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Corporate Governance on the Minds of Investors Worldwide

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ROCKVILLE, Md. (–Investment advisers from hedge funds, mutual funds and pension funds around the world may have widely disparate views on investing, risk and strategies, but according to a newly released survey from Institutional Shareholder Services, nearly all agree that corporate governance is no longer a compliance obligation for companies, but an imperative business responsibility.

Ninety-four percent of the 320 firms surveyed in the 2006 Global Investors Study from ISS said that corporate governance is important to their firms, and four major concerns were shared among all advisers and regions: better board accountability, aligning executive pay with performance, more trustworthy disclosure, and bottom-line performance by companies and their chief executives.

Comprising interviews with investment officers in 18 countries, the survey was predicated on the idea that corporate governance is no longer an issue limited to Anglo-American markets. A majority of investors in all markets ISS studied said that corporate governance was either “very important” or “extremely important” to their affairs, ranging from 61% in Europe up to 90% in China.

Another example can be found in investors’ dealings with issuers, according to Stephen Deane, director of ISS’s Center for Corporate Governance.

“A majority of investors in all markets said relationships with portfolio companies have become more constructive over the last three years,” said Mr. Deane, speaking in a June 7 conference call discussing the survey results. Investors, particularly those who vote proxies, are often agents for change, helped along by the expansion of cross-border proxy voting and governance standards.

Investors in the United States were the most likely to vote proxies across borders, with 73% voting at least half of the shares held outside their home market. Sixty-seven percent of Canadian investors and 60% of U.K. investors reported that they did the same.

Globally, 71% of investors surveyed said that corporate governance has become more important over the last three years, with scandals (45%) and compliance (40%) viewed as the biggest drivers during that time. Of the 63% of investors predicting corporate governance to increase in importance over the next three years, however, only 37% listed compliance as a driving factor, while enhanced investment returns (33%), client demands (32%) and risk management (21%) were seen as bigger issues than scandals.

Points of perspective

There were differences along with the shared themes, Mr. Deane noted. For example, different investor types approach corporate governance from different points of view. Pension funds were the most likely to say that enhanced returns were the biggest advantage to corporate governance involvement, and also tended to be very long-term investors.

Hedge funds, meanwhile, showed the most willingness to take on management and were the least likely to say that the tone of interaction with issuers had improved–no surprise to anyone following the actions of activist funds in recent years. Mutual funds remained reluctant activists but were the most likely to say that corporate governance was important to them, according to Mr. Deane.

Hedge funds, perhaps searching for an edge after 2005′s somewhat flat returns, were also the most likely to cite corporate governance as a competitive advantage in their equity investments.

Regional context also brought out contrasting opinions. While most markets picked enhanced returns as the biggest benefit of corporate governance, 80% of Chinese investors said that increased risk management was the main advantage. “It really stresses how important portfolio value is to them,” said Randy Hancock, executive vice president of global research for ISS.

Executive compensation drew differing views from Canadian and U.S. investors. Bloated salaries for chief executives were seen as a problem everywhere, but in the United States most of all; however, Canadian investors rated it a higher priority than U.S. investors. The reason, according to Mr. Deane, is that many Canadian companies use their southern neighbor as a benchmark, and “They don’t want to catch the disease from the U.S.,” he said.

Different market cultures can also breed different terms of engagement between investors and issuers. Among U.K. respondents, proxy voting is viewed as a blunt instrument, and investors in general prefer to engage companies collectively–to approach as a group and ask for change, whereas U.S. and Japanese investors tended to take a more individual approach. The survey also found that engagement was on the rise in Canada and Australia, with the formation of new investor trade organizations.

The survey showed no clear consensus along investor profile or geographic lines when it came to the issue of social responsibility, a topic that drew the most polarized and passionate responses, according to Mr. Deane. “The basic theme was that there are those who are non-believers ?? 1/2 and those who are believers,” he said. One pension fund slammed social responsibility proponents for being overly conscious while having “no skin in the game,” while another chief financial officer said that social responsibility risk was considered equally alongside environmental and corporate risk as part of the firm’s “holistic approach.”

“In our view, a consensus is possible and [social responsibility] could be an emerging trend, but to gain that, advocates need to put it in terms of not just morality but in terms of the economic interest of investors,” said Mr. Deane.

Challenges and China

One of the biggest issues facing investors globally is quantifying the impact of investors’ corporate governance involvement. When asked whether their firm had metrics in place to measure the success of corporate governance activities, only 16% said yes; the biggest disadvantage listed was the cost.

Some approaches to corporate governance reported by investors in the survey included: driving change from the top, with leaders possessing a long-term vision; removing the “Chinese wall” between the corporate governance division and the investment division, to broaden both views; and turning the focus inward following a proxy session, to evaluate what was done right, what was done wrong, and what can be improved the next time a company is engaged.

The ISS survey also included a special report on China, which Mr. Deane described as possibly the next “hot spot” for corporate governance. A regulatory framework is expected to be adopted there in next 18 to 24 months, and many Chinese investors are concerned with the issues of insider-dominated boards and protecting the rights of minority investors. The country presents “an optimistic picture,” according to Mr. Deane.

The 100-page report is available for download from the ISS web site here.

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Contact Bob Keane with questions or comments at [email protected].


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