Download CORPORATE GOVERNANCE AR(DEC)

CORPORATE GOVERNANCE: ANNUAL REPORT
The Teesside Fund has an active Corporate Governance policy based on two distinct engagement
strategies:

Voting at company Annual General Meetings (AGM) and Extraordinary General
Meetings (EGM) in accordance with agreed guidelines.

Engagement with companies as a member of the Local Authority Pension Fund
Forum (LAPFF) in furtherance of agreed campaigns.
The Fund's Statement of Investment Principles states that:
As a responsible investor the Teesside Pension Fund wishes to promote corporate social
responsibility, good practice and improved company performance amongst all companies
in which it invests. The Fund will therefore monitor investee companies to ensure that
they meet standards of best practice in relation to their key stakeholders. The Fund
considers that the pursuit of such standards aligns the interests of Fund members and
beneficiaries with those of society as a whole. In furtherance of this policy, the Fund will
support standards of best practice on disclosure and management of corporate social
responsibility issues by companies and will pursue constructive shareholder engagement
with companies on those issues consistent with the Fund's fiduciary responsibilities.
This report is intended to provide an overview of activity in the year 2004.
VOTING ACTIVITY 2004.
In the year to December the Teesside Fund will cast its votes at over 250 AGMs and EGMs for
companies within the FTSE 350 Index. This is a small increase in activity over 2003. The Fund
aims to cast all its votes for company meetings in the UK. In 2004 the Fund voted in 95% of the
meetings at which it was entitled to vote. This is the same level as in 2003.
The Fund relies on data supplied by National Association of Pension Funds (NAPF) voting
service to implement the Fund's voting policies. Members may recall that the NAPF was
appointed in 2002 for a three year fixed price contract which expires in October 2005. It has
been noticable, over this period, that the NAPF (who recently sub-contracted the voting issues
service to RREV Ltd) has tended to adopt a softer tone when dealing with potential conlict
situations at a company vote. This has not affected how the Fund has implemented its own
policies as officers overlay the Fund's own voting guidelines on the NAPF advice.
Looking at the UK Institutional sector as a whole, despite the Myners' Review of Institutional
Investments requiring that institutional investors be prepared to intervene in companies in which
they invest there has been only a marginal increase in the number of votes cast. Pensions
Investment Research Consultants (PIRC) report that the percentage for 2004 is likely to be 53%,
an increase of 1% over 2003, but still well short of the Government's target of 60%. In reality
these figures present a misleading picture, with wide fluctuations in the numbers of votes cast.
Those companies which recorded very high voting turnout, such as William Morrison and
Schroders, have significant majority shareholders. Others, such as Shell Transport & Trading,
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the UK arm of the Anglo Dutch oil group, reported a voting turnout of just 17%, despite
considerable media interest in the reporting of its oil reserves.
For the Teesside Fund the most significant corporate governance issues in 2004 concerned the
role of auditors and issues relating to company directors.
The Fund considers that a company's external auditors fulfil a key role in protecting the interests
of shareholders and that they should be able to demonstrate independence by avoiding conflicts
of interest.
The Fund's voting guidelines state that:
The Fund will vote for the appointment of auditors which are judged to be independent in
terms of level of fees for audit, and in terms of individual personal connections with the
board, but will oppose any appointment which fails to meet the Fund's requirements on
independence and non-audit fees.
In furtherance of that policy the Fund voted against the re-appointment of auditors in 96% of
company AGM's in 2004. The Fund has maintained a strong line on this issue for a number of
years, believing that auditors must demonstrate that there are no conflicts of interest when
carrying out audit work which is, after all, on behalf of shareholders. In the majority of cases the
Fund voted against the re-appointment of auditors because of the level of non-audit fees.
The new Combined Code on Corporate Governance calls for a greater role for the audit
committee in monitoring financial reporting, reinforcing the independence of the external auditor
and reviewing risk. The Code recommends that, if non-audit fees are charged, the client
company should disclose how auditor independence and objectivity is maintained. Despite this,
the majority of companies do not provide sufficient detail to allow investors to evaluate the
nature of non-audit work. This failure to disclose means that the Fund is sometimes unable to
support the re-appointment of auditors even when it may have been able to do so had proper
information been available.
There is clear evidence that shareholder attention to this issue, largely because of recent
corporate scandals such as Enron, Worldcom and Tyco, has improved the situation. PIRC report
that the ratio of audit to non-audit work for FTSE companies fell from a peak average of 2.8
times in 2001 to 1.5 times last year. Although non-audit fees have fallen, average audit fees have
started rising owing to the growing complexity of company accounts.
On issues relating to Directors, the current voting guidelines are very comprehensive. In
summary the guidelines:

promote and support the role of independent non-executive directors

require that the roles of Chief Executive and Chairman are separated

support best disclosure practice in identifying levels of director's and senior executive's
remuneration packages and that the report of the remuneration committee should be
submitted to a separate vote at the AGM
Perhaps the most complicated area of corporate governance relating to boards of directors is that
concerning independent non-executive directors. The National Association of Pension Funds
(NAPF) considers that independent directors are "the bastions of security for shareholders" and,
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while that may be somewhat optimistic there is no doubt that the appointment of properly
qualified independent directors is important. Although the new Code sets out a definition of
"independence", and the Fund has adopted its own definition based on the Code, there is a great
deal of interpretation involved and many companies appear to be paying lip service to the Code.
In 2004 the Fund was only able to vote for 13% of the directors put forward as independent,
either because they failed to meet the Fund's definition of independence, or insufficient
biographical detail was provided.
Perhaps the most controversial part of the definition of "independent" relates to the 9-year rule.
This means that a board member cannot he considered independent if he or she has served on the
board for nine years. This "deterioration of independence" may take place over different
timescales but, for practical purposes, a target period has to be set. Many companies, however,
continue to claim that long-serving board members can remain independent and put up
convincing arguments to support these claims.
Case Study : Persimmon
Sir Chips Keswick was not considered independent by NAPF as he had served on the Board
since 1984. The Board appointed a new independent director in January 2004 but would still
need to recruit additional independents in order to meet the recommendation of the new Code
that at least half the Board, excluding the Chairman, should be independent. The Board
supported the re-election of Sir Chips Keswick with a statement supporting his continued
independence and value to the company.
This issue illustrates the difficulty with having a rigid rule. Clearly it does not allow "special
pleading" of individual cases on the grounds that every company seems to be making similar
cases for exemptions from the 9-year rule. However there is the real danger that directors who
are of real value to the company and who would act as "bastions of security for shareholders"
will be voted off.
The outcome of this case was that although the Fund voted against Sir Chips Keswick he was
re-appointed.
In the United Kingdom there is now a general consensus that the roles of Chairman and Chief
Executive should not be combined in the same individual. The principal behind this separation is
to establish a division of responsibilities at the head of the company. The Maxwell scandal in the
1990s clearly demonstrated the dangers involved. The role of the Chairman is to ensure that the
board directs the company effectively and that it retains shareholder confidence. The Chairman
is the main representative of the board, which is elected by and accountable to the company's
owners - its shareholders. Therefore, it is the Chairman's responsibility to ensure that the board
performs its duties with the interests of shareholders foremost.
The new Code requires public justification if the two roles are combined. It also recommends
that a Chief Executive should not go on to be Chairman of the same company. In 1991 it was
recorded that 28 of the FTSE 100 companies combined both roles. Recent data indicates that that
number is down to 9.
Case Study : Barclays Bank
In October 2003 Barclays announced that its Chief Executive, Matthew Barrett, would replace
Sir Peter Middleton as Chairman from 1 January 2005. This move was contrary to the spirit of
the new Code, that a Chief Executive should not go on to be Chairman. The company published
a statement explaining why the Board considered its decision to be appropriate. The statement
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set out the process by which the appointment had been made and during that process Sir Peter
Middleton had stepped aside as Chairman of the Nominations Committee. The statement further
set out the case for the appointment of Matthew Barrett, based on his experience and the need to
ensure stability within the company.
As this appointment was not put before shareholders there was no chance for the Fund to
exercise its vote. The Fund welcomes the commitment Barclays have made to strengthen the
Board by the appointment of new independent non-executives but will monitor the situation
closely through 2005.
The most controversial area relating to directors is remuneration policy. The Fund's corporate
governance policy is designed to ensure that best disclosure practice has been followed and,
where that is not the case, the Fund will vote accordingly. The Fund has the right to expect that
companies will demonstrate, through effective communication with shareholders, that executive
remuneration packages are robustly tied to performance and linked clearly to the achievement of
enhanced shareholder value. Most newspaper headlines focus on the level of director's and senior
executive's remuneration, particularly the total remuneration package, including pay, bonuses
and pension rights. While there have been many such headlines highlighting "Fat Cat" salaries,
in fact what has happened during 2004 has been a mixture of good and bad in terms of corporate
governance:

executive basic salary increases running at twice national average earnings growth, while
increases in total remuneration packages are running at three and a half times the growth in
the equivalent national average

virtual withdrawal of two-year service contracts due to shareholder pressure

large increase in number and complexity of performance-based incentive plans

removal of resetting of existing plans due to shareholder pressure
One area of particular concern is the way in which companies report the outcome against
performance targets, which are used in calculating executive's bonuses and performance-linked
pay. The level of disclosure varies widely. The NAPF reports " in the majority of cases we have
found disclosure to be poor". As the design of new and amended annual bonus plans is becoming
more complex it is even more important that shareholders are provided with adequate
information.
Case Study : Reckitt Benckiser
As a result of shareholder engagement, the company responded to concerns over several aspects
of its executive remuneration policy. In particular, it significantly reduced the risk of "rewards
for failure" by reducing the entitlement under the executive director's service contracts on
termination. Executive directors also moved to contracts with six months notice period with
greatly reduced payouts on termination (from 150% of pay plus bonus to 50% of pay plus
bonus).
LOCAL AUTHORITY PENSION FUND FORUM
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In order to pursue a policy of active engagement, the Fund is an active member of the Local
Authority Pension Fund Forum (www.lapfforum.org) a grouping of Local Authority funds with
investments valued in excess of £50 billion. The Forum works by concentrating on a number of
key long-term campaigns, covering corporate governance and corporate responsibility issues, as
well as being able to mobilise support for campaigns relating to individual companies. The
Forum recognises that investment in a company brings rights and responsibilities. It is the
Forum's view that
good governance of the companies in which members invest is best achieved where directors are
held accountable through informed dialogue and the exercise of shareholder rights provided
under company law.
In July the Forum considered a report reviewing strategy and identified the priority areas for
intervention as:

board structures

executive remuneration

shareholder rights

separation of audit and non-audit work

environmental issues/ sustainability/ greenhouse gas emissions
The current long-term campaigns are:
DIRECTORS' REMUNERATION
The Forum has had a clear policy on director's remuneration for a number of years and has led a
number of campaigns highlighting excesses. Members of the Forum do not dispute the need to
recruit and retain key executives with appropriate remuneration packages, but do require that the
mechanism for determining remuneration be transparent, be approved by shareholders and those
performance-related awards are based on challenging performance targets. The Forum is pleased
that the Government has responded to shareholder pressure by requiring companies to put the
report from company remuneration committees before shareholders.
Although there have been some high-profile successes in the campaign, most notably the refusal
of shareholders to approve the remuneration package of GlaxoSmithKline's Chief Executive
Jean-Paul Garnier, there appears to be a reluctance by many shareholders to do anything other
than rubber-stamp Board resolutions.
The Forum concentrates on issuing weekly alerts in advance of company AGMs where there are
concerns over remuneration policy. This allows Forum members to evaluate board proposals
against their own voting guidelines and vote accordingly. As has been noted earlier the Forum
experience is of an improving situation with regard to period of director's contracts.
GREENHOUSE GAS EMISSIONS
The campaign to encourage rigorous reporting on greenhouse gas emissions is based on
continuing research on disclosure by FTSE 100 companies, according to eight core guidelines
published by the Department for Environment, Food & Rural Affairs (DEFRA). Based on this,
the Forum has collaborated with the Environment Agency Pension Fund on a joint shareholder
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engagement initiative to raise with companies the importance of reporting their greenhouse
emissions.The breadth of the campaign has been widened and a study has been commissioned on
"Local Authority Pension Funds and Climate Change".
During 2004 the Forum attended a number of company AGMs to ask companies about their
disclosure of greenhouse gas emissions. The AGMs attended included Amvescap, Smith &
Nephew, Logica and Shire Pharmaceuticals. A positive response was received with those
companies committing to look at the issue of reporting.
OVERSEAS EMPLOYMENT STANDARDS
This is the longest-running Forum campaign. Starting in 1998 the Forum initiated a campaign to
persuade UK companies in the retail sector to adopt codes of conduct, backed up by the
development of monitoring and verification mechanisms, which they would require their
supplier companies to meet. Although the campaign was initially aimed at the use of under-age
labour it quickly broadened to include the interrelated and wider problem of working conditions
in the export manufacturing sectors of developing countries. Although the complex issues
involved in this campaign require far more space than is available here, a full report is on the
Teesside Pension Fund website www.teespen.org.uk
In summary the campaign has been very successful in raising awareness among UK companies
of the issues involved and encouraging them to bring about changes of behaviour among
suppliers that does not disadvantage the workforce. The Forum has now commenced work on the
next stage of this campaign, focussing on a sample of industry sectors with interests in China.
The aim is to ascertain how they are addressing the risks related to operating in China, with
particular regards to labour standards in the supply chain.
FORUM MEMBERSHIP
City & County of Swansea
City of Edinburgh Council
Clwyd Pension Fund
Derbyshire CC
Greater Gwent Fund
Greater Manchester Pension Fund
Lancashire CC
LB Bexley
LB Brent
LB Camden
LB Croydon
LB Hackney
LB Hammersmith & Fulham
LB Islington
LB Newham
London Pension Fund Authority
Merseyside Pension Fund
Norfolk Pension Fund
Northamptonshire CC
North Yorkshire CC
Nottinghamshire CC
Shropshire CC
Somerset CC
South Yorkshire Pension Fund
South Yorkshire PTE Pension Fund
Teesside Pension Fund
Tyne & Wear Pension Fund
West Midlands Pension Fund
West Midlands PTA Pension Fund
West Yorkshire Pension Fund
Wiltshire CC
Worcestershire CC
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