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January 24, 2018

How can good governance ensure a company’s future?

by Thomson Reuters.

Does bad corporate behavior lead to poor financial outcomes? Corporate governance failures have been easy to spot in recent years, with business headlines dominated by corporates that have failed to ensure they are run according to robust rules, guidelines and strategies. With companies held under much more scrutiny by their various stakeholders – not just limited to owners and shareholders, but also extending to their employees, the general public and beyond – there is more pressure on boards and management to have a watertight system of practices to achieve their objectives.

Investors have been leant increasing powers to influence corporate culture, too, and with the aid of proxy advisors and other bodies can coordinate their efforts to effect change at investee companies. In many countries, for example, the annual general meeting provides an opportunity for investors to vote out problematic board directors or management in favor of better replacements, for example, or to require a company to disclose certain information points.

Poor corporate governance is sometimes hard to quantify and can take some time to be revealed. At one large European engineering company, for example, a failure to pick appropriate auditors meant that published financial results were erroneous – and misleading – for some years, hugely damaging the firm’s trustworthiness and public image further down the line. Inappropriate pay packages for management can fail to incentivize good leadership and decision-making, which may not be obvious at a firm where the practice has been going on for decades, or poorly structured boards might mask ineffective strategy in the same way.  

Chris Welsford, IFA and Managing Director of Ayres Punchard Investment Management Limited, articulated this exact problem when speaking on a panel at the 12th annual Lipper Alpha Expert Forum: “Bad governance is a factor that’s always in there, it’s a threat. You don’t know when it will happen,” he said. “Never underestimate how bad governance will destroy worlds”.

Indeed, share prices and company valuations can even increase in the face of poor governance. Speaking on the same panel, Andrew Parry, Head of Sustainable Investing at fund manager Hermes, explained that investors will ignore these red flags in favor of short or medium-term returns. Not only is it an investor threat, he added, but it could “come back to bite companies”.

Welsford then added: “This is where fund managers are letting investors down. They’re not doing that work that should be – as I say – just a normal part of the analytical process”.

Integrating ESG factors into investment decisions is not an easy process, however, with a full assessment of an investee company potentially requiring a great deal of time and know-how and often a forensic look at prior accounts, directors’ voting histories and more.

On the other hand, in the age of deep-dive company analysis it is possible to examine a company’s disclosures, standardize such information and make it comparable across a range of corporate bodies – such as is the case with Refinitiv, which provides ESG data, analytics and scores that do just this. By measuring more than fifty different governance indicators obtained by a close, weighted analysis of a company’s reports, disclosures and other information points, companies can be modeled and scored based on how effectively they are governed.

In other words, governance data can begin to give a concrete answer to the question of how bad corporate behavior leads to bad future outcomes.

Armed with such information, investors are far better placed to make informed decisions about investee companies and the state of their corporate governance. It can also help point to problematic aspects of a company’s structure, whether it might be a difficult executive, imbalanced board or wider strategic problem.

To start assessing the impact that governance can have on your portfolio’s performance, find out more about ESG Data here.

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