Corporate Govenance and the United Kingdom (Part 2)

In an earlier post, we discussed some of the governance provisions contained in the Combined Code on Corporate Governance in the United Kingdom.  These included a separation of chairperson and CEO, a definition of director independence that corrected for structural bias, and increases responsibilities on the board for communicating with shareholders.  

Other governance provisions exist in the Companies Act in 2006.  One of them is almost unlimited access to the proxy for large shareholders or for a large group of small shareholders.  Some of these matters were explained succinctly at the roundtables held by the SEC back in May.  At the roundtables, the Division of Corporation Finance invited William Underhill, a partner at Slaughter and May in London. He noted that shareholders have greater authority to approve matters in the UK than in the US.   

• "changes to the by-laws, the articles, as we call it, but also authorizing directors to allot shares, authorizing  directors to allot shares for cash on a non-preemptive basis; authorizing buy-back of shares; major acquisitions and  disposals, and that's at a 25 percent level; transactions with directors or substantial shareholders will require shareholder approval; approval of share plans, long-term incentive plans need shareholder approval. Political contributions, as mentioned in the earlier panel, that also anyway requires shareholder approval for U.K. companies.

In the debate over access in the United States, and the parade of horrors raised by opponents, it is interesting to note that the Companies Act allows access. Specifically, Section 338 of the Act requires companies to circulate resolutions submitted by qualified shareholders.  The right is extended to shareholders representing 5% or more of the total voting rights or a group of shareholders of no less than 100, each owning at least L100 worth of shares.  

The proposal must be in writing and submitted at least six weeks before the meeting.  The Section provides grounds for excluding a proposal but they are extremely narrow, limited to proposals that are ineffective, defamatory, frivolous or vexatious.  In other words, there would be no grounds for excluding a bylaw that required the company to include in the proxy materials a nominee submitted by an eligible shareholder.  The system does not, therefore, involve a government agency approving any decision to exclude.  At the same time, however, directors who improperly exclude a proposal can be fined, something that, as Underhill noted, "focuses the directors' minds."

• I think directors for U.K. companies are very reluctant -- would be very reluctant to take those steps. Failure to propose a resolution or issue a statement is a criminal offense -- sanctionable by a fine, but it's still a criminal offense, so that concentrates the directors' minds. If they fail to requisition a meeting properly, then the meeting can be convened by the shareholders and then the costs recovered directly from the directors out of their remuneration. That also focuses the directors' minds.  So when it comes to taking a fine judgment on a legal point as to whether the resolution is valid and can be put, directors would usually decide to spend the company's money and put the resolution, convene the meeting or circulate the statement rather than take risks themselves.

Similarly, the Companies Act allows"say on pay."  Section 439 provides that quoted companies must submit to shareholders "a resolution approving the directors’ remuneration report for the financial year."   As Underhill described: 

• "We have this phenomenon of the remuneration report which is a detailed report describing the remuneration policies and remuneration of the executives that has to be put to shareholders at the annual meeting. It's voted on with a merely advisory vote but that's one that shareholders take seriously and management takes seriously and that's been the source of many upsets, in fact, where public companies have found they've had to rework their compensation plans and their bonus schemes in order to meet shareholder pressure."

Shareholders, therefore, have greater authority and can use the annual meeting more effectively to express views or influence the company's direction.  These rights, however, are balanced against a more difficult time accessing the courts.  As Underhill noted:

• all of this is against a background where shareholders' access to the courts in order to enforce proper governance and proper standards by their directors is very much less, perhaps, than it is here, that the prospect of class actions is very much diminished, that the ability to bring a derivative action, while that's changing, is still not going to be an open door. So the courts aren't really an answer. All shareholders have is access to general meetings and that's why these rules are particularly important.

The Companies Act did expand the instances in which a derivative suit could be maintained.  While these suits may be easier to file in the United States, the procedural hurdles imposed by the Delaware courts make them very difficult to maintain.

Shareholders, therefore, have substantially greater rights in the UK than in the US.  And, despite some weak arguments to the contrary, there is no evidence that capitalism in the UK has suffered as a result.  In fact, the era of shareholder rights in the UK has occurred at the same time the country has improved its economic and competitive position in the global economy.