A review of some ideas discussed last week at the annual Millstein Governance Forum at Columbia Law School.
The forum’s strong suit is its willingness to consider often-thorny governance issues in the broader context of the ever-evolving capital markets. In deference to the Chatham House Rule attendees agree to, I’m not able to say who said what, but the ideas themselves are paramount here.
For example, what are the implications for corporate governance when companies around the world have become financed far more by debt than equity issuance? Today there is five to six times as much debt as equity in global markets, compared with two to three times as much just a few years ago. The primary reason for that, of course, is how cheap debt is now, a lingering effect of the economic damage wrought by the financial crisis of 2008-2009. It makes you wonder how responsive public companies feel the need to be to their shareholders when in the back of their minds they know they can finance whatever business strategies they hatch by borrowing instead of issuing equity.
IPOs have become a last resort for financing, increasingly being eclipsed by secondary public offerings, which now comprise roughly 80 percent of total public offerings, up from less than 60 percent in 2008. In the first two quarters of 2014, rising IPO and M&A activity has fed optimism about the global economy, but there are now about 1,000 IPOs each year, one third of the volume in 2007. And more than 40 percent of new IPOs in the first half of this year have been private equity and venture capital-related, serving as exit strategies for those types of investors, which was less the case a few years back.
Institutional investors are losing interest in smaller companies, and trading has become accelerated to the point that there is less time to devote to thinking about corporate governance of portfolio holdings. Of the $2.5 trillion in cash held by publicly traded companies worldwide, half sits on the balance sheets of the top 1 percent of public companies. That’s partly due to the fact that smaller firms are being bought out faster by larger ones, before having the opportunity to scale up on their own. At the same time, however, smaller companies now have greater access to capital due mainly to diversified markets such as hedge funds and activist funds. That signals ‘a fundamental change in the nature of the relationship between public companies and the investors who invest in them’, where investors are feeling more emboldened by things such as say-on-pay votes, one panelist said. ‘The amount of capital raised by activist funds is going to put pressure on companies because [those funds] need to deploy that capital.’
Another panelist suggested corporate governance needs to be represented by formulas, where metrics are attached to specific policies, resulting in an algorithm or other method that translates governance policies into measurable financial effects. Corporate governance won’t have much influence if it remains purely a fiduciary and regulatory exercise, he added.
In the EU, a new proposal for a shareholder rights directive based mostly on the UK’s ‘one share, one vote’ model is generating debate about whether the directive ignores the diversity of business structures that exist, including family ownership, which is more prevalent in southern Europe. Family-owned companies are sometimes viewed as less fair and less vibrant than broader ownership models, yet they are often much more focused on the longer term than other kinds of companies.
The longer-term health and direction of companies is something investors in the UK seem more focused on. Recently investors have told the UK’s Financial Reporting Council they want clarity as well as consistency in small companies’ financial reporting. They are seeking a better forward-looking view of the businesses they invest in than the typical one-year outlook companies provide.