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What Board Members Should Know About Network Theory

13 May 2018  | Oliver Schutzmann, CEO

With annual general meetings season around the corner, a fascinating study has shed light on the psychology behind shareholder voting habits.

Oxford University corporate law professor Luca Enriques and Yale University researcher Alessandro Romano have investigated the behaviour behind institutional investor’s voting patterns – and what they found provides a warning signal for Gulf companies.

Until now, the voting behaviour of institutional shareholders was understood to be a direct outcome of management action: if we propose X, we can expect a vote of Y. In other words, when shareholders vote on company resolutions, either in person or by proxy, it was assumed they made up their minds individually through research and study, and voted on the CEO’s pay or the appointment of Board members accordingly.

Now, using Network Theory, Enriques and Romano demonstrate that the connections of and among those investors matter more, and that very often voting patterns follow pre-established networks of relationships.

“The voting behaviour of institutional investors is affected by their connections with other institutional investors, and with the agents that populate their networks (proxy voters, portfolio company management, etc.),” say the authors in their paper “Institutional Investor Voting Behaviour: A Network Theory Perspective”, published by the European Corporate Governance Institute.

Put simply, the result of votes at company AGMs is more likely to reflect the interests and views of a network of individuals than the actions or views of management, or even best practice in corporate governance . “Institutional investors are embedded in a network formed by various agents, while also being connected among each other through a complex web of co-ownership, formal, and geographical ties,” they continue.

So far so academic. But why is this so pertinent for GCC company boardrooms?

Large-scale institutional funds are very quickly becoming a significant element of regional company ownership, and the network theory of how they vote at AGMs and on other issues is now of growing importance to issuers.

But don’t just take our word for it: evidence of the network is already being seen in shareholder votes in the region. Shareholder fallouts related to expenses management and dividend pay-outs have been a mainstay of regional general meetings. But recent weeks have seen increasingly aggressive shareholders votes against company boards at Dubai-listed Damac, Drake and Skull, and Union Properties, and in Kuwait at Human Soft. And each of these firms suffered a share price fall following the disagreements between shareholders and management. Meanwhile, the dispute between Sharjah-based Dana Gas and holders of its sukuk continues to rumble through the UK courts.

Given this trend, companies need to better understand the motivations of their shareholders when it comes to voting on management plans. And, crucially, they need to understand what, who, and how is influencing those votes. Which is where the Network Theory comes in.

In general, regional executives and board directors have limited links to institutional shareholders, especially passive asset managers and voting teams at active firms, and they are therefore unable to become part of the circle of influence: they remain outside the networks identified by Enriques and Romano that drives voting patterns.

The solution is clear: if companies want to understand their shareholders, influence their voting decisions, and gain a place on the inside of their networks, they have to start undertaking significantly more outreach to those institutions as part of an increasingly proactive and regular shareholder engagement calendar.

To be fair, CEOs and CFOs from the region are already regulars on the roadshow circuit to London and New York. This research suggests, however, that their shareholder networks start much closer to home, and that shareholder revolts driven by network theory need to be addressed though investor relations activities here in the GCC.

Company boards should ask themselves three key questions:

  1. How many shareholders have we met that are not a member of the board of directors?
  2. What do we know about the regional shareowner’s perception about our company?
  3. When was the last time we held an investor day or gave a formal strategy presentation for our regional shareholders? 

Until these questions can be answered, there will be more shareholder revolts, more share price surprises, and more red faces in the boardroom after general meetings.