcett Ltd (1942) 1 All ER 116. 125 Secretary of State v Deverell [2001] Ch 340. 126 Section 994, Companies Act 2006. 127 Ch5, Walker Review Final Report, also see UK Stewardship Code (July 2010) at .

136 Theoretical Foundations and Critical Perspectives the collectivity of the general meeting. Hermes for example, uses mainly private negotiations on an intensive level to push for changes in the target company. This book regards Hermes’ activism as more of an offensive form of activism which shall be discussed shortly in the second paradigm of shareholder activism. It is acknowledged that if an extra-ordinary general meeting is called for every new matter in the open-ended contracting process that a shareholder wishes to establish, this could be unduly cumbersome and costly for the company and may also be disruptive. Furthermore, the extra-ordinary general meeting has often been viewed not as a means of outworking in the natural open-ended contracting process but as a hostile response made public. That said, given that many institutions do not hold up to 10 per cent of a company’s stock, and would often require the collective action of others to call an extra-ordinary general meeting, the 10 per cent threshold could act as a mechanism to facilitate collective dialogue and discussion within the nexus. Hence, as policy-makers are moving towards encouraging more intense activism,128 especially beyond meetings, it is imperative to look into how the law may facilitate collectivity in the open-ended contracting process, so that the process is inclusive and consistent with the nature of the nexus. Besides the FSA Clarification on institutional shareholder activism, the Walker Review has also called for the law to encourage and take a benign position with respect to shareholder dialogue and collective action in activism that is pursuant to the open-ended contracting process. In particular, safe harbours would be developed by the FSA in relation to fears regarding market abuse and concert parties.129 The present climate is not likely to be antagonistic to institutional shareholder activists even if they engage in private activism. This is because such engagement usually relates to corporate governance improvements and shareholder rights, and may be perceived to be in a ‘representative’ capacity to benefit other shareholders.130 Further, it may be argued that shareholders not actively participating in the activist campaign are generally supportive of the activism, as the activist shareholders help in overcoming the free-riding problem faced in the collective action dilemma amongst shareholders.131 There has been no reported evidence of counter-activism or anti-activism. Hence, the current conduct of institutional shareholders in the UK and general evidence of acceptance and support

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Recommendations 18B–20, Walker Review Final Report. Recommendation 20B, Walker Review Final Report. 130 IB Lee, ‘Corporate Law, Profit-Maximisation and the Responsible Shareholder’ (2005) 10 Stanford Journal of Law, Business and Finance 31. 131 Smith, ‘Shareholder Activism by Institutional Investors’ (1996), n 111. 129

Institutional Shareholder Activism as Open-Ended Contracting 137 from the industry mean that issues of improper pressure and unfairness in the nexus are unlikely to be mounted. The perspective of institutional shareholder activism as ‘open-ended contracting’ locates such activism within the internal governance of the company, and is hence prima facie not related to issues of social good. Any social benefit of such activism would therefore be a by-product of the bargaining process132 although that could help in the positive perception and acceptance of such activism. However, in response to the Walker Review, institutions would have to become more engaged in private activism. Such private activism would be a form of intelligent and considered monitoring of investee companies, not based merely on the corporate governance industry’s advisory work on how to vote in accordance with the blueprint of the Code. The Review is concerned with the hitherto inadequate level of activism, as it is believed that tougher shareholder scrutiny may have revealed the weaknesses in the UK banks that failed in the global financial crisis.133 It is suggested that going forward, institutions’ increased private engagement with companies would still have to be reviewed in terms of the effects upon the collectivity of the general meeting. Further, as private forms of activism may undermine the collectivity of the general meeting, it is submitted that the trade-off may only be justified if there is evidence of social benefit that entails. Empirical evidence needs to be gathered as to the social good such activism achieves. As policy-makers are have given a more intense mandate to institutional shareholders to engage with their investee companies for the purposes of public interest, the theoretical location of institutional shareholder activism may move from the ‘open-ended contracting’ process in the enabling framework of company law, to a more communitarian model of company law, where corporate governance entails a wider accountability than being confined to the nexus of contracts. This book submits that this is the key dilemma for policy-makers and company law theorists in the UK. The underlying freedom in the ‘open-contracting

132 Although some commentators insist that shareholder value maximisation will also result in the maximisation of utility of stakeholders, beginning with the classic piece by M Friedman, ‘The Social Responsibility of Business Is to Increase Its Profits’ (NY Times, 1970); MC Jensen, ‘Value Maximization, Stakeholder Theory, and the Corporate Objective Function’ (2002) 12 Business Ethics Quarterly 235; HG Manne and HC Wallich, The Modern Corporation and Social Responsibility (Washington, American Enterprise Institute for Public Policy, 1972); BS Black and R Kraakman, ‘A Self-Enforcing Model of Corporate Law’ (1996) 109 Harvard Law Review 1911; H Hansmann and R Kraakman, ‘The End of History for Corporate Law’ (2001) 89 Georgetown Law Journal 439; P Goldenberg, ‘Shareholders vs Stakeholders: The Bogus Argument’ (1998) 19 Company Lawyer 34. 133 The Financial Times columnist John Plender however thinks that shareholders are not likely to be able to do more than what they currently do in their role, see ‘Banking: Rarely Pointed Finger’, Financial Times (17 Jan 2010).

138 Theoretical Foundations and Critical Perspectives process’, to engage or not to engage, is being replaced by articulations of share ownership as a form of stewardship whose social legitimacy has to be sustained. However, we are short of adopting a communitarian model of the company that also expressly articulates that companies are obliged to be governed for the wider social good and not merely the good of the shareholders. This is arguably not a satisfactory position if the company is still regarded as an internal nexus of contracts, but the bargaining process that shareholders engage in would have to be guided by notions of public interest and good. Further, there is a need to ascertain that instances of activism are based on and are likely to deliver public interest, where such activism may depart from the collective and open forms of activism surrounding general meetings. The existence of social benefit would be regarded as an important legitimating factor as contributing to common good and reinforcing common acceptance and legitimacy.134 For example, calls for reforming excessive executive compensation may entail a social benefit in lessening the gap between top managers and employees, and may be perceived as having a distributive benefit as corporate gains are not concentrated at the top.135 Hence, the call to institutional shareholders to engage more intensely in private forms of activism should be followed by objective study into the effects of such activism, especially if these forms of activism move away from the collective and open forms of representative activism in general meetings as currently practised. Empirical evidence should ascertain if social benefit such as better stakeholder relations or improved perceptions of social responsibility may entail, as these may indicate the existence of wider social benefits flowing from the activism.136 Empirical research seems to suggest a link between improved corporate governance and stakeholder relations, as improvements in governance often lead to strategic reconfigurations in stakeholder relations, such as employee, supplier or customer relations, improving the longer term operating performance of the company.137 However, empirical research is less conclusive on the link between corporate governance

134 Common good as a legitimating factor is discussed in other contexts in articles such as L Häikiö, ‘Expertise, Representation and the Common Good: Grounds for Legitimacy in the Urban Governance Network’ (2007) 44 Urban Studies 2147; S Collignon, ‘The Three Sources of Legitimacy for European Fiscal Policy’ (2007) 28 International Political Science Review 155. 135 The Walker Review’s recommendation to widen the remuneration committee’s remit to look at remuneration of all employees as a whole may be in tune with this social concern. See Recommendation 29, Walker Review Final Report. 136 Although it is acknowledged that measurements of corporate social responsibility are still being developed, the Global Reporting Initiative for example has standardised many social responsibility issues into a highly usable template. 137 B Scholtens and Y Zhou, ‘Stakeholder Relations and Financial Performance’ (2008) 16 Sustainable Development 213; R Baukol, ‘Corporate Governance and Social Responsibility’ (2002) Caux Round Table, Tokyo.

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and social responsibility in general, such as better labour policies in the supply chain, respect for human rights or support for communities.138 To date, empirical research indicates that social responsibility may flow from better financial performance, but may also lead to better financial performance.139 It has been noted in the US that some activism has also been framed in terms of both sound corporate governance and corporate social responsibility, showing that activists are keen to garner wider legitimacy for activism being consistent with public interest and long term considerations.140 Hence, there is room for further research to elucidate the link between wider social benefit and more intense forms of private institutional shareholder activism. In sum, it is important and necessary for policy-makers to encourage and fund research into looking at the conduct of private activism by institutions, the trade-off between intensity in private engagement and collectivity in the general meeting and the social benefit that could entail from such private engagement. Empirical evidence is also needed to shed light on how notions of public interest may work with the perception of shareholder activism as located within the theoretical contracting process in the internal governance of the company. 5. OFFENSIVE ACTIVISM, VALUE EXTRACTION AND EXIT

Chapter 3 has discussed a contemporary form of shareholder activism described as ‘offensive activism’, and this part of the chapter now critically looks into whether and how offensive activism may be accommodated or otherwise in the theoretical and legal framework of the company. Offensive forms of shareholder activism generally relate to issues that could entail value extraction from the company for the benefit of the activist. Such value extraction may be achieved by a reallocation of the company’s assets, for example, by selling off certain businesses or assets,141 scaling down international operations,142 scaling down

138 L Starks, ‘Corporate Governance and Social Responsibility’ (2009) EFA Keynote Speech, University of Texas at Austin. 139 MG Soana, ‘The Relationship between Corporate Social Performance and Corporate Financial Performance in the Banking Sector’ at http://ssrn.com/abstract=1325956; M Orlitzky, FL Schmidt and SL Rynes, ‘Corporate Social and Financial Performance: A MetaAnalysis’ (2003) 24 Organisation Studies 403; S Waddock, ‘The Corporate Social PerformanceFinancial Performance Link’ (1997) 18 Strategic Management 303. 140 B Rogers, ‘The Complexities of Shareholder Primacy—A Response to Sanford Jacoby’ (2008) 30 Comparative Labour Law and Policy Journal 95. 141 Nelson Peltz’s Trian Fund campaign against Cadbury Schweppes to separate its drinks and candy businesses, 2007. Also Rothchilds’ campaign to halt Barclays’ acquisition of ABNAmro, 2007. 142 Knight Vinke’s activism against HSBC.

140 Theoretical Foundations and Critical Perspectives expenditures such as research or employment, or to expand into certain areas believed to generate more shareholder value.143 Value extraction may also be achieved by demanding cash from the company, either through a campaign for dividends,144 or share buybacks where ‘offensive’145 activists believe that companies are ‘sitting on a cash pile’.146 In this book, it is submitted that ‘offensive’ forms of activism (as defined in chapters 1 and 3) with an end to value extraction is arguably not wellfounded in theory and law and also raises concerns as to whether any ‘social benefit’ may entail. There is arguably a case to be made for saying that the type of issues raised in ‘offensive’ forms of shareholder activism with a view to value extraction, is different from the type of issues raised largely by institutional shareholders pursuant to open-ended contracting. First, campaigns involving issues of reallocation of corporate assets do not prima facie fall within the realm of open-ended contracting. Where shareholders intervene in reallocation decisions involving company property and assets, such decisions generally lie in the bundle of management powers the Board is entrusted with, unless the reserve power of the general meeting may be summoned to change the Board’s decision.147 Such intervention is prima facie not well-founded in the legal conception of the shareholders’ role and amounts to a form of co-management which is also not envisaged in the organisational theory of the firm. Hence, there are arguably issues of legitimacy and efficiency that may be raised if such forms of activism were to become the norm for shareholder involvement in a company. Although the chain of causation that leads up to final management decision to reallocate assets may be indirect and tortuous to determine,148 the influence of aggressive offensive activism is often obvious. Hence, ignoring strict issues of causation, it is arguable that offensive activists who campaign for specific issues leading to the company’s adoption of that issue, may be regarded as having appropriated a share of management powers over corporate property. This form of activism is arguably tantamount to a form of co-management and seems to be founded upon a loose fabrication of share ownership as proprietary ownership. As discussed earlier, the fabrication of ownership in the residual claimant

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Eg Peltz’s campaign for Kraft to expand into frozen foods and pizzas, 2007. Eg the Children’s Investment Fund’s campaign against J-Power in June 2007. 145 Within the meaning of ‘offensive shareholder activism’ as used in this book. 146 Eg CalPERS’ campaigns against their Japanese investee companies in the 1980s, Sanford M Jacoby, “Convergence by Design: The Case of CalPERS in Japan” (2007) 55 American Journal of Comparative Law 239. 147 Breckland Holdings v London and Suffolk Properties Ltd and Others [1989] BCLC 100 and Quin & Axtens v Salmon n 42. 148 Anabtawi and Stout, ‘Fiduciary Duties for Activist Shareholders’ (2008) n 123. 144

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theory is premised upon efficiency, particularly in terms of monitoring the Board, and is hence not an absolute ‘proprietary’ right. Further, the legal framework has also never fabricated share ownership as equivalent to a form of proprietary ownership over corporate assets. Thus, any power of co-management appropriated by offensive activists would have to be justified in both theory and law. Where theory is concerned, if we refer to the most pro-shareholder theory of the firm, ie the residual claimant theory from a finance perspective, the primacy accorded to shareholders is in relation to monitoring management to prevent self-dealing and jeopardy to shareholder interests. Such a form of primacy is hence limited in scope, and does not necessarily extend to shareholders intervening in the reallocation of corporate assets or extracting value from the company for private gain, (largely) in order to facilitate a timely exit. As Chapter 3 discussed earlier, many offensive shareholder activists such as hedge funds are not activists for the purposes of ameliorating the agency problem. Many hedge funds are activists mainly for the purpose of extracting value from well-run companies. Hence, using ownership as a means to extract value for private gain is arguably inconsistent with the efficiency rationale behind the fabrication of shareholders as residual claimants. This is because according to the institutional theories of the firm, a firm is regarded as a team of inputs coordinated by a centralised contracting agent (management) as an efficient structure flanked by monitoring residual claimants. Shareholders’ primacy is thus rooted in a monitoring role in a long term open-ended relationship with the firm. Shareholder primacy is thus not tantamount to endorsing shareholder appropriation of management power as such. Further, it would be almost ironic or arguably perverse to allow shareholder activism in the name of shareholder primacy to extract value from the company, when the residual claimant theory with the finance perspective is intended to prevent such self-serving extraction. Further, as the law regards management as having default powers to allocate company assets and property unless the reserve power in the general meeting directs otherwise, an aggressive minority shareholder’s offensive activism could relate to an interference with the managerial discretion traditionally upheld in the model of separation of ownership from control affirmed in the Model Articles. It may be argued that offensive activists are not exercising managerial power as such but are only making demands to management to exercise their powers in a certain way, hence there is no subversion of the principles upheld in Breckland Holdings. However, if activist shareholders could get a company to reallocate its corporate assets after a series of campaigns, then such activists would have been able to surpass the limitations of their non-majority stake, to circumvent the need to summon the reserve power of the general

142 Theoretical Foundations and Critical Perspectives meeting, and the opposing views of other shareholders149 in achieving their demands. Hence, such forms of activism that affect how the legal framework has allocated control and governance rights over a company’s property arguably undermine the values supported by the legal framework itself.150 Where the Model Articles and Breckland Holdings apply, the nexus has made a fundamental bargain that vests management powers in directors with reserve power to the general meeting in special majority. Although the division of powers is not immutable, the issue being situated in the enabling framework of company law, changes to the division of power would possibly have to be negotiated through the nexus and not imposed arbitrarily by any one constituent within the nexus. Shareholder activists who are in a position to push through their agendas would have undermined the nexus and effectively appropriated some management power without having the legal safeguards of director liability imposed on them. If one argues from the property thesis that ‘offensive activists’ are entitled to exercise –ownership’ rights in activism as an incident of property, then that is arguably mistaken as the legal framework has not fabricated share ownership rights in the internal dimension as a form of pure property. In sum, the finance perspective accords shareholders with primacy in order to fulfil a monitoring function and the value extraction agenda of offensive activists is thus not consistent with the theoretical model that is arguably most pro- shareholder. The legal framework also does not envisage individual activists exercising inappropriate influence over management and power is reposed in the collectivity of the general meeting. Hence, a critical examination of the theoretical foundations of offensive activism may entail the finding that such activism is arguably not well supported in theory and in law. Shareholder activism in issues such as calling for share buybacks, and asking for firms to restructure their businesses or assets, may arguably be tantamount to a form of interference with management.151 It is an interesting question whether other members of the company may be able to stop such activists by alleging a breach of the company’s constitution where the division of powers is enshrined. Jurisprudence on section 33 of the Companies Act 2006 has dealt with specific breaches of Articles,152 and it would be questionable as to whether

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MacDougall v Gardiner, n 119, Allen v Gold Reefs, n 39. A couple of commentators in the US also doubt that shareholders should appropriate for themselves a right akin to co-management. See FH Alexander and JD Honaker, ‘Power to the Franchise or the Fiduciaries?: An Analysis of the Limits on Stockholder Activist Bylaws’ (2008) 33 Delaware Journal of Corporate Law 749. 151 LV Ryan, ‘Shareholders and the Atom of Property: Fission or Fusion?’ (2000) 39 Business and Society 49. 152 Eg Pender v Lushington, (1877) 6 Ch D 70; Hickman v Kent or Romney Marsh Sheepbreeders Association n 33 . 150

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shareholders can sue an activist minority for breach of an Article relating to the division of power that confers management powers upon the Board. Such enforcement would benefit management, who are hitherto regarded as ‘outsiders’ to the constitution. However, if offensive activists get themselves elected onto the Board, then shareholders generally would be regarded as having appointed them as managers and the objection against their interference with management may not apply. But if activists get themselves elected onto the Board and hence become part of management, their freedom to extract value from the company would have to be curtailed in light of the fiduciary duties they owe the company, and activists should then be subject to monitoring by other shareholders.

Critically Examining Offensive Activism in Action Offensive activists often campaign for dividends in their bid for value extraction from the target company. Although shareholders do not have a right to dividends, if it is a legitimate understanding that shareholders should receive regular returns on investment,153 or as a form of remuneration,154 then asking for dividends is arguably part of the open-ended contracting process. However, as the legal framework has reposed the decision to declare dividends in the hands of management, and restrictions are placed upon the financial condition of the company to declare dividends,155 this is arguably not wholly an area left for the enabling framework of company law. Hence, offensive shareholder activism targeted towards dividend declaration may not be wholly supported as part of the open-ended contracting process, and as will be argued shortly, the desire to extract value may itself be unsupported in theory and law. As for demanding buybacks of shares using company’s cash, there may be two perspectives to this. One is that the use of the company’s cash is an allocation decision and hence should be independently exercised by management and not unduly influenced by a noisy and aggressive shareholder without the application of the reserve power in the general meeting. However, on the other hand, as mandatory law clearly allows companies to buy back shares in limited circumstances156 as part of the

153 In Re Sam Weller & Sons Ltd (1990) Ch 682 the persistent declaration of the same dividends over 37 years could amount to unfair prejudice to a minority shareholder, who believed the level of dividends not to reflect a fair distribution of gains from the company to its long term shareholders. 154 Croly v Good & Ors [2010] EWHC 1 (Ch). 155 s 829ff, Companies Act 2006. 156 s 693, Companies Act 2006.

144 Theoretical Foundations and Critical Perspectives liberalisation of capital maintenance rules, it may be argued that shareholders are entitled to raise such issues. However, as share buybacks need to be carried out with at least an ordinary resolution at the general meeting,157 it may also be argued that the mandatory law allows shareholders collectively to make a decision on the matter, bringing the matter within the types of issues that shareholder governance is ordinarily sought anyway under the law. It is acknowledged that demands for cash in the form of dividends or share buybacks are not per se outside of the scope of shareholder participation, but it is important to discern why such demands are made. As many offensive activists demanding share buybacks or dividends desire to extract value from the company in order to make abnormal gains on holding the equity, it will be argued that the objective of value extraction may place certain offensive forms of shareholder activism that are for the purposes of value extraction into a category that is not well-founded in theory and law. Thus far, this book argues that some popular strategies that offensive activists carry out such as demanding the company to reallocate its assets and making purchasing/disposal decisions could amount to a form of undue interference with management that is incompatible with both theory and law. However, demanding cash in the form of dividends and share buybacks may still fall within what theory and law accept as part of the open-ended contracting process for shareholders. This book will go on to argue that although asking for dividends and share buybacks may not prima facie fall outside of the scope of open-ended contracting, such activism may still not be supported as pursuant to value extraction from the company. Offensive forms of activism campaigning for these are with a view to extracting value from the company in order to generate abnormal share price earnings on the equity. We shall now turn to examine whether activities aimed at value extraction may themselves be well-founded in theory and law.

Value Extraction from the Company ‘Value extraction’ is a term that has been used in relation to how private equity investors make capital gains from companies through ownership participation, but such capital gains are ultimately extracted for the benefit of the few.158 Although supporters of hedge fund activism have not described the gains made by offensive activists in the same terms, the aim 157 On market purchases to be authorised by ordinary resolution, s 700, Companies Act 2006, and off-market purchases to be authorised by special resolution, s 694. 158 J Froud and K Williams, “Private Equity and the Culture of Value Extraction” (2007) 12 New Political Economy 405.

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of offensive activism is arguably towards “value extraction”.159 “Value extraction” is carried out based on a belief that the company’s share price does not currently reflect what the price ought to be, and that activists may be able to offer suggestions which, if taken by the company, would allow the market to revalue the share price of the company positively. First, it will be argued that offensive activism that gives rise to value extraction is incompatible with theory and law as it is usually carried out with a view to exit. Second, it will be argued that such activism is unlikely to generate social benefit by the way. ‘Offensive’ activism towards value extraction from the company should be examined in the context of the nexus of contracts. Justifying offensive activism without consideration for the nexus is misplaced, as the de-contextualisation of offensive activism can only be justified based on a pure property rights thesis, which is not supported in theory and law. Hence, any simplistic justification of offensive shareholder activism in the name of ‘ownership’ or ‘residual claimancy’ has the tendency to mislead the wider community into supporting such activism as an exercise of the shareholder’s right, and to justifiably exclude consideration for other constituents in the nexus, since exclusion is characteristic of pure notions of ‘property’. As shareholders’ rights are not purely proprietary, offensive forms of shareholder activism have to be considered within the context of how they relate to the relationships within the nexus. Institutional theories favour the residual claimant and advocate that the residual claimant has monitoring powers. The assumption being made is that residual claimants have an open-ended contract, and hence the assumption is based upon the model of the long term investor, employee or creditor. Where the participation of any constituent in the nexus may be for a more defined term, exit may be contractually contemplated and provided for, and hence the risks of being in a long term open-ended contract may be mitigated by the contemplated exit. It is on this basis that the chapter advocates the rethinking of offensive activists’ position and not to readily assume that they have the status of residual claimant in order to carry out activities in the name of shareholder primacy. Vice Chancellor Strine of the US Delaware Chancery Court opines: ...[I]investors with very short-term perspectives, such as hedge funds, public pension funds, and other institutions that have built up staffs with a vested interest in promoting corporate governance changes, because the very continuation of strife justifies the existence of those staffs. ...[Th]ere are now a large number of well-compensated people whose livelihoods are in large part dependent on corporate governance tumult. For these and many other reasons,

159 RD Orol, Extreme Value Hedging: How Activist Hedge Fund Managers are Taking on the World (Chicester, John Wiley & Sons, 2007).

146 Theoretical Foundations and Critical Perspectives one must acknowledge that there is reason to be skeptical that the corporate governance agenda advanced by [these investors] is one that advances well the interests of their clients, ordinary Americans who invest for the long term. Indeed, there are forceful arguments that support doing more to constrain the ability of [these] investors to exploit the separation of ownership from ownership for their own ends.160

Many ‘offensive’ activists carry out shareholder activism with a view to value extraction and then exit. It is arguable that the extraction of value for private benefit with a view to early exit potentially changes the nature of the open-ended relationship which has allowed us to frame a theoretical paradigm of shareholder primacy supported by the perspective of the residual claimant. Exit usually occurs after the value extraction, and such exit allows the activist to prematurely determine its risk as a residual claimant. Although the exit is not ex ante defined and the activist strictly speaking is an open-ended residual claimant to begin with, there is arguably a case for saying that there is a pattern of behaviour among hedge fund activists that orchestrate activism with a view to increasing share value, and then to exit after value extraction.161 The orchestration of the activism may augment risk to the other constituents in the nexus, and may create new risks. The activist’s exit would leave the nexus with these risks while the activist may have extracted private benefit or at least terminated its open-ended risk. Would it not be ironic to justify such activism as pursuant to the primacy accorded to residual claimants, when such activism is intended to determine the residual claimant status and risks of the offensive activist? Where a shareholder is trying to realise its gain before other residual claimants, and then close the open-ended nature of his/her investment in the company, why should the nexus regard such shareholders as belonging to the special group of residual claimants, especially if the remaining constituents of the nexus may have to bear new or increased levels of risk after the orchestration of changes manoeuvred by the activist? However, where exit is not contemplated in the short term, does the above objection apply? Where exit is not contemplated in the short term, it is arguably still important to ascertain whether the abnormal increase in share value sought by offensive activists is carried out at the expense of the other residual claimants in the nexus. There could be potential longer term cost and externalities that may be imposed on the other residual

160 LE Strine Jr, ‘Breaking the Corporate Governance Logjam in Washington: Some Constructive Thoughts on a Responsible Path Forward’ (2008) 63 Business Lawyer 1079, 1083–1084. This view finds favour with Treasury Minister Lord Myners, see ‘Opposition Grows to Two-Tier Share Plans’, Financial Times (2 Aug 2009). 161 Discussed in chapter 3, and for example, discussion in The Conference Board, Hedge Fund Activism: Findings and Recommendations for Corporations and Investors (2008).

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claimants. For example, allowing offensive activists to receive a fat oneoff dividend would reduce retained earnings for companies which may then have to be funded by increased levels of leverage. Increased levels of leverage could make a company much more vulnerable in a market downturn.

Does Offensive Activism Entail Beneficial Effects? Commentators162 have suggested that shareholder value maximisation in a company is tantamount to the maximisation of utility for all concerned, a rather purist view of the aggregate good that individualistic capitalism will necessarily entail. The findings from empirical literature seem to suggest that shareholder activism in general (not distinguishing between the two types) may result in some abnormal returns in share price at the announcement date that activism has commenced163 and when the activism objectives have been achieved.164 However, there is also empirical evidence showing that abnormal earnings on share price as a result of activism are not significant.165 A cursory meta-survey of empirical literature suggests that: shareholder activism often has some sort of effect on share price, but these are not generally significant enough on a consistent basis post exit or reflect in improved operating performance of companies. Indeed, empirical evidence shows that shareholder activism does not have a significant impact on the operating performance of the firm,166 and it is arguable that the firm’s actual revenues, turnover, market share and profitability are possibly more important to the other constituents in the nexus, such as employees and management. The community in

162 See Goldenberg, ‘Shareholders vs Stakeholders: The Bogus Argument’ (1998) n 132; M Friedman, ‘The Social Responsibility of Business Is to Increase Its Profits’ (NY Times, 1970). 163 Could be a Schedule 13D filing for activist shareholders acquiring more than 5% of equity with the view to influencing control of the issuer. 164 M Becht et al, ‘Returns to Shareholder Activism: Evidence from a Clinical Study of the Hermes UK Focus Fund’ (2008) 10 Review of Financial Studies 1093; MP Smith ‘Shareholder Activism by Institutional Investors: Evidence from CalPERS’ (1996), n 111. 165 Karpoff, ‘The Impact of Shareholder Activism in Target Companies’ (2001) n 111; Wahal, ‘Pension Fund Activism and Firm Performance’ (1996) n 111. 166 WT Carleton, JM Nelson and MS Weisbach, ‘The Influence of Institutions on Corporate Governance through Private Negotiations: Evidence from TIAA-CREF” (1998) 53 Journal of Finance 1335; MP Smith ‘Shareholder Activism by Institutional Investors: Evidence from CalPERS’ (1996) n 111; Becht et al, ‘Returns to Shareholder Activism’ (2008), n 163 also finds no statistically significant increase in operating revenues; on hedge funds, see Allaire, ‘Hedge Funds as “Activist Shareholders”’ (2007) n 111; A Klein and E Zur, ‘Entrepreneurial Shareholder Activism: Hedge Funds and Other Private Investors’ (2006) at . But see Boyson and Mooradian, ‘Hedge Funds as Shareholder Activists from 1994–2005’ (2007) n 111 where improved long term performance of companies is reportedly achieved through some forms of hedge fund activism.

148 Theoretical Foundations and Critical Perspectives which the firm is operating, such as charities in the community may benefit more from the firm in a profitable year where donations may also be more generous, than from increases in shareholders’ stock price earnings. Hence, the focus on abnormal share price increases may obscure the fact that many firms do not fundamentally become more successful in the long run. If this is so, one should query whether the expense of activist resources and the costs incurred by targeted companies are socially wasteful, compared to the private gains made by activists on the share price earnings. Fisch167 also argues that it is narrow-minded for a firm to measure its value primarily in terms of shareholder gains as stock price performance and gains in shareholder wealth do not show the actual operating performance or profitability of the firm itself. The value of the firm is not always reflected in its stock price,168 and wealth transfers of the firm to creditors and suppliers are completely ignored if one takes only stock price performance as an indication of firm value.169 This raises the question of whether private benefit extraction by shareholder activists actually generate any wider benefit for other shareholders and stakeholders, if the success or sustainability of the company in the long run is not necessarily improved by the activism. The principal benefit to a company from increases in share price is that there is likely to be a reduction in the cost of capital. It may be argued that companies can use increased capital to invest in research and expansion and this may benefit not only shareholders but also stakeholders. However, would short term increases in share price necessarily result in corporate decisions for growth?170 Further, share price increases and

167 JE Fisch, ‘Measuring Efficiency in Corporate Law: The Role of Shareholder Primacy’ (2006) 31 Journal of Corporation Law 637. 168 This is the semi-strong version of the Efficient Capital Markets Hypothesis but it is questioned by many commentators, see EF Fama, ‘Efficient Markets: A Review of Theory and Practical Work’ 25 Journal of Finance (No. 2) 383 (May 1970). Other models of share price behaviour have since arisen including the random walk theory. See also J Tobin, ‘On the Efficiency of the Financial System’ (July 1984) Lloyd’s Bank Review 1, quoted in Parkinson, Corporate Power and Responsibility (1993) n 3. However, the Martingale model still continues to uphold efficient capital markets. See discussion in SF LeRoy, ‘Efficient Capital Markets and Martingales’ (1989) 27 Journal of Economic Literature 1583 and EF Fama, ‘Efficient Capital Markets II’ (1991) 66 Journal of Finance (No. 5) 1575. Behavioural finance has most recently attacked the theory, and has many followers, see SM Bainbridge, ‘Mandatory Disclosure—A Behavioural Analysis’ (2000) 68 University of Cincinnati Law Review 1023; RJ Shiller, Irrational Exuberance (Broadway, 2001); R Prentice, ‘Whither Securities Regulation? Some Behavioural Observations Regarding Proposals for its Future’ (2002) 51 Duke Law Journal 1397. 169 WW Bratton Jr, ‘Enron and the Dark Side of Shareholder Value’ (2002) 76 Tulane Law Review 1275. 170 If managers become dedicated to maintaining quarterly share price increases, this would invariably compromise long term growth, see M Cheng, KR Subramanyam and Y Zhang, ‘Earnings Guidance and Managerial Myopia’ (2005) at .

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growth in earnings per share may be unsustainable171 and may affect corporate well-being if rigorously and unwavering pursued. It has been opined that A policy of increasing the earnings per share growth rate through capital expansion, though doubtless the most popular method, can be quite complex and must ultimately break down as the company matures. It is necessary to find an acceptable rate of earnings per share growth and sustain it through the accompanying capital expansion for a substantial number of years.172

Although it could be argued that pensions savers and retirees in the community will benefit from increases in shareholder value, whether such increases in value may be sustainable is very debatable. Furthermore, other stakeholders may not benefit as the real operating performance of the company may not have improved. Further to the uncertainty of any social benefit, there is a possibility that offensive activists may impose private cost upon the other constituents in the nexus and even social cost. The extraction of value by offensive activists may entail new risks or augmented risks, such as from increased leverage in the company. Such risks would be borne by the other constituents in the nexus after exit has been made by the offensive activists. If offensive activists’ private benefits in value extraction entail longer term costs on the other constituents in the nexus, then any perception of benefit from short term increases in share price is also rather illusory, and will have to take into account the private cost of unfair disadvantage that has been imposed on the other constituents in the nexus. Social cost may also follow if target companies shed employment or switch suppliers, relocate to low cost manufacturing jurisdictions or even puts themselves up for sale. The achievement of short term gains for the activists that exit may entail longer term social cost. The now highly discredited Royal Bank of Scotland takeover of the Dutch bank ABN-AMRO as mentioned in chapter 3, was supported by hedge fund activists who had a stake in ABN-AMRO, and benefitted from RBS’ enormous premium. RBS however has been pushed to the brink of insolvency carrying the debts and toxic assets of the Dutch Bank after the collapse of the collaterised debt obligations market in late 2008. Although there is relatively minimal literature that suggests that ‘offensive’ activists leave the company in a poorer shape than before,173 most empirical research do not point

171 Although the opposite is also true, see CA Ramezani, L Soenen and A Jung, ‘Growth, Corporate Profitability and Value Creation’ (2002) 58 Financial Analysts’ Journal 56 where it is opined that dedicated pursuit of growth as such will also destroy earnings per share beyond a certain point. 172 PG Carlson, ‘Planning, Growth and the Efficient Use of Capital’ (1975) 4 Financial Management 27. 173 Allaire, ‘Hedge funds as “Activist Shareholders”’ (2007) n 111.

150 Theoretical Foundations and Critical Perspectives to unambivalent longer term improved operational performance and earnings.174 However, some empirical evidence on the results of shareholder activism report not only gains in share price earnings,175 but some long term gains to the operating performance, and improvements to the long term sustainability of the company as well.176 Such evidence relate mainly to activism in the realm of open-ended contracting. Value extraction by offensive activists however leads to increases in the share price for the short term with little empirical evidence to suggest real improvements to a company’s business or profitability.177

174 Clifford, ‘Value Creation or Destruction?’ (2007) n 111, although see the opposing view in NM Boyson and RM Mooradian, ‘Hedge Funds as Shareholder Activists from 1994–2005’ (2007) n 111 which charts corporate performance over a period of 11 years. It may however be argued that the period under research ie 1994–2005 are relatively trouble free and the challenge of recession did not occur during that time to test the mettle of what hedge fund activists have left behind. 175 Becht et al, (2008) n 163; MP Smith ‘Shareholder Activism by Institutional Investors: Evidence from CalPERS’ (1996), n 111, C Alves and V Mendes, ‘Corporate Governance Policy and Company Performance: The Portuguese Case’ (2004) 12 Corporate Governance 290 (relevant to where activists call for companies to adhere to the best practices code of corporate governance). Improvements in corporate governance also mainly lead to increased market valuation of companies on exchanges in emerging markets, eg Tunisia see IK El Mehdi, ‘Empirical Evidence on Corporate Governance and Corporate Performance in Tunisia’ (2007) 15 Corporate Governance 1429. However, a study in Venezuela measured corporate governance quality against the level of dividend payout, testing corporate governance against firm profitability which may not be the same as market valuation and may be a longer term measure, and found a positive correlation, see U Garay and M Gonzalez, ‘Corporate Governance and Firm Value: The Case of Venezuela’ (2008) 16 Corporate Governance 194. 176 See Martin and Thomas, ‘The Effect of Shareholder Proposals on Executive Compensation’ (1999) n 108; LD Brown and ML Caylor, ‘Corporate Governance and Firm Operating Performance’ (2007) at http://ssrn.com/abstract=814205 argue that certain corporate governance changes do result in longer term returns such as improved operating performance and returns on assets; JH Mulherin and AB Poulsen, ‘Proxy Contests, Shareholder Wealth and Operating Performance: An Analysis in the 1980s’ (1999) at argue that removal of takeover defences in the US and changes in management secured positive results for operating performance of sampled companies. But see W-L Song et al, ‘Does Coordinated Institutional Investor Activism Reverse the Fortunes of Underperforming Firms?’ (2003) 38 Journal of Financial Quarterly Analysis 317; S Bhagat and BS Black, ‘The Uncertain Relationship Between Board Composition and Firm Performance’ (1999) 54 Business Lawyer 921 (relevant to where shareholder activism may pertain to changing the Board composition); also see V Dulewiscz and P Herbert, ‘Does the Composition and Practice of Boards of Directors Bear Any Relationship to the Performance of their Companies?’ (2004) 12 Corporate Governance 263; and citations in n 165. 177 See Allaire, ‘Hedge funds as “Activist Shareholders” ’ (2007) n 111; Klein and Zur, “Entrepreneurial Shareholder Activism” (2006) n 165. But see Boyson and Mooradian, ‘Hedge Funds as Shareholder Activists from 1994–2005’ (2007) n 111 where improved long term performance of companies is reportedly achieved through some forms of hedge fund activism.

Concluding Remarks 151 6. THE CALPERS OR HERMES FOCUS FUND TYPE ACTIVISM

What however, should we make of the CalPERS’ type of activism which seeks to unlock value in underperforming companies, such as that undertaken by the Hermes Focus Fund discussed in chapter 3? This book is of the view that targeting underperforming companies in order to unlock and improve value sits between the two categories of open-ended contracting and offensive activism with a view to value extraction. As the Hermes Focus Fund sometimes pushes for corporate governance changes in order to improve the value of the company, such activism would be a legitimate pursuit of investment protection within the open-ended contracting framework. However, as the Focus Fund employs largely the methodology of private negotiations and dialogue, it would have to be considered carefully to what extent the informal contact is inclusive of the nexus and is carried out in such a manner that would generate wider social benefit for the other constituents in the nexus. As to the Fund’s objective of value extraction after activism, should the Fund be looked at differently from other offensive activists with the same objective? The main distinction between the Focus Fund and perhaps other offensive activists is that the Focus Fund only targets underperforming companies with a view to improving their value. Hence although the Fund intends to extract gains and then exit after successful activism, the Fund also intends to confer improvement of value to the target company, and as such, more benefit may ensue from the Fund’s activities to shareholders and perhaps stakeholders, than those offensive activities carried out by hedge funds against well-performing companies. This however needs more empirical evidence as the recent major piece of empirical evidence178 on Hermes’ private shareholder activism focuses on Hermes’ gains and not the longer term benefit that ensues to the company, and perhaps to other stakeholders. Although this book argues that offensive forms of activism with a view to value extraction is less well-founded in theory, the consideration of benefit and externalities is also extremely important to our acceptance or otherwise of such shareholder activism, and the net benefit that ensues from any activism should be sustainable and not illusory, for it to weigh up against other theoretical and principled considerations. 7. CONCLUDING REMARKS

Although offensive activism with a view to value extraction and exit is not arguably supported in theory and principle, it may not be regarded unfavourably in the present climate. For too long, shareholders have

178

M Becht et al, ‘Returns to Shareholder Activism’ (2008) n 163.

152 Theoretical Foundations and Critical Perspectives been indifferent to their investee companies and hence any activism may be regarded as welcome and not regarded as a malaise.179 Further, it is arguable that shareholder activism is not carried out on a large enough scale to threaten the unwinding of any institution,180 and hence it is not imperative to critically consider the nature and role of offensive activism. Third, there may be regulator and industry support for such activism as it is perceived that accompanying social benefit may well be derived from activists’ actions. This book argues that one should be wary of extremes and not regard shareholder activism as a cure for shareholder indifference that has been the norm in the 1990s. Shareholder indifference is a different problem from shareholder activism, and offensive activism does not cure the problems of indifference, and generates concerns of its own. Further, this chapter doubts that offensive forms of shareholder activism are too rare to warrant attention, and argues that we can expect to see more ‘legitimate’ offensive shareholder activism filling the vaccum in ‘regulating’ corporate governance after the onset of the financial crisis in the UK in late 2008. Finally, it also seems that shareholder activism is generally supported by the regulator and industry as it is perceived to generate social benefit.181 Regulators see shareholder activists as resourceful actors that generate disciplining effects and hence contribute to ‘regulatory action’ in the regulatory space. However, this chapter has argued that it is imperative to locate the foundational support for shareholder activism and to regard with more scepticism the characteristics of value extraction and exit in offensive activism. The chapter has argued that offensive activism should not be regarded on the same footing as activism usually carried out by institutional shareholders in the open-ended contracting process. Even if the extraction of private benefit by shareholder activists also produces certain social benefits in the short or medium term share price, it is important to take into account the private cost of disadvantage that may have been imposed on the other constituents in the nexus. ‘Social benefit’ in the form of increased short or medium term share price following successful offensive activism, may actually be illusory, unless there is more empirical evidence that is dedicated to showing how ‘offensive’ forms of shareholder activism may benefit the company, the other constituents in the nexus and the wider community over the longer term.

179 D Tsuk Mitchell, ‘Shareholders as Proxies: The Contours of Shareholder Democracy’ (2006) 65 Washington and Lee Law Review 4. 180 BS Black, ‘Shareholder Passivity Re-examined’ (1990) 89 Michigan Law Review 520 available at . 181 Department of Work and Pensions, Encouraging Shareholder Activism (Consultation Paper, 2002) at .

Concluding Remarks 153 A better case may be made for ‘open-ended contracting’ activism and its legitimacy but whether more intense forms of private engagement by institutions should be supported remains an open question. More empirical evidence is needed to determine whether such private engagement makes a difference to the governance of the company and mitigates the agency problem, and produces quantifiable or qualitatively observable benefits to the company and the wider nexus and community, such as in improved operating performance, long term competitiveness, or a company’s better image, reputation and appeal.182 Could it be argued, however, that it is simplistic to vilify offensive forms of activism because of the existence of value extraction, and install institutional shareholder activism as the only legitimate form of shareholder activism? After all, institutional shareholders are also motivated by private gains in share value. It has been argued that institutional investors who demand quarterly or half yearly results from their investment managers are often motivated by short term share price earnings, and may engage in activism183 or vote with management184 towards that end. Hotchkiss et al also argue that institutional investors display extremely sensitive responses in market selling or buying around the periods where company earnings are reported every quarter (in the US), and show that their preponderant concern is for share price earnings.185 This book is not advocating that institutional shareholders be not allowed to sell stock in the short run. What needs to be determined is whether any orchestration of activism that puts pressure on management to take any particular actions or introduces any new risk to the constituents in the nexus, is legitimate. At the moment, issues of appointments, removals, governance, shareholder rights and issues within the enabling framework of company law legitimately allow shareholder participation. The use of reserve power also legitimates shareholders carrying on a management function within the ambit of the resolution passed by the special majority. However for 182 S Kumar Sen, ‘Societal, Environmental and Stakeholder Drivers of Competitive Advantage in International Firms’ (2006) at ; GA Steiner and JF Steiner, Business, Government, and Society: A Managerial Perspective, Text and Cases (New York, McGraw Hill/Irwin, 2006) showing that businesses that take into account a wider context of concerns generally tend to gain a competitive advantage in the market as well; W Lazonick, ‘Investment in Innovation, Corporate Governance and Employment: Is Prosperity Sustainable in the United States?’ (1998) at . DN Rao, K Shankariah and A Al-Hakmani, ‘Developing Customer Loyalty: A Case-study of National Bank of Oman’ (2003) at opine that good corporate governance contributes to a company developing customer loyalty and retention. 183 Hendry et al, ‘Responsible Ownership, Shareholder Value and New Shareholder Activism’ ESRC Centre for Business Research Working Paper 297, University of Cambridge (Dec 2004). 184 RC Smith and I Walter, Governing the Modern Corporation (Oxford, OUP, 2006) 146–47. 185 ES Hotchkiss et al, ‘Does Shareholder Composition Matter? Evidence from the Market Reaction to Corporate Earnings Announcement’ (2003) 58 Journal of Finance 1469.

154 Theoretical Foundations and Critical Perspectives issues not falling within that scope or in grey areas, it is important to examine the theoretical legitimacy of the activism and its private and social cost. It is arguably not legitimate to carry out activism in the name of the exercise of ‘monitoring powers’ in the capacity of residual claimant, in order to extract private value for the purposes of early determination of residual claimant risks. However, the existence of social benefit is not yet well-ascertained and should be carefully documented to weigh up against the potential private cost resulting to other residual claimants by the offensive activists’ seizure of advantage. Shareholders are naturally placed in the regulatory space to be coopted to check managerial performance and abuse. The prevention of management self-dealing may be more effective than cure by shareholder or regulator litigation. Shareholder litigation may suffer from a free-riding problem, and since the value reduction in the firm affects many other constituents, which shareholder would take the initiative to litigate? Regulator litigation would mean that public money is used to subsidise the value loss suffered by private parties in the nexus of contracts in the firm. Hence, the two forms of shareholder activism discussed would still have to relate to the fundamental agency paradigm. The open-ended contracting process sits safely within the enabling framework of company law and the emphasis on general meeting issues reinforce the legitimacy of such activism in its respect for the collectivity of the general meeting. On the other hand, ‘offensive’ forms of activism may not relate to the agency paradigm and may generate private benefits at the expense of other residual claimants in the nexus. It needs to be examined if offensive activism is balanced by the existence of net social benefit. It is arguably regrettable that, with management scandals from Enron in 2002 to the failure of several large investment banks such as Lehman Brothers in September 2008, the tide has revolted against the managerial class. Issues of excessive executive remuneration that emerge from failed institutions have also exacerbated the perception of the agency problem. This social distrust of the managerial class may give rise to swings of opinion asking for trust and power to be increasingly reposed in shareholders, especially activist ones.186 However, this should not extend to an unconditional support for shareholder activism, and it has to be discerned as to what type of activism is being carried out and at what cost and benefit. Ultimately, regulators should not automatically see shareholder activism as a complementary regulatory force

186 ‘The first line of defence ... remains the shareholders of financial companies. They have done too little so far, and they have suffered more than most as a result. Expect more diligence in future’, Editorial Comment, Financial Times (22 Sep 2008).

Concluding Remarks 155 or as substitutes for regulation.187 Regulators should study carefully what aspects of governance and public goods may entail from shareholder activism,188 and whether shareholder activism may result in losses and externalities, and may warrant some form of regulatory control instead.189 In the next chapter, the book will discuss the merits of various legal reform proposals in respect of shareholder activism in general.

187 N Fligstein and R Freeland, ‘Theoretical and Comparative Perspectives on Corporate Governance’ (1995) 21 Annual Review of Sociology 21 seems to treat regulatory intervention as a ‘leftover’ response to patch up what may be missing from shareholder actions. 188 See section 3, IH-Y Chiu, ‘Enhancing Responsibility in Financial Regulation—Critically Examining the Future of Public-Private Governance’ (2010) ECB Legal Research Working Paper and Law and Financial Markets Review, forthcoming. 189 There is existing literature discussing forms of control or restraint to be imposed on activist behaviour, and these will be dealt with in chapter 5.

5 The Role of Law in Shareholder Activism 1. ARE LEGAL REFORMS NECESSARY?

T

HE PREVIOUS CHAPTER has discussed the concerns that may arise in shareholder activism. Although some forms of shareholder activism may be a legitimate outworking of the open-ended contractual process from the perspective of the firm as a nexus of contracts, concerns may arise out of the potential exclusion of other constituents in the nexus and stakeholders. This concern may be especially relevant after the Walker Review which encourages institutional shareholder activism to be intensified in private engagement.1 That said, the Walker Report also recognises that some reforms may be necessary to encourage more collective shareholder participation within the open-ended contracting process, outside of the general meeting. As for offensive forms of shareholder activism for the purposes of value extraction with a view to exit, concerns may arise as to the potential disadvantage imposed on the other constituents in the nexus and the existence or otherwise of social benefit. Some of these concerns have been recognised and in this chapter, examination will be made of the legal solutions that have been proposed in academic literature. This chapter will also critically discuss whether there is any need to incorporate shareholder activism into the legal framework in the UK. As mentioned in chapter 2, policy-makers see shareholder activists, especially institutional shareholders, as part of the ‘regulatory space’. Contemporary governance has moved away from the state-based concepts of authority and regulation.2 However, governance does not mean the eclipse of regulation as such. Regulatory governance remains part of the whole dynamic of governance, termed as ‘regulatory capitalism’.3 Where policy-makers may perceive that public interest needs to be 1

D Walker, Corporate Governance in Banks and Financial Institutions in the UK (Nov 2009). O Lobel, ‘The Renew Deal: The Fall of Regulation and the Rise of Governance in Contemporary Legal Thought’ (2004–5) 89 Minnesota Law Review 342. 3 D Levi-Faur, ‘The Global Diffusion of Regulatory Capitalism’ (2005) 598 The ANNALS of the American Academy of Political and Social Science 12–32; J Braithwaite, Regulatory Capitalism (Cheltenham, Edward Elgar, 2008) at 40. 2

Are Legal Reforms Necessary? 157 achieved in certain aspects of corporate governance, private actors in the ‘regulatory space’ could in effect be ‘delegated’ with a form of ‘privatepublic governance’.4 Any regulatory control over such activism may then be seen as ‘regulatory governance’ in the wider governance landscape. This chapter looks into the role for law and regulatory governance in respect of shareholder activism. Further, the chapter will also look into proposed reforms to the legal framework dealing with the relationship between shareholders and the company. Company law has always recognised shareholder rights and directors’ duties. The principal-agent paradigm forms the basis for much of the mandatory law on shareholders’ governance. In view of the developments in shareholder activism, is it now necessary to consider if shareholders should also owe duties to the company or to other constituents in the nexus, or stakeholders? Further, should shareholder activism be subject to regulatory accountability as well? Karmel suggests that legal duties could be imposed on shareholders due to the fact that they are exercising ‘real power’, directly influencing management as discussed in chapter 4.5 Anabtawi and Stout are of the view that mandatory law in fiduciary duties are intended to restrain self-interested impulses. The likelihood that self-interested impulses may undermine other interests is strongest when directors are exercising power over the inputs supplied by the constituents in the nexus. Hence, legal restraint upon self-serving behaviour where power is exercised is acceptable in company law. Where shareholders also appropriate and exercise power to influence how the company is to be run, the same legal restraints upon potential self-serving behaviour is argued by the commentators to be warranted.6 This chapter however queries if such proposed accountability via the imposition of legal duties is a narrow form of private accountability to other shareholders, or is actually a wider form of accountability that could be in the public interest. The second part of the chapter will discuss how the legal framework may be affected by proposed reforms in the Walker Review to facilitate institutional shareholder activism. Next, this chapter wishes to explore the options available in law to introduce controls on shareholder activism (where such controls may be decided to be desirable in policy) and what such controls may achieve. This approach allows us to work backwards by looking at the regulatory instruments frequently at policy-makers’

4 These concepts are discussed in IH-Y Chiu, ‘Enhancing Responsibility in Financial Regulation: Critically Examining the Future of Public-Private Governance’ (2010) ECB Legal Research Working Paper, also forthcoming in the Law and Financial Markets Review. 5 R Karmel, ‘Should A Duty To The Corporation Be Imposed On Institutional Shareholders?’ (2004) 60 Business Lawyer 1. 6 I Anabtawi and L Stout, ‘Fiduciary Duties for Activist Shareholders’ (2008) 60 Stanford Law Review 1255.

158 The Role of Law in Shareholder Activism disposal and consider how they may be used to govern activist activities, and what they can achieve. This examination may also go towards answering whether there is any role for legal controls. 2. FACILITATING INSTITUTIONAL SHAREHOLDER ACTIVISM IN THE NAME OF STEWARDSHIP

In chapter 4, it was argued that institutional shareholder activism within the enabling framework of company law and in the context of corporate governance issues arising out of the Corporate Governance Code, is theoretically supported and likely to be socially beneficial. The IMA and NAPF carry out yearly surveys of member activism, and the surveys report that much of institutional shareholder activism is carried out at general meetings, relying upon research and recommendations issued by advisory and voting services.7 Hence, such shareholder activism is a largely open and inclusive process even if some institutions may be more vocal than others or may take more visible forms of leadership. However, informal forms of engagement also take place between institutions and their investee companies, and these may be less transparent and inclusive. Although the book does not advocate the extreme position that all issues that shareholders wish to put forward should be put at a general meeting, informal engagement, especially by individual institutions, could give rise to concerns of having insufficient regard to the nature of the nexus of contracts and the legal framework conferring power on the general meeting as a collective body. Policy-makers however see the encouragement of collective informal engagement as the way forward.8 Lord Myners also sees the strengthening of voting rights for institutions holding shares for the long term as being key to enhancing their role in corporate governance.9 Collective Informal Engagement Institutions may be wary of collective informal engagement with investee companies because of the legal framework governing market abuse and fair disclosure, and the rules on mandatory bids in takeover law. 7 National Association of Pension Funds (NAPF), Institutional Investment in the UK Six Years On (2007); IMA, Annual Engagement Survey from years 2003–2008. 8 HM Treasury, Reforming Financial Markets (8 Jul 2009); FSA, ‘FSA provides clarity for activist shareholders’, 19 Aug 2009, at ; D Walker, A Review of Corporate Governance in UK Banks and Other Financial Entities (16 Jul 2009 and Nov 2009). 9 ‘Opposition Grows to Two-Tier Share Plans’, Financial Times (2 Aug 2009); ‘Myners Eyes Non-Voting Shares’, Financial Times (13 Aug 2009).

Facilitating Institutional Shareholder Activism in the name of Stewardship 159 Under the Market Abuse Directive which has been re-enacted in the FSA’s Market Conduct Handbook (MAR) and the Disclosure and Transparency Handbook (DTR), institutional shareholders may be concerned that: informal engagement entails disclosure of any information that could be treated as ‘inside information’,10 and institutional shareholders who may make investment decisions based on such information before such information becomes publicly available may then be caught by the prohibition against insider dealing. Under the Directive,11 issuers are obliged to make public disclosure without delay of inside information communicated to third parties. However the FSA Handbook is keen to emphasise that not every such selective communication to investors or analysts need to be disclosed as such communication may not be ‘inside information’.12 As ‘inside information’ is not susceptible to a clear definition and bright lines are not easily drawn, potential market abuse liability may affect the enthusiasm of institutions in making informal engagement whether individually or collectively. The FSA has recently issued a communication to clarify that market abuse rules do not prevent investors from acting collectively in engaging with their investee companies. Although this is intended to encourage more collective engagement, there are still no bright lines drawn or safe harbours provided. One approach could be to provide for an absolute prohibition of trading on a company’s stock for 3–5 days following the engagement, assuming that in this period of time, the issuer would have made any inside information public, as it is ultimately the issuer’s obligation to disclose. Another approach could be for shareholder activists to seek dialogue with the FSA for assurances similar to the US SEC’s ‘no-action letter’ in order to proceed with the informal engagement. It is submitted that the position taken in the FSA Clarification as such may not be sufficient to assist investors who may be contemplating informal engagement with the company but are concerned about the application of market abuse rules. The seeking of ‘no-action’ letters may also make transparent such activism and involves the regulator’s consideration in this issue. This may be a way to address the accountability aspect of institutional shareholder activism as a facet of ‘governance’. Next, institutional shareholders may also be concerned as to whether collective engagement would result in the aggregate of their holdings for various legal obligations, such as a substantial shareholdings notification13 or being regarded as ‘acting in concert’ under takeover rules.14 The FSA

10 11 12 13 14

D.T.R. 2.23–2.28, FSA Handbook. Article 6, Market Abuse Directive. D.T.R 2.2. 10, FSA Handbook. D.T.R 5.2 and 5.7, FSA Handbook. Rules 9 and 24, Takeover Code.

160 The Role of Law in Shareholder Activism Clarification has also stated that ‘ad hoc’ discussions and understandings between shareholders on various corporate issues or corporate governance should not be regarded as amounting to a situation where the aggregate of shareholdings should take place for the application of notification and takeover rules. Further, although the Takeover Panel is unwilling to provide upfront safe harbours for shareholder activism against ‘acting in concert’ thresholds, it has indicated willingness to provide a Practice Note to set out more specific guidelines.15 However, in order to encourage institutions to be more activist, especially in light of the UK banking crisis that has revealed shareholders to be passive, the Walker Review proposes that collective engagement should be facilitated by establishing Memoranda of Understanding between long-only investors in respect of engagement with their investee companies. This arrangement would enhance long term investors’ sense of continuing monitoring and responsibility. But it would arguably be inconsistent with the type of ‘ad hoc’ discussions that the FSA is willing to tolerate. The Walker Review hence suggests that reforms in law may be necessary, or that the FSA may be involved in vetting the MoUs.16 This approach would be similar to a ‘no-action letter’ approach, but it would provide ex ante assurance to investors who may wish to carry out collective activism. However, the proposal for MoUs has been left out in the final report, as institutions are unwilling to commit upfront to future activist events they could not foresee, but they would be committed to a Code of Stewardship that envisages ongoing engagement with investee companies.17 Going forward, the legal framework surrounding market abuse and concert parties is likely to be enforced less severely in the interest of encouraging institutional shareholder activism. This would also leave institutions to determine the nature and extent of any private or collective form of activism. The previous blueprint of the Code and issues surrounding the general meeting in the open-ended contracting process found a natural point of convergence at meetings, an inherently inclusive and participative space for other shareholders. Stepping outside of this space, the MoUs could have been a template for regulating such collective action, whether among shareholders inter se or having a sense of public accountability. The revised Institutional Shareholders Committee Code on the Responsibilities of Institutional Shareholders states that institutions ‘should be willing’ to collaborate with other investors, and in particular, ‘[c]ollaborative engagement may be most appropriate at times of significant corporate or wider economic stress, or when the risks

15

Para 5.43, 5.44, Walker Review. Para 5.45. 17 Walker Review Final Report, para 5.46, 5.47, see also UK Stewardship Code (July 2010) at . 16

Facilitating Institutional Shareholder Activism in the name of Stewardship 161 posed threaten the ability of the company to continue’.18 Institutions engaging in collective engagement are asked to disclose their collective engagement policy and have regard to the risks of conflicts of interests and misusing inside information. However, there is still an issue of to whom the disclosure is targeted and hence to whom do institutions owe accountability for their collective engagement. This is an important issue as collective activism is envisaged especially in times where social losses and consequences may entail from ‘significant corporate or wider economic stress’. The language of ‘stewardship’ in the Walker Report could point to the accountability of investment managers to the institutions, or the accountability of the institutions to their beneficiaries. Where the former is concerned, institutions outsource to investment managers because they are generally not as well-staffed and sophisticated to manage the vast sums of savers’ money entrusted to them. As discussed in chapter 2, institutions have been hiring and firing investment managers based largely on performance. The current policy of enhancing the responsibility of institutions’ ‘stewardship’ would require institutions to engage in a different modus of evaluating investment managers. Where the empirical evidence is still not sufficiently robust to link activism and improvements in performance, especially in the short term, the onus is now placed on institutions, which have needed to outsource the management of investment, to evaluate investment managers based on criteria that are more complex than merely short term performance. Institutions and investment managers are now left to work out what the new evaluative criteria in ‘stewardship’ entails, and collective activism in the name of stewardship would likely be more complex. If the accountability for stewardship actually refers to accountability to the beneficiaries of institutions, these are myriad and individual savers who have little knowledge or insight as to the implications of ‘comply-or-explain’ approaches taken by institutions. This chapter doubts that market-based discipline can be exercised by the beneficiaries of institutions. If legal reforms are contemplated to make such accountability more robust in law, these reforms would also invariably change the nature of collective investment schemes and how they should be regulated in general. It is submitted that the vision of the Walker Report, to institute a rejuvenated form of collective market discipline by institutions based on a new culture of stewardship, exactly places institutions in the dilemma that Donahue refers to in discussing the nature of ‘market-based governance’—ie ‘[g]overnance and markets... tend to be tangled with each other....’, but ‘does engaging the market offer the most promising

18

Principle 5.

162 The Role of Law in Shareholder Activism blueprint for accountability in the pursuit of particular public goals?’19 Hence, as chapter 2 has earlier pointed out, collective private engagement by institutions as ‘stewards’ is envisaged not only to be activism for the institutions’ investment interests or pursuant to the open-ended contracting process, but for a wider mandate of public interest. In that light, should the accountability of collective activists be defined as narrow forms of private accountability or include a form of wider or public scrutiny? It will be argued later20 that the proposed accountability for stewardship, supported by disclosure required under the UK Stewardship Code published by the Institutional Shareholders Committee21 could be used to co-opt other shareholder and stakeholder views and input. Disclosure made by institutions could become a platform for observeability and comment and this in turn may provide the conditions for the accountability required of institutions although the channel of accountability may not be clearly and narrowly defined. Institutions understandably fear that regulatory templates would take over the freedom of the open-ended contracting process. However, the stewardship era also challenges what scope is left for a purely contractual perspective of the company. Just as company law has evolved into an enabling framework existing alongside a mandatory legal framework, it is possible for corporate governance to develop into the twin aspects of a) contractual matters where the open-ended contracting process involving institutions continues to exist, and b) matters of public interest where perhaps the institutions’ role would pertain to a form of governance. This chapter would like to point to the example of collective legal proceedings, especially for fraud on the market in the US, and reforms that are suggested by various academics, as an example to develop thoughts on how collective institutional shareholder activism may evolve in the future, not necessarily through legal proceedings. Collective civil enforcement has been an important tenet of securities regulation in the US, as investors collectively may be able to discipline corporations for securities fraud, and obtain redress for their losses as well. Empirical research has pointed to the importance of collective civil enforcement as a market-based discipline in the governance landscape of the US securities market.22 This model of civil enforcement arguably

19 JD Donahue, ‘Market-based Governance and the Architecture of Accountability’ in JD Donahue and JS Nye eds, Market-based Governance (Mass, Brookings Institution Press, 2002) at 1 and 4. 20 Part 3 of this chapter. 21 UK Stewardship Code (July 2010) at , at Principles 1, 5, 6 and 7. 22 R La Porta, F Lopez de Silanes and A Shleifer, ‘What Works in Securities Laws?’ (Tuck Sch. of Bus. at Dartmouth, Working Paper No. 03-22, 2003), available at .

Facilitating Institutional Shareholder Activism in the name of Stewardship 163 allows an ex-post form of regulation by looking at actual consequences of the ex ante regulation and firm behaviour.23 It allows individuals to be compensated,24 and empirical literature has documented a corresponding decrease in the cost of equity and increase in market liquidity as a result of civil enforcement that exists alongside regulators’ public enforcement.25 However, commentators warn against the proliferation of frivolous suits, the tendency to target large firms for bounty-hunter enforcement26 and the incentives of attorneys to profit from the litigation.27 To mitigate the ills associated with civil enforcement, Rose and Coffee have argued that the regulator can have oversight of, input into, or an approval machinery to control frivolous and unmeritorious claims.28 This co-opts the regulator into the civil enforcement landscape as well, and could mutually reinforce both types of enforcement.29 The individual corporate governance needs of each company may present different issues and problems that may not be regulated in a one-size-fits-all prescriptive manner. The stewardship era arguably not only co-opts institutional shareholders in a monitoring role as traditionally supported by theory, but also to engage in more intense and critical scrutiny as a collective body for the purposes of public interest. This form of governance is similar to the market-based yet collective discipline that is represented by collective shareholder litigation in the US. In market-based governance, self-interest and public interest are both objectives to be achieved, and it is not possible to assume their reconciliation by compelling the definition of institutions as ‘Enlightened Shareholders’ or by assuming that the maximisation of shareholders’ interest would be tantamount to achieving public good. Hence, Rose and Coffee as mentioned above propose the enmeshing

23 EC Burch, ‘Securities Class Actions as Pragmatic Ex Post Regulation’ (2008) 43 Georgia Law Review 63. 24 HE Jackson and MJ Roe, ‘Public and Private Enforcement of Securities Laws: Resource-based Evidence’ (2009) at http://papers.ssrn.com/sol3/papers.cfm?abstract_ id=1000086; SJ Choi, ‘The Evidence on Securities Class Actions’ (2004) at . 25 U Battacharya, ‘Enforcement and Its Impact on Cost of Equity and Liquidity of the Market’ (2006, Working Paper, Kelley School of Business, Indiana University). 26 A Rose, ‘Reforming Securities Litigation Reform: Restructuring the Relationship between Public and Private Enforcement of Rule 10b-5’ (2008) 108 Columbia Law Review 1301. 27 Choi, ‘The Evidence on Securities Class Actions’ (2004), n 24, 28 Rose, ‘Reforming Securities Litigation’ (2008), n 26; JC Coffee Jnr, ‘Reforming the Securities Class Action: An Essay On Deterrence and Its Implementation’ (2006) at . 29 JD Cox and RS Thomas, ‘Public and Private Enforcement of the Securities Laws: Have Things Changed Since Enron?’ (2004) 80 Notre Dame Law Review 893, also at ; G Ferranini and P Guidici, ‘Financial Scandals and the Role of Private Enforcement: The Parmalat Case’ ECGI Working Paper 2005.

164 The Role of Law in Shareholder Activism of civil enforcement with public accountability so that both aspects of self and public interest may be addressed. It is submitted that as collective engagement by institutions is a form of market-based governance that straddles private and public interest, the public interest aspect of corporate governance may be addressed by some form of accountability to regulatory governance, as Rose and Coffee have argued for the shareholder litigation process in the US. Hence, it is proposed that the initial suggestion made in the Walker Review that collective private engagement should be carried out on the basis of Memoranda of Understanding vetted and approved by the Financial Services Authority is preferable to the final recommendation in the Walker Report. The accountability to the regulator meets the needs of the public interest aspect in empowering institutional shareholder activism. Further, as one concern of private engagement by institutional shareholders would be the exclusion of the other constituents in the nexus,30 institutions concerned about the legitimacy of their activism may be able to better support their case for activism if such activism is in a collective form and supported by the regulator.

Two-Tier Voting Rights In order to encourage more shareholder activism in general, Lord Myners has proposed that greater voting rights could be given to longer term investors, and that shares could be created with no voting rights. Nonvoting shares could be of interest to investors who do not wish to engage in monitoring their investee companies, leaving those who hold voting rights to indicate that they are more likely to be engaged.31 However, initial reactions to the two-tier voting rights proposal have been sceptical in the institutional quarter, as institutions are concerned that they would become locked into a company just because they have been sufficiently long investors, and this affects their trading decisions. The suggestion also appears contrary to the ‘one-share, one vote’32 movement that has been championed by in the EU,33 although this concern has now been abandoned by the Commission. It is queried whether

30

As discussed in chapter 4. See ‘Opposition Grows to Two-Tier Share Plans’ and ‘Myners Eyes New Non-Voting Shares’, n 9 above. 32 See critique in M Burkhart and S Lee, ‘The One Share One Vote Debate: A Theoretical Perspective’ (2007), ECGI Working Paper at . 33 However, after a number of studies commissioned into looking at the support for and practical implications of rolling out a ‘one-share one vote’ rule, the Commission decided that there was no need for further action. See . 31

Facilitating Institutional Shareholder Activism in the name of Stewardship 165 increases in voting rights would naturally give shareholders an increased incentive to monitor and be engaged. This proposal may also be too much of a direct application of Jensen and Meckling’s agency paradigm from the finance perspective. As institutions have been entrenched in the philosophy of portfolio diversification, it is uncertain having more power or say in an investee firm would be regarded as a priority. This returns to the wider issue that there is still a need to reconcile the erstwhile investment management tenets based on short term performance and those of the new ‘stewardship’. However, recent research from McConvill34 argues that giving institutions an enhanced experience of power in the corporation encourages that experience to be positively regarded and developed and may de-commodify the nature of the voting power enjoyed so that it becomes internalised and personalised. The counter-argument to the above would be that the proposal to roll out voting and non-voting shares, with non-voting shares being priced at a discount, would create a market in voting rights. This would entail a commodification of voting rights. The commodification of voting rights may not help towards building up a sense of responsibility in ownership that would entail meaningful engagement. Such commodification could result in behaviour that intends to profit out of activism, similar to the ‘offensive’ forms of activism discussed earlier. It is arguable that the commodification of voting rights would possibly facilitate easier exit by offensive activists who not only have the option to sell out completely but would also have the option to convert into non-voting shares, selling the voting rights for a profit after a successful campaign. This could encourage offensive activists to build up nonvoting stakes in wait for opportunistic campaigns against the investee companies. In sum, the activism expected of institutions, especially in collective activism, is related to public interest, and the book is of the view that this aspect should be honestly addressed, and that the limitations of marketbased governance in addressing public interest should also be faced. In co-opting institutional shareholders not only as traditional monitors, but as more engaged stewards, the empowering of their activism should be carefully studied in terms of the governance effects that entail and the need for accountability not only within the collectivity of the nexus and the general meeting but also to the wider community. The chapter now moves on to look into whether any legal or regulatory controls are necessary for ‘offensive’ activism.

34 J McConvill, ‘Shareholder Empowerment as an End in Itself: A New Perspective on Allocation of Power in the Modern Corporation’ (2007) 33 Ohio Northern University Law Review 1013.

166 The Role of Law in Shareholder Activism 3. LEGAL OR REGULATORY CONTROLS OF OFFENSIVE SHAREHOLDER ACTIVISM

The Imposition of Fiduciary Duties Karmel argues that shareholders accessing proxy contests in the US could be in a position to wield real power as they could put a nominee director on the Board. Hence, she suggests that shareholders could be imposed with a fiduciary duty in that context to ensure that nominated directors do not succumb to conflicts of interest and act only in the interest of the nominating shareholder.35 Anabtawi and Stout further argue that such a latent fiduciary duty may be imposed on shareholders in any context as long as they may be in a position of controlling or influencing Board decisions. Anabtawi and Stout argue that fiduciary duties may be imposed on minority activist investors in a latent form, which ‘activate’ if the activist investor is pursuing his/her own self-interest in the process, viz These latent duties would be triggered whenever a particular shareholder— whether or not it is technically a shareholder capable of controlling the boards’ decisions as to all matters—in fact manages to successfully influence the company’s actions with regard to a particular issue in which that shareholder has a material, personal economic interest.36

Anabtawi and Stout’s model is based on an extension of the fiduciary duty already recognised in the US to be imposed on majority shareholders in blockheld companies. The proposed duty specifically seeks to restrain self-serving tendencies in shareholder activism. Hence the onus is placed on activist shareholders to demonstrate how their activism may benefit other shareholders as a whole and how any conflicts of interest may be satisfactorily managed.37 Where the UK is concerned, there is no equivalent fiduciary duty imposed on majority shareholders, and minority shareholders’ access to remedies for unfair prejudice under s 994 of the Companies Act does not translate into a legal duty on the part of majority shareholders. In this context, UK courts may not be willing to articulate the imposition of any equitable duties on minority shareholders. That said, fiduciary duties have their origins in equity, and in a relationship of trust and reliance and potential abuse and unfair advantage, courts could articulate

35 R Karmel, ‘Should A Duty To The Corporation Be Imposed On Institutional Shareholders?’ (2004) 60 Business Lawyer 1. 36 Anabtawi and Stout, ‘Fiduciary Duties for Activist Shareholders’ (2008) n 6 above at 1295. 37 Anabtawi and Stout, n 6 1255.

Legal or Regulatory Controls of Offensive Shareholder Activism 167 the prophylactic protection embodied in the fiduciary duty to favour the less advantaged party/parties.38 But should fiduciary duties be imposed on activist shareholders just because the activism may be carried out with personal interests in mind? Fiduciary law places restraints on selfserving behaviour because the fiduciary is in a position of power, and is expected to serve another set of interests first and foremost. Hence, it has to be determined that activist shareholders, by serving their own personal interests, are wrongfully subordinating another set of interests that should take precedence. The legal framework in the UK currently empowers shareholders to exercise their powers within the enabling framework of company law, and where prescribed, within the mandatory framework of company law. Where shareholders are exercising power conferred on them under the enabling and mandatory law, for example in voting on corporate governance issues or in considering whether to ratify any matters at the general meeting, the power to vote freely has been well established, only subject to a few qualifications.39 Hence, the concept of applying duties to shareholders’ roles in the company is seen as the exception and not the norm. In contrast, mandatory law on directors’ duties is founded upon directors’ general power to manage, which shareholders do not enjoy. The nature of the power that attracts directors’ fiduciary duties is power that is exercised for the benefit of others. The principal-agent problem regards such power as not one’s own, but delegated by a “principal” and hence exercised on trust.40 As regards who the “principal” is, the theories of company law provide two contesting and unresolved alternatives: one, the principals are shareholders as residual claimants from the finance perspective. The other is based on the real entity perspective of the

38 See articles debating the boundaries of fiduciary duties and on whom such duties may be imposed, PD Finn, ‘The Fiduciary Principle’ in TG Youdan ed, Equity, Fiduciaries and Trusts (Sydney, The Law Book Co Ltd, 1989) at 1; J Glover, ‘Identification of Fiduciaries’ in P Birks ed, Privacy and Loyalty (Oxford, Clarendon Press, 1997); PD Finn, ‘Fiduciary Law’ in E McKendrick ed, Commercial Aspects of Trusts and Fiduciary Obligations (Oxford, Clarendon, 1992) at 7; JR Lehane, ‘Fiduciaries in a Commercial Context’ in PD Finn ed, Essays in Equity (Sydney, The Law Book Co Ltd, 1985) at 95; G McCormack, ‘Fiduciaries in a Changing Commercial Climate’ (1997) Company Lawyer 38; R Flannigan, ‘The Adulteration of Fiduciary Doctrine in Corporate Law’ (2006) LQR 449. 39 Northern Counties Securities Ltd v Jackson & Steeple Ltd [l974] 2 All ER 625; Allen v Gold Reefs of W. Africa Ltd [1900] 1 Ch 656; Greenhalgh v Arderne Cinemas Ltd [1951] Ch 286—where the power to vote may be subject to a bona fides test that the shareholder reasonably believed that his or her vote is of general benefit to the shareholders as a whole, where amendments to the constitution are proposed. Clemens v Clemens Bros Ltd [1976] 2 All ER 268 arguably allows the court to impose that restraint on the freedom to vote even when it comes to other resolutions such as the application of pre-emption rights, but such a restraint was imposed on a shareholder with a significant stake. 40 See generally, L Johnson and D Millon, ‘Recalling Why Corporate Officers are Fiduciaries’ (2005) 46 William and Mary Law Review 1597.

168 The Role of Law in Shareholder Activism company that the principal is the company as an institution, and directors are subject to legal duties to the institution as a whole.41 Activists who try to exercise a degree of power and influence upon management could be argued to be exercising power that stems from share ownership, hence such power is ‘own power’, derived from the premises of share ownership. As such, could it be argued that such exercise of power is not subject to fiduciary duties in the absence of a principal-agent paradigm? However, in chapter 4, it has been argued that the perception that ‘offensive’ activists are using ‘own power’ may actually be less supported than it seems, as the aim of value extraction with a view to exit may disentitle them from claiming shareholder primacy as residual claimants subject to an open-ended relationship with the company. Such ‘own power’ is hence a much more limited power, recalling that chapter 4 argues that the power residual claimants enjoy goes towards monitoring under the principal-agent paradigm. Further, mandatory law has prescribed only for certain circumstances where shareholders would exercise determinative power, such as where directors enter into substantial transactions with the company, and where ratification of irregularities is concerned. Shareholders’ exercise of ‘own power’ is theoretically based on monitoring management. Offensive activists purporting to exercise ‘own power’ to intervene in management may hence be mistaken as to the scope of theoretical support in shareholder primacy. It is arguable that, where ‘offensive’ activists are trying to interfere with management, they have stepped beyond the boundaries of ‘own power’ into the area of the general power of management. Hence, any purported exercise of such power could arguably be subject to the same duties as imposed on directors. As mentioned earlier, directors’ duties are foundationally located in accountability as agents exercising ‘delegated’ power. Hence, if an ‘offensive’ activist purports to act in a ‘co-managing’ capacity to influence directorial actions, then accountability could similarly be attracted. Such accountability could be attracted as if the exercise of the power is accountable to the ‘principal’, ie shareholders collectively, according to the finance perspective, or the company as an institution according to the real entity theory. Such accountability may be warranted, or otherwise, unappointed persons would be able to intervene in management with a greater degree of freedom than appointed management, and this would be against the spirit of the law, which has already extended to shadow and de facto directors.42 Although the law on shadow and de facto directors may not unequivocally encompass the activities of

41 S Worthington, ‘Shares and Shareholders: Property, Power and Entitlements Part 2’ (2001) 22 Company Lawyer 307. 42 Eg Secretary of State for Trade and Industry v Deverell [2000] 2 BCLC 133.

Legal or Regulatory Controls of Offensive Shareholder Activism 169 offensive activist at this point, the perspective from theory may warrant the imposition of duties upon the activist interfering with management. The legal difficulty may lie in establishing the proximate link between Board decisions and activists’ influence, which may, depending on the facts of each case, present different challenges. If the proximity between an activist’s influence and Board decisions can be established, then both the finance and real entity theories are arguably able to support the imposition of directorial-type duties upon ‘offensive’ activists. However, a counter-argument to the above would be that, it needs to be established that the activist should protect another set of interests before his own in order to be treated as a fiduciary. Can that superior set of interests be located? Anabtawi and Stout’s arguments are heavily premised on the activists’ ability to extract personal benefits and unfairly disadvantage other shareholders and stakeholders in the company. However chapter 4 recognises the freedom of shareholders in the legitimate open-ended contracting process framed by the enabling paradigm of company law. Shareholders engaging in the open-ended contracting process may be concurrently serving personal and wider interests, as they are investors to begin with. It would be difficult to conceptualise shareholders as being bound to serve a superior set of interests to their investment objectives. The totally ‘unconflicted’ shareholder in Anabtawi and Stout’s thesis would arguably be impossible to locate, and restricts us to a conceptualisation of shareholder activism that is only for the collective good. In the era of ‘stewardship’, the imposition of fiduciary duties may also be counter-productive to determining if institutions as stewards may deliver public interest goods. Hence, the imposition of fiduciary duties would arguably curtail more shareholder freedom than is necessary. This author is of the view that the fiduciary thesis is unnecessarily restrictive for legitimate and perhaps productive forms of shareholder activism that are consistent with the enabling legal framework. However, chapter 4’s concerns regarding the ‘offensive’ activists who desire to extract value from the company for early exit, may be exactly the type of activists that Anabtawi and Stout are cautious of. This book nevertheless doubts that fiduciary obligations should be imposed on such investors just because they are heavily conflicted. The analysis preferred is that presented in chapter 4, that the theoretical and social legitimacy of such activism should be carefully examined. In particular, future evidence of social benefit or externalities would affect the social legitimacy of such activism even if theoretical legitimacy has been argued to be weak. More empirical evidence is required to fully assess the social benefits and externalities flowing from ‘offensive’ forms of activism. Hence, absolute prohibition by the law may be premature. However, are there actions that may be taken by shareholders under the current legal framework to exert control over offensive activists’ activities? It is suggested that s 994

170 The Role of Law in Shareholder Activism of the Companies Act 2006 may be wide enough to take into account of actions taken by minority shareholders against activist minority shareholders. However, as the section is concerned with ‘company affairs’ being conducted in an unfairly prejudicial manner, it remains to be seen if courts would regard activism as being ‘company affairs’, if such activism is merely a vocal demand that the company should take a particular course of action. Further, if activist demands have been acquiesced to by the Board, then would not the Board be regarded as having conducted ‘company affairs’ in the allegedly prejudicial manner, and not the activist who initiated it? The jurisprudence on s 994 also tends to focus on the contractual understandings between members which may be breached,43 or the use of constitutional rules in an unfair manner where a company is a close-knit quasi partnership.44 Publicly listed UK companies where membership is diverse do not often attract the application of the unfair prejudice remedy, where a natural ‘remedy’ for the unhappy petitioner would be to sell out the stake on a liquid market. Hence, it is unlikely that the current legal framework would allow shareholders to exert governance over each other in activism except through informal negotiation, persuasion or peer influence through the membership of trade associations such as the IMA and NAPF, or even the use of vocal opposition. The key difficulty in sustaining any complaint against activists is that it may be difficult to prove a proximate link between the activism and management decisions,45 to show that the activist has directly intervened in the decisions. Further, there may be issues of determining what the appropriate remedy may be and what ‘loss’ is suffered on the part of the other shareholders. As the minority activist is not actually able to summon de facto power to manage or direct the company, the court may also view the matter as capable of internal remedy by the Board or general meeting. Hence, this book argues that leaving the other shareholders to find legal remedies via private litigation is highly unlikely. Viewed in this light, regulation may arguably be a viable means to impose controls on questionable activist behaviour. Imposing legal controls on activist behaviour however risks running into a dilemma—on the one hand, regulation may be a testing ground to meet current needs and to determine if refinements need to be made (such as the role of disclosure regulation as discussed earlier). One the other hand, regulation may be seen as policy articulation accepting that such behaviour is legitimate, except subject to controls. This book has argued in chapter 4

43 O’Neil v Phillips [1999] BCC 600; Cobden Investments v RWM Langport [2008] EWHC 2810 (Ch). 44 Ebrahimi v Westbourne Galleries Ltd and Others [1972] 2 All ER 491. 45 D Demott, ‘The Mechanisms of Control’ (1999) 13 Connecticut Journal of International Law 233 at 246ff.

Legal or Regulatory Controls of Offensive Shareholder Activism 171 that the legitimacy of ‘offensive’ forms of activism is still in question, and should arguably still be questioned until more empirical evidence of its externalities and social benefits may be made known, and hence, it has to be considered whether imposing any regulation on activists may be tantamount to making a premature statement of the acceptability of ‘offensive’ forms of activism. In order to avoid making such a premature statement, it is submitted that disclosure mechanisms would be more appropriate than prescriptive regulation or the imposition of fiduciary duties. Disclosure mechanisms leave the ends of the regulation unspecified, but provide a procedure for policy-makers, shareholders and stakeholders, and the wider community to discern and judge the outworking of such activism.

The Role of Disclosure Regulation In the UK, disclosure is required of acquisitions of shareholdings in publicly listed companies so that creeping ownership may be detected in order to prevent surprise raids on companies. Such market transparency alerts the company and other shareholders as to the intent of any particular shareholder to acquire control over the company. The threshold in the UK for disclosure of acquisitions of interests in financial instruments that result in the acquisition of voting rights starts at 3 per cent and then every 1 per cent increase thereafter up to a 100 per cent.46 In the US, the threshold for disclosure of acquisitions of beneficial ownership in equity starts at 5 per cent.47 However, acquirers of beneficial interests in equity may choose to disclose their identities and interests in one of two forms, either a Schedule 13D form or a Schedule 13G form. Investors with an activist intent generally file a Schedule 13D form, which requires detailed disclosure of possible plans of takeover and the intended plans for the target company upon such takeover. This may be so even if the activist investor does not intend to take over control of the company. Passive investors who cross the 5 per cent threshold would be required to file a Schedule 13G form. As can be seen, disclosure regulation over substantial acquisitions of shareholdings largely relates to takeover regulation, and not activist regulation as such. Although the US SEC’s forms 13D and 13G have taken into account of the modern offensive forms of shareholder activism, form 13D does not strictly speaking require an activist to set out its campaign and what it intends to achieve in value extraction, and its projected exit. It is thus not completely adapted to the modern

46 47

D.T.R. 5.1.2, FSA Handbook. Section 13(d), Securities Exchange Act 1934.

172 The Role of Law in Shareholder Activism strategies of the offensive minority activist. Current disclosure regulation of acquisitions of substantial shareholdings is generally not intended as a form of regulatory control over shareholder activism as such. However, is there potential to introduce disclosure regulation of shareholder activism, especially for offensive activism? What would be the scope of such disclosure and what would it achieve? In terms of the scope of disclosure, it may be observed that most shareholder activists offer a substantial amount of voluntary disclosure at the moment. This may be a way of avoiding any liability for market abuse if trades are carried out after activism. Institutional shareholder activists rely heavily on research companies such as PIRC and RiskMetrics to advise on how to vote and whether any governance issue may be of concern. The recommendations of these advisory agencies are usually highly visible and available to the public. Insurance companies as members of the ABI also obtain advice from the ABI’s advisory voting service whose advice and recommendations are also highly visible and publicly available. Offensive activists may sometimes publish detailed particulars of the activist campaign, such as Knight Vinke’s full page advertisements against Suez, and Trian Fund’s open letters to Cadbury Schweppes. However, not all offensive activists decide to embark on such a level of transparency. Further, hedge funds voluntarily subscribing to the Hedge Funds Standards Board’s code of conduct would have to disclose to their investors their relationships with investee companies and the steps taken to manage any risks of market abuse that may be related to activist engagement. On the whole, voluntary disclosure exists but is a patchy landscape. Hermes Focus Fund for example specialises in behind-the-scenes activism and opts for low visibility and publicity. What would disclosure achieve? Disclosure regulation, whether in the form of soft law or mandatory disclosure, is a regulatory strategy that intends to achieve some or all of the following objectives: (a) Correcting market failure due to information asymmetry;48 (b) Providing transparency so that the market may itself respond to affirm or exert pressure and challenge the behaviour of any particular

48 SK Ripken, ‘The Dangers And Drawbacks of the Disclosure Antidote: Toward a More Substantive Approach to Securities Regulation’ (2006) 58 Baylor Law Review 139; FH Easterbrook, and DR Fischel, ‘Mandatory Disclosure and the Protection of Investors’ (1984) 70 Virginia Law Review 669; PG Mahoney, ‘Mandatory Disclosure as a Solution to Agency Problems’ (1995) 62 Chicago Law Review 1047, although a later work made the empirical conclusion that mandatory disclosure is not able to eliminate information asymmetries as it has intended, see PG Mahoney and J Mei, ‘Mandatory vs Contractual Disclosure in the Securities Markets: Evidence from the 1930s’, University of Virginia Legal Working Papers 2006, at http://papers.ssrn.com/sol3/papers.cfm?abstract_ id=883706.

Legal or Regulatory Controls of Offensive Shareholder Activism 173

(c)

entity, in order to encourage the entity to comply with accepted norms of behaviour;49 Providing a framework for self-regulation and reflexive regulation so that the exact needs of further regulation may be ascertained.50

In terms of correcting information asymmetries, the role of disclosure regulation is most relevant to situations where purchase decisions may have to be made and informed judgment may only be facilitated by disclosure on the part of the producer or issuer. Activist intentions may affect investor decisions since empirical research has provided evidence of how activist filings of forms 13D in the US generally trigger share price movements.51 It could be argued that, since the commencement of activism is price sensitive information, that should be made available to the public. The details of the campaign and what the campaign intends to achieve may also be price sensitive information. It could be argued that information on activism is price-sensitive and ought to be disclosed to the market.52 It may also be argued that disclosure regulation provides a balanced form of control over activist behaviour as it does not impose any specific form of prescription but allows the transparency to draw out responses from the market in order to shape the behaviour of the activist. Such transparency allows other investors to consider the activist’s campaign and demands, and to evaluate for themselves whether the activism is beneficial or otherwise for themselves and for the company. The transparency arguably also co-opts stakeholders who may engage via public or media discussions, to express the community’s expectations and views on the activist behaviour. The countervailing pressures from shareholder and stakeholder camps may shape the development of activism in a way that could become acceptable to the shareholders, stakeholders and community, without direct regulatory intervention.

49 DW Case, ‘Corporate Environmental Reporting as Informational Regulation: A Law and Economics Perspective’ (2005) 76 University of Colorado Law Review 379; S Konar and MA Cohen, ‘Information as Regulation: The Effect of Community Right to Know Law on Toxic Emissions’ (1997) 32 Journal of Environmental Economics and Management 109; S Arora and S Gangopadhyay, ‘Toward a Theoretical Model of Voluntary Overcompliance’ (1995) 28 Journal of Economic Behaviour and Organisation 289. 50 CR Sunstein, ‘Informational Regulation and Informational Standing: Akins and Beyond’ (1999) 147 University of Pennsylvania Law Review 613; W Cage, ‘Regulating Through Information: Disclosure Laws and American Health Care’ (1999) 99 Columbia Law Review 1701. 51 NM Boyson and RM Mooradian, ‘Hedge Funds as Shareholder Activists from 1994– 2005’ (2007) at ; A Klein and E Zur, ‘Entrepreneurial Shareholder Activism: Hedge Funds and Other Private Investors’ (2006) at or (2009) Journal of Finance (forthcoming). 52 I have earlier discussed the nature of ad hoc ongoing securities disclosure in IH-Y Chiu, ‘Examining the Justifications for Mandatory Ongoing Disclosure in Securities Regulation’ (2005) 26 Company Lawyer 67.

174 The Role of Law in Shareholder Activism Disclosure regulation may hence be able to facilitate dialogue amongst various constituents on the appropriateness, expectations of or challenges against any activist’s campaign, and this may overcome the concerns raised in chapter 4 regarding informal activism that may exclude other constituents of the nexus, and prejudice other residual claimants where value extraction with a view to exit takes place. If all concerned constituents are able to exert dialogic pressures on the activist, the democracy of participation facilitated by disclosure may be realised.53 Disclosure regulation may not only empower other shareholders but also stakeholders and the wider community. What may be the drawbacks of requiring activists to make disclosure? It may be argued that making public one’s activist campaigns sets such campaign on a confrontational footing before any constructive engagement could take place with the management. Disclosure may prematurely polarise the positions between the activist and management and may lead to management manoeuvres to entrench their positions and policies.54 Disclosure may also influence share prices in the market in an inefficient manner if the market adopts irrational perceptions55 and responses to such disclosure. In considering the imposition of disclosure regulation, disclosure could first be made subject to a self-regulatory regime. For example, the disclosure required of institutions’ activist policy and collective activism policy under the revised Principles of Responsibility published by the Institutional Shareholders Committee.56 The Hedge Funds Standards

53

Sunstein, ‘Informational Regulation and Informational Standing’ (1999) n 50. Although this is not explicitly said in Hermes Focus Fund’s engagement policy, the informality and behind-the-scenes engagement may be crucial to constructive outworking with the management in its engagement, see M Becht, J Franks, C Mayer and S Rossi, ‘Returns to Shareholder Activism: Evidence from a Clinical Study of the Hermes UK Focus Fund’ (2008) 10 Review of Financial Studies 1093. 55 See generally, T Gilovich, D Griffin and D Kahneman eds, Heuristics and Biases: The Psychology of Intuitive Judgment (Cambridge, Cambridge University Press, 2002); D Kahneman and A Tversky eds, Choices, Values and Frames (Cambridge, Cambridge University Press, 2003), discussed more specifically in R Prentice, ‘Whither Securities Regulation?’ (2002) 51 Duke Law Journal 1397 and TA Paredes, ‘Blinded by the Light: Information Overload and its Consequences for Securities Regulation’ (2003) 81 Washington University Law Quarterly 417. Recent discussions outline the efficient markets hypothesis and empirical evidence regarding how it works in A Durnev, M Fox, R Morck, and B Yeung, ‘Law, Share Price Accuracy, and Economic Performance: The New Evidence’ (2003) 102 Michigan Law Review 331–386 as against GA Akerlof and RJ Schiller, Animal Spirits: How Human Psychology Drives the Economy, and Why It Matters for Global Capitalism (NJ, Princeton University Press, 2009). A middle way may be achieved by arguing that the efficient markets hypothesis works in calmer times and is out of order when tendencies for irrational behaviour such as risk aversion or risk taking overtake in booms and busts, see AW Lo, ‘The Adaptive Markets Hypothesis: Market Efficiency from an Evolutionary Perspective’ (Wharton Working Paper 2004) at . 56 16 November 2009. 54

Conclusion 175 Board also currently requires disclosure of activist policies of member funds to be made to investors, but perhaps more disclosure to the Board itself could be facilitated and more signatories from significant activists such as Knight Vinke would be desirable. A self-regulatory regime may be able to provide a form of reflexive regulation that acts as a testing ground for policy-makers’ discernment as to whether mandatory disclosure is required, and whether market failure in transparency may persist even after the self-regulation comes into place. This may be superior to the ad hoc and voluntary disclosure made by activists at the moment. This book is slow to recommend the imposition of mandatory disclosure right away, as it is important to discern the pros and cons of such disclosure on the companies, the nexus, the markets and the wider community. Such is also in the tradition of ‘negotiated regulation’ in the UK.57 4. CONCLUSION

In the recession following the global financial crisis of 2008/9, offensive forms of shareholder activism with a value-extracting emphasis have waned as many companies struggle to survive, while institutional shareholder activism continues to maintain a focus on sound corporate governance and the long term well-being of companies. The phenomenon of activism is thus highly sensitive to market developments, and any legal controls contemplated may thus be premature. This chapter has examined the role of law and regulation in two slightly different aspects: one, the issues surrounding facilitating more institutional shareholder activism as part of the governance landscape, and the second, in addressing academic recommendations that deal with the concerns raised by offensive forms of shareholder activism. This chapter has examined in particular Anabtawi and Stout’s recommendation that shareholder activists should be subject to latent fiduciary duties. The book is of the view that this form of prescriptive control may unduly stifle legitimate forms of shareholder activism pursuant to the openended contracting model, and possibly in the pursuit of public interest as ‘stewardship’. It is however recognised that such fiduciary duties may constrain the selfish impulses of activists who wish to extract value at an advantage over other residual claimants in the company, and hence, it is imperative that more empirical evidence be found as to the social benefits (or otherwise) of value-extracting activism and the level of intensity of such activities in the publicly listed corporate landscape.

57 A Dignam, ‘Exporting Corporate Governance: UK Regulatory Systems in a Global Economy’ (2000) Company Lawyer 70.

176 The Role of Law in Shareholder Activism In sum, the book is of the view that disclosure regulation, as a form of best practice to begin with, is appropriate going forward to address both issues. Disclosure regulation facilitates the observeability of institutional shareholder activism that is being urged to become a force of governance for public interest. Disclosure would also allow critical examination of offensive forms of shareholder activism and how that may affect the company and the other constituents of the nexus. It is surmised that the regulator may not be totally distant in this governance landscape, as regulatory governance is often a necessary counterpart to the uncertain achievements of market-based governance. The developments in remuneration practices in financial institutions for example, will be a key area to watch going forward as a microcosmic representation of the interplay between market-based and regulatory governance.

6 Conclusion

A

T THE TIME of writing this book, the economy is suffering the after-effects of the global financial crisis 2008/9, and it is anticipated that the patterns of shareholder activism may change in the UK. The financial crisis in 2008/9 is diagnosed to have been caused by a number of factors, from legislative inadequacies, regulatory failures and corporate governance failures.1 The lack of shareholder monitoring in risk-taking banks that suffered the most during the crisis, has been highlighted to be an issue of concern.2 Shareholders have been called upon to cease acting as ‘absentee landlords’ and to engage ‘along deeper lines’.3 Institutional shareholder activism in the UK has been called upon to be intensified and to become more accountable. The book examines the actual practice of two dominant forms of shareholder activism in the UK. First, institutional shareholder activism, which is largely premised upon corporate governance issues and within the enabling framework of company law. Such activism has been most visible at general meetings and in the exercise of voting power. Next, the book looks into ‘offensive’ forms of activism largely spearheaded by hedge funds, characterised by a desire to seize an opportunity in a company in order to extract value in the form of equity gains. Offensive activists often keep their stakes for 2–3 years, selling off upon the materialisation of gain or where the campaign is not likely to achieve much without increased cost. Such activism is characterised by the exertion of the activists’ influence upon the company, and frequently relates to the company’s allocation, distribution and capital decisions. The book delves into the theoretical organisation of the company, and legal framework surrounding the roles of shareholders, to critically consider whether shareholder

1 FSA, The Turner Review: A Regulatory Response to the Global Banking Crisis (Mar 2009); J de Larossière, The High-Level Group on Financial Supervision in the EU (25 Feb 2009); HM Treasury, Reforming Financial Markets (Jul 2009); US Department of the Treasury White Paper, A New Foundation: Rebuilding Financial Supervision and Regulation (Mar 2009); M Brunnermeier, A Crockett, C Goodhart, AD Persaud and H Shin, ‘The Fundamental Principles of Financial Regulation’, (2009) Geneva Reports on the World Economy . 2 HM Treasury, Reforming Financial Markets (8 Jul 2009). 3 ‘Myners Lashes out at Landlord Shareholders’, Financial Times (21 Apr 2009).

178 Conclusion activism of both types may be accommodated within the theoretical and legal frameworks. It is believed that this approach provides a more comprehensive and well-rounded understanding of the supportability of shareholder activism. It is believed that the supportability of activism should not only be based on an instrumental view, ie relating the desirability of activism to numbers relating to the company’s share price. It is argued that theory and law would likely support the type of activism practised today by institutional shareholders. However, institutional shareholder activism as it is practised today may be criticised as insufficiently tailored to act as a monitor of a particular investee company. Nevertheless, it could also be argued that private processes in activism may unfairly disadvantage other constituents in the nexus of contracts constituting the company. As institutions are called upon to engage in more private forms of activism in the role of monitoring, this would present challenges to how institutions perceive their investment management and its connection with shareholder activism. Institutions would also likely be challenged in their wider role in contributing to the landscape of governance for public interest. ‘Offensive’ forms of activism are arguably not as well supported in theory and law, as it is argued that two features of such activism are problematic. One, offensive activism may be engaged in issues such as allocational decisions that are reserved for management, and the way offensive activism is mounted is intended to influence management outside of the legal framework providing for exceptional control by the general meeting. Second, offensive activists often wish to extract value from the company in order to make an exit, and such behaviour is often justified in the name of shareholder primacy as activists see themselves as the ultimate beneficiaries of the corporation under the residual claimant theory. It is argued, however, that the primacy that goes to protect residual claimants is in relation to long term monitoring and should not apply to equity participants who have used active means to augment their self-interest prior to closing off their residual claimant status. It is hence argued that allowing value extraction by activists in the name of shareholder primacy is misplaced. The two concerns together may result in the imposition of private cost upon the other shareholders and stakeholders. Further, there is no existing legal duty imposed on activists to countervail the behaviour that may generate externalities. The book however also notes that more empirical evidence especially of any wider social benefit that may result from either form of activism is necessary to determine whether shareholder activism should be encouraged and in what form. Hence, the discussion of the role of law in controlling activism by prescriptive force may be premature in this context. However, as there is some literature on this issue, this book concludes by commenting on the options, ie the imposition of fiduciary duties on activist shareholders and the use of regulatory controls such as disclosure. Any

Conclusion 179 intrusive form of regulation is arguably premature and may actually be inconsistent with the existing framework on shareholder freedoms and rights. Hence, the book is of the view that if regulation is necessary, then the nature of activist plans, intent, strategies, forms of engagement and what is sought to be achieved through the engagement could be subject to disclosure. Such disclosure could be administered by the bodies representing most investors in the UK at the moment. The outworking of such best practice may be relevant for deciding whether mandatory disclosure is necessary. As the US already has Form 13D which relates to the disclosure of activist acquisitions of equity exceeding 5 per cent for activist purposes, the UK could consider introducing a similar form of disclosure, albeit subject to self-regulation at first, with the requisite modifications. The book’s main concern is to point out the foundational differences between the two dominant types of shareholder activism in the UK. These two types of activism give rise to different concerns. The key challenge facing institutional shareholder activism is how it may undertake a role in monitoring that serves not only private but also public interest. In the wake of the financial crisis that started in late 2008, and the revelation of management inadequacies in major banks in the UK, Hector Sants, Chief Executive of the UK Financial Services Authority made the following remarks: [Shareholders’] traditional role [is] in protecting the money entrusted to them— which usually leads them to sell shares rather than press for changes—but ... they also ha[ve] a duty to use their influence to help maintain financial stability. [They] have a major role in addressing the issues arising from this financial crisis.4

The role of shareholders is seen to be critical for their own interests as well as in the ‘regulatory space’ that governs the management of companies in the UK, and hence, the legitimation of shareholder activism would also come from its contribution to the regulatory space. Shareholder activism is unlikely to remain a merely private contractual matter, but it is inherently difficult to frame a form of market-based governance by institutional shareholders that serve both private and public needs. However, encouraging shareholder activism should possibly not be extended indiscriminatingly to ‘offensive’ forms of activism, unless supported by robust empirical evidence of benefit to the company, its general body of shareholders and stakeholders. One commentator posits, Turning firms over to shareholder management will produce problems that are the mirror image of those caused when hired managers are left unsupervised. If agency costs are to be feared when management controls a firm, there will

4

‘FSA Chief Lambasts Uncritical Investors’, Financial Times (11 Mar 2009).

180 Conclusion be principal costs—a term which only seems to be an oxymoron—when and if shareholders gain control.5

The legitimacy of shareholder activism ultimately depends on its foundations, its actual outworking, its contribution to the ‘regulatory space’ and the existence or otherwise of social benefit.

5 AD Boyer, ‘Activist Shareholders, Corporate Directors, and Institutional Investment: Some Lessons from the Robber Barons’ (1993) 50 Washington and Lee Review 977 at 983. This comment is made in the context of critically examining buy-outs in the US where buyout investors turned out to be robber barons raiding corporate value. The analogy may be arguably extreme but not completely inappropriate to considering the notion of ‘value extraction’.

Bibliography of Books and Chapters in Books Agnblad, J, Berglof, E, Hogfeldt, P and Svancar, H, ‘Ownership and Control in Sweden: Strong Owners, Weak Minorities and Social Control’ in F Barca and M Becht eds, The Control of Corporate Europe (Oxford, OUP, 2002) 250–55 Akerlof, GA and Schiller, RJ, Animal Spirits: How Human Psychology Drives the Economy, and Why It Matters for Global Capitalism (NJ, Princeton University Press, 2009) Ararat, M, Sener, B and Taboglu, E, ‘v-Net: a Case of Family Owned Conglomerates’ in C Mallin (ed), International Corporate Governance: A Case Study Approach (Cheltenham, Edward Elgar, 2006) Arrow, KJ, Social Choice and Individual Values 2nd ed (Conn, Yale University Press 1970) Balotti, R Franklin, Finkelstein, JA, Williams, GP, Meetings of Stockholders (Aspen Publishers Online, 1996) Berle, AA and Means, GC, The Modern Corporation and Private Property 2nd ed (Transaction Publishers US, 1991) Blair, M, Ownership and Control (Washington DC, Brookings Institution Press, 1995) Bowles, S and Gintis, H, Democracy and Capitalism: Property, Community, and the Contradictions of Modern Social Thought (New York, NY, Basic Books, 1998) Braithwaite, J, Regulatory Capitalism (Cheltenham, Edward Elgar, 2008) Brunnermeier, M, Crockett, A, Goodhart, C, Persaud, AD and Shin, H, The Fundamental Principles of Financial Regulation, Geneva Reports on the World Economy (2009) Burgel, O, ‘UK Venture Capital and Private Equity as an Asset Class for Institutional Investors’ Research Report for the BVCA (2000) BVCA, Private Equity in the UK: The First 25 Years (2007), available at www.bvca. co.uk Cadbury, A, Report of the Committee on the Financial Aspects of Corporate Governance (Dec 1992) Carlsson, RH, Ownership and Value Creation (Chichester, John Wiley and Sons, 2001) Cheffins, BR, Corporate Ownership and Control: British Businesses Transformed (Oxford, Oxford University Press, 2008) Conference Board, The, Hedge Fund Activism: Findings and Recommendations for Corporations and Investors (2008) Davis, JH, Schoorman, FD and Donaldson, L, ‘Toward a Stewardship Theory of Management’ in T Clarke, Theories of Corporate Governance (London and New York, Routledge, 2004) ch 9 de Larossière, J, The High-Level Group on Financial Supervision in the EU (2009)

182 Bibliography of Books and Chapters in Books Department of Work and Pensions, Encouraging Shareholder Activism (Consultation Paper, 2002) at Department of Trade and Industry, Company Law Reform (March 2005) ——, Modern Company Law for a Competitive Economy: Completing the Structure (2000). Donahue, JD and Nye, JS, eds, Market-based Governance (Mass, Brookings Institution Press, 2002) Easterbrook, FH and Fischel, DR The Economic Structure of Corporate Law (Cambridge, Mass, Harvard University Press, 1991) Finn, PD, ‘Fiduciary Law’ in E McKendrick ed, Commercial Aspects of Trusts and Fiduciary Obligations (Oxford, Clarendon, 1992) 7 ——, ‘The Fiduciary Principle’ in TG Youdan ed, Equity, Fiduciaries and Trusts (Sydney, The Law Book Co Ltd, 1989) 1 Freeman, RE, ‘A Stakeholder Theory of the Modern Corporation’ reproduced in MB Clarkson ed, The Corporation and Its Stakeholders (Toronto, University of Toronto Press, 1998) 125 FSA, Hedge Funds: A Discussion of Risk and Regulatory Engagement (2004) ——, The Turner Review: A Regulatory Response to the Global Banking Crisis (2009) Gapper, J and Denton, N, All That Glitters: The Fall of Barings (London, Penguin Books, 1997) Gilovich, T, Griffin, D and Kahneman, D (eds), Heuristics and Biases: The Psychology of Intuitive Judgment (Cambridge, Cambridge University Press, 2002) Glover, J, ‘Identification of Fiduciaries’ in P Birks ed, Privacy and Loyalty (Oxford, Clarendon Press, 1997) Goode, R, Commercial Law (London, Penguin Books, 2004) Greenbury, R, Report: Directors’ Remuneration (17 July 1995) HM Treasury, Reforming Financial Markets (July 2009) Hampel, R, Committee on Corporate Governance: Report (Jan 1998) Hawley, JP and Williams, AT, The Rise of Fiduciary Capitalism: How Institutional Investors Can Make Corporate America More Democratic (Pennsylvania, University of Pennsylvania Press, 2000) Hedge Funds Standards Board (led by Sir Andrew Large), Hedge Fund Standards: Final Report (Jan 2008) Higgs, D, Review on the Role and Effectiveness of Non-executive Directors (Jan 2003), Hirschmann, AO, Exit, Voice and Loyalty: Responses to Decline in Firms, Organizations, and States. (Cambridge, MA, Harvard University Press, 1970) Huse, M, Boards, Governance and Value Creation: The Human Side of Corporate Governance (Cambridge, CUP, 2007). Investment Management Association, Survey of Fund Managers’ Engagement with Companies For the Year Ending 2004, 2005, 2006, Jensen, MC, ‘Value Maximisation, Stakeholder Theory and the Corporate Objective Function’ reproduced in DH Chew and S Gillan eds, Corporate Governance at the Crossroads (Irwin, McGraw-Hill, 2005) Kahneman, D and Tversky, A eds, Choices, Values and Frames (Cambridge, Cambridge University Press, 2003)

Bibliography of Books and Chapters in Books 183 L’Habitant, FS, Handbook on Hedge Funds (Chichester, John Wiley and Sons, 2006) Law Commission, Shareholder Remedies (1998) Lehane, JR, ‘Fiduciaries in a Commercial Context’ in PD Finn ed, Essays in Equity (Sydney, The Law Book Co Ltd, 1985) 95 MARC and RSM, Classification and Analysis of Major European Business Failures (Research Project Commissioned by the European Contact Group)Oct 2005 Martin, R, Casson, PD and Nisar, TM, Investor Engagement (Oxford, OUP, 2008) McDermott, J, Corporate Society: Class, Property and Contemporary Capitalism (Boulder, West View Press, 1991) McKinsey and Co, Global Investor Opinion Surveys: Key Findings (London 2001), at www. mckinsey.com/governance Monks, R, The New Global Investors (Oxford, Capstone Publishing, 2001) ——, The Emperor’s Nightingale (Reading MA, Perseus Books, 1999) Myners, P, Institutional Investment in the UK: A Review (2001) NAPF, Pension Funds’ Engagement with Companies 2004, 2005, 2006 and 2007 National Association of Pension Funds (NAPF), Institutional Investment in the UK Six Years On (2007) OECD Steering Group, The Implications of Alternative Investment Vehicles for Corporate Governance: A Synthesis of Research about Private Equity Firms and Activist Hedge Funds (2007) Parkinson, J, Corporate Power and Responsibility (Oxford, Clarendon Press, 1993) PIRC, Survey of Voting Trends (1998), cited in Mallin, CA, “Institutional Investors and Voting Practices: an international comparison” (2001) 9 Corporate Governance 118 Reisberg, A, Derivative Actions and Corporate Governance (Oxford, Oxford University Press, 2007). Roe, M, Strong Managers, Weak Owners (NJ, Princeton University Press, 1996) Sabel, CF and Prokop, JE ‘Stabilisation through Reorganisation’ in R Frydman et al eds, Corporate Governance in Central Europe and Russia (Budapest, London, NY, Central European University Press, 1996)151 Selvaggi, M and Upton, J, Governance and Performance in Corporate Britain: Evidence from the IVIS Colour-coding System (ABI Research Paper 7, 2008). Shiller, RJ Irrational Exuberance (New York, NY, Broadway, 2001) Short, H and Keasey, K, ‘Institutional Shareholders and Corporate Governance in the UK’ in Keasey et al eds, Corporate Governance (Chichester, John Wiley and Sons, 1997) 61–92 Smith, RC and Walter, I, Governing the Modern Corporation (Oxford, OUP, 2006) Steiner, GA and Steiner, JF, Business, Government, and Society: A Managerial Perspective, Text and Cases (New York, NY, McGraw Hill/Irwin, 2006) Takizowa, H, ‘New Institutional Arrangements for Product Innovation in Silicon Valley’ in L Sun ed, Ownership and Governance of Enterprises: Recent Innovative Developments (Basingstoke, Palgrave Macmillan, 2003) 69 US Department of the Treasury White Paper, A New Foundation: Rebuilding Financial Supervision and Regulation (March 2009) Van Nunen, A, Fiduciary Management: Blue Print for Pension Fund Excellence (NJ, Wiley Finance, 2008) Walker, D, A Review of Corporate Governance in UK Banks and other Entities in the Financial Services Industry (July 2009)

184 Bibliography of Books and Chapters in Books Walker Working Group, Guidelines for Disclosure and Transparency in Private Equity (Nov 2007) Williamson, OE, The Economic Institutions of Capitalism (NY, Free Press, 1985) World Bank, Minority Shareholders (Aug 2003) at

Bibliography of Articles in Journals Acharya, VV and Kehoe, C, ‘Corporate Governance and Value Creation; Evidence from Private Equity’ (London Business School 2008) at Acharya, VV, Kehoe, C and Reyer, M, ‘Private Equity vs Plc Boards: A Comparison of Practices and Effectiveness’ (London Business School Aug 2008) at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1324019 Admati, AR, Pfleiderer, P and Zechner, J, ‘Large Shareholder Activism, Risk Sharing, and Financial Market Equilibrium’ (1994) 102 Journal of Political Economy 1097 Alchian, A and Woodward, S, ‘The Firm Is Dead; Long Live The Firm. A Review of Oliver E Williamson’s The Economic Institutions of Capitalism’ (1988) 26 Journal of Economic Literature 65 Alchian, A and Demsetz, H, ‘Production, Information Costs and Economic Organisation’ (1972) 62 The American Economic Review 777 Alexander, C, Chen, M, Seppi, D and Spatt, C, ‘The Role of Advisory Services in Proxy Voting’ (2006) University of Maryland working paper Alexander, FH and Honaker, JD, ‘Power to the Franchise or the Fiduciaries?: An Analysis of the Limits on Stockholder Activist Bylaws’ (2008) 33 Delaware Journal of Corporate Law 749 Alves, C and Mendes, V, ‘Corporate Governance Policy and Company Performance: The Portuguese Case’ (2004) 12 Corporate Governance 290 Anabtawi, I, ‘Some Skepticism about Increasing Shareholder Power’ (2006) 53 UCLA Law Review 561 Anabtawi, I and Stout, L, ‘Fiduciary Duties for Activist Shareholders’ (2008) 60 Stanford Law Review 1255 Anderson, K, Ramsay, I, Marshall, S and Mitchell, R, ‘Union Shareholder Activism in the Context of Declining Labour Law Protection: Four Australian Case Studies’ (2007) 15 Corporate Governance 45 Arden, M, ‘Reforming the Companies Acts: The Way Ahead’ (2002) Journal of Business Law 579 Arora, S and Gangopadhyay, S, ‘Toward a Theoretical Model of Voluntary Overcompliance’ (1995) 28 Journal of Economic Behaviour and Organisation 289 Arsalidou, D, ‘Objectivity vs Flexibility in Civil Law Jurisdictions and the Possible Introduction of the Business Judgment Rule in English Law’ (2003) 24 Company Lawyer 228 Ashraf, R and Jayaraman, N, ‘Determinants and Consequences of Proxy Voting by Mutual Funds on Shareholder Proposals’ at Attenborough, D, ‘The Company Law Reform Bill: An Analysis of Directors’ Duties and the Objective of the Company’ [2006] Company Lawyer 162 Ayres, I and Cramton, P, ‘Relational Investing and Agency Theory’ (1994) 15 Cardozo Law Review 1033

186 Bibliography of Articles in Journals Badian, L and Harrington, G, ‘The Politics of Sovereign Wealth’ (Winter 2008) International Economy 5 Bainbridge, SM, ‘Director Primacy and Shareholder Disempowerment’ (2006) 119 Harvard Law Review 1735 Bainbridge, SM, ‘Shareholder Activism and Institutional Investors’ (2005) University of California at Los Angeles School of Law, Law and Econ. Research Paper Series, Research Paper No 05-20, at Bainbridge, SM, ‘Mandatory Disclosure—A Behavioural Analysis’ (2000) 68 University of Cincinnati Law Review 1023 Balding, C, ‘A Portfolio Analysis of Sovereign Wealth Funds’ (2008) at Bebchuk, LA, ‘The Case for Increasing Shareholder Power’ (2005) 118 Harvard Law Review 833 Becht, M, Franks, J, Mayer, C and Rossi, S, ‘Returns to Shareholder Activism: Evidence from a Clinical Study of the Hermes UK Focus Fund’ (2008) 10 Review of Financial Studies 1093 Berle, A, ‘Corporation Powers as Powers in Trust’ (1931) 44 Harvard Law Review 1049 Bethel, JE and Gillan, SL, ‘Corporate Voting and the Proxy Process: Managerial Control Versus Shareholder Oversight’ (2005) at Bhagat, S and Black, BS, ‘The Uncertain Relationship Between Board Composition and Firm Performance’ (1999) 54 Business Lawyer 921 Bird, H, ‘A Critique of the Proprietary Nature of Share Rights in Australian Publicly Listed Corporations’ (1998) 22 Melbourne University Law Review 131 Black, BS and Kraakman, R, ‘A Self-Enforcing Model of Corporate Law’ (1996) 109 Harvard Law Review 1911 Black, BS, ‘Shareholder Passivity Re-examined’ (1990) 89 Michigan Law Review 520 Black, J, ‘Enrolling Actors in Regulatory Processes: Examples from UK Financial Services Regulation’ (2003) Public Law 63 Black, J, ‘Decentring Regulation’ (2001) Current Legal Problems 103 Blair, MM and Stout, L, ‘Specific Investment: Explaining Anomalies in Corporate Law’ (2006) 31 Journal of Corporation Law 719 Blair, MM and Stout, L, ‘A Team Production Theory of Corporate Law’ (1999) 85 Virginia Law Reivew 247 Boyer, AD, ‘Activist Shareholders, Corporate Directors, and Institutional Investment: Some Lessons from the Robber Barons’ (1993) 50 Washington and Lee Review 977 Boyson, NM and Mooradian, RM, ‘Hedge Funds as Shareholder Activists from 1994–2005’ (2007) at , (2008) 14 Journal of Corporate Finance 323 Bratton, W, ‘Hedge Funds and Governance Targets’ (2007) 95 Georgetown Law Journal 1375, also at Bratton, WW Jr, ‘Berle and Means Reconsidered at the Century’s Turn’ (2001) Journal of Corporation Law 737 Bratton, WW Jr, ‘Enron and the Dark Side of Shareholder Value’ (2002) 76 Tulane Law Review 1275

Bibliography of Articles in Journals 187 Brav, A, Jiang, W, Thomas, RS and Partnoy, F, ‘Hedge Fund Activism, Corporate Governance and Firm Performance’ (2007) at Briggs, TW, ‘Corporate Governance and the New Hedge Fund Activism: An Empirical Analysis’ (2007) 32 Journal of Corporation Law 681 Brown, LD and Caylor, ML, ‘Corporate Governance and Firm Operating Performance’ (2007) at Burns, T and Paterson, J, ‘Gold Plating, Gold Standard or Base Metal? Making Sense of Narrative Reporting after the Repeal of the Operating and Financial Review Regulations’ (2007) 26 International Company and Commercial Law Review 247 Cage, W, ‘Regulating Through Information: Disclosure Laws and American Health Care’ (1999) 99 Columbia Law Review 1701 Carleton, WT, Nelson, JM and Weisbach, MS, ‘The Influence of Institutions on Corporate Governance through Private Negotiations: Evidence from TIAACREF’ (1998) 53 Journal of Finance 1335 Carlson, PG, ‘Planning, Growth and the Efficient Use of Capital’ (1975) 4 Financial Management 27 Carman, KG, ‘Social Influences and the Private Provision of Public Goods: Evidence from Charitable Contributions in the Workplace’ (Stanford Institute of Economic Policy Research 2003), SIEPR Discussion Paper No. 02–13, at Case, DA, ‘Corporate Environmental Reporting as Informational Regulation: A Law and Economics Perspective’ (2005) 76 University of Colorado Law Review 379 Cheng, M, Subramanyam, KR and Zhang, Y, ‘Earnings Guidance and Managerial Myopia’ (2005) at Chidambaran, NK and Woidtke, T, ‘The Role of Negotiations in Corporate Governance: Evidence from Withdrawn Shareholder-Initiated Proposals’ (1999), EFA 0458; WP EFMA Athens 2000 and NYU, Ctr for Law and Business Research Paper No. 99-12, also found on the ssrn at Chiu, IH-Y, ‘The Role of a Company’s Constitution in Corporate Governance’ Journal of Business Law (forthcoming 2010) Chiu, IH-Y, ‘The Role of Securities Disclosure Regulation in Investor Protection Relating to Corporate Insolvency? Some Observations of the US, EU and UK Regulatory Frameworks’ (2008) Company Lawyer 35 Chiu, IH-Y, ‘Can UK Small Businesses Obtain Growth Capital in the Public Equity Markets? An Overview of the Shortcomings in the UK and European Securities Regulation and Considerations for Reform’ (2004) 28 Delaware Journal of Corporate Law 933 Choi, SJ and Fisch, JE, ‘On Beyond CalPERS: Survey Evidence on the Developing Role of Public Pension Funds in Corporate Governance’ (2008) 61 Vanderbilt Law Review 315 Choi, SJ, Fisch, JE and Pritchard, AC, ‘Do Institutions Matter? The Impact of the Lead Plaintiff Provision of the Private Securities Litigation Reform Act’ (2005) 83 Washington University Law Quarterly 869 Chueh, K-W, ‘Is Hedge Fund Activism New Hope for the Market?’ (2008) Columbia Business Law Review 724

188 Bibliography of Articles in Journals Clark, GL and Knight, ER, ‘Institutional Investors, The Political Economy of Corporate Disclosure, and the Market for Corporate Environmental and Social Responsibility: Implications from the UK Companies Act’ (Paper Presented at Sloan Industry Conference, Boston, 2008) Clearfield, AM, ‘ “With Friends Like These, Who Needs Enemies?” The Structure of the Investment Industry and Its Reluctance to Exercise Governance Oversight’ (2005) 13 Corporate Governance 114 Clifford, C, ‘Value Creation or Destruction? Hedge Funds as Shareholder Activists’ (2007) at Clyde, P, ‘Do Institutional Shareholders Police Management?’ (1997) 18 Managerial and Decision Economics 1 Coase, RH, ‘The Nature of the Firm’ (1937) 4 Economica 386 ——, ‘The Problem of Social Cost’ (1960) 3 Journal of Law and Economics 1 Coffee, JC, ‘Liquidity versus Control: The Institutional Investor as Corporate Monitor’ (1991) 91 Columbia Law Review 1278 Coffee, JC and Black, BS, ‘Institutional Investor Behaviour in the UK’ (1993–4) 92 Michigan Law Review 1999 Collin, S-O, ‘Governance Strategy: A Property Right Approach Turning Governance into Action’ (2007) 11 Journal of Managerial Governance 215 Collins, R, ‘Weber’s Last Theory of Capitalism’ (1980) 45 American Sociological Review 925 Cox, P, Brammer, S and Millington, A, ‘Pension Fund Manager Tournaments and Attitudes Towards Corporate Characteristics’ (2007) 34 Journal of Business Finance and Accounting 1307 Crutchley, CE, Hudson, CD and Jensen, MR, ‘The Shareholder Wealth Effects of CalPERS’ Activism’ (1998) 7 Financial Services Review 1, available at Davies, P, ‘The Enlightened Shareholder Value and New Responsibilities of Directors’ also at http://www.google.co.uk/url?sa=t&source=web&cd=4&ve d=0CCoQFjAD&url=http%3A%2F%2Fcclsr.law.unimelb.edu.au%2Fdownload. cfm%3FDownloadFile%3DBC82395E-09AD-DB76-F1D0B2AFFB41CF9D&ei=kt YITOrdOd-T4gauo9yjAQ&usg=AFQjCNG2YYcJMKO7mdf3jxxWgyGKtE8fsw &sig2=Zk2TJuLtzj3kympINGQuaA, 1–9 Davis, GF and Kim, EH, ‘Would Mutual Funds Bite the Hand that Feeds Them? Business Ties and Proxy Voting’ (2005) at , (2007) 85 Journal of Financial Economics 552 De Jong, A, De Jong, DV, Roosenboom, P and Mertens, G, ‘Royal Ahold: A Failure of Corporate Governance’ (Feb 2005) at http://ssrn.com/abstract=663504 Del Guercio, D, Seery, L and Woidtke, T, ‘Do Boards Pay Attention when Institutional Investor Activists Just Vote No?’ (2008) at , (2008) 90 Journal of Financial Economics 84 Demott, D, ‘The Mechanisms of Control’ (1999) 13 Connecticut Journal of International Law 233 Demsetz, H, ‘Toward A Theory of Property Rights II: The Competition between Private and Collective Ownership’ (2002) 31 Journal of Legal Studies 653 Dignam, A, ‘Capturing Corporate Governance: The End of the UK Self-regulating System’ (2007) 4 International Journal of Disclosure and Governance 24

Bibliography of Articles in Journals 189 ——, ‘Exporting Corporate Governance: UK Regulatory Systems in a Global Economy’ (2000) Company Lawyer 70 Dodd, EM, ‘For Whom are Corporate Managers Trustees?’ (1932) 45 Harvard Law Review 1057 Dulewiscz, V and Herbert, P, ‘Does the Composition and Practice of Boards of Directors Bear Any Relationship to the Performance of their Companies?’ (2004) 12 Corporate Governance 263 Durnev, A, Fox, M, Morck, R and Yeung, B, ‘Law, Share Price Accuracy, and Economic Performance: The New Evidence’ (2003) 102 Michigan Law Review 331–86 Easterbrook, FH and Fischel, DR, ‘Mandatory Disclosure and the Protection of Investors’ (1984) 70 Virginia Law Review 669 El Mehdi, IK, ‘Empirical Evidence on Corporate Governance and Corporate Performance in Tunisia’ (2007) 15 Corporate Governance 1429 English, PC, Smythe, TI and MacNeil, CR, ‘The CalPERS’ Effect Revisited’ (2004) 10 Journal of Corporate Finance 157 Ereftheriadis, P, ‘The Analysis of Property Rights’ (1996) 16 Oxford Journal of Legal Studies 31 Fama, EF, ‘Efficient Markets: A Review of Theory and Practical Work’ (1970) 25 Journal of Finance (No 2) 383 ——, ‘Efficient Capital Markets II’ (1991) 66 Journal of Finance (No 5) 1575 Fama, EF and Jensen, MC, ‘Separation of Ownership and Control’ (1983) 26 Journal of Law and Economics 301 Finch, V, ‘Corporate Governance and Cadbury: Self regulation and Alternatives’ (1994) Journal of Business Law 51 Fisch, JE, ‘Measuring Efficiency in Corporate Law: The Role of Shareholder Primacy’ (2006) 31 Journal of Corporation Law 637 Flannigan, R, ‘The Adulteration of Fiduciary Doctrine in Corporate Law’ (2006) Law Quarterly Review 449 Fligstein, N and Feeland, R, ‘Theoretical and Comparative Perspectives on Corporate Governance’ (1995) 21 Annual Review of Sociology 21 Fort, TL, ‘Goldilocks and Business Ethics: A Paradigm That Fits “Just Right”’ (1998) 23 Journal of Corporation Law 245 Fotak, V, Bertolotti, B and Megginson, W, ‘The Financial Impact of Sovereign Wealth Fund Investments in Listed Companies’ (2008), at Furubotn, EG and Pejovich, S, ‘Property Rights and Economic Theory’ (1972) 10 Journal of Economic Literature 1137 Garay, U and Gonzalez, M, ‘Corporate Governance and Firm Value: The Case of Venezuela’ (2008) 16 Corporate Governance 194 Gillan, SL and Sparks, LT, ‘The Evolution of Shareholder Activism in the US’ (2007) at Gilson, R, ‘A Survey of Shareholder Activism: Motivation and Empirical Evidence’ (1998) at http://ssrn.com/abstract=663523 ——, ‘Controlling Shareholders and Corporate Governance’ (2006) 119 Harvard Law Review 1641, also an ECGI Working Paper 49/2005, available at

190 Bibliography of Articles in Journals Gilson, RJ and Milhaupt, C, ‘Sovereign Wealth Funds and Corporate Governance: A Minimalist Response to the New Mercantilism’ (2008) 60 Stanford Law Review 1345 Goldenberg, P, ‘Shareholders vs Stakeholders: The Bogus Argument’ (1998) 19 Company Lawyer 34 Gordon, JN, ‘Proxy Contests in an Era of Increasing Shareholder Power: Forget Issuer Proxy Access and Focus on E-Proxy’ (2008) ECGI—Law Working Paper No. 92/2008, (2008) Vanderbilt Law Review 1 Gordon, JN, ‘Shareholder Initiative and Delegation: A Social Choice and Game Theoretic Approach to Corporate Law’ (1991) 60 University of Cincinnati Law Review 347 Goyal, A and Wahal, S, ‘The Selection and Termination of Investment Management Firms by Plan Sponsors’ (2008) 63 Journal of Finance 1805 Grantham, Ross, ‘The Doctrinal Basis of the Rights of Company Shareholders’ (1998) Cambridge Law Journal 554 Grossman, SJ and Hart, OD, ‘The Costs and Benefits of Ownership: A Theory of Vertical and Lateral Integration’ (1986) 94 Journal of Political Economy 691 Hansmann, H and Kraakman, R, ‘The End of History for Corporate Law’ (2001) 89 Georgetown Law Journal 439 Hart, OD, ‘An Economist’s Perspective on the Theory of the Firm’ (1989) 89 Columbia Law Review 1757 Hendry, J, Sanderson, P, Barker, R and Roberts, J, ‘Responsible Ownership, Shareholder Value and New Shareholder Activism’ ESRC Centre for Business Research Working Paper 297, University of Cambridge (Dec 2004) Heracleous, L, ‘What is the Impact of CG on Organisational Performance?’ (2001) 9 Corporate Goverance 166 Hill, J, ‘Visions and Revisions of the Shareholder’ (1998) 48 American Journal of Comparative Law 39 Hirt, H, ‘In what Circumstances Should Breaches of Directors’ Duties Give Rise to a Remedy under ss 459–461 of the Companies Act 1985?’ (2003) 24 Company Lawyer 100 Honore, T, ‘A Theory of Coercion’ (1990) Oxford Journal of Legal Studies 94 Hotchkiss, ES et al, ‘Does Shareholder Composition Matter? Evidence from the Market Reaction to Corporate Earnings Announcement’ (2003) 58 Journal of Finance 1469 Hu, HT and Black, BS, ‘Equity and Debt Decoupling and Empty Voting II’ (2008) 156 University of Pennsylvania Law Review 625 Hu, HT and Black, BS, ‘The New Vote Buying: Empty Voting and Hidden (Morphable) Ownership’ (2006) 76 Southern California Law Review 811 Illig, RC, ‘What Hedge Funds Can Teach Corporate America: A Roadmap for Achieving Institutional Investor Oversight’ (2007) 57 American University Law Review 225 Jackson, A, ‘Towards A Mutual Understanding of Objectives? Attitudes of Institutional Investors and Listed Companies to Corporate Governance Reforms’ (2001) 9 Corporate Governance 196 Jansson, A, ‘Types of Shareholder Activism: Offensive Opportunity Seizure or Defensive Safeguarding of the Investment?’ School Of Management and Economics Working Paper, University of Växjö

Bibliography of Articles in Journals 191 Jensen, MC and Meckling, WH, ‘Theory of the Firm: Managerial Behaviour, Agency Costs and Ownership Structure’ (1976) 3 Journal of Financial Economics 305 Johnson, L and Millon, D, ‘Recalling Why Corporate Officers are Fiduciaries’ (2005) 46 William and Mary Law Review 1597 Kahan, M and Rock, EB, ‘Hedge Funds in Corporate Governance and Corporate Control’ (2007) 155 University of Pennsylvania Law Review 5 Kaltchev, G, ‘Corporate Governance and Shareholder Litigation’ (2008) at

Kang, DL and Sorensen, AB, ‘Ownership, Organisation and Firm Performance’ (1999) 25 Annual Review of Sociology 121 Karmel, R, ‘Should A Duty To The Corporation Be Imposed On Institutional Shareholders?’ (2004) 60 Business Lawyer 1 Karpoff, JM, ‘The Impact of Shareholder Activism in Target Companies: A Survey of Empirical Findings’ (2001) at Keay, A, ‘Section 172(1) of the Companies Act 2006: An Interpretation and Assessment’ (2007) Company Lawyer 106 ——, ‘Formulating a Framework for Directors’ Duties to Creditors: An Entity Maximisation Approach’ (2005) 64 Cambridge Law Journal 614 Klein, A and Zur, E, ‘Entrepreneurial Shareholder Activism: Hedge Funds and Other Private Investors’ (2006) at ; (2009) Journal of Finance (forthcoming 2010) Konar, S and Cohen, MA, ‘Information as Regulation: The Effect of Community Right to Know Law on Toxic Emissions’ (1997) 32 Journal of Environmental Economics and Management 109 Kraakman, RH and Hansmann, H, ‘The End of History for Corporate Law’ (1994) 82 Georgetown Law Review 1733 Kulpa, AM and Long, B, ‘The Wolf in Shareholder’s Clothing: Hedge Fund Use of Cooperative Game Theory and Voting Structures to Exploit Corporate Control and Governance’ (2005) 6 UC Davis Business Law Journal 4 La Porta, R et al, ‘What Works in Securities Laws?’ at Lazonick, W, ‘Investment in Innovation, Corporate Governance and Employment: Is Prosperity Sustainable in the United States?’ (1998) Levy Institute Public Policy Brief No. 37 at Lee, IB, ‘Corporate Law, Profit-Maximisation and the Responsible Shareholder’ (2005) 10 Stanford Journal of Law, Business and Finance 31 Levine, R, ‘Law, Endowments and Property Rights’ (2005) 19 Journal of Economic Perspectives 61 Lipton, M and Rowe, PK, ‘The Inconvenient Truth about Corporate Governance: Some Thoughts on Vice-Chancellor Strine’s Essay’ (2007) 33 Journal of Corporate Law 63 Ljungqvist, A and Richardson, MP, ‘The Cash Flow, Return and Risk Characteristics of Private Equity’ (2003) at , (2003) Working Paper No. 9495, NBER Lo, AW, ‘The Adaptive Markets Hypothesis: Market Efficiency from an Evolutionary Perspective’ (Wharton Working Paper 2004) at

192 Bibliography of Articles in Journals Logsdon, JM and van Bulen, HJ, ‘Justice and Large Corporations: What do Activist Shareholders Want?’ (2008) 47 Business and Society 523 Lyons, G, ‘State Capitalism—The Rise of Sovereign Wealth Funds’ (2008) 4 Law and Business Review of the Americas 179 MacNeil, I and Li, X, ‘ “Comply or Explain”: Market Discipline and Non-compliance with the Combined Code’ (2006) 14 Corporate Governance 286 Mahoney, PG, ‘Mandatory Disclosure as a Solution to Agency Problems’, (1995) 62 Chicago Law Review 1047 Mahoney, PG and Mei, J, ‘Mandatory vs Contractual Disclosure in the Securities Markets: Evidence from the 1930s’, University of Virginia Legal Working Papers 2006, at Mallin, C, ‘Institutional Investors and Voting Practices: An International Comparison’ (2001) 9 Corporate Governance 118 Marens, R, ‘Activism in an Era of Financial Hegemony Going to War With the Army You Have: Labor’s Shareholder’ (2008) 47 Business and Society 312 Martin, KJ and Thomas, RS, ‘The Effect of Shareholder Proposals on Executive Compensation’ (1999) 67 University of Cincinnati Law Review 1021 McCormack, G, ‘Fiduciaries in a Changing Commercial Climate’ (1997) Company Lawyer 38 Milhaupt, CJ, ‘Property Rights in Firms’ (1998) 84 Virginia Law Review 1145 Mirvis, TN, Rowe, PK and Savitt, W, ‘Bebchuk’s Case for Increasing Shareholder Power: An Opposition’ (2005) 118 Harvard Law Review 833 also at Mitchell, DT, ‘Shareholders as Proxies: The Contours of Shareholder Democracy’ (2006) 65 Washington and Lee Law Review 4 Mitchell, WC, ‘Commons on the Legal Foundations of Capitalism’ (1924) 14 The American Economic Review 24 Monk, AH, ‘Recasting the Sovereign Wealth Fund Debate: Organizational Legitimacy, Institutional Governance and Geopolitics’ (2008) at Monks, R, Miller, A and Cook, J, ‘Shareholder Activism on Environmental Issues: A Study of Proposals at Large US Corporations (2000–2003)’ (2004) 28 Natural Resources Forum 317 Morck, R, ‘A History of Corporate Governance and of the Oddity of the British’ at

Mulherin, JH and Poulsen, AB, ‘Proxy Contests, Shareholder Wealth and Operating Performance: An Analysis in the 1980s’ (1998) 47 Journal of Financial Economics 279, also at Nesbitt, S, ‘Long-term Rewards from Shareholder Activism: A Study of the CalPERS Effect’ (1994) 6 Journal of Applied Corporate Finance 75 Nikoskelainen, E and Wright, M, ‘The Impact of Corporate Governance Mechanisms on Value Increase in Leveraged Buyouts’ (2005) available at , (2007) 13 Journal of Corporate Finance 439 Nolan, RC, ‘The Legal Control of Directors’ Conflicts of Interest in the UK: Nonexecutive Directors following the Higgs Report’ (2005) 6 Theoretical Inquiries in the Law 413 ——, ‘The Continuing Evolution of Shareholder Governance’ (2006) Cambridge Law Journal 92

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Index Association of British Insurers 44, 50 IVIS 31, 128 Barclays Plc 58 Barings Plc 21, 25 British Energy 78 Polygon Global Opportunities Master Fund 73, 76, 79, 88 Cadbury Committee Report 33, 40, 132 Cadbury Schweppes Plc 78, 87, 139, 172 Trian Fund Management 85, 139, 172 CalPERS 9, 65, 82, 91, 105, 128, 140, 150 Focus List 10, 91 Companies Act 2006 21, 43, 101, 113, 125, 142, 166 Derivative action 21, 81, 125 Directors’ duties 20, 115, 125, 167 Minority shareholder litigation 8, 21, 135 Company law theory 167 nexus of contracts 46, 118, 125, 145, 154, 178 Real entity theory 111, 125, 167 stakeholder theory 106, 123, 137 Company Law Review 43, 126 Corporate governance 5, 23, 41, 77, 121, 151 agency problem 7, 20, 46, 74, 120, 165 Board of directors 17, 64, 94, 132 Cadbury Committee Report 3, 34, 132 Combined Code of Corporate Governance 18, 32, 43, 54, 61 Corporate Governance Code 17, 44, 67, 89, 132, 158 Greenbury Committee Report 37, 44 Hampel Committee Report 38, 44 Higgs Report 40, 44, 46 Myners Report 27, 39 Non-executive directors 34, 40, 63, 90 Remuneration committee 37, 57, 63, 138 Walker Report on Corporate Governance 16, 29, 37, 41, 56, 67, 133, 156 Defensive shareholder activism 8, 30, 55, 92 Director primacy 111, 121 Disclosure regulation 170 Information asymmetry 172 Division of powers 111, 127, 142 Ratification 114, 126, 134

Reserve power 114, 125, 140, 153 Reversion of power 114 Enlightened shareholder value 45, 68, 89, 126, 163 Equitable Life 22 Penrose Report 22 Executive remuneration 18, 30, 70, 132, 154, 176 Advisory vote 37, 57, 132 FSA Remuneration Code 58, 70 Greenbury Committee Report see Corporate governance Free-rider problem 45, 51 Glaxo Smith Kline Plc 56 Greenbury Committee Report see Corporate governance Hampel Committee Report see Corporate governance Hedge funds 7, 36, 72–97, 141, 173 absolute returns 72, 102 Conference Board Report 72, 146 Hedge Funds Standards Board 72, 92, 172 Large Report 92 Polygon Global Opportunities Master Fund see British Energy Knight Vinke Asset Management 75–80, 139, 172 Value extraction 86, 139 Hermes Focus Fund 11, 53, 65, 90, 128, 172 Underperforming companies 39, 72, 128, 151 Higgs Report see Corporate governance HSBC Holdings Plc 75, 105, 139 Knight Vinke Asset Management see Hedge funds Institutional shareholders Association of British Insurers, see Association of British Insurers above Institutional Shareholders Committee 34, 41, 102, 160, 174 Investment Management Association 39, 42, 61

Index 197 National Association of Pension Funds 36, 42, 158 Stewardship 33, 48, 63, 92, 102, 138, 158, 175 Investment Management Association see Institutional shareholders Annual Survey 39, 42, 52, 61 ITV Plc 53 JS Sainsbury Plc 57, 73 Knight Vinke Asset Management see Hedge funds LENS Fund 11, 15, 89 Marks and Spencer Plc 42, 52, 61 Myners Report see Corporate governance MyTravel.com 56 National Association of Pension Funds (NAPF) see Institutional shareholders Offensive shareholder activism 8, 71–77, 150–154 Open-ended contracts 118, 130, 168 PIRC 39, 49, 57, 172 Polygon Global Opportunities Master Fund see British Energy Private equity 72, 97–105, 144 British Venture Capital Association (BVCA) 98–101 Walker Report on Private Equity 101

Public pension funds 13, 14, 128, 145 CalPERS see CalPERS, above Regulatory space 18, 33, 43–46, 68, 93, 124, 152, 179 Relational investing 3, 15, 49, 62, 72 RiskMetrics 49, 62 Share ownership 107, 114–116, 133, 168 finance perspective 106, 120, 165 residual claimant theory 115, 145, 168, 174 shareholder primacy 47, 69, 115, 120, 141, 168, 178 two-tier voting rights 164 voting 6, 35, 95, 102, 113, 135, 164, 165, 167 Sovereign wealth funds 5, 6, 59, 86 TIAA-CREF 2, 11, 128 Trian Fund Management see Hedge funds Under-performing companies see Hermes Focus Fund Value extraction see Hedge funds Voting and advisory services 29, 53, 62, 158, 172 PIRC see PIRC Walker Report on Corporate Governance see Corporate governance