Supervisory boards need to engage with their shareholders
Investor communication with boards has long been non-existent in two-tier board systems. Whereas non-executive directors in the US and the UK are regularly involved in investor relations activities, the same does not apply for many European countries. In Germany, an initiative of investors, companies, researchers and standard setters has developed principles for the dialog between investors and the board. An interview with co-initiator Dr Hans-Christoph Hirt, Hermes.
Dr Hirt, you supported the German initiative “Developing Shareholder Communication”. Why? What was your reasoning for this?
First of all, adequate investor and supervisory board communication is an important issue. After all, investors elect the members of the board, including non-executive directors. But there is a lot of uncertainty in two-tier system markets like Germany. Partly this is because non-executives directors are not accustomed to speaking directly with investors. Although investor relations activities with executive boards or committees have become an established corporate practice, historically the supervisory board of most companies had virtually no relationship with the capital markets. In addition, some lawyers believe that under German company law, communications between investors and supervisory boards are not allowed. All of this means that there is uncertainty on how to engage from a company and an investor perspective. As representatives from the investor side who regularly engage with companies, including non-executive directors, we co-founded the initiative “Developing Shareholder Communication” to develop some guidance addressing investor demands on the one hand, and company uncertainty on the other.
Why is there no established practice?
The German two-tier system is very different from the UK one-tier system. If you strictly interpret German law you can come to the conclusion that the supervisory board does not or should not have a role in communications with investors. There is a lot of legal uncertainty, and there are a lot of lawyers who say that German non-executive directors should not speak with investors. What we wanted to achieve with this initiative is to address the uncertainty, and define guidelines for investors and supervisory boards. We clearly understand that a German non-executive chair cannot speak about the same topics as an UK non-executive chair. But investors want and need to speak to the supervisory board, so the guidelines are aimed at enabling a more effective dialog and providing more clarity when it comes to the investor supervisory board interaction.
Has there been any reaction to the initiative from German companies?
We had excellent participation in the project by major German companies*. Having said this, I have not yet received direct reactions, positive or negative. German DAX companies have already begun to establish investor supervisory board relationships, so from their perspective the initiative is really describing current practices. For smaller companies like MDAX or SDAX it is still new territory. I expect that the critical discussion will take place among legal academics and not among companies, as the benefits for both investors and supervisory boards are clear.
In a nutshell, what are the most important prerequisites for shareholder board communication?
A willingness to engage and have constructive conversations when there is a salient request from a shareholder is most important. And then to engage within an appropriate time frame, and on the right topics. For example, it is not particularly helpful to initiate conversations four weeks before the AGM when all decisions have been made. What best-practice companies are doing is to reach out to investors between nine to twelve months before supervisory board elections to discuss the nomination criteria perhaps based on a recent board evaluation. As outlined in the guidelines we do not want to propose candidates, but we think it is useful for companies to talk about candidate profiles with investors.
What are the right topics?
Everyone would agree that there are a number of issues that cannot be addressed by the management board, e.g. the supervisory board composition and its performance, management board appointments and remuneration.
The guidelines address the situation in Germany, but do they also apply to other two-tier systems?
Yes, absolutely. Germany was at the top of the agenda but there is a wider issue worldwide regarding communications between investors and non-executive directors. Two-tier systems add a layer of complexity because of the differing roles and responsibilities.
What improvements are necessary to further enhance corporate governance practices and shareholder board dialog?
The principal right of investors is to elect the members of the board. When you look at current investor practices and compare how much time is devoted to remuneration issues as opposed to board composition, candidate profiles or board performance the balance is not quite right. Companies are increasingly open to discuss the composition and performance of the board, rather than just remuneration, even in the Asian countries.
You are not only responsible for governance aspects, but also sustainability issues in general. How interested are mainstream investors in this?
This is an area in which we have seen significant developments over the last decade. Most investors focus on sustainability in the context of business performance and long-term financial success. This is the way companies need to address them. It’s important to think about the mainstream, not just ESG investors. And communications should be led by the CEO or CFO and not by a junior IR specialist. The key here is integration on both the investor and the company side.
What is your take on integrated reporting?
It is a good idea, but it will take more time to prove useful for everyone involved – investors and companies alike. The real value is the focus on ESG aspects that relate to the business model. However, too often we see that a good idea in theory is still very much work in progress in practice and little more than an amalgamation of traditional annual and sustainability reports.
*Members of the task force: Prof. Dr Alexander Bassen (University of Hamburg), Dr Jürgen Hambrecht (BASF, Daimler, Fuchs Petrolub), Dr Hans-Christoph Hirt (Hermes Investment Management), Prof. Dr Dr Dr h.c. mult. Klaus J. Hopt (Director (em) Max Planck Institute for Comparative and International Private Law, Hamburg), Prof. Dr Ulrich Lehner (E.ON, Henkel, Deutsche Telekom, Porsche Automobil Holding, ThyssenKrupp), Dr Stephan Lowis (RWE), Ingo R. Mainert (Allianz Global Investors), Daniela Mattheus (EY), Prof. Christian Strenger (HHL Leipzig Graduate School of Management).
Guiding principles for the dialog between investors and supervisory board
According to the new EU Shareholders’ Rights Directive effective 2017, going forward institutional investors should assume a more active role in the monitoring of publicly listed companies. To do so, extensive dialog between investors and the supervisory board as the central monitoring body is key to fostering mutual trust and enhancing transparency.
The initiative “Developing Shareholder Communication” has formulated eight guiding principles for direct communication between investors and supervisory boards that provide practical dialog guidance. The guiding principles pertain to the following areas of communication between investors and supervisory board: pertinent issues; composition and remuneration of the supervisory board; internal organisation and monitoring process; board appointment, termination and remuneration; strategy development and implementation; auditors, parties involved, configuration.