3 Ways To Protect Yourself From Mismanaged Companies

Nissan CEO Carlos Ghosn’s arrest in November for understating his pay shocked the world.  Nissan swiftly fired Ghosn, and committed to a full investigation and immediate steps to strengthen corporate governance.  Nissan’s stock price (7201: TYO) has dropped 10% since the arrest.

It should be noted that at the time of this writing, Ghosn‘s case is still pending trial.  Nevertheless, the unfolding drama provides an excellent object lesson to retail investors on the importance of strong corporate governance, and what defenses can protect us when management runs amok.

Government Regulation

The Hong Kong Exchange provides investors’ first line of defense. It’s the exchange’s responsibility to enforce corporate governance and protect investors.  That includes implementing the “Corporate Governance Structure” among all companies listed on the Exchange, and ensuring companies act in compliance with the Corporate Governance Code.

Companies must adopt the mandated structure, which includes a Board of Directors, nine board Committees, a Company Secretary, three Consultative Panels, a Management Committee, and an external and internal auditor.  The Code then gives detailed guidelines on the obligation and responsibility of each of these roles.  It also contains a list of disclosure requirements, including remuneration details, and any stock interests and short positions of the directors and senior management. Companies that fail to comply with the Corporate Governance Code risk de-listing.

Shareholder Activists

Activist investors, who buy into companies in hopes of straightening out their operations, provide regular investors with a second line of defense. Traditionally, these activists focus more on the US than Asia, but that trend is certainly changing.  In the last few years, a number of activist hedge funds have been raising their stakes in Asian companies, lobbying for shareholders’ rights.  Profit motives notwithstanding, their banner issue is often governance.

Witness Elliott Management’s feud with Bank of East Asia back in 2015; the former accused the latter of being mismanaged, and argued that it should be sold.  It culminated into a lawsuit in 2017, with Elliott suing Bank of East Asia and its directors over a share placement. As those legal proceedings dragon,  Elliott still owns 8% of the bank.

On a different scale, but no less important, Hong Kong’s David Webb and his Webb-site Reports provide insightful commentaries and observations on companies.  His famed report “The Enigma Network: 50 Stocks Not to Own” in 2017 was a compelling read, causing quite a stir in the market.  Most importantly, it exposed the potential problems these companies might pose to ordinary investors.

Of these 50 stocks, some are “bubble”  companies with no actual business, engineered by the other listed companies that own them.  Others exploited loopholes in the disclosure regulations to hide ownership interests, in order to amass voting power.  All these masked the true operations of these listed companies, which could be harmful to the interest of small shareholders.  After the report was published, the stock prices of 38 of these companies plunged suddenly, some by 90%.  After the SFC launched an extensive investigation, four companies in the report were subsequently suspended from the HKEX.

Signs of potential trouble

If companies intentionally cheat, retail investors are less likely than regulators and industry experts to detect such foul play.  But they can’t completely protect you. To help safeguard your money, you’ll need to serve as your own third line of defense.

You can start by learning some of the common characteristics of companies with governance issues:

  1. Too much power at the top, too many divisions beneath: Nissan suffered from an extreme concentration of authority in one person, and an ambitious yet delicate axial structure across three companies and two countries.
  2. Results that defy reality: Toshiba, which plunged itself into a massive 2015 scandal after overstating seven years’ worth of profits, provided too-good-to-be-true results even as the wider electronics industry took a beating.
  3. Shadowy structures: The “bubble” companies spotlighted in Webb’s Enigma Network report, many with stock prices well below HK$1, tended to involve complicated cross-holding structures designed to hide their operations from investors.

Any of the above characteristics don’t necessarily mean that a company has governance issues – but they all signal that Fools should exercise more caution than usual.

We live in an age of increasing transparency. Companies that do not respect governance will eventually pay the price– but so will their shareholders.  If we want to buy, hold, and profit from stocks for the long haul, we need to pay attention to the nuances of corporate governance just as closely as we examine financial and business fundamentals.  While good governance doesn’t exactly make a company, the lack of it can certainly break one.


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HK MoneyClub (www.hkmoneyclub.com)