Sustainable Investing: The Importance of Governance
Aimee B. Forsythe, CFA Senior Vice President, Senior Portfolio Manager
Stig Zarle Vice President, Portfolio Manager
Tatiana Grava Investment Associate
Questions an investor should consider when evaluating a company’s corporate governance:
Is there diversity within the board and executive management? Multiple studies have shown the importance of having boards that are diverse in both gender and ethnicity. Diversity not only helps boards to be better aligned with stakeholders but can also lend itself to more thoughtful decision making.
Are the board and its key committees fully independent? Independence is key to strong corporate governance as it allows directors to act objectively and for the benefit of stakeholders.
Are any directors overboarded? While directors often serve on multiple boards, investors should consider the number of other board seats held. Directors serving on too many boards (and who may also be working full time) may not have adequate time to serve any one board or prepare for meetings. Attendance records for meetings should also be considered.
Have any directors previously served on the boards of companies that have failed? While not necessarily a strike against a director, previous service on the board of a troubled company can be a sign of inexperience or inattention. Consideration should be given to the time frame of service and whether it occurred before or after problems arose.
How long have directors been serving on the board? While a long tenure can lend needed experience and understanding of a company or industry to the Board, long serving directors may become too entrenched with management and lose objectivity.
What are the rights of shareholders? Investors should consider shareholder access to bring forth proposals, vote on bylaw amendments and participate in engagement.
Are non-audit fees paid to company auditors excessive? Outsized non-audit services may cause an auditor to lose objectivity.
Strong and Weak Governance
American Express and Microsoft have been recognized as leaders among their peers for corporate governance. With largely independent, diverse directors, American Express and Microsoft have boards that are well positioned to effectively oversee management and company operations on behalf of shareholders. Apart from their respective CEOs, all other board members are independent at both firms and all committees are fully independent from management. In cases where the CEO serves on the board, the best practice would be to ensure that there is an independent chairperson. Microsoft has successfully divided those two roles; however, American Express has a combined role for the CEO and the Chair of the Board.
Contributing to the success of their boards, none of the individual board members at American Express or Microsoft are considered overboarded, and between the two boards, there is only one long-tenured director (serving on American Express’s board for the past 18 years). A regular rotation of new members helps to bring fresh perspectives, and by limiting the boards that they serve on, board members should have adequate time to focus on company operations. These boards will likely be successful in acting in the best interest of shareholders, and shareholders are also likely to be better afforded the ability to influence decisions. Neither firm has a controlling shareholder, and both companies grant one vote per one common share. As a result of their ownership structures, the voting power for American Express and Microsoft shareholders is well aligned with their economic stake in the company.
By contrast, Wells Fargo, has demonstrated poor performance in corporate governance. The quality of individuals on Wells Fargo’s board possibly impedes their ability to effectively oversee management and act in the best interest of shareholders. As an example of their shortcomings, there is an ongoing lawsuit, which was initiated by shareholders in May of 2018 against the CEO and other senior officials over an alleged “culture of lawlessness” within the bank. Wells Fargo’s inability to avoid controversies, which have damaged shareholder value, may stem from their poor corporate governance.
How will governance evolve post-pandemic?
Ultimately, organizations that view governance as a strategic imperative embrace the idea of operational consistency and a long-term view of their business that promotes transparency. Less robust governance structures frequently result in cultures that are both reactive and prone to short-termism where avoidable risks arise. The financial markets often reward strong governance structures with improved access to capital at a lower cost than organizations with less robust governance structures.
Corporate governance will continue to evolve, particularly as the SRI community grows in size and engagement. World events also create change. For example, as events have moved online to promote social distancing, company annual meetings have followed suit. According to Institutional Shareholder Services, over 900 virtual meetings have been scheduled so far this year. While virtual annual meetings have the benefit of allowing geographically distant shareholders to attend and saving the company the cost of hosting an in-person meeting, there can be disadvantages as well. Virtual meetings may be shorter and allow for greater focus on management’s point of view. While questions can often be submitted beforehand, in person meetings offer spontaneous discussions that shareholders may find beneficial to hear and participate in. It remains to be seen if virtual meetings are a temporary accommodation or will become standard in coming years. Other forms of governance metrics and more robust disclosure are also likely to arise as post-pandemic reporting evolves and improves.
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