ESG QUICK TAKES

Cartica's perspective on ESG in Emerging Markets

This month Cartica takes a closer look at best practices for a company's Board of Directors.

BOARDROOM BEST PRACTICE

Cartica routinely assesses the Boards of Directors of portfolio companies with a focus on structure, composition, processes, and culture.

Board Responsibilities
Act in good faith to provide long-term value
Board members have duties of care and loyalty. They have a fiduciary responsibility to promote the long-term interests, success, and sustainability of the company. Board members must act in good faith for the benefit of all shareholders and stakeholders. They must be diligent in seeking out and understanding all relevant information to make decisions in the best interest of the company.

The 2021 revisions to the ICGN Global Governance Principles stress that investors and companies should focus on enhancing human and natural capital in addition to financial capital. Further, considering environmental, social, and governance (ESG) risks and opportunities and the company’s corporate culture at the Board level is increasingly viewed as industry best practice.

Board Structure
Independent Chair and relevant committees strengthen oversight

The separation of Chair and CEO is viewed as industry best practice. Cartica encourages this to ensure Chief Executive accountability and avoid conflicts of interest.

Cartica recommends companies form at least Audit, Nomination, and Compensation committees, though we encourage companies to form a Strategy and Sustainability committee and industry-specific committees as well. Each Board member should serve on at least one committee, and non-Board members should not serve on any committees. The Audit and Compensation committees should be comprised entirely of Independent Directors to ensure the integrity of financial controls and reporting.

Board Composition
Independent and diverse Boards improve objectivity, mitigate groupthink

Though Board composition requirements vary by country, Cartica maintains that best-in-class Boards are comprised of majority Independent, Non-Executive Directors who represent a diversity of backgrounds and have clear plans for succession and refreshment.

Independent Directors serve a critical function on the Board by providing specialized expertise and objectivity while mitigating the risk of groupthink. Cartica and many of our investors consider any Director with over 10-years tenure no longer Independent. The UK, France, India, Malaysia, Singapore, Hong Kong, and the Philippines have rules and guidelines advising against long-serving Directors.

Cartica engages with companies to appoint Directors with a diversity of skills, backgrounds, genders, and ages. We often receive pushback from companies on boardroom diversity recommendations (particularly around gender). However, investors and regulators increasingly see diversity as critical, and research supports this: several studies by McKinsey & Company, BCG, and Deloitte have shown a correlation between diverse leadership and improved financial performance. 

CHART OF THE MONTH: THE BUSINESS CASE FOR DIVERSITY IN LEADERSHIP

Cartica believes there is a strong business case for diversity in corporate leadership. Based on a data set of ~1,000 large companies in 15 countries, a 2020 McKinsey study found that companies in the top quartile of gender diversity on executive teams were 25% more likely to experience above-average profitability than peer companies in the fourth quartile. Companies in the top quartile on ethnic and cultural diversity outperformed those in the bottom quartile by 36% in terms of profitability.

¹Difference in likelihood of financial outperformance vs the national industry median of five years average EBIT margin, using the full dataset of companies in each year.

May 2020
Copyright © McKinsey & Company

TOP 3 MUST-READS THIS MONTH

Institutional Investor: The Case for Active in Emerging Markets Has Always Been Strong. Why Do Investors Still Favor Index Funds? Featuring Cartica’s Teresa Barger

New York Times: China Opened a National Carbon Market. Here's Why It Matters.

S&P Global: Brazil’s banking system braces for new ESG regulation

The companies profiled in the “Company Highlights” section are, or have previously been, held in Cartica’s portfolio and are included solely for purposes of illustration. Approaches to, and results of, ESG engagement vary materially. Nothing in this newsletter should be read to suggest any particular future result. This is not a recommendation of, nor an offer to sell or buy, the securities described herein.

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