The Corporate Governance Checklist

Preserving the corporate governance plays a crucial role in determining the company’s future performance. The funds running with ESG as their theme have an upper hand, even though they fail to predict the future cash flows because corporate governance is concerned with the management transparency and strives to improve the efficacy of running the business. Managers strongly believe that a management which is rich in integrity will run an efficient business in every economic and political distresses. These are some takeaways to know the company you purchased have the rectitude on making business decisions.

We look for three things when we hire people. We look for intelligence, we look for initiative or energy, and we look for integrity. And if they don’t have the latter, the first two will kill you, because if you’re going to get someone without integrity, you want them lazy and dumb.

Warren Buffett

Employee Stock Options, warrants:

ESOPs are a form of equity vouchsafed by the management as a fraction of the salary or a bonus. Employees getting stocks as a part of their remuneration is a promising detail of ensuring trustworthy workers serving for their company. The peril that lurks in writing a cash bounty is often seen as uncooperative. This can be viewed as a sign of dismissal, but Berkshire Hathaway rewards their CEOs with huge cash check in contrast. ESOPs cannot be overrated as the uncertainty pushes out to scrutinize in other forms of governance.

Back track how the check is spent, is the check used to buy stocks of the company or spent on a weekend. If the person spends it on the same business which he/she is running, you should tick the box of ESOPs. Sometimes the employees are restricted from trading in and out. Often businesses draft rules on trading in their stock, such as allowing offloads after 3 years or holding it till retirement and so on.

Avoid redeems of smaller size because employees withdraw for personal needs that are quite common in dealing with the stock option filter. The rationale backing bulk deals by officials will be out shortly and the most common would be restructuring.

Stock Holder Conflicts:

Seek for shareholder conflicts which often arise in merger and acquisitions where the management cuts off super majority voting (3/4 of the total votes), where the minority shareholders are given the maximum power. Differential voting right shares (DVR) are issued in order to raise funds without diluting the voting power. People often rush to buy at the cost of their rights which is hardly compensated with higher dividends.

Cumulative voting is grouping the individual votes for a single category voting. Instead, voting for two separate positions of managing directors, you vote for the same category twice.

Proxy Voting, leads to passing the vote, providing you a flexibility of selecting whom your proxy should be. Therefore the proxy acts as a majority shareholder who is an active investor and is well aware of business dynamics, votes in the best interest of the shareholders. Ensure these kind of voting possibilities the company offers, that indirectly shows the director is inclined to the minors. If you are aware of the Franklin Templeton mutual fund (Debt) closure, it has become mandatory in the mutual fund world, where in the votes left without response should move to the pool of the unit holder’s best interest.

The only company which is surviving business cycles with DVR issued is Tata Motors, started issuing DVR shares in 2008 and have disbursed INR 44.5 and a 1 year return of 268% (as of June 2021).

Shareholder activism:

Among all the financial institutions, hedge funds are the loosely regulated institution and can thus pursue a greater range of activism opportunities. Legal proceeding initiated by shareholders against board of directors, management, controlling shareholders is often brought up by the media forming a public opinion even before the trial dates. In filing a lawsuit, the shareholding isn’t a problem unlike voting rights. The line of distinction is a mirage in the proceeding between a stakeholder and shareholder.

External Auditing Committee:

Every company is monitored by SEBI and the ICAI steps up inspection every year, contributing to the integrity of capital markets. Officers are adding up to skew the reports till the last drop of being legitimate preserving the investor’s confidence in corporate accounting. A major parameter would be the revenue coupled with the auditor’s fee. Beware of the proportional increase, but this had been a trend long back and this relative movement is diminishing. Go with cash flows rather than the sales numbers which are relatively easier to cook which even now professionals would have found a way to bend rules and regulations.

Bonuses and compensation policies:

The company’s remuneration policy might suggest a strong correlation between bonus issue, compensation and revenue, but shareholder’s should ensure the genuity of the words. The disbursement department or the investment committee fights back interest rates not on a yearly basis, but to the daily interest charges. If the perquisites aren’t tied up with the margin produced all the background work on intricacies of capital allocation and liquidity analysis does go in vain. To improve personal gains the managers have to promote the business which in turn treats them in bountiful.

Say on pay is one feature provided to shareholders where they determine whether an executive can be paid a bonus or incentive. In spite of the fact, it’s non-binding, i.e., calling for a vote, but the remuneration committee has no legal obligation to abide by the voting.

Multi Expertise in the board of directors

Look for a board with rich in knowledge and experience. Most of the founders would still hold a fraction and have a seat harnessed but the people come in between should be interested in running the business. The mixture of experts can promote the business in every possible way. The subject matter experts would have undergone business cycles, credit crunch, cash crunch, sales drop and many more which, when they implement, there’s no way but to head north. Rather than relying on one man to run the business, a bunch of professionals can handle the business even they step out. This is a specific business risk which subjects the board to seek for the a member with similar expertise in the field.

A better filter would be a middle aged member who is a talented wizard and interested in running a business. This is where CEOs play a major role. Even though the director is pacing out, the business stays the same. Staggered board is one a shareholder can expect in the bylaws where the entire director crew comes to a vote. This is a wonderful way of shuffling the boardroom in a single year.

The Cupid analysis has it all.

Is a Corporate Governance officer appointed?

Companies typically assign a compliance or Corporate Governance Officer to implement the codes, receive violation reports and resolve ethical matters. Although appointing an officer to this post is a no pass, management does have an officer appointed to take care of the employee’s well being. Few businesses have a director who represents the interest of the workers to maintain the righteousness in the decision of management which is beneficial for the workers and shareholders.

Company’s Ownership:

Businesses which are older than a century or in an aggressive expansion, will result in absolute promoter stake dilution for fund raising with no capital cost. With RBIs conditional sale of 85%, most of the banks are run with no promoter stake and are run well. The checklist collectively showcases an overall score on the company’s corporate governance. A better CEO is often elected by multiple ownership of board members rather than a highly weighted promoter assigning a new Officer making unconformity.

Hand picked by Market cap and Management excellence

Whether the voting structure advantageous to minority shareholders?

As already told, the only association between the shareholder and the manager is the Managing director of the company who finally approves giant leaps of governance. Infrequently the credit providers suffer from non-repayment than the shareholders who try to shout out loud ending up doing what the majority voters pray for.

Are they trading with a company in which any director holds stake?

In case of a director holding stake in multiple businesses sometimes clash with the trading operations otherwise called related party transactions. The worst manifestation would be recommending the other company for services or raw materials. Imagine company B is the service provider and in company A one of the directors recommends company B for a software purchase. Since the order is confirmed by the director, company B with an upper hand plays with the price. This might profit company B, company A is losing money on a relatively cheap service by other companies.

Work on corporate integrity.