Monday, 21 May 2018

Ryanair: ownership and control

Ryanair's latest results are out today. Aside from the update on negotiations on unions, which I won't comment on..., the bit that caught my eye is the commentary on Brexit and the potential knock-on impact on Ryanair's shareholders:
We remain concerned at the likely impact of a hard Brexit. While there is a general belief that an 18 month transition agreement from March 2019 to December 2020 will be implemented and further extended, it is in the best interest of our shareholders that we continue to plan for a hard Brexit in March 2019. In these circumstances, it is likely that our UK shareholders will be treated as non-EU and this could potentially affect Ryanair's licencing and flight rights. Accordingly, in line with our Articles, we intend to restrict the voting rights of all non-EU shareholders in the event of a hard Brexit, so that we can ensure that Ryanair is majority owned and controlled by EU shareholders at all times to comply with our licences. This would result in non-EU shareholders not being able to vote on shareholder resolutions. In the meantime, we have applied for a UK AOC which we hope to receive before the end of 2018.
Just as a remainder, Ryanair has to be majority EU-owned and controlled to qualify as a European carrier. Currently something like 45% of its shares are accounted for by ADRs held by primarily US investors, so it is close to the limit. The problem is that once the UK leaves the EU whatever shares are held by UK investors will likely count against it. The rough estimate is that UK investors account for about 20% of shares held, so you see the problem.

Ryanair's route to get around this is quite interesting for a number of reasons. First up, what is proposed here - taking away voting rights - is a new twist. Ryanair had previously talked about forced sales of shares, or the creation of new European vehicles to hold shares for UK investors. Now they are talking about taking away voting rights from shareholders. [As an aside I note that the language talks about not voting on 'shareholder resolutions'. Surely this must apply to management-proposed resolutions as well or not much changes!]

The company states that it already has the power to do this in its articles, and I dimly remember some commentary related to the ability to disenfranchise shareholders when it was introduced years back. I'll have to go back and read to see how it works. Notably Ryanair would rather have non-voting shareholders than leaving voting rights alone and enforcing share sales. In a Bloomberg interview, O'Leary said that he felt that different shareholders would have different views on this, but if they didn't like it they could sell.

I assume that Ryanair will only do this in the event of a hard Brexit, but I'm not clear if it needs to do anything to put this into action (i.e. seek approval), so that deserves a look too.

It's also worth considering who would get hit. If we take the statement at face value it is ALL non-EU shareholders, and in the Bloomberg interview O'Leary talks about both the UK and US (and the language was the same on the earnings call). So that suggests that shareholders representing, say, 65% of Ryanair's shares lose their votes.

And which investors specifically would lose out? I reckon most of the big ones (data from Capital IQ): -


Here's my rough take on the largest holders: Capital's holdings are through ADRs, FMR is a mixture of US and UK, HSBC, Baillie Gifford and Jupiter are UK, Janus Henderson is a mixture of ADRs and UK.

If that group of investors loses its votes, then the largest voting shareholder would be Michael O'Leary, in a voting float of say 35% (though of course this might change in practice as some UK and US investors decide they don't want non-voting shares). That's interesting for Ryanair's corporate governance, especially given that its board is not overburdened with independent representation.

Wednesday, 16 May 2018

Carillion: shareholder primacy plus shareholder inaction

As most people will be aware, the Work and Pensions and BEIS committee have published their joint report on the Carillion collapse today. I won't bother rehashing much better summaries of what it says that you can read elsewhere, rather I want to focus in on a couple of things I found particularly interesting.

First, whilst clearly the Carillion collapse in first and foremost the responsibility of the directors of the company, I think there is an accomplice in the room that is not identified: shareholder primacy, or at least the Actually Existing version of it.

One of the quotes I found most interesting in the report is below:
Mr Murchison said that, while dividends should be “a residual”, payable once liabilities had been met, there was a problem with “corporate cultures where a lot of management teams believe dividends are their priority”. Carillion’s board was a classic such case, showing:
desire to present to investors a company that was very cash generative and capable of paying out high sustainable dividends. They took a lot of pride in their dividend paying track record. Such an approach was inconsistent with the long-term sustainability of the company. (page 19)
This comes from the head of Kiltearn Partners which was one of Carillion's largest shareholders. I think it is spot on, and is exactly the point that Colin Crouch made a few years back (longer blog on these sorts of issues here):
In theory, shareholders’ earnings, their dividends, based on profits, are the residuum in a firm’s trading activities, the last claim that is made on a firm after all claims from bond-holders, employees, creditors, investment needs and other requirements have been met. This is the risk-bearing activity at the heart of capitalism that enables firms to be innovative and that justifies shareholder maximisation: if the shareholders must wait until all other contractual claims on a firm have been met then they need to be able to have the final say over how the firm is managed. Also, their rewards from successful transactions must be high, as these must compensate them for the losses that will come from risks that go wrong. 
This principle remains valid if a firm goes bankrupt; shareholders have the last claims on any assets. But during routine operations of a viable company it has been heavily compromised by the emergence of profit expectations within today’s highly volatile stock markets. Ideas spread as to what short-term return on profits ought to be available in the market; remember shares are being bought and sold with an eye primarily on the secondary markets. There will therefore be a flight from shares of firms not meeting the prevailing idea of a good return. Such firms become vulnerable to hostile takeover, something which senior managers are keen to avoid, as it often leads to them losing their jobs. Managers are therefore under strong pressure to meet or exceed a target level of return to shareholders. If necessary, investment plans, customer service and employee compensation will have to be held back to meet this target. Once this occurs, distributed profits are no longer a residuum but are an early call on a firm’s earnings.
I think this pretty much how many public companies are run. Although the theory is that shareholders are a residual claimant, in practice directors put them much higher up the pecking order. Of course, it doesn't always end up like Carillion, but we should be worried that even asset managers acknowledge that there is a problem with directors prioritising dividends. 

The other interesting thing that Carillion shows us is that shareholders (really asset managers) don't necessarily pressure management, at least not all the time, but they don't need to. Directors would rather keep one step ahead of the pack, so I think they've internalised shareholder demands to the extent they don't often have to be explicitly made. 

When you look at the engagement that took place with Carillion it's surprising to me how limited it seems to have been in some cases. Some investors don't really seem to have done a lot, even as the warning lights were flashing. What's more it's difficult to see any real change in behaviour compared to how shareholders engaged with banks in the run up to their collapse. 

It's good that this report refers to the Stewardship Code, but I think they let the shareholders off the hook. Is there much evidence of any process to stewardship activity? I can't see any indication of escalation for example, despite a) the seriousness of the situation and b) this being part of the Stewardship Code. The report says that shareholders were "rational" to sell their shares. Fair enough, but that option is there in every case and was the pre Stewardship Code era defence asset managers used to deploy. So why even pretend that stewardship is a meaningful activity in a situation like this? 

Remember, this was a company in serious trouble, and there were plenty of signs that financial market participants thought so. In that case, shouldn't we have seen a great deal of 'stewardship'? Wasn't the whole point of the Code to try and get investors to engage effectively rather than be hands-off and/or just flog their shares if things were going wrong. And remembers to that this was a case of business performance, not some abstract governance issue, so shouldn't the Investor Forum have been in there? There are a lot of threads still hanging in my opinion.

Finally, there are a few minor points about other market activity I would make. First, there was a major shareholder sitting on the register that did nothing - Deutsche Bank. According to the report it held 5.8% of Carillion in March 2017, and here's the reason why:
Not proprietary investments. Shares held on behalf of clients and for hedging purposes. No engagement with Carillion management.
I'm not clear exactly what this means. Is it this institutional asset management clients sitting behind a nominee account, shares held to hedge derivatives exposure, a mixture of both, or what? Large positions held by banks - rather than asset managers - often have an interesting story behind them. I think the report should have dug into this a bit, especially given the size of holding. 

Secondly, the issue of shorting is hardly touched on. The question I still grapple with is if you are short on the active side but long on the passive side, does this create a conflict in how you approach stewardship? More precisely, are your active team going to want you to engage with the company to address any cause of underpreformance?

Thirdly, who was lending all the stock? According to reports, the total short position in Carillion at its peak was about 25%. That is a lot of shares. So where did they come from? I know that data on stock lending is made available to market participants (and regulators?) but it's not public. But I would put money on it, given the scale of shorting, that some of our pension funds let stock that was used to short. Maybe that's fair enough (a question for another day), but maybe it also ought to be disclosed somewhere that us ordinary mortals can see it?

Sunday, 13 May 2018

Lynn Stout and shareholder capitalism

Lynn Stout, one of the most interesting thinkers/writers on corporate governance, sadly died recently at the ridiculously early age of 60. She was definitely someone who has had an influence on my thinking, and I strongly recommend her books (which are very readable) to anyone who shares my interest in corporate governance and related topics.

What is particularly striking is how her perspective has gradually come into vogue. When I first got seriously interested in the various schools of thought around governance about 15 years ago I remember some people suggesting she was a fringe thinker and/or not helpful in terms of practical advances in governance reform.

The reason for this is pretty clear: she was a strong opponent of shareholder-focused governance. More recently she did some terrific work showing that some of our assumptions about this model - like that directors have legal duties to act in the interests of shareholders - are very wonky. The longer I have looked at these issues, the clearer it has become that foundational beliefs in 1990s corporate governance model (like that shareholders 'own' companies) are highly contentious, if not flat out wrong. Yet they are treated by far too many people as Gospel truths.

Well, Lynn Stout was one of the heretics, and it's a shame she died too young to see the governance debate reorient towards her views.

Here are a few excerpts from The Shareholder Value Myth that give you an insight into her perspective:


“The standard shareholder-oriented model of the corporation teaches that it is not only acceptable but morally correct for shareholders to pressure managers to raise share price in any way possible, without regard for how the corporation’s actions impact stakeholders, society, or the environment. Shareholder value rhetoric also inevitably signals that most other investors are behaving selfishly. Finally, the standard model teaches that selfish investing, far from harming others, actually benefits them by promoting better corporate performance and economic efficiency.”

“[D]iversified shareholders who are uninvolved in and ignorant of a company’s day-to-day business decisions are in no position to police against, or even know about, antisocial corporate behaviour. To the contrary, because the only thing most investors see i stock price, they are likely to pressure corporate directors and executives to adopt strategies that… make corporate harms to third parties more likely. And when disaster strikes, uninvolved shareholders are unlikely to feel personally responsible. How many BP shareholders felt responsible for the Deepwater Horizon disaster.”

“[T]he lack of information and rational apathy that makes individual investors poor guardians of their universal portfolios also makes beneficiaries of pension and mutual funds poor judges of whether their portfolio managers are doing a good job of stewarding their universal interests. Just as retail investors default to the cheap, easy strategy of judging corporate performance by whether the share price went up or down yesterday, pension and mutual fund beneficiaries judge the performance of fund managers according to whether the value of the fund went up or down yesterday.”

“[E]ven when directors have perfectly well-tuned moral compasses, shareholder value thinking subjects them to relentless shareholder pressure from investors who may act as if they have no moral compass at all.”

And a bit from Cultivating Conscience:

"Corporations are legal fictions, but they are also very real social institutions. More specifically, they are very real social contexts. The employee who walks through the front door of the corporate headquarters and takes the elevator upstairs to his office enters a world that provides a powerful mix of social signals about what is expected, what others are doing, and how his actions affect others. If he does not become as purely self-interested as Economic Man, he may at least behave like his second cousin, Corporation Man. In other words, it is true that corporations act only through 'their ' people. But corporations also influence how 'their' people act.

"Sometimes the corporate context pushes human behaviour in a conscientious direction. Inside the firm, corporations often try to encourage trust, co-operation and dedication to team goals through inspirational posters, motivational team meetings, and team-building in its most obvious and hilarious form, the corporate retreat... When it comes to dealing with those outside the firm, however, the story may be quite different. Especially in large public companies, the corporate environment often channels human behaviour in a direction that moves it closer to the psychopathic ideal of the homo economics model. This is because business typically employ the familiar social levers of obedience, imitation and empathy to encourage employees think primarily about the welfare of those 'inside' the corporation (executives, employees), not those 'outside' it (customers, the community, outside investors)."  



Wednesday, 9 May 2018

Exec pay, again

Two bits in the FT caught my eye recently, and I think both are indicative of why executive pay will continue to cause fuel the public's belief that corporate boards are making out like bandits and there needs to radical action to tackle it.

First is this piece by Attracta Mooney, who sees the behaviour of investors around the monster LTIP awards to the chief executive at Persimmon as a significant event. She argues, correctly in my view, that the failure to vote down the remuneration report - even in a symbolic gesture - was a serious misjudgment.

Just to highlight a couple of bits:

The vote at Persimmon reinforces concerns that asset managers do not take the issue of excessive executive pay seriously enough. The suspicion is that because many portfolio managers and other figures in the fund industry are well paid, they are less willing to tackle contentious pay at the companies where they invest.

And:
The situation at Persimmon brings into focus whether shareholders are the right people to police executive pay. If they don’t get fired up over £110m packages, what will it take? It also suggests that shareholders are out of touch. Survey after survey shows the public believe many bosses are paid too much: and consumers are the ultimate clients of asset managers. 
I think this is bang on. I've had various conversations with people in different bits of the weird world I inhabit (a crossover of unions, the City and public policy) who all feel the same way - if this wasn't too much, what is? Why don't shareholders ever pull the trigger?

As I've said before, personally I cannot in good faith advocate further attempts to strengthen shareholder oversight of pay, when it is so obviously ineffective. We've tried 15-20 years of it, it didn't work very well, so let's try something else now.

Which brings me on to the second piece, which covers an FT focus group session and polling looking at how swing voters react to both Labour policies and the Labour leader. To cut a long story short, there was very strong support for very interventionist policies in respect of pay - both tax increases for the top 5% of earners, and a pay ratio capped at 20:1. Notably, there is both strong support and little strong opposition to both, whereas other policies - such as corporate tax rises - are popular but also provoke a strong negative reaction from some.

Given Labour seems to be in stalemate with the Tories, perhaps riffing more often on these themes more regularly (as opposed to, say, foreign policy) would be productive.

More generally, both pieces suggest a few points that I think are emerging as common sense around exec pay policy:

  • Shareholder oversight is ineffective as a restraint on pay
  • Shareholders (which really means asset managers) hold views on pay that are far more accepting of high pay and intra-firm inequality than the public 
  • The scale of pay matters, not just the structure of it - it is reasonable to talk about fairness
  • Significant intervention is justified to tackle excessive pay
What policies might flow from this is another question. Personally I'm more interested in things like revitalised collective bargaining, profit-sharing and employee ownership and representation, to ensure that the workforce gets a fairer share of the wealth they create at source than taxing the top tier alone. But that's for another day.

One final point, if the above is roughly right, it's interesting that you could reverse each of these positions and get a lot of "sensible" people within the exec pay system (rem comm members, asset managers etc) nodding along:

  • Shareholders should have primary responsibly for overseeing exec pay as they have the right incentives to act
  • Shareholders are focused on the *right* issues, rather than populists and a misinformed public
  • Performance linkage matters more than scale, fairness doesn't really come into it
  • Interventionist policy would be counter-productive / dangerous

I've been hearing this set of arguments for as long as I've been interested in corp gov. But these days I wonder if trotting these lines out actually helps make the case for radical policy. Certainly each time I hear a right-wing wonk argue in public that exec pay doesn't really matter, and we should leave it all up to the shareholders, I feel like we inched forward a bit...

Tuesday, 8 May 2018

Apollo backs away from FirstGroup

A few weeks back, FirstGroup's share price went on a mysterious upwards journey. Then, a few days later, it was revealed that FirstGroup had rebuffed an approach from US-listed private equity mob Apollo.

Almost immediately it became clear that, aside from the financial merits of such a deal, there would be plenty of obstacles. Not only was there the question of how a change in ownership would be viewed in respect of First's rail franchises, it was clear that such a takeover, coming so quickly after GKN, would set off a political storm. Given where public opinion is on ownership of the railways, allowing the last major UK player to be gobbled up would have been controversial, and Labour was straight out of the blocks to say such a take-over should not go ahead.

Even after the spurned offer was announced, there was some activity by Apollo in the derivative market. Regulatory filings show that the firm has been playing about with CFDs.

But people I've spoken to in the last couple of weeks have been pretty sceptical. It's not obvious that a takeover can quickly resolve the sorts of issues that asset managers may want to see addressed. There was a good piece in the Sunday Times in which an HSBC analyst suggested that the rail franchises almost act as a poison pill.

Well, today Apollo officially backed off, resulting in a drop in the FirstGroup share price. So, for Apollo at least, the game is over for the time being.

Tuesday, 1 May 2018

Derivatives, influence, tax, policy etc

One of the things that was left hanging after the Melrose/GKN bid was the nature of the relationship between hedge funds and similar investors and their counter parties, and how this plays out during bid situations.

When I watched Greg Clark defending his own inaction in relation to the bid in parliament last week, and some of the questions / comments he received in response, it was clear that a lot of the technical detail was still confused. For example, Clark talked about hedge fund acquiring shares from long-term holders, where as in reality most never held shares. And there was talk too of a "vote" of GKN shareholders to accept the deal, which did not happen.

This stuff is important, because it also affects how much tax is paid. There was a good piece in Lex at the end of March. The key bit is below:
The broader advantage of prime brokers is that they are exempt from stamp duty. This means clients can generally buy and sell shares tax-free at arm’s length. If they vote the shares, they could crystallise a liability. Experts say the danger of that is less in a hostile bid, where investors show support by tendering shares to the bidder. However, critics of the Melrose bid are likely to resent tax breaks for hedge funds. 
So, if you're a hedge fund holding CFDs in a target that is the subject of hostile bid resulting in an offer to shareholders (but not a vote) it doesn't look like you get hit with tax if things go to plan.

The interesting question for me is whether the counterparty responds to the bid, and in a way that aligns with the interests of its client? I think that is likely - and as as reminder here is what the Takeover Panel said on this point a few years back:
a counterparty will usually know the derivative investor’s likely wishes and therefore it would be na├»ve to assume that the counterparty (who has no economic interest in any hedge securities it holds but who does have an ongoing client relationship with the investor) will act without having some regard to those wishes
This points to an interesting policy question. As I understand it, CFD holders incur tax when they have voting rights to tackle the problem of them acting like shareholders, but on the cheap (on this point there's a good FT piece, a bit old, on Elliott's tilt at BHP here). But surely the decision to sell a company (despite the wishes of its management) is even more important than the right to vote? Why on earth would we let this happen, and in a tax-advantaged way?

If counter parties are tendering shares by reference to the clients' wishes I would suggest that this is an easy target for Labour. It should be the case that only those who both hold shares and have the economic interest in them should be able to respond to a bid. In addition, we could increase the tax paid on CFDs and other instruments that allow access to voting rights in order that they are less attractive than holding shares.

This in turn suggests other policy interventions. A lot of this stuff couldn't happen without a load of stock lending going on. So why doesn't Labour commit to introduce a stock-lending register, hosted by the FCA? This would provide the names of lenders in a given stock above a certain ownership threshold (say 0.1%). This would enable us to see if, for example, asset managers are lending stock belonging to the sponsor of a corporate pension scheme that is being used to short the same company.

In addition there should be transparency around who gets what when stock is lent. After all, it is the property of the client (pension fund or whatever else) so let's have a look at how much the client and manager take respectively from the lending fee. This info must be captured already, so let's get it into the public domain.

Finally Labour could also ensure that the Stewardship Code is rewritten to require section on M&A and related activity. It's seems odd in retrospect that it doesn't feature when this has a major impact on the companies concerned. The guidance could include that asset managers must actively consult clients on bids (again there could be a threshold). For example, I suspect there will be one or two out there who were surprised that their manager backed Melrose in the GKN bid. So the onus should be on the manager to consult.

So there are quite a few potential policy angles on this one. And this is before we start talking about a public interest test...

PS. Judging from the feedback I've had over the past couple of months, it is striking how much companies and some key groups within them hate the behaviour of many hedge funds and activists. Even where they accept the nature the takeover regime in general, there is clearly a view that some of these funds bend the rules. I think a proper overhaul of this stuff would actually be seen as a good thing by some players that are not natural Labour supporters.