Market Perspectives: Responsible Investing

Shareholder spring 2016: A contentious voting season in Europe

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Background:

  • Executive pay awards have attracted significant investor discontent this year in Europe.
  • Shareholders have been emboldened to use their voting rights to penalize inappropriate pay plans for executives and vote against board directors in a number of high profile revolts.
  • The high levels of votes against represent a defining moment for shareholders and U.K. boards. It remains to be seen whether this is the new normal or a “flash in the pan.”

The 2016 voting season proved to be one of the most contentious ever. The term “Shareholder Spring” reappeared in media coverage as investors voted against executive pay resolutions at a succession of companies in Europe — particularly in the U.K. Despite many years of engagement between investors and companies, significant concerns remain over corporate governance practices at major companies.

Back in the spring of 2012, we witnessed investor dissent at shareholder meetings rise to a level not seen in more than a decade, with the main focus on executive pay. CEOs were toppled, and high profile business figures such as Sir Martin Sorrell of WPP plc had to justify their pay level. As companies were experiencing this increased level of shareholder dissent, the Department for Business Innovation and Skills (BIS) sought to enhance shareholder rights by requiring companies to seek binding shareholder approval for their remuneration policy (at least once every three years starting in 2014) before they could grant awards.

Companies and investors alike hoped at the time that with increased shareholder powers, engagement and guidance on executive remuneration, another 2012-style “Shareholder Spring” would be avoided in the future. However, four years on we have witnessed even greater levels of dissent in what some commentators are referring to as “Shareholder Spring II”.

Deteriorating corporate earnings, the shift in energy prices and continued sluggish economic outlook around the globe have all played a part in setting the tone for this year’s events. Nevertheless, the high levels of dissent seen at some companies has surprised observers.

Pay is not the only focus of shareholder discontent this year. We have seen high dissent levels with respect to director elections and strong support for shareholder proposals at underperforming companies.

These trends are likely to continue in the U.K. market during the second wave of shareholder meetings in July, principally covering companies with financial years ending in March. It is not yet clear whether uncertainty following the U.K. EU referendum outcome will influence investor voting patterns. Sustained levels of votes against management in July would herald a defining shift in investor attitudes towards executive pay and is something we will follow closely.

UK pay – jargon buster

In the U.K., there are two types of pay-related resolutions on which investors can vote.

Remuneration policy: This defines the framework adopted by a company to decide on executives’ pay. This includes the balance between salary, annual bonus, long-term equity plans and pensions. It also details the key performance indicators and targets. This is a binding vote — so companies have to follow investors’ wishes. It is voted on every three years.

Remuneration report: This is an annual vote on how the remuneration policy was implemented. This includes performance achieved and payouts made. This is an advisory vote — so companies retain discretion on whether the investors’ wishes are followed.

Remuneration in focus

Following the 2015 voting season, in which only one remuneration report was voted down at Intertek, few in the market were anticipating the forthcoming events. Many assumed that this would be a year for steadily sailing the ship into port before the next round of binding remuneration policy votes in 2017.

However, as meeting information was released, significant press coverage around the 2016 voting season began to hone in on remuneration at large U.K. companies. An increased attention from wider society on the level of pay awarded to executives was supported by large international investors gaining an appetite for voting against egregious pay packages following years of largely watching from the sidelines. The scene was set for an eventful season.

As at the time of writing (June 28, 2016), we had seen five remuneration-related proposals at FTSE All-Share Index companies voted down, two of which were binding. Many others had received high levels of dissent, with Shire dodging a bullet with an extremely narrow 50.55% approval rate due to a 25% salary increase for the specialty pharmaceutical company’s CEO.

This year we saw the first binding remuneration policy voted down at the engineering company Weir Group. If there was ever talk of investors previously shying away from voting against binding remuneration resolutions this result ended that theory, with over 72% of investors voting against the policy resolution. In addition, a similar percentage of investors did not support the proposed long-term incentive plan at the same meeting.

Weir Group proposed to grant share awards to participants that were restricted to vest over several years, although the company did not include performance conditions. This was in response to the challenging operating environment and desire to retain and motivate staff. Given the binding nature of the proposals, the company will have to go back to the drawing board and present something more palatable to shareholders.

In mid-April, BP lost its remuneration-report vote with approximately 59% of shareholders abstaining or voting against management. In a year when the energy company had announced its largest-ever loss of $6.5 billion, the remuneration committee approved maximum awards under the annual bonus scheme and vesting of the long-term incentive awards. The CEO Bob Dudley’s pay totalled £14m for 2016. This award, in light of company performance and judgements made by the remuneration committee, was deemed to be excessive.

BMO engaged with the company prior to the Annual General Meeting (AGM) and are continuing this conversation ahead of the 2017 remuneration policy vote. The majority of shareholders recognised that the problems arose due to a pay for performance disconnect at the company. The awards were made possible under the existing pay policy which was approved by investors in 2014. Investors and the company are now required to draw upon this experience to ensure safeguards are built into the remuneration policy to avoid such perverse outcomes in the future.

Elsewhere at Smith & Nephew, 53% of shareholders voted against the annual remuneration report of the medical devices company. The point of contention focused on the use of discretion by the remuneration committee in adjusting the performance result for the long-term incentive award resulting in threshold vesting being achieved (25% of the potential maximum award for the Total Share Return (TSR) element). Over the period the company had achieved around an 80% absolute return and outperformed the upper quartile of the FTSE 100 Index on a relative basis. However, against the chosen comparator peer group the company finished slightly below median with the remuneration committee deciding that an adjustment to this result was warranted.

Whilst the above two companies set the voting season off to a momentous start, they were by no means the only companies to receive high levels of dissent. Some further interesting cases are highlighted below.

Paysafe Group: Remuneration report voted down. Significant increase in salary awarded to the CEO along with increases to bonus limits. The company also chose not to disclose sufficient information relating to the annual bonus performance conditions and also made a significant non-performance related award to the CFO on recruitment.

Anglo American: Performance issues following collapse in commodity prices resulting in a 75% fall in share price over the year under review. However, the remuneration committee chose to continue awarding long-term incentive grants at their normal level, disregarding poor underlying performance. Due to the share price fall, this resulted in a much higher number of shares being awarded which would provide a large payout should share price recover.

In continental Europe, we also saw high profile cases of shareholders revolting against pay. A majority of investors voted against pay plans at French carmaker Renault and German lender Deutsche Bank. 54% of Renault’s investors, including the French government, voted against CEO Carlos Ghosn’s 2015 remuneration package (€7.2m). This was the first time that shareholders have rejected a say-on-pay proposal in France in the two years since it was introduced. Renault’s board chose to keep the CEO’s pay at that level, and this caused a swift response by the government. It retaliated by toughening market rules and introducing a binding vote on pay in France. The rejection of the remuneration system at Deutsche Bank stemmed from concerns about the poor link between pay and performance. In addition, in a year when the company did not award bonuses or long-term incentives, investors nevertheless questioned the discretion that the Supervisory Board could exercise over awards in future.

Director elections

Remuneration was not the sole issue that led to high levels of votes against management. The re-election process for U.K. board directors has become more rigorous in recent years as a result of the introduction of annual director re-elections at the majority of U.K. companies and amendments to the Listing Rules to require companies with a controlling shareholder to grant minority shareholders a separate vote on the election of independent directors.

The force of the new Listing Rule was felt at majority controlled Ferrexpo where 75% of minority shareholders did not support the re-election of five non-executive directors. The iron ore company is now required to hold a shareholder meeting to seek approval of the re-election of these directors. This will take place following a consultation process to understand investor concerns.

House builder Persimmon, also received an unusually high level of dissent (47%) on the election of new Non-Executive Director Nigel Mills. Having served as a Senior Adviser at Citigroup Global Markets, and also as Chairman of Corporate Broking at Citi between 2005 and 2015, investors questioned Mr. Mills’ independence given that Citi is one of Persimmon’s financial advisers/stockbrokers. His appointment resulted in further reduction in the proportion of independent representatives on the board which is detrimental to the investor interests.

Whilst the board believed there is no issue relating to his independence, the company intends to meet with shareholders to discuss the issue. Due to the high level of compliance with the U.K. Combined Code at FTSE 100 companies, higher levels of dissent may be seen in future where the Code is not followed.

Outcome and next steps

Despite the increased disclosure, shareholder engagement, remuneration committee independence and the binding remuneration policy vote, so far this year investor support for pay overall is going down, not up. The second phase of shareholder meetings in the U.K. take place in late-July, and this may bring further upsets for companies. We did not support any of the resolutions covered and are planning to engage with the companies on the issues.

We will be particularly critical of remuneration committees which chose to ignore investor views. We plan to release an update in the autumn on our engagement activities and future plans. With the next round of remuneration policy votes approaching in 2017, we expect a continued and intense focus on pay in the coming year.

 

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