The Accountant – Is Good Governance on our Agenda?  –  Summer 2020 (MIA Publication)

If an investment portfolio is akin to an art collection, then investors are the art collectors who are constantly on the lookout for their next centrepiece and in this day and age, companies with robust and effective corporate governance are considered the masterpieces.

A new era in asset management is sweeping through the global capital markets. This new concept in investment is characterised by ESG (Environmental, Social and Governance) investing criteria which are setting new standards for companies who want to attract investment. The third pillar ‘Governance’, underscores the importance of a robust governance framework which, is not only valued by investors but also by other stakeholders, employees and customers alike and plays a significant role on the company’s reputation.

Capital markets exert considerable influence on the corporate governance practices of listed companies or potential future market participants that can be both direct and indirect. Direct measures that are imposed on listed companies include: tighter listing requirements, controlling insider trading, imposing disclosure and accounting rules and ensuring investor protection. The major indirect way that markets exert influence on listed companies is through the pricing mechanisms. Such mechanisms allow investors to express their opinion on the issuer’s established corporate governance practices and performance by buying or selling the respective security.

An effective corporate governance environment is built on a national-level and a firm-level approach. The combination of both approaches is conducive to sustainable economic growth, transparency and market integrity. National-level corporate governance is made up of a cohesive legal, regulatory and institutional framework which, allows market participants to establish private contractual relations. The primary elements of this framework include legislation, regulation, self-regulatory arrangements and voluntary commitments. These elements are implemented together with governance codes on a ‘comply and explain’ principle to allow flexibility for the multitude of different types of participants. Stock exchanges have a central role in a country’s corporate governance framework because they are acting as the ‘gatekeepers’ to the capital markets. This highlights the importance of the quality of a stock exchange’s rules and regulations that govern listing criteria and trading practices.

At the time of writing, Malta is being evaluated by MoneyVal, the permanent monitoring body of the Council of Europe tasked with assessing compliance with the principal international standards to counter money laundering and financing of terrorism, the effectiveness of their implementation and with making recommendations to national authorities. This is an evaluation of Malta’s governance framework on the international stage which, is crucial to the level of trust that countries, companies and investors can put in Malta and hence has a direct impact on its commercial and investment prospects.

Firm-level corporate governance is determined by multiple components including ownership structure, shareholder rights, board and management diversity, disclosures and audits and responsibility towards all the stakeholders. These different components must be organised and aligned towards the same goal which, is not always the case. The governance framework needs to outline the performance criteria of each of the components in order to ensure that they all remain aligned towards the common interest of all stakeholders. The role of the independent non-executive directors who, can exercise impartial judgement whilst providing the necessary transparency for the investor is an underpinning factor of the whole corporate governance framework.

The importance of corporate governance is highlighted when a firm is trying to appeal to the broad spectrum of investors, from sophisticated institutional investors to retail investors. This is particularly relevant to the Maltese capital markets which, has the potential of attracting more institutional investment. An effective approach in debt financing which, is the most prevalent financing route for Maltese capital markets participants, is by voluntarily proposing strong and actionable covenants linked to corporate governance metrics.

The turbulence experienced in capital markets over the years has pushed investor expectations to new highs. Firms that want to be held in high regard, have had to implement robust governance frameworks not just to satisfy the diverse regulatory bodies but also to attract investment at a more competitive weighted average cost of capital (WACC).

"According to research, from an economic perspective, the more a firm demonstrates a track record of voluntary activism the greater the reduction in agency costs and heightened investors’ optimism in the firm’s future cash-flow and growth prospects."

In a nutshell, firm-level corporate governance quality can enhance both the firm’s ability to gain access to finance and its financial performance which, eventually lead to capital market development.

Looking forward, with the continuing emergence of ESG investing on the asset management arena and the new evaluation metrics that it has brought to bear on companies, the importance of good and effective governance frameworks will continue to grow at a rapid pace as the investor community becomes more sensitive to how companies govern themselves and the regulatory frameworks they operate in.

Mark Azzopardi is the director of Asset Management and co-founder of Jesmond Mizzi Financial Advisors Ltd. He has 20 years of financial industry experience.