Around this time of year an inevitable article is published in the Financial Review criticising the role of proxy advisers and defending corporate board members who are really just misunderstood (rather than incompetent). Enter Quintin Digby and Timothy Stutt of HerbertSmith Freehills, on cue, who wrote last week in the Fin that proxy advisers “need to be regulated” due to the “extent of their influence” and “inadequacy of their approach to engagement”.
Fortunately, your correspondent is in a fairly good position to comment on the merits of these claims having worked at both Freehills and the predecessor of Ownership Matters, Australia’s most respected proxy adviser firm.
Taking a step back one must first try to understand the problem proxy firms were created to solve. The answer is the basic principle of agency costs — that is, shareholders who own public companies have (in most cases) virtually nothing to do with how those companies are run (the only exception being interventionist fund managers). What tended to happen (and I covered this extensively in my book. Pigs at the Trough: Lessons from Australia’s Decade of Corporate Greed) is that executives and their complicit board members serve to enrich themselves first and foremost. If, by coincidence shareholders benefit, that’s more good luck than good management.
The clearest manifestation was the ever-increasing realm of executive pay for Australia’s biggest companies. By 2010 CEO pay for the top 20 ASX companies had quietly risen 150 times that of the average worker. If that weren’t bad enough, the so-called elite CEOs tended to get paid regardless of how badly they performed. Mike Smith, the former CEO of ANZ who lost billions with an ill-fated Asian expansion, collected as astonishing $88 million from the bank over his tenure. The former BHP boss, Marius Kloppers, who smoked billions of dollars of shareholder value with idiotic investments like US shale oil, took home $85 million. Then there was the truly ridiculous like the Babcock & Brown gang, who took home hundreds of millions in pay before the bank collapsed in a heap in 2008.
Hence proxy advisers, who started assisting superannuation funds on how to understand and vote on corporate governance issues (and, especially in the case of Ownership Matters, had a stunningly good success rate of spotting shonky managers). Proxy advisers provide advice to shareholders, and they can choose to accept or reject that advice. Because the recommendations are usually considered and independent (and the subject matter fairly complex), the advice tends to be accepted, much to the chagrin of board members, executives and their highly paid helpers.
Enter my alma mater, Freehills.
Freehills, like all law firms, investment banks and accountants, are appointed by executives to help with transactions. Firms are reliant on CEOs and general counsel for their revenue so will tend to do everything they can to support management, regardless of the effect on shareholders (incidentally, it is a bit rich for a law firm to call for regulation of proxy advisers given law and accounting firms are “regulated” by essentially themselves).
I recall one instance at Freehills when, as a very junior lawyer (being charged out at $300 an hour), it was my job to verify an information memorandum for a fund raise. The job was essentially to check that the words in a digital document were correctly typeset in the final version. Law firms love this kind of work because they can charge a fortune for junior lawyers to do it (even though the work should have been done by a far less expensive paralegal or secretary). One of my then colleagues discovered that Microsoft Word had a handy function that allowed a document to be read aloud — that meant instead of requiring two junior lawyers to perform this menial and largely useless task, it could be done (more accurately) by one lawyer, at half the price.
The odious partner involved (who would later move to MFS briefly before it collapsed) later found out about this piece of ingenuity very quickly put a stop to it. One lawyer doing the same amount of work meant less fees the client had to pay, which of course meant less earnings for that partner. I’m guessing unitholders in the fund wouldn’t have been overly impressed if they knew.
This is of course one tiny example of what goes on daily at big firms. They pay the piper — that is, the highly paid executives who appoint them. They care little, if anything for shareholders – unlike proxy advisers, who, while fallible, genuinely seek to hold management and directors to account for their failings.
Digby and Stutt claimed “reform of the industry would be a burden for existing proxy advisory firms and may involve consolidation of firms or, at least, an overhaul of their current staffing practices. However, ultimately, increased accountability and transparency of such firms is vital to their continued relevance.”
Lawyers like Digby and Stutt in reality, probably couldn’t care less about proxy advisers. But their paymasters certainly do. And the more unhappy CEOs are about proxy advisers, the better job they are doing. That is certainly in the best interests of shareholders. Unlike big legal bills.
* Adam Schwab is a former corporate lawyer and author of Pigs at the Trough: Lessons from Australia’s Decade of Corporate Greed, published by John Wiley & Sons in 2010