In the third in this series on equity investing, Hugh Young discusses the importance of fair treatment of shareholders.
Who are companies run for? In a public company the shareholders are the owners. In theory, at least, the company is run for them. Yet almost since the beginning of the joint stock company in the 19th century, it has been recognised that there is a flaw in the system.
When owners are passive shareholders and entrust management to outsiders, problems of agency may occur. The manager, possessing more information on the day-to-day business of the company, will naturally try to maximise his wealth at the expense of the owner, creating a conflict of interest.
In the modern company this conflict is played out all the time. CEOs leave office having earned millions despite an underperforming share price. In theory (again) codes exist to determine ‘best practice’ in governance. A standard recommendation is for a majority independent non-executive board of directors to oversee managers on behalf of shareholders.
But there is no such thing as perfection in governance and models. In the US the chairman and chief executive is often the same person. In Germany supervisory boards representing owners and workers exert oversight. Meanwhile, Japanese companies are run for employees, communities and interest groups (such as banks or suppliers) as much as shareholders. It is almost impossible to buy one’s way into a position of control.
In the ‘bad old days’, Asia was synonymous with ‘crony capitalism’ and the family-controlled public company invited widespread scepticism. Minorities could do little but blame themselves when companies syphoned money away from listed companies into private concerns – or injected overvalued assets into the company. Impunity was rife.
Nowadays listed companies across the region have to follow much tighter governance codes. The best family-controlled concerns are actually very good now; many employ professional managers and make a habit of consulting shareholders. Having their own money in the business means they are more careful as to how it’s spent.
That does not mean Asia is full of reformed characters; reputations last and memories are long. As an investor it is always worth knowing the background of the main company sponsor – because that is the best guide to behaviour in the future.
Reputation also matters because laws to protect shareholders in Asia lack bite. Despite strides in governance codes, often form prevails over substance. A board may look independent, but non-executives may turn out to be relatives, friendly lawyers or useful business mates.
It is still legal in parts of Asia to issue up to 10 per cent of new shares without votes (a useful way to dilute the influence of undesirables); to take shareholder approval on significant matters on a show of hands (putting more power in the hands of a myopic CEO and rendering proxy votes, such as those we make on behalf of client funds, almost meaningless); and to trade shares up to a month before annual results (long a source of insider abuse in Hong Kong).
It would be unfair to suggest Asian companies are alone in bending the rules. There are many listed companies in Asia that are Western subsidiaries. Although they promise Western standards of governance, they are not immune from sharp practice. Over the years, as minorities, we have been on the receiving end of buy-out bids from parent companies that have undervalued our shares – and where independents failed to stand up for a better price.
Last year consumer products giant Unilever proposed a hike in royalty fees from its listed subsidiaries in Indonesia and India. In Indonesia, local governance codes were silent on the need for a shareholder vote and Unilever just went ahead.
What good governance boils down to is a proper system of checks and balances and that more subtle thing, which is trust. Structure is no guarantee in itself. For example we have long held stakes in the old Hong Kong ‘hongs’, Swire and Jardines, despite dual-share structures that confer voting rights disproportionately.
As Chinese online commerce company Alibaba has discovered, this sort of thing isn’t allowed for listings candidates in Hong Kong these days. So the company will list in the US where, oddly enough, this sort of equity apartheid is still permitted.
Hugh Young is managing director of Aberdeen Asset Management Asia Limited.
