Tuesday, September 16, 2008

Value Investing Today: Chp 7: Corporate Governance and the Value Investor

Brandes describes corporate governance as the relationship between a company and its shareholders. The board of directors are elected by the shareholders and have fiducial responsibility for the shareholders. The board of directors appoint officers to manage the company. Problems often arise because of a lack of alignment between shareholders and the management of the company. Shareholders own stock and get their rewards through return on investment whereas management often receives upside only returns (no downside risk like shareholders) through salaries and stock options.

Brandes suggests watching out for the following principles to help avoid potential conflicts between shareholder and management:

1) The board should be made up of a majority of non-executive, truly independent directors
2) A board nomination committee should exist and be responsible for putting forth the director nominees
3) A board compensation committee should exist and establish fair and transparent compensation for the executive directors
4) A board audit committee should exist and ensure the integrity of the company's financial information
5) There should be transparent, effective and fair procedures available for how to conduct shareholder meetings and for how to allow shareholders to exercise their votes.

Shareholder activism is one way to try to make changes on how management is behaving. Brandes believes that effective shareholder activism needs to be conducted by institutional investors (generally they have more leverage than individual investors) and should focus on corporate governance values rather than operational issues. To be effective with shareholder activism, the activists need to be persistent and consistently raise the same issues with management until they are resolved. Many institutions forgo shareholder activism because it is time consuming, can be expensive with professional legal assistance and might hurt the institutional firms chances of getting (or lose) business from the target company for example to manage their pension assets.

Unlike many institutional money management firms that invest for short term (speculative) profits, value investors invest for much longer time frames as they wait for the market to recognize a company's intrinsic value. For this reason, value investors may be more interested in being active shareholders.

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