Large Investors, Small Obligations: How to Engage EU Shareholders

Aleksandra Pajic, Ph.D., LL.M.
Lecturer in Securities Regulation, University of Saskatchewan

Targeted development of the EU corporate governance framework is a timely and necessary move.

The past few years have shown some serious shortcomings in corporate governance of EU companies. The lack of effective control mechanisms has contributed to excessive risk taking, and subsequently to failures of many financial and non-financial institutions. Those failures are associated with a set of factors:

  • The lengthening of the investment chain;
  • The increasing “short-termism” of the capital markets;[1]
  • The remuneration of institutional investors based on the volume of assets they manage;
  • The costs associated with active engagement in governance; and
  • The lack of effective rights allowing shareholders to exercise control.

The initiative to enhance European company law and corporate governance was first outlined in the Action Plan. The Action Plan encouraged stakeholder engagement—primarily in the context of publicly listed companies—and called for enhanced transparency and improvements to the cross-border operating framework of the EU companies. The EU Commission now seeks to right the wrongs discovered in the latest financial crisis. The Commission has proposed changes to the Shareholder Rights Directive and announced an initiative on related-party transactions.

Misplaced Hope in Institutional Investors

Publicly held limited liability companies have wide-ranging numbers of shareholders, who are usually represented by proxies and through large investors. Institutional investors—such as pension funds, investment funds, hedge funds, insurance companies, and asset managers—are steadily increasing their stake in public equity. The increased presence of large institutional investors fostered the expectation that these highly skilled and well-resourced professional shareholders would make informed use of their rights, promoting good corporate governance in their portfolio companies. Ideally, all shareholders, retail and institutional, would fulfill their role as the owners of the company: They would take regular interest in its activities and performance, and make elected management accountable for their actions. Unfortunately, while the volume of assets controlled by institutional investors has increased, these investors’ interest in the companies has not followed the same trend.

The EC’s Proposed Changes to the Shareholder Rights Directive

In its Proposal to revise the Shareholder Rights Directive, the Commission addresses two main corporate governance shortcomings identified across EU listed companies: insufficient shareholder engagement and lack of adequate transparency. The Commission’s goal is twofold:

  • Offer shareholders more possibilities to oversee remuneration policies and related party transactions, and
  • Impose a limited number of direct legal obligations on institutional investors and proxy advisors to bring about effective engagement.

If this proposal is enacted, institutional investors will be required to disclose how their equity investment strategy aligns with the profile and duration of their liabilities, and how it contributes to the medium to long-term performance of their assets. Listed companies will need to publish detailed and user-friendly information on the remuneration policy overall and on the individual remuneration of directors. Shareholders will have the right to approve that remuneration policy and to vote on the remuneration report, which will describe actual application of the remuneration policy in the prior year.

The Proposal further requires that companies submit certain related party transactions—those representing more than 5% of the listed companies’ assets and transactions with a potentially significant impact on profits or turnover—to the approval of shareholders. In addition, related party transactions may not be unconditionally concluded without shareholder approval.

Institutional investors and asset managers will also need to identify shareholders, using just name and contact details. Such disclosure is only required where the information is used to facilitate the exercise of shareholder rights, and does not impact the shareholder’s rights to privacy and protection of personal data, as recognized in the Treaty on the Functioning of the European Union (TFEU) and in the Charter of Fundamental Rights of the European Union.

The European Parliament recognized the need to encourage more shareholder engagement, but expressed concern that this involvement should be a discretionary choice and never an obligation. However, the EC Proposal would use the “comply or explain” language for most of these provisions, leaving enough discretion to the companies, while introducing necessary improvements.

Member States Intervene

In an effort to promote longer term and more engaged shareholders, some Member States have already introduced new rights. For example:

  1. The UK is well ahead of the curve with the legislative changes after the “shareholder spring.”[2]
  2. France has introduced double voting rights for long-term investors.
  3. Italy is permitting loyalty shares to long-term shareholders.

All of these are steps in the direction to more engaged shareholders. But partial and fragmented remedies at the Member State level could hinder the EU-level playing field, as well as cross-border investment.

Without broader action on the EU level, well-known problems in the corporate governance model, including the misalignment between small, independent and large institutional shareholders, will likely persist. Targeted development of the EU legal framework for corporate governance is a timely and necessary move.

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[1] According to a study conducted by the European Parliament, the average holding period is eight months.

[2] Shareholders, most of whom were institutional investors, challenged management on a host of issues and led to series of pay revolts during the 2012 annual general meeting season in the UK.