Enabling the Business of Corporate Governance Corporate Governance and Sustainability: What Institutional Investors Want Featuring the 2006 ISS Global Institutional Investor Study on Corporate Governance Presentation to Russian Delegation April 24, 2007
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Enabling the Business of Corporate Governance Corporate Governance and Sustainability: What Institutional Investors Want Featuring the 2006 ISS Global.
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Enabling the Business of Corporate Governance
Corporate Governance and Sustainability: What Institutional Investors Want
Featuring the 2006 ISS Global Institutional Investor Study on Corporate Governance
“Unless companies start paying more attention to corporate governance, emerging markets could remain stuck in the backwaters of global finance for years to come.”
headquarters Rockville, Maryland Washington, D.C. Chicago Toronto London Paris Frankfurt Brussels Amsterdam Tokyo Singapore Melbourne Manila Research &
The ISS 2006 Global Study finds investors voicing five major themes highlighting the value of corporate governance
1. Corporate governance has shifted from a compliance obligation to a business imperative:– First came compliance– But investors are seeing corporate governance in a new light, with competitive and portfolio
advantages– And they expect the importance of corporate governance to grow
2. Corporate governance is global:– There are universal views on the importance of corporate governance, and – Global forces are shaping corporate governance practices
3. Investors globally share four fundamental concerns:– Better boards, aligned executive pay, improved and trusted disclosure, and bottom-line company
and CEO performance
4. One size doesn’t fit all investors:– Meaningful differences appear across regions and types of investors– Corporate social responsibility offers a case study of contrasting views
5. Investors face undeniable challenges in corporate governance:– Yet investors are adopting innovative approaches to meet the challenges and, in the best of cases,
are turning costs into profit
Institutional Investors Voice Five Major Themes
Introducing the 2006 ISS Global Institutional Investor Study
Corporate governance has shifted from a compliance obligation to a business imperative
First Came Compliance: Compliance requirements, which were raised in response to well-publicized corporate scandals, provided the catalyst behind the increased importance of corporate governance
Shift to a Business Imperative: Investors increasingly seeing corporate governance in a new light – as a business imperative – due to:
– Recognition of ownership responsibilities – “it’s the right thing to do” – Increased competitive requirements– Enhancement of portfolio value
Forecasted Increased Importance: 63% of investors globally expect increased growth in the importance of corporate governance for their firms over the next three years
1. From compliance obligation to business imperative
Most investors also believe that corporate governance offers business value, with very few seeing it as merely compliance
1. From compliance obligation to business imperative
“Just because it's hard to quantify doesn't mean it cannot be a competitive advantage.” – U.S. investment manager
The focus on corporate governance has increased significantly in the last couple of years because of new proxy voting regulations. Now as more data comes in, we are beginning to look at it as possibly a good investment and performance tool.”
– U.S. mutual fund
We have materially outperformed the S&P 500 over the last decade.” – U.S. activist investor
Corporate governance is global – it’s not just limited to Anglo-American markets but is important everywhere
Universal Views on Corporate Governance Importance: Investors share strong views on the value of corporate governance regardless of their region
Global Forces Shaping Corporate Governance Practices: Globalizing forces exert a pull that shapes and accelerates the development of corporate governance in markets throughout the world:
– Spread of governance standards, such as The U.S. Sarbanes Oxley Act
Pan-European standards
Shareholder voting on remuneration plans has spread from the U.K. to the Netherlands, Sweden, and Australia – and now has shareholder proponents in Switzerland and the U.S.
– Increase in cross-border proxy voting Investors use the power of the ballot box to improve standards in global markets
A majority of investors in all markets studied consider corporate governance very or extremely important to them
2. The globalization of corporate governance
Answers range from a high of 90% of Chinese investors, to a low of 61% in continental Europe Percentage of investors saying that governance is not important is limited to single digits in
every market studied Majority of investors in every market also believe their relationships with portfolio companies
Investors themselves are agents for change – and are interested in the views of overseas investors
2. The globalization of corporate governance
The U.S., Canada, and Australia are the most likely to vote global – and we also find anecdotal evidence of increasing cross-border voting in markets from France to Australia
“Before, we had a proxy committee but did little voting. Starting in January 2005, we have a global committee.” – Dutch asset manager
“We are interested in learning…how overseas investors’ views of Japanese issuers might be changing.”– Japanese asset manager
Investors globally share four fundamental concerns about corporate governance over the next three years
Better Boards: The number one priority in all markets except Japan – includes board structure, composition, and independence as well as the process of nominating and electing directors.
Aligned Executive Pay: One of the top three priorities in all markets studied except Japan. While significant numbers of investors believe that pay should be reined in, their key concern is pay for performance. Investors want boards to disclose the performance metrics and demonstrate the links justifying executive compensation.
Improved and Trusted Disclosure: Financial reporting is one of the top three priorities in most markets. More broadly, more than seven in 10 investors globally cite improved disclosure in all areas, not just financial reporting, as an improvement they most want.
Bottom-line Performance: Institutional investors increasingly view corporate governance as a business imperative – and they rank company and CEO performance among the top three issues in four of seven markets studied.
From board accountability to pay for performance, investors explain why the rank these four issues their priorities
3. Global concerns: four fundamental issues
Better Boards
Better Boards: If you get the board right, the rest takes care of itself.”
– U.K. investment manager
Aligned Executive Pay: “The compensation committees on most boards are out of touch with reality.”
– U.S. hedge fund
“Executive compensation is a razor-like ray that gets shareholders into the boardroom…This is where you see whether directors in fact are independent in action.”
– U.S. pension fund
Improved and Trusted Disclosure: After the scandals and the subsequent catching-up in the financial reporting area,
problems still persist. It’s the basics of corporate governance to have good reporting…”– Belgian investment manager
Bottom-line Performance: “[Company and CEO performance] is the bottom line for everything.”
One size doesn’t fit all investors – investors also reveal differences in their views on corporate governance
Markets Exhibit Distinct Differences: While there are significant similarities in how institutional investors view corporate governance on a global basis, meaningful differences appear across regions on these issues:
– Collective engagement, an emerging trend in some markets– Protecting minority shareholders, especially where family firms and parent
corporations prevail– Claiming securities class action settlements, with interest spreading from the U.S. – The Australia-New Zealand market: a chance to leapfrog?
Where You Sit Influences Where You Stand: Patterns emerge from the ISS Global Institutional Investor Study revealing profiles of each type of investor group studied:
– Pension Funds: The True Believers– Mutual Funds: “Reluctant Activists” Revisited– Hedge Funds: The New Force– Investment Managers: A Microcosm of the Investment World
Corporate Social Responsibility: CSR offers a case study in the diversity of investor views, drawing polarized and passionate responses on an issue that, its advocates contend, represents the next generation of corporate governance.
For example, regional context influences investors’ perceptions about the advantages of corporate governance
Two markets stand out:– 80% of Japanese investors cite enhanced
returns as the most important advantage of corporate governance, compared to global average of 37%
– Only 7% of Chinese investors chose enhanced returns, with 80% pointing to risk management
Investors in China, continental Europe, and Japan are the most likely to say that corporate governance will be more important over the next three years
“So far corporate governance has been window dressing, but shareholders are discovering the real value of corporate governance and the state of corporate governance in Europe: they will have to react. We are on the verge of in-depth corporate governance design changes.”
We’ve developed profiles based on the differences between pension funds, mutual funds, hedge funds, and asset managers
Pension Funds: The True Believers?– The most likely group to cite enhanced returns as the most significant CG advantage
(53%)– They say they are unique among institutional investors in their long-term perspective
Mutual Funds: “Reluctant Activists” Revisited– They are the most likely to say that CG is important to them (84%)
Hedge Funds: The New Force– True to their image, show a willingness to take on management and focus on M&As– Least likely to say that the tone of interaction with issuers has improved (50%)
Investment Managers: Microcosm of the Investment World– Most of the other investor groups are their clients– As a result, their responses align closely with global investor averages– They differed from the average only in their emphasis on client demands
In addition to the five themes, we found that China may become the next hot spot globally for corporate governance
China reminds the rest of the world why corporate governance has become so important
Chinese investors feel the need for corporate governance practices and protections that counterparts in developed markets take for granted:
– Companies lack oversight– Boards fail to provide proper checks and balances– Markets stir distrust instead of building investor confidence – Constraints conspire to hold back the growth of capital markets
But China also presents great prospects for growth, with study participants pointing to a raft of reforms that they expect to propel the country forward in developing a framework of corporate governance laws and standards
These findings show why some China watchers insist that it can become the world’s next hot spot in corporate governance
Board independence, a top priority in nearly all markets, soars in importance among Chinese investors
Special report on China
“One of the major problems facing corporate governance in China is insider control. A well-balanced independent board can well defend against insider control.” – Chinese mutual fund professional
New Incentives Needed: Chinese investors emphasize pay for performance as an improvement they most want to see
Special report: on China
Cultural shift: Managers must now meet shareholder needs, not government quotas. So China must introduce new incentives to align managers’ interests with those of shareholders.
“The executive has no incentive to perform well. And there is no punishment for bad performance.” – Chinese investor
The topic of corporate social responsibility (CSR) drew polarized and passionate responses
“Corporate governance is just one part of all governance risks – social, environmental and corporate… We favor a holistic response.”
– Australian superannuation (pension) fund
“The concept of corporate governance must be more broadly defined and understood. It’s more than boards and executive pay; rather, it’s all of sustainable development. Boards must actively pursue environmental and social issues management. Companies and investors must move away from the historically very narrow view of corporate governance.”
– U.S. pension fund
“It’s been delegated to special interests and moral issues. But there is increasing evidence that it has economic impact. We have a new, long-term project to look at the issues and try to bring it into the mainstream.”
– U.S. pension fund
“SRI is impractical warring between people competing for the same space: investment managers versus the ‘conscience of the world’ with no skin in the game. Everyone has gotten so pious.”
– Australia-New Zealand pension fund
“We don’t follow any type of SRI philosophy. But we believe strongly in corporate governance in all of our holdings, whether it’s Philip Morris or GE or whatever. The state or the EPA [Environmental Protection Agency] should regulate. That is not our scope or mission. We’re an investor.”
– U.S. pension fund
“We aren’t sure, as we think about a sustainable society, that shareholders should be the dominant stakeholder vote.”
Investors are looking for opportunities to capture value as the market rewards companies with improving governance
DEC ’03 Comp committee independent; increase board size; limits on board service
JAN ‘04 Majority of board is independent; nominating committee independentFEB ‘04 Shareholders vote to fill board vacancies; policy on auditor rotation
DEC ‘04 Disclosed CEO related party transactionJAN ‘05 Option plan costs are deemed
reasonable SEP ’05 New CGQ methodology
OCT ’05 Board independence increases
CGQ Index Scores
Many managers are looking for positive trends in governance “momentum”
How can you leverage corporate governance – and ESG – for Russia and your individual companies?
“Unless companies start paying more attention to corporate governance, emerging markets could remain stuck in the backwaters of global finance for years to come.”