According to Sir Karl Popper, the central question in democracy is not “who should rule?”, but “how can we organize political institutions to ensure that bad, or incompetent rulers can be prevented from doing too much damage?”
This distinction between the position of the ruler and the system of ruling, or “governance”, is as important for investors as it is for democracies. In both cases, the system of governance offers some protection to constituents that their interests will not be compromised by dishonest, incompetent, or self-serving leaders.
Agency costs – the costs of hiring others to run your business – can cover a multitude of sins. This ranges from incompetence, negligence, recklessness, conflicts of interests, a lack of transparency, to unfair and unequal treatment of shareholders, insufficient separation of the powers of the executive committee and the board and insufficiently diverse boards.
The pervasiveness of the misuse and abuse of power in business in both developed as well as emerging markets is exemplified by scandals such as Enron, Parmalat, Elf, Madoff, Volkswagen and Kobe Steel in the former and Petrobras, Asia Pulp and Paper, Polly Peck in the latter.
At Mobius Capital Partners, we believe that strong governance is key when it comes to managing risk. Good governance standards could have prevented many if not all of those scandals mentioned. Without robust governance, and the good management that it fosters, environmentally and socially responsible policies are unlikely to be adopted and implemented.
By “good” governance, we mean a particular set of corporate principles which we regard as universal in that they are logical and are common sense. Good corporate governance touches all interested parties: shareholders, staff, customers and the society as a whole. For shareholders in particular it is:
- Fair, in that all shareholders are treated equally
- Open, in that all relevant information is disclosed to all shareholders at the same time
- Aligned, in that the interests of the company’s management are the same as those of shareholders
- Rules based.
Increasingly the need for emerging market companies and countries to attract investment is putting them under pressure to respect good governance principles. If they do not, they’ll be denied access to the mobile pool of global capital.
While passive investors have surrendered their power to influence poor corporate governance active investors can have a major impact on a company. They gather knowledge, work with management on reform, and help to ensure compliance with appropriate standards.
As active investors, we see Governance as the primus inter pares (first among equals) in the world of Environmental Social and Governance factors. Active investors, however small must exert their power, as owners, basing their activity on the rules and regulations governing corporate behavior.
There are some recurring themes in our efforts to bring about governance reform. We see the composition of boards as important evidence of the seriousness with which companies take their responsibilities to minority shareholders. Such factors as dividend policies, reporting transparency, executive remuneration linked to performance are some of the variables of fundamental interest.
There are many examples that demonstrate the value of shareholder engagement and advocacy at a time when the general trend is towards passive investment. Actively engaging with companies on governance issues should benefit the company and its employees as much as it will benefit the investors.