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ESG ESG Newsletter published on October 3, 2016

Incentivizing Corporate Long-Termism

Pressure to meet quarterly earnings guidance and maintain near-term share price performance continues to push public companies to trade long-term results for short-term gains. As a consequence, far too many companies have continued to drift farther and farther away from the fundamental business drivers that determine long-term success.

Within this context, it was refreshing to learn of the Commonsense Corporate Governance Principles that were released in late July by a group of leading CEOs and large institutional investors that include, among others, Warren Buffett of Berkshire Hathaway, Larry Fink of BlackRock and Mary Barra of General Motors. The group’s goal is to put forth a set of corporate governance guidelines that will help drive long-term prosperity not only for companies and shareholders but also for American citizens. They explain:

“The health of America’s public corporations and financial markets – and public trust in both – is critical to economic growth and a better financial future for American workers, retirees and investors … Our future depends on these companies being managed effectively for long-term prosperity, which is why the governance of American companies is so important to every American. Corporate governance in recent years has often been an area of intense debate among investors, corporate leaders and other stakeholders. Yet, too often, that debate has generated more heat than light.”

The proposed Governance Principles include issues such as the composition and governance of the board of directors, board of directors’ responsibilities and perspectives, shareholder rights, public reporting, management succession planning, management compensation and the asset managers’ role in corporate governance. Collectively, the Governance Principles aim to inform sound corporate governance that emphasizes long-term value creation.

At Breckinridge, we believe that long-term perspective is one of the core determinants of creditworthiness of an issuer. A long-term horizon informs the way we evaluate issuers, both with respect to their credit fundamentals and to their material environmental, social and governance (ESG) factors. Given our focus on the long term, we were pleased to discover that the Governance Principles emphasize a number of important areas that underpin our corporate credit research and analysis.

First, we agree with the Governance Principles that companies should focus on developing and clearly articulating their long-term strategic goals. This should include discussion of market positioning, key growth drivers and determinants of future profitability. We also think that attention should be paid to an issuer’s appetite for mergers and acquisitions, not just in the near term but also as it pertains to its long-term strategic goals. This comprehensive long-range view provides an effective framework to evaluate the probability of an issuer’s performance over the lifetime of a bond, while simultaneously helping inform investors on near-term priorities of the issuer.

Second, we think that the integration of ESG analysis into the investment research process offers additional depth for a careful examination of an issuer’s senior management and its board of directors. The Governance Principles emphasize quality, composition, independence and overall level of engagement of an issuer’s board as key determinants of sound governance, with an aim to create long-term value. Indeed, our own ESG research supports the argument that there is a strong relationship between a company’s overall commitment to delivering value over the long term and its appointment of board members who are highly knowledgeable, diverse, independent and engaged.

Third, we believe that through active engagement, investors play an important role in encouraging companies to prioritize long-term considerations. To this end, we conduct engagement calls with issuers to learn more about their business drivers as well as about their sustainability efforts. Through these discussions with issuers, we often find that companies are eager to hear from us and other long-term investors because our perspective offers a valuable counterpoint to quarterly earnings calls that focus on near-term financial results over longer-term strategic drivers. We see this effort as greater than ourselves and are eager to collaborate with others in order to broaden our impact.

At bottom, we think that a long-term perspective is a critical factor in many investment strategies. While some market participants tend to overlook longer-term considerations, we believe that a long-term view is a prerequisite to sufficiently assessing the material challenges and opportunities that lie ahead.

By seeking investment opportunities that prioritize sound governance and long-term value creation in our strategies, we hope to encourage investors to take part in the emerging shift toward long-termism. We are confident that together ― Breckinridge, investors, companies and other stakeholders ― can make meaningful strides toward creating lasting value for all.

 

DISCLAIMER: The material in this document is prepared for our clients and other interested parties and contains the opinions of Breckinridge Capital Advisors. Nothing in this document should be construed or relied upon as legal or financial advice. Any specific securities or portfolio characteristics listed above are for illustrative purposes and example only. They may not reflect actual investments in a client portfolio. All investments involve risk – including loss of principal. An investor should consult with an investment professional before making any investment decisions. Companies mentioned are provided as illustrative examples and do not necessarily represent past, current or future portfolio holdings. This document may contain material directly taken from unaffiliated third party sources, including but not limited to federal and various state & local government documents, official financial reports, academic articles, and other public materials. If third party material is included, it is believed to be accurate, and reliable. However, none of the third party information should be relied upon without independent verification. All information contained in this document is current as of the date(s) indicated, and is subject to change without notice. No assurance can be given that any forward looking statements or estimates will prove accurate or profitable.