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Is Bad Governance Chronic?

Once again Larcker and Tayan (Stanford Graduate School of Business and Stanford Closer Look Series, Corporate Governance Research Initiative (CGRI), April 14, 2016) offer us their insightful views on Corporate Governance, and we will briefly draft their contribution in this post.

In their brief article “Governance Aches and Pains: is bad governance chronic?”(1) they present us their view on Bad Governance as a common species, and particularly their perception that Bad Governance is often discovered only once bad decisions (damaging the interest of the corporation and its shareholders) have been adopted. They argue that governance quality is not easy to assess for shareholders and advisors.

In brief they advocate for a bigger awareness by shareholders of the relevance of corporate governance and the need for better discerning tools by them in order to use corporate governance more as an indicator for future bad performance than as a proof that there was a something that had to be tackled before the damage happened.

Larcker and Tayan describe some cases that help them expose their views:

1.- The Massey Energy case.

The case affects a mining accident where many casualties occurred in a company frequently affected previously by minor other accidents. The company had also previous legal violations regarding environmental and free competition practices. In this particular case the company was accused of negligence and bad faith to avoid complying with regulations, its long-time Chairman and Ceo (very well connected until then) resigned and was later sent to prison together with some lower rank managers.

2.- The Nabor Industries case.

A new Chairman and Ceo was hired in 1987 at an oilfield that was going out of chapter eleven procedures after a large underinvestment period. He was offered large amounts of stock options, a big bonus opportunity, and he also bought stock and company notes. His turnaround plan succeeded operationally and financially by 1990. His contract became even more generous as time and good results passed, (change of control and termination packages, stock option reloading, …), but in 2007 shareholders took the realm, and started to curtail his pay only before adopting SoP and rejecting it when results worsened.

3.- The Yahoo case.

For years Yahoo failed to compete effectively with Google and others in both search and advertising activities, then rejected a takeover bid by Microsoft thus destroying value for shareholders. A board dominated by the founder and Ceo at the time, was accused for that, and also for failing to find an effective leadership once successively hired Ceos were dismissed. After the Alibaba tax-free transaction was not assured by the USA IRS and new efforts pursuing growth faded, Yahoo set up an independent committee in order to find strategic alternatives, where the new Ceo was not elected.

4.- The Chesapeake Energy case.

I have referred to this particular case before,(2) and Larcker and Tayan perfectly describe the chaos in corporate governance that occurred in the company for years, in connection with the Ceo and founder`s pay and co-investments, for instance.

They conclude stating their opinion about the critical relevance of corporate governance; they wonder how can investors distinguish bad events that emerge as a result of bad governance and those that are simply the result of “business as usual”. They provide certain ideas:

  • As sometimes it is difficult to attribute a result to the Ceo or to the board, at least investors need to assess that the board performs independently from the Ceo, thus being able to monitor its behavior.
  • Secondly, as the Massey case shows, sometimes culture is responsible for certain major failures, and investors need to be able to verify it the culture prevailing in a firm is the adequate.
  • Thirdly, as the Nabor case presents, sometimes a company`s governance goes down a slope very slowly and that goes unnoticed by shareholders, that should have the means to identify the moment when this starts to happen.
  • Succession planning and board and Ceo evaluation arise as a critical need from the Yahoo and Chesapeake cases.

I certainly agree that corporate governance is an indicator of future problems, but as Larcker and Tayan show in the case of the USA, (and that also happens abroad), retail and institutional investors and of course regulators don`t always succeed to unveil governance flaws in due time.

  1. https://www.gsb.stanford.edu/faculty-research/publications/governance-aches-pains-bad-governance-chronic
  2. https://joaquinbarquero.wordpress.com/2012/04/28/chesapeake-conflictos-de-interes-y-falta-de-comunicacion/
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