http://www.forbes.com/sites/nathanielparishflannery/2011/09/27/new-survey-do-latin-american-management-structures-pose-a-risk-for-investors/

Nathaniel Parish Flannery, Contributor

I write about Latin American companies and political risk.

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Leadership

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9/27/2011 @ 3:09PM |1.185 views

New Survey: Do Latin American

Management Structures Pose a Risk for

Investors?

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Over the last twenty years, many Latin

American companies have emerged as global leaders and attracted the attention of

international investors. Companies like LAN Airlines and Vinas Concha y Toro (Chile),

Cemex, Televisa, and America Movil (Mexico), Embraer (Brazil), and Bancolombia

(Colombia) have built strong brands and stepped into the global spotlight. In the last few

years, as growth in mature markets has slowed, investors have shown heightened interest in

tapping into fast growing markets in Latin America. According to the International

Monetary Fund, Latin America’s economy should expand by 4.5% this year. Many

http://www.forbes.com/sites/nathanielparishflannery/2011/09/27/new-survey-do-latin-american-management-structures-pose-a-risk-for-investors/

investors, however, have expressed concern over the fact that Latin American corporate

governance practices lag behind globally recognized best practices. According to a recent

survey by J.P. Morgan’s Depositary Receipts (DR) business, institutional investors in North

America and Europe “believe that corporate governance standards in Latin America have

improved, but stress how vital it is for companies to further bolster their efforts” in this

area.

The survey, which was conducted in June and July of 2011, gathered the opinions of 40

institutional investors, a group that holds a combined US$57 billion of actively managed

equity in Latin American companies.

According to the study, investors recognize the value of solid corporate governance. Over

50% of survey participants said that they believe that Brazil has the best corporate

governance standards in Latin America, primarily due to the creation of the Novo Mercado,

a special market for companies that voluntarily adhere to a set of governance guidelines

that more closely track recognized governance best practices.

According to the study, some of the major weaknesses of Latin American companies

corporate governance policies are executive compensation disclosure, board independence,

related party transactions, and share structures. Latin America, after all, is defined by the

presence of conglomerates and family owned firms. Controlling shareholders are common

and most companies have not appointed majority-independent boards.

According to data from GMI, the New York City-based corporate governance research firm

the 124 largest companies in Brazil, Chile, Colombia, Mexico and Peru have an average

level of board independence of only 31%. In other words, more than two thirds of directors

at Latin America’s major companies are not independent. By contrast, GMI data shows that

the 1742 largest publicly listed companies in the U.S. have an average level of board

independence of 75%.

Corporate boards are charged with the responsibility of overseeing companies’ operations.

In the U.S., most boards are filled with independent directors. In Latin America, by

contrast, most boards are filled with directors who have ties to the company’s management

and may be compromised in their ability to provide independent oversight on behalf of

shareholders.

For example, at Televisa, the media company that has been controlled for three generations

by Mexico’s Azcarraga family, only five of the company’s 20 directors appear to be fully

independent from management and fully disconnected from any type of related party

transactions with the company. This low level of board independence, which is typical at

major Latin American companies, means that investors must be confident in management,

since independent voices are largely shut out. Mike Lubrano, the Managing Director of

Corporate Governance at Cartica Capital, a Washington D.C.-based emerging markets

investment specialist, explained that in Mexico, controlled companies are the “dominant

form.” In Mexico, he explained, “you have to be confident in the controlling shareholder or

you wouldn’t be there.”

http://www.forbes.com/sites/nathanielparishflannery/2011/09/27/new-survey-do-latin-american-management-structures-pose-a-risk-for-investors/

Still, the number of interconnections between Televisa’s board members and the company’s

management is striking.

For example, Televisa has made a donation to a school that company director Carlos

Fernandez partially owns and sells advertising to Grupo Modelo, a beer company he

manages. Several of Televisa’s other directors serve on the boards of companies like

Banamex, Grupo Mexico, FEMSA, and Kimberly Clark de Mexico, companies that are

involved in business deals with Televisa. For instance, Banamex has given Televisa a loan

worth US$180 million. These types of relationships matter, because directors with strong

relationships with company management are usually less able to provide effective

independent oversight.

America Movil, Telmex, and other companies owned by Mexican billionaire Carlos Slim

show similar governance structures. According to data from GMI, the corporate governance

research firm, on average the largest 22 Mexican companies fill only 40% of their board

seats with independent directors. In other words, most Mexican companies have boards that

are mostly filled with directors who have connections to management. Furthermore, not one

of Mexico’s largest corporations has appointed an independent board chairman.

Similar governance structures can be found at major companies in Colombia, Peru, Chile

and Brazil. Overall, less than one fifth of Latin America’s major corporations have

appointed majority independent boards.

Many Latin American companies have delivered impressive returns to investors and

emerged as global leaders within their industries. However, the experiences of companies

like Cemex and Comercial Mexicana, both of which were severely affected by the outbreak

of the global financial crisis, show that concentrated leadership can lead to increased risk

exposure.

As global financial markets become increasingly integrated, and Latin American companies

try to attract the attention of international investors, competition for capital is becoming

increasingly fierce. After all, Latin American companies are no longer just competing with

each other for capital, but also with companies in other emerging markets, such as South

Africa and India. Companies like LAN Airlines, Cemex, Televisa, and Embraer have

succeeded in building global brands. Major companies in Latin America would do well to

bring their governance practices in line with globally recognized best practices.

After all, companies like Natura Cosmeticos, the Brazilian cosmetic manufacturer, have

shown that implementing governance reforms can help attract attention from international

investors.

To see a recent article I wrote about governance risks at Cemex, click here.

To see an article I wrote on improving governance practices in Brazil, click here.