Page 38 - FINAL CFA II SLIDES JUNE 2019 DAY 6

LOS 24.f: Describe elements of a company’s statement of
corporate governance policies that investment analysts READING 24: CORPORATE GOVERNANCE
should assess.

• Codes of ethics. A corporate code of ethics articulates the values, responsibilities, and ethical conduct of an organization.
• Directors’ oversight, monitoring, and review responsibilities. These include statements regarding internal controls, risk management, audit and
accounting disclosure policies, regulatory compliance, nominations, and compensation.
• Management’s responsibility to the board. These include management’s responsibility to provide complete and timely information to board
members, and to provide directors with direct access to the company’s control and compliance functions.
• Reports of directors’ oversight and review of management.
• Board self assessments.
• Management performance assessments.
• Director training. Includes training that is provided to directors before they join the board as well as ongoing training.
LOS 24.g: Describe environmental, social, and
governance risk exposures –ESG risk can be: LOS 24.h: Explain the valuation implications of corporate governance.

Legislative and Regulatory Risk • The best governed companies generate an ROE of about 23.8% higher.
A company that has invested in cleaner or safer technologies is
less likely to suffer from new legislation than their competitors. • Portfolios of companies with strong shareholder-rights protections
outperform weaker protections by 8.5% annually.
Legal Risk
Examine the regulatory filings, such as form 10-K (for legal risk • Weak or ineffective corporate governance system increases the risk to an
exposures). Consider the industry, as well as its specific
operations! investor, thus reducing the value of the company.

Reputational Risk Key investor concerns leading to valuation discount include:
Past scant regard for regard for environmental, social, and
corporate governance issues means valuation discount compared • Financial disclosure risk: Information is incomplete, misleading,
to competitors! or materially misstated.
• Asset risk: Abuse of company assets, e.g. excessive
Operating Risk compensation and “perks.”
Examine the danger of being forced to modify an operation, or • Liability risk: Off-balance-sheet obligations that reduce the value
shut it down altogether, due to impact of ESG factors. of the shareholders’ stake in the company.
• Strategic policy risk: Transactions that may not be in the best
Financial Risk interests of shareholders, but will provide benefits for
The risk that the ESG risk factors will result in a monetary costs. management (empire building)
Analysts should examine all possible sources of ESG risk and
include these potential risk impacts in the valuation.