Public stakes in public companies: Does the Northern Rock private shareholder-government dispute portend the future of investor relations at bailed out companies?
In recent months, the possibility and desirability of government nationalization has entered into the public discourse. Media reports on government plans for the creation of a national 'bad bank' or 'deteriorated assets purchase and management agency' now appear frequently, even as governments explore options of ownership in sectors critical to economic recovery. Such a move, which would have been unthinkable a few years ago, makes it necessary for investor relations officers to prepare for the probable implications of government majority holdings in public companies on traditional investor communications. In coming years, the burning issue for investor relations officers will be how they reconcile the interests of their traditional private capital sources with those of the government, as major shareholder. In this post, we use the Northern Rock case to show the types of conflicts that can arise when governments rescue companies in distress, the difficulties these salvage operations place on corporate investor relations and the implications of the mode of government takeover for the future of capital markets.
As the aggressive privatization of the last two decades u-turns to creeping nationalization, governments are replacing institutional shareholders and financial institutions as the key constituency to win over in the competition for capital. Most commentators, including the media, have focused on the explicit cost implications of this source of capital. But there are also hidden costs involved in government ownership of significant stakes. It is an irony that government intervention which seems inevitable to unblock the freeze in capital markets, may put it at long-term risk.
Barely a month after the UK government announced its bailout of Northern Rock, the troubled mortgage lender in September 2007, Robin Ashby formed the Northern Rock Small Shareholders Group (NRSSG), with the following stated objectives:
A preference for Northern Rock to remain an independent, publicly quoted business headquartered in the North East, supporting the Northern Rock Charitable Foundation.
Vigorous opposition to a ‘fire sale’ of the company’s assets at below true value, and the dismemberment of the business.
A stipulation that if the company is acquired, the NRSSG’s preference will be for a buyer of the shares who gives small shareholders the option of remaining shareholders going forward.
Avowal to resist pressure by authorities to compel Northern Rock to actions which are not in the best interest of the small shareholders.
Ashby whose campaign has received a lot of publicity has become the flagbearer for shareholders of financial institutions who are challenging the terms of government financial support through credit facilities and equity participation in their companies. In the following interview Ashby describes the grievances of these shareholders.
A few weeks after the NRSSG was formed, Robert Harris, who owned 1,500 ordinary shares in the troubled lender, wrote a reply to a letter sent to the bank’s shareholders by Andrew Caldwell of BDO Stoy Hayward, the UK government- appointed independent valuer of the lender. In his reply, Harris stated his views on the recent events at the bank and the government’s role in the worsening of the situation.
Perhaps, one could easily dismiss Ashby, and his group as investors with insignificant stakes and that their concerns were limited to the retail base of Northern Rock’s share register. Nothing could be further from the truth.
Two hedge funds, SRM Global and RAB Capital, which together owned about 20% of the bank’s shares were also vehemently opposed to the planned fire sale of the bank. Working in concert, the funds pressured the bank’s board to call an extra-ordinary shareholders’ meeting in January 2008 to amend the company’s articles of association specifically so that any disposal of more that 5% of the bank’s shares would require shareholder approval.
A month later, to the shareholders’ utmost surprise, the Brown government announced the nationalization of the bank. In his remarks on the government action, Alistair Darling, chancellor of the Exchequer, said that it was ‘the right decision at the right time.’
Shareholders immediately disagreed with the basis of government action. The battle lines were drawn.
Let us now examine the causes of dispute.
The validity and sustainability of the business model versus the shock and unpredictability of current economic climate: Shareholders of the bank have always insisted that the bank had a lucrative and perfectly sustainable business model. They further argue that while the bank’s business model depended heavily on short-term funding and as a result, faced risks because of the asset-liability mismatch, there is no doubt that it had a high quality loan book and low default rates. According to a Financial Services Authority statement in September 2007, ‘Northern Rock is solvent, exceeds its regulatory capital requirement and has a good quality loan book. The decision to provide a liquidity support facility to Northern Rock reflects the difficulties that it has had in accessing longer term funding and the mortgage securitization market, on which Northern Rock is particularly reliant.’ According to shareholders, the credit markets drought is unprecedented. The bank should not be unduly penalized because it is a victim of the crisis and not the cause.
The basis for intervention: Shareholders argued that the Bank of England had an obligation as the lender of last resort to come to the bank’s rescue. This is the duty of central banks, when the financial institution in distress has satisfactory collateral. In its statement, the Bank of England said that ‘central banks, in their traditional lender of last resort (LOLR) role, can lend “against good collateral at a penalty rate” to an individual bank facing temporary liquidity problems, but that is otherwise regarded as solvent. The rationale would be that the failure of such a bank would lead to serious economic damage, including to the customers of the bank. The moral hazard of an increase in risk-taking resulting from the provision of LOLR lending is reduced by making liquidity available only at a penalty rate.’
The entire crisis was precipitated by the failure of the Bank of England to understand bank risk and to make adequate provisions for same: In his letter to Andrew Caldwell, the government-appointed independent valuer, Robert LS Harris stated that, ‘the crux of this matter is the enormously damaging impact on the share-price and trading conditions of Northern Rock by the ineptitude of the Government, most particularly the Tripartite authorities (Bank of England, Financial Services Authority and HM Treasury). . . From the foregoing, the facts suggest that the scope of your remit must include a proper examination of the central role of the Government in bringing about the demise of Northern Rock as an entity owned by shareholders whose property rights should have been protected by Law against nationalisation by that same Government whose Tripartite authorities had a duty to properly regulate Banks which, in turn, would protect automatically the interests of shareholders.’
The valuation of the company: Northern Rock shareholders actively rejected the terms of reference given to the independent valuer because it contradicted the understanding that the bank had a temporary liquidity problem as opposed to a permanent disruption. According to Andrew Caldwell, the independent valuer, compensation payable by the UK government would be based on a valuation model that assumed that Northern Rock would be unable to continue as a going concern, and that it is already in administration. The UK Shareholders Association has made clear its vehement opposition to the basis of valuation used by the government appointed independent valuer.
The strategic options on the future of the company: The shareholders had urged that the government give serious consideration to the purchase interest of Olivant, led by Luqman Arnold, former chief executive of Abbey National, and reject the bid of the Virgin Group led by Richard Branson. The government was disposed to approve Branson’s bid.
These grave disputes have led to a bifurcation of interests between the government as the new owner of bank, and legacy shareholders, who have seen a drastic diminution in the value of their holding.
What does all this mean for corporate investor relations? We have some hypotheses.
Different perceptions between key shareholder constituencies about the worth of the firm limit its ability to enter strategic transactions whose completion is dependent on the value of the equity component.
For the current crisis period, the government position will likely prevail over those of other shareholders in the contest for determination of corporate priorities. However, this influence while remaining significant, will diminish over time.
Traditionally, the message crafted by corporate investor relations focused on the profit maximization goal with only a formal nod to the social costs of achieving this objective. The presence of government as majority equity holder of bailed out companies will ensure a bigger social component in the company’s value narrative and investments.
The increased attention on the social component at bailed out firms may affect their ability to compete with firms which are not saddled with those considerations.
Since the incentives and strategies of governments change, and their incentives are not primarily profit-driven, companies that receive bailout funds may find themselves in a tight alley, where their strategic options are limited by the approval of the government.
Since governments are unlikely to focus on capital gains as the significant metric for keeping or selling a stock, and the ability of firms to raise capital will depend on factors other than their risk profile, for instance, political connections, the share price as a measure of value created may gradually become less relevant.
Investor relations will play a bigger role in corporate strategy at bailed-out institutions. It used to be that the role of head of investor relations was at best, a middle management position. All that is set to change.
Investor relations officers will need to add executive branch and legislature relations to their skills portfolio.
Analyst coverage may gradually become less important since government portfolio trading will hardly be determined by BUY, SELL, HOLD recommendations. Instead, an oversight role within government offices may slowly replace the role currently played by analysts.
There may be a reversal or slow down in corporate performance disclosure.
The retail shareholder base of bailed out companies with decline to a negligible percentage.
The retail shareholder-institutional shareholder dichotomy as regards access to management will shift to institutional shareholder-government dichotomy because when companies will approach the market to raise the next round of capital to shore up their depleted equity, they are likely to do so via placements with deep pocketed capital, that will lock up their holding for a specified period.
The move from public markets to ’sheltered’ markets will require corporate investor relations departments to shift the vicious short-term public reporting cycle to a longer-term one similar to private equity.
Shareholders, that is the government mainly, will play an increasingly bigger role in the determination of strategy, even as there will be divergences on strategy between governments and institutional shareholders on the register.
Shareholder wealth creation may assume contradictory meanings for the different shareholder constituencies.
All these will materially change the role of investor relations within the corporation and how it is perceived both within and outside the organization.
In the past, the role of corporate investor relations was to assure the company’s success in the competition for capital, broadly defined. Now, in addition to that, corporate investor relations will have to advice the board on how to manage its two groups of investors, private and public capital, in their competition for control.
So while corporate investor relations will continue with its traditional administrative and communications responsibilities, it will take on a wider strategic remit within corporations. As investor relations enters this unfamiliar phase, things will never be the same again.
One cannot help noticing how Niyi Meka Olowola, Oando's Head of Corp Comms, is nodding in approval. Maybe Goldman Sachs can learn lessons.04:47:49 PM January 25, 2012from HootSuite
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