Opening Up the Boardroom
At Grupo Dragados' annual meeting in April, 2002, management seemed intent on offering a seminar on how to abuse the shareholder. The Madrid-based construction and transportation-services giant capped voting rights at 25%, regardless of how much capital a shareholder owned. Amendments related to takeovers would now require 75% of shareholders' approval. And only a director who had served on the company's board for a minimum of five years would be eligible to become chairman -- effectively blocking any outside raider from making his mark. Shareholders -- who listens to them anyway?
Well, turns out Dragados does. In the year since, the company came under unrelenting attack by activists, led by U.S.-based Institutional Shareholder Services. "While other Spanish companies were making efforts to improve corporate governance, it seemed Grupo Dragados was taking a step backward," says Nadia Villegomez, a senior analyst at Rockville (Md.)-based ISS. Amazingly, the pressure worked: At this year's shareholders' meeting on Apr. 30, the company quietly abolished all of the disputed measures. "A year ago those measures looked smart and convenient," says José Azpilicueta, director of investor relations. "But after a year of reflection, we saw they don't really hold up well in the new sprit of corporate transparency."
Chalk up another victory for the long-suffering shareholder rights' movement in Europe. For most of the postwar era, shareholder rights and corporate governance were seen as concepts only fringe activists and stock-crazy Americans obsessed about. The walls protecting many European companies -- state-owned "golden shares," secret cross-shareholdings, opaque accounting -- seemed strong enough to withstand any assault.
Yet the walls are starting to crack. Secretive cross-shareholding deals are being unravelled. Disclosure of crucial financial data is finally improving. Details about executive pay are actually coming to light. Large and unwieldy boards -- in Germany and Spain it's common to have 25 or more directors -- are slimming down. More companies are creating board committees to oversee important areas such as compensation and audits. A study by Deminor, a corporate governance ratings agency in Brussels, found that the number of European boards having at least one independent member rose from 53% in 2001 to 59% in 2002.
It's not a complete revolution. "The rules are still in a state of development," admits Karl-Hermann Baumann, chairman of the supervisory board of Siemens. Nonetheless, "Europe is making real headway on improving corporate governance," says John Glynn, partner at PricewaterhouseCoopers in London. "It's become a front-burner issue everywhere."
What happened? Europe's companies certainly haven't been stricken with a sudden attack of conscience. Instead, they are feeling increasingly exposed to the currents that rule global markets. Years of privatization programs at some of Europe's flagship companies have gradually eroded state control. Half a decade of mergers and acquisitions has led to an influx of foreign, especially U.S., capital. Family ownership is gradually being diluted as the heirs give control to outsiders. U.S. pension funds such as TIAA-CREF are teaming up with European funds such as ABP of the Netherlands and Hermes of Britain to turn up the heat on companies. "There's been a big change in who really owns Corporate Europe," says London-based Paul Coombes, director of McKinsey & Co.'s corporate governance practice.
Then, of course, there are the scandals. Even as Enron Corp. imploded two years ago, there was a feeling of Schadenfreude in Europe Inc. "It could never happen here" was the common refrain among Europe's biggest corporate bosses, who maintained that European firms had none of the cowboy culture common to America.
But over the last 18 months, Europeans learned what they were capable of. Witness the problems at France's Vivendi Universal (opaque accounting, princely compensation), Marconi and Cable & Wireless in Britain (totally somnolent boards), Ireland's Elan Corp. (really creative accounting), Deutsche Telekom in Germany (addicted to debt), and ABB in Sweden (for a staid engineering company, they sure knew how to make a golden parachute). Europe's bourses were rocked, and shareholders realized more than ever that bad governance costs them money.
None of the revelations has hit harder than the recent meltdown of the Netherlands' formerly respected Royal Ahold. The Dutch supermarket and food-service giant admitted it had overstated its 2001 and 2002 earnings at U.S. and Argentine affiliates by at least $500 million. Ahold shares, widely held by ordinary Dutch citizens and loved for their ever-climbing price, have lost three-quarters of their value since late February. Ahold's CEO and chief financial officer paid the ultimate price by resigning in disgrace. Now Dutch prosecutors are probing to see if management committed fraud. "Corporate governance, transparency, and control issues are not limited to the U.S. or emerging markets," says Nick Bradley, managing director of Standard & Poor's governance-services division in London.
Exactly. That's why over the past year, Spain and Germany introduced their first governance codes for listed companies, while France and Italy updated theirs. Most such codes are voluntary: Companies are told either to disclose more information -- or explain why they won't. Companies are getting the idea. France's Vivendi Universal, bowing to shareholder outrage, no longer allows for discounts under its stock option plan. It slimmed board membership from 19 to 12, and filled all the seats on the audit committee with independent directors.
The British, meanwhile, have laid out sweeping proposals to change company law and published two new reports: the Higgs Review, setting out rules on nonexecutive directors; and the Myners Report, which makes recommendations on oversight by institutional investors. In January, the British government also unveiled a plan to set up a single regulator to oversee accounting and auditing standards and called on firms to rotate audit partners every five years. Beginning this year, British shareholders will finally get to vote on companies' executive compensation plans.
Switzerland, long known for its clubby and secretive corporate culture, is also tackling changes. Last year, the Swiss Stock Exchange began requiring companies to give detailed information on executive compensation, cross-shareholdings, and audit fees, or explain in their annual report why they don't. "Corporate governance has become a very important topic," says Daniel Vasella, chairman and CEO of Swiss drugmaker Novartis. "The old style of doing business in Switzerland is fading away."
It's healthy change, but a trifle disorganized. That's where the European Union comes in. It weighed in at the end of 2002 with a plan to harmonize more than 40 European corporate governance codes. Although national codes all support the same general principles of good governance, different legal and cultural environments are a barrier to the creation of one system used throughout the EU.
What's more, the continent is in a delicate intermediate stage where many sound proposals have been made, but not all of them adopted. Voting rights in many continental countries aren't always linked to investors' economic stakes in companies. Many still cap voting rights at 20% or less -- regardless of how much stock is owned above that level. Anti-takeover mechanisms, or so-called poison pill provisions, are widespread, making unfriendly mergers and acquisitions nearly impossible.
Time to get organized. On May 21, the European Commission will outline an action plan that recommends all EU states have some form of public oversight of auditing. The aim is to prevent more Ahold-type debacles. The Commission already has proposed that all listed companies to adopt International Accounting Standards by 2005 to improve transparency and to homogenize European disclosure standards.
Shareholder advocates who felt like lone voices a decade ago are actually beginning to hope. They point out that as recently as a decade ago, very few continental companies had investor relations departments, and getting even the most basic information was always an uphill battle. German companies were notorious for this. But no longer. "Europe has made dramatic improvements in the holy trinity of good corporate governance: independence, accountability, and disclosure," says Stanley Dubiel, director of research at ISS.
One area that especially concerns the Europeans is the effectiveness of boards in blocking strategic blunders. Take Marconi PLC. Once one of Britain's biggest companies, it has lost $56 billion in market value in the past four years. Marconi is now a penny stock, thanks to an ill-conceived strategy to turn the former electronics systems company into a technology highflier. The two men who oversaw the company, Lord George Simpson and John Mayo, left it last year with $6 million in combined severance. That's a lot by British standards, especially considering Marconi's rapid demise. The Marconi fiasco is one reason the British government is considering legislation to link pay to performance and limit payments for departing executives.
Britain's activist stance has long put it at the forefront of corporate governance reform in Europe. But increasingly, investors across the continent are realizing there is a link between good corporate governance and the value of their investment, says Jean-Nicolas Caprasse, a partner in Deminor. A study by Rob Bauer, a professor at the University of Maastricht and chief research officer for Europe's biggest pension fund, ABP, looked at two portfolios, one comprised of companies that were rated in the top 20% by Deminor and another in the bottom 20%. He found well-governed companies returned nearly 3% a year more over five years than poorly governed ones.
This evidence is pushing the governments and companies to act. Last year, France passed a law requiring companies to disclose compensation information for top executives. Even in Italy, where shareholders have long been ill-treated, change is afoot. On Jan. 17, it introduced a reform of corporate law affecting joint stock as well as limited liability companies. The inclusion of nonlisted companies is an important shift, since Italy is dominated by private, often family-owned firms. Companies will be allowed to choose between three different models of corporate governance. Although companies must comply with the new statute by Jan. 1, 2004, many already are adopting the new rules, and doing even more. Italy's white-goods maker, Merloni Elettrodomestici, recently approved tougher rules on insider trading than those of Italy's stock exchange. "There's a real competition not to be last to implement rules of good governance," says general counsel Fabrizio Simoncini.
But experts say Italy still has a long way to go. "The new law modernizes some aspects of governance, [yet] it still leaves a lot of flexibility in choosing best practices," says Marco Ventoruzzo, assistant professor of corporate law at Bocconi University in Milan and an adviser to the Italian Stock Exchange. The long-complaining shareholders at Mediobanca, Italy's secretive investment bank, needed two years to oust CEO Vincenzo Maranghi for repeatedly failing to inform shareholders about strategic moves, setting up secret pacts, and disregarding the bank's governance code.
It's a similar story in Germany, where a handful of recent scandals, starting with the dot-com boom and ending with the collapse of media giant Kirch Group, have spurred the government to act. A recent amendment to the German Stock Corporation Act obliges all listed companies to declare annually how well they comply with the German Corporate Governance Code. German companies are scrambling to comply. Siemens, for instance, has published a code of conduct for board members, plus a statement addressing possible conflicts of interest and detailed information on employee stock option plans. Yet while Germany has clearly introduced improvements, it took a step backward earlier this year with legislation permitting poison pills.
But if there are still shadows falling across the landscape, there's plenty more light than before. Spain's two largest banks, Santander Central Hispano and Banco Bilbao Vizcaya Argentaria, recently decided to abolish their anti-takeover measures. In the wake of a scandal involving secret slush funds that were set up a decade before his arrival, BBVA Chairman Francisco Gonzalez has dramatically overhauled the bank's governance code, setting up totally independent audit, compensation, and risk oversight committees. Eager to win back investors' trust by becoming a Continental beacon of good corporate governance, he adopted the New York Stock Exchange code as a base and then built on it. "You have to take care on a daily basis that there are no conflicts of interest," says Gonzalez. "I'm much surer now that the numbers are accurate."
Volkswagen, long regarded as one of Europe's least transparent companies, is starting to change. It still hides behind a wall. Some 20% of the carmaker's shares are held by an investor with overriding interests in preserving jobs: the state of Lower Saxony, where VW's main factories are located. But since the arrival of ex-BMW CEO Bernd Pischetsrieder, who became CEO in April, 2002, VW has been making slow but steady strides. At their last meeting with analysts, VW execs even offered up for the first time the breakeven point for each of their factories. "Communications clearly has a new value at Volkswagen," says Trudbert Merkel, fund manager at Deka Investment Management in Frankfurt. Listen up, managers of Europe. Investors would like a word with you.
By Kerry Capell in London, with Gail Edmondson and David Fairlamb in Frankfurt and bureau reports