Corporate Governance Analysis

Corporate Governance Analysis

Objective

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Assess the company’s corporate governance structure and examine the relationships between different stakeholders in the business (society, bondholders, financial markets).

Key Steps

  1. Examine whether there is a separation between the management of a business and its
    • owners. If so, also assess how much power owners have in monitoring management and influencing decisions.
  2. If the firm has borrowed money, either form banks or in the form of bonds, evaluate the potential for conflicts of interest between the equity investors and lenders and how it is managed.
  3. If the firm is publicly traded, examine how markets get information about the firm and investor reactions and assessments of the stock.
  4. Evaluate the company’s standing as a corporate citizen, by looking at its reputation (good or bad) in society.

 Framework for Analysis

    • Corporate Governance
      1. Voting Structure: If it is a publicly traded firm, look at whether the firm has multiple classes of shares and if so, whether they have different voting rights. If the government is an investor, check to see whether it has veto powers (golden shares) over key decisions.
      2. Ownership structure: Start by looking at proportions of the outstanding stock held by institutions, insiders and individuals. This data is generally available in public sources, in most countries.
      3. Top shareholders: Look at the top ten to twenty holders of the company’s shares. In addition to checking to see how many are institutions, look for the presence of founders and activist investors on the list. (You are trying to see if these stockholders will be willing to stand and contest management, if they feel that their value is being put at risk.)
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      4. CEO and top management: Look at the background of the CEO and examine how he or she got to the position. In particular, check for tenure (how long he or she been CE)), whether the CEO came up through the ranks or from another
        • rganization, his/her age and connections to the ownership of the company. If you can, ask the same questions about the rest of the top management team.
      5. Board of Directors: Look at the composition of the board of directors and in particular at connections that the directors may have to the top management and, in particular, to the CEO. Check to see if there are external assessments of the board’s independence and quality but also check news stories to evaluate whether there is evidence that the board is willing to stand up to management. There are services that measure the quality of corporate governance, such as Institutional Shareholder Services (ISS) in the United States.
      6. Compensation Structure: Find out how much the CEO/top managers were paid in recent periods and in what form (cash, restricted stock, options) and how these payments relate to company performance over the same periods (both in terms of accounting profits and stock prices).
    • Bondholder Concerns
      1. Debt type: If your firm borrows money, examine whether it borrows from banks or by issuing bonds. With either one, follow through and find more details on the borrowing.
      2. Debt covenants: Check to see if there are covenants or restrictions imposed by the lenders. You may be able to find this information in the annual report or filings with the regulatory agencies.
      3. Default risk measures: If your company has been rated by a ratings agency (S&P, Moody’s, Fitch), find out the bond rating and the ratings agency’s views of the company.
    • Financial Markets
      1. Trading and Liquidity: If it is a publicly traded company, examine the portion of the shares that is available for trading (free float) and how much trading there is in the company (by looking at trading volume, relative to market value). If you can, get measures of liquidity costs from the market including bid-ask spreads.
      2. Analyst following: If it is a publicly traded company, see if you can find a listing
        • f the sell-side analysts who follow the company and what they think about the stock. Many services provide information on both metrics, with a breakdown of buy, sell and hold recommendations from analysts following a company.
  1. Society and other Stakeholders
    1. Employee satisfaction: Look for hard data on employee satisfaction such as employee turnover and compensation numbers for your company, relative to its peer group. Also, look for qualitative assessments of the company as an employer, generally from news stories about the issue.
    2. Society: In general, it is tough to get a measure of how a company stands with society, unless your company is at one of the extremes. In addition to looking for news stories that mention your company is a social context, you can try to see if the company makes the lists of socially responsible corporations that are published by some external entities (environmental, labor and political) but recognize that they may be no consensus, since these groups have different agendas.

 

Stockholder Analysis

 

Objective

Identify the average and marginal investors in the company are, with the intent of figuring out how diversified they are, and get a measure of the risk (both amount and type) in your company.

Key Steps

  1. Given the investor breakdown in your company’s equity, identify the average investor in your company.
  2. Given the investor breakdown in your company’s equity, identify the marginal investor in your company.
  3. Develop a risk profile for your company and break the risk down into its component parts: firm specific and market risks, micro or macro risk, discrete or continuous risks, small or large risks.
  4. Get a measure of variability risk in your company’s stock and a measure of default risk for its debt, if available.

Framework for Analysis

  1. Stockholder composition
    1. Looking at the breakdown of your stock holdings by type of investor – institutional, individual and insider, make a judgment on the “average” or “typical” investor in your company.
    2. Looking at the list of top holders of stock in your company, make a judgment on the “marginal” investor in your company.
    3. If you have significant insider holdings in your company, identify who these insiders are and what role they play in key decisions made by the company.
  2. Risk Profiling
    1. Make a list of all of the risks that your company is exposed to in its business and classify these risks into firm specific, sector wide and market wide buckets.
    2. Looking at risk item in your profile list, consider how that risk will be viewed by managers, the average investor and the marginal investor and think of how each
      • f them may view this risk and how they may try to manage that risk.
  1. Risk Measures
    1. Estimate the standard deviation in your company’s stock, if publicly traded. You can download stock prices for past periods from online (and free) databases, like Yahoo! Finance. Compare to the standard deviations of other stocks in your peer group and in the market.
    2. If your company’s debt is rated by a ratings agency, obtain the bond rating. If it is rated by multiple agencies, examine differences in the ratings and see if you can find reasons for those differences.

 

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