The corporate governance debate took wrong turning early in the piece and missed the most pressing corporate governance issue: how to address the under-performance of companies so that they are more accountable to shareholders and other stakeholders?
Whether you are running large corporation, small business or are trustee managing Treaty settlement assets, the name of the game must be to build sustainable wealth. Corporate governance is fundamentally about stewardship of assets with the explicit or implicit instruction from the beneficiaries of those assets to grow their worth. No one invests their savings to make loss.
The weight of literature and advice focused on board process and structure misses the point. The emphasis should be on performance.
In recent issue of Management magazine (July 2003, Is the corporate governance debate out of control?), I detailed concerns about the way the debate on corporate governance has evolved. This subject has become ‘monster’, and one that has become difficult to control.
Directors can rightly claim to be perplexed and concerned about where this will lead. For example, reflecting personal risk and public perception, will commercial judgement and entrepreneurial flair be crippled by policies, regulations and laws? Will honourable failure in competition become cause for public humiliation, or something worse? Will technocratic skills replace commercial acuity as key criteria for board membership? Will an ‘A’ grade for compliance become the primary concern of boards, and wealth creation (performance) secondary priority?
These are real issues. Boards and shareholders should be very concerned.
Because we don’t have culture of holding business managers and boards accountable for performance, there is natural tendency to focus on compliance. The professions – lawyers and accountants – have compliance as natural part of their DNA, thus reinforcing this bias. This is not criticism – it’s just the way things are.
In terms of the debate there are five important issues to keep in mind:
1. The history of corporate governance as public policy debate has been linked to scandals – the Bond Corporation, Maxwell, Enron, HIH Insurance, etc – and the business community always finds itself on the back foot.
2. Public concern causes political reaction and the predictable response is legislation (or regulation) – when the only tool in the toolbox is hammer, all problems look like nail!
3. Where has the voice of the shareholder been in all of this? One of the real flaws in our corporate governance arrangements has been absent shareholders, or shareholder apathy. We still see less than 30 percent of shareholder votes used at company meetings and very little shareholder interest, for example, in board composition and the incentive arrangements of top management – except in extreme situations, and often when it is far too late. This is huge issue.
4. In my opinion the corporate governance problem also includes the inadequate information given to shareholders on how the business is really performing. What is the wealth creation scorecard? So much of our financial information is steeped in conventions based on Generally Accepted Accounting Principles (GAAP) and company law that are more geared toward the interests of creditors – including bankers – than shareholders. Again, shareholder apathy might be reason for this. If shareholders don’t use their ‘voice’, is it fair to criticise companies?
5. Reform may now be inevitable even where there may be feeling that the problems are not evident in particular market. This is what economists call “contagion risk”. I believe that in global capital markets, there is corporate governance contagion risk. Therefore, there is little mileage in arguing that “we have no problems”. That may be the case, but the public is increasingly cynical and the only effective response is to actively engage in influencing the debate rather than being victim of it.
However despite the high profile nature of the topic, few people acknowledge that the issues relating to corporate governance have been around for very long time. Adam Smith talked about this some 200 years ago. Harvard’s Michael Jensen wrote extensively on the subject in the 1970s and 1980s.
Few also acknowledge that the scandals such as Enron, Marconi, WorldCom, HIH Insurance, One.Tel, New Zealand’s own Fortex and many others, represent only drop in the ocean compared to the wealth destruction that has been going on for years in the guise of under-performance.
Using EVA as measure, over the past decade the aggregate wealth scorecard of the NZSE40 equals negative $22 billion – no Enron, HIH Insurance or WorldCom scandals involved here, but in some of our largest companies there has been degree of wealth destruction that is almost breathtaking.
And now, according to recent article in The Australian, large insurance company has been responsible for destroying A$20 billion-plus of shareholder wealth, using share price movements as measure, over the past five years.
In these examples, as with HIH Insurance and others, all of the requisite compliance procedures – audit and remuneration committees, significant number of non-executive directors, etc – were in place. There are many more examples; fraud and malpractice is minor issue compared to the real corporate governance problem.
Back to basics
I believe it is important that the debate on corporate governance gets back to basic principle, which is fundamentally the stewardship of shareholders’ property. That stewardship also means ensuring that the business is responsible citizen of the communities in which it operates.
No responsible investor, management team or board would condone the creation of shareholder wealth in way that violates trust, creates socially unacceptable costs and damages the reputation of business in the community.
And yet, public opinion often decries wealth creation: it’s seen as greedy and myopic, self-serving and profiteering at someone’s expense. There are many books now being published proclaiming the sins of shareholder focus.
I bought coffee recently from kiosk in central London. The coffee business had printed on the paper cup: “we are responsible to you (our customer), whereas others are responsible to their shareholders”. Such propaganda is disappointing, unhelpful and demonstrates lack of appreciation of how good businesses are run – yet it feeds the market for ill-informed popular opinion and again, puts the business community on the back foot.
The absentee shareholder
The lack of interest in the affairs and performance of businesses by absentee owners is long-term major issue with corporate governance. Large institutional shareholders are particularly guilty of this.
I believe it’s unfair to level too much criticism at company’s corporate governance arrangements after the fact – if the owners of the business have not engaged in constructive way until it’s too late.
This lack of active shareholder engagement is serious flaw despite the duty that fund managers have to the beneficiaries of the funds they manage.
Investors should be concerned about ensuring that top management’s interests are aligned to wealth creation outcomes. The alignment of interests is at the heart of stewardship.
Incentive arrangements are central to the alignment of interests and are therefore legitimate topic of interest for investors, but that doesn’t mean that individual privacy rights have to be violated or commercially sensitive information unnecessarily released. The ‘How’ of incentives is far more important than the ‘What’. Investors need to know how their agents are paid; eg fixed versus variable, links to performance criteria that are meaningful to wealth creation, cash versus equity, lock-ups etc. Good quality information can be provided on the structure of incentives without disclosing what someone is paid. It’s the insight provided by quality information tha
