How Understanding Corporate Governance Can Make You a Better Investor

Recent business headlines have reignited my interest in the important investing topic of corporate governance.

Some of these headlines include the sudden departure of the chief executive of Singapore Post Limited (SGX: S08) as well as an article in The Business Times pointing out potential issues with the company’s board. In China, there is a probe by the country’s government into key corporate leaders such as Fosun International’s Guo Guang Chang, who is nicknamed China’s “Warren Buffet,” and Chang Xiao Bing of China Telecom.

For individual investors like you and me, corporate governance may seem like something that is out of our reach – a subject that we will not fully comprehend, let alone analyse, when we are making investing decisions. But, I think that this is just a misconception. So, let us look at what is corporate governance and whether we can tackle it.

The business of governing business

Corporate governance is the system by which companies are directed and controlled in the interest of shareholders and potentially other stakeholders.

In 1992, the Cadbury Report was produced in the United Kingdom, as a response to major corporate scandals and failures in the country. Though initially limited to preventing corporate fraud, the report has become a standard that has since expanded to corporate governance in general.

In a nutshell, corporate governance is a way to manage a company to safeguard shareholders’ wealth.

There are generally five main areas in corporate governance:

  1. Leadership of the company
  2. Effectiveness of the board
  3. Accountability of the board
  4. Remuneration of the board
  5. Board relationship with institutional investors

As individual investors, we might not have oversight of all the aspects listed above and we may even have limited ability to effect change. But, we can still focus on a few issues when making investing decisions – we can “vote with our wallets,” so to speak. Here are some questions we can ask ourselves, with a ‘yes’ answer being the desirable response:

  1. Is there a balance of power in the board? Is any board member, especially the chief executive or chairman, too powerful? (The second question here would see a ‘No’ as being the answer to see.)
  2. Does the management team demonstrate a) competence in terms of having vision and execution ability, b) sound character in terms of having integrity and transparency, and c) commitment in terms of having an aligned economic interest together with shareholders?
  3. Do the board of directors have the relevant business skills and experience?
  4. Are the remuneration levels for the board and management team reasonable as compared to industry peers and more importantly, tied to the long-term economic performance of the company?
  5. Are the independent directors really independent?
  6. Do major shareholders/institutional investors take an active interest in the governance of the company?
  7. Does the company have a functioning audit committee?

Though the above list is far from complete, they contain areas that individual investors like you and I can form a reasonable opinion of, using published and easily accessbile information. By asking a few key questions, we can make better investment decisions and avoid the risk of investing in companies that are weak in corporate governance.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore contributor Lawrence Nga doesn’t own shares in any companies mentioned.