12 February 2009
The financial crisis of the past year has rekindled debate and discussions about Corporate Governance and its place in financial investing. The fact that so many banks, brokerages, and investment firms were all equally impacted by the mortgage market melt-down demonstrates, to me at least, that having greater financial business knowledge in the board room and better financial disclosures to those boards could have helped mitigate this catastrophe. The fact that many of the people we entrust our financial futures to either don’t fully grasp the complexities of the instruments and assets they’re buying and selling “for our benefit”, or that their internal risk and reporting systems do not work as advertised I find appalling. And for all the investments these firms have made in creating computer generated financial models, my guess would be that if their models were designed, say, to build an aircraft, the resulting aircraft would be capable of just two (2) things: taking off and flying at a 45 degree angle on a sunny day.
The key failure in this entire financial debacle is rooted in poor corporate governance quality. Weak governance structure is the gorilla in our darkened financial living-room and because the room is dark no one knows if the gorilla is 100, 200, 400, or 800 pounds; and nobody wants to put the lights on to see just how big the problem is because nearly everyone wants to remain ignorant of the risk; hear no evil, see no evil, speak no evil. But if you’re not measuring and managing “governance risk”, then your portfolio, mutual fund or brokerage account will always be measured and managed by something you’re willfully keeping yourself in the dark about. How smart is that?
The measuring and assessing of corporate governance quality is something I would equate to a fiduciary duty. How can any investment or mutual fund manager, plan-sponsor trustee, or securities analyst look anybody in the eye and say with a straight face, “corporate governance quality is not my concern, it doesn’t matter in the final analysis with regard to investment selection”? And likewise I would also say to the firms like Dow Jones, S&P, Russell, Nasdaq, etc…, who have created truly great products with regard to their index services, to please refrain from adding firms to an index that do not pass the smell-test of sound governance quality. And a classic example of this is S&P’s replacing Worldcom, in May 2002, with Apollo Group (APOL). Regardless of Apollo’s potential for success, this company continues to be an affront to shareholders; Apollo has a dual-class stock structure, they do not offer shareholders of the publicly traded Class A shares voting-rights, there is no access to a proxy, they do not hold regular annual meetings, there is no meaningful separation of management and the board, and the firm can be classified as a “controlled company”. If Apollo Group were to go the way of Enron, Worldcom, or Lehman Brothers would anybody be able to hold S&P accountable for imbedding a corporate governance Frankenstein in every index fund in America? What would their excuse possibly be? Yeah, I like that line from “Animal House” too.
Corporate governance isn’t just about believing everything one former Vice President says about climate change or getting tobacco companies not to sell cigarettes to our children. The dominant factor in getting our heads wrapped around corporate governance quality is to better understand “risk” and increase “shareholder value”.
The key failure in this entire financial debacle is rooted in poor corporate governance quality. Weak governance structure is the gorilla in our darkened financial living-room and because the room is dark no one knows if the gorilla is 100, 200, 400, or 800 pounds; and nobody wants to put the lights on to see just how big the problem is because nearly everyone wants to remain ignorant of the risk; hear no evil, see no evil, speak no evil. But if you’re not measuring and managing “governance risk”, then your portfolio, mutual fund or brokerage account will always be measured and managed by something you’re willfully keeping yourself in the dark about. How smart is that?
The measuring and assessing of corporate governance quality is something I would equate to a fiduciary duty. How can any investment or mutual fund manager, plan-sponsor trustee, or securities analyst look anybody in the eye and say with a straight face, “corporate governance quality is not my concern, it doesn’t matter in the final analysis with regard to investment selection”? And likewise I would also say to the firms like Dow Jones, S&P, Russell, Nasdaq, etc…, who have created truly great products with regard to their index services, to please refrain from adding firms to an index that do not pass the smell-test of sound governance quality. And a classic example of this is S&P’s replacing Worldcom, in May 2002, with Apollo Group (APOL). Regardless of Apollo’s potential for success, this company continues to be an affront to shareholders; Apollo has a dual-class stock structure, they do not offer shareholders of the publicly traded Class A shares voting-rights, there is no access to a proxy, they do not hold regular annual meetings, there is no meaningful separation of management and the board, and the firm can be classified as a “controlled company”. If Apollo Group were to go the way of Enron, Worldcom, or Lehman Brothers would anybody be able to hold S&P accountable for imbedding a corporate governance Frankenstein in every index fund in America? What would their excuse possibly be? Yeah, I like that line from “Animal House” too.
Corporate governance isn’t just about believing everything one former Vice President says about climate change or getting tobacco companies not to sell cigarettes to our children. The dominant factor in getting our heads wrapped around corporate governance quality is to better understand “risk” and increase “shareholder value”.
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