Factors Relevant to the Analysis of Corporate Governance

There are several factors which 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.

Factors

The factors which analysts look at include:

  1. Economic Ownership and Voting Control: Corporations usually have a voting structure which involves one vote for each share. Shareholders are however exposed to significant risk when economic ownership becomes separated from control. Dual-class structures, in which shares are commonly divided into two classes with one having 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.
  2. Board of Director Representation: Analysts look at available information to determine whether the experience and skill sets of board members are aligned with the current and future needs of the company. It is quite possible that a board’s composition is appropriate for a particular point in time in the company’s history but may need changing in order to adjust to new business needs. Additionally, a board composition that is dominated by long-tenured board members may restrict the board’s ability to adapt to change.
  3. 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 there are certain warning signs that may lead to further scrutiny1.
  4. 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.
  5. 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.
  6. 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.

1These warning signs include:

– Plans which offer little alignment with 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

– Plans that are based on incentives which are from an earlier period in the company’s life

Question

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

A. A board with a significant number of long-tenured board members is better able to adapt to change than one with short-tenured members.

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

C. Analysts attempt to determine whether the experience and skill sets of board members are aligned with 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 composition is aligned with  a company’s needs, both now and in the future. A is incorrect because long-tenured board members are usually slower to adapt to changing circumstances. B is incorrect because there is no such thing as an optimal board structure. It makes economic sense for a board’s composition to change with changing times.

 

Reading 34 LOS 34i

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

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