Big problem in making boards behave

Anthony Hilton
20 Jul 2009

Sir David Walker last week unveiled proposals to encourage shareholders to take more interest in their investments in the hope that their greater involvement would prevent a recurrence of the boardroom failures that contributed to the banking debacle.

His ideas will now be kicked around and discussed, and eventually a consensus should emerge on which proposals might be incorporated into the combined code of corporate governance, which is itself undergoing a review to prevent a gulf opening up between it and Walker.

This at least is the outcome favoured by the advocates of self-regulation, but the fact that Walker was asked by the Government to produce this report should not be lost on anybody — and in particular not on those who feel there is no need to change.

The alternative to the intelligent voluntary adoption of Walker's best ideas is legislation, from a Government impatient to be seen to be doing something. This is in many ways the last chance for self-regulation and the principle of comply or explain to show that it still had relevance in the modern world. There is that much at stake.

But there is another issue nestling in the long grass, and this is just who are these shareholders whom Walker intends to mobilise?

The easy answer its that they are what we used to call the long-only institutions, which was shorthand for the vast funds controlled by pension funds and insurance companies in the days when these bodies controlled an estimated four fifths of the London share market. These were the days when Cazenove was the most powerful stockbroker in London because the “friends of Caz” were these same institutions, and it was from these relationships that it derived its awesome placing power.

But these days have gone. Cazenove is evolving into just another deal-driven American-style investment bank, though it will be mortified to see itself described as such in print. It is not there yet, but that is certainly the direction of travel and it is changing because its world has changed. Indeed, that is the point. Cazenove has recognised that those long-only shareholders from which it derived its strength, and which are meant to make big companies quail, no longer have the power to do so.

Major structural changes in pensions and insurance have caused both to struggle to maintain their relevance. Modern portfolio theory has driven them to favour bonds over equities and to diversify what equity holdings they do have with the result that the UK proportion is much reduced.

The growth of trackers and passive investment styles wakens their clout further because such funds lack the sanction of being able to sell even when they are unhappy with a company's response to criticism.

And the most telling fact of all is that instead of controlling 80% of the market, they now control about 30%. Even when they band together — which rarely happens — a determined chief executive can face them down.

In their place are overseas investors who for the most part do not want to get involved, hedge funds who usually have too short a time horizon to care and sovereign wealth funds who are still feeling their way, and are unwilling to be seen to be throwing their weight around, even in a good cause.

This then is the big problem for the Walker review and for all those who think that shareholders should do more to keep boards under the cosh. We need to work out which shareholders we are talking about, because the usual suspects are probably not up to the job any more — or will not be for much longer.

The challenge facing Friends

The bid for Friends Provident sparks off the attempt by Resolution to restructure and remodel the life assurance industry that was foreshadowed here on 9 July.

However, it has run into flak. The target company has only recently come under the new management of Trevor Matthews, and its board is surely duty bound to try to give him a chance to show what he can do. Its case is not helped however by its desire to merge with an earlier version of Resolution not long ago, nor it is strengthened by the rather far-fetched proposal floated over the weekend that it might bid instead for Resolution.

The key question Friends Provident needs to answer is: “What is an insurance company for?” Most of the reasons it and its peers grew strong have gone. Much of what they traditionally offer is available elsewhere. The tax break for savers went ages ago. More recently, tax wrappers have become the staple offering of IFAs, so they have lost that monopoly.

They still have investment expertise but not always with the brand strength to make it count in the retail area. This is a problem as they have to rely on intermediaries to bring in their customers, having run down their door-to-door sales forces.

John Tiner and the team at Resolution have what they believe is a clear strategy for the future based on consolidation and focus on term assurance, annuities and guaranteed savings products. Friends Provident's challenge now is to come up with something more convincing.