Nomination Committees and Corporate Governance: Lessons from Sweden and the UK

Sophie Nachemson-Ekwall is an Affiliated Researcher at the Stockholm School of Economics. This post is based on a recent paper by Ms. Nachemson-Ekwall and Colin Mayer, Peter Moores Professor of Management Studies at the University of Oxford Said Business School.

The board of director nomination-process is a particularly important but largely ignored aspect of corporate governance. It has been ignored in relation to the attention that has been paid to other corporate governance committees, such as the remuneration and audit committees. Both of these appear to have greater relevance to the financial performance of firms and the correction of managerial failure. EU legislation has addressed both areas.

This paper suggests that, on the contrary, the nomination committee (NC) should be a primary focus of attention in corporate governance debates. As custodians of the corporate purpose and firm values, the board plays a critical role in establishing the objectives of the firm and overseeing their implementation through the formulation of strategy, measurement of performance and setting of standards and incentives. The identification of the right members of the board is therefore a primary influence on the operation of the firm. Thus, the legitimacy of the NC in the eyes of the shareholder community and the trust received from minority shareholders is pivotal to the empowerment of the board.

In particular, the NC is critical to concerns about the ownership of companies and the engagement of institutional investors in active oversight and monitoring of management. It will be suggested that the NC can be instrumental in both promoting the type of large, long-term shareholdings that are a prerequisite to effective engagement by institutional investors and a means by which that engagement is exercised. Furthermore they provide a basis for resolving potential conflicts that arise between different shareholders, most notably between dominant and minority shareholders.

The paper will do this by contrasting the operation of NCs in two countries: Sweden and the UK. Both countries embody what is termed “shareholder primacy”, namely legal, regulatory and institutional structures that privilege shareholders over the interests of other parties, and both countries have a substantial presence of institutional investors as well as national pension funds. They are in the forefront of Europe’s most liberalized and active market economies, based predominantly on self-regulation as against legal statute. They therefore stand in contrast to several other Continental European countries and many other parts of the rest of the world where shareholder interests receive less prominence in relation to that of other parties to the firm. They are in this respect similar to other common law countries, such as the US, and the analysis reported here has relevance to them too.

While therefore similar in many respects, the nature of the two countries’ NCs are very different. In the UK, the NC is an internal committee of the board on which independent members sit and nominate successor members of the board. In Sweden it is an external committee in which shareholders play an important role in the selection process. The internal system of the UK delegates the nomination of new members of the board to its non-executive members. In Sweden, on the other hand, the nomination process resides with representatives of shareholders themselves.

As will be described in the paper, in general Swedish companies have large controlling shareholders who have incentives to exert significant influence over the nomination process. Consequently, by giving them a presence on the NC, its nomination process encourages their direct engagement in the appointment process and mitigates the shareholder disengagement problems that afflict the UK internal system. On the other hand, it does this at the expense of creating another problem, namely potential divergences of interests between different types of shareholders, notably between large, well-informed and small, uninformed, shareholders.

As we will see, differences in the nature of ownership and norms of governance explain much of the difference in operation of NCs in the two countries. Understanding the way in which NCs operate in Sweden and the UK is therefore fundamental to an appreciation of the merits and deficiencies of different forms of capitalism as reflected in their ownership and governance of firms. Growing societal pressure on institutional investors to undertake engaged responsible corporate governance (as proposed by, for example, the Kay Review, 2012 and the EU Shareholders’ Rights Directive, 2014/17) strengthens expectations about the role of NCs in corporate governance (the UK Stewardship Code, 2012; Lipton, World Economic Forum, 2016). This paper asks the questions whether the UK system would benefit from having more engagement by institutional investors in the nomination process and an external rather than an internal NC and would Sweden be advised to reduce the power of dominant shareholders in the nomination process and create a greater level of independence of NCs from large shareholders?

To address these questions, we examine how the institutional corporate governance settings of Sweden and the UK work to empower institutional investors through the NC. The paper draws on a mixture of academic research, legal documents and official as well as semiofficial reports. These sources show how ownership has evolved since the 1980s until now and the relevance of company law in defining the role of independent directors.

The paper draws on novel research showing how Swedish institutional investors have begun to take larger stakes in investee companies that are evaluated over longer time horizons than was previously the case. In the process, institutional investors engage in the NC on a longer-term basis, collaborating both with controlling shareholders and other long-term institutional investors.

As shown in the paper there are advantages and disadvantages in both systems. One the one hand the UK procedure keeps the nomination process independent of any particular shareholding group and promotes the fair treatment of all shareholders. As a drawback, the British ownership market is highly dispersed and thus opens for a serious free rider problem that has given rise to the phenomenon of the “ownerless corporation” in which no investor plays an active governance role. In Sweden, an external nomination committee provides a forum in which the contrasting views of dominant shareholders about the composition of boards can be resolved. At the same time the Swedish system offers inevitable and unavoidable privileging of those present on the nomination committee.

The paper concludes with a discussion of the possibility of achieving superior outcomes by combining features of the Swedish and UK nomination process. For example, some of the board positions could be nominated by external and other by internal committees. Alternatively, all appointments could be by internal committee as in the UK but with some external shareholder representation and, within both models, collaboration between external and internal parties can be encouraged to ensure the nomination of a cohesive team of directors. A flexible application of internal and external nomination committees may help to address many of the issues associated with free-riding and conflicts of interests in corporate governance while promoting sustainable wealth creation in the interest of the company and its shareholders as a whole.

The complete paper is available here.

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