UK: THE POWER BEHIND THE PUTSCH.

UK: THE POWER BEHIND THE PUTSCH. - The ousting of Maurice Saatchi was a highly visible example of shareholder muscle-flexing - UK institutions much prefer to 'achieve change' quietly.

by Martin Vander Weyer.
Last Updated: 31 Aug 2010

The ousting of Maurice Saatchi was a highly visible example of shareholder muscle-flexing - UK institutions much prefer to 'achieve change' quietly.

'Shareholders in Saatchi & Saatchi have not merely deposed an advertising icon,' the Financial Times Lex columnist observed of the ousting of Maurice Saatchi last December, 'they have introduced a striking new dimension to corporate governance in the UK.' Stanley Kalms, chairman of Dixons and a long-time Saatchi client, was less equivocal: it was, he said, 'one of the worst examples of corporate governance I've ever experienced'.

The banding together of institutional shareholders to force management change on British public companies is by no means a new phenomenon, but the Saatchi showdown had a very American flavour to it, and may well be a sign of things to come on this side of the Atlantic. The toppling of Maurice Saatchi was in effect a coup by maverick Chicago fund manager David Herro of Harris Associates, backed by unit trust managers M&G and other investors accounting (according to Herro) for more than 40% of Saatchi's stock.

Simmering unhappiness with Maurice Saatchi's chairmanship had come to a head with the presentation to shareholders of a 'super option' plan which would have awarded Saatchi the equivalent of a £5 million bonus if the firm's deflated share price had doubled over the next three years. In an intervention reminiscent of Michael Douglas's role in the film Wall Street, Herro threatened to convene an extraordinary meeting and, if necessary, launch a proxy battle to have Saatchi removed.

Warburgs, the company's merchant bankers, and Macfarlanes, its solicitors, advised against calling Herro's bluff, despite support for Saatchi from high-profile clients such as British Airways - and, it may be assumed, from such key non-executive directors as former BP chairman Sir Peter Walters, whose remuneration committee had proposed the controversial option package. After an eight-hour meeting interspersed with angry transatlantic phone-calls, the board caved in. Maurice Saatchi, having declined the well-paid honorific position offered to him as a consolation, departed in a flurry of recrimination. As a phalanx of key senior colleagues followed and plans emerged for the formation of a rival agency, the firm itself appeared to be in some disarray. Its share price dived.

The episode provides one of the most vivid examples to date of the institutional muscle-flexing which is increasingly evident in corporate governance, and highlights themes underlying many of the recent battles in British boardrooms: that if market conditions demand a radical change of direction, then a change of helmsman is almost always the first requirement; that tenure at the top should not be sentimentally prolonged, and failure should not be lavishly rewarded; that rewards for top management should in general bear some identifiable relationship to returns to shareholders; and that if non-executive directors fail to fulfil their duty in all these respects as the objective proponents of necessary change, institutional shareholders - or some of them, at least - are increasingly prepared to do it for them.

But is that always in the best interests of investors? Minor shareholders in Saatchi & Saatchi were left wondering whether the sledgehammer intervention from Chicago had really done them a favour, by bringing an obvious problem to a swift conclusion, or had merely vandalised the value of their investment. Were the directors right to cave in immediately to Herro, rather than letting the matter go to a shareholders' poll? Not so, according to one of Britain's senior industrialists, British Airways president Lord King, who described the whole episode as 'lamentable'. 'Surely the directors' fiduciary duty pointed in the direction of democracy rather than of the Windy City,' he thundered.

The truth is that in such disputes neither the moral obligations of the parties involved, nor their modus operandi, are clear cut. In boardroom drama, the construction of the plot up to the moment of assassination is often as obscure and complex as anything investigated by Inspector Morse. And in the best tradition of the detective genre, there may well turn out to be several sets of fingerprints on the dagger, as well as a variety of shifty accomplices and accessories after the fact. Institutional fund managers, and behind them pension-fund trustees, usually have a part to play; disgruntled smaller shareholders sometimes get in on the action; and there are sure to be bankers and lawyers whispering in the conspirators' ears, as well as journalists and investment analysts shouting from the wings. But the rounding up of the usual suspects should properly start with non-executive directors.

Colin St Johnston, director of Pro Ned, the Bank of England-sponsored agency for non executive directorships, explains its pivotal position: 'Every director's first duty is to the company itself, and for non execs that means a balanced responsibility towards all stakeholders. When the management is just basically looking after the management, rather than the interests of the whole company, then it's up to the non execs to say that enough is enough.

'Non execs don't have to be bolshie but they do have to be objective. Only the non execs can sack the CEO. The management itself can't do it. Sometimes the non execs may have to say "We go or you go". The threat is usually enough for the CEO to realise that in the end he just isn't going to win.'

Responsible non execs have an acute sense of the prejudices and interests of substantial investors, without the necessity of getting into a huddle with them.'Things have usually reached a dire point if there has to be direct contact between non execs and institutional shareholders,' St Johnston says. 'That can create all sorts of complication, because of the sensitivity of the information involved. It's an act of desperation.'

In at least one notorious case - Spring Ram, the troubled bathrooms and kitchens manufacturer which the Economist had once said 'may be the most successful manufacturer in Britain' - non execs and institutions were unable to talk to each other for the simple reason that the company had no non executive directors at all. In that case, after what one investor involved calls 'months and months of attempts to talk to the incumbent management, who were just incorrigible optimists hanging on for the recession to end', institutions led by the Prudential forced first the appointment of one non executive, veteran company doctor Roy Barber, and then the replacement of founder chairman Bill Rooney by their own appointee, Roger Regan, followed swiftly by the dismissal of several other executives and a full accountant's investigation.

The company is now limping back to health, and Barber for one is convinced that institutional action saved it from certain disaster. 'It's quite wrong to talk about "interference",' he says. 'Institutions have an obligation to take the lead, the problem is that they don't do it quickly enough or often enough.'

The preferred British way is to deal with a problem behind closed boardroom doors, before that problem reaches desperation point. The modalities of the smoothly executed 'restructuring' are best seen in the affairs of major companies such as BP and Barclays, rather than the here-today-gone-tomorrow growth stocks of the 1980s, where hindsight tells us that crisis was not only inevitable but was always going to be difficult to manage. Well-constituted boards of mature companies ought to be capable of reacting to swelling tides of investor opinion without waiting for shareholders to stand up and start shouting at them. At Barclays, the board reacted - perhaps not as quickly as it should have done, but consensually and in the end very effectively - to a clear signal of institutional discontent over Andrew Buxton's dual role as chairman and chief executive. A sub-committee of knightly non execs was deputed to find a new chief executive, and succeeded in due course in hiring the youthful Martin Taylor of Courtaulds.

At BP, the non-executive directors decided in June 1992 that chairman and chief executive Bob Horton's combative, imperious style was no longer what the company needed: meanwhile, his determination to maintain BP's dividend in the face of faltering results had become untenable. They swiftly replaced him with the ultimate safe pair of City hands in the person of Lord Ashburton, formerly Sir John Baring, in tandem with long-serving BP man David Simon as chief executive.

There are several famous recent cases in which non executive directors have taken the initiative for change, but powerful institutions have been found lurking in the shadows. In the ousting of George Walker from Brent Walker on the night of 29 May 1991, non executive chairman Lord Kindersley was, he says 'primarily responsible for the move to get him out'. But the banks (which, by force of circumstance, had become significant shareholders) actually dictated terms to the board during the meeting, telling one director who tried to resign rather than vote against Walker, that he would be sued if he did so: the vote went against Walker by six votes to five, with three abstentions.

Almost as controversial was the forced resignation in 1991 of Granada chief executive Derek Lewis, now embattled on an entirely new front as head of the prison service. Supporters of Lewis felt that he had been turned into a scapegoat, and that the blame for the company 's soaring debts and slashed dividend should at least have been shared by chairman Alex Bernstein. Chief assassins in this case were non executives Peter Davis of Reed and ex-ICI finance director Alan Clements, but a controversial part was also played by Warburgs, which was thought to have advised, on the basis of institutional soundings, that the departure of Lewis was effectively a precondition for a successful rights issue to keep Granada alive. In a rare public comment, Warburgs' corporate finance chief Derek Higgs denied active responsibility: 'It's our job as an adviser not to form opinions, but to reflect them,' he said.

A similar example was Pentos, the book-shop group. Owner of Dillons, Hatchards and Athena, Pentos had been one of the hottest retailing names of the 1980s, but was hit hard by the recession, with evidence of particularly weak financial management. Founder chairman Terry Maher had agreed to appoint a new chief executive under him, but instead found himself abruptly ousted in September 1993. His side of the story is told in his autobiography Against My Better Judgement, which includes recriminations against the three non execs who forced his departure. They were merchant banker Victor Blank, property expert Jim Clark and former Midland Bank chief Sir Kit McMahon, who took over the Pentos chair. 'Victor Blank was clearly the leader of the pack,' Maher wrote. 'We had been friends and colleagues for more than 20 years but he spoke to me in a direct and almost brutal manner ... Kit may have helped to load the gun but it was Victor who pulled the trigger.' And behind the three directors were at least two of the City's most powerful institutions: Mercury Asset Management (MAM) and Phillips & Drew Fund Management. Carol Galley, deputy chairman of MAM was the chief agitator, together with Huw Jones, head of corporate finance at the Prudential, David Rough from Legal and General, Michael Bishop from Gartmore and a handful of others.

Other cases in which like-minded institutions have joined forces to get rid of unsatisfactory managers include the clothing company Alexon, whose major product was the quintessential late-'80s downmarket fashion item, the pastel-shaded tracksuit. Overstocked, reluctant to discount, the company reached a point at which one of its own advisers commented that 'It would be amazing if shareholders weren't hopping mad'. And so they were: led by Gartmore, with Scottish Amicable, Norwich Union and Friend's Provident, they saw off the chairman, chief executive and all but one of the executive directors in April 1993.

Gartmore also led the attack on John Fletcher as chairman of grocery chain Budgens, while Michael Sandland of Norwich Union was a player in the removal of the rumbustuous Jock Mackenzie as chairman of Tace, the engineering group. Mackenzie attempted to yield gracefully to institutional pressure by securing the appointment of the respectable Sir David Nicolson in his place, only to find the institutions demanding an EGM at which the entire board was summarily dismissed.

Mackenzie's son, John, was one of the directors forced out. 'Sandland wanted to push his point and he got the press on his side,' he recalls. 'It was a pure act of bullying. It forced the company to a lot of expense on lawyers and accountants' investigations, the share price hasn't done well since and all the best men have gone.'

Such is the clout of the inner circle of top fund managers, that ousted executives are very rarely so willing to speak out against them. 'I'm still involved in public companies so I can't say publicly what I think,' says one, 'but I can tell you that they were pretty violent in the way they dealt with me and I'm highly critical of the way they use small stakes to impose their will on companies like mine.'

But by no means are all fund managers so aggressive. 'Most corporate governance questions are just a pain' is a typical comment from the school of investors who believe that the most effective vote of no confidence is the act of selling out of a company's stock as soon as it appears to be in trouble, rather than hanging on and trying to interfere in its management. The duty to maximise the return on their clients' portfolio is, after all, a higher priority than the duty to behave as a responsible owner of all the companies in which they happen to hold small minority stakes - and the two duties do not necessarily coincide.

There is a long tradition of outspokenness among smaller British investors, dating back to the days 30 years ago when a Yorkshire investor got up at a BSA annual meeting and complained about chairman Sir Bernard Docker's famous Rolls Royce: 'We're not interested in gold cars but in brass.' But most British institutions have traditionally remained silent and have been reluctant even to exercise their votes at AGMs. In particular, most would not consider themselves best qualified to pick new managers for industrial companies. Boardroom manoeuvres can be very demanding of senior fund managers' time and can also attract adverse media publicity, not least because the investor may be thought to have made a bad decision in the first place in putting money into the troubled company.

And once the share price has collapsed, the holding has by simple arithmetic become less significant in the manager's portfolio. Not only that, but to be closely involved often means being given access to 'insider' information, which then disbars the investor from dealing in the stock at all. For fund managers within integrated investment banks, conflicts of interest may arise if, for instance, the bank is also an adviser or broker to the troubled company or to a potential bidder for it. Finally, for any fund management house whose major clients, being corporate pension fund trustees, are themselves executive directors of public companies, a display of eagerness to topple other directors or to restrict their remuneration packages may turn out to be bad for the fund managers' own marketing profile.

But as Alastair Ross Goobey, chief investment officer of PosTel, points out, it is not the fund managers themselves who are the chief instigators of institutional intervention: 'A lot of the impetus for change is coming from the ultimate clients, the pension fund trustees, especially those which are not dominated by corporate management appointees.' Trade union and local-authority trustees, for example, tend to have strong views on remuneration questions, while others have become increasingly interested in the wider field of 'ethical investment'.

And some institutions are obliged by their own sheer size and spread of investments to take an active interest in corporate governance. Managers of 'index funds' (which are designed to track stock-market indices) are effectively committed to remaining invested in all the stocks which make up the relevant index. Sir Martin Jacomb, former chairman of PosTel and chairman designate of another massive institutional investor, Prudential Assurance, explains the special position of Britain's largest pension fund manager: 'At PosTel, our size - we own an average of 1.66% of all British public companies - means that usually we can't simply sell our shares and walk away if we can see that a company is underperforming, even if we want to. On the other hand, the size of our holding does mean that we are likely to be able to exercise some influence on the situation. So we've tried for quite a while to stay close to the management of companies, and we do get involved quite often when we have a point of view. We don't mind being made insiders if there's a good reason, even though that prevents us from dealing.'

'We have strong views on some particular things: on non-execs who are not truly independent, for example, and about three-year rolling contracts and option packages for chief executives. We're not concerned with the absolute amount in remuneration packages but we are very keen to see remuneration related to total return to shareholders. We'd rather deal directly with the people concerned rather than through the newspapers but we're prepared to put our heads above the parapet if necessary. What appears in the newspapers is only a recent outward manifestation of a process which has been in train for some time.'

'The expression "behind closed doors" has the wrong sort of flavour to it,' says another City investor, 'but we certainly prefer to achieve change quietly. Apart from anything else, press coverage isn't always in the best interest of shareholder value.'

Jacomb's former colleague, Alastair Ross Goobey, is prepared to elaborate on his own modus operandi: 'We tend to follow a pretty formal escalation strategy if we're dissatisfied with the way a company is being run. First we write to the company, then we seek meetings with the executives. If that doesn't work we will go to the non-execs, and we may then start talking to other funds. Finally we may have to go public, getting the financial press interested in order to alert the small shareholders - who can be very useful for asking questions at AGMs and so on. There's a lot of talk about proxy battles, but you have to remember that proxies aren't actually counted until a poll has been demanded at a general meeting.'

In at least one recent case - the software company, Pegasus - PosTel, with the support of the Prudential, has requisitioned an EGM in order to instal its own nominee as chairman.

Guy Jubb, an experienced operator in this field who has responsibility for corporate governance matters at Standard Life in Edinburgh, takes a slightly different approach. He distinguishes between 'preventive' and 'reactive' governance. On the former, he says: 'We're spending much more time talking ... I probably have two or three meetings per week with public companies. We're particularly concerned with the workings of the remuneration committee, the accountability of the board, and the nature of service contracts.' As to the reactive side, 'When there's a need for real change in a company we proceed on a case-by-case basis. We don't follow a set pattern, because no two cases are the same and it would be tactically unwise.'

Those who are suspicious of institutional power tend to look for cabals and conspiracies: it is often suggested that Scots institutions, particularly the independent life assurance companies, tend to move in a pack. But another source in the Edinburgh financial community denies this. 'It is wrong to talk of a Scottish institutional mafia. Proximity may improve the liaison between us, and there may be some cultural coincidence in our Presbyterian origins, but when institutions get together on boardroom issues there's rarely any geographical bias.'

Whatever the linkage, institutions are becoming more and more closely aligned in their thinking on governance issues. If there is a bias, according to the proponents of the kind of active intervention seen in the Saatchi case, it is simply a bias in favour of responsive management and against outright greed. As Roy Barber of Spring Ram says: 'Unless the institutions take action, it's the small shareholders who suffer most in the end; it's their duty to effect change and to pull the rest of the shareholders along with them.'

Those on the other side of the debate may argue that institutional interference is often for short-term, share-price-driven panic measures, which may not be in the small shareholders interests at all. But all constitutional structures need checks and balances: non-executive directors are there to stop executives from becoming a law unto themselves, and institutional shareholders are best placed to exercise the influence of ownership if directors are not doing a satisfactory job. Occasional spillages of blood on boardroom carpets are vivid reminders to the survivors of the serious responsibilities of corporate stewardship.

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