We are living in a world where increasingly, assessing corporate governance factors is becoming a checklist exercise. From a plethora of rating agencies scoring on governance factors, to ESG funds who screen out the worst offenders. In this interview, I speak to Mark Mobius on the limitations of utilising such an approach and what the ingredients are for a great board.
Usman: Mark, you have sat on numerous boards. What do you believe investors overlook when they assess the competence of a board?
Mark: As active investors, the composition of boards is one of the first things we look at when considering investing in a company. A balanced board has a crucial role to play in maintaining corporate governance standards which we consider an important lever for social, environmental and operational improvements.
However, this is not always straightforward. For example, if one looks at Enron, the board seemed to tick all the governance boxes. The board members turned up for meetings, they were aligned as they had personal money invested in the company and they had all the necessary committees. There were independent directors on the board and the board itself was not too big or small nor was it too old or young.
Investors tend to focus on procedural issues when assessing if a board is competent and assume these factors produce a well-functioning and attentive board. What is so scary about corporate scandals over the years is that in spite of these companies ticking the conventional boxes of good governance, they failed. In reality, boards are complex social systems which cannot be reduced to statistics.
Usman: What are your thoughts on the optimal skillset of a board?
Mark: It is important for at least some board members to have strong expertise with the underlying business. Moreover, there must be a genuine interest in the company. A breadth of skills is helpful but a willingness to ask difficult questions is particularly important. These issues cannot easily be assessed by equity investors sitting behind a computer.
My experience on boards has been very educational in the sense that I realised, that to do a great job, you have to spend a lot of time and effort studying the underlying business. Whilst serving on the board of an oil company, I quickly realised my knowledge of the oil market was limited and it was necessary for me to learn fast. I therefore asked the President to arrange a tour of the firm’s major facilities, so I could talk to people on the ground and observe what they were doing. This experience was invaluable and enabled me to understand the challenges and opportunities the company was dealing with in a more granular way.
Usman: What is difficult for public equity investors to assess?
Mark: Whilst many investors and rating agencies are quantitatively scoring companies on board independence, board size, compensation practices, separated Chairman and CEO positions etc, one cannot quantitatively assess ethics and board dynamics.
We once invested in a large Mexican retailer partly because of its high corporate governance standards; they were transparent and the executives played by the rules. Then one day, a pair of investment bankers flew in from Wall Street and dazzled the company’s finance director with visions of the profits the retailer could make from the “super Peso”, as Mexico’s currency was being characterised in the press in 2008. The CFO was persuaded, and exposed the company to a huge, off-balance-sheet currency risk by taking a speculative position in currency derivatives with escalating payoff structures that allowed losses to accumulate rapidly.
The company, which was very profitable, filed for bankruptcy a few months later with losses approaching $2 billion. There was a lesson here. The company’s governance system was good by Mexican standards, but the CFO didn’t feel it obliged him to be prudent.
Usman: So what would the ideal board look like?
Mark: In my opinion a well-functioning board consists of members who respect each other. Vice-versa, a management team and the CEO in particular, must trust the board and share complete information in a timely fashion. I have experienced boards where the CEO has hidden information from the board or has failed to deliver complete information in a timely manner. This must not be underestimated. Sending a board pack on a Monday for a Tuesday board meeting is poor practice. These issues are extremely difficult to assess behind a desk. In addition to requiring an understanding of the local culture, they require close interaction with board members and the management team. Even then, board members may not always be honest to investors.
Usman: How concerned are you about groupthink in the boardroom?
Mark: Whilst mutual respect for fellow board members is incredibly important, this must coincide with the capacity to challenge one another’s assumptions and beliefs. Group think is unfortunately very common in boardrooms. Chuck Prince, the former CEO of Citigroup, illustrated the dangerous power of group think, when he explained Citi’s ill-fated enthusiasm for subprime mortgages and consumer loans in July 2007 in the Financial Times: “..as long as the music is playing, you’ve got to get up and dance.” Four months later Prince resigned, after Citigroup announced a fourth quarter loss of almost $10 billion.
Over the years, I’ve observed board members who feel under pressure to fit in, so they’ll be renominated. When executive search firms and nomination committees search for new board members, they often search for compliant people. No one likes a trouble maker. However, in my experience, it just takes one dissenter on a board who can make a valuable difference. Great boards are not afraid of dissent, nor do they discredit dissenters.
Usman: What would be your advice to boards and investors?
Mark: Boards of public companies must think about all stakeholders, which includes minority investors. There must be a sufficient number of independent directors as a minimum, but this alone is not adequate.
Board members ought to be open to scrutiny and should be subject to external board evaluations. In emerging and frontier markets, this is still uncommon. At the same time, boards should make an effort to engage with their investor base: after all, the independent directors are there to represent shareholders. A lack of feedback is one of the biggest self-inflicted problems a board may possess.
Investors should also bear in mind that assessing great boards is an art, not a science. Even when a board looks perfect when numerically scored, one must dig deeper into the issues mentioned above. Board dynamics cannot be quantitatively scored: they require human judgement and face-to-face interaction. At a time when flows to passive funds are increasing, it is even more important for active managers to partner with their portfolio companies and provide constructive feedback to boards.