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30 November 2013 / The Star

Invest only in companies with good governance records

More and more global institutional investors are embracing the environment, social and governance (ESG) perspective when deciding where to allocate their assets. Governments, too, are increasingly studying how their prospective projects will affect ESG issues.

In all this, there are two areas of focus – ensuring greater transparency and improving accountability for one’s actions. The importance of both becomes clear when you consider that the biggest challenges governments face when they try to improve governance are corruption and self-interest.

If you are new to the idea of governance, you may wonder why ESG should matter so much these days. Well, a few recent cases of poor governance from around the region will have you sitting up and taking notice of how important good governance is.

Let us first examine Japan, which adheres to a very strong corporate culture, but still has a lot of work to do in improving corporate governance. One most recent striking example is the nuclear plant fiasco after its devastating earthquake and tsunami in 2011. Its long-time energy provider bungled badly the post-disaster clean-up of Fukushima and the areas around it, putting a great many lives at risk. Around this time, there was also massive fraud in their now infamous camera maker.

Its neighbour, China, has fared no better. There has been a spate of suicides among employees of its high-tech factories, after they were made to work very long hours for a pittance, and intimidated whenever they dared ask for a raise, more food at lunch or protest against poor pay.

Some workers in India and Bangladesh are not only paid very little, but also risk their lives every day working in factories which are badly built and crammed. The investing community has seen some of these factories in the garment industry collapse, killing thousands of people in them. On the flipside, we have also seen companies that ignore the welfare of their workers being exposed to lawsuits. These suits have wiped out their entire asset bases after the courts make them pay compensation to the families of their employees who had died at their workplaces due to the companies’ neglect.

You may be surprised to learn that many investors still question the need to study ESG seriously. But any prudent and far-seeing investor well knows that any investment should go only to deserving companies, that is, one that is able to sustain its operations without destroying the environment, burdening society or robbing people of their rights and benefits.

The same goes for countries; foreign investors will want to know that they are banking on governments that understand the real issue of sustainability and the impact on all stakeholders.

Good governance is the backbone of any successful company. Without such structure, a company is more likely to trip up when there are unforeseen threats such as natural disasters, global financial crises or social upheavals. It is as hard to build a company with strong, ethical foundations as it is only too easy for one scandal to bring a lesser company, and everything and everyone related to it, down.

For those committed to shaping companies that prize good governance above all, there are four principles to start them off: First, do not bribe anyone or any entity. Second, be transparent in all dealings. Third, avoid all conflicts of interest. Fourth, work on increasing everyone’s accountability for a company’s actions.

These principles were agreed on by some of the world’s largest multinationals in 2008, in the wake of massive corporate frauds such as Enron. Since then, more governments and businesses are keener than before to hone and polish business standards.

Still, many companies who are doing business in a foreign country keep repeating the excuse that “greasing palms is the only way to get business done”. And, the interesting point is that these are the same foreign corporates or individuals who do not plan to stay on in the foreign country for long.

So, they have no real compunction to uphold the highest ethical standards and improve their own employer’s governance record. This is lamentable but only too real. For such corporations or individuals, their only priority is to get business done so that they can go home to their preferred “honest” homeground sooner.

Worse yet, these are the very same corporations or people who participate in and respond to the various corruption perception indices; and, happily (without any conscience) rank countries as being corrupt or otherwise. So, these foreigners or expatriates are just prolonging a vicious circle of their own making.

Against this sorry state of affairs, countries are stepping up their efforts to combat corruption, impress upon others the importance of taking responsibility for mistakes, and being open and honest in how one operates.

Investors, both as foreign direct investors or portfolio investors, are particularly crucial to the success of such efforts because businesses have to listen to them. All investors can put a stop to supporting companies with poor governance records. To find out which companies should and should not be supported, an investor should first clearly examine a company’s supply chain. Besides just looking at the basic fundamentals, it is wise to start asking the questions on the sustainability of operations. This can include working out the details of how realistic it would take to complete particular projects, or how long it would take to obtain all the licences needed to run operations.

If we have convinced you to police companies better before putting money in them, you might well ask: Well, where should I start? Answer: Be very aware of ESG issues whenever you conduct due diligence on a company. You also need to resolve not to invest in any company that disregards ethics in any way or form.

In the meantime, many market regulators are tightening their requirements on companies, and trustees of public pensions are also raising requirements on supply chain management. So there are already some serious steps to good governance, but it is just the beginning, and everyone needs to participate in this governance movement for it to be a success.