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Reading 31: Corporate Governance: Introduction (Stakeholder (Company…
Reading 31: Corporate Governance: Introduction
Description
Corporate governance is the internal controls and procedures for managing a company
Theories
Shareholder theory: focus on interest of company's owners (common shareholders)
Stakeholder theory: focus on managing conflicts among interests of stakeholder groups
Stakeholder
Company stakeholder groups
Board of Directors
Seniors management
Employees
Creditor
Suppliers
Shareholder
Customers
Government / regulators
Principal-agent relationship & Conflicts of Interest
Principal-agent relationship: An agent is hired to act in the interests of a principal
Conflict of interest may arise between agents' interests and principals' interest
Stakeholder management
is the management of the company relation with stakeholders
based on
having a good understanding of stakeholder interests
maintaining effective communication with stakeholder
Terminology
Legal infrastructure: Laws relevant to stakeholders
Contractual infrastructure:Contracts between company and stakeholders
Organizational infrastructure: Corporate governance processes, management of stakeholder relationships
Governmental infrastructure: Regulations under which company operates
with shareholders
Annual general meeting
Extraordinary general meetings - special resolutions
Proxy voting
Majority: one vote per share for each board seat
Cumulative: Votes = shares x seats; may cast all votes for one board candidate
Board of Directors
Duties
Select senior management, set their compensation and evaluate their performance, decide succession.
Set the strategic direction for the company
Approve capital structure changes, significant acquisitions, and large investment expenditures.
Review company performance and implement any necessary corrective steps
Establishing, monitoring and overseeing firm's internal controls and risk management.
Ensure the quality of the firm's financial reporting and internal audit.
Tiers
One-tier board
Includes internal directors (senior managers) and external directors (called
independent directors
if they have no other relationship with company)
Two-tier board
Supervisory board (external directors) and Management board (internal directors)
Committees
Audit: oversee financial reporting, internal controls and internal audit; recommend external auditor to Board
Governance: Implement company code of ethics; monitor changes in laws and regulations and ensure company's compliance.
Nominations Search for and propose candidates for Board, align Board compensation with company goals
Investment: Review proposed capital investment projects, acquisitions, and asset sales
Compensation (remuneration): Recommend compensation levels and types for directors and senior managers; oversee employee benefit plans
Risk: Recommend appropriate risk policy and risk tolerance; oversee risk management processes
Factors affecting stakeholder relationship & corporate governance
Market factors
Pressure from activist shareholders for changes that they believe will increase the company value
Threat of hostile takeover and existence of anti-takeover provisions.
Non-market factors
Company's legal environment
Third-party ratings of corporate governance
Potential risk of poor governance
Weak Controls (audits, board oversight)
Poor or fraudulent accounting
Lax oversight of management: sub-optimal risk levels, related-party transactions, or compensation not aligned with company goals
Legal and eputational effects
Default risk
Factors relevance to corporate governance analysis
Ownership & voting structure
Holdings by affiliated companies or institutions, activist shareholders, or company founders (dual-class structure may favor interests of one group of shareholders over another)
Board composition
Director independence from management, expertise suited to company's strategy
Management Remuneration
Alignment with company strategy; long-term or short-term focus; stability over time (performance targets too easy?)
strength of shareholder rights
Weaker with staggered board, anti-takeover provisions, or dual share classes
Environmental and social consideration in investment analysis
ESG Investing
a.k.a sustainable or responsible investing
is the use of environmental, social, and governance factors in making investment decision.
Several issues to consider:
Potential environmental effect
Changing demographic of workers.
Changing work preference
How to use ESG in investment analysis
Integrating ESG concerns into portfolio construction
Negative Screening: Excluding companies or sectors based on ESG factors
Impact investing
Thematic investing: Investing based on a specific ESG-related goal
Positive screening: Identify companies with positive practices related to ESG factors
Includes relative/ best-in-class approach: Identify companies in each industry with best ESG practices, typically maintains benchmark sector weightings
May concentrate in only a few industries --> affect risk profits
Full integration: Including ESG factors in fundamental analysis
Engagement/ active ownership: Using share ownership to promote ESG goals through proxy voting and contact with senior managers and directors
Green finance: Achieve economic growth while reducing pollution
Green bonds: are issued to fund environmental projects
Overlay/ portfolio tilt strategies: Manage ESG characteristics of overall portfolio
Risk factor / risk premium investing: treat ESG factors as a source of systematic risk
ESG vs. Fiduciary Duty
ESG focus may conflict with fiduciary duty under Employee Retirement Income Security Act (ERISA)
NOT A VIOLATION for pension fund managers to consider ESG factors when:
Eveluating a security's risk and expected return
Choosing between 2 investments with otherwise similar risk and return characteristics