Chapter 5: Relations with shareholders and disclosure

Chapter learning objectives

Upon completion of this chapter you will be able to:

  • analyse and discuss the role and influence of institutional investors in corporate governance systems and structures, e.g. the roles and influences of pension funds, insurance companies and mutual funds
  • explain and analyse the purposes of the annual general meeting (AGM) and extraordinary general meetings (EGMs) for information exchange between board and shareholders
  • describe and assess the role of proxy voting in corporate governance
  • explain and assess the general principles of disclosure and communication with shareholders
  • explain and analyse 'best practice' corporate governance disclosure requirements
  • define and distinguish between mandatory and voluntary disclosure of corporate information in the normal reporting cycle
  • explain and explore the nature of, and reasons and motivations for, voluntary disclosure in a principles-based reporting environment (compared to, for example, the reporting regime in the USA).

1 Development of corporate governance regarding shareholders and disclosure

As discussed in chapter 2 the development of corporate governance codes is closely associated with the UK.

The Cadbury Report (1992) first recognised the importance and role of the institutional shareholders. It was noted that there is a need for greater director dialogue and engagement with this group. From this dialogue would emerge a greater understanding of the need to appreciate and respond to the needs of other stakeholders.

Also in the 2010 review of the UK Corporate Governance Code the Financial Reporting Council concluded that the impact of shareholders in monitoring the code could and should be enhanced by better interaction between the boards of listed companies and their shareholders.

2 Institutional Investors

Institutional investors manage funds invested by individuals.

In the UK there are four types of institutional investor:

  • pension funds
  • life assurance companies
  • unit trust
  • investment trusts.

Importance of institutional investors

The key issue is the increasing dominance of this investor class and its potentially positive contribution to governance by concentrating power in a few hands.

Fund managers and other professionals working for the institutions have the skills and expertise to contribute towards the direction and management of a company.

Potential problems

In the separation between ownership and control there are a number of intermediaries, creating a complex web of agency relationships:

  • investor
  • pension fund trustee
  • pension fund manager
  • company.

Institutional shareholder dominance

Problems that have arisen from institutional shareholder dominance involve:

  • Fund managers: the short-termism of fund managers who, according to Keynes, are concerned 'not with what an investment is really worth to a man that buys it for keeps but with what the market will value it at under the influence of mass psychology three months or a year hence. Thus the professional concerns himself with beating the gun or anticipating impending change in the news or atmosphere'.
  • Pension fund trustees: the trustee is often a lawyer or company secretary. 70% have no qualification in finance or investment and over 50% spend less than a day a year considering the issue. This woeful lack of interest and ambition does not suggest any interest in company operations beyond immediate short term returns.

In this model the distance between shareholder and company creates a governance vacuum:

  • Individual shareholders have no voice in how their investee companies operate since they do not directly own shares. Hence they do not have the right to attend the AGM and speak.
  • Pension funds need to examine their own governance structures as to how they invest and operate since they do have a voice and own shares in these companies.

Solution: shareholder activism

The advent of the Cadbury report and the Code (UK example only) has seen a marked change in institutional investor relationships with organisations. This is from simply being a trader to one of responsible ownership, from a passive role to one of shareholder activism.

This activism can be in the form of:

  • making positive use of voting rights
  • engagement and dialogue with the directors of investee companies
  • paying attention to board composition/governance of investee companies (evaluation of governance disclosure)
  • presenting resolutions for voting on at the AGM (rarely used in UK)
  • requesting an EGM and presenting resolutions.

Institutional shareholder intervention

Intervention by an institutional investor in a company whose stock it holds is considered to be a radical step. There are a number of conditions under which it would be appropriate for institutional investors to intervene:

  • Strategy: this might be in terms of products sold, markets serviced, expansion pursued or any other aspect of strategic positioning.
  • Operational performance: this might be in terms of divisions within the corporate structure that have persistently under-performed.
  • Acquisitions and disposals: this might be in terms of executive decisions that have been inadequately challenged by NEDs.
  • Remuneration policy: this might relate to a failure of the remuneration committee to curtail extreme or self-serving executive rewards.
  • Internal controls: might relate to failure in health and safety, quality control, budgetary control or IT projects.
  • Succession planning: this might relate to a failure to adequately balance board composition or recommendation of replacement executives without adequate consideration of the quality of the candidate.
  • Social responsibility: this might relate to a failure to adequately protect or respond to instances of environmental contamination or other areas of public concern.
  • Failure to comply with relevant codes: consistent and unexplained non-compliance in a principles-based country will be penalised by the market. In a rules-based country it would have been penalised as a matter of law.

Illustration 1 – Current need for institutional shareholder dialogue

According to the Organisation for Economic Cooperation and Development (OECD), the 2008 crash has wiped a total of $5 trillion off the value of private pension funds in rich countries over the course of a single year.

Almost half of the total loss has been sustained by US investors although seismic shockwaves have affected all those whose wealth is intrinsically tied with the movements of the market.

The OECD calculates that UK pension funds have declined by more than 15% ($300 billion) during 2008 and warns of far worse if the cost of falling property values were factored in. Among 28 countries covered in the study, Ireland's workers have been worse hit with their retirement fund falling by more than 30%.

In the light of these findings the OECD has called for a strengthening of governance regulation through bodies such as the Financial Services Authority in order to ensure that institutional shareholders such as the large pension funds carry out adequate risk management of all portfolio organisations and do not simply rely on index tracking as a basis for investment decisions.

3 General meetings

A general meeting of an organisation is one which all shareholders or members are entitled to attend.

Annual and extraordinary general meetings


  • Held once a year by management to present the company to its shareholders.
  • Various corporate actions may be presented and voted upon by shareholders or their proxies. These might include:
    • accepting the directors' report and statement of accounts for the year
    • reappointment of directors and auditors
    • approval of directors' and auditors' remuneration
    • approval of final dividends.
  • The board should use the AGM to communicate with investors and to encourage their participation.
  • Separate resolutions should be proposed on each substantially separate issue.

The UK Corporate Governance Code (2010) states that for listed companies:

  • The chairman should arrange for the chairmen of the audit, remuneration and nomination committees to be available to answer questions at the AGM and for all directors to attend.
  • The company should arrange for the notice of the AGM and related papers to be sent to shareholders at least 20 working days before the meeting.
  • There must be a 'question and answer' session within the AGM to allow shareholders to respond to the presentation.


  • These are irregularly held meetings arranged to approve special events such as acquisitions, takeovers, rights issues, etc.
  • Separate resolutions should be proposed on each substantially separate issue.
  • EGMs are usually called where an issue arises which requires the input of the entire membership and is too serious or urgent to wait until the next AGM.
  • All general meetings, other than the AGM, are called EGMs.

4 Proxy voting

Proxy voting systems are implemented to ensure that shareholders who are unable to attend general meetings where resolutions will be proposed and voted on can still make their opinions heard.

The UK Corporate Governance Code (2010) requires that:

  • for each resolution proposed at a general meeting, proxy appointment forms should provide shareholders with the option to direct their proxy to vote either for or against the resolution or to withhold their vote
  • the proxy form and any announcement of the results of a vote should make it clear that a 'vote withheld' is not a vote in law and will not be counted in the calculation of the proportion of the votes for and against the resolution
  • the company should ensure that all valid proxy appointments received for general meetings are properly recorded and counted
  • for each resolution, after a vote has been taken, except where taken on a poll, the company should ensure that the following information is given at the meeting and made available as soon as reasonably practicable on a website which is maintained by or on behalf of the company:
    • number of shares in respect of which proxy appointments have been validly made
    • number of votes for the resolution
    • number of votes against the resolution, and
    • number of shares in respect of which the vote was directed to be withheld.

5 Disclosure – general principles

Shareholders are the legal owners of a company and therefore entitled to sufficient information to enable them to make investment decisions.

  • The AGM is seen as the most important, and perhaps only, opportunity for the directors to communicate with the shareholders of the company.
  • As the only legally-required disclosure to shareholders, the annual report and accounts are often the only information shareholders receive from the company.

General principles of disclosure relate to the need to create and maintain communication channels with shareholders and other stakeholders. This disclosure becomes the mechanism through which governance is given transparency.

Principles of mandatory disclosure discuss the target for disclosure (particularly shareholders) and the mechanism for disclosure (annual report or meetings).

6 Disclosure: best practice corporate governance requirements

The issue of governance and disclosure are closely intertwined. Disclosure is the means by which governance is communicated and possibly assured since it leads to stakeholder scrutiny and shareholder activism.

Codes such as the UK Corporate Governance Code (2010) provide best practice governance. Adherence can only be communicated through transparency of Code implementation, and in its detailed inclusion in the annual report.

7 Mandatory versus voluntary disclosure

Organisations disclose a wide range of information, both mandatory and voluntary.

Test your understanding 1

Suggest examples of the following types of disclosure:

(a)Mandatory disclosure

(b)Voluntary disclosure

Annual report

The annual report becomes the tool for 'voluntary disclosure'. The report includes:

(1)  Chairman and CEO statements regarding company position - This is voluntary in the sense that it is a requirement of the Code but obviously to not include this would be unimaginable.

(2)  Business review (formerly OFR) - This detailed report is written in non-financial language in order to ensure information is accessible by a broad range of users, not just sophisticated analysts and accountants.

(3)  The accounts - Including statement of comprehensive income, statement of financial position and cash flow statements plus notes and compliance statements.

(4)  Governance - A section devoted to compliance with the Code including all provisions shown above.

(5)  AOB (any other business) - Shareholder information including notification of AGM, dividend history and shareholder taxation position.

Operating and financial review

The OFR narrative was intended to be forward-looking rather than historical.

There were high hopes for the OFR when it became mandatory, but then it was almost immediately revoked as a mandatory requirement by government in the UK, and was replaced with the softer Business Review.

Stakeholders such as institutional investors and environmental lobbyists hoped the OFR would be a vehicle for:

  • risk disclosure
  • social and environmental reporting.

Expansion of disclosure beyond the annual report

Since disclosure refers to the whole array of different forms of information produced by the company it also includes:

  • press releases
  • management forecasts
  • analysts' presentations
  • the AGM
  • information on the corporate web site such as stand-alone social and environmental reporting.

Improvements in disclosure result in better transparency, which is the most important aim of governance reform worldwide.

'The lifeblood of the markets is information and any barriers to the flow represents imperfection. The more transparent the activities of the company, the more accurately securities will be valued.' (Cadbury Report)

Motivations behind voluntary disclosure

Overall in a principle-based reporting environment the disclosure of voluntary information can enhance companies' accountability to investors, because voluntary disclosures are an effective way of redressing the information asymmetry that exists between management and investors.

In adding to mandatory content, voluntary disclosures give the following benefits:

  • Gives a fuller picture of the state of the company.
  • More information helps investors decide whether the company matches investors' risk, strategic and ethical criteria, and expectations.
  • Makes the annual report more forward looking (predictive) whereas the majority of the numerical content is backward facing on what has been.
  • Helps transparency in communicating more fully thereby better meeting the agency accountability to investors, particularly shareholders. There is a considerable amount of qualitative information that cannot be conveyed using statutory numbers (such as strategy, ethical content, social reporting, etc)
  • Voluntary disclosure gives a more rounded and more complete view of the company, its activities, strategies, purposes and values.
  • Voluntary disclosure enables the company to address specific shareholder concerns as they arise (such as responding to negative publicity).

These further points are extracted from the Examiners answer to the December 2008 Question 1.

In the USA the reporting regime under Sarbanes-Oxley offers little room for Voluntary disclosures. The act itself contains various specific requirements, such as section 404:

'The commission shall prescribe rules requiring each annual contain an internal control report which shall...........' going on to detail very precisely all necessary disclosure.

The motivations for voluntary disclosure are thus as follows:

  • Accountability: disclosure is the dominant philosophy of the modern system and the essential aspect of corporate accountability.
  • Information asymmetry: attempts to deal with information asymmetry between managers and owners in terms of agency theory. The more this is reduced the less chance there is of moral hazard and adverse share selection problems.
  • Attracts investment: institutional investors are attracted by increased disclosure and transparency. Greater disclosure reduces risk and with it the cost of capital to the company.
  • Compliance: non-compliance threatens listing and fines through civil action in the courts. In the US non-compliance makes directors personally liable for criminal prosecution under SOX.
  • Alignment of objectives: possibly 50% of directors' remuneration is in relation to published financial indicators.
  • Assurance: the mass of disclosure gives the user assurance that the management are active and competent in terms of managing the operations of the organisation.
  • Stakeholders: greater voluntary disclosure assists in discharging the multiple accountabilities of various stakeholder groups.

8 Chapter summary

Test your understanding answers

Test your understanding 1

(a) Mandatory disclosure examples:

  • statement of comprehensive income (income or profit and loss statement)
  • statement of financial position (balance sheet)
  • statement of cash flow
  • statement of changes in equity
  • operating segmental information
  • auditors' report
  • corporate governance disclosure such as remuneration report and some items in the directors' report (e.g. summary of operating position)
  • in the UK, the business review is compulsory.

(b) Voluntary disclosure examples:

  • risk information
  • operating review
  • social and environmental information
  • chief executive's review.

Created at 5/24/2012 12:28 PM  by System Account  (GMT) Greenwich Mean Time : Dublin, Edinburgh, Lisbon, London
Last modified at 8/15/2012 12:12 PM  by System Account  (GMT) Greenwich Mean Time : Dublin, Edinburgh, Lisbon, London

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