Factors Relevant to the Analysis of Corporate Governance

There are several factors that analysts consider when assessing a company’s corporate governance structure and stakeholder management. These factors can provide important insights into the quality of management and the sources of potential risk. The factors that analysts look at include:

Economic Ownership and Voting Control

Corporations usually have a voting structure that involves one vote for each share. Shareholders are however exposed to significant risk when economic ownership is separated from control.

Dual-class structures, in which shares are commonly divided into two classes in which one has superior voting rights to the other (for example, class A and class B shares), is a popular way in which voting power can be separated from economic ownership. Analysts are particularly interested in determining the extent to which this separation occurs.

Board of Director Representation

Analysts look at available information to determine whether the experiences and skillsets of board members are aligned to the current and future needs of a company. It is quite possible that the composition of a board is appropriate for a particular point in time in the history of a company. The membership might, nonetheless, need to be changed to facilitate the  adjustment of the company to new business needs.

Additionally, if the membership of a board is dominated by long-tenured individuals, the capacity of a company to adapt to change might be restricted.

Remuneration and Company Performance

Analysts assess the components of remuneration plans to determine if they support or conflict with key performance drivers. This assessment is somewhat subjective but certain warning signs may lead to further scrutiny. These warning signs include:

• plans which offer little alignment to shareholders’ interests;
• plans which exhibit little variation in results over multiple years;
• plans which have excessive payouts relative to companies with comparable performance;
• plans which have specific strategic implications; and
• plans that are based on incentives which are from an earlier period in the company’s life.

The Effect of Investors in the Company

Investor behavior can limit or enhance the process of effecting corporate changes. For example, a sizable affiliated shareholder can shield a company from the voting done by outside shareholders. Shareholder activism can also create a substantial turnover in a company’s shareholder composition.

The Strength of Shareholder’s Rights

Analysts are interested in determining whether the rights of the shareholders in a company are strong, weak, or average when compared with other companies.

The Management of Long-term Risks

Analysts may consider how a company manages its long-term risks as a significant factor in their overall assessment of the company.

Question

Which of the following most accurately reflects an analyst’s sentiments towards board composition?

A. A board whose membership is made up of a significant number of long-tenured individuals adapts to change better than one with short-tenured members.

B. Once an optimal board structure is derived, there is no need to change the board membership to adjust to changing business needs.

C. Analysts attempt to determine whether the experiences and skillsets of board members are aligned to the current and future needs of a company.

Solution

The correct answer is C.

Analysts are concerned with whether or not a company’s board membership is aligned to a company’s needs, both now and in the future.

Option A is incorrect because long-tenured board members are usually slower to adapt to changing circumstances.

Option B is incorrect because there is no such thing as an optimal board structure. It makes economic sense for a board membership to change with changing times.

Reading 31 LOS 31i:

Describe factors relevant to the analysis of corporate governance and stakeholder management