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Unlocking Potential Through Corporate Governance

January 21, 2010 Leave a comment Go to comments

We are having our global analyst conference this week where members of our portfolio management and research team gather together to discuss emerging trends and challenges.

As many companies now begin their new financial year, I would like to make a case on why improving corporate governance should be at the top of every company’s agenda. One of my readers, James from the UK, recently asked whether corporate governance and transparency is becoming less of an issue, given that he had seen improving standards in emerging markets. I think corporate governance should always be at the top of investors’ minds when they invest in any company, be it in emerging or developed markets. Assuming otherwise might cause an investor to be blindsided, as seen in former U.S. and European corporate scandals.

With greater globalization and new markets opening up, the emphasis on corporate governance is increasing as more efforts are being made to attract foreign investments. Accountability to shareholders and the need for transparency today form the backbone of the trust that investors have in a company, even though the concept of “corporate governance” has been recognized in the past. These areas of focus also provide the foundation for a management system that not only works smoothly but also increases the efficiency and effectiveness of companies, by having a high degree of awareness and information flow.

What exactly is good corporate governance? A simple definition might classify it as an environment where individuals in control of a company provide quality management to improve its performance in the interests of all shareholders, regardless of whether they are minority or majority shareholders.

In my opinion, good corporate governance brings with it transparency and accountability that serve to govern those who control the company’s affairs. This oversight creates a system whereby managers are discouraged from mismanaging the company, be it through a lack of diligence, excessive spending (including their own remuneration packages), improper decision-making, or even intentional improper behavior. This deterrence clearly stems from the fact that managers and their actions should be scrutinized by an independent board of directors that serves all shareholders.

It is basically about fair play. In order to allow wealth to filter down fairly, we must have a capital market that enables the person on the street, who invests in stocks or mutual funds, to be treated as fairly and equally as the wealthiest person. If we can establish such a system, everything else should fall into place. Apologists in many countries sometimes retreat to the defence of cultural differences as an excuse for not implementing good corporate governance and fairness to minority investors. I believe fairness has no regional, country, cultural or ethnic boundaries. It would be best for all – owners and investors, foreign and domestic, institutional and retail – to level the playing fields and to make business dealings transparent. Only then will confidence in these markets, which had been lacking in corporate governance, benefit all from unlocking the potential in global markets.

Clearly, my view is that sound corporate governance pays. Studies by various organizations have shown that a company’s performance improves when: (1) investors have greater confidence in companies that are responsible, have a high level of transparency and demonstrate strong, core values, and (2) the company shows evidence of good discipline and regard for shareholder views.

I cannot stress enough my belief of the strength of the correlation between good governance and good corporate performance. As a result of this connection, we often see stock prices rise as a result of both increased earnings prospects and perceptions of good corporate governance. That is why so many investors campaign for good corporate governance. In simple economic terms, the premium can be very easily explained by supply and demand principles – the more comfortable a company’s management makes investors feel about investing in them, the greater the supply of investors will seek to do so. The increased demand for shares contributes to higher share prices, which then results in a premium. I believe the perceived costs associated with implementing corporate governance practices would be more than compensated for by the potential long-term gains.

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