Assessing Corporate Structure in Relation to Investing in Emerging Markets
Corporate structure refers to the ownership and organization of a company. If you’re investing in emerging markets, understanding the corporate structure and corporate governance is key as these issues can be complicated and can definitely influence the value of an investment.
Actions to take prior to investing include:
Investigating the board of directors: In some countries, companies are required to include worker representatives, but in a typical situation, the board is made up of representatives of any controlling shareholders and prominent businesspeople who have some kind of relationship to senior management and the controlling shareholders.
Before you invest in a company, find out who’s on the board of directors. Look for incestuous relationships among other boards, especially situations where someone on the board is a top executive at or owner of a company that’s a customer or supplier of the business you want to invest in. When push comes to shove, that board member won’t be looking out for your interests.
Assessing executive compensation: The issue isn’t the absolute amount of pay but rather whether the pay is fair for the work performed. Investors should look at just that. They should also be sure to include cash and stock compensation, perks and benefits that the executives receive, and the pay of executives relative to other employees in the corporation.
In some countries, companies are required to report the salaries of the highest-paid executives. That’s useful information if you can get it. If not, you may just have to ask a lot of questions and look carefully at a company’s expenses to see whether they’re in line with the industry.
Also consider the perks that the senior executives receive. Because income taxes can be very high in some countries, it’s not unusual for employees to receive company cars, club memberships, or even some personal staff rather than salary. These perks probably won’t be disclosed, so you have to look at overall expenses relative to profits and relative to other companies in the industry.
Corralling the controlling investors: In emerging markets, where families may control companies and where managers have little experience dealing with professional investors, getting information may be difficult. Executives may be reluctant to answer questions or give minority shareholders information because they don’t want to anger or offend the family that controls their jobs.
Identifying protections for minority investors: Many companies all over the world limit the percentage of shares held by outside investors. Many large companies are publicly traded but still owned in large part by the founder, the founder’s descendants, or another large corporation. That doesn’t necessarily mean that the controlling investors can run roughshod over everyone else. In some jurisdictions, mergers or other corporate decisions require a supermajority vote of shareholders. This means that the owning family may not have enough votes on their own, so they have to lobby the minority shareholders to support their decisions.
Looking for corporate social responsibility: Corporate social responsibility looks at how companies treat employees, the community, and the environment. The thought is that companies that do the right thing socially are more likely to do well financially. The evidence on corporate social responsibility as a way to build a long-term sustainable advantage is mixed, but it’s become a common way to look at companies in developed countries.
For the most part, companies in emerging markets haven’t been as quick to embrace corporate social responsibility practices, in large part, because the companies are newer. They haven’t had their relationships tested in ways that lead to new practices, nor do they have the resources to do governance the same way that countries in developed markets do.