One of the casualties of the recession and stock market plunge has been investors' confidence in the integrity of the public equities markets and the companies they represent.
It's no secret that management of public companies does not always act in the stock owners' best interests. We have seen many examples of "management gone bad" in recent years: Dennis Kozlowski at Tyco, Ken Lay at Enron, and Bernard Ebbers at Worldcom, to name a few. More recently, we've learned about compensation abuses at Merrill Lynch, AIG, KB Homes, and numerous other public companies.
Boards of Directors are responsible for executive compensation and, in most of these instances, failed to exercise their oversight responsibilities on behalf of shareholders. Why? And why aren't members of boards being held accountable?
Quite simply, that's not the way it works. Board members and management often share personal and business connections. They don't exhibit the true independence and objectivity that they should possess. Also, board members are shielded from liability through insurance paid for by the company.
So how is an investor's interest really represented? Obviously, it's best when corporate management acts with integrity, and board members exercise their oversight powers.
There are other things that can be done—and are being done with greater frequency—that also can have a positive impact:
BWFA believes that using information from independent monitoring and reporting companies has the potential to significantly improve the effectiveness of our investment process and also to pressure companies to improve their practices.
We began utilizing the services of Governance Metrics International (GMI) and Institutional Shareholder Services (ISS) in 2004. Over the past several years, GMI and ISS have developed highly specific metrics to measure and rate corporate governance. Research by ISS has shown a direct relationship between good corporate governance scores and financial performance. Factors that go into a GMI or ISS rating include: Boards of Directors' effectiveness, including executive compensation; audit practices; stock compensation; and takeover defense measures.
Through GMI and ISS, BWFA is able to obtain and monitor corporate governance ratings for the companies we buy for our clients. We are pleased and hope you are too, to note that the average corporate governance rating for companies BWFA owns on behalf of its clients is in the upper 20% of all 3,600 companies that GMI and ISS rate.
In conclusion, evaluating the integrity of management is tough. But it's fair to say that good companies are always more transparent than bad ones. By watching how companies behave and the way they report (or don't report) what's going on, we can try to make good decisions about where to invest our client's assets.
