Sent: 23-11-2010 13:50:37
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The Chinese Show Who's the Boss
The Chinese investors behind Mount Gibson Iron have flexed their muscles to reject the election of an independent director, effectively raising their middle finger to Australia's corporate governance standards.
Last week's ATC e-mail drew attention to a potential loss of shareholder rights arising from mining companies giving up their strategic independence to corporates investing to gain control of raw material supplies.
The ink was hardly dry on those comments about Mount Gibson Iron and Matilda Minerals before the Chinese investors in Mount Gibson Iron blocked the election of an independent director to the board of the company at a meeting of shareholders on Wednesday.
The effect of the vote was to deliver a majority of board seats to appointees of Chinese companies ultimately controlled by the Shougang iron and steel group whose chief executive has conceded publicly that it intends to control all of the production of Mount Gibson Iron for the life of its operations.
In moving as they did, the Chinese gave notice of a new set of governance standards where they are involved. Their presence means minority investors can no longer assume commonly accepted protections will always be available.
Many investors would have thought participation by Chinese companies acting on behalf of the Asian giant's steel industry made their investments safer because their presence guaranteed market access.
Investors now need to consider whether this comes with too many strings attached.
- Capital management may be undermined. Funds generated by current mining activities may not be used in the best interests of non-Chinese investors. Chinese investors may be more inclined to have the company invest in new projects to meet China's strategic raw material needs and less inclined to pay dividends, for example.
- Project quality might deteriorate. China's need for raw materials may take the captured company into less desirable projects left behind by other companies. Investment in relatively poor quality projects could reduce the return on capital employed leading to share price underperformance, a higher cost of capital and, ultimately, greater dilution for existing private shareholders.
- Captured boards may be more likely to agree to less favourable commercial terms in negotiating offtake agreements or finance contracts with entities known to the directors in China.
- The quality of management may fall. Managers may become reluctant to join a company dominated by decision makers ultimately directed by government officials in Beijing and less concerned than others about the best long-term interests of the company and the majority of its shareholders.
- The quality of board personnel will decline. Truly independent directors are likely to give up rather than stay and fight against the odds.
- Overall company standards may fall. Chinese directors looking after their own strategic interests may become less inclined to apply the standards of a modern western corporation. This would normally include balancing corporate obligations toward a diverse range of stakeholders including those with an interest in safety and environmental standards.
One lesson from last week's events is the importance of voting. Votes against the appointment of Peter Knowles accounted for 58% of the total votes cast. However, 30% of eligible votes were not cast. If 40% of these votes had not been withheld and, instead, had been lodged in favour of Knowles, he would have retained his position on the board.
Against this background, the attitude toward Chinese investment could change. Companies inviting Chinese participation will become more wary about the benefits and shareholders, given the choice, will be less enthusiastic about embracing capital from this source than they might have been in the past.
The lobbying and vote counting in the approach to shareholder meetings will intensify. Kevin Rudd will have to explain that Australians are not racist. They simply want to stop Chinese investors getting away with behaviour generally regarded as unacceptable.
This email is general in nature only and does not constitute or convey specific or professional advice. Legislation changes may occur quickly. Formal advice should be sought before acting in any of the areas discussed. Be aware that the information in these articles may become innaccurate with time. Responsibility is disclaimed for any inaccuracies, errors or omissions. Particular investments are neither invited nor recommended and hence this publication is not "financial product advice" as defined in Section 766B of the above legislation. All expressions of opinion by contributors are published on the basis that they are not to be regarded as expressing the official opinion of any other person or entity unless expressly stated. No responsibility for the accuracy of the opinions or information contained in the contributor's articles is accepted by any other person or entity. Copyright: This publication is copyright. If you wish to reproduce this article you require a license, which can be purchased here, to do so.