Given the highly interlinked nature of today’s capital markets, companies and investors cannot ignore events occurring in other parts of the world. The Asian flu has spread all too rapidly to Latin America and other emerging markets. But it hasn’t just increased the volatility of equity investment: latest indications are that it may also be affecting direct corporate investment in these regions. The latter is generally viewed as more stable corporate investment and its increased volatility could have potentially massive repercussions for the world economy.
This is all the more reason for corporate governance to be increasingly viewed in a broader perspective. After the shocks to the global equity markets of the past two years, governance is no longer just about getting along with your company’s traditional base of home country shareholders. Nor is it merely about coping with a relatively small new segment of foreign institutions that are now shareholders. Corporations that have these aspects of governance under control must now turn their attentions to global governance issues that affect the stability of global portfolios and direct investment.
Short-term view
In emerging markets, equity investment has always been seen as short-term and much more volatile than direct investment in plant and equipment. In fact, the International Monetary Fund and the World Bank actually classify equity as short-term, regardless of the fact that many large institutional investors, such as TIAA-Cref and Calpers, are very long-term oriented in their investment outlooks.
At a recent Conference Board event in Chile, one chairman of a major corporation railed against the ‘herd’ of institutional investors who are destabilizing global markets and robbing regions such as Latin America of direct investment. But when pushed a bit to look at which individual institutions had actually been trading this company’s stock, it turned out that TIAA-Cref was a long-term holder. It had not traded in the face of the flight of equity capital caused by the spillover of the Asian flu to Latin America.
But this chairman was reacting against something which is, indeed, very unfair. Latin American equity markets have suffered because they are tarred with the brush of Asia. Their decline is not based on fundamentals, but on a general lack of confidence in emerging markets as a whole. This fact can be seen in the second and third charts opposite. These illustrate the correlation between Latin America and Asian countries and between Russia’s equity market and those of Brazil and Mexico. The graphs show a very recent trend for Latin American stock markets to track the markets in Asia and for Brazil and Mexico to track Russia.
While there is some trade between Asia and Latin America, especially on the western coast of Latin America, it’s hard to see how it’s enough to account for such a major linking of these markets. And what possible correspondence can there be between the stock markets of Brazil and Mexico and Russia, given the small size of the Russian economy and its relatively insular trading?
The answer is confidence. Where markets do not instil confidence, they risk being swept away. Where they do instil investor confidence, they can withstand negative spillover. And this is precisely where global corporate governance standards come in: they can provide a floor or a base for investor confidence against excessive trading volatility.
Confidence indicators
Certain major US pension funds can be long-term ‘stabilizing’ players in these volatile equity markets. There are clearly other types of institutional investors in Europe and elsewhere, which can and do act as stabilizing forces. Indeed, they appear to be as much disturbed by mindless volatility as the companies in which they are invested.
Contrary to popular wisdom, every single investor in the market does not necessarily have to behave as a member of the herd. This does not mean there should be restrictions on trading which will result in dampened liquidity. Rather, a much more detailed picture (such as the model The Conference Board has constructed with respect to US institutional investors) of global institutional investment and trading patterns needs to be developed for investors throughout the world.
In this way, companies can target long-term shareholders. They can analyze and change their shareholder base to attract investors (not momentum traders). This has the potential for reducing the volatility of a company’s stock and lowering its cost of capital.
Even in the midst of this volatile market, consulting firms that supply corporations with targeting and surveillance data are starting to report that managements are turning their attention away from short-term oriented, intra-day trading activity. Instead, they are beginning to look at the longer-term ebb and flow of institutional capital. Rather than studying which institution is snapping up a block of shares today, they are looking at which institution or group of institutions are showing signs of a gradually increasing interest in particular sectors or valuation fundamentals over several quarters. This signifies that corporations are taking a longer-term, strategic approach to shaping the shareholder base, instead of using ownership data as a ‘shark watch’ tool to fend off would-be raiders.
Soup-to-nuts assurances
One final note. As markets become more volatile those in a position to provide equity investment are beginning to demand greater assurances of confidence.
US funds are taking the lead in pushing for a global corporate governance model to increase confidence. Elements of this emerging model include ‘soup-to-nuts’ assurances that investors can be confident in the management, financial information, voting, and settlement procedures of companies throughout the world regardless of their location.
It is in the interests of all parties involved for companies to work with global investors to develop a set of indicators of corporate-investor confidence. The OECD, the IMF and the World Bank are all working in this area.
However, if these confidence indicators are imposed from outside, rather than developed by the companies and the investors themselves the real beneficiaries of such developments they are not likely to be reflective of the true nature of global capital markets.
Dr Carolyn Kay Brancato is director of the Conference Board’s Global Corporate Governance Center
