The Corporate Governance Performance Conundrum 

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    By: Peter de Auer

    Niall McGee in an excellent article in the Globe and Mail dated September 22, raised the age old question of management compensation, as well as mentioning ‘long-term investing.’

    With respect to the latter, it is largely a myth. The fallacy can be related to the ‘life cycle of companies.’

    Consider that Thomas John Watson, Sr., the American industrialist who built the International Business Machines Corporation (IBM) into the largest manufacturer of electric typewriters and data-processing equipment in the world, would neither recognize, nor hire IBM’s Watson supercomputer which destroyed all humans on the television game show jeopardy.

    Or Henry Ford who wanted to invent a faster horse when he came up with the first automobile that middle class Americans could afford.

    However, back to corporations.

    Tying remuneration to stock prices raises the fundamental misunderstanding between corporate managers and investors. The former should be judged on operating benchmarks of the company over which they have at least some control rather than stock prices, over which they have none.

    The corporate benchmarks include a number of traditional measurements, both actual and relative to a chosen universe. They are much influenced by uncontrollable developments and those within management’s prerogative. These are well understood and documented in literature.

    Key Variable

    A key variable is the timelines needed to make decisions. As an example, the ‘old’ Teck Resources always used to open mines at the bottom of the economic cycle, while most of its competitors waited until high metal prices to start planning and building. Negative short term, but hugely positive over time.

    Most companies cut back on capital expenditures and R&D when times are tough, while others ‘bull through.’ The ‘new’ Stelco fits into the latter category and is on its way to becoming the low cost steel producer in North America.

    Investors are judged only on stock prices. These have their own dynamics, liquidity, and holding periods being two notable ones.

    Pension funds, with positive cash flows differ from those with either no, or smaller needs for short-term considerations.

    The latter simply cannot afford to hold through even relatively short time periods of stock market declines. They must sell, often regardless of the state of the market.

    The role of directors has also been ill-defined, except for their participating in strategy and supervising management.

    The two groups mentioned in Niall’s article raised a number of governance issues, some more worthwhile in our opinion than others.

    Having ‘skin in the game’ is an expression I have never liked.

    It assumes two things: all directors have the same ability to have sufficient liquid assets to buy lots of stock. Also that all directors are willing to hold for as long as they are on the board, for example, give up their ability to sell, for whatever reason, while outside investors retain that privilege.

    An example of the group’s stated objectives is to have more experienced operators (mining engineers etc). That assumes that these are financially very well off, which bears no relationship to their professional competence.

    My favourite is going back to the beginning of ‘scripts’ ( a wonderful arcane term for the modern stock!).

    Competent Captain

    Spice trade was based on finding a competent captain for a ship that would take well over a year to navigate to the sources of spices and return. He undoubtedly had never heard of Lloyd’s Coffee House the early version of the stock exchange. Captain Bligh, the world best navigator, would have been a candidate!

    Investors are warming up to investing in gold. Assumes that they know that the poor record of the past is about to be reversed. Hindsight.

    Conclusion: everything is in a state of flux, including the status quo. The old model never worked, so we need a new one.

    Peter de Auer
    manages Encap Corporation, a business advising and participating in creative initiatives for smaller companies in Northumberland County. He was former head of research in the investment department of the Bank of Nova Scotia; manager, Canadian equities, of OMERS; and helped form ABN AMRO.