We believe that governance is revealed by the behavior of the people within the entity. Measuring it is done by assessing how a country or company regulates both itself and the people who are part of its environment and, importantly, how it interacts with its constituents. Honesty and transparency are the foundation of good governance. On the other hand, fraud, corruption and other undesirable actions are corrosive to good governance, and can more easily occur in opaque environments.
Countries must demonstrate the ability to create an economic, legal, and regulatory environment where output can grow, investment opportunities are attractive, and investor rights are protected. Just because a country has laws and regulations on the books does not necessarily mean that they have good governance. It is the enforcement of these laws and regulations, not just the stated intentions, that is the determining factor of what is actually happening in a country.
The selection of international equity investments has traditionally relied on much the same investment analysis as is conducted on domestic securities. However, since every country is governed differently, this analysis may be like comparing apples to oranges. When addressing international equity investments, an investor must know for a given country:
Today, country governance is generally not explicitly included in investment decision making. The required information is not easy to find or to incorporate into the investment decision-making process. What is required is a systematic technique for collecting, processing, and organizing country data and organizing it into a format suitable for guiding investment decision.
Companies must demonstrate strong, deep relationships and the transparency to reduce the risk of corruption and malfeasance. Companies may have rules and regulations; they may publicly state their beliefs during press conferences, publish marketing materials, and have pages of their intentions on their websites, but that doesn’t always translate into what is actually happening in a company. A company can have an attractive brochure and even a green logo, yet have material governance weaknesses that increase the risk of major problems, including environmental disasters, poor safety records, and significant loss of company value. Measuring an organization’s behavior and actions is the best indicator of good corporate governance.
As we have mentioned, traditional governance information tends to focus on not only intent but also structural factors (e.g., executive pay, diversity of board of directors, independent board chairman, auditing, etc.). While structural factors are a part of understanding the role of governance in a company, these may not be a reliable indicator of behavior of the company. One or more women can be directors of a company, yet the company can still have major issues, including an under-representation of woman among employees (and especially in upper ranks), unequal treatment of women, and even a culture of hiding sexual harassment.
An independent chairman is part of having an independent board; however, chairmen that meet the technical definition of independence may not act independently. Board independence requires skilled board members, good information, and the ongoing interactions with the employees to understand the company and its operations. A strong board with a good perspective on the company is more important than simply making sure the chairman is independent. Getting a better view of governance requires better quality data instead of a greater quantity of intent and structural data.