Selling governance

I’m getting my act together and taking it on the road,’ proclaimed the heroine of a hit musical in the 1970s. Senior managers and directors of some prominent companies are singing the same tune with respect to their corporate governance.

With new laws requiring more disclosure about governance policies and practices – along with increased demand from investors and analysts – listed companies are giving greater prominence to governance issues in their annual reports, analyst presentations, web sites and shareholder letters.

Fund managers also are finding sophisticated new ways to incorporate evaluations of governance practices into their overall assessments of corporate performance. For their part, some listed companies are even staging special governance ‘road shows’ to talk about how they have, indeed, got their governance act together.

Calgary-based energy giant Nexen is one example. Its corporate secretary, John McWilliams, started doing governance road shows in 2002, when Sarbanes-Oxley loomed large on the horizon.

As a voluntary 10K filer in the US, Nexen needed to react to US regulations faster than its non-filing peers in Canada, explains Sylvia Groves, manager of Nexen’s governance office and assistant corporate secretary. So the company’s first road show included meetings with the NYSE and other experts in the new regulations. ‘The timing was impeccable, let me tell you,’ Groves says.

A neighbor in Calgary, Fording Canadian Coal Trust, has also launched governance road shows, mainly to reassure investors that the governance of an income trust can be relied on just as much as that of an incorporated company.

‘There is a view that the governance of the income-trust sector is not up to snuff,’ says Colin Petryk, Fording’s administrator for corporate secretarial services. In its meetings with the Toronto Stock Exchange, the Canadian Coalition of Good Governance and other stakeholder groups, the company ‘wanted to make sure people knew that we govern ourselves much like a corporation does, and that we do not cut corners,’ he explains.

According to research developed by equity analysts and fund managers, a focus on good governance – including an emphasis on openly communicating a company’s structure and practices – correlates to better financials and stronger share prices.

Deutsche Bank’s equity research, for example, ‘continues to find a link between governance standards, governance change and equity performance,’ according to Gavin Grant, a Deutsche Bank corporate governance research analyst, speaking at the annual meeting of the German Shareholders Association in 2004. ‘Corporate governance is a component of equity risk.’

Deutsche Bank has developed analytical tools to measure companies’ governance standards and the momentum with which their governance principles have evolved. The bank’s conclusion – detailed in a 2004 study titled ‘Beyond the numbers’ – is this: ‘Investments in companies with the highest quality of governance structures and behavior have significantly outperformed those with the weakest governance.’

Fund managers, equity analysts and company watchers in general have been quick to catch on to this connection, demanding more information about the structure of companies’ boards, the independence of directors and other key governance issues.

Companies have responded well to shareholder demands generally, even though it’s not always clear that the information being requested is relevant to company performance, according to Groves. Presenting investors with this type of information proves very popular and definitely provides a significant boost to a company’s relationship with the investing community.

‘There has been a huge surge in corporate governance information published by companies, and that continues to increase,’ Groves says. ‘Some of the issues may appear to be less important – for example, the matter of term limits for directors. We think it is more important to measure a board member’s effectiveness, rather than only look at how long the director has served on the board. But the information requested by investors continues to evolve and, over time, we will figure out what is the most important governance information and focus on that.’

Nonetheless, it’s clear that the demand for contextual information about how companies work will not let up. ‘The increased focus on contextual issues is a worldwide phenomenon,’ notes Simon Wilkinson, manager of IR solutions for the London Stock Exchange. ‘Investors are particularly focused on governance. In many ways, governance is a proxy for how well the company is managing its risks and its business in general.’

According to Matteo Tonello, acting associate director of the Conference Board’s corporate governance center, the surge of information includes a great deal of detail, ‘for example, how companies recruit members of their audit committees and what their internal controls and risk management measures are.’

Pushed by the law

In most developed countries, the drive for companies to disclose greater amounts of governance information through various channels, including road shows and shareholder presentations, originated with governance legislation.

In the US, the main impetus originally came from Sarbanes-Oxley, and additional disclosure requirements continue to appear on the horizon. In January, for example, the SEC proposed revised rules on executive compensation disclosure, including the definition of procedures for negotiating pay rates.

In the European Union, a company law directive expected to be finalized this summer will require companies to refer to a corporate governance code and to discuss whether they are complying with it, and if they are not in compliance, to explain why.

In Britain, the Combined Code regulation recently updated following a governance inquiry by the Higgs Commission requires more governance disclosures, particularly concerning the appointment of independent and non-executive directors, director training and board member evaluation.

‘The better companies take advantage of the opportunity and describe how the board actually works and what issues the board has considered,’ states Ken Rushton, a partner with Nestor Advisors in London and former corporate secretary of ICI, the UK-based chemical company. The more interactive approach has always been well received by investors. However, Rushton adds that there are only a few companies that do this, citing BP and Barclays as examples.

In France, listed companies have been required since 2003 to publish an annual ‘president’s report’ on governance and internal controls. Part of the report must focus on the organization and functioning of the board of directors.

‘Since 2003, there has been a lot more disclosure on corporate governance,’ says Emmanuel Du Boullay, co-founder and member of the board of the Institut Francais des Administrateurs, an association of senior corporate administrators. ‘Greater efforts are being made to communicate on matters of governance to all stakeholders. This can take the form of letters to shareholders or presentations by senior managers – whether by the CEO, the chairman, the CFO, the head of investor relations or the corporate secretary. No single person has a privileged position on making such presentations.’

Preventive medicine

For directors and senior executives, such road shows can serve as preventive medicine – making investors, fund managers, analysts and the media better acquainted with the company and its situation, so that a foundation of trust is in place in case of a crisis.

‘When things go wrong, investors start crawling all over a company, and part of that could be because they have not seen much governance information in the annual report and they don’t know how the company works,’ says Rushton. ‘We are now seeing better ongoing communication between listed companies and investors, although not always by smaller listed companies.’

‘Large companies in particular are keen to deal with governance, basically as a hygiene issue, to make sure people don’t start questioning things they are doing,’ agrees David Somerlinck, corporate governance policy manager for Pensions and Investment Research Consultants (PIRC) in London.

In Britain, the newly required Operating and Financial Review ‘is a way for companies to sell what they are doing in the area of corporate governance,’ suggests Somerlinck.

For Fording Canadian Coal Trust, ‘the main reason for governance road shows is prevention,’ says Petryk. ‘If we don’t go down that road, a discount to our value would eventually apply. There is a mistrust out there, and if I can say that we have done road shows to learn about best practices and have taken steps to educate our directors and inform investors, then all this will help to build trust.’

Divided attention

That said, companies trying to tell their governance stories during investor and analyst road shows often find that they have to overcome divided attention within their audiences, with some interested mainly in financial results and others focused on governance.

‘Large institutional investment fund managers often work in silos – that is, internally they separate the people who make investment decisions from those who specialize in looking at corporate governance,’ says Rushton. ‘The larger funds can be quite compartmentalized.’

‘Listed companies are weaving more governance information into their presentations to investors, but it must be said that in those meetings, they are not asked too many questions about the bigger picture,’ suggests Wilkinson.

Nonetheless, the trend is for governance experts to have more input into fund managers’ investment decisions. ‘This growing influence is not yet reflected in active questioning during company presentations, but that influence is there,’ Wilkinson adds.

To avoid this division of interest, companies such as Nexen are running road shows specifically related to governance and separate from the investment side of things.

Good listeners

Companies making governance presentations emphasize that listening to investors, analysts, governance ratings firms and proxy solicitors can be just as important as telling them the company’s governance story.

Past road shows by Nexen, for example, have included visits to the Toronto and New York stock exchanges, Georgeson Shareholder, the division of Moody’s that prepares governance ratings and the company’s own external counsel in New York. ‘If I had to rank the reasons for these trips, the most important is the relationships we create, second is the information we receive and third is the information we impart,’ says Groves. ‘These meetings are about building good relationships.’

In addition, Nexen seeks clarity in meetings with institutional shareholders on what they might actually be looking for when proposing changes in governance. ‘In governance, there is always the issue of the day, for example, compensation of directors,’ Groves explains. ‘It’s important for us to determine exactly what lies behind these concerns and what people advocating certain changes really want to know.’

‘These meetings involve asking questions, meeting with individuals and trying to improve our governance practices,’ agrees Petryk. ‘If we are trying to implement best practices, we have to deal with what shareholders want.’

For some companies, governance road shows can also be used to negotiate with investors and head off proposals from activist shareholders. ‘More shareholder proposals are coming in, and there is now a growth trend for companies to negotiate with the proponents rather than just publish these proposals the way they come in,’ says Groves. ‘By sitting down and talking with them, we can go through the process and decide what to do, and hopefully have the proposals withdrawn.’

Effective communication of corporate governance practices and procedures – and how they’ve been decided upon – should form an essential part of every company’s IR and corporate development strategy. The corporate secretary has a vital role to play in ensuring that the process runs smoothly and may find that, if done correctly, it can even make the task of governance easier and strengthen relationships with all stakeholders.