Home > Corporate Governance Theory > Engagement: an eclectic approach

Engagement: an eclectic approach

In a paper published in the spring of 2016, (1) Mattew J. Mallow and Jasmin Sethi dip into two opposing views in Corporate Governance, the one advocating to give shareholders as much power as possible to influence directors and management´s decisions, (favoring unclassified boards, frequent voting, ability to change the company`s charter), and the one pushing for keeping the board insulated from them, (opposite recommendations and overall deference to elected directors). (1)

 Bebchhuk (who states that shareholders activism increases firm value) and Strine, (who asserts it only favors short-termism) both rely in empirical studies which are not conclusive.

 Mallow and Sethi introduce “Engagement” in the discussion. Whatever the definition, it refers to some cooperation between board and shareholders or institutional investors´ managrs, and at least an enhanced dynamism in their relationship. Managers are supposed to owe fiduciary duties to final investors in order to maintain the log-term value of the investments. We will herein follow their analysis in several topics:

 1.- Engagement: description and purpose

 Engagement means being aware of the objectives and strategies designed by board and managers, so as to induce change and influence outcomes. Engagement lies beyond voting, (be it frequent or not), and represents a friendly and not confrontational approach. It can be formal or informal and adopt different shapes and communication channels. The purpose for shareholders is to express opinions that can at least be considered by managers, a communication channel that grows on trust and long-term relationships. Engagement can save managers´ time and reduce the resources they otherwise dedicate to convince the shareholder base to adopt certain policies when they have been badly informed previously.

 2.- Effectiveness.

 Vanguard, T. Rowe Price, and many other institutional investors usually engage with boards and managers, sometimes reaching agreements over changes in board composition, ESR policies, corporate strategy and so on. Firms disclosing their engagement efforts often describe changes introduced in these management aspects, and investment or pension funds also recognize their success in changing certain firm behaviors when disclosing their engagement efforts. It is difficult to identify the exact net results of engagement, but certain correlations can be discovered that persuade academics to recommend engagement; even though, engagement is very often something private, whose positive results can`t be fully traced.

 3.- Engagement`s increasing role.

 Long-term investing and engagement will persist and rise in the future, according to Mallow and Sethi, ao that engagement will remain a helpful tool.

Some reasons support their view: (i) a large share of investors are long-term ones because family goals are usually long-term: retirement, college, desired investments, and so on. (ii) a large number of funds are index funds, so that investments are naturally long-term; (iii) companies are also recognizing engagement as a satisfactory tool.

 4.- How to increase engagement and its effectiveness.

 The academic focus has until now centered in voting practices, not in engagement. Engagement and its results are more difficult to measure and perhaps other analysis could help academia expand the virtues of engagement, such as case studies, interviews or surveys; otherwise, some resources could help managers use engagement, such as the Shareholder–Director Exchange Protocol (SDX Protocol) (2), the adherence to the Six Principles for Responsible Investment, (3), the proxy access mechanisms and so on.

 5.- Engagement and executive compensation

 Compensation is a good governance aspect as every company is unique so that engagement should produce better results than standard and uniform regulation. If the company is prepared to discuss and share information about its particularities, (risk, industry trends, peer firms, strategy, performance metrics, etc) a case by case approach should prevail.

Because of that, compensation is usually a good starting point for engagement, which in any should grow stronger in the near future.

 

 

(1) http://www.nyujlb.org/wp-content/uploads/Engagement.pdf

(2) www.sdxprotocol.com/wp-content/uploads/2014/07/SDX_Investor-Letter.pdf

(3) The Six Principles for Responsible Investment, PRI ASS’N (2006), http://www.unpri.org/about-pri/the-six-

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