Since the financial crisis, regulators have hardwired banks for safety and as a result, bank balance sheets are the strongest in a generation. However, there is no question that banks must further improve corporate governance. Banks need to narrow the “governance gap” – the difference between the interests of shareholders and the actions of management – and more clearly demonstrate governance-as-tied-to-performance.
Closing the governance gap involves a greater link of strategy with execution and incentives. Bank stocks surged after the 2016 presidential election due to expectations of higher interest rates, faster growth, and deregulation. Yet, banks should not confuse brains with a bull market. While these factors may help future earnings, they are completely outside of management’s control. Meanwhile, new proxies for large US global banks mostly indicate future incentive pay for performance similar to that already achieved. Would you do this if you owned 100% of the company?
Annual meetings can help provide transparency in literally the only forum where investors hold boards publicly accountable for answers to their questions. For my part, I plan to ask questions at bank annual meetings for the fifth straight year. My hope is that governance will include more qualitative considerations, fund manager engagement with managements, and analyses that unify the work in proxies with that in annual reports.
First, institutional fund managers must look beyond traditional governance scorecards to exercise effective due diligence.
If you go back a decade, many failing and troubled firms scored favorably on many governance scorecards. Those scorecards are a vital source of information on companies – but they may not tell the whole story. Citigroup is a good case-in-point. In 2007, then CEO Chuck Prince made ill-timed management moves while Citi was on the brink of insolvency, yet was praised by one of Citi’s senior counselors Robert Rubin, who may have never spoken with one of the many disgruntled shareholders. At the time, Rubin announced that “Chuck Prince would be around for many years to come.” After we downgraded the stock due to governance concerns, some disagreed using an “independent scorecard” to support Citigroup. Do I believe that today’s governance scorecards would have captured Citigroup’s tumult in 2007? I don’t think they would.
Second, institutional fund managers must be more willing to actively and constructively engage with their portfolio companies – and use the forum of the Annual General Meeting to make their case.
After more than $300 billion of outflows in 2016, many active fund managers are being pressured to show the benefits of an active strategy. Funds that engage companies can positively help investment performance and brand. Comerica is a good case study.
Early last year, we upgraded Comerica on the view that its board would either improve governance, sell the bank, or replace top management. Comerica was the least optimized large regional bank with the worst stock performance among large banks with long tenured CEOs. I called each large Comerica shareholder to highlight our research, urging them to speak up if they saw a concern. These conversations were productive and I arranged to see many of them at the annual meeting if they were to attend. In the end, the experience left me both extremely gratified and extremely frustrated.
The Comerica annual meeting was extraordinary. In the end, 10 large institutional investors – mostly page 1 holders – boarded planes to attend Comerica’s annual meeting (in Dallas of all places) and stood up publicly to voice their concerns – a memorable moment for shareholder rights. Most meetings don’t draw one institutional investor, let alone ten. One month later, Comerica announced a broad restructuring and the stock was the best performing among the 30 largest banks in 2016. Kudos to large mutual funds such as Invesco and Fiduciary who attended and spoke up (unusual for them to do so publicly) to protect the interests of the investors in their funds.
Though not all funds went out on a limb. There were still several investors who said a public rebuke would not be “our style,” fearing that speaking out would upset management. But I was relentless in my efforts to get management teams to do the right thing. When my calls went unreturned by portfolio managers, I would reach out to fund CEOs or corporate governance divisions. It didn’t go over well with certain clients – I was harshly reprimanded by some – but to a degree, this is an old story. Disgruntled shareholders often prefer to stay quiet and just sell their shares due to limited incentives for engagement, such as higher costs, reduced access to management, and a reputation as a less cooperative shareholder for their other investments.
Nevertheless, investor pressure can (and has) made a difference, especially for underperforming companies. One current example is Citigroup. Its proxy repeats a prior year proposal to review a break-up which seems fair based on a CEO letter that insists the bank’s restructuring is “over” even while it posts a key financial target (return on tangible common equity) that has been delayed by four years.
Board chairs and/or lead directors have started speaking with investors more often, which is helpful. However, these “investors” are sometimes not the bank experts but rather function as corporate governance watchdogs. Fair or not, there is a perception among investors that full-time governance people act in a “check-the-box” manner for topics that don’t necessarily matter to investment performance.
Third, institutional fund managers should hold boards accountable for developing executive compensation programs that are transparent and align with published performance targets.
Financial metrics reported in annual reports should be in sync both with company targets in investor presentations and executive performance reviews in proxies. This is often not the case. If a bank CEO thinks his or her company should have an ROA of 1% over time and wants investors to buy that stock based on this target, then that target should also be part of compensation. However, banks sometimes sidestep reality by either shifting targets, dropping targets when they appear unattainable, or changing peer groups, all which contribute to a perception of a rigged system.
In sum, there are several ways to narrow the governance gap, including more effective use of annual meetings, closer linkages between the annual reports and the proxies, and greater engagement of senior executives by institutional fund managers. Investors must fill-in where regulation pulls back and can at least make sure that the reasoning is explained and understood. This is our job as stewards of shareholder capital.
If you have views about how this type of governance work is valued by the buyside, please contact me at mikemayo2017@gmail.com.
Mike Mayo has nearly 30 years of bank analyst experience, ranging from CLSA Americas where until recently he served as Head of US Bank Research, to Deutsche Bank, Prudential, CSFB, and more. Mike was presented with the 2013 annual CFA award for ethics and standards of practice, and was named by CNN and Fortune as one of eight who “saw the crisis coming.” Mike was the first analyst to testify on the causes of the financial crisis to the Financial Crisis Inquiry Commission (FCIC) and the only analyst to testify to Congress for the passage of the Sarbanes-Oxley act in 2002.
