Archive for September, 2012

Engagement: concept, objectives, and phases

September 22, 2012 1 comment

We can think of Engagement as the investors` attitude towards Envoronmental, Social and Governance issues, requiring  companies to improve their related practices.

The objective may be:

  1. Optimising Long-term Value: emphasis relies on alignment of interests, (so that optimal risk adjusted returns are met); in this case, investors focus on governance, strategy and financial aspects.
  2. Other investors concentrate their efforts in companies that might lead them to face reputational risks, (human rights, environment, etc.).
  3. Other institutions, such as unions, employee groups, NGO`s, try to foster their agenda, and although their objectives are different, they may converge.
  4. Complying with regulation forcing investors, fund managers, and so on, to explain their vote practices and policies.

The engagement policy can be aimed at obtaining more information on ESG practices, or at having those practices improved by the target companies.

What are the main activities developed by investors involved in the Engagement policy?

  1. Establishing priority areas, among those cited above: for example if one investor`s focus is governance, he might be interested in independence of directors, board structure, ….
  2. Identify companies: funds, large investors, have usually investments in many companies, so that they need to determine what sectors, industries, tipes of companies, etc., are more likely to be exposed to the priority areas.
  3. Dialogue with company: it usually starts with a direct contact with managers, by phone, letter, etc., so that the investor`s concern is made clear to the company. Then, a medium-long term monitoring process starts, during which the investors puts light into progress being made by the company.
  4. Transparency about the engagement policy, the specific targeted companies and areas involved in each case, their progress,
  5. Exercising voting rights: a responsibility, (in somer cases a legal obligation), this gives visibility to the investor, and consists in a previous dialogue over the General Meeting proposals, voting, and voting policiy disclosure.
  6. Involvement in general meetings: submitting questions, filing resolutions to be included in the GM agenda, (sometimes retirement before the GM is a success story); regulation states who can send those resolutions, (% and permanence of ownership).
  7. Joining forces through neetworks and coalitions: this reduces costs and increases the influence.
  8. Divestment: it is a last resort tool, but it can also behave as a credible threat, as investors divesting usually disclose publicly their action and the reasons below.

In a forthcoming, we will deal with the major challenges that investors face in their effort to have an effective and efficient engagement policy with companies.


Why independence in the Board, how do NEDs need to be, and how to assure their effectiveness

September 10, 2012 Leave a comment


a) Independent and friendly outside directors. Firm Value.


Corporate Governance scandals in early 2000`s led to increased director independence as a result of regulation. As Sung Wook Joh and Jin-Young Jung show –“Effects of Independent and Friendly Outside Directors”-, many studies bring forward the fact that directors connected with Ceo and management are “more likely to pay excessively the management, that succesively performs worse than otherwise”. Those studies centered on the Directors`monitoring role. In large firms, in those where directors easily acquire information, whithout asimmetries, this is the case.

But the advisory role, and the directors` connectedness (that helps expand businesses), both are also related with firm value, and perhaps this is more relevant when monitoring is already effective externally, through equity markets and the M&A threat, or because of a highly volatile environment. Friendly outsiders can in this case be positive for firm value, as they do in stand-alone and distressed firms.

When there is a strong regulatory pressure, politically connected ousiders are positive for firm value, through their help in resources` acquisition, (licenses, and so on). This is also the case for firms acting locally.


This helps understand why some firms still keep recruiting friendly directors, deeply believing that they act efficiently, even if they send a negative signal to markets


It would also help understand why “When regulation forces a board to become more independent than endogenously determined, the CEO may counteract by strengthening connectedness with other key players governing the firm” so as to weaken the regulatory effect, (“The Independent Board Requirement and CEO Connectedness”, by E. Han Kim and Yao Lu, where the authors consider a bad effect of Ceo connectedness on governance, monitoring, performance, and hence, firm value).


b) What is an Independent Director?


The Spanish Governance Code, (Código Conthe), establishes that an independent director is one that is elected for his/her personal and professional profile, and is isolated from pressure coming from management, significant shareholders and the corporation itself. He cannot have been Director in other group`s firm, he cannot be employee or otherwise receive significant fees or payments from the company; he cannot be himself or have been named to represent a significant shareholder; he cannot be a manager`s relative; he must have been proposed by the Nomination Committee. Basically, he needs to be an unconflicted director. As Richard Leblanc affirms, (“Rethinking what it means to be an “independent” Director”),  the problem is the way conflict is determined: it is usually judged by the Board, whether “there are material relationships,…., that can reasonably be expected,…, to interfere with their independent judgement”. For an employee, a conflict of interest is understood to exist, when a superior and objective body, (a manager, the Board), thinks it exists, and the judgement is not limited to what the employee thinks by himself. But when the Board assesses the subject itself, it very often forgets to notice social connection among directors, long tenure, other perks and capture instruments offered by management, and so on. Perhaps the existence of conflicts of interest should be assesed in a much objective, even external to the Board, manner.


c) What are the main qualities of an Independent Director?


According to a survey and report by Korn Ferry International, (“Greatness Cultivated in the Boardroom”), there are different sets of required attributes for a NED:

–         Core characteristics: they need to be strong but not domineering, strategic but able to drive into the detail, engaged and team oriented, while able to preserve thinking independence, and committed. Of course, experienced.

–         Characteristics on the rise: they need to deeply understand risk, (so as to determine the company`s risk appetite, not just approving managers` decisions on that), have a global outlook, be responsive to change, and familiar with new technologies and social media; of course, they need to have a long term view and perspective,  (both on corporate responsibility matters, and strategy).


There is also a perceived list of behaviors that Neds need to avoid:


–         Hostility, egocentrism, uncommitment, policeman style, captiveness of compliance.

–         Non-stop talkers, nodders, hesitators.

–         Particularly relevant, NEDs need to understand the challenges the company is facing.


d) What should a Board/and the NEDs themselves do to optimise a NED`s performance


–         Boards should use personal and collective evaluation of NEDs and boards, and of course provide them with all reasonable support.

–         NEDs need to: learn as much and as fast as possible, ask and listen before issuing uneducated comments, commit to add value, and reach out other directors and relevant people.