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Corporate value destruction: economics versus corporate governance

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By: Seamus Gillen, Eureka Financial Faculty

I remember once discussing with George Alagiah, long-time journalist and BBC presenter, his views on value destruction. He said he had come to realise that ‘it all boiled down to economics’, which reminded me of President Clinton’s comment that “it’s the economy, stupid!”

I had a different view, and after we had discussed the issue, I realised that my analysis had been partly incomplete (though so also had his!) I had argued that ‘it all boils down to governance’, and once I had recalibrated my thinking, came to a conclusion which has stood me in good stead since that discussion some five years previously.

Corporate Governance failures

Strategic Corporate Governance Programme

Value destruction occurs inside companies for economic reasons when the company’s strategy, and business model, fails to be sufficiently flexible to cope with changes in economic circumstances. A rather pointed example of this is the oil sector, where the price of a barrel of oil has, over the past year, fallen from over $100 to under $30. I work with many oil companies and, even if the risk of a fall in the value of oil had appeared on their risk registers, few of them had envisaged that it would actually happen, so drastically, and with such catastrophic consequences.

The inability of the oil sector to have foreseen the phenomenon, and to have planned for it, has resulted in significant amounts of value destruction through stranded or mothballed assets, massive job lay-offs, a screeching halt in capital investment, and so on.

Many people would argue that corporate governance failures could not possibly have the same effect, and impact, but that is wrong. Compliance Week recently published its top five list of ethical and compliance failures in 2015. The list brings home the consequences of a company being prepared to accept low standards of governance and, in these specific cases, an unprofessional attitude towards ethical policies and processes.

Compliance Week suggests the most egregious forms of ethics and compliance failure were evidenced in – wait for it – VW, Petrobras, FIFA, Toshiba and Deutsche Bank. Whether or not we agree with that list – let’s face it, there was a lot of competition – these are five excellent case studies of how value is destroyed inside companies by weaknesses in cultures and controls. (You can see my own analysis of the VW scandal as it unfolded on my website – www.valuealpha.com. I thought my analysis then was gloomy, but the situation has deteriorated even more since I posted those articles).

As a result of the corporate governance failures inside these companies we have seen regime change (ie lots of board and director heads have rolled), significant share price shock, very large regulatory sanctions and fines, massive damage to reputation and brand, and a loss of customer and stakeholder trust so severe that the repercussions have been felt far and wide – in the case of Petrobras, for example, reaching into the heart of government.

The common features of these governance failures are a weak and sometimes poisonous culture, inadequate operational controls, managers both permitting and sometimes encouraging rule-breaking, and an attitude to bribery and corruption completely out of sync with what customers, the public, regulators and politicians consider acceptable.

This week’s announcement that Adidas was prematurely ending its contract with the athletics world governing body (IAAF) because of a doping scandal – losing that body an estimated $30m in revenue – is just the most recent example of a governance failure.

The good news is that there are many well-run companies which are creating value by having a strong, positive culture, a board and a management team exhibiting a leadership of integrity, effective controls in place, and well-thought through incentivisation schemes which encourage appropriate behaviour.

I suppose the point I would make now to George Alagiah is that, while companies cannot always control economic developments, they can certainly control their governance systems.

If you want to improve corporate governance within your organisation and learn about the best current practices, attend a 2 day Strategic Corporate Governance course conducted by Seamus Gillen.

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Eureka Financial is a market leader in banking and finance and corporate education. We offer over 100 public and in-company training courses in risk management and regulatory, corporate governance, banking and asset management, corporate finance and M&A, compliance, risk management,  investments, wealth management, soft skills and more. For more details visit: www.eurekafinancial.com

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