Corp Gov Roundup: Corruption Report, Russia’s Trust Problem, Say-on-Audit Votes

From majority vote listing requirements in Canada and independent directors in Japan to an ownership threshold law in the Netherlands, it’s time to span the corporate governance globe to review important developments from the month of July.

International

A not-so-encouraging report on corruption worldwide from MSCI notes that 28% of companies in the MSCI All Country World Index have been implicated in a new or ongoing case of bribery in the past three years. These cases are concentrated in a relatively small number of industries and generally relate to operations in emerging markets.

According to the report, companies prosecuted for corrupt acts under the U.S. Foreign Corrupt Practices Act (FCPA) have faced significant penalties. In dollar terms, these have been as much as US$1.65 billion in the case of Siemens AG, while other companies have faced penalties as high as 140% of EBITDA or 9% of annual sales. FCPA penalties have risen over time, with the largest 10 penalties occurring since 2008. Anti-corruption regulation has also tightened in other markets, such as the U.K., in recent years.

Authorities in China have also stated new commitment to stamping out corruption. If backed up with new enforcement action, it may pose a threat to a range of domestic and foreign firms with operations in China. In contrast, enforcement remains weak in India, another market identified as having systemic corruption.

Canada

A majority vote listing requirement under development by the Toronto Stock Exchange (TSX) follows a 2012 rule instituting majority voting on a comply-or-explain basis.

The rule requires that, following each meeting of security holders at which there is a vote on the election of directors, each TSX-listed issuer must issue a news release disclosing the detailed results of the vote for the election of directors. Rule guidance calls for issuers to disclose one of the following in their news release: the percentages of votes received “for” and “withheld” for each director; the total votes cast by proxy and ballot, together with the number that each director received “for;” or the percentages and total number of votes received “for” each director.

Japan

A recent survey of Tokyo Stock Exchange (TSE) listed companies shows that nearly 73% of TOPIX 500 firms have at least one independent director, up from 60% in 2012. The figure increases to 86% for the larger companies in the TOPIX 100, up from 77% in 2012. This is indeed progress, but slow progress. Most Japanese publicly listed companies are still dominated by insiders, and few boards have more than just a few independent voices on the board.

Netherlands

A law took effect in the Netherlands on 1 July that lifts the ownership threshold investors must meet to put proposals before an annual general meeting from 1% to 3%. The law allows issuers to keep the lower threshold, and investors would have to approve of any change.

It may come as no surprise that executives with more short-term incentives engage in myopic behavior by reducing real investment. It is an argument we have been making for some time. But researchers from the University of Amsterdam recently published a paper, The Effect of Managerial Short‐Termism on Corporate Investment, showing that the capital investment of more than 700 U.S. firms accelerated stock option vesting periods to avoid an accounting expense dictated by a 2005 Financial Accounting Standards Board rule.

Russia

Sberbank Investment Research recently announced the release of its new corporate governance research report. The report, Russian Corporate Governance — Embracing the Opportunity, provides an overview of Russian corporate governance. The report also analyzes Russia’s new draft corporate governance code.

The report shows that poor corporate governance is often the reason fund managers avoid Russian securities. The report categorizes 160 Russian corporate governance events over the past decade for Russia’s largest listed equities into 12 quantifiable corporate governance factors; it then analyzes these against each company and sector’s subsequent share price performance across various time periods.

The report concludes that despite attractive valuations, the perception (and reality) of corporate governance risk tops most investor concerns when it comes to investing in Russian equities. Simply put, attractive valuations and superior growth characteristics of specific equities matter less when there is no trust and when fear of the unpredictable overshadows rational decision making.

In a related matter, Russia’s capital markets regulator, the Federal Service for Financial Markets, is expected to adopt a new corporate governance code this fall reflecting significant changes from the current regime.

Much of the draft language of the code is based on standards developed for banks and financial institutions. Principles on compensation are designed to align executive pay with performance. The new code calls for the establishment of separate compensation and nominating committees. Rules on board independence would set a new limit on director ownership of a company’s stock and would boost board independence levels by increasing the recommended minimum ratio of independent directors from one-quarter to one-third.

United Kingdom

For all of those governance geeks who were excited about say-on-pay votes around the world, British regulators may have something else for you — say-on-audit votes. The idea was proposed by the U.K. Competition Commission (CC) as part of a major audit industry overhaul. The CC stated that it wants “to require companies to hold an advisory vote on sufficiency of the disclosures in the Audit Committee Report.” The CC decided not to call for mandatory auditor rotation, instead proposing that companies be required to put audit contracts up for bid every five years.

United States

Two of the directors on JPMorgan’s risk committee retired 19 July following low support (just over 50%) they received at the company’s May  annual meeting. One member of the risk committee remains, though the board has stated that it seeks to fill the vacant posts.

One novel answer to such board problems may be more “professional boards.” An academic paper, Boards-R-Us: Reconceptualizing Corporate Boards, published on 10 July by of University of California–Los Angeles law professor Stephen Bainbridge and University of Chicago law professor Todd Henderson suggests that board accountability would improve if directors came from professional service companies set up for that purpose, similar to the way firms outsource external auditing services.  The authors argue that “this could create a market for corporate governance separate and distinct from market for corporate control.”

Critics of such a plan for professional services firms to provide board directors raise concerns as to whether such directors can adequately fulfill their fiduciary duty of serving shareowners, especially if they are called on to serve on a large number of boards that would not allow them to dedicate adequate time to each company at which they serve.

Photo credit: iStockphoto/YinYang