I am concerned about the way in which the debate on corporate governance has evolved. The subject has become a "monster" and one that has become difficult to control! It has attracted the interest of a range of groups--some of whom have a very poor (or even hostile) appreciation of business--and it's fair to say there is much misinformation and confusion on what we really mean when we talk about "corporate governance".
Directors can rightly claim to be perplexed and concerned as to where this will all end up! For example, reflecting personal risk and public perception, will commercial judgement and entrepreneurial flair be cannibalised by policies, regulations and laws? Will honourable failure in competition become a cause for public humiliation, or something worse? Will technocrats replace commercial skills as a key criterion for boards? Will an 'A' for compliance become the primary concern of boards and wealth creation (performance) a second-order concern? These are real issues for investors and directors.
Better definition needed
Any discussion on corporate governance should start with a clear sense of what we mean by the term? What failures are we trying to address? What do we really mean when we talk about 'corporate social responsibility'? Do we understand cause and effect? Do we understand the role of culture? What is our objective? What are the desired outcomes? Do we understand the real cost/benefits of proposed solutions? In thinking about corporate governance, these tests apply equally to all business entities of "economic significance", be they private or public (including cooperatives), whilst recognising that businesses are not a homogeneous form and a rigid one-size-fits-all approach will do more damage than good.
The primary purpose of business is the legitimate goal of making an economic profit by meeting the needs of society, whilst respecting the rights of others to do the same. A business must compete, innovate, motivate and compensate (capital and labour) and it must do all four well if it is to succeed over the long-term.
What are shareholders looking for?
The answer is simple: investors expect a return on their capital commensurate with the risk they are taking. Given future needs, investors want to see their stock of wealth grow. No one saves to have less in the future. A company's corporate governance emphasis and arrangements should therefore recognise that investors want their wealth to grow through stock price appreciation and dividends.
It follows that investors have this simple instruction to boards: manage the assets of the business in a way that maximises long-term value. Keep true to this simple principle and with good governance the business will succeed.
There will always be business failures. Risk taking is essential if success is to be sustained and the discipline of failure is crucial to a vibrant economy. Creative destruction is a reality and there is no disgrace in honourable failure in business as in sport. People make mistakes--honestly made and if quickly addressed, there is nothing wrong with that.
Investors (and boards) will continue to be concerned about how to 'govern' behaviour, attitudes and corporate culture. There is no magic solution here or safe proof protection. In all of this, the alignment of interests is very important. It goes to the heart of stewardship.
Central to the alignment of interests are incentive arrangements. For that reason the structure of incentives is a 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. How is more important than 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, etc. Good quality information can be provided on the structure of incentives without disclosing what someone is paid and surely it's the insight provided by quality information that really counts. The more million-dollar compensation packages the better, so long as incentive structures ensure the right behaviour and outcomes and do not distort behaviour and ethics or encourage gaming.
On the theme of quality information to investors, no one would argue against attempts to improve the quality of information, but quality not quantity is what counts. Too much information can be as effective as too little in disguising performance problems.
Investors expect businesses to be well managed; to be good corporate citizens; to have a good reputation; to be ethical in their dealings and values; to comply in letter and in spirit with laws and regulations; to provide meaningful (quality) information in a timely manner; not to mislead; not to purposely disadvantage some shareholders to the benefit of others, to avoid conflicts of interest and to grow rather than decline. And, if growth is difficult, then ensure that there are minimum costs to replacing management or returning capital so that it can be reemployed elsewhere in the economy.
In all of this, whilst it is important that boards never lose sight of their overriding responsibility to shareholders, no credible investor, no credible management team, will see shareholder wealth creation achieved in a way that violates trust, creates socially unacceptable costs and damages the reputation of business in the community. That companies are highly rated by customers and staff is a basic requirement for sustainable growth in shareholder value. Investors care about a 'balanced scorecard' and how businesses rate on these points as they are leading indicators of performance sustainability.
I cannot conceive of any situation where a contrary philosophy would accord with any definition of a well-managed business. And yet there are many who see wealth creation as a trade-off between shareholders and other stakeholders and as a result the debate becomes unnecessarily politicised and can end up in the ideological cross fire between capitalism versus socialism.
Governance & performance
Good corporate governance is intrinsically linked to good performance (although I accept that causation is difficult to establish). I emphasise 'performance' because, what we do know is that there is more value lost to shareholders, employees and society in general through poor corporate (and board) performance, than through fraud and malpractice. Commentators lose sight of this fact and yet this is the key corporate governance issue that investors should be concerned about. It is an issue that has been around for a very long time--we know, for example, that a handful of large New Zealand corporates destroyed close to $20 billion of shareholder wealth over the past decade (using EVA as a benchmark).
Good corporate governance therefore must be intrinsically tied to the primary purpose of business and viewed as an economic imperative. In thinking about triple bottom line, sustainable development and so on, there is no argument about the need to be a responsible corporate citizen and to behave as suggested earlier, but beyond that? Good businesses understand that reputation is a highly valued economic asset the value of which is often only known when it lies in tatters.
As mentioned earlier, clarity of purpose and the legitimacy of goals are important. Businesses that find themselves accountable for a range of stakeholders run the risk of ultimately failing to please anyone, despite heroic attempts. There are those who define corporate governance in a way that is difficult to identify a primary purpose beyond striving for utopia! This is the great risk in the shareholder/stakeholder debate--that business loses sight of its primary purpose. For that reason, it is important that boards remember that whilst they are responsible for relations with stakeholders, they are accountable to shareholders.
Investors and society should rightly expect high standards of honesty and ethics from those managing and governing businesses and they should reject businesses where those standards are in question. Business must behave morally and ethically in order to prosper, recognising that unethical behaviour will be punished. Investors and society should expect that the regulatory and legal framework will exact swift and meaningful punishment on those who violate laws so as to deter others. Effective deterrents to wrongdoings are important.
All that said, it is important that public opinion should be reminded of the fact that the vast majority of businesses exhibit high standards. It is a great pity that the acts of a few can damage the reputation and standing of so many. The hammer solution will not address this.
Joseph Healy is head of regional investment banking and private equity at ANZ Investment Bank, Sydney. Email: firstname.lastname@example.org…