Research Trends and Conclusions: Corporate Governance 2009
Heather Brown -
September 2008 proved to be a defining month for the United States economy as the largest state rescue plan in history was launched to support the country's biggest mortgage companies Fannie Mae (Federal National Mortgage Association) and Freddie Mac (Federal Home Loan Mortgage Corporation), which between them lend or guarantee upwards of US$5 trillion.
In the same month the US Federal Reserve announced a US$85 billion rescue plan for AIG (American International Group), the country's biggest insurance company, and confidence was lost in financial services group Lehman Brothers, which filed for chapter 11 bankruptcy.
The impact of the economic crisis in the United States was reflected around the world and soon caused companies to question how they could improve their own corporate governance to prevent similar difficulties overtaking them. Corporate governance lawyers, who had in the past been predominantly called on in M&A deals were now being called in to ensure that boards of directors were in a suitable position to survive the fallout.
Companies began to assess their own vulnerability and risk taking. "Given the economic pressures, there are likely to be more companies hitting the wall over the coming months - shareholders and the media are quick to point the finger at the board. So the need to be doing the right thing and to be seen to be doing the right thing will be more important than ever," says Mark Rawlinson of Freshfields Bruckhaus Deringer LLP in London.
Although everyday advice is still in demand, crisis prevention came to the forefront. Governments across the world updated their corporate governance policies and lawyers were called to ensure the companies complied with the stricter rules.
THE BANKING BAILOUT
The media soon began to question how Fannie Mae, Freddie Mac and hundreds of other financial services companies had experienced such a dramatic decline. The President of the Association of Chartered Certified Accountants, Richard Aitken-Davies, saw the credit crisis as a direct product of poor corporate governance, "Remuneration and incentive packages have encouraged short-term thinking. We need to ask what inhibited banks' boards from asking the right questions and understanding the risks that were being run by their managements."
Failing banks and other financial institutions across Europe were now faced with the difficult decision of whether to try to rectify the situation themselves and take a risk with their customers or whether to accept public money and risk upsetting shareholders and taxpayers.
In September 2007, following months of speculation, UK-based building society Northern Rock announced that it was in financial difficulty. Following a failed rescue bid from Lloyds TSB, Northern Rock was taken over by the Bank of England in February 2008, making it the UK's first nationalised bank in more than 100 years. In neighbouring Ireland the government was also forced to take control of Anglo Irish Bank and in the Netherlands Fortis was nationalised. In October 2008 the Icelandic Financial Supervisory Authority took control of Kaupthing Bank, which had offices in 13 countries including Finland, where the government has stepped in to ensure the repayment of deposits to bank customers.
When the governments launched rescue plans for failing banks, large profits-based bonuses, golden parachutes and share based remuneration schemes, which had previously been taken for granted in the good times, became terms of negotiation.
"A number of financial institutions have begun reorganising their top level governance procedures, and in particular a lot of pressure has been put on them to review their corporate compensation arrangements," says Rolf Watter of Bär & Karrer AG in Zurich.
CHANGES TO CORPORATE GOVERNANCE POLICY
Not only have the responsibilities of the board of directors come under more public scrutiny, in many regions new regulations have also brought more restrictions. "Changes to the Belgian Corporate Governance Code 2004 have created stricter guidelines for listed companies. There is now a legal obligation to provide for an audit committee and the concept of independent director has been strengthened," says Jan Peeters of Stibbe in Brussels. The 2008 Act set in stone what had previously only been guideline procedures.
Brazil has also set stricter regulations. "The current focus on corporate governance is having a positive effect in Brazil and has encouraged greater transparency among companies. Changes have also been made to the operations of the São Paulo stock exchange, which have helped to foster capital markets in Brazil," says Fernando Alves Meira of Pinheiro Neto Advogados
THE ROLE OF SHAREHOLDERS
Not just the responsibilities of the board have come into question: shareholders, both as individuals and in collective action, have taken on extra responsibility and activism is becoming more common. "In the current climate there is likely to be more focus on whether directors and shareholders are meeting their respective corporate governance responsibilities," says Vanessa Knapp of Freshfields Bruckhaus Deringer LLP.
In 2004, the Tabaksblat Code committee in the Netherlands recommended greater powers for shareholders, which was followed by a new law in October 2004. Shareholders were given a number of rights including that 1 per cent can raise an agenda point and the shareholders' power to dismiss the whole supervisory board. The court then appoints interim supervisory directors, who nominate new supervisory directors, subject to shareholder approval. However, in the first case of its kind in 2007, the decision of the shareholders was overturned by a court in Amsterdam in favour of Dutch industrial company Stork. The court ruled that the demands of major shareholders Centaurus and Paulson were not in the best interest of the company, however the judge also ruled that Stork Foundation should not have used a poison-pill strategy to become the main shareholder. The court appointed interim special supervisory directors above the supervisory board. New regulations in the Netherlands have recently been proposed to define the responsibilities and the rights of the shareholders. "Companies will have more rights to know their shareholders and the shareholders are obliged to disclose who they are," says Willem Calkoen of NautaDutilh in Rotterdam.
LOOKING TO THE FUTURE
The state of the economy has also had a dramatic negative effect on M&A transactions worldwide. "Large clients are looking at future opportunities, but are tending not to make the move in the current economic climate," says Stephen Minns of Mallesons Stephen Jaques in Melbourne. Companies are more focused on maintaining investor support by avoiding new debt, maintaining the share price and minimising the risk of a hostile takeover.
An example of maintaining shareholder value was recently seen when natural resources company, BHP Billiton recently withdrew an unsolicited offer for mining and exploration company Rio Tinto. The Chairman of BHP Billiton, Don Argus, announced that a combination of the current economic climate and protecting the company's shareholders had influenced the decision. However, Argus declared that he would be interested in completing the deal when the time was right.
In Wachtell Lipton Rosen & Katz's guide, "Some Thoughts for Boards of Directors in 2009", the firm identifies a number of key points for the coming year. Risk management is an increasingly important issue and "the board's role is one of informed oversight rather than direct management of risk". One such risk likely to be faced by many companies is that of unsolicited takeovers, and as such, boards should "review their takeover defences and areas of potential exposure to pressure tactics".
Other issues mentioned in the guide include the need to monitor executive compensation, CEO succession planning and the establishment of direct lines of communications with shareholders. However, the guide warns that shareholder communication is not always a positive experience and can take a lot of time and organisation.
The separation of the role of the chairman and CEO positions is also likely to be called in the question more in the coming year. The authors note that the issue came to the forefront in 2008 when descendants of oil magnate John D Rockefeller joined a coalition of activist and pension fund investors that wished to split the CEO and chairman positions at Exxon Mobil. Only 39.5 per cent of votes cast were in favour of the proposal, but when the same measure was presented at Washington Mutual, it was passed with 51.5 per cent support of votes cast. Similar proposals at Time Warner, Pfizer and Weyerhaeuser also received more than 40 per cent shareholder support in 2008. "The issue will be back in 2009 and will likely continue to be promoted by governance activists."
Perhaps most importantly of all, the document emphasises the need for boards to "take a long-term perspective when setting the strategic direction and goals of their companies" and to carefully navigate what is termed the "zone of insolvency", where companies find themselves close to facing bankruptcy.
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Although mergers and acquisitions are likely to remain quiet in the next few years the role of the corporate governance lawyer has become one of increasing importance and this trend is likely to continue as companies review their current practices to cope with the new challenges that they face.
Lawyers able to give practical, up-to-date and effective advice are more valuable to their clients than ever before, as the tightening economic circumstances continue to challenge companies. Arthur Golden from Davis Polk & Wardwell in New York sums up the current situation. "On the whole, companies have become more conscientious in response to the deteriorating economic environment. Directors are paying more attention to executive compensation and are redressing any excesses of the past. Boards are becoming more informed about risk, and operating management are making greater efforts to keep boards informed of risk factors and their proposed decisions about how to deal with them. The result has been a strengthened collaborative process between senior management and directors."