Moment in the sun for corporate governance is not coming too soon. The lessons for investors from VW are not straightforward, nor are the remedies simply administered.
VW is a high profile victim of poor corporate governance
By Ian McVeigh
Truly these are heady times for us, the mainly male and middle-aged members of the corporate governance fraternity.
Never has the subject had higher profile. Speaking on a recent conference call on VW, I was told that no less than 300 people had signed in. Celeb status beckons.
As I write, a colleague has just informed me that a lady called Christine Hohmann-Dennhardt has been appointed Board Member for Integrity and Legal Affairs by the German car giant. Corporate governance does really seem to be having its moment in the sun.
The global financial crisis has made the public much more aware that what is going on in the great business corporations is of real importance. Only last year, the BBC’s Andrew Marr said that if he had his time again, he would rather have studied economics than politics – business has global reach; British politics seldom has.
VW is another chapter in this saga. Increasingly the focus is on company boards and the job they are doing or not doing: our world of corporate governance. The lessons for investors from VW are not straightforward, nor are the remedies simply administered.
New boss Matthias Mueller will have to put right what went so wrong at VW.
At the same time, if we can see what a bad structure looks like, can we also see what a good one looks like? In London there seems to be a certain amount of mirth, schadenfreude even, that the German model went wrong. We were told the large shareholdings of the Porsche and Piech families, worker directors and regional government appointees provided a base for measured, long-term investment.
In much the same way, the Co-op was once held up as an aspirational governance model. The fate of these two very different companies tells us there is no universal model.
After the fall, it is always so obvious. At 20 strong, the VW board was probably far too big and unwieldy. This former model of long-term and stable thinking now became the story of a warring family, clapped-out regional politicians and a load of time-serving trade unionists. It may seem obvious, but it wasn’t. Dysfunctional boards, like dysfunctional families, can survive far longer than anyone imagines, prospering even.
All of these issues have been around for a long time. The company, with €200bn (£145bn) in sales and nearly 600,000 employees may be just too big to manage. It has, though, been that way for ever and in the last 10 years VW has been one of the best performing shares on the German stock market.
This does not mean that investors were blind to the risks, just that other things were more relevant. In that 10-year period, demand from China was the bit of the story that mattered and VW was one of the earliest to seize that opportunity.
The issue that investors face now is what to do. Most of the shareholders unusually have almost no votes. The family and the government of Lower Saxony own the voting shares. This structure is common in Europe.
Investors, of course, bought in knowing this was the case and taking the view that so great were the other strengths of VW that it was a risk worth taking. Once it has gone wrong though, there is little an outside investor can do other than wail or sell out.
UK investors anxiously watching can in general feel reasonably relaxed about the standard of governance over here in my view. In global comparative rankings, our companies traditionally score very highly. We have held shares for a long time in two companies, Howden Joinery and Arrow Global, which we think serve as examples, not the only ones, of many of the things investors might like to consider when deciding whether a firm is well run or not. I am not saying whether the shares are cheap or dear, that is another discussion.
Both have strong positions in their markets – Howden, which supplies kitchens to small local builders who service the “done for you” market, and Arrow, buying and managing debt from a range of businesses. Critically, we believe that the businesses are of a scale that is big enough to be material but not to be unmanageable. Both executive and non-executive management have a chance of knowing what is going on, of being on top of the detail.
In both cases, the founder/directors have significant shareholdings. There is no better way of ensuring alignment of interest with outside investors. At the same time, these shares have been bought by the directors with a decent amount of their own money. Shares issued free as options to employees can be seen as “free money” and, as a result, often don’t produce the right sort of behaviour.
Both Howden and Arrow have what we would call right-sized boards: eight board members at Howden, seven at Arrow. The boards have always struck me as cohesive: big enough to have a diverse range of different and relevant experience, but not so big that they are hard to manage. We have noted in both a good relationship between chairman and CEO, but one where appropriate distance is maintained. I recall a FTSE 100 director at another company who chaired the remuneration committee, telling me how much he had enjoyed a weekend’s shooting at the home of his CEO. Not what we want.
Investors can get a sense of whether they have a board that is likely to function well, from the reports and accounts: a huge amount of information is available. Have a look at tenure for instance. How long have the directors been on the board? Long enough to know the ropes or so long that they are part of the furniture?
Ultimately though, the critical contribution of a board is to appoint a top-notch chief executive. They must then support and monitor their chosen appointment, paying them well but be ready to fire them if they come up short. This is the single most important aspect of a non-executive director’s role. In an era where board members find their time increasingly taken up by the need to ensure companies meet an ever-growing set of complex, and at times burdensome, regulations, it can be all too easy for a board to lose its main raison d’être.
As for you, the investor, it is impossible to overstate the importance of doing your best to make sure that the board is competent, organised and looking after the interests of all the shareholders at all times.
Ian McVeigh is head of governance at Jupiter Asset Management.
Within the New Zealand Corporate world Governance as a performance enhancing and enabling discipline is rarely accorded the attention and focus it deserves.