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The world of corporate governance isn’t as wild as it used to be.
I was a young analyst at a corporate governance rating firm in 2001 when I was assigned to follow companies such as Worldcom and Enron. For those too young to remember, Enron was an energy-trading firm that perpetrated one of the largest accounting frauds in American history in 2001, resulting in the company’s bankruptcy. In Enron’s case, it was clear that the board members on the audit committee of the board had no idea how to police the fraudulent accounting perpetrated by company management.
Soon after the Enron scandal, Worldcom, an American telecom company, perpetrated its own accounting fraud, resulting in that company’s eventual bankruptcy.
My team at that ratings firm was tasked with judging the corporate governance and shareholder rights at public companies around the world. There were plenty of other examples of poor governance; from weak boards to abuses of shareowner rights, related party transactions between the company and board members and many others.
It was clear that Enron blew up in 2001 due to horrific board oversight. The cozy relationships between directors and company leaders made it easier for the board to overlook the glaring red flags that were raised when our team rated the company's corporate governance. It was clear that the board was in no way independent, and it did not possess the expertise to properly oversee the company’s audit.
One common feature among corporate boards during that timeframe was the practice of "interlocking directors." These interlocks happened when an executive from Company A (often the CEO) would sit on the board of Company B, and an executive of Company B (again, often the CEO) would sit on the board of Company A.
Corporate governance practices evolved after Worldcom and Enron and Congress eventually figured out interlocks were a bad idea, so protections were put in place to discourage this practice — not just in the United States, but in most markets around the world.
The modern era of board interlocks
Regardless of that change, many directors serve on multiple boards, and it’s worth taking a closer look at those relationships.
Borrowing the same algorithms social media companies use to figure out who might be in your circle of friends, you can evaluate which board members are most closely connected based on all the boards they’ve sat on, companies they worked at and affiliations they have. It is instructive to understand the communities in which a director sits, and what that means.
To take a closer look at these board communities, I used the Free Float Analytics Database, which tracks the influence and performance of more than 220,000 directors at over 10,000 publicly traded companies. This universe covers the MSCI ACWII Investable Market Index, which includes about 99 percent of the investible global equity market. The database analyzes a director’s network (their personal connections), the team dynamics of a board (how the board members interact with each other) and the influence a board member has on company decisions. For this analysis, I was interested in how the relationships between directors might have an impact on carbon emissions.
The director communities for finance and energy share close relations
One issue I considere
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