Peer Pressure and Active Investors Drive Improved Governance

10/17/2014

Among the risks associated with investing in smaller emerging markets, poor governance standards are often considered one of the most difficult to mitigate.

Now a new report by East Capital, a Stockholm-based firm that invests in frontier and emerging markets including Russia, Eastern Europe, China and emerging Asia, argues that governance standards are improving—in some cases more rapidly than in the developed markets.

The report’s authors have identified the key factors driving the development and enforcement of higher corporate governance standards: active investors, free and independent media, peer pressure and positive influence from corporate governance associations, sector initiatives, research groups and international institutions.

“Corporate governance issues all over the world are continuing to trend upwards and a lot of clients are naturally concerned about these issues,” says Louise Hedberg, East Capital’s head of corporate governance and author of the paper titled “Navigating Emerging and Frontier Markets with Corporate Governance.”

And while frontier and emerging markets tend to get a bad press over their corporate governance, Ms. Hedberg says frontier market countries are among those pushing for higher corporate governance standards. Nigeria’s stock exchange, for example, has joined the the Sustainable Stock Exchange initiative, which Ms. Hedberg describes as a voluntary commitment to promote improved governance practices among the companies listed on exchanges.

Active investors, Ms. Hedberg says, play a key role when getting involved in the countries and companies they invest in. “We are there meeting them, we are writing letters to them and we are voting at the meetings,” Ms. Hedberg says, adding this is a way to push companies in the right direction.

She adds that having free and independent media is also crucial to sound corporate governance. “This is seen as the ultimate force of self-regulation,” she says. “Companies don’t want to be on the front page with a negative headline and they want to preserve their brand value.” However, she concedes many emerging and frontier markets don’t have well established independent media.

Ms. Hedberg believes peer pressure among companies in emerging and frontier markets is growing. “Companies understand that if they fall behind this may lead investors to look at the other alternatives,” in their industries, she says. Industrial and banking sector companies are particularly prone to “glancing at each other”, she comments.

“Ultimately as investors we need to understand what rules can we depend on and if something does go wrong where can we go to get help,” she adds.