The Corporate Governance Of Listed Companies: A Manual For Investors (Part 3)

This is my last post of the Corporate Governance of Listed Companies. In this last post, I’m going to discuss about the companies’ policies relating to voting rules, share owner sponsored proposals, common stock classes and takeover defenses.

The ability to vote proxies is a fundamental shareholder right. If the firm makes it difficult to vote proxies, it limits the ability of shareholders to express their views and affect the firm's future direction. Investors should consider whether the firm:

• Limits the ability to vote shares by requiring attendance at annual meeting.
• Groups its meetings to be held the same day as other companies in the same region and also requires attendance to cast votes.
• Allows proxy voting by some remote mechanism.
• Is allowed under its governance code to use share blocking, a mechanism that prevents investors who wish to vote their shares from trading their shares during a period prior to the annual meeting.

Investors should determine if shareholders are able to cast confidential votes. This can encourage unbiased voting. In looking at this issue, investors should consider whether:

• The firm uses a third party to tabulate votes.
• The third party or the firm retains voting records.
• The tabulation is subject to audit.
• Shareholders are entitled to vote only if present.

Shareholders may be able to cast the cumulative number of votes allotted to their shares for one or a limited number of board nominees. Be cautious in the event the firm has a considerable minority shareholder group, such as a founding family, that can serve its own interests through cumulative voting. Information on possible cumulative voting rights will be contained in the articles of organization and by-laws and the prospectus.

Changes to corporate structure or policies can change the relationship between shareholders and the firm. Watch for changes to:

• Articles of organization.
• By-laws.
• Governance structures.
• Voting rights and procedures.
• Poison pill provisions (these are impediments to an acquisition of the firm).
• Provisions for change-in –control.

Regarding issues requiring shareholder approval consider whether shareholders:

• Must approve corporate change proposal s with supermajority votes.
• Will be able to vote on the sale of the firm, or part of it, to a third-party buyer.
• Will be able to vote on major executive compensation issues.
• Will be able to approve any anti-takeover measures.
• Will be able to periodically reconsider and re-vote on rules that require supermajority voting to revise any governance documents.
• Have the ability to vote for changes in articles of organization, by-laws, governance structures, and voting rights and procedures.
• Have the ability to use their relatively small ownership interest to force a vote on a special interest issue.

Investors should also be able to review issues such as:

• Share buy-back programs that may be used to fund share- based compensation grants.
• Amendments or other changes to a firm's charter and by-laws.
• Issuance of new capital stock.

Investors need to determine whether the firm's shareholders have the power to put forth an independent board nominee. Having such flexibility is positive for investors as it allows them to address their concerns and protect their interests through direct board representation. Additional items to consider:

• Under what circumstances can a shareholder nominate a board member?
• Can share owners vote to remove a board member?
• How does the firm handle contested board elections?

The proxy statement is a good source document for information about these issues in the United States. In many jurisdictions, articles of organization and corporate by-laws are other good sources of information on shareholder rights.

The right to propose initiatives for consideration at the annual meeting is an important shareholder method to send a message to management. Investors should look at whether:

• The firm requires a simple majority or a super majority vote to pass a resolution.
• Shareholders can hold a special meeting to vote on a special initiative.
• Shareholder-proposed initiatives will benefit all shareholders, rather than just a small group.

Investors should find out if the board and management are required to actually implement any shareholder approved proposals. Investors should determine whether:

• The firm has implemented or ignored such proposals in the past.
• The firm requires a super majority of votes to approve changes to its by-laws and articles of organization.
• Any regulatory agencies have pressured firm s to act on the terms of any approved shareholder initiatives.

Different classes of common equity within a firm may separate the voting rights of those shares from their economic value. Firms with dual classes of common equity could encourage prospective acquirers to only deal directly with shareholders with the super majority rights. Firms that separate voting rights from economic rights have historically had more trouble raising equity capital for fixed investment and product development than firms that combine those rights. When looking at a firm's ownership structure, examine whether:

• Safeguards in the by-laws and articles of organization protect shareholders who have inferior voting rights.
• The firm was recently privatized by a government entity and the selling entity retained voting rights. This may prevent shareholders from receiving full value for their shares.
• Any super-voting rights kept by certain classes of shareholders impair the firm's ability to raise equity capital. If a firm has to turn to debt financing, the increase in leverage can harm the firm.

Information on these issues can be found in the proxy, web site, prospectus, or notes to the financial statements.

Examine whether the investor has the legal right under the corporate governance co de and other legal statutes of the jurisdiction in which the firm is headquartered to seek legal redress or regulatory action to enforce and protect shareholder rights. Investors should determine whether:

• Legal statutes allow shareholders to take legal actions to enforce ownership rights.
• The local market regulator, in similar situations, has taken action to enforce shareholder rights.
• Shareholders are allowed to take legal or regulatory action against the firm's management or board in the case of fraud.
• Shareholders have “dissenters ' rights" which require the firm to repurchase their shares at fair market value in the even t of a problem.

Takeover defenses include golden parachutes, poison pills, and greenmail (use of corporate funds to buy back the shares of a hostile acquirer at a premium to their market value). All of these defenses may be used to counter a hostile bid, and their probable effect is to decrease share value. When reviewing the firm's takeover defenses, investors should:

• Ask whether the firm requires shareholder approval to implement such takeover measures.
• Ask whether the firm has received any acquisition interest in the past. Consider that the firm may use its cash to "pay off" a hostile bidder. Shareholders should take steps to discourage this activity.
• Consider whether any change of control issue s would invoke the interest of a national or local government and, as a result, pressure the seller to change the terms of the acquisition or merger.

Although most of the points mentioned here are based in the US contact. However, the points served as a guideline to take note of when investing in stock anywhere in the world. Personally I feel that this is an area where investors will not spend much time with although it is equally important to know about the corporate governance as well as what and how the company is doing.

The few recent cases that happened here in Singapore are good examples. We may not be able to identify them and avoid it but some understanding how the corporate governance may help investors to be smarter in their next investment.

The Corporate Governance Of Listed Companies: A Manual For Investors (Part 2)

This is a continuation of my previous post. Besides those points that I mentioned from my previous post, there are a few more things that investors need to look out for in the Corporate Governance of Listed Companies.

A code of ethics for a firm sets the standard for basic principles of integrity, trust, and honesty. It gives the staff behavioral standards and addresses conflicts of interest. Ethical breaches can lead to big problems for firms, resulting in sanctions, fines, management turnover, and unwanted negative publicity. Having an ethical code can be a mitigating factor with regulators if a breach occurs.

When analyzing ethics codes, these are items to be considered:

• Make sure the board of directors receives relevant corporate information in a timely manner.
• Ethics codes should be in compliance with the corporate governance laws of the location country and with the governance requirements set forth by the local stock exchange. Firms should disclose whether they adhered to their own ethical code, including any reasons for failure.
• The ethical code should prohibit advantages to the firm's insiders that are not offered to shareowners.
• A person should be designated to be responsible for corporate governance.
• If selected management personnel receive waivers from the ethics code, reasons should be given.
• If any provisions of the ethics code were waived recently, the firm should explain why.
• The firm's ethics code should be audited and improved periodically.

In evaluating management, investors should:

• Verify that the firm has committed to an ethical framework and adopted a code of ethics.
• See if the firm permits board members or management to use firm assets for personal reasons.
• Analyze executive compensation to assess whether it is commensurate with responsibilities and performance.
• Look into the size, purpose, means of financing, and duration of any share-repurchase programs.

Beside the management, we have to be aware of the Audit committee, the Nominations committee and other Board committee. We need also to be aware of the remuneration and compensation package to analyze if they are tied with their responsibilities and performance.

The Audit committee ensures that the financial information provided to shareholders is complete, accurate, reliable, relevant, and timely. Investors must determine whether:

• Proper accounting and auditing procedures have been followed.
• The external auditor is free from management influence.
• Any conflicts between the external auditor and the firm are resolved in a manner that favors the shareholder.
• Independent auditors have authority over the audit of all the company's affiliates and divisions.
• All board members serving on the audit committee are independent.
• Committee members are financial experts.
• The shareholders vote on the approval of the board's selection of the external auditor.
• The audit committee has authority to approve or reject any proposed non-audit engagements with the external audit firm.
• The firm has provisions and procedures that specify to whom the internal auditor reports. Internal auditors must have no restrictions on their contact with the audit committee.
• There have been any discussions between the audit committee and the external auditor resulting in a change in financial reports due to questionable interpretation of accounting rules, fraud, etc.
• The audit committee controls the audit budget.

Investors should be sure a committee of independent board members sets executive compensation, commensurate with responsibilities and performance. The committee can further these goals by making sure all committee member s are independent, and by linking compensation to long-term firm performance and profitability.

Investors, when analyzing this committee, should determine whether:

• Executive compensation is appropriate.
• The firm has provided loans or the u se of company property to board members.
• Committee members attend regularly.
• Policies and procedures for this committee are in place.
• The firm has provided details to shareholders regarding compensation in public documents.
• Terms and conditions of options granted are reasonable.
• Any obligations regarding share-based compensation are met through issuance of new shares.
• The firm and the board are required to receive shareholder approval for any share-based remuneration plans, since these plans can create potential dilution issues.
• Senior executives from other firms have cross-directorship links with the firm or committee members. Watch for situations where individuals may benefit directly from reciprocal decisions on board compensation.

The nominations committee handles recruiting of new (independent) board members. It is responsible for:

• Recruiting qualified board members.
• Regularly reviewing performance, independence, skills, and experience of existing board members.
• Creating nomination procedures and policies.
• Preparing an executive management succession plan.

Candidates proposed by this committee will affect whether or not the board works for the benefit of shareholders. Performance assessment of board members should be fair and appropriate. Investors should review company reports over several years to see if this committee has properly recruited board members who have fairly protected shareholder interests. Investors should also review:

• Criteria for selecting new board members.
• Composition, background, and expertise of present board members. How do proposed new members complement the existing board?
• The process for finding new members (i.e., input from outside the firm versus management suggestions).
• Attendance records.
• Succession plans for executive management (if such plans exist).
• The committee's report, including any actions, decisions, and discussion.

Additional or other board committees can provide more insight into goals and strategies of the firm. These committees are more likely to fall outside typical corporate governance codes, so they are more likely to be comprised of members of executive management. Be wary of this-independence is once again critical to maintain shareowners' best interests.

I'll continue on my next post regarding the companies' policies with regard to voting rules. Cheers.

The Corporate Governance Of Listed Companies: A Manual For Investors (Part 1)

There are many times when investors invest, they do not really know what the companies they are investing in are doing, let alone if their managements are good in managing and sustaining the businesses. It is very important to know what are the directions of the management and if the managements have the best of shareholders' interests.

Corporate governance is the set of internal controls, processes, and procedures by which firms are managed. It defines the appropriate rights, roles, and responsibilities of management, the board of directors, and shareholders within an organization. It is the firm's checks and balances. Good corporate governance practices seek to ensure that:

• The board of directors protects shareholder interests.
• The firm acts lawfully and ethically in dealings with shareholders.
• The rights of shareholders are protected and shareholders have a voice in governance.
• The board acts independently from management.
• Proper procedures and controls cover management's day-to-day operations.
• The firm's financial, operating, and governance activities are reported to shareholders in a fair, accurate, and timely manner.

To properly protect their long-term interests as shareholders, investors should consider whether:

• A majority of the board of directors is comprised of independent members (not management).
• The board meets regularly outside the presence of management.
• The chairman of the board is also the CEO or a former CEO of the firm. This may impair the ability and willingness of independent board members to express opinions contrary to those of management.
• Independent board members have a primary or leading board member in cases where the chairman is not independent.
• Board members are closely aligned with a firm supplier, customer, share-option plan or pension adviser. Can board members recuse themselves on any potential areas of conflict?
• A non-independent board is more likely to make decisions that unfairly or improperly benefit management and those who have influence over management. These also may harm shareholders' long-term interests.

There is often a need for specific, specialized, independent advice on various firm issues and risks, including compensation, mergers and acquisitions, legal, regulatory, and financial matters, and issues relating to the firm's reputation. A truly independent board will have the ability to hire external consultants without management approval. This enables the board to receive specialized advice on technical issues and provides the board with independent advice that is not influenced by management interests.

The board election should be held frequently. Anything beyond a two- or three-year limit on board member tenure limits shareowners' ability to change the board's composition if board members fail to represent shareowners' interests fairly. While reviewing firm policy regarding election of the board, investors should consider:

• Whether there are annual elections or staggered multiple-year terms (a classified board). A classified board may serve another purpose-to act as a takeover defense.
• Whether the board filled a vacant position for a remaining term without shareholder approval.
• Whether shareholders can remove a board member.
• Whether the board is the proper size for the specific facts and circumstances of the firm.

An independent board member must work to protect shareholders' long-term interests. Board members need to have not only independence, but experience and resources. The board of directors must have autonomy to operate independently from management.

If board members are not independent, they may be more likely to make decisions that benefit either management or those who have influence over management, thus harming shareholders' long-term interests.

To make sure board members act independently, the firm should have policies in place to discourage board members from receiving consulting fees for work done on the firm's behalf or receiving finders' fees for bringing mergers, acquisitions, and sales to management's attention. Further, procedures should limit board members' and associates' ability to receive compensation beyond the scope of their board responsibilities.

The firm should disclose all material related party transactions or commercial relationships it has with board members or nominees. The same goes for any property that is leased, loaned, or otherwise provided to the firm by board members or executive officers. Receiving personal benefits from the firm can create conflicts of interest.

Board members without the requisite skills and experience are more likely to defer to management when making decisions. This can be a threat to shareholder interests.

When evaluating the qualifications of board members, consider whether board members:

• Can make informed decisions about the firm's future.
• Can act with care and competence as a result of their experience with:
• Technologies, products, services which the firm offers.
• Financial operations and accounting and auditing topics.
• Legal issues.
• Strategies and planning.
• Business risks the firm faces.
• Have made any public statements indicating their ethical stances.
• Have had any legal or regulatory problems as a result of working for or serving on the firm's board or the board of another firm.
• Have other board experience.
• Regularly attend meetings.
• Are committed to shareholders. Do they have significant stock positions? Have they eliminated any conflicts of interest?
• Have necessary experience and qualifications.
• Have served on board for more than ten years. While this adds experience, these board members may be too closely allied with management.

Investors should also consider how many board and committee meetings are held, and the attendance record of the meetings; whether the board and its committees conduct self-assessments; and whether the board provides adequate training for its members.

There are more things in the corporate governance that investors should be aware of. I shall mention them in my next post.