Shareholder rights and engagement and director remuniration

Question 1

Briefly describe the most common types of shareholders. (5)

Answer 1

Below is a list of the most common types of ‘shareholders’.
* Member – a person (or corporation) entered into the Register of Members of the company as a holder of the company’s shares.
* Beneficial shareowner – a person or organisation that ultimately owns a share in a company. The shareowner may
or may not be a ‘member’ of the company.
* Nominee/Custodian – a person or organisation that holds shares as a «member’ on behalf of another person or organisation who may or may not be the ultimate owner of the shares.
* Retail shareholder – individual investors who buy and sell securities for their personal account, and not for another company or organisation. The individual usually registers the shares in the name of a nominee belonging to a stock broking firm, e.g. Barclays Nominees Limited.
* Institutional shareholder – a person or organisation that trades securities in large quantities or monetary amounts on
behalf of multiple beneficiaries.

Question 2

Name four examples of shareholder abuse (4)

Answer 2

• insider trading
• dilution (CS - ensure AGM - allotment of shares/waiving pre-emption rights), e.g. ownership percentage of voting control is reduced. CA 2006 - allotment of shares by directors must authorized by shareholders (exc. private companies, employee share schemes).
• tunnelling
  Tunnelling occurs when the value of the shares held by a shareholder is reduced (sold non-market prices; corporate opportunities are exploited by related companies and not the company itself; changes, including mergers, acquisitions and disposals, are made which affect the fundamental legal and de facto bases of the company.
  Chapter 10 of the Listing Rules: ‘Significant Transactions’, requires listed companies to notify their shareholders of certain transactions of more than 5% of the company’s value calculated by a series of ratios. Where the transaction value is more than 25% a shareholder vote is required.
  The company secretary should monitor the activities of directors and controlling shareholders to ensure that these types of abuses do not occur.
• related party transactions

Question 3

Why should institutional shareholders take an interest in good corporate governance?

Answer 3

‘checks and balances’ - reasonable return-downside risk-fiduciary duty, decent return on investment = promoting good corporate governance

Institutional investors should take an interest in good corporate governance as:
* Investors expect a return on their investment. Most evidence suggests that well-governed companies deliver reasonable returns over the long term, and shareholders in these companies are less exposed to downside risk than shareholders in companies that are not so well governed.
* Institutional investors also have legal responsibilities (fiduciary duties) to the individuals on whose behalf they invest. For pension funds, these individuals are the beneficiaries of the funds. In fulfilling their responsibilities, institutions should try to ensure that they make a decent return on investment, and promoting good corporate governance is one way of trying to do this.

Question 4

Why might there be more successful prosecutions for insider dealing under the market abuse regime than under the Criminal Justice Act 1973?

Answer 4

The market abuse offence of insider dealing is a civil offence. Accordingly, it is only necessary to prove that a person’s behaviour was illegal ‘on the balance of probabilities’ as opposed to the ‘beyond reasonable doubt’ test applied in criminal prosecutions for insider dealing under the Criminal Justice Act 1993

Question 5

What is a derivative claim? Who is able to bring it and when? (4)

Answer 5

CA2006 introduced the possibility of a ‘derivative claim’ by shareholders on the grounds that the company itself has a cause of action against the directors of the company. The cause of action must involve some negligence, default or breach of duty on the part of the director and may be brought against the director involved in the breach. There is no
need to show that the company has suffered a financial loss. Minority shareholders are therefore able to bring actions against directors who have acted in a way that is preferential to a majority shareholder and have breached their duty to promote the interests of shares as a whole.

Special court procedure which enables shareholders to bring a legal action in the name of company against a director(s) for breach of duty. If the action succeeds, any compensation is awarded to the company rather than to to the shareholders who initiated it.

Question 6

What are the ways in which an investor can pursue an SRI strategy? page 312

Answer 6

• engagement strategy (acquires - engages with board to make improvements in CSR policies);
• investment preference - investor develops a set guidelines that companies should meet
• screening (With a screening strategy, investments are restricted to companies that pass a ‘screen test’ for ethical behaviour. Positive screening means that companies must meet certain criteria for ethical and socially responsible behaviour; otherwise, the investor will not buy its shares.
  Negative screening means that an investor will identify companies that fail to meet certain minimum criteria for socially responsible behaviour and will refuse to buy shares in those companies. The screening process could make use of a published CSR index, such as the Dow Jones Sustainability Indices or the FTSE 4 Good Indices.

Question 7

What is inside information and why are listed companies required to publish inside information so promptly? (4)

Answer 7

• information of a precise nature;
• which has not been made public;
• relating, directly or indirectly, to one or more issuers or to one or more financial instruments; and
• which, if it were made public, would be likely to have a significant effect on the prices of those financial instruments or on the price of related derivative financial instruments.

Information is not inside information unless each of the criteria in the above definition is met.

Listed companies are required to publish inside information promptly in order to minimise the opportunities for insider dealing and the creation of a false market where the information has leaked

Question 8

What are the main sources of shareholder rights? (7)

Answer 8

The main sources of powers and rights for shareholders are as follows:

Legislation –- the two main areas of law that relate to shareholders are company laws and securities laws.

Regulations – listed companies are subject to the requirements of the Listing Rules, Disclosure and Transparency Rules (DTRs) and the Takeover Code.

Case law – some protection for minority shareholders can be found in common law rules, which often operate when legislation is silent.

Corporate governance codes and principles such as the OECD Principles of Corporate Governance.

Articles of association of the company usually contain powers and rights of members, such as those for the holding of general meetings.

Resolutions passed at general meetings of shareholders reinforce pre-emption rights, the rights to share by way of
dividend in the profits of the company and the rights to elect the board of directors and the company’s auditors.

Shareholder agreements which may regulate:
* the purchase and sale of shares;
* the preference to acquire shares;
* the exercise of voting rights;
* the exercise of control;
* the company’s policy on investments;
* the company’s budget;
* the right of first refusal;
* the tag-along and drag-along clauses;
* the preparatory meetings among the shareholders who executed the shareholder’s agreement to decide how to vote in the general meetings of the company

Question 9

What is the difference between responsible investing and socially responsible investment?

Answer 9

• Responsible or ethical investing means refusing to invest in ‘unethical’ companies and ‘sin stocks’, that is, companies that produce or sell addictive substances (like alcohol, gambling and tobacco) because the activities of the company are inconsistent with the investor’s ethical, moral or religious beliefs.
• SRI investing goes further. It includes refusing to invest in ‘unethical’ companies, but SRI investors also encourage companies to develop CSR policies and objectives, in addition to pursuing financial objectives. SRI investors will seek out companies engaged in social justice, environmental sustainability and alternative energy/clean technology efforts. SRI investors may also be involved in shareholder activism when companies have social or environmental policies with which they disagree

Question 10

In what ways does a company know who its interested shareholders are?

Answer 10

substantial holding in a warns the company (takeover)

initial disclosure is triggered at 3% of total voting rights
exemptions for market
makers holding less than 10% so long as they don’t influence the management of At 10% and over the entire holding is disclosable.

Public companies can, under the CA2006, - give notice to any person

court order

Question 11

Give examples of shareholder rights. (6)

Answer 11

• ownership and transfer of shares;
• equal treatment;
• share in profits;
• receipt of information;
• attend and vote at shareholder meetings; and
• enfranchising indirect shareholders.

Question 12

What are the seven principles of the stewardship code?

Answer 12

• how they will discharge - Principle 1: Institutional investors should publicly disclose their policy on how they will discharge their stewardship responsibilities.
• conflicts of interest - Principle 2: Institutional investors should have a robust policy on managing conflicts of interest in relation to
  stewardship, which should be publicly disclosed.
• monitor - Principle 3: Institutional investors should monitor their investee companies.
• escalate - Principle 4: Institutional investors should establish clear guidelines on when and how they will escalate their stewardship activities.
• act collectively - Principle 5: Institutional shareholders should be willing to act collectively with other investors where appropriate.
• voting - Principle 6: Institutional investors should have a clear policy on voting and disclosure of voting activity.
• report - Principle 7: Institutional investors should report periodically on their stewardship and voting activities.

Question 13

What are four types of market abuse? (5)

Answer 13

engaging or attempting to engage insider dealing
recomendation that another person engage in insider dealing or inducing another person to do so
unlawfully disclosing insider information
engaging in, attemting to engage in market manipulation

Question 14

What are the typical components of an executive director’s remuneration package? (5)

Answer 14

The remuneration package for a director or senior executive is likely to consist of a combination of:
* a basic salary;
* payments into a pension scheme for the individual (or payments in lieu);
* an annual bonus, usually linked to the annual financial performance of the company;
* long-term incentives, usually in the form of share options or share awards (sometimes called ‘restricted stock awards’);
* other benefits and perks, such as free medical insurance, a company car or accommodation.

Question 15

What company performance targets might be used as a basis for fixing annual bonus payments to a CEO?

Answer 15

Bonus payments may depend on the achievement of both individual targets and the performance of the company over the previous financial year.

Question 16

What are the problems with linking rewards to performance for senior executives? (9)

Answer 16

It is difficult to design performance-related remuneration for the following reasons:
* selecting the right performance measures;
* setting the thresholds at which rewards are paid;
* setting a cap on any rewards under the incentive scheme;
* ensuring that the targets used promote the long-term success of the company;
* ensuring that the targets used do not promote bad behaviour;
* ensuring that executives who perform well are rewarded and preventing those that don’t from piggy-backing on the success of their colleagues;
* executives may develop an expectation that they should receive annual rewards regardless of the actual performance of the company; and
* designing a scheme that will be satisfactory to shareholders.

Question 17

What company performance targets might be used as a basis for deciding how many shares should be granted to a senior executive as a long-term incentive arrangement?

Answer 17

Most companies use total shareholder returns (TSR) or earnings per share (EPS) against a comparator group of companies.

Question 18

What are the drawbacks to using share options for long-term incentive schemes?

Answer 18

The drawbacks of using share options as a long-term incentive are:
* volatile - Share prices are volatile. Option holders may be unjustly enriched in a bull market where prices are rising and inadequately rewarded in a bear market when prices are falling.
* no incentive - If the market price of a company’s shares falls below the exercise price for the share options, those options may no longer provide any incentive for the directors.
* have to sell - It is more difficult to apply a holding period for shares acquired under a share option scheme as directors and senior executives may need to sell at least part of their holding in order to finance the exercise.
* expenses International Financial Reporting Standard 2 (IFRS2) Share-based Payment requires companies to recognise the award of share options as an expense, chargeable against the company’s profits, from the time that the share options are granted.

Question 19

What does the UK Corporate Governance Code say about the general level of executive remuneration?

Answer 19

Principle P of the 2018 Code now provides:

‘Remuneration policies and practices should be designed to support strategy and promote long-term sustainable success. Executive remuneration should be aligned to company purpose and values, and be clearly linked to the successful delivery of the company’s long-term strategy.’

Principle R of the 2018 Code states that:
‘Directors should exercise independent judgement and discretion when authorising remuneration outcomes, taking account of company and individual performance, and wider circumstances.’

Question 20

What is the main guidance in the UK Corporate Governance Code on the design of performance-related pay?

Answer 20

Code Provision 40 recommends that:
* remuneration arrangements should be transparent and promote effective engagement with shareholders and the workforce;
* remuneration structures should avoid complexity and their rationale and operation should be easy to understand;
* remuneration arrangements should ensure reputational and other risks from excessive rewards, and behavioural
risks that can arise from target-based incentive plans, are identified and mitigated;
* the range of possible values of rewards to individual directors and any other limits or discretions should be identified
and explained at the time of approving the policy;
* the link between individual awards, the delivery of strategy and the long-term performance of the company should be clear. Outcomes should not reward poor performance; and
* incentive schemes should drive behaviours consistent with company purpose, values and strategy.

Question 21

What are the principal duties of the remuneration committee under the UK Code?

Answer 21

Code Provision 33 provides that the remuneration committee should have delegated responsibility for:
* determining the policy for executive director remuneration; and
* setting remuneration for the chair, executive directors and senior management.
It also states that the committee should ‘review workforce remuneration and related policies and the alignment of incentives and rewards with culture, taking these into account when setting the policy for executive director remuneration’.

Question 22

2. Describe the recommendations of the Code regarding the composition of the remuneration committee.

Answer 22

Code Provision 32 states that the remuneration committee should consist exclusively of independent non-executive directors and should comprise at least three or, in the case of smaller companies, two such directors. The company chair is permitted to serve on the remuneration committee if they were considered independent on appointment as chair (although they are not allowed to chair the committee). The chair of the remuneration committee must have served on a remuneration committee for at least 12 months before their appointment.

Question 23

What provisions are included in the Code on remuneration consultants and why?

Answer 23

Code Provision 35 provides that:
* Where remuneration consultants are appointed, this should be the responsibility of the remuneration committee.
* The consultant should be identified in the annual report alongside a statement about any other connection it has
with the company or individual directors.

• Independent judgement should be exercised when evaluating the advice of external third parties and when receiving views from executive directors and senior management.
  These provisions reflect concern about potential conflicts of interest remuneration consultants may have which may
  compromise their objectivity.

Question 24

What are the two main component parts of the directors’ remuneration report?

Answer 24

The two main components of the directors’ remuneration report are:
* the directors’ remuneration policy; and
* the annual remuneration report.

Question 25

What is the purpose of the annual remuneration report?

Answer 25

The purpose of the annual remuneration report is to disclose to shareholders how the board has implemented the
directors’ remuneration policy during the financial year.

Question 26

What are the principles and provisions of the UK Code with regard to severance payments for senior executives? (4)

Answer 26

The UK Corporate Governance provides in Code Provision 39 that:
* Notice or contract periods should be one year or less.
* If it is necessary to offer longer periods to new directors recruited from outside the company, such periods should reduce to one year or less after the initial period.
* The remuneration committee should ensure compensation commitments in directors’ terms of appointment do not reward poor performance.
* They should be robust in reducing compensation to reflect departing directors’ obligations to mitigate loss

Question 27

What are ‘malus’ and ‘clawback’ provisions and where might you find them?

Answer 27

Code Provision 37
‘Malus’ provisions allow the company, in specified circumstances, to forfeit all or part of a bonus or long-term incentive award before it has vested and been paid (also known as ‘performance adjustment’).

‘Clawback’ provisions allow the company to recover sums already paid.

Directors’ remuneration policy

Question 28

Who should set the fees of NEDs?

Answer 28

Code provision 34 provides that the remuneration of non-executive directors should be determined in accordance with the articles of association or, alternatively, by the board. In practice the chair and the executive directors will take the lead on making a proposal to the board regarding the fees that should be paid to non-executives, probably after taking advice from the company’s remuneration consultants. Remember that, under the Code, the remuneration of the chair (even if non-executive) must be determined by the remuneration committee.

Question 29

Why is it inappropriate for NEDs to participate in performance-related schemes?

Answer 29

Non-executive directors are expected to play a role in setting the risk appetite of the company. Anyone whose remuneration is based on short- to medium-term performance has an incentive to take more risk in order to chase profits. Shareholders expect non-executive directors to act as a moderating influence in this regard. If they were allowed to participate in performance-related schemes, their interests would be more closely aligned with those of the executive team, rather than the interests of shareholders.

Question 30

Why might it be appropriate for some or all of NED fees to be paid in shares? What are the practical difficulties with this proposal?

Answer 30

Some people argue that paying NEDs fees in shares would more closely align their interests with those of the shareholders, as it would force them to become shareholders themselves. However, if you want them to remain as shareholders, you would have to impose a minimum holding period. They could, for example, be required to hold the shares until they ceased to hold office. This would potentially mean that they did not receive any remuneration for their services until the end of their tenure. This would be likely to give rise to recruitment and retention problems. Accordingly, non-executives would probably have to be allowed to sell at least some of their shares. However, share sales by directors always send a negative message to the market. Setting up a system where these become a regular occurrence is not an attractive prospect for companies. A possible compromise might be for a minimum percentage of their fees to be paid in shares (say 20%), in which case a minimum holding period could also be applied. The minimum holding period could allow them to sell those shares after, say, three to five years. The average tenure of NEDs is around four years.

Question 31

Why are the IA Principles of Remuneration and the PLSA Policy so influential?

Answer 31

The IA Principles of Remuneration and the PLSA Policy represent the views of institutional shareholders (e.g. investment managers and pension funds) who hold a significant stake in most listed companies. Most companies realise that shareholders will not support remuneration policies and structures that breach the guidelines issued by the two bodies. In addition, both bodies have a significant influence on government and regulatory policy in the field of corporate governance. Even if the majority of companies comply with the guidance, policy makers often give those recommendations more force by adopting them as legislative or code requirements.

Question 32

Give two broad examples of things covered in the IA Principles and two broad examples of things covered by the PLSA Policy.

Answer 32

The IA Principles cover levels of pay, bonuses, pensions, long-term incentive schemes, contract terms and severance payments. A particular focus in recent years has been on ‘malus’ and ‘clawback’ arrangements.
The Pensions and Lifetime Savings Association - Stewardship and Voting Guidelines (PLSA Policy) covers a wide range of corporate governance issues of which remuneration is only one. It focuses more on matters that will be voted on by shareholders at the AGM. Accordingly, it focuses on the directors’ remuneration policy and the annual remuneration report and explains the circumstances in which shareholders are most likely to vote against any resolution on those matters.