SWFs and shareholder governance

As the financial crisis of 2007-09 begins to recede and the world comes out of fire-fighting mode, so the emphasis is switching from handling the immediate consequences of the crash to understanding the causes. And there is no shortage of candidates:  weak management of financial companies, inadequate risk control, misguided regulation and global imbalances have all been highlighted as contributing to the conflagration.

One area that many commentators have pinpointed is weak shareholder governance. The western (Anglo-Saxon) system of company ownership confers not only rights on shareholders, as the owners of their companies, but also obligations.  In particular shareholders are required to exercise control over executive management, and to hold them to account.  And in too many cases in the run-up to the crisis, shareholders failed in this duty.  Executive management was allowed too free a hand, and in many cases abused this freedom to drive their companies to destruction, to the detriment of not only their shareholder-owners but society at large.

While there is widespread agreement with the general principle that shareholders should in future exercise greater control over their companies, for one particular class of shareholders this poses a particular challenge. While many institutional shareholders have merely been lax about exercising their role as owners, many sovereign wealth funds (SWFs) have taken a positive decision not to play any part in the management of the companies they have invested in.  They have pointedly not taken up the directorships their shareholdings would entitle them to, and have in general abstained from exercising their rights to vote.

This conscious decision by SWFs to play an entirely passive role arose from their experiences in 2007, when a succession of high profile SWF purchases of stakes in the developed world’s financial companies engendered considerable comment, much of it hostile, in the western media on how control of the West’s companies was being ceded to overseas holders. Most SWFs hastened to reassure their Western partners that this was not their intention, and backed up these words by declaring that they would waive their shareholder rights.  However, while this was undoubtedly meant as a friendly gesture, it weakened shareholder governance and allowed headstrong and poor management too much freedom.

It is now widely agreed that such complete passivity is not optimal, and that companies benefit from a greater involvement from their owners. But for SWFs, there is a fine line separating involvement in their companies and interference.  Too little involvement, and they stand accused of failing in their obligations.  Too much, and they risk renewed criticism from populist western commentators that they are seeking to exercise undue control.

This remains one of the central issues that SWFs need to resolve. With their large stakes, their global viewpoint and their very long investment horizons, they have the potential to make a major contribution towards the better governance of western companies.  The leading SWFs are well aware of this;  the challenge remains however of finding a way for them to do so in a manner that is acceptable to all.