The Oslo-based Norges Bank Investment Management (NBIM), which manages the USD 650 billion Government Pension Fund Global, has published a discussion note setting out its expectations on corporate governance in equities it owns around the world. In particular, the firm outlines reasons it concentrates ownership resources on board accountability and equal treatment of shareholders.
In defining its expectations, NBIM has considered the challenges of protecting its interests as a globally diversified minority shareholder in light of empirical and theoretical evidence. Such a perspective has led the firm to question the basis for the near-universal consensus in support of features appearing in corporate governance codes, given that NBIM finds gaps in academic evidence for many of them. The discussion note takes the view that principles should be seen as best practices only. Deviations from them, if well thought out and persuasively justified, should be both expected and welcomed, in NBIM’s view.
NBIM’s intention is not to provide another code of corporate governance for companies to comply with or report against. Rather, it seeks to set out priorities for corporate governance as a means to foster dialogue and mutual understanding. Underlying the firm’s expectation statement is the idea that market practices should conform to high-level universal principles rather than to detailed prescriptive rules. To this end, NBIM invited input and testing of its views by a number of practitioner and stakeholder groups. The firm continues to welcome comments from all stakeholders, as mentioned at the end of the discussion note.
Protection of shareholder interests
The Government Pension Fund Global is invested 60 percent in listed equities. The equity portfolio is invested globally with minority positions in publicly listed companies. The Fund cannot directly control management of these companies; there is a risk that management interests may at times not fully align with the interests of minority shareholders. This calls upon investors to seek protection of interests by means other than control rights.
From a long-term portfolio perspective, NBIM’s ownership activities aim at promoting factors that support competitiveness, innovation and profitability at the companies in which the Fund has invested. Sometimes, profit-maximizing major shareholders ensure effective monitoring of management, or top management are major shareholders themselves. Monitoring is, however, often left to dispersed minority shareholders. NBIM’s primary corporate-governance focus is therefore on mechanisms shareholders can use directly and indirectly to influence companies towards sustained business success. This challenge is addressed in the section of the paper on board accountability.
The Fund is dependent on companies’ sustained profitability and a reasonable share of this being distributed to shareholders. Minority shareholders may be vulnerable to return leaks favoring participants closer to decision-makers. Examples of this problem could be the discriminatory distribution of benefits to controlling shareholders, or unfair related-party transactions. These issues are addressed in the discussion note’s section on the equal treatment of shareholders.
While guiding and monitoring companies and their management is an important ownership challenge, shareholders are exposed to a free-rider problem. In many cases, the costs of active ownership are borne by the active owner, while the benefits are also enjoyed by passive owners. Only when the investment is substantial can the costs of active ownership be justified by individual shareholders. This could imply a need for minority shareholders to coordinate and share efforts to monitor companies through effective corporate governance.
Diversified investment by institutional investors is frequently reflected in dispersed ownership of individual companies. Often there are no dominant shareholders who can be trusted to effectively monitor on behalf of all shareholders. Dispersed ownership and investors’ free-rider problem may leave an ownership vacuum where companies struggle to obtain balanced information on shareholders’ expectations. This presents an opportunity for large, long-term shareholders such as NBIM who are willing and able to engage.
To meet these challenges, NBIM operates an in-house corporate-governance program. Setting out generic expectations for good corporate governance is one of several responsibilities of the program and the topic of the discussion note.
Expectations on board accountability
NBIM has chosen to break its “board accountability” focus area down into five headline expectations of portfolio companies:
- A. The board has a thorough comprehension of its role
- B. The board fulfills its duties through high-quality work
- C. Shareholders have the freedom to elect, and change, the board
- D. The board sets out its strategies, processes and results in a transparent manner
- E. The board assumes accountability for outcomes
This set of expectations forms a holistic argument regarding board accountability, and the roles of, and division of responsibility between, the board and shareholders. NBIM emphasizes the high-quality advice that the board should contribute to the company. NBIM expects the board to ensure the company reports comprehensively and truthfully to shareholders, and that it takes responsibility for the outcomes delivered. As a shareholder, NBIM asserts that it will determine when a board needs to change.
This set of expectations distinguishes itself from certain other observed investor statements on corporate governance in four respects:
- It takes a high-level approach as opposed to giving detailed prescriptions
- It focuses on outcomes for the shareholder rather than technical compliance by the company
- It expresses support for the board and protects against shareholder intrusion into the remits of the board and management
- It calls on shareholders themselves to take action to hold boards accountable whenever needed
Expectations on the equal treatment of shareholders
NBIM’s paper breaks down the “equal treatment of shareholders” focus area into three expectations:
- A. The board will act in the interests of all shareholders
- B. Board decisions should treat shareholders equitably
- C. The board will consider steps towards equality
Through this set of principles NBIM seeks a principled yet practicable approach to achieving and maintaining equality, acknowledging the global variety in law, tradition and practices. Against this background, NBIM aspires to develop an agreed roadmap towards equality and investor protection.
NBIM’s expectations reflect a global approach, while many other institutional investors assume their domestic market as the point of reference. This perspective provides for some approaches not often seen in investor statements on corporate governance. For example:
- While advocating equal treatment and rights among shareholders, NBIM accepts differentiation if the benefits can be evidenced to the satisfaction of different shareholder groups
- The board is expected to regularly test presumptions justifying unequal treatment
- The board must set out what the differences are, how they are justified historically and going forward, and their likely effects
NBIM view is that its expectations statement can be considered effective if portfolio company boards recognize it as a catalyst for deeper communication and consideration of corporate governance. The full discussion note can be read at http://www.nbim.no/en/press-and-publications/News-List/2012/nbim-discussion-note-on-corporate-governance/.