Michał, thank you very much for accepting the invitation to ESG 12on12! You are a corporate governance practitioner, you have looked at our Polish capital market from the perspective of an institutional investor nominating independent supervisory board members. Over the last years, you have been sitting on supervisory boards as a professional independent board member, often also a member of audit committees. Also our discussion will revolve around corporate governance.
Milena, I am very pleased that you invited me to join your series. In the field of ESG, that last letter, „G for governance”, is often treated a little lightly and definitely overshadowed by environmental issues. And the truth is that corporate culture, which relates to the quality of governance and control, is fundamental to long-term value of companies. I firmly believe that only companies with high standards of corporate governance can achieve real long-term success.
The Warsaw Stock Exchange recently celebrated its 30th birthday. How do you look back on those three decades? What has changed?
For a Polish investor, these 30 years seem like a very long time to develop the capital market, but from the perspective of mature stock exchanges that have been in existence for over hundred years, we are still in the early stages of development, with all the childhood diseases that accompany it. Nevertheless, our market should definitely be praised for its legal and technical infrastructure, increase in market accessibility for retail investors and development of the range of instruments on offer. There is certainly still a lack of ETF or REIT-type instruments, which would help encourage a wider range of Poles to invest. Creation of best practices remains open as unfortunately, like the tail-coat, do not fit well with the first generation.
It would seem to me that 30 is such a mature age, when the mistakes of youth are no longer made. And yet, in September 2020, in a survey on corporate governance, which I prepared for CFA Society Poland, no one out of 101 respondents answered that the level of corporate governance in Poland is high, and the vast majority answered that it is low. What is the reason for this in your opinion?
We are making definite progress in improving the quality of corporate governance, for example through systematic implementation of the Best Practices for Listed Companies and the grass-roots work of independent supervisory board members. However, it is precisely the youth of the Polish market and listed companies, which is inextricably linked to ownership structure, that makes this a very laborious process. The Polish stock market is definitely dominated by two types of companies: state-controlled and „family-owned”. The former dominate the WIG20 index and the finance, energy and raw materials sectors, i.e. those crucial for the economy and for the development of the capital market. The latter are mostly small and medium-sized growth companies, offering the market a chance for dynamic growth of results and valuations. According to the WSE, out of 422 listed companies, as many as 172 have a family status, i.e. are controlled by founders, often entire families who sit on company boards. Very few companies are controlled by institutional investors, which is standard for mature corporations listed on mature markets. Corporate governance in a company is always imposed by the leading owners. Without their goodwill, no amount of legislation or best practice will improve the situation.
Is there a chance for our capital market? What changes/reforms would have to be made to improve it?
Considering how important Poland is, how dynamic its economy is, how well educated and hard-working Poles are, definitely our capital market has a good time ahead of it. Of course, I am talking here about long-term horizon. In the current difficult geopolitical reality, I remain optimistic and believe that Poland can be the West’s gateway to rebuild the East, both materially after the war and institutionally towards democratisation and a market economy. And in a strong economy there must be a strong capital market that allows companies to raise capital and price it optimally, and shares and bonds of these companies should be a natural part of the portfolios of wealthy citizens.
Certainly the authorities should be expected to build confidence in the capital market, which should lead to an increase in the scale of savings and private investment, primarily in long-term savings and pension plans, which should be a natural source of capital for Polish companies. Efforts should be made to support development of institutional investors, such as mutual funds and pension funds, which manage the savings of Poles. These institutions, if they grow to an appropriate size, will have a positive impact on long-term development of companies and on improving the standards of the capital market. Ideally, it would be possible to reform the way state-controlled companies are supervised, so as to maximally exclude the influence of short-term decisions of those currently in power on the composition of company boards and their strategies.
There is much discussion on the capital market about the „passivity” of institutional investors, i.e. institutions professionally engaged in investing savings entrusted to them by their clients. Do you think this is the case or are institutional investors’ hands often tied?
It is true that the structure of the market forces a focus on short-term performance rather than on corporate actions. This is also what clients, especially of mutual funds, expect. There are literally only a few institutional investors that are large enough to care systematically about the quality of corporate governance in Polish companies. A vast majority of Polish mutual and pension funds prefer to take a position under 5% of equity in a company in order to be more flexible with the generally low liquidity of the shares. As a rule, managers make a conscious decision to remain passive in corporate matters; they do not want to influence the shape of the company’s governing bodies and strategy, as this generates the inevitable conflict with the largest shareholders I mentioned earlier. This will change only when the scale of investment funds’ assets is much larger, and when changes take place in the shareholdings of companies, primarily as a result of succession after their founders, as I would not count on privatisation of large companies.
One of the ways in which institutional investors have influence is through their voting rights at general meetings. Which votes at general meetings do you think are the most important and could change the status quo?
First, there must be a long-term increase in the scale of assets under management of institutional investors so that they have a real say in the decision of general meetings. Then there must be a fundamental change in the attitude of fund managers to recognise the value of corporate action, sometimes at the expense of short-term performance. Then there is a definite need to reform corporate bylaws, which are often not very modern and do not take into account the interests of investors beyond the company’s founders. The next step is to reform the approach to the composition of supervisory boards to build a well-thought-out team of people with complementary qualities, competences and experience to do a specific job for the company and its shareholders.
You mentioned supervisory boards. Institutional investors have a possibility to nominate independent supervisory board members. How often do they use this opportunity and how do they select these individuals?
It is an accepted practice that an institutional investor who has more than 5% of votes in a company has the right to propose a candidate for the supervisory board. But I keep coming back to the shareholder structure. Each supervisory board member is elected by a simple majority. Voting by groups is a fringe that means war in the company, so everyone wants to avoid it. So a major shareholder, who virtually always has majority at the AGM, must agree to allow an independent board member into the company. It is not obvious that every candidate, especially „too independent”, will be accepted by the leading shareholder. So the work of such an independent member of the supervisory board, in the realities of the Polish ownership structure of companies, is in practice balancing on the borderline between professional supervision of the management board and maintaining proper relations with the main owner and the management board, which always sides with the largest shareholder. Often such a person is alone on the supervisory board, and practically always in the minority. Thus, when choosing a candidate, the investor must take into account his or her specific industry or financial skills, experience on corporate boards and the character traits that will enable him or her to function effectively in the realities described above.
30% Club Poland survey „Diversity on Supervisory Boards 2021 ” conducted among domestic institutional investors in September 2021 showed that the key value for institutional investors is the „independence” of a supervisory board member. I talked about statutory independence with Iwona Gębusia, Phd Habil. in April. What does this word mean to you?
Above all, it is about factual independence. A supervisory board member should be free to express his or her opinion and take decisions in the interests of the company and all its shareholders and stakeholders more broadly because he or she is personally responsible for the fate of the company. If such a person is in any way related, materially or personally, to the company, the management board or a major shareholder, this always precludes independence. It is very difficult to write it down in the law or best practice, and even more difficult to verify. Unfortunately, solutions currently functioning on the Polish capital market are far from effective, and it is quite common for members of boards to submit written declarations of independence, but they are far from that status.
And how to maintain such independence in practice, when it is customary for the majority shareholder to dictate his/her own terms in the supervisory board and in the general meeting, not being very interested in any other opinion, and also when institutional investors may not be supportive (they may care more about relations with the management than about an independent supervisory board member)?
This is a very serious and real problem in Polish conditions. Fund managers do indeed value good relations with the management boards of companies in which they have significant stakes, which is quite natural. There is a natural conflict between a properly functioning supervisory board and management board, which should be understood and accepted by all stakeholders.
An independent board member who wants to be effective must have strong team skills and above-average interpersonal skills. It is important to remember that the board is a collegial body and a single member can easily be outvoted or ultimately removed from the board. It must be made clear to everyone involved that you are acting in good faith in the interests of the company and all its shareholders, including the lead shareholder and all board members, each of whom is personally liable if the board does not act properly. If this is not understood and accepted by the majority of key people in the company, there is no chance of successfully fulfilling the role of an independent board member.
The corporate governance survey I mentioned earlier showed that one of the solutions that institutional investors see is the appointment and dismissal of independent supervisory board members by minority shareholders, i.e. excluding the main shareholder. What do you think about this solution and is it feasible to implement in Poland?
At the outset, I would like to point out that the fact that a given candidate is not voted for by a leading shareholder does not prejudge his independence, because he may in fact be dependent on a minority institutional investor. Rather, we need to ensure that a best practice develops of naming as independent candidates those persons who in fact are such and will act in the interest of the company and all its shareholders. It is crucial to understand that independence of judgement, courage in presenting one’s own opinion, criticality in evaluating documents and financial reports and facts of company life, is always good in the long run for the value of the company, i.e. it also supports the interest of its shareholders, including the dominant one. For the solution you ask about to be effective, there must be a strong base of active institutional investors in Polish companies. If, in practice, at a general meeting there are often, in addition to the main owner of the company, who has more than 80% of the votes, management board members with some shares and one or two funds and sometimes an individual investor, such an election of a board member would be a de facto delegation. Under Polish law, each member of the board works for all shareholders, so he or she should have the mandate of the vast majority of them. In my opinion, such a tool of appointing independent members makes sense only in companies where there is a wide range of active shareholders, including institutional ones.
We are both members of the Association of Independent Supervisory Board Members. In your opinion, what should characterise an independent supervisory board member? Who is „suitable” for such a position?
It is crucial that such a person is professionally and financially stable, so that his or her professional and material status does not depend on his or her fate in the given board, on his or her remuneration or potentially on his or her dismissal from the board. She or he should have a high level of both specialist (financial or industry) and interpersonal competences, because this is above all working with people. You also need a high level of assertiveness, as pressure and conflict are inevitable, as well as the ability to reach a compromise. You also need to be uncompromising when it comes to the company’s compliance with the law.
How do you see the role of the supervisory board in communicating with capital market participants. What are the standards currently, and what do you think they could look like?
Formally, the role of the supervisory board is to oversee the company’s compliance with its disclosure obligations, for which the management is responsible. It is best practice for the board to discuss how management should fulfil this function in order to properly inform market participants about the company’s performance and strategy in such a way that the company surprises the market as little as possible. The purpose of communication is to obtain a reliable image of the company on the market. Care should also be taken to ensure that management does not succumb to the temptation to manage investors’ emotions excessively through unnecessary or inappropriately edited current reports. Supervisory board members, particularly the audit committee, should read in detail each financial report of the company and submit their comments to the management board before the report is published. It is best practice for a delegation of the supervisory board to be present at the company’s general meeting to answer shareholders’ questions. The presence of the chair of the supervisory board is, in my opinion, mandatory. In my opinion, there is also a need for consultation with major shareholders prior to the most important decisions for the company. It is crucial here to stick to the principle that the information wall in the company is between the supervisory board and all shareholders, so the discussion can only take place on the basis of generally available information.
The role of a supervisory board is currently quite limited. However, a new law is due to come into force – please give us a summary on what the key changes are.
I should note at the outset that I am not a lawyer, so I take a fairly practical approach to legal regulations.
The amendment to the Code of Commercial Companies introduces a Holding Law which will make it possible for the management board to take account of the parent company’s strategy in its management of the company and for the supervisory board to gain more effective insight into the situation in subsidiaries. In this respect the changes apply primarily to complex capital groups, in particular those controlled by the state, or which are part of international concerns.
The modalities and scope of information to be provided by management to the supervisory board will also be clarified. A very important principle will also be introduced, namely that an auditor who audits the company’s accounts must be present at a supervisory board meeting to assess the company’s financial statements. Until now, practice in this area has varied, especially in smaller companies. And the truth is that the independent auditor is the most important tool the supervisory board has in auditing a company’s financial reporting.
Finally, a change that could be fundamental for the supervisory board, which until now has been deprived of its budget, because it could not sign any contracts in the name of the company and had to ask the management board to do it. After the changes, the supervisory board will be able to hire an advisor without the company’s management, but the management will be obliged to provide the advisor with information or documents. This is of key importance in the case of internal audits commissioned by the supervisory board in selected areas of the company’s operation and in the case of hiring executive search consultants. As a practitioner in supervisory boards of small and medium-sized companies, this change will be most important for me.
Michał, thank you so much for sharing your knowledge and experiences.
Milena, thank you very much.