How shipping makes related-party transactions work for shareholders
Don’t be misled by simplistic methodology, writes Nicolas Bornozis, president of Capital Link. With the right corporate governance, public companies can reap benefits from the relationship with their private entities
Can related-party transactions and proper corporate governance co- exist in listed shipping companies? A recent research report by Wells Fargo claims they cannot, while admitting that the quantitative research model does not take into consideration the relative costs or profitability, which in many cases is the reason behind such transactions.
In our opinion, proper corporate governance can ensure that companies benefit from such practices, as long as they generate results that enhance shareholder value. Obviously, related-party transactions without proper corporate governance can have the opposite effect. Thus, this is a qualitative judgment on a case-by-case basis, rather than a quantitative generalisation.
Corporate governance relates to the supervision of a company’s management, process and procedures, whether the management is internal to the company or in an external entity managed by insiders or outsiders.
As a result of the simplistic methodology employed in the report, the mere existence of an affiliated external management structure uniformly ranks a company’s governance in the lowest quartile, without regard to its record of leveraging its structure to drive cost controls and efficiencies.
The analysis contains no discussion or comparison of conventional criteria to evaluate the actual performance of any of the companies included in the rankings. Moreover, the governance analysis, with its narrow quantitative approach, fails to properly weigh the experience and strengths of members of the board, or other governance policies and practices, which are of paramount importance to good corporate governance.
Shipping companies must adhere to the strictest laws and regulations of countries, international organisations, classification societies, flag states and, for those that are publicly listed, capital markets. Furthermore, they are continuously vetted by charterers, including the major names in the commodity and energy markets, which want to ensure their operational safety and efficiency. It is unfortunate that a computer model can create the perception of impropriety for companies that have earned their laurels in the marketplace.
Shipping is one of the most competitive businesses. Greeks have traditionally been the leaders, with 20% of the global fleet, followed by Asian and Scandinavian owners.
Today, less than 10% of the global fleet is owned by publicly listed companies. In many cases, the public entities came out of pre-existing, well-established private groups. The new public entities have relied on and benefited from the operational record, goodwill, capabilities and industry footprint of the private parent. There are many other solid reasons for the existence of such practices.
It is a widely accepted industry practice that certain services, primarily commercial and technical, need to be sourced for a fee. What is the basis to claim that when these are bought from a third party, they are “good”, but when they are procured from a related entity, they are “bad”? Several of the largest, most solid operators in the industry rely on such practices, and evidence shows there can be significant advantages, translating into enhanced shareholder value. Procuring technical, commercial, insurance or other operational services from related parties can provide companies with enhanced quality, efficiency and cost control, with significant cost savings.
A company with all the management as part of the public vehicle, but with no or poor corporate governance, could see its costs rocket. On the other hand, the costs of companies using outside management, whether by ‘insiders’ or not, are easier to monitor, as the managers charge fees on a ship-per-day or per-month basis.
Solid industry operators have established corporate governance procedures to ensure that the services they acquire from related parties are on an arm’s-length basis. Some companies use outside auditors to vet these transactions, while board committees provide another level of scrutiny.
Shipping is an industry with an abundant amount and quality of information, so benchmarking for many services is readily available, easy to monitor and does not leave room for misinterpretation when the proper corporate governance procedure is in place.
Most companies have majority independent boards with highly respected, recognised industry figures, including former Nobel laureates, bankers and auditors. Some non-US companies have even voluntarily subjected themselves to the corporate governance requirements that apply to domestic US issuers.
It is interesting to note that many of the companies ranked in the report’s so-called lowest quartile are industry leaders, have never defaulted on their obligations, have consistently generated solid operational performances and have repeatedly tapped the bank finance and capital markets. Their customer base includes some of the industry’s best names with the toughest vetting procedures.
Some of them have been uninterrupted dividend payers since their listing. It is probably this record that leads the analyst, despite the “low corporate governance rankings,” to attribute to them the “Outperform” rating, thereby including them among his top investment recommendations.