Much has been written about the role of directors and boards but far too little on the how shareholders can add value. Carolyn Kay Brancato did so in her excellent book, Institutional Investors and Corporate Governance: Best Practices for Increasing Corporate Value. However, Brancato was primarily writing from the perspective of managers. Although there was general recognition that shareholders can add value, the thrust of the book was on what managers need to know about shareholders and how to attract shareholders who will support them. Charkham and Simpson take a larger societal viewpoint. At bottom, they are concerned not with what is best for managers but what system will best provide the goods and services that society needs.
The authors provide a short history of the corporation, from the Bubble Act of 1720, which circumscribed the use of charters, through general enabling laws and subsequent limited liability acts. They discuss the legal framework of directors, the voluntary Cadbury Code, the growth of activist investors such as LENS, UK Active Value Fund and end with a discussion of needed reforms.
A four year study of British proxy voting shows a marginal decline in votes cast in favor of management, from 99.3% to 98.6%. This is not exactly strong evidence of a shareholder revolution. The potential is there but the current system is riddled with “practical inefficiencies,” “outmoded rules,” and “conflicts of interest which prevent effective oversight by institutional shareholders, who are in turn not required to be accountable to those on whose behalf they invest.”
While Charkham and Simpson acknowledge that no country can afford to impose burdens on shareholders if it hopes to attract international capital, at bottom they appear to want to stand Milton Friedman on his head. Instead of “the only social responsibility of business is to make a profit,” they appear to be working toward a world where the only businesses to make a profit will be those that are socially responsible. But their expressed concerns in this area aren’t for specific measures, such as being kind to animals, but to the larger framework which defines the rights and behavior of owners. For example, one of the major changes they seek is for institutions to be less diversified. Holdings should not be too fragmented to warrant investment of time and resources in monitoring. This would shift institutions away from speculation to investment.
In Britain, institutions hold about 80% of the market. Cadbury indicated voting rights are an asset and should be exercised on behalf of those for whom the institution invests. Trustees must be able to demonstrate their voting activity is prudent, carried out with care and in the sole interests of beneficiaries. Charkham and Simpson are ready to move shareholder responsibility to the next level by asserting that trustees not only have a fiduciary duty to monitor companies and vote on behalf of shareholders but also to take positive action if problems are looming. “The duty of care extends to maintaining the health of the company.” (p. 145)
Some of their proposed reforms are specific to the British situation, but many are not. One of their more innovative is that dividends should include a bonus for those that voted in the last election. They would like to see a growth of shareholder associations and “deeper” share ownership. Included are ideas for making the annual meeting more than a ritual. One is to give shareholders the right to do more that vote down pay. Let them amend pay. The authors oppose the use of options as in incentive for CEOs and directors. They note the quality of reporting on non-financials (environment, social) needs dramatic improvement and that training for trustees should be mandatory.
In general, the authors argue that ownership of a significant proportion of a company’s shares imposes obligations. Just as the tax system obligates those who earn more to pay more, owners with larger holdings should be held to an enhanced duty of care. Larger shareholders have resources and interest that others lack. All fiduciaries have an obligation to see that shares are voted, records are kept of votes and reports are made to beneficiaries. These obligations apply to insurers and mutual funds, as well as to pension funds.
Charkham and Simpson are at the cutting edge of democratic corporate governance. Their vision fits nicely with the technology of the internet which will facilitate the spread of democracy into the world of finance. Widespread reading of Fair Shares and Ms. Simpson’s move to the World Bank are sure to add movement to their vision.