In a recent survey of global institutional and private wealth managers by the CFA institute, 67 percent said they use governance as a factor when evaluating investments.
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Why Corporate Governance Matters
How important is corporate governance to evaluating a prospective investment? Consider some of these recent governance failures and the answer becomes obvious.
- In 2012, JP Morgan Chase seated no directors with risk expertise on the board’s risk committee until after the “London Whale” caused $6 billion in trading losses.
- The implosion of shareholder value at GE as an unwieldy board allowed capital investment decisions to run amok and failed to rein in a bloated expense structure.
- A Wells Fargo board that misidentified a customer account opening scandal as a people problem rather than a process problem culminated in regulators capping its future ability to grow.
Corporate governance is the system by which companies are directed and controlled. The board of directors has the ultimate responsibility to ensure that executive management adheres to the rules, values and processes that govern the company.
There is little debate that good corporate governance can increase shareholder value and poor governance can harm it; so it’s not surprising that using governance as an investment criterion continues to grow.
In a recent survey of global institutional and private wealth managers by the CFA institute, 67 percent said they use governance as a factor when evaluating investments, with board accountability as the top concern.1
Corporate Governance Principles: Best Practices
It’s not always easy to define what represents “best practices” for corporate governance since perspectives can differ and little hard data exists to support one viewpoint over another. For example, is there any “right” answer to the question, “Should the CEO and president roles be combined or separate?”
However, there may be some principles on which most can agree, including:
- Accountability—Are senior management and members of the board held accountable? Actions must have consequences. If poor performance or misconduct is tolerated, it may be setting the stage for future shareholder harm.
- Alignment of Interests—Is executive compensation aligned with long-term value creation or short-term results? Compensation drives behavior, and understanding how senior management is compensated is a great window into how the company is managed.
- Transparency—Accountability is impossible if the organization is opaque. How forthcoming senior managers are in answering questions with investors and the media may provide insight to how transparent they are.
- Engagement with Stakeholders—The interests and goals of multiple stakeholders don’t always intersect, but active engagement is often the better alternative to ignoring inconvenient voices.
- Board Composition—How experienced are board members with the company’s business? What is its level of diversity? Are there mandatory term limits or meaningful board evaluations?
While incorporating corporate governance into the investment evaluation process may not offer the quantifiable nature of cash flows or sales numbers, it may, nevertheless, be too risky to ignore governance considerations altogether.
See referenced disclosure (2) at http://blog.americanportfolios.com/disclosures/