2.2.4 Who are the shareholders and what is their influence?

The fragmented share ownership of the inter-war period has been replaced by a concentrated form of share ownership as an increasing proportion of shares have come to be owned by institutions. Individuals held over half of UK shares in 1963. Today they hold one eighth. UK pension funds have become particularly dominant by as early as 1970. Around 75-80% of shares of British companies are now held by institutions, with pension funds alone owning about 30%.1

This change in the pattere of share ownership in favour of investing institutions, such as pension funds and insurance companies, has encouraged those institutions to use their influence based on the number of their votes. This has increased shareholder influence in general.

Boards cannot disregard the views of important shareholders, especially if there is some degree of consensus between them.

Institutional investors now have powerful incentives to use their influence to improve the performance of their portfolios. Their holdings are collectively so large, selling has become difficult since this would influence the market. "Get out" is giving way to "influence". These institutions take a fairly long-term view of their investments. Few UK companies have dominant shareholders with more than, say 25%, ownership, which is also the case in the US, Japan and The Netherlands. There is therefore an incentive for institutional shareholders to "persuade" each other and to create strong voting blocks when particular matters are put to a vote.2 The key lever that shareholders control is their ability to vote at general meetings, but the practice is that "persuasion" takes place first and then "pressure" to avoid cumbersome general meetings.3

The most recent development is that more and more foreign institutions, particularly from the US, hold UK shares. There is a tradition of good "oneon-one" communication with large shareholders.4 However, this is less easy with foreign shareholders. What the role of hedge funds and of shareholder activists is going to be remains to be seen. Some of them are well-inforrned about companies in which they take stakes and can engage effectively with management. Some of them recognize, too, that corporate governance is connected to value. For example: a better board structure can increase shareholder prices.5

British institutional investors, increasingly via voting associations, have influenced corporate governance in various ways, generally by "pressure" and "persuasion":

After the Higgs Review of 2003 on the separation of the roles of CEO and chairman and the introduction of the senior independent director (SID)6 institutional investors have taken a strong stance and pressed for the proposed reforms in many companies.7

Institutional investors in the same way as outside directors, want to be included actively in strategie decisions and risk management. This is clear from their support of the Codes of Best Practices.8

In the UK it is crucial for shareholders to have the power onder company law to appoint and dismiss directors.9 In practice it is quite rare in the UK for shareholders to propose individuals as candidates for a particular board.

This normally happens only after a company has run into trouble. Even then there is reluctance to usurp the nomination committee's right to select.

Directors representing institutional investors often use indirect pressure to influence the nomination committee, which also sounds out shareholders. In general, shareholders have pushed for the introduction of a senior independent Director to whom they can communicate any comments on the functioning of the Chairman and the CEO.

Shareholders also play a role in establishing remuneration structure policy. The ABI, representing shareholders, now receives over 200 requests a year from companies seeking shareholder views on remuneration policy. This has led to less extreme short-term option schemes than in the US.13

CEOs and/or chairmen of companies hold many one-on-one meetings with influential shareholders. Hermes, an influential UK pension fund, for example, always divides its one-on-one meetings as a shareholder with CEOs and/or chairmen into three parts: one-third strategy, one-third remuneration and one-third succession.14

Companies are now15 obliged to offer shareholders an advisory vote on their remuneration report. As before, a separate binding vote is required on share incentive schemes that are dilutive and/or involve the issue of shares to directors. The press watches votes on remuneration closely, and companies are concerned about the loss of reputation that may flow from evidence of widespread opposition to their remuneration policy. Moreover, a public dispute over remuneration can seriously demotivate directors. For these reasons companies increasingly seek dialogue with shareholders in order to soit out problems before they arise.16

There are three reasons why shareholders have become involved with remuneration. First, a conflict of interest arises when boards have the task of deciding on the remuneration of directors who sit on these same boards. Shareholders have a responsibility to help mitigate this effect. Second, remuneration creates incentives that will determine the approach taken by management in driving the company forward. Shareholders have a strong direct interest in what happens. Finally, there is a general need to preserve the integrity of the system. If lack of discipline and oversight allows companies to bestow lavish rewards on mediocrity and failure, it will no longer be possible to reward success. This will damage entrepreneurialism and inhibit wealth creation.

The efforts of shareholders over the years have met with some success, particularly with regard to the structure of remuneration. It was always possible for the UK to avoid the bonus extremes of the US, where it has become a subject of public interest and anger in the last few years.17

Shareholders have had less influence on the overall amounts of remuneration, which is being driven higher and higher. This is partly because they do not wish to get involved in setting the going rate. The ratchet effect is caused by disclosure, which aimed to have a limiting influence through public exposure, but the opposite happened.

Shareholders have had an important indirect influence on better interaal control.

Finally, shareholders have a significant say in important strategic questions. The UK Listing Rules made by the Financial Services Authority18 give them the right to vote when a company wishes to make a substantial purchase or disposal of assets that will alter the shape of the company. This right is regarded as highly important. In practice shareholders have not used this right to bluntly block actions proposed by the board, but the mere fact that shareholders have such a right forces boards to consider in advance whether they will be able to carry their shareholders with them in any decision. This background explains why strategy and strategic decisions are extensively discussed in boards with non-executive directors at an early stage.19

Voting associations20 often give shareholders advice on how they should vote. This advice if often followed by institutions that do not wish to make costs investigating voting alternatives.