Governance Factors Flashcards
What are the two A’s of corporate governance?
Accountability:
People need to authority and responsibility for decision making
Alignment:
When properly aligned execs and board members are not subject to incentives to protect their own interests contrary to the interests of the company owners/shareholders.
What is the flow/chain of corporate accountability?
Workforce => Management => Corp board => Fund manager => Asset Owner => Beneficiaries
What is the “agency problem” and in what types of companies is this problem magnified?
First discussed in the publication “ The Modern Corp and Private Property”, agency problem arises when the interests of professional managers/agents are not wholly aligned with the interests of the business owners.
This is magnified in larger public companies.
What are 3 key committees usually required by corporate governance code?
1) Nominations Committee (or Corp Governance Committee) - ensures that board is balanced, effective and accountable
2) Audit Committee: Oversees financial reporting and audit. Many times has Risk oversight as well.
3) Remuneration Committee:
Seeks proper alignment through exec pay.
Expectation that the Audit and Remuneration committee is populated solely by independent non-exec directors.
What is the only major world market to NOT have a “Cadbury Code” model of board recommendations?
USA - because corporate law is set at the state level, not federal.
What are the 5 themes of the Corp Governance Code in the UK aka Cadbury Code ( comply or explain)?
1) Board Leadership and Company Purpose
2) Division of Responsibilities
3) Composition, succession, and evaluation
4) Audit, Risk and internal controls
5) Remuneration
These themes are consistent with most of the worlds corp gov codes.
Also Guide to Board Effectiveness published with new code
ICGN ( Int’l Corporate Governance Network)
Global Governance Principles provide what?
A complete investor perspective on independence criteria of board members - extend on some of the already included criteria. Proposes there will be questions about the independence of an individual who:
1) Previous company executive that has not had sufficient gap between joining the board
2) Received or has received incentive pay from the company ( anything that goes on beyond normal board fees)
3) Close family ties with any of the company advisers, senior mgmt, or directors
4) Significant shareholder in company or representative of the state
5) Has been a director so long that independence is compromised.**
**The issue of the length of tenure on the board and independence is one generally recognised around the world
(though it is not acknowledged even as an issue in some major markets, most notably the US), but where different standards are applied.
What provides the greatest conflict of interest between shareholders and management?
Executive Comp - especially in its variable forms which are bonus and LTIP.
4 main categories are:
- Annual Pay
- Benefits including pension
- Annual Bonus
- Share linked incentives ( Long term incentive plans: LTIP)
Name the largest shareholder concerns for Financial Integrity and Capital Allocation?
- Distribution of Cashflow
- Capital structure especially debt
- Balance between financial resilience and maximizing short term gains
Issues central to an ethical approach to business aka Business Ethics?
- Expected behavioral standards for all staff
- Treating employees fairly including health, safety, and human rights
- Avoid discrimination, treat customer fairly ( no marketplace collusion)
- Paying suppliers appropriately
- Developing appropriate relationships with local communities
- Pay taxes
- Approach lobbying in a fair manner
- Protect company reputation
US & Corp Governance is unique…list the reasons why?
What the best practice guides utilized?
- Only major market not to have its own Corp Governance Code, reason why is because of corp gov is a state law, not federal. This has lead to a race to the bottom in terms of corp law as it pertains to company standards in order to garner as much corp tax as possible. Delaware has won this rice accounting for half of all US publicly traded corps in the world.
- Best practice guides include:
1) Common Sense Corp Gov Principles established by a coalition of financial groups - focuses on inner workings of governance including board effectiveness, accountability and alignment
2) ISG ( Investor Stewardship Groups) Corp Gov Principles: focuses on company relationship with shareholders.
3) Corporate Governance Policies of the Council of Institutional Investors (CII): Less of a set up principles and more an indication of positions by CII members
What are the two key questions investors need to ask themselves when evaluating whether a board is adequate in its oversight, knowledge and capabilities?
- Is there the right mix of skills and experience, and enough of the right skills and experience, to properly oversee the next stage of development of this business? If there are obvious gaps, investors need to consider how those gaps might best be filled.
- Is there the right dynamic around the board table to enable the views of the appropriately skilled individuals on the board to be heard? This is about behaviours and so is inevitably harder to identify from outside; nonetheless, there are often indicators suggesting that the board dynamic
is not as effective as it might be.
Fun Fact: And when evaluating founders/disruptors: “How do you go from succeeding by not listening to succeeding by listening?”….
The G in ESG has the strongest academically researched correlation to financial performance….
As indicated by Bernile, Bhagwat and Yonker’s 2017 study concludes that diversity in the board of directors reduces stock return volatility (consistent with diverse backgrounds working as a governance mechanism) and that firms with diverse boards tend to adopt policies that are more stable and persistent, consistent with the board decisions being less subject to idiosyncrasies
In addition, while diverse boards take less financial risk, Governance failings lead to fines and additional liabilities, as well as litigation and other costs. Revenues also fall as trust is eroded and customers boycott the company or buy from competitors, and profits fall as additional cost burdens are placed to mitigate future risks.
All of these effects harm security values. Governance analysis should be a core component of valuation practice.
Name the different ways managers incorporate Governance factors into their decision making processes…?
1) Threshold Assessment: Formal mgmt team and governance structure minimum criterion before they consider making an investment
2) Risk Assessment: may represent the level of confidence about future earnings or the multiple on which those earnings are placed in a valuation – e.g. recognising negative governance characteristics by way of adding a risk premium to the cost of capital or raising the discount rate applied.
3) Opportunistic Investing: logic being that governance can be improved through active dialogue with management and proxy voting such that past underperformance, on which the company is valued in the market currently,
is reversed and the valuation can be enhanced by stronger performance and an expectation for more positive performance in the future.
Name the one asset class where governance will always have a different meaning and why?
one asset class where the G of ESG will always have a very different meaning. In the sovereign debt arena, G means the effectiveness of the governance and robustness of the state and its institutions,the approach to the rule of law and the general business environment (including such issues as competition and anti-corruption).
ESG-minded investors are
increasingly integrating the analysis of these issues into their broader financial analysis of sovereign credits
