Shareholders in the United Kingdom

The United States and the United Kingdom are lumped put together as ‘dispersed shareholder’ jurisdictions and contrasted with the concentrated shareholdings found in the rest of the world. This paper, Shareholders in the United Kingdom, argues that it would be better to view the UK, at least over the past half century, as a semi-dispersed rather than as simply a dispersed shareholder jurisdiction, and that there are interesting contrasts between the UK and the US experience.

Whilst the typical company listed on the main market of the London Stock Exchange certainly lacks a single (or even a cohesive small group) of shareholders with legal control, neither does the typical company display atomised shareholdings, for example, where no single shareholder holds more than 1% of the voting rights. Typically, a coalition of six or so of the largest shareholders can put together enough votes to have a fighting chance of carrying a resolution at a shareholder meeting against the wishes of the management. The question thus becomes one of the incentives and disincentives for those shareholders to coordinate their actions.

This process of semi-concentration has parallels with recent US developments, but there are significant differences. First, the rise of institutional shareholders in the UK seems to have preceded a similar development in the US by a couple of decades. Second, the leading UK institutions have been highly successful in overcoming their coordination problems, not so much in relation to the management of investee companies, as in relation to the setting of UK corporate governance rules. It is true that the British companies legislation has always been more shareholder-centric than, for example, Delaware law—though the latter too is now moving away from a strongly managerialist position. Since the Companies Act 1948 UK shareholders have had the right to remove all or any of the directors at any time by simple majority vote (and relatively easy mechanisms for convening shareholder meetings against management wishes have been available to them). So, no staggered boards in the UK and no point in management ramming nominees down the throats of reluctant shareholders.

However, all the significant pro-shareholder changes in the governance rules since 1948 have occurred, not through changes to legislation, but through rules made by governmental agencies or quasi-self-regulatory bodies. This type of rule-making institutional shareholders have been better placed to influence than general legislation, and they have been able to lobby effectively for pro-shareholder rules. Notable examples are:

• (a) The adoption in the (then) self-regulatory City Code on Takeovers of a board neutrality rule prohibiting unilateral defensive action by management and adopting a mandatory bid rule which gave shareholders an exit right on attractive terms upon a change of control, even if that change was achieved through a private purchase.
• (b) The adoption in the Listing Rules of the London Stock Exchange in the early 1970s of provisions which subjected all economically large corporate transactions to prior shareholder consent.
• (c) The introduction in the 1950s, again in the Listing Rules, of a default pre-emption option for existing shareholders on an issue of new shares for cash and the subsequent development by the institutions of strict (but informal) guidelines on the circumstances in which they would be willing to waive their entitlements under default rule.
• (d) Leading the opposition to non-voting, restricted voting or multiple-vote shares in favour of the principle of one share, one vote. Through market pressure (ie the refusal to buy such shares or to subscribe to regular issues of new shares unless voting inequalities on existing shares were removed) such shares ceased to be a significant feature of companies quoted on the London market.
• (e) Promoting a greater role for non-executive directors on corporate boards and on board committees. The initial version of the UK Corporate Governance Code reflected the prior views of institutional shareholders and the institutions have been successful in influencing the subsequent development of the Code in a pro-shareholder direction.

The effectiveness of the institutional shareholders’ lobbying seems to have been partly due to the fact that decision-making in these areas was in effect delegated by government to the ‘City of London’ where financial interests outweighed those of management. In addition, the lobbying was conducted by the representative associations of the institutional shareholders, thus spreading the lobbying costs across the institutions as a whole. By contrast, portfolio level interventions to change managerial decisions became significant but arguably did not reach their optimal level because of free rider problems among and conflicts of interest within the institutional shareholders. Selling out to a takeover bidder was often the easier option as compared with a long and possibly unrewarding slog of changing managerial policy.

This century, the above picture has changed in three ways. First, with the removal of restrictions on capital flows across jurisdictions, UK institutions have shifted part of their equity investments abroad and, equally, foreign institutions have moved into the London market in a significant way. Foreign institutions are now the largest single category of investor in that market. Foreign investors are as likely to favour shareholder interests as domestic ones, of course, but the institutional shareholder body may become less cohesive. Second, government has moved from an essentially ‘hands-off’ policy to one of encouraging institutional shareholders and their asset managers to ‘engage’ with portfolio companies, i.e. to intervene to change managerial policies which are not in the long-term interests of the company. This policy is expressed through the Stewardship Code (enforceable on a ‘comply or explain’ basis). Formally, it encourages engagement only when that is in the interests of the beneficiaries of pension funds and other institutional shareholders. Given the opacity of what those long-term interests are, institutions may come under pressure to act even where the beneficiaries’ benefit is unclear, in order to avoid direct legislation. At the same time, the growth in the proportion of the market held by foreign institutions makes it more difficult for governments informally to influence the engagement policies of the institutions as a whole. Third, as in the US, the arrival of activist hedge funds, on the one hand, holds out the promise of a mechanism which will help reduce the coordination costs of an increasingly disparate body of institutional shareholders, but also the threat that activism will go in directions which were not anticipated by the drafters of the Stewardship Code.

The full paper is available for download here.