David Gait explains why encouraging company stewardship in Asia can only be a good thing for investors.
A 450-page offer document recently landed on the desk of Asian investors, courtesy of an Asian company that hoped to list.
A cursory glance revealed a number of worrying corporate governance issues:
- the owners had previously been banned by the regulator from accessing the stock market for two years for engaging in stock price manipulation;
- the company had 172 outstanding litigation cases covering 31 pages;
- there were significant conflicts of interest;
- there had been three different auditors in the past three years; and
- there were several serious environmental issues outstanding.
In terms of corporate governance, it would have been hard to give it more than one out of 10. Yet far from scaring off investors, the issue was oversubscribed 39 times. For now, at least, corporate governance is firmly off the radar screen for many Asian investors.
Following the recent turmoil in financial markets, shareholders are looking to become engaged with the companies that they own. Through active ownership and improved stewardship, shareholders can look to improve standards of corporate governance and long-term sustainability.
The contrast between East and West is noticeable. In the UK, the debate about corporate governance, the ‘ownerless’ corporation and engagement has reached a crescendo.
All institutional investors will be subject to a Stewardship Code that aims to improve the quality of engagement between shareholders and the companies they own.
Unlike their Western counterparts, Asian markets are not dominated by ownerless corporations.
Nonetheless, better stewardship is desperately needed in Asia too.
Good stewardship requires three simple steps. Firstly, and most importantly, investors need to open their eyes.
Too many still hide behind the excuse that information about governance, environmental management or social performance is not available.
This is not true.
The information is there — albeit not always in the places one might expect to find it. As a useful rule of thumb, the greater the number of pictures of smiling children in the sustainability report, the greater the problems lurking beneath.
Yet by far the best source of information remains the companies themselves.
The ability of management teams to convincingly articulate their approach to corporate governance or environmental management is very revealing.
They can also be a rich source of both positive and negative information about their peers.
Reputation checks on owners, independent directors and auditors are usually easily done, while local non-government organisations provide invaluable insights.
Elsewhere, there are often plenty of clues in the notes to the accounts, while flotation documents offer a once-in-a-corporate-lifetime glimpse at what are usually well-hidden skeletons.
A second useful guideline is to recognise that there is no such thing as the perfect company, and that stewardship comes in shades of grey.
There must be tangible evidence of an improving trend, even if it is of the ‘two steps forward, one step back’ variety.
Corporate culture matters, and management teams must be willing to admit their weaknesses and mistakes and then learn from them. Incentivisation schemes need to encourage a long-term mindset and focus on risks as well as rewards.
Above all, when investors come across issues, they must engage with management.
The third important guideline is to ensure this engagement is constructive, not destructive. Aggressive letters rarely, if ever, work.
Building a rapport can be as simple as writing thank you letters after meetings. The more time spent on the shareholder register, the more productive the engagement becomes.
Investors need to lean on independent directors for support. If confidence is lost in management’s ability to address the problem, agitate behind the scenes for a change in personnel.
This is usually much more effective than waiting for a confrontational showdown at the next annual general meeting.
Some investors have wondered if the introduction of policies such as delayed dividends, deferred voting rights and short-term capital gains taxes might be more effective. A financial version of the Hippocratic Oath has even been suggested.
Above all, good stewardship requires the right mindset.
Buying a share means buying not only a piece of paper or electronic ticker, but part of a real business with all the rights and responsibilities that go with this. Get it right, and everything else follows.
Get it wrong, and investment becomes little more than an elaborate game of speculation. And speculation and stewardship are not natural bedfellows.
David Gait is senior analyst global emerging markets at Colonial First State Global Asset Management.
