The rise of shareholder intervention
By Murray Steele, Senior Lecturer in Strategic Management
What do Marks & Spencer, Barclays Bank, the Rank Organisation, Reckitt & Coleman,
and the Mirror Group all have in common? In the closing months of 1998 and the
opening months of 1999 these companies all changed their chief executive principally
due to institutional investor pressure previously unseen in the UK.
The Mirror Group is a good example of this new wave of institutional investor activism.
On 25 January 1999 Peter Butler, a director of Hermes (the British Telecom and Post
Office Pension Fund) and the first executive ever appointed in the UK to a position
responsible for stimulating shareholder value and corporate governance on behalf of
investors, telephoned Sir Victor Blank, the chairman of Mirror Group and demanded that
David Montgomery, the newspaper group’s chief executive be removed. A few days later
he resigned.
Hermes was not alone. Phillips and Drew - which had a 22% stake in the Mirror Group and Prudential had also been agitating for change. However, this direct request for the
removal of a high profile chief executive on the grounds of poor performance was
something relatively new in the British corporate landscape.
In the past the most that institutional investors would do would be to ‘huff and puff’ to
boards of companies where they were dissatisfied with performance. They rarely took any
action more dramatic than abstaining at the Annual General Meeting, or more likely
would dispose of their holdings in the company concerned, often at a loss.
Growing dissatisfaction
So what has happened to cause this change in emphasis of institutional investors? There
are several interlinked forces. Over the last few years there has been growing
dissatisfaction among institutional investors about the performance of quoted companies
in terms of shareholder value, leading to greater interest in better corporate governance.
© Management Focus Issue 12 Summer 1999 (Cranfield School of Management
Linked to this trend is the arrival from the US of expertise in active value fund
management or focus funds.
Focus funds target underperforming companies and take significant stakes in them to
increase their influence for change with the board. Institutional investors mainly track an
index; Hermes, for example, owns about 1.5% of all companies in the FTSE All-Share
Index. In October 1998 Hermes established a UK joint venture active fund with Lens, one
of the most feared US Focus Funds. One of their first targets was Mirror Group.
Although the mention of focus funds undoubtedly sends shudders round down many a
boardroom spine, the majority of organisations benefit from institutions that take a
geniune interest in the company’s well-being. Focus funds have traditionally placed great
emphasis on corporate governance and there is clear evidence from the US that corporate
governance pays. For example:

If you had invested $1 million in the Lens Focus Fund in August 1992, five years
later its value would have shown a compound annual growth of 26% to $3.2 million.
A similar investment in the S&P 500 would only have returned $2.5 million.

A survey of US chief executives and investors published by the McKinsey Quarterly
(1996-Q4) concluded that good corporate governance at the level of the board of
directors added 11% to the value of a company.

Of the 53 companies targeted by Calpers (the California State Pension Fund) from
1987 to 1995, 75% had underperformed the S&P Index five years before being
targeted; five years after being targeted 54% had outperformed the S&P Index.
These are powerful arguments in favour of greater shareholder intervention.
What is corporate governance?
The classic definition of corporate governance is: “The system by which companies are
directed and controlled for the benefit of shareholders.”
Critical to the activity of corporate governance is the fact that boards of directors are
responsible for the governance of their companies.
© Management Focus Issue 12 Summer 1999 (Cranfield School of Management
In the true tradition of the British amateur approach, it was not until the 1990s that any
guidance on corporate governance was provided. The Companies Act only provides a
legal framework within which companies must exist. It does not provide any guidance as
to how companies should manage themselves.
In the 1990s three major reports considered the topic.
The Cadbury Report, 1992: Sir Adrian Cadbury’s report was prompted by a series of
highly publicised company failures, the rapid growth in executive remuneration and
conflicts of interest between directors and shareholders. It defined, for the first time, the
composition of the board, its responsibilities, and the responsibilities of the chairman, and
the audit and remuneration committees.
The Greenbury Report, 1995: This report was prompted by growing public concern
about the growth in executive remuneration, especially to departing directors and to the
directors of privatised utilities, at a time when prices were rising, pay was being
restrained and staff made redundant. Greenbury attempted to develop a code of practice,
with special emphasis on accountability and transparency. Much of the report dealt with
the role of the remuneration committee and the information about remuneration to be
disclosed in the Annual Report. Greenbury’s most contentious recommendation was that
executive service contracts should be one year or less.
The Hampel Report, 1998: Hampel conducted a review of Cadbury and Greenbury with
the intention of creating an overall code of corporate governance. His report reiterated the
responsibility of directors to shareholders, and placed greater emphasis on shareholder
value than box ticking, one of the criticisms often levelled at corporate governance. His
report was broad ranging with comment on topics such as:

Board performance

Disclosure of information

Remuneration

Role of the audit committee

Training

Role of the nomination committee
© Management Focus Issue 12 Summer 1999 (Cranfield School of Management

Conduct of AGMs

Role of the remuneration committee

Roles of chairman and chief executive

Directors’ contracts
In June 1998 the key elements of the Hampel Report were incorporated in the Stock
Exchange Rules, governing all companies listed on the Stock Market.
Criticism
Although the development of a code for corporate governance was a step forward,
Hampel’s report not meet with universal accord. Critics said that little was new; that the
committee comprised businessmen and their advisers who therefore had a vested interest;
that it provided no real accountability and consisted of broad principles which would be
hard to put into detailed practice.
Margaret Beckett, the Minister then in charge of the DTI, agreed with the criticisms,
particularly in the areas of accountability and transparency, and hinted that she might be
prepared to propose legislation in the field of Corporate Governance. As recently as
February 1999 a report in the Financial Times suggested that Stephen Byers, Secretary for
Trade and Industry, wanted the Stock Exchange to change its rules so that companies
would have to put their pay plans to shareholders every year for approval.
In other words, despite its apparently late start in the field of corporate governance, the
flurry of reports in the 1990s have made the UK a world leader with many other countries
expected to adopt similar codes of practice.
Here for good
Corporate governance is here to stay. The series of reports; the Government’s interest in
the subject, particularly remuneration; the new-found interest of institutional shareholders
© Management Focus Issue 12 Summer 1999 (Cranfield School of Management
in increased shareholder value; the growth of active value fund managers; and the
growing media interest in business mean it will only increase its significance.
The landscape for directors of both large and small companies has changed irrevocably.
Gone are the days when corporate governance was an item on the board agenda only
when the Annual Report and Accounts were being finalised. Directors will now have to
be aware of all aspects on an ongoing basis. The penalty for failing to do so will probably
be that they have the opportunity to spend more time with their families. If a company of
the pedigree of Marks & Spencer - whose chief executive Sir Richard Greenbury was one
of the leading lights of corporate governance - can be caught out, then who is safe?
Cranfield School of Management offers a two-day programme in corporate governance
for existing and aspiring non-executive directors. The programme was created with the
assistance of Hermes.
© Management Focus Issue 12 Summer 1999 (Cranfield School of Management