Reading 16: Corporate Governance and other ESG Consideration in Investment Analysis

Page No. 143Date / /Reading 16 : Corporate GovernanceAnd Other ESG Consideration ininvest" EmalysisGlobal Ownership StructuresConcentratedVSDisspersedOwnershipConcentraded ownership : A single shareholder or a group ofShareholder have Control over the corporation% ownership is not always reliable (eg vertical owners hiparrangement , dual - class Shares).Ownership Structures & Conflicts1 Dispersed ownership and dispersed voting power :- Weak shareholders , strong managersprincipal-agent - inflicts- Can be mitigated if Controlling shareholders are present2Concentrated ownership 7 concentrated voting power- Strong shareholders , + weak managers +10can monitor mgmtPrincipal-Principal probleman allocate Co resourcesmajority minorityto their benefit Page No. 145Date//3Dispersed ownership 1 Concentracted voting power : via pyramidstructures or dua - class - share Principal - principal problem.Weak majority Strong minority4Concentrated Ownership weak voting power : due to voting CopsdispersedPrincipal - agent problem.- result of restrictions on voting rights of large sharepositionsvoting CapsNotesDegree the of share ownership alone doesn't neccessarily reflectsif Corporate ownership is Concentrated or dispersedControlling Shareholder may either be majority sharehodor (i.e own methan 50% of Corporation share) or minority shareholder (ie own lessthan 50% of shares)Horizontal On or Vertical ownershipHorizontal Ownershipwith Companies with mutual biz int have cross-holders share arrangementseach other.This structer can help facilities strategic alliances and fosterlong term relationship among such companiesVertical Ownership (Pyramid Owner )A Company or group that has a controlling int in two or moreholding 6. which in turn have controlling int in variousoperating co. Page No. 145Date / /Dual - class (Multiple - class) Share sever to disc the dayreeDual - Class of - share giant one share class I Superior has or evenshare ownership from actual Controlvotesing rights, whereas the other share classinferior or no voting rightsInfluential ShareholderBank:As lenders or equity investor can exert influence Maymisuse power to lend at to the firm at higher than -market rates.Dual relationship Can give rise to conflits of int where loans to bankspressurize such organizations to take out largeto the deteriment of other sh holder.Families , :Family ownership / interlocking directorships results in concentrationof control of one many Companieswhite principal agent problem may be reduced problemwith recuriting professionalmang", lack of transparency, accutibilityState-owned - enterprises (SOE) :-InStrategic industries, seeks to provide societal beh fits ratherthan focus on shareholder wealth max.tend to have lower scrutiny of mgmt Page No. 146Date//Institutional Investor :Provide expertise and wield their influence to reduce theprincipal - agent problem.Reduce principal - agent problem by linking many" CompensationPrivate equity firms:to performanceGroup Companies :Similar to family ownership Cross-holdings make it hard foroutsiders to take control Related-party transaction contributeto principal principal problemForeign Investors :Typically benefits minority shareholder in emerging markets bydemanding greater mang" accountabilityForeign ownership > domestic ownershipManagers and Board DirectorsAlign the int of insiders with that of other investorsas Insider ownership , more likely to adopt a long- term focuseco int aligned with external shareholdersHower , too much ownership may give rise toprincipal-principal conflits Page No. 197Date//Corporate GovernanceDirector Independence :-Important when principal - agent - problem is severse (dispersed )no material employment + ownership 1 remunerationIndependence higher with dispersed ownership structerhelps mitigate the principal - agent conflitBoard Structures ;One - tier :- internal (executive) director & external (non executive)Two-tier:- Superiory board supervising the mng" board.Special voting arrangements :Provide an advantage to minority Shareholders in Boardnomination 4 electionmitigates concentrated voting powerIndependent directors must be approved byI,Majority vote2Majority vote of minority shareholdersCorporate goveranance codes law & listing req :"Comply or explain" provisions req firms to follow bestpractices in corporate governance codes - or explainwhy they have not.Stewardship Codes :Seek to engage investors in Corport e governance byexercising their legal rightsVo Voluntary codesencourage investors to exersise their legalrights and increase their M of engagement. Page No. 198Date //2Board Policies and PracticesaStructure :- CEO duality / Chair separation should be indepobBoard independence :- Majority independent to reduce principal-agestproblem. (%.age or no. ?)CCommittees : : Those related to financing reporting mang Selectionand Compensation should be sufficiently independent.dMember skill / experience : Sufficient industry -specific experienceto provide effective supervisioneComposition Diversity Cage gender, length of tenure, edu , culture,and place of birth) promotes effectivenessbother considerations: Include Structure tenure culture, interaction withmang self - evaluations or evaluations from outsideEvaluating Corporate Governance Policies & ProceduresRegular dialogue and engagement efforts with Companies Can helpinvestors understand the benefits of Corporate governancepolicies & proceduresShareholder activision refers to strategic used by shareholdoi toCompel a Co. to act in a desired manner Page No. 199Date//Benefits of effective e Corporate governance include:Higher profitabilityGrowth in return oh equityBetter access rocreditHigher 4 sustainable divFavourable long-term Share performanceLower cost of Capital*Compensation / Voting rightsExecutive Compensation : Linked to performance - with15clowbackprovisions.Shareholdervoting rights : May be diminshed in thepresenceofdual - class sharesESG Disclosures IMPESG - relateddisclosureshave risenwithaw renessofESG - relatedrisksDisclosuresvoluntary-arenouniformitySomecanbepurelyfound in CorporatecommunicationsaswellasuinCorporate filingsAnalystsshouldconsiderinvest"horizon&materialityofinfoNote : Executive Remuneration- transparency of Compensation}Clawblack if certainPerformance criticia for incentive planevent occure - misconduct--- link with Companystrategybreach of law- Pay differentialvs avg workerAppropriate or excessive Page No. 150nd2 March 2023 ThuesdayDate//2KESG FactorAnalysts should first determine which ESG factors are mostrelevant to that industry & then collect that info1 Propretary Methods :Analysts use their own judgment or firm's methodsused to gather info from govt group t published report 10ks etc2]organization environments groupESG data providers :Data provider such as MSCI sustainalytics & RepRisk provideranking + scores & quantitative analysis.3Non-for-Profit industry organizations or initiatives.Provide data & insight on ESGIIRC & SASB provide standardized ESG related infoAnalyst IssuesWrossy aboutFixed- income analysts usually will focus on ESGfactor downside risksESG factors might render an equipment obsolete (i.e abonds Standed asset issue) . & the value of the firm's long -termthat should be particularly Sensitive to the riskEquity analysis consider both the upside and downside impactof ESG factor when valuing a firm stock, reducing discrate for firms with favoroble ESG policies while increasingit for firms with negative policies PageNo. 151Date / /Equity VS Fixed Income generally only focused on downsid riskOpportunitities & downside riskESG IntegrationESG factors can be included in a firm's valuation bymaking various adj to the Co financial statThe credit Spread of a fixed - income instrupment may beadj to reflect ESG concernsAn adj to disc rate or cost of Capital may be used toreflect ESG considerations in an equity analysts.Green Bond :-Proceeds designated to fund specific projects that haveenvironment or climate benefitsIssuers typically incur additional costs related to themonitoring & reporting of the use of the bond proceedsProceeds may be diverted to other uses lie green washing )GreenwashingRisk that bond proceeds are not actually usedfor a beneficial environment or climate - ratedprojectLiquitytypically purchased by buy -and- hold investors Page No. 152Date//Example1a Example I ( environment factor) : Soft- - drink co lowering water wage(- in manufacturing process leads to higher margin higher Stiprices & lower credit spreads on the firm's bonds.Example 2 (social factor) : A drug Co with a history of productrecalls & hoquidity quality concerns may have brand sepulationconcerns Incorporating this info would lead to lower futurestock price & higher credit Spread,Ex 3 (governance issues): A bank's board is sligned with themang" . Equity & credit risk prem for valuation of the banksstocks & bond would be higher