Annual Investor Corporate Governance Report Corporate Governance trends and issues

for 2016

November 2015

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Introduction

This is the second edition of the CMi2i annual Investor Corporate Governance Report

(“ICGR”) which highlights the growing importance investors attach to best practice. Our

findings reflect the views of a range of critical stakeholders from directors of corporate

governance and those responsible for proxy voting from influential global institutional

investors. In total, the survey obtained responses from investors managing in excess of

US$10.4 trillion of assets.

The purpose of the ICGR is to identify the key corporate governance issues which investors

are likely to monitor as we enter 2016. Our focus was to assess which of these will affect

investment decisions.

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Key Findings

Some of the key findings from the ICGR have been summarised below:

• Remuneration, Board Elections and Related Party Transactions are the key areas

investors will pay particular attention to in 2016.

• There is a clear misalignment of the topics investors wish to discuss, compared to

the topics issuers prefer to engage on, particularly concerning Risk Management,

Board Composition and Strategy.

• Investor-to-issuer and investor-to-investor engagement is expected to increase over

the next 3 years.

• There is an increasing link between Risk Management and Board Elections.

• There are increasing investor concerns about how companies propose to deal with

the growing threat to cybersecurity.

• The level of disclosure of Succession Planning processes is a clear weakness.

• Share Blocking continues to be an obstacle to voting

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Outlook for 2016

In summary, respondents indicated that they will pay particular attention to the following

areas: Remuneration (100%), Board Elections (83%) and Related Party Transactions (67%).

In addition, Board Tenure (44%) and Succession Planning (44%) were also of major interest.

Remuneration and Board elections were the key areas in last year’s report, however Related

Party Transactions saw the greatest increase from 9% to 67%.

Graph 1: Corporate governance areas investors will pay particular attention to in 2016

Issuers can expect their shareholders’ policies or principles to continue to change as 69% of

respondents’ voting policies are expected to update in 2016, particularly with regards to

Remuneration. Investors are likely to scrutinise whether remuneration policies reflect the Key

Performance Indicators against the company’s own performance benchmark. Accordingly,

companies are recommended to monitor their investors’ policies/principles on a continual

basis in order to foresee potential issues.

100%

83%

67%

44% 44% 39% 39%

11% 11%

22%

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Engagement

Investors in this years’ survey are typical ‘active’ investors in respect to engagement with

their portfolio companies. Of the respondents, 94% indicated they have an engagement

policy1.

Level of Engagement Outlook

Graph 2: Expected level of investor-to-issuer engagement

An interesting finding from last year’s survey suggested 55% of respondents expected their

level of engagement with portfolio companies to increase in the following year. Our latest

survey suggests that this trend has accelerated with 63% of investors expecting their level of

engagement to increase in 2016. Furthermore, none expected their level of engagement to

decrease, implying that companies will face increasing requests for contact from their

investors; this is likely due to a heightened sense of responsibility by investors encouraged

by regulatory developments such as the Shareholder Rights Directive and National Investors

Stewardship Codes.

Investor-to-Investor Engagement

The results from the survey also suggest that investor-to-investor engagement has seen

recent significant changes; 94% of respondents stated that they have been approached by

other shareholders to discuss corporate governance related issues or concerns in the lead

up to a shareholder meeting. Furthermore, over the last three years, 80% of respondents

stated that this had increased. Additionally, 56% of investors state that they believe investor-

to-investor engagement is likely to increase even further over the next 3 years whilst the

remaining 44% state that the level will remain constant.

1 Engagement policy is defined as an investor seeking to engage with a company in order to start a dialogue to discuss

decisions before they are formalised.

61%

39%

0%

55%

45%

0%

Increase Remain the same Decrease

2016 Outlook 2015 Outlook

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Graph 3: Investor-to-investor engagement: level of investors which have been approached by shareholders in the lead

up to a shareholder meeting

The results above suggest that dialogue amongst investors is becoming increasingly

common. Corporate governance industry bodies, such as the International Corporate

Governance Network also provide platforms which encourage this level of engagement.

Informed Engagement

The survey sheds some light on some of the practical issues investors face during

engagement with companies. Only 7% of investors stated their portfolio companies have

‘Good Knowledge’ of their policies; 50% of respondents stated their portfolio companies

have a ‘Broad and General Knowledge’ of their policies; whilst 14% of respondents stated

that their portfolio companies have ‘No Knowledge’ on their voting guidelines or policies.

Representatives of companies should prepare and familiarise themselves with their

investors’ voting policies or principles, prior to engagement, which should complement

effective engagement.

Graph 4: The level of knowledge issuers have on their investors voting policies/principles

Another important issue companies should consider is timing their engagement efforts

around their investors and to avoid busy periods, such as ‘Proxy Season’, where access can

be limited. The Graph 5 illustrates the best time to approach investors from their perspective.

Clearly, companies should ideally seek to focus engagement efforts outside of April, May

and June for a better chance of securing engagement opportunities.

94%

6%

Yes

No

13%

50%

25%

13%

Good Broad Limited No Knowledge

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Graph 5: Best time to engage with investors

Topics of Discussion

Graph 6: Topics of discussion: topics initiated by investor versus topics initiated by issuers

0% 20% 40% 60% 80% 100%

December

November

October

September

August

July

June

May

April

March

February

January

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

Initiated by Investor Initiated by Issuer Difference

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Investors were asked whether the topics they wish to discuss with companies were aligned

with topics companies wanted to engage on. Our survey suggests the top two topics of

discussion for investors are Risk Management and Board Composition, whereas companies

prefer to engage on Executive Compensation and Performance. The most significant

disconnect lies with Risk Management, where 88% of investors commonly discuss this when

initiating engagement compared to only 29% of issuers. It could be concluded that that

issuers are less pro-active in discussing areas such as Risk Management, even though it is

a topic of strong interest to investors. Furthermore, issuers are encouraged to identify

investors’ topics of interest and not to purely discuss those topics which require immediate

attention commonly used in a re-active approach to engagement. This also highlights the

disconnect of Risk Management impact and the ability of Boards to address this to their

investors. Given that investors wish to discuss a wide range of topics with companies, the

challenge for companies is ensuring that relevant representatives within management or

board directors are available to engage with investors. Other areas of significant

misalignment include Board Practices / Policies, Management Oversight, Environmental,

Audit & Accounting Issues and Strategy.

Risk Management

Cybersecurity, Environmental & Social, Internal Controls and Succession Planning are the

risk management areas respondents will be scrutinising in 2016. According to the survey,

81% of respondents stated that risk management of their portfolio companies will impact

their voting behaviour. Moreover, respondents continue to link risk management with board

elections; 100% of respondents would consider voting against or withhold at board elections

if a portfolio company experiences a material failure of risk oversight.

Graph 7: Key risk management areas investors will pay particular attention to in 2016

38% 38%

25% 25%

13% 13% 13% 13% 13% 13% 13%

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Level of Disclosure

The quality of risk management disclosure in general was a concern for investors as 58% of

respondents stated that their portfolio companies do not provide sufficient disclosure on their

risk management policy and internal control process, preventing respondents from

effectively evaluating them against their own internal guidelines/policies. The disclosure of

risk management is increasingly linked to board elections; 63% of respondents would

consider voting against a board if there was no risk management policies disclosed, which is

an increase from 32% last year.

Graph 8: A 2016 versus 2015 comparison on whether investors will vote against a board if there were not risk

management policies

Cybersecurity

A number of recent high profile intentional cybersecurity threats have resulted in increased

scrutiny from investors regarding the level of disclosure of cybersecurity risk and prevention

measures. Cybersecurity prevention itself remains a concern for respondents, as 50%

believe their portfolio companies do not have the relevant risk measures in place to deal with

the increasing threat. In the U.S., the Securities and Exchange Commission has addressed

this issue and implemented disclosure guidelines for companies regarding skill sets of their

board. It will be interesting to see whether European bodies follow suit by implementing its

own set of cybersecurity disclosure guidelines.

Graph 9: Do investors feel their portfolio companies have the relevant risk measures in place to deal with the

increasing threat of cybersecurity?

62%

38% 32%

68%

Yes No

2016 2015

50% 50% Yes

No

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Environmental & Social

Environmental issues are likely to become higher priority issues following the December

2015 Conference of Parties meeting in Paris as well as number of shareholder initiatives

directed at Greenhouse Gas (“GHG”) emissions and companies strategies for reducing their

environmental impact both on GHG emissions and water usage. Climate Change and Health

& Safety were the top two ranked Environmental & Social areas investors will look to

scrutinise in 2016.

Graph 10: Key Environmental & Social areas investors will pay particular attention to in 2016

Succession Planning

Institutional investors are becoming increasingly concerned of succession planning and

whether or not the board of companies has discussed this issue on a regular basis.

This section provides an insight as to what extent investors prefer to be involved in the

succession planning process, the level of disclosure provided on the process and whether

investors believe their portfolio companies are prepared for long and short term succession.

56% of respondents stated they believe companies should be more pro-active in including

their investors in the succession planning process. Investors outlined three main stages to

the succession planning process: Criteria Setting, Screening and Selection.

0% 10% 20% 30% 40% 50% 60% 70% 80% 90%

Supply chain breakdowns

Gender diversity

Bribery and corruption

Human rights

Resource depletion

Health and safety

Climate change

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Graph 11: Should companies be more pro-active in including investors in the succession planning process?

There were varying preferences as to which stage of the succession planning process

investors preferred to be involved. With respect to having involvement in criteria setting one

investor commented “Engagement around the individual's ideal qualifications would be

important as well as around the direction of the company post change. Particularly the

impact on the board functioning”.

Graph 12: Should companies discuss a short-list of potential candidates with their investors?

Respondents’ views were mixed in relation to the screening stage; 71% of respondents

believe companies should not discuss a short-list of candidates with their investors. On the

other hand one investor commented, “Companies should circulate the CEO and board

profiles and discuss with their shareholders”. Then again, another investor stated that they

“Trust the Board with the screening of candidates and do not require to do so ourselves.

However, there are certain cases where we would request this. Whether we are involved

prior to or after the recruitment search depends on the specific situation. In the past we have

done both.” Lastly, 54% of respondents prefer to be involved after the recruitment search.

56%

44% Yes

No

29%

71%

Yes

No

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Graph 13: Do investors prefer to be involved prior to or after the recruitment search?

The results presented in this report clearly suggests that there is no single answer as to

whether companies should be more proactive by including their investors in the succession

planning process and, if so, at which stage. Accordingly, nomination committees of

companies are encouraged to open a dialogue with investors to discuss what their

preferences are. With Cybersecurity and Environmental & Social areas being key risk

management areas for respondents, Boards can expect increasing engagement by investors

ensuring that they have the relevant skills and experience within these areas.

Disclosure

A further point companies should consider is how their investors view the quality of

disclosure of succession planning within their annual report: 70% of investors indicated that

this was less than “Satisfactory” with zero investors describing the level of succession

planning as ‘Satisfactory to High’ or ‘High’.

Graph 14: Quality of succession planning disclosure

Low Low -

satisfactory Satisfactory Satisfactory -

High High

29% 41% 29% 0% 0%

A second point to consider is that only 47% of respondents stated that their portfolio

companies were equally prepared for long and short term succession. Concerns relating to

the quality of disclosure and whether companies are equally prepared to deal with short or

long term succession may help explain the request for investors to be involved with the

various stages of the process.

54% 46%

After the recruitment search Prior to the recruitment search

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Graph 15: Level of preparedness for short term and long term succession

Remuneration Policy

Graph 16: Management resolutions investors are most likely to vote against in 2016

Similar to the 2014 findings, Remuneration is the key management resolution investors are

expected to vote against in 2016. Given the efforts by the European Union on capping

bonuses and Dutch laws restricting bonuses, remuneration levels are going to be under

increased scrutiny going into 2016.

Disclosure

The link between the level of disclosure of remuneration policies and voting behaviour is

strong with 33% of respondents indicating they would vote against a remuneration proposal,

which is particularly relevant if there were no forward-looking performance criteria disclosed,

emphasising the importance of linking remuneration to long-term performance. The majority

of respondents would review this on a case-by-case basis suggesting that this isn’t

necessarily a systematic decision for all investors.

47%

27% 27%

Equally prepared Short Term Long Term

67%

42%

33%

25%

17% 17%

8%

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One respondent justified voting against a remuneration policy by commenting with the

following, “We do vote against comp plans and say-on-pay proposals when there is a lack of

disclosure that impairs our ability to objectively evaluate the plan's incentive ability and

ultimate success.”

Performance Criteria

Investors continue to use a range of performance measures when evaluating proposed

schemes as 100% of respondents prefer to use more than one performance metric.

Respondents were asked which stock based remuneration performance measures investors

are currently using to evaluate a proposed scheme. Total Shareholder Return (TSR) versus

Peer Group and TSR versus Index are the preferred external performance criteria.

With respect to TSR, there are growing concerns that this may be an inappropriate

benchmark as there are many factors affecting stock performance which go beyond an

individual company’s financial performance, such as macroeconomic, geo-political and

regulatory changes.

Graph 17: External remuneration performance criteria

Internal performance criteria tends to be wide spread across a range of criteria including

Return on Capital (94%), Company-Specific Key Performance Indicators (89%), Earnings

per Share Targets (72%), and Cash Flow (67%). Interestingly, last year Non-financial

Measures2 (65%) was the most common criteria, however this year it is the least popular

with only 50% of investors considering using this when evaluating proposed schemes.

Return on Capital saw the greatest difference as last year this was only selected by 55% of

investors.

2 Non-financial measures 65%, Company-specific Key Performance Indicators 55%, Return On Capital Targets 55%, TSR Targets 50%, EPS Targets 50%, Cash Flow Targets 35%, None 5%.

88%

65% 59%

47%

18%

Total shareholderreturn (TSR) versus

peer group

TSR versus index Earnings per sharegrowth versus peers

Earnings per sharegrowth versus index

None

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Graph 18: Internal remuneration performance criteria

Voting Issues

Stock Lending

Stock lending activity levels remain the same as last year as 68% of respondents are

involved with this practice. The survey revealed that Investors are more likely to recall

shares, in order to vote, during M&A transactions rather than AGMs. Stock lending can have

significant impacts on voting outcomes at shareholder meetings, particularly during

contentious meetings or scheme of arrangements whereby fair representation is required

thus companies encourage maximum voting participation. The drivers behind the decision as

to whether investors recall shares varies based on the best interests of either the client or

the issuer. To illustrate this, one investor mentioned recalling shares on loan would be driven

based on their client’s interest rather than that of the issuer. A French respondent stated that

they systematically recall shares for French Issuers and they would treat all other

jurisdictions on a case-by-case basis. Whilst others stated that their decision will be based

around specific events such as proxy events or any controversial resolutions. Companies

need to take into account to what extent their investor base lends stock when preparing for

investor engagement in the lead up to a shareholder meeting, allowing them to assess

potential risks associated with non-votes.

94% 89%

72% 67%

61%

50%

0%

Return on Capital Company-specifickey performance

indicators

Earnings pershare targets

Cash flow TSR targets Non-financialmeasures, (e.g.

employee orcustomer

satisfaction,health & safety,

etc.)

None

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Obstacles to Voting

Graph 19: Most common investor obstacles to voting

Similar to last year, the stand out voting practice which prevent shareholders from voting is

share blocking3; 83% of investors stated this was the key obstacle to voting, an increase of

16% from last year. Share blocking is that exists in some European countries and despite

the European Commission’s Shareholder Rights Directive calling to eliminate it prevails to be

an issue for voting proxies. Other practices such as Powers of Attorney and Personal

Representation Required are also areas investors highlighted.

3 Share blocking is a practice implemented by markets which prevents shareholders from trading or loaning shares for a period

of time up to a shareholder meeting.

83%

44% 39%

22%

11%

Share blocking Powers of attorney Personalrepresentation

required

Re-registration None

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