Thursday November 27, 2014

Governance Risks: A Wake-up Call for Innocents Abroad

The biggest potential threats for U.S companies operating abroad are brewing in the governance and CSR arena.

Ask most American companies and their boards where they’re looking for growth in the next few years, and the emerging markets are bound to be near the top of the list. For most U.S. boards, consideration of doing business in international and emerging markets typically means balancing the revenue opportunity presented by management against a checklist of fairly standard business and financial risks. But increasingly, the biggest potential threats to success internationally are brewing in the governance and CSR arena, where many U.S. and developed-market companies face challenges from institutional investors and even state-owned enterprises flexing their muscle through a variety of CSR and governance mechanisms.

Christopher R. O'Dea

Christopher R. O’Dea

In one situation, a Dutch pension fund’s CSR consultant questioned a defense industry stock held in the portfolio of a fund in which the pension fund had invested. The issue: one of the company’s divisions produced land mines that were on a UN prohibited list. Even for this sophisticated firm, the level of detail of the consultant’s mission—to specifically assess compliance with CSR and ESG criteria—was some surprise, as was the requirement to establish a documented internal procedure to review and resolve such inquiries. For less astute companies, the need to create and manage such a detailed new compliance procedure could present a significant barrier to doing business in countries where CSR criteria are on a par with financial reporting requirements.

This is just one illustration of how governance-based and CSR requirements have become sophisticated tools of business strategy and national policy outside the United States and for the most part—Argentina’s seizure of YSF shares owned by Spain’s Repsol notwithstanding—go well beyond blunt instruments like nationalization.

In Chile, the state-owned copper mining company, Codelco, recently demonstrated how a new marriage of resource-based leverage with savvy understanding of the tools and techniques of corporate governance and global capital markets can fuel a new style of fighting for control of nationally critical natural and corporate resources. The Codelco matter drew in two major Japanese banks as financing sources, along with a host of lawyers and IR/PR reps from Santiago to Tokyo and London. The heart of the dispute was an option to buy a major stake in Chile’s Sur copper complex that was granted by the Chilean government to ExxonMobil in 1978 and subsequently renegotiated twice. In October 2011, Codelco moved to exercise its option to buy 49 percent of the Sur mine held by Anglo, arranging a bridge loan from Mitsui to finance the purchase; a month later Anglo sold 24.5 percent of that stake to Mitsubishi, triggering a legal dispute over who could do what—and at what price. Anglo and Codelco settled after nearly a year of intense litigation, cobbling together a four-party arrangement with a separate board of directors to run the Sur mine. The settlement will allow development of the mine to proceed, but the episode provides boards with a template for assessing the risks that might arise from the use of the latest governance and activism techniques in a context of rising resource nationalism, state capitalism and constrained global growth.

While CSR and ESG issues certainly aren’t unknown to American companies, they don’t yet command the respect from American boards and management that such matters receive in the EU and emerging markets. When it comes to CSR topics, “in the U.S. we do not have anywhere near as rich a dialogue as other democracies,” says Steve Coll, president of the New America Foundation and author of Private Empire: ExxonMobil and American Power. Speaking to the Chicago Council on Global Affairs recently, Coll noted that the American political economy hasn’t created U.S. government-owned companies like the oil and other resource/utility companies found in most other developed economies, where those running both companies and the government share a common philosophy about business and the congruence of national with industrial goals. In contrast, the roles of a colossus like ExxonMobil and the United States in the world “are not contiguous,” Coll says. For the U.S., the result is a system where companies evaluate social policies as investment decisions, in stark contrast to other developed economies and emerging markets where social and environmental policies are integrated into both business and political life.

Ernst & Young’s proxy season data show that CSR and environmental resolutions increased to 40 percent of total resolutions in 2011 compared to 30 percent in 2010. While such resolutions are winning more shareholder support, with an average vote in favor of more than 18 percent in 2010 compared to just 7.5 percent in 2000, CSR/E resolutions still fell short of the 30 percent hurdle that garners board attention, with barely more than one-quarter winning that support in 2008. There are indications from professionals in the CSR and environmental fields that boards and top management may merely tolerate, rather than embrace, the entire sector. For example, a recent program offered by the PR University unit of Bulldog Reporter, a public-relations industry website, trumpeted a webinar on CSR with the inauspicious title “Sure-Fire Strategies for Boosting Brand Equity and Proving ROI to the C-Suite.” PR pros were told that “in just 90 information-packed minutes,” they could expect to “discover dozens of new ways of maximizing the return on your CSR efforts.”

Another sign that CSR initiatives perhaps haven’t become embedded at the board strategy level is turf battles among staff departments for influence over governance matters. With say-on-pay discussions, for example, the National Investor Relations Institute says “IR plays a limited—if any—role in say-on-pay discussions, according to a survey earlier this year of 181 US companies by IR Insight, the research arm of IR magazine.” According to NIRI, the corporate secretary tends to take the lead, with just 41 percent of IROs who responded to the survey saying they had any involvement at all in say on pay during 2011. In its e-mail about the survey, NIRI notes, “for IR, one of the challenges of reaching out is that your existing buy-side contacts are normally not involved in pay discussions, so new relationships must be forged with governance teams. Looking at this positively, it’s clear say on pay has helped IR broaden its influence and network of contacts.”

While say-on-pay isn’t directly related to emerging market matters, concerns about staff influence and the lack of organizational clarity for dealing with any governance issues threatens to short-circuit the board’s ability to count on accurate, timely information about complex governance matters in emerging markets—markets that might be major strategic growth targets.

What’s shaping up for all U.S. companies operating internationally is an agenda much like what Coll describes already at ExxonMobil: a portfolio of increasing political, geological and environmental risks. Such a risk profile requires acute sensitivity to local issues and communities in every country where a company operates. Emerging market nations are adopting legal tools from the developed world that will enable consumers and investors to pursue governance initiatives—Mexico last year passed legislation allowing class-action suits for the first time, illustrating that every board overseeing international operations will be well-served to modernize its emerging-market risk assessment matrix and update it frequently.

Complicating the picture, emerging market nations are having trouble meeting their own lofty CSR and ESG goals. Brazil, for instance, has committed to 2020 targets of a nearly 40 percent cut in its growth curve of greenhouse gas emissions and a reduction of Amazon deforestation levels by 80 percent compared to average rates registered for the period of 1996-2005. These are commitments of global interest to the environmental community, but they may be out of reach because of the latest revisions to the Brazilian Forest Code.

Former Brazilian Senator and Environment Minister Marina Silva gave an impassioned sketch of the tension between development and the environment at a private conference in Santiago with the Dean’s International Council of the University of Chicago Harris School of Public Policy, just before the Brazilian Senate passed the controversial rainforest bill. “The bill that was approved by the Senate undermines protection of the forest, provides amnesty for those who deforest and will increase deforestation,” Silva said after the vote.

Part of the problem facing boards is the lack of information about governance practices and CSR issues in emerging markets.  According to the IFC’s Global Corporate Governance Forum, for the past three years, approximately 1,000–1,200 papers have been published each year on the Social Sciences Research Network with the term “corporate governance” appearing as a key word in the abstract—but fewer than 1 percent of these papers focus on emerging markets.  And many of those focus on the board structures of companies that are part of family-controlled groups that are common in emerging market economies. This leaves a gap about emerging substantive trends that could impact financial, operational, legal and regulatory matters.

Filling in that information gap would help every board better evaluate its emerging market risks, and creating a dynamic, streamlined organization that handles CSR matters with the same alacrity as financial reporting would be a sensible first step for many boards.

Christopher O’Dea is a business consultant who focuses on global growth strategy. He can be reached at 312-804-1720 or

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