Corporations depend
on a variety of financial partners for their development and survival,
including stockowners, bondholders, private investors, and, at financial
services firms, depositors. Boards of directors, corporate managers, and those
entrusted with the management of investors’ funds act as fiduciaries and agents
for others. As such, they bear a particular obligation to communicate clearly
and transparently with these financial partners, to manage their assets with
the utmost integrity, to act in the best interests of investors, and to
maintain the highest levels of ethical responsibility.
This obligation can
be subsumed under the rubric of good corporate governance. However, the term
corporate governance is often used narrowly, particularly in the United States,
to assert an obligation on the part of boards of directors and corporate
managers to maximize profits for shareholders. Properly understood, we believe that corporate governance should
encompass a responsibility to the corporation as a whole and include a duty to
understand and address the full range of social and environmental risks faced
by the firm itself and posed by the firm for others. As such, it is of great
concern to us.
Although the term
corporate governance is not specifically used in the themes described here, we
believe that companies that perform well in the areas outlined below must,
essentially by definition, be governed well. Our positions on the more
traditional measures of good governance (e.g., separation of the roles of chairman of the board and chief
executive officer, staggered boards, independence of key board committees, and
so on) are described in our Proxy Voting Guidelines. These structural mechanisms can
help ensure that there are checks and balances in place, and create an
environment where broader accountability is at least possible.
A company’s financial
partners play a crucial role in maintaining the credit, stock price, liquidity,
and financial viability of a firm and their good faith and trust is therefore
vital to the firm. This reciprocal relationship is crucial to the long-term
financial viability of the corporation, as it is to the long-term financial
prospects of its various investors.
Themes
The following are the
four major themes by which we assess the strength of corporations’
relationships with their financial partners:
While other issues
are also important in this regard, these four are those which we believe we can
most meaningfully and consistently assess.
Accounting, Credibility, and Business Ethics
Markets cannot be
efficient and effective unless they are honest. Financial regulators and
legislators have devoted much attention to assuring the credibility of the
financial accounting systems for publicly traded companies. In addition, an
increasing number of companies are voluntarily implementing ethics programs to
assure that employees conduct their affairs honestly. When companies such as Enron
or Parmalat lie outright about their financial condition, the cost to the
public can be tremendous. Similarly, bribery scandals can cause firms major
political and financial difficulties. Once this trust is broken, it is
difficult to restore. At the same time, we recognize that accounting is a
profession involving considerable judgment, and honest differences can arise
between regulators and firms. By the same token, the line between questionable
payments and legitimate business practices is not always clear.
We consequently look for companies that cultivate a culture
of honest accounting and business practices throughout their daily operations,
with adequate systems and safeguards in place to prevent systematic abuse, and view with concern those that have a pattern of
accounting fraud or business scandals.
Openness in Communications
Markets also cannot
be efficient and effective unless communications are open and free with
shareholders, bond owners, and others who have invested financial assets in a
firm. In our opinion, these communications should cover not only traditional
financial indicators, but also nontraditional financial indicators such as
social and environment factors. We believe that these social and environmental
factors are relevant to investors’ assessments of the competence and quality of
management, and can have profound long-term (and occasionally short-term)
financial implications for firms that often go unrecognized by the mainstream
financial community.
We therefore look for companies that communicate openly
about the challenges they face, are willing to be thorough in the data they
provide, and are willing to enter into ongoing dialogue with stakeholders with
legitimate concerns in these areas.
We do not, however, automatically take failure to communicate as a sign that a
company has no positive initiatives, nor do we automatically take willingness
to communicate as a positive indicator. It is the quality of these
communications and the company’s actual record that are our primary concern.
Commitment to Diversity of Representation
As with diversity among employees, diversity on a firm’s
board of directors can bring vitality and openness to a corporation. It is surprising to us, for example, when consumer products
companies that serve primarily female consumers have boards consisting of only
men. Similarly, in an increasingly diverse global economy, individuals with
diverse ethnic and racial backgrounds can provide valuable insights about doing
business in different countries, cultures, and economic environments. Moreover,
as the pace of innovation increases, a culturally diverse board is likely to
understand new trends, to innovate, and to seek changes that benefit society
broadly. Finally, the public is generally well served by corporations that lead
by example in giving equal opportunity to all segments of society in this
strategically important and high-profile public role.
Relationships with Controlling Owners
Cross-ownership among
companies or ownership by governments, foundations, or families can raise
complicated questions for us in setting standards. If controlling interest
rests with an organization other than the firm itself, we generally evaluate
the company as if it were a wholly owned subsidiary of the controlling entity.
When the controlling entity is a corporation, this process is fairly
straightforward — a positive or negative record for the controlling company
becomes the crucial factor in our decision-making, outweighing most other
factors.
However, when the controlling owner is a family or
individual, a foundation, or a government, the situation becomes more
complicated. We evaluate these situations case-by-case, but some general
principles apply. When the
controlling owner is an individual or family, we generally do not factor the
family’s reputation or politics into our analysis. However, if the owners have
a record of public or political involvement that in our opinion threatens to
cause conflicts of interest in the operation of the company or to harm the
company’s reputation, we will take these factors into account. Our sensitivity
to such conflicts varies from industry to industry. For example, if a media
company is controlled by an individual holding high public office, we view this
with great concern.
In general, we regard
ownership by foundations with a public service mission favorably. If, however,
the foundation is simply a vehicle for family control, the same positives do
not necessarily apply. Indeed, in family-controlled companies, whether the
control is direct or through a foundation, the owners may on occasion have
access to financial information not available to general investors in the
marketplace that introduces conflicts and inefficiencies into stock pricing and
even potentially into the management of the firm.
Finally, in the case
of majority ownership by national governments, we evaluate such situations
carefully. Although it can be argued that the state should logically be
expected to play the role of an owner who takes the public interest to heart,
in fact numerous possibilities for conflicts of interest exist under state
control. We look to several factors in our evaluations, including the
government’s record for honesty and public service and the likelihood of the
abuse of the company for purely personal or political purposes.
When third parties
own 20% to 50% of a company’s stock, we look for indications of whether these
parties exercise significant or effective control. If they do, then we apply
the same general principles as if they held a majority ownership. If they do
not, we consider them passive investors, and do not take their ownership into
account. The relationship between such owners and the companies in which they
hold stock is often difficult to evaluate and considerable judgment is required
on our part.
