Investing Responsibly: Company Interaction

We have 3500 company meetings every year. Our starting point is to support the company while being clear about our expectations.

The fund’s approach to company interaction has developed over the years. However, some premises have been in place from the outset. First, we have maintained that company dialogue contributes to the protection of shareholder interests and supports the fund’s objective of achieving the highest possible return. Second, we have sought to be principled and transparent about the matters that we discuss with companies. Third, we have preferred to interact with a number of companies within a sector on the same issues rather than engage in individual company dialogue. Fourth, we have been mindful about the fund’s characteristics when interacting with companies, considering our ownership share, our global presence and our nature as a sovereign investor.

We integrate corporate governance and responsible business conduct into our investment decisions to support the fund’s objective of achieving the highest possible return with moderate risk. We have integrated governance expertise into the management of the fund, making sure that corporate governance analysts and equity analysts work together.

Company interaction differs from voting in that the interaction is often more informal in nature, offering opportunities to communicate our views but also engage in discussion and learn from companies. Whereas voting is a legal right, interaction is a tool that we have chosen to make use of but where we depend on the willingness of the company to interact with us. Successful interactions between investors and companies also develop over time rather than being a one-off expression of views.

Voting and company interaction are most effective as ownership tools when they complement each other. We have used company interaction to inform companies of how we intend to vote at a shareholder meeting and to explain after the meeting why we voted the way we did. We have also used our voting rights to reiterate views that we explained in meetings with companies.

Ownership interests

As early as 2003, we defined what we considered to be the fundamental purpose of exercising our ownership rights. This was to ensure that the interests of all shareholders were sufficiently protected by the governing bodies of the companies that we were invested in. The focus on protecting shareholder interests came in response to cases where the rights and financial interests of shareholders had been poorly protected, or not protected at all, as illustrated by some large corporate failures in the US in particular at the turn of the millennium.

We observed that a number of large institutional investors had started to collaborate to play a more influential role in safeguarding their financial interests. At the same time, our average holdings in global equity markets were rapidly increasing. The growth in our ownership interests, combined with the possibility of exerting influence through co-operation with other institutional investors, was considered key to our ability to help protect and develop the fund’s financial interests through active ownership.

Another important consideration for basing the exercise of ownership rights on safeguarding financial interests was that we wanted to create predictability as to our behaviour as an owner. We considered that such predictability would help establish strong relations with other investors and portfolio companies as well as enable us to exert more influence in matters considered important to the fund. The publication of our corporate governance principles in 2004 and subsequent dissemination of the principles to the largest companies in our portfolio in 2005 illustrate how we sought to be predictable from the outset.

We also stressed our focus on safeguarding long-term financial interests, which in our view had been neglected both by corporate managers and by other investors. Poor governance practices had too often come about due to a short-term focus, and we considered the exercise of ownership rights even more pertinent for protecting the interests of long- term investors such as ourselves.

Following the adoption of the 2004 ethical guidelines, we concluded that there could also be an ethical dimension to the exercise of ownership rights. We found that poor corporate governance was sometimes a result of a fundamental lack of ethics, as illustrated by lack of accountability. We also found that corporate priorities were sometimes driven by special interests rather than the interests of shareholders and the common good. Further, we recognised that there could be synergies between ethics and financial interests for long- term, universal investors, given that our investments around the world could be impacted by lack of respect for rights, lack of environmental protection, conflict and instability. We also argued that the long-term financial soundness of the fund was a genuinely ethical concern, given the needs of future generations, and that ethics and financial interests could therefore be complementary. At the same time, we noted that it would not be appropriate to use our ownership rights to address ethical concerns that could not be justified on the basis of financial considerations.

The protection of our long-term financial interests has remained a fundamental purpose for the exercise of ownership rights. Interaction with companies has always been part of our toolkit and has broadly had three objectives: to hold boards to account, to contribute to changes in portfolio companies and markets, and to gather information about company practices.

Holding boards to account

We concluded early on that holding companies’ boards of directors to account was crucial for us a financial investor, and a key objective of company interaction, given the role of the board in supervising a company’s management and operations and representing shareholder interests. This naturally centres around board accountability for company strategy, but also extends to the environmental and social consequences of company operations. Without well-functioning boards, we lose out as investors.

This is why we decided in 2005 that direct contact with individual companies on governance issues should primarily be with the board of directors. In later years, we elaborated on the rationale for holding boards to account, noting that attempts by single shareholders to micromanage a company with dispersed ownership are likely to frustrate and undermine management, disturb strategy processes and blur lines of responsibility.

The better option for shareholders like ourselves would be to retreat from detailed involvement in corporate decision-making and hold the board accountable for its actions and outcomes. We observed that market practices were often insufficient to hold boards accountable, partly due to inadequate mechanisms allowing boards to insulate or entrench themselves, and partly due to a lack of initiative from shareholders to involve themselves in overseeing boards. We therefore decided that being a constructive and firm owner overseeing boards and holding them to account would be a priority for the fund.

From 2006 onwards, we stepped up our interaction with individual companies, emphasising that the chairperson and key board representatives would be the most important points of contact on governance issues. From 2013, we started to engage more systematically with company chairpersons to discuss the board’s working culture and dynamics, including how the chairperson ensured useful debate and safeguarded the quality of the board’s work.

That year, we had 77 meetings with the chairpersons of companies in which we held large stakes. These meetings covered a wide range of ownership issues, centring on the board’s role in establishing effective governance. Specific issues raised in these meetings included the responsibilities of the chairperson, strategy setting, role of board members, nomination of directors, shareholder consultation, and sustainable business practices.

In 2015, we introduced a sector-specific focus to our dialogue with company chairpersons, targeting 12 chairpersons of European banks. These dialogues focused on capital adequacy and allocation, strategy setting and execution, succession planning and board effectiveness. In 2016, the dialogue was extended to include US financial institutions, and we met the chairperson or lead independent director of 15 financial institutions in the US.

Since then, we have sought to engage with the boards of our top 50 holdings regularly. The dialogue has concerned issues such as industry expertise on the board, directors’ time commitments, and governance and sustainability practices.

Our interaction with boards has increased year on year, from 70 interactions in 2013 to 167 in 2019. Despite our focus on holding boards to account, most of our company dialogue over the years has nonetheless been with members of management. While we generally have access to boards thanks to the size of the fund, access in some markets, including the US, has been challenging. Further, some of our dialogues have pursued objectives other than board accountability, such as information gathering or contributing to changing company governance and sustainability practices. While these are objectives that we have often pursued at board level, it has also been necessary to address issues with other parts of company management, such as the CEO, or sustainability experts for more detailed discussions or information gathering. Lastly, we only meet boards when we are confident that we can make the meeting mutually beneficial, i.e. when we are able to match the level of seniority, have the prerequisite knowledge and expertise about the company and sector, and want to convey views and questions that warrant the board’s attention.

Improving company and market practices

The development of the ethical guidelines for the fund in 2003-2004 established that the fund had an ethical duty to work on improving company practices through the exercise of ownership rights, including company dialogue. Exercising this duty through ownership activities would have the benefit of improving the situation for those negatively affected by a company’s activities. However, it was also noted that there could be associated risks, for example that the fund could contribute to unethical practices if unsuccessful in exercising its ownership rights in a way that led to improvements in company practices.

This duty to exercise ownership rights was described at the time as a duty to remain invested while using our rights as an owner to influence portfolio companies. Exerting influence was understood in this context as the responsibility to ensure that portfolio companies were made aware of the fund’s corporate governance principles. Exerting influence was not understood to mean that the fund should seek to direct corporate strategy.

While it was recognised that direct dialogue with company boards would be limited to key holdings, such dialogue would be an opportunity to raise a broader set of issues in a way that would not be possible solely through voting. Social and environmental issues rarely figured routinely on the agendas of shareholder meetings at the time. Dialogue was therefore seen to be a particularly useful tool for raising ethical concerns related to human rights and environmental practices.

It is important to note that the ethical duty to use our ownership rights to influence companies was not seen as an objective in itself. Rather, it was seen as integral to the objective of achieving the highest possible long-term return.

A clear example of such a dialogue is the meetings that the we held with the chairperson of BP Plc in response to the Deepwater Horizon incident in 2010. The objective of this meeting was to ascertain that the board would commission an independent review of the accident and make it public. We also wanted the board to reaffirm health and safety as its utmost priority. There was a clear link between our environmental concerns and our financial interests in the company.

Although we recognised that we have an ethical obligation to use our ownership rights to promote changes in company practices, and that the objectives of company dialogue in this respect would be to convey our views and nudge companies towards better reporting and responsible business practices, we also acknowledged that the results of these dialogues would be difficult to measure.

First, it is hard to establish whether a change in business practice is due to our interaction with the company, the interactions that the company might have with other investors, or occurred independently of investor outreach. Second, it is difficult to ascertain how a company’s revenues and share price would have developed had the company not changed its practice. Third, companies will normally present changes as their own initiatives rather than a reaction to investors’ wishes, thus making the result of ownership activities difficult to document. Finally, the exercise of ownership rights through individual dialogue often takes time, and effects are therefore unlikely to emerge in the short term.

Notwithstanding these challenges, we noted that dialogue might still contribute to raising awareness at board level and enhance internal communication within a company about the concerns that we raise through our interactions. Over time, we have also observed changes in company practices even if we cannot attribute these to our interaction. In terms of our measuring the overall results of ownership activities, it was considered that the best approach would be to focus on activities undertaken and how effectively these activities have been organised.

Gathering information

During the development of the ethical guidelines for the fund, it was recognised that the information that we gather through contact with companies forms a basis for efficient and effective exercise of ownership rights. A lack of comprehensive and consistent reporting across markets on environmental, social and governance issues has meant that, in practice, we have used company meetings to gather information that we need for further risk analysis.

In some cases, we have also sought to gather information through company meetings to inform the development of our own positions and expectations. For example, we consulted a number of chairpersons of portfolio companies to inform the development of our expectations on board accountability in 2012. We have also interacted with companies in relation to our voting. Some voting decisions, in particular on shareholder proposals related to sustainability issues, that sometimes require us to gather additional information from companies in order to inform our decisions.

Another example of how we use company interaction for information gathering and internal knowledge building is our work on the nomination committees of selected Swedish companies starting in 2013. This interaction has enabled us to gather invaluable information about nomination processes under the Swedish corporate governance model and about effective board evaluations.

The complete publication is available here.