Two weeks ago, I had the privilege of speaking on Impact Investment and Microfinance at the Responsible Investor ESG Europe Conference. This is the 3rd RI ESG conference I’ve attended and the first at which Impact Investment had a seat at the table, so overall, a positive development. Kudos to Harry Hummels, Director of Impact Investments at SNS Asset Mangement for his role in bringing impact investment into these mainstream discussions. Nevertheless, I was struck by a number of “convergence” issues across exchange-traded “socially responsible investment” (SRI) and non-exchange traded impact investment, most notably governance.
As you would imagine, given that “ESG” stands for “environmental, social and governance”, governance was a major focus of discussion. In the exchange-traded universe, this means emphasis on issues of executive pay, shareholder proxies and defining the nature of Board responsibility with respect to the pursuit of social and environmental goals. Only this last topic would make it onto my list of governance priorities for non-exchange traded ventures with social impact. Other priorities? Protecting minority rights, controlling or eliminating related party transactions; ensuring that Board composition can create value for the company (including appropriate independent representation); establishing Board level Committees that provide effective oversight of key risk areas (finance, audit, governance, etc); developing succession and disaster recovery protocols; and last but not by any means least, managing conflicts of interest.
Why should we care about the difference in governance concerns between publicly traded and privately held companies? I would argue that the size and scope of public markets puts us in a bit of a “chicken before the egg” situation. Most public companies start life as privately held concerns and move into the public space once their operations have reached a certain scale and profitability. Securities regulations dictate how public companies must behave with respect to reporting, minority rights and governance. An increasing body of research suggests that good governance, as well as a concern for social and environmental impact, translate into better long-term corporate performance, so this regulations-driven approach to corporate stewardship clearly has its merits.
Private companies generally enjoy greater freedom to define Board functionality and the extent to which they will report on their operations and results. In emerging markets, private concerns are often held by families whose governance practices may be quite informal compared to public company governance practices. How though do we expect private companies to move from relatively fluid, convenience-dictated governance to a more transparent, responsible and responsive governance style in advance of a public offering? Is it OK if companies adopt wholesale changes in governance at the time of a public offering, or does effective governance change require a more pro-active approach? I would argue that the work of defining and embodying “’good governance” in privately held companies can have a significantly positive impact on how these companies grow and how they perform once they become publicly held concerns, which should matter to us as investors.
Granted, my “evidence” for the importance of active good governance is largely based on personal experience and therefore anecdotal in nature. Nevertheless, if we accept the importance of good governance in publicly held companies, understanding how good governance applies in the context of privately held companies would seem worthy of greater discussion and debate.
If you are investing in a privately held mobile payments company (for example) in an emerging market, you should be prepared to attend all (or the vast majority) of Board meetings whether monthly or quarterly. In addition, it’s worth arriving before the Board to talk with other Directors and outside sources of industry information and staying on after the Board to recap any pending issues with company management. Number one complaint I hear from General Managers of ventures with social impact about their Boards is that Directors fly in on the red-eye, fall asleep halfway through the Board meeting and then depart immediately afterwards leaving all parties none the wiser for the visit.
Bearing in mind that your role as a Director is to act in the best interests of the company (and not on behalf of the Shareholder whom you represent), you should also take the time to understand the company’s industry and stakeholders both within the local context and in a broader view of global competitive forces. Understanding and managing the tensions between potential synergies and conflicts of interest (or the appearance of conflicts of interest) is also likely to require time and energy. When I sat on the Board and Governance Committee of an African financial services firm, I found that the Governance Committee work took far more time, energy and creativity than my primary Board responsibilities. In this particular instance, Committee work fell heavily on those Directors who took an active view of governance engagement, with a substantial minority of Directors preferring not to get involved. As a Board, we would have been more effective had we all been equally engaged and explicitly (rather than implicitly) aligned with regard to the goals and objectives we should be supporting and monitoring.
Perhaps because of the anecdotal nature of how good governance works in ventures with social impact, the concerns that I find myself highlighting when I define governance training programs are rarely discussed in industry forums. “Good governance’ for many means asking for a Board seat to ensure access to information, but rarely includes a defined plan to make effective use of that Board seat. Is it just because traveling to Board meetings in emerging markets is time consuming and expensive? Or are we perhaps failing to realize that we need to play a more active role on some types of Boards than on others? Is the notion that Board members of ventures with social impact should not be compensated for their time creating positive value or precluding the active engagement of those whose households or organizations are not wealthy?
If securities regulations stipulate governance, reporting and minority rights conventions for firms that go public, do we really need to worry about how these issues are addressed before the firm goes public? From my optic, developing a good governance culture and learning how to guide strategy without micromanaging operations can never begin too soon. How we behave when we have internalized certain values is different than how we behave when we are complying with regulations or requirements that have no personal resonance.
Here’s a recent piece of anecdotal evidence. The second in command (and son of the Founder) of a large specialty financial services firm in Mexico serves on the Board of a regional specialty microfinance firm with me. We’re a tough Board in terms of requiring timely information disclosure, frank discussion of problem areas, contingency planning and so on. Despite the occasionally tense Board sessions, this 2nd in command commented to me recently that he can really appreciate the value to the company in having an informed and vigilant Board. He noted that Board meetings in his company usually consist of himself, his father and mother sitting in the family kitchen discussing what they ought to do. While the ease of decision-making this provides had worked well for the family, he could appreciate that bringing broader collective wisdom to the table might compensate for a more complex decision-making environment. Having seen “good governance” in action and perceived its value, this gentleman is inclined to push for changes in his family’s company that will enhance both performance and transparency going forward.
Would a legal requirement with regard to Board composition have produced the same results? On paper, sure it would. A formal Board would be conformed, probably consisting of a number of close family friends, and the letter of the law could be complied with, but the intrinsic value of good governance would not necessarily inform the Board’s functioning in any way.
Good governance isn’t just about following a certain set of rules. It is fundamentally about understanding ethics, corporate values, competitive environment and how all of these elements need to inter-relate with regard to strategy and operations. Good governance requires knowing when and where there are grey areas and helping the company move out of the grey in a positive manner. Public and private markets function in different ways. Increasingly visible and vocal public debate on what good governance means in publicly held companies is a positive and important trend. Let’s complement that trend by exploring how good governance differs for privately held companies and what we can do, as investors, to strengthen that function and add value to our portfolio companies.