“Good governance practices are important for the sound financial growth of a corporation—the board directs and protects,” said Stephen Kibsey, VP Equity Risk Management at Caisse de dépôt et placement du Québec. On May 8, 2013 he addressed a noon-hour seminar of financial analysts and portfolio managers through remote link on the subject of corporate governance at the offices of the CFA Society Toronto. His talk was the first part of a two-speaker panel moderated by Toby Heaps, co-founder and president of Corporate Knights.

Kibsey pointed out that concern over matters like environment, social and governance (ESG) issues within a company is not a new phenomenon. “It all started in the seventeenth century,” he said, when Quakers first applied certain standards of sustainability to their endeavours.

He contrasted “20th century” fundamental analysis with “21st century” models that have added ESG factors to the traditional parameters. “Analysts have discovered over time that we are not putting in all the factors we should,” he said.

There are three general steps to identify poor governance, said Kibsey. First, an investor should obtain methodical scoring and comparison by a third party  Second, practical judgement assessment based on experience is required.  Past and present directors should be willing to share their past experience. Third, there should be investigation by the investor/analyst. “Ask the tough questions,” he said.

Kibsey described four “red flag” areas, referring in passing to the methodology of the annual Globe & Mail Board Games feature. He detailed the concerns in the areas of board composition, executive compensation, shareholder rights, and disclosure. “Make a checklist of these when you look at companies,” he urged. [Ed. Note: See related postings on executive compensation and how CEOs game the system.]

He presented a set of ten lessons distilled from thirty years at the board table based on the experience of Paul Tellier, who sat on Bell and Alcan boards, among others.  Rule three, which says a good board should not neglect risk management, “hits close to home,” said Kibsey, whose background is risk management.

Kibsey summarized the governance viewpoints of William George, professor of management practice at Harvard Business School, in the form of “Seven Cardinal Sins.” These were broader than Tellier’s points and included vague “sins” such as “lack of chemistry among directors.”

The challenge, said Kibsey, is to convert qualitative information into something that is “compatible with financial models.” The Caisse asks its analysts to “quantify the qualitative,” ranking management quality out of 20 points, board of directors (10 points), competitive environment and position (30 points), value creation (20 points) and financial health (20 points).

The ESG-adjusted qualitative score can then be factored into the weighted average cost of capital (WACC). “The difference between a company with a good sustainability program versus a company with a poor one, noted Kibsey, can be 1 percent of the weighted average cost of capital and about 15 percent of its intrinsic value. In response to a question from the audience, he said WACC appeared easier to work with than, say, a discounted cash flow approach. He cautioned against double-counting. “If there are environmental issues, we will adjust cost of future expenditures,” such as for clean-up.

Kibsey urged the analysts to make companies accountable by exposing the issues. Analysts should be prepared to challenge the governance set by boards. It is possible, he concluded, to turn unfavourable ESG rankings into principles of good governance, providing there is adequate analysis and dialogue.   ª

Go to Part 2. ª

The graphic symbolizing board diversity is copyright by the web site: http://vator.tv/news/2011-06-01-reinventing-the-board-meeting-part-1-of-2

The graphic detailing ESG issues is from the MSCI web site: http://www.msci.com/products/indices/esg/esg_research_methodology.html