Model Stewardship Code for Long-Term Behavior

Bhakti Mirchandani is Managing Director at FCLTGlobal. This post is based on a FCLTGlobal memorandum by Ms. Mirchandani, Steve Boxer, Evan Horowitz, and Victoria Tellez. Related research from the Program on Corporate Governance includes Index Funds and the Future of Corporate Governance: Theory, Evidence, and Policy (discussed on the forum here) by Lucian Bebchuk and Scott Hirst; and The Agency Problems of Institutional Investors by Lucian Bebchuk, Alma Cohen, and Scott Hirst (discussed on the Forum here).

A good stewardship code helps clarify the responsibilities of institutional investors, laying out core principles to foster a shared understanding among stakeholders including regulators, investors, and investees.

To ensure that stewardship codes put primary emphasis on long-term value creation, FCLTGlobal has worked with its members to identify seven principles of long-term ownership that could be incorporated into new or revised stewardship codes. These codes represent the highest common denominator of high-quality codes around the world, using principles that are equally applicable for asset owners and asset managers. Given FCLTGlobal’s mission of focusing capital on the long term, our interest is in the subset of stewardship that is concerned with fostering an ownership mindset to promote long-term value. Valuable work has been done by International Corporate Governance Network (ICGN) and others on the broader universe of issues that can be addressed via stewardship codes. [1]

Principle 1
Theme: Long-term alignment

Implement incentives, such as fee and compensation structures, to prioritize clients’ long-term best interests. [2]

Guidance: Carefully-targeted incentives can help investors stay focused on the long-term needs of their clients. FCLTGlobal has done extensive work on mechanisms that can be used to align incentives through investment mandates between asset owners and asset managers. As part of the mandate terms, investors can require that external managers or subadvisors report stewardship activities and metrics in a manner that facilitates monitoring progress toward stewardship objectives.

More generally, investors can consider the following mechanisms to promote and reward long-term value creation:

  • Offering fee discounts that increase with longevity may strengthen owners’ commitment and give managers more flexibility to make long-term investments.
  • Organizing performance reports to emphasize long-term returns while prioritizing comments on annual or longer performance periods could focus organizational attention on longer-term issues.
  • Scheduling regular evaluations may enable more open communication about long-term value than relying on watch-listing during periods of underperformance.
  • A three- to five-year contract term may set longer-term expectations than an at-will contract and still give the owner discretion to terminate, if necessary.

Principle 2
Theme: ESG integration

Incorporate all considerations with a material impact on long-term value creation into investment decision processes, including environmental, social, and governance (ESG) factors. [3]

Guidance: Prudent, long-term investing requires investors to account for all factors that have a material impact on value creation over time, which may include effects of climate change, cybersecurity, robustness of the supply chain, corporate governance and business ethics standards, corporate culture, and other intangible issues. Material factors are those that would affect the judgment of an informed investor who intends to be invested over a long-term horizon.

Principle 3
Theme: Understand investee stakeholder perspectives

Seek to understand the potential risks and opportunities related to relevant investee stakeholders. [4]

Guidance: Companies execute their strategies to achieve long-term value in a multi-stakeholder context. Investors can broaden their long-term vision by considering the concerns of relevant stakeholders and the potential long-term business implications of those concerns. Stakeholders include employees, customers, suppliers, and communities.

Principle 4
Theme: Monitoring investees

Develop and implement a monitoring policy and process to promote long-term value creation. [5]

Guidance: By monitoring investees’ long-term potential, rather than overly focusing on quarterly or other short-term events, institutional investors enhance medium- to long-term value, improve capital efficiency, and support sustainable company growth. This monitoring process can include strategies around talent, innovation, capital allocation, and risk management, as well as oversight by boards and governance structures.

Beyond looking at public disclosures, or primary and third-party research, institutional investors can monitor investees by:

  • engaging with investees, including with their audit committees
  • sharing research and information with other investors, subject to applicable laws and regulations
  • attending or monitoring formal shareholder meetings
  • indicating a willingness to become insiders—and a mechanism by which this could be done, if applicable

FCLTGlobal has done extensive work on what information investment decision makers want to learn from corporate investees. Factors to monitor may include:

  • capital allocation priorities and capital structure
  • investee long-term strategic plans, including long-term objectives and core drivers of growth
  • investee governance, including board composition, subcommittee structure, independent director oversight, internal controls, quality of reporting, overall soundness of explanations for corporate governance issues, and any departures from corporate governance best practices
  • strategic alignment of executive compensation structure with goals
  • executive compensation duration relative to measurement period for goals
  • environmental or social issues
  • interest in cultivating long-term shareholders, including through discontinuing short-term guidance

Principle 5
Theme: Regular, effective, and targeted investee communication

Communicate regularly and effectively with investees on issues with a material impact on long-term value creation. [6]

Guidance: Effective long-term stewards engage with investee management teams, boards, or controlling shareholders on issues that materially impact long-term value creation. Effective engagement includes providing companies with both negative and positive feedback when appropriate.

To maximize the impact of these engagements, investors can design a process to ensure appropriate communication with investees, spelling out the frequency of dialogue with investees, the issues and types of information that merit sharing, and mechanisms for providing candid and direct feedback to investees—while applying controls to prevent the sharing of insider information.

More broadly, long-term communication with investees requires a long-term commitment. This process involves developing an in-depth knowledge of investees and their business environments, setting clear objectives and milestones for engagement, and understanding that engagement is a multi-year process.

As these engagements are primarily about the long-term strategy of the institutional investor, the investment decision maker is often best positioned to lead such engagement activities.

Principle 6
Theme: Escalation

Establish clear processes on escalating engagement activities when there are concerns about risks to long-term value. [7]

Guidance: When concerns arise about risks to long-term value, investors can follow a deliberate process of escalation and intensive engagement with investees. Examples of such risks include: investee deviation from long-term corporate governance practices; changes to the investee’s strategy or remuneration that could limit long-term success; or significant risks to the environment.

In these cases, investors can take the following steps:

  • Provide feedback to the investee:
    • Write or meet with the board or management, confidentially
    • Write or meet with the board or management, publicly
    • Collaborate with other investors to provide feedback to the investee, subject to applicable laws
    • Make public statements that include information about any previous attempts at engagement
  • Use their votes to seek change:
    • Withhold votes from directors
    • Vote against directors
    • Vote against management say-on-pay resolutions
    • Vote for or against other proposals
    • Propose changes to board membership
  • Actively participate in shareholder meetings:
    • Raise issues at shareholder meetings
    • Support or submit shareholder proposals
    • Submit shareholder resolutions at general meetings
    • Requisition a general meeting
  • Seek improvements through remediation
  • Sell investee shares, if consistent with the investment strategy

Principle 7
Theme: Collective engagement

Act collectively with other long-term investors, when appropriate, to enhance or preserve long-term value. [8]

Guidance: The preferences of long-term investors can be difficult to glean amid the more frenzied activities of short-term investors. To elevate their views and enhance long-term value by leveraging their collective voice, long-term investors can adopt policies for collective engagement with other owners and disclose their rationale for collective engagement. This may be particularly important at times of significant economic or corporate stress.

When considering such coordination, it is vital to ensure compliance with applicable laws and regulations, including rules on acting in concert.

Endnotes

1In this work, FCLTGlobal focused solely on the 22 stewardship codes and principles that are standalone, at the exclusion of the Belgian Asset Managers Association Code of Conduct and the German Corporate Governance Code for Asset Management Companies. (go back)

2Sources: ICGN stewardship principles and Canada, Taiwan, and Thailand stewardship codes address incentives. This principle aggregates the collective guidance from all of the codes.(go back)

3Sources: ICGN stewardship principles and Canada, South Africa, Malaysia, Italy, Brazil, Hong Kong, India, OECD, Thailand, Kenya, Australia, and Netherlands stewardship codes address ESG integration. This principle aggregates the collective guidance from all of the codes.(go back)

4Sources: OECD, Thailand, Kenya, and Netherlands stewardship codes address stakeholder perspectives. This principle aggregates the collective guidance from all of the codes.(go back)

5Sources: 21 stewardship codes (all but Switzerland) address monitoring investees. This principle aggregates the collective guidance from all of the codes.(go back)

6Sources: 20 stewardship codes (all but Switzerland and the UK) address regular and effective investee communication. This principle aggregates the collective guidance from all of the codes.(go back)

7Sources: 19 stewardship codes (all but Brazil, Japan, and Switzerland) address escalation. This principle aggregates the collective guidance from all of the codes.(go back)

8Sources: ICGN stewardship principles and UK, Canada, EU, Italy, Brazil, Singapore, Hong Kong, Denmark, ISG, India, Netherlands, South Africa, Japan, Taiwan, OECD, Thailand, Kenya, and Australia stewardship codes address collective engagement. This principle aggregates the collective guidance from all of the codes.

For additional reading, see The New Paradigm from the World Economic Forum and Martin Lipton, Lawyer, Wachtell Lipton Rosen & Katz. Also What is Stewardship? by Alex Edmans, London Business School(go back)

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