Chronicles of 2022 and Beyond

One of the major newsmakers in 2022 was Elon Musk and the saga of taking over Twitter, which was quite a disturbance both for users and investors. Not only Twitter’s stakeholders suffered, but also Tesla’s stakeholders also ‘enjoyed’ erratic stock price patterns after Elon’s tweets. Musk’s influence as the dominant CEO and his uncontrollable public rhetoric usually has an outrageous effect on stock prices of the companies, where he is a member of the management team.

Such a huge influence of one person poses a substantial risk to the company’s valuation and its operational activity. Well-managed companies try to mitigate the risk of dominant person as he or she may become incapable of further management physically or mentally.

Historically, we have seen lots of examples, which had a negative effect on the company and its investors, whether short-term or long-term. Take the example of Steve Jobs and his death effect on Apple. It was a huge uncertainty about how well the company will continue to be managed, weakening the share price as soon as Jobs was diagnosed with cancer.

Alibaba has also suffered massively when Jack Ma disappeared for three months in 2020 after the mounting problems with Alibaba’s subsidiary Ant Finance.

One more vivid example is Mark Zuckerberg, who is used to mean Facebook for many. In the summer of 2020, a few major companies, including Coca-Cola and Verizon, suspended their advertising on Facebook to protest the company’s handling of hate speech and misinformation on the platform. The boycott led to a decline in Facebook’s stock price. Some critics argued that Zuckerberg’s management style and lack of accountability were major factors in the company’s failure to address these issues. Additionally, his strong push into the Metaverse, with over $100 bn spent on R&D projects to date and uncertain payoffs, is blamed to cause investor pushback, which resulted in the record one-day drop in the market’s history of $252 bn in 2022.

CEO of Uber, Travis Kalanick, was criticized for creating a culture of sexism and harassment in the company, and his leadership was blamed for several high-profile scandals, including the mishandling of a data breach and allegations of stealing trade secrets from a competitor.

Importance of Good Corporate Governance

Talented leader of a company, especially in its development stage, is, indeed, the cornerstone of thriving development. In the research based on data from 35’000 manufacturing plants it was found that for the overall plant’s success, management talent matters more than R&D, employee skills and IT spending, – aspects that are often being admitted as the main drivers for a company’s productivity (1).

However, dominant CEO in the management, given poor corporate governance quality, can lead to unjustified risk. Overconfident dominant CEO usually exerts high risk on stock price crash (2). In another study, positive correlation between CEO power and idiosyncratic as well as total risk was discovered. However, dominant position can be justified in the conditions of high market competition and in case of strong corporate governance (3).

Corporate governance eco-system should be well-established for the company to grow sustainably fast. In this case it can stimulate R&D, faster growth, and lead to lower risk of the operations. For instance, R&D investments are more often being stimulated when the independence degree of board of directors is higher and, overall, the boards are more diverse (4).

Risk Management at Quality Companies

At Hérens Quality we have a rigorous procedure to assess corporate governance of potential candidates before we add them into the portfolios. Particular attention is devoted to the risk mitigation aspect of the corporate governance.

Therefore, Board of directors (BoD) independence criterion is imperative within the selection process. We aim to invest in companies with high BoD independence degree, which results in solid average independence ratios (fig. 1). US and European Quality companies in average have 80% BoD independence, which is a necessary premise for ensuring sustainable governance.

Figure 1: Average Board of Directors Independence degree in Quality companies (1 point – 0% independence, 5 points – 100% independence)

Source: Hérens Quality AM

Additionally, we look at the CEO and Chairman position separation, which obviously reduces the risk in case of dominant CEO. However, this factor to a certain extent depends on the overall corporate culture accepted in the particular region as can be seen in Fig. 2. The overwhelming majority of Quality companies in Europe and the US have, indeed, a supervisory body over the management team.

Figure 2: Chairman and CEO position separation in Quality companies

Source: Hérens Quality AM

The quality of corporate governance encourages creation of the atmosphere, which promotes sustainable development of the company. As seen in Fig.3, on average, Quality companies in all regions are on the upper scale, having rating above 4 out of maximum 5 points, which suggests high corporate governance quality.

Figure 3: Overall Corporate Governance Evaluation in Quality companies (corporate governance rating is based on 12 evaluation criteria, minimum – 1 point, maximum – 5 points)

Source: Hérens Quality AM

Dominant leader is a great asset for a company. CEO is able to take the company to the new heights extremely fast. However, the return comes at risk, which may mean lack of diversity of opinions, excessive risk taking, poor succession planning or difficulty in attracting and retaining talent. Potential risk should be acknowledged by investors, thus evaluation of corporate governance quality should not be skipped but rather receive an equal attention as the financials.