Like similar calls in the US following the ENRON debacle and the ’07–’09 financial crisis, the Volkswagen (DE:VOWG) scandal has led to calls of “Where was the board?” In each of these instances, shareholders suffered heavy financial losses. VW shares are down some 35% since the company’s diesel emissions cheating was reported on September 18. The full costs to the company and its shareholders are not yet known but could well be enormous. In the September 30 Financial Times, John Plender concluded his “Insight” column with the following: “VW remains a governance horror story, and the link between bad governance and value destruction cannot be ignored.” In ourSeptember 19 commentary on the G20/OECD endorsement of its revised Principles of Corporate Governance, we welcomed the inclusion of a number of the most important emerging markets in the process. Their participation will, we hope, lead to the strengthening of governance in those countries. The above-cited events, however, illustrate the fact that some of the most advanced economies are still deficient in the protection provided to minority investors, though that protection is an important area of corporate governance.
World Bank Weighs In
Revealing new information on this situation is provided in the Doing Business 2016 report released by the World Bank on Thursday, October 29. This report is the 13th in an annual series that provides comparative measures of aspects of business regulation in 189 economies. “Protecting Minority Shareholders” is one of the 10 areas covered in the report. Effective regulations for protecting minority shareholders, according to the World Bank, “define related-transactions precisely, promote clear and efficient disclosure requirements, require shareholder participation in major decisions of the company and set detailed standards of accountability for company insiders.” Protection of minority shareholders from conflicts of interest is measured through one set of indicators, and shareholder rights in corporate governance are measured through another set. The two measures are combined in an overall strength of protection index.
The results of this analysis give high grades to the United Kingdom, ranked fourth, and to markets strongly influenced historically by the UK (Hong Kong, New Zealand, Singapore, Malaysia, and Canada), which, together with the UK, account for the top six positions, with Ireland and India close behind. Also highly ranked are some small frontier markets – seventh-ranked Slovenia, for example. Apparently, these countries have been strongly influenced by the global standards, the G20/OECD “Principles,” when they designed their corporate governance systems. The United States is ranked 35th globally in protecting minority shareholders, with its weakest score being for the “Extent of Shareholder Rights” index (4.0 out of 10). This index measures shareholders’ rights and their role in major corporate decisions such as calling extraordinary meetings of shareholders, issuing new shares, and electing and dismissing external auditors. Germany is even further down the ranking at 49th, with relatively weak indexes for “Ease of Shareholder Suits,” “Extent of Director Liability,” and “Extent of Disclosure.”
Disturbing Rankings
Minority shareholders in US and German firms should find these low-governance rankings disturbing. As indicated in the G20/OECD Principles, “Investors’ confidence that the capital they provide will be protected from misuse or misappropriation by corporate managers, board members or controlling shareholders is an important factor in the development and proper functioning of capital markets.” If shareholders have adequate rights to information about the corporation and are able to influence the corporation by participating in general shareholder meetings, voting, and seeking redress once rights have been violated, managers and board members are more likely to be held accountable for any misuse or misappropriation of investors’ capital. Reducing deficiencies in investor protection will be difficult but well worth the effort.
Through diversification, investors can reduce the risk to their portfolios arising from firm-specific scandals. ETFs provide a good way to do this. For example, at Cumberland Advisors we are using in our International and Global Equity ETF Portfolios the iShares Currency Hedged MSCI Germany ETF, (N:HEWG), which has 54 holdings. The position in Volkswagen is only 1.7%. HEWG is up 10.97% over the past month.
Bill Witherell, Chief Global Economist.