Investment Initiatives » Corporate Governance and Business Strategy

06.11.10

Corporate Governance and Business Strategy

Posted in Blog at 3:06 pm

In an exchange on the role and importance of corporate governance as a driver for business performance, a respondent seemed to feel that I was making governance out to be a compliance issue, rather than, as he saw it, a strategic issue for companies.  I thought that this mistook my position, and felt the need to respond.  Although I do not consider corporate governance a strategic matter per se, but rather a question of risk management, good governance is essential in order to execute a strategy properly over time.  In fact, it is frequently an important element in enabling that the best strategy is chosen. However, recent history is full of examples of companies which seemed to have winning business models, but which nevertheless blew up because of weak governance, leaving many investors who’d been convinced by the company’s strategy holding the bag:

WHERE did you get the idea that I see governance as mere compliance???  Compliance is making sure that the laws and regulations have been complied with; by definition, that is backward-looking. Governance is an aspect of risk management, which is inherently forward-looking. Good management manages its risks well; it produces the highest possible returns commensurate with an acceptable level of risk. Bad management is hyper-cautious, or bets the farm on a risky strategy (sometimes both in alternation!)

I think people get hung up on seeing this as a negative, merely because it will only manifest itself to outsiders if the roof falls in. Rather it is, if you will, the exercise of foresight that allows a good strategy to shine through. But governance is not itself the strategy, it is not the growth factor. And you need growth factors as well if the company is to do well.

The issue for investors is that there will be plenty of successful growth strategies that succeed over the short-to-medium term because the company got lucky: if you bought WorldCom in 1994 and sold it in 1999, you did well. AIG shareholders were lucky for years. Their luck ran out because of defects in governance which were visible if one paid attention to them. Spotting AIG early as a high risk saved my clients a lot of money, and I believe that’s where the most demonstrable value-added in governance activity is situated.

Sure, if anybody could have convinced Hank Greenberg twenty years ago to break down the silo structure he had created, and to allow his board to have a succession plan (among other things) you would have saved everyone a lot of money, a lot of jobs, a lot of financial stability. But that wasn’t easy, and Greenberg probably wouldn’t have listened to anyone who tried. So the next best thing is the scolds, who point out the shortcomings, and (mostly) persuade a minority that is willing to listen to stay away from risky practices. Yes, you want the best board possible, but you can’t guarantee that they will all do their jobs properly, so you monitor, and you try to assure that all the structures are working, and to make sure than no one is asleep at their post.

Those who oppose the rights of shareholders to monitor and speak out on governance issues seem to believe that human nature changes when people walk into a boardroom.  It doesn’t.

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