Fidelio has a clear focus on value and in particular the Board’s contribution. Given current levels of scrutiny and the challenging environment, shareholders and stakeholders want comfort and clarity about the role of the Board in overseeing and generating value. Boards that cannot articulate this value contribution will increasingly be held to account. In Fidelio’s Board Search and Evaluation assignments, value and valuation feature prominently. For listed businesses the stock market is a key arbiter, but there are clearly other constituents who determine value and judge the success of the Board. These are the themes of Fidelio's forthcoming Board breakfast with Edward Bonham Carter, Vice Chairman of Jupiter: “Boards, Governance, Shareholders and Asset Management”.
Markets or Stakeholders
Boards of quoted companies have a clear obligation to understand the market’s perspective and how it might be modified and influenced if necessary. However, the stakeholder perspective cannot be ignored: while the US has historically insisted on shareholder primacy, corporate governance codes in continental Europe place much stronger weight on delivering stakeholder value. In a number of countries employee representation is enshrined, for example in the Co-Determination Law governing the Supervisory Boards of larger Germany companies. The Netherlands, too, is explicit in defining Board obligations to stakeholders and a Board failing taking these into account in a major corporate or strategic decision could find itself exposed: “A company is a long-term alliance between the various stakeholders of the company. Stakeholders are groups and individuals who, directly or indirectly, influence (…) the attainment of the company’s objectives: employees, shareholders and other lenders, suppliers, customers and other stakeholders. The management board and the supervisory board have responsibility for weighing up these interests (...) generally with a view to ensuring the continuity of the company and its affiliated enterprise, as the company seeks to create long-term value.” (Dutch Corporate Governance Code 2016) The UK has witnessed a shift in understanding and the nod in section 172 of the 2006 Companies Act taking account of stakeholder interests has taken more explicit form in the most recent iteration of the Corporate Governance Code. It is clearly desirable that Boards do not define value too narrowly; a broader definition of value clearly makes greater demands on the Board.
Decoding the Market View
A listed Board needs a firm understanding of what constitutes value for its broader shareholder base. While management’s and Board members’ perspective on the business may well be coloured by years of personal commitment to industry and company, that of the shareholder is dispassionate and financially driven. Frequently pilloried for short-termism, many investors take a long-term view in line with the requirement to drive long-term returns for their funds’ beneficiaries. Nonetheless, there is tension between the need for a long-term perspective and the tendency for review and remuneration systems – for both company executives and fund managers – to operate on cycles of 12 months or less. A Board member seeking to understand the investor perspective should start with analysis of the company and its competitors – a good Investor Relations department will already have addressed the following:
How does the company compare with its competitors - both quoted and unquoted - on financial metrics such as gross and net margins, earnings multiples, EV/EBITDA, net debt/EBITDA and dividend yield?
To what extent do these differences reflect business mix, geographical location and expected growth rates?
What is the investment controversy surrounding the industry? For example, the impact of online business models on retailers and commercial property firms.
What are the apparent disconnects in the financial metrics? An abnormally high dividend yield, for example, can mean that the market doubts the sustainability of the dividend.
What does sell-side research reveal about what analysts and investors are saying about the industry and its competitors?
In depth analysis of these data, combined with regular discussions with management should enable Board members to synthesise a coherent picture of the market’s perspective on the company and highlight opportunities for improvement. This is a good framework for understanding and measuring value but a partial one.
Value for Stakeholders
Clearly a business needs to be profitable – or at least sufficiently cash generative – to service the needs of stakeholders and to meet the requirements of shareholders. There is typically a substantial alignment of interest. But there are also situations where interests diverge. Most frequently these will be where job losses are anticipated as part of a restructuring. The role of the Board in these situations is firstly to make a well-founded strategic decision in the long-term and sustainable interests of the company – involving employee representatives as necessary - and secondly to communicate this well, both internally and externally. As regulation and governance increases companies are also being made responsible for a range of social obligations in terms of inclusion, fairness and community relations, as well as environmental obligations to achieve cleaner air and water and to mitigate climate change. For the company and its Board, each new regulation can feel like the straw breaking the camel’s back. Traditionally Boards have weighted stakeholder interests and a particularly prominent stakeholder interest will be reflected in the Board’s composition and skill matrix. Utility and Financial Services Boards frequently include former regulators; FMCG Boards often draw upon NGO / supply chain experience. But not all stakeholder interests can be directly represented in the Board, and the complex value equation of at times competing interests still needs to be resolved. This is not a mathematical formula. Boards that make most headway do so through synthesizing a broader purpose for the company and ensuring that this is communicated clearly and effectively to both stakeholders and shareholders. Not least this creates an understanding of what is material and where the Board and management are rightly focusing attention. The recent increase in salience of Climate Change and other ESG factors make this an urgent task. Arguably it is the only way for Boards to deliver value and accountability for both shareholders and stakeholders. “We are seeing more and more clients looking to have a social impact beyond just purely financial returns with their investments. The mood music is changing.” - Peter Harrison, chief executive, Schroders
Value & Board Composition
For the Board to add value in a highly competitive and disruptive market, a blend of skills is required above and beyond sector expertise, including:
An understanding of financial value and the perspective of the financial markets
A firm grasp of the stakeholder landscape and what represents value for those key stakeholder groups
The ability to synthesize these insights into a coherent strategy predicated on a credible purpose
Boards that are deficient in the above will struggle to convince either shareholders or stakeholders that value is being delivered. In an age of scrutiny and accountability Chairs will find their Boards to be exposed if the above skills are lacking.
For more information on how Fidelio can support your Board through Search and Evaluation, please contact Mark Cumberlege.