During times of crisis, high-quality corporate governance comes into its own. This involves effective boards working closely with motivated executive teams to provide exceptional leadership. That in turn puts companies in the best possible position to emerge from the crisis with engaged workforces, reliable supply chains and loyal customers.
This environment in which boards and management are now operating in is unprecedented. Many service-sector companies – like airlines and hospitality businesses – have seen their markets disappear overnight through forced and voluntary social distancing. They also face considerable uncertainty about how much and how quickly demand will return. Others – like supermarkets and online service providers – have seen sharp increases in demand, though some are vulnerable to the second-round effects caused by the deep recession. Meanwhile, banks have become instruments of government policy, delivering subsidised support to small businesses.
Companies’ handling of these issues is under the closest possible scrutiny from society, the press and government. The decisions being taken by those responsible for the governance of companies must now also demonstrably consider a broader set of stakeholders, including the environment and wider society. Through the way they manage their companies during this crisis, management and boards will determine whether their social licences are extended and thus define their potential for future success.
The pandemic is also bringing the role of investors into sharper focus. Asset managers transform their clients’ savings into capital that both drives and benefits from the growth created by companies that are successful over the long-term. For economies to be able to return to sustained growth after the current crisis, companies will need strong support from those responsible for the allocation of capital. This means working closely with the companies they have selected, allocating additional capital where appropriate, recognising the need for reduced dividend payments in many circumstances and, where necessary, relaxing some of the restrictions normally applied to processes such as issuing new shares.
At the same time, investors must provide the necessary scrutiny and oversight to ensure that boards and management can be held to account for how they have governed their companies.
Reflecting the new environment in which companies and investors are now operating, Aberdeen Standard Investments wrote to UK companies in which we had made active investments. We outlined how we would support them and how they should consider the interests of their shareholders and other stakeholders. We highlighted how future success was dependent upon aligning their corporate purpose with their role in society and the need to do the right thing for their broader stakeholders, including their employees and suppliers.
Below, we discuss some of the key areas on which companies and investors will need to focus through and in the years following the COVID-19 crisis.
As companies deal with the pandemic they will incur additional costs, particularly when treating stakeholders with fairness and respect. Taking steps to protect the health of employees is paramount given the nature of the current crisis. They should also do what they can to support the financial security of employees within the bounds of what is affordable. In addition, companies should work closely with their suppliers so that these enduring relationships are still in place when a degree of normality begins to return.
In circumstances where it becomes necessary for a company to seek further capital, investors should endeavour to provide support when it is their clients’ or customers’ best interests. However, such capital-raising exercises must give full consideration to the interests of existing shareholders.
In seeking additional capital, companies must be able to provide a strong business case and detailed analysis of how the planned capital raising will meet the company’s needs for a minimum of 12 months. This should take account of any reduction in dividends, renegotiation of debt covenants and the use of emergency support from banks and the government. Arrangements to support companies and the economy will be multifaceted and require the open and transparent engagement of all involved.
The assessment of risks within scenario planning will be challenging in this environment. For example, while pre-COVID-19 stress tests may have factored in revenue losses in the range of 20 per cent to 40 per cent, revised stress scenarios may have to contend with loss of revenue of 50 per cent to 100 per cent in some cases. Companies may also need to strengthen their processes for identifying and modelling emerging tail risks that have the potential to cause significant damage to their earnings.
As well as cases where additional capital may be required, boards and management will need to consider broader aspects of capital conservation. These include the payment of dividends and share-buyback policies. Companies should be expected to do their utmost to retain the capital required to meet their future needs. But companies whose businesses continue to run successfully without external support and are well placed to maintain their dividend policy should continue to do so.
In the current environment, it is more important than ever for companies to maintain close links to their major investors and to engage openly with them. An important part of the regular engagements between companies and their shareholders is the annual general meeting (AGM). We are now in the middle of the AGM season, which runs from April to June. This is when most companies around the world with a December financial year end hold their annual meetings.
Because in most countries gatherings such as AGMs are currently prohibited, the latest round of annual shareholder meetings has been postponed, closed to attendees or exclusively virtual. Virtual meetings at least allow shareholders to hear a report from the company’s board and, possibly, to ask questions. With both virtual and closed meetings, shareholders can vote in their normal way by providing their proxy with an instruction ahead of the meeting.
The AGM is an important event at which shareholders can hold boards and management to account face-to-face. Shareholders object to virtual-only meetings in the normal course of events, as they feel that their ability to participate is reduced. Under the current circumstances, both virtual and closed meetings are being generally accepted, but they should not become the future norm as long as any safe social distancing guidelines are adhered to once formal restrictions have been lifted.
In some countries, the postponement of AGMs has been the main method of handling COVID-19 restrictions. In many markets, companies have been given extra time to finalise annual reports. Regulators have indicated that, in taking additional time, companies need to assess the current uncertainties carefully so as to be as open as possible with shareholders.
Remuneration is an almost continual topic of engagement in some markets such as the UK and, increasingly, the European Union. So far, the manner in which companies and executives have dealt with pay to address the impact of COVID-19 has been generally positive. Some executives have taken cuts in fixed or variable pay or have donated a portion of their pay to assist those affected by the pandemic.
Companies and executive directors need to show regard for their employees and wider society. They also need to demonstrate awareness of their licence to operate when considering their compensation policies and the overall level of remuneration. Current experience in the UK indicates that, under the COVID-19 spotlight, a number of executives and remuneration committees have been willing to take steps to adjust pay.
A further consideration is that demonstrating the right behaviours in relation to executive remuneration during the crisis could help the corporate sector emerge from the crisis with an enhanced reputation.
Shareholders will continue to assess the outcomes of executive remuneration at this year’s AGMs and are likely to vote in support of companies that consider the broader impact of COVID-19 in their pay arrangements. However, it is not until next year that we will see how companies handle the full impact of the pandemic on their performance and related pay outcomes. We expect companies to handle next year’s pay arrangements in the same responsible manner.
Investing for a better future
In conclusion, the restrictions applied around the world to deal with the pandemic have created an environment in which executive management and board decision-making have been stripped back to the basics of what is necessary to ensure survival. These include the following:
How to manage the company’s finances through the period of turmoil, including and what support may be needed and from whom; how to determine the level and structure of the workforce that allows the company to be best positioned for the future once restrictions begin to relax; how to work with key suppliers to help them through the crisis to reinforce availability when growth returns; and what opportunities are available to connect with wider society to ensure continued or enhanced loyalty from customers.
The boards and managers that can successfully govern their companies through this crisis will lay the foundations for their companies’ long-term success. They should emerge with enhanced reputations, clearer purpose and loyal customers, employees and suppliers. Asset managers who identify and support these companies now will be investing for a better future.
Mike Everett, ESG investment director at Aberdeen Standard Investments