Archive for March, 2013

Who should sit on Corporate Boards (I): Industry Experts

Industry expertise provides a better understanding of risks, opportunities, regulatory environment, and competitive landscape. It is a general belief that directors should provide the boards with industry experience, perhaps only second to financial knowledge.

But, does it really improve board effectiveness? What else is necessary, or when is that assertion correct?

Faleye, Hoitash and Hoitash find evidence that industry expertise enhances firm value, while taking companies to better innovation results, by facilitating and bettering organic investments results, (on the other hand, there is not a correlation of industry expertise and firm value generated from acquisitions).

Industry expertise also provides a higher connectedness, through the directors`s connections and relationships in the industry and the regulatory bodies, which can be of a certain firm value relevance in certain industries, where regulation is demanding and local activities are predominant.

Dr Richard Leblanc, in his “Banking directors need to be at the top of their game” post, highlights the fact that directors in Lehman Brothers were well past their retirement age, so probably outdated on the complexities of the new financial products. So, when assessing the capacities of directors, “current experience” is also needed, not just “experience”. Just taking the example of the Online Display Advertising”, as a fast-changing industry, we will recognize the absolute need for this updated directors`expertise. Please look at the enclosed video by the industry association IAB, and be aware of the changes that took place in just ten years. Past experience would have become irrelevant in that time. (

Dr. Richard Leblanc in his Corporate Governance blog points out that lack of industry expertise is one of the reasons why boards lack the courage needed to “do what is needed”, however disruptive it is to the company history or management. Just think of Kodak, and so many other firms, that failed to see what seemed to be evident for many others, except for management, and perhaps to a complacent board lacking industry expertise to be opposed to that of managers, who obviously somehow captured the board.

“People/director of one listed company should not be independent director of another listed company, and it should be clearly defined in the corporate governance guidelines,” Dr M Baki Khalili, the research director of Centre for Corporate Governance and Finance Studies (CCGFS) of Dhaka University, told “Experts alone should be independent directors, otherwise the whole purpose of having independent directors will be defeated,”.

Gregory Pratt, a President of the Capital Area Chapter of the National Association of Corporate Directors, says”The role of industry expertise in determining proper governance is a central piece of the puzzle going forward”.

But, what`s the real life of boards regarding this particular point? There are several studies on this subject, and for instance, one made by GovernanceMetrics International outlined that in each of the US largest companies, at least two directors had outstanding industry experience. Regulation should probably not go further than that, for several reasons: first, diversity could be hit by a general industry expertise requirement; second, a board could turn to be “parochial”, or forced into the kind of “groupthink” that so much harm causes to companies; third, not introducing members from nearby industries, or from industries with similar features, (regulatory pressure, growth path, etc), condemns the firm to lose that part of the picture; fourth, a board is charged with decisions not always connected to the industry strategy or facts, but also to accounting, law and regulation, crisis management, and a board only made of industry experts would eventually fail to satisfactorily comply with its duties.

As Richard Levick points out in Forbes: Whom would you need on the board in an accounting scandal, in a product recall, in a FCPA (Foreign Corrupt Practices Act) probe? How much actual knowledge of your specific markets will your directors need in such eventualities? Alternatively, how much of a broader world view would be needed?

To end up with, let me cite a McKinsey & Co. 2006 report saying: “…in our work with boards we find that too many simply lack directors who have industry expertise to participate effectively in shaping strategy… We believe that on a board of, say, a dozen directors, a litmus test of strategic energy is the presence of at least three or four members who have deep industry expertise in the core business and market conditions the company faces……… Once that expertise is in place, other board members can be screened for deep functional or geographic expertise” (Carey and Patsalos-Fox, 2006).


Faleye, Hoitash and Hoitash: Industry Expertise on Corporate Boards.

Richard Leblanc: Why Corporate boards lack courage?, in his blog:

Richard Levick, on

Shaping strategy from the boardroom, by Carey and Patsalos-Fox, 2006, McKinsey Review.


PESCANOVA, a fantastic firm, in big trouble

March 26, 2013 1 comment

In 1931, a small entrepreneur from Galicia, (Northwestern Spain) died. He had been a meat and cattle dealer. His three sons continued the father`s business, and were very successful, partly because of their innovations, such as the idea to freeze meat for transportation to the market.

They invested the returns in other businesses, as the one we will refer to in this post, Pescanova.

Pescanova is an industrial fishing firm, which was one the first to introduce freezer vessels in the activity in the 60`s. They afterwards bought an old transatlantic boat, which was renewed into a fish processing floating factory. In recent times, it has developed a new but related activity, aquaculture, (they grow turbot, shrimp, and salmon).

It is present in the five continents, it employs more than 8000 people worldwide, it integrates vertically more than 160 companies, it is adapted to new times, (aquaculture already accounts for a third of their Ebitda), and it has acceptable profitability, (as per 3rd quarter results, see here:

Many analysts had been recommending purchasing the company stock, as it had a promising business mix, international exposure that was helping the business grow, and Spanish operations that appeared to be very resilient to the crisis, (in fact revenue was increasing slightly).

But then, the date they should have sent the audited accounts for 2012 to the Spanish SEC equivalent,, (february 28th) they din`t, and instead they communicated that they would not be sending them until they sold certain assets, or until they renegotiated debt with banks. This second option is followed by the company, (March 1st).

What happens next?

Information is leaking little by little: apparently a larger debt volume exists than the volume registered until now in the company books, and it appears that the complex corporate structure, could have helped hide the high leverage.

On March 12th, the company states that discrepancies had been found between actual debt levels and the volume recorded in the books.

On March 14th, an extraordinary board meeting is held, (after some shareholders and their directors asked it), where the Chairman exposed the firm situation, the need for a reconciliation between debt as recorded in the books, and the real debt volume the company had acquired.

A notice is sent to the regulator, where it is stated the board that day had unanimously agreed to pursue the path to renegotiate the company debt. Slightly afterwards, some board members sent a notice denying such unanimity. They state that once the auditors determine the actual debt value, a board meeting was to be held. The company then answered, (again via notice to the Sec equivalent), that the board decided to pursue the renegotiation, (avoiding to give more details on the eventual vote), and that no board meeting had been called yet.

The same day, banks have built a commission that would be charged with mapping all the company debt, (they will retain a financial advisor and an audit company).

What can be said about the company corporate governance? according to the Corporate Governance Report for 2011:

–         The board is made of twelve members, only two of them independents. One of them was recently named Audit Committee Chair. The rest are owners` representatives, except for the Executive Chairman, also owner of a 14% stake.

–         There is no Committee responsible for Corporate Governance: the board itself has that role.

–         Independents are not a third of the total. Directors are mostly shareholders or their representatives.

–         There are not enough tools to counter the power of the main executive, and only board and general assembly are said to be responsible to execute checks and balances, (just a formal say, clearly).

–         There is no relevant role for independents in calling the board, including points in the agenda, evaluating the board, or taking care of the external directors`views.

–         Audit committee met only twice in 2011; the Compensation and Recruiting committee, three times. The AC is not charged with wistleblowing activities, that have not an established and protective channel.

–         There are no limits to the number of directorships they can hold.

–         The board is responsible for (among other things) the financing and investing policy, the corporate structure of holding and subsidiaries, and risk assessment and control.

–         The Audit Committee is responsible for mapping risks, assessing them, controlling them, including: the perimeter. There is an Internal Audit function.

–         Significant holdings include up to 18.931% by non-directors, and 38.276% by directors, thus a total 57.206%.

What did the regulator do?

The regulator has opened an investigation for possible market abuse activities by the company, stemming from the fact that the accounts may have been wrong, and eventually from insider information related transactions.

Of course, it has urged the company to deliver its accounts, but the delay had to be extended, as the company is finding great difficulties in doing so.

Some news in the Press.

News in the press point to a certain subsidiary or subsidiaries, only 49% owned by the Pescanova group, as being involved in certain transactions that stayed out of sight, as the audited consolidated accounts did not include all assets and liabilities for these companies. It appears, according to other sources, that those companies helped the company hide the debt. The company nonetheless, states these companies developed normal activities.

The company auditor (BDO) and the auditor named by the bank group (KPMG) are said to be trying to unveil the truth, so that the company can deliver its reshaped books to the Cnmv, which should take place sometime before the end of March.

On April 4th a board meeting is held, for 13 hours, in which the situation is analysed; as a result, the company issues a notice to the CNMV, (you can see it here{d615f08f-4665-4dd8-956e-353e109d0add}, where it states: first, the company, given the difficulties in achieving an agreement with creditors, declares voluntarily a bankruptcy situation, (which entails it should prepare an agreement proposal to creditors which will assure the company`s survival); second, the company has decided to ask the judge to revoke the auditor`s nomination and name a different one.

According to the press, the auditor, BDO, did not receive in the last days enough and timely information, so that the company has not been able to provide its accounts, as the auditor would have rejected to sign them. In fact, the company in his statement did not include information as to what the actual debt level is. Also according to the press, Pescanova would be preparing to sue the auditor.

The CNMV has issued a press release on April 5th in which it informs that it has opened a procedure, that could end with a fine being imposed to the company, for having failed to send the second semester accounts and complementary information, required by the Cnmv in two previous deadlines, the last ending on April 5th. That gives time to the company until April 11th.

The situation is worsening day by day, and as the press info show: the auditor –BDO- is still working, but there is not a good relationship with management, so they are probably not receiving much openness from the company. Management is still in place, (no info has been released regarding the internal auditor, CFO, or any other), not a single director has been dismissed, the Executive Chairman rejects to leave, the banks have apparently rejected to offer any help whatsoever before having access to 2012 accounts, (as they fear there is even much more debt that the level published in the press), and the company apparently has only a few days of liquidity.

As one of shareholders points out in its annual accounts, an urgent and not explained cash need in February was the red flag two shareholders raised, in the board that should have  (and did not) approve the 2012 accounts. This is very clarifying, but information goes out very slowly.

To be followed and updated…

Just a small update:


–         The Executive Chairman sold half his 14% stake months before the problem was unveiled, in order to provide cash to the company: he obtained € 30 million, but gave a 9 million loan to the company. He did not notice that to the market, as he should have done. Of course, after the facts were discovered, the stock price plunged, and trading was suspended: the rest of shareholders are stuck.

–         On April 15th the company has filed for bankruptcy.

–         On April 15th, the auditor, BDO, rejects that any cause exists for its dismissal as auditor, and demands the company to provide the required information.

–         On April 15th the company has not provided to the Cnmv the Second Half 2012 accounts with enough transparency and sound accounting standards.

–         The Spanish Sec equivalent,, has opened an inquiry, and has decided to follow-up the tasks of KPMG, as a forensic auditor retained by the company.


Nobody explains yet the origin of the liquidity shortage and the reason for such an extraordinary unknown debt level, what the debt was used for, and so on.


To be updated…

Boards determine a company`s approach to risk, but…how?

One of many areas to which boards are currently dedicating more time is risk oversight. It goes with a director`s “duty of care and skill” that they, and a board as a collective team, are responsible for the risk oversight.

One of the responsibilities involved with Risk Oversight involves establishing the company`s approach to risk. But, what does that mean as an actual board task? Let`s see some different approaches:

First, the board may seek to define a global or aggregate risk appetite for the company as a whole. This may seem difficult, for several reasons: a) some of the risks are difficult to quantify; b) some of them are difficult to mitigate; c) sometimes, groups with very diverse activities find it tough to draft a coherent global risk map; d) risk cost and appetite can vary with time.

Second, some companies think all they can do is having a good understanding of the company`s risks, and of the way each of them varies with changes in strategy, operations and environment.

Third, some boards would only accept to be able to determine appetite or tolerance for individual risks. So probably a map of acceptable risks and those that should be avoided could be their risk indication tool.

What is usual in companies is directors thinking they have a clear and common view on risk appetite on the board, although they might not have a formal framework. Nevertheless, when directors dive into the details, they realize they don`t have the same view of the company`s risk approach.

Moreover, there are many examples in very diverse sectors, where boards and even C-suites were not even aware of risks, and exposed their firms to legal claims, environmental disasters and reputation events, kidnappings,  and so on.

How to address the issue?

A path to define the risk appetite of a firm could be drafted as follows:

First, an input is needed on the company`s ambitions.

Second, stakeholders can be asked for the level of exposure acceptable to them for a certain risk, given its likelihood and effects. So, a matrix of “Tolerate”, “Terminate”, “Treat”, (to reduce likelihood or effects), and “Transfer” can be built.

Putting together this matrix may be a starting point.

There are several methodologies companies and advisors use, such as COSO or ISO 31000, but sometimes it is an ad-hoc or based on experience system.

Categories: Enterprise Risk Tags:

One Share, one Vote.

March 5, 2013 3 comments

According to Professor Colleen Dunlavy of the University of Wisconsin-Madison, corporations were not governed by this principle during the first 19th century decades, so that big shareholders did not hold as much power as they did afterwards. Shareholders were more equally treated than their investments would have suggested. By the middle of the century, democratic norms were pushed and the huge power concentration so  normal at the end of the century started. The change was presumably led by wealthy lobbies, which were able to make legislation passed through.

Anthony Kammer thus argues it is not so rare to propose a different system.

Some realities in the capital markets today lead to rethink the principle. Firstly, decoupling, that is, the split of voting and economic rights, (through derivative markets, share lending activities, and so on), forces to reconsider the principle as “empty voters” have a different interest than “full owners”, the last ones still holding an economic interest and risk, so that the two groups would vote differently. Secondly, a difference might be done between long-term shareholders and short-term ones, so as to avoid the kind of bad behaviors and performance deeply responsible for part of the damages generated by the 2008 financial crisis. Regulation is being pushed in that sense, in the EU and beyond.

In fact several endogenous mechanisms allow some shareholders to hold higher voting rights that those corresponding to their investment and risk exposure: dual-class share systems, pyramidal structures, cross-holdings and so on.

Since the 1990`s, the principle has been dominant, and separation from it has been narrowed, even in those countries where a dual class share system was possible, (Sweden in 2004). But their presence gives room to some empirical studies.

First, what are the reasons for that separation from the principle? Some ideas follow:

–         Shares with higher voting rights usually extract a higher premium in acquisitions.

–         Founders launching an IPO usually want  higher proportion of voting rights than cash-flow risk, having cashed-in for the free-float.

–         Some control of private benefits for controlling shareholders might be guaranteed.

–         The cost of capital tends to be higher in dual-class firms, so a reduced need of funds might be present.

A critical point in assessing this kind of proposal, concerns the effects of the disproportionate allocation of voting rights to some shares. Does it affect shareholder value? Although not empirically irrefutable, it is widely accepted that outside equity loses value, because there is a tendency towards private benefits being extracted by controlling shareholders, and because of a higher cost of capital in these economies/firms.

In terms of social welfare, disproportionate control seems to have certain effects, basically connected to the underdevelopment of the financial markets, (the current political trend is probably populist, or led by recent financial events, so that this fact will probably be disregarded). We also refered to the increase in the cost of capital, so these economies would eventually face a certain underinvestment.

A factor worth being considered is the extent to which the level of disproportion in the allocation of voting rights affects the results, and it appears to be relevant, so that a reduced disproportion could have little shareholder value and welfare effects, and so allow for the current regulatory proposals to have some acceptance.

Consequently, the case for extraordinary allocation of voting rights to long-term shareholders can be made. The aim of enhancing long-term shareholding and behavior is laudable, and the effects could to some extent be disregarded. It exists in some countries and companies, (in Sweden, France, Germany), with a degree of success, (as in the case of LVMH, Volkswagen, L`Oreal, and so on). Some unwanted effects can follow if also extraordinary dividend rights are granted, -as proposed in the EU-, (think of the difficulty to calculate the dividend cost and adequate policy).

But the main discussion concerns whether the measure is the best to guarantee the desired result: a cost and benefit analysis should be done to compare it versus other tools to that purpose.

This post follows several articles or comments in HBR, FT, Anthony Kammer, Adams and Ferreira, and others.