Identifying 210 Companies that could face #MeToo Investment Risks

Introduction

This is the second part of our series where we explore the importance of how well a company performs on Censible’s Women in Leadership Ratings, and how its gender diversity rating correlates with positive stock performance as well as potential hidden, off-balance sheet risks.

In Part I, we focused on how companies with gender diverse executive teams have delivered higher profitability and return on equity compared to industry peers with male dominated leadership teams. Meanwhile, the #MeToo movement has created substantial awareness surrounding allegations of sexual assault and misconduct by several executives resulting in severe disruptions to the associated businesses. While investors can positively screen for gender diverse companies using Censible’s Women in Leadership Ratings, can investors also apply Censible’s ratings framework to systematically identify companies that face a higher potential for risk of future misconduct or harassment incidents among executives?

Building a Negative Screen

To begin building a negative screen, Censible decided to focus on founder led companies that have a founder currently serving as either CEO, COO, Chairman or President. Not only would a celebrated founder perhaps generate larger media coverage from a misconduct allegation, but research has also shown that founder led companies have demonstrated outperformance relative to non-founder led companies. Therefore, a sudden departure could be problematic for the underlying operating fundamentals of the business. Additionally, the departed founder’s concentrated ownership position has the potential to create internal turmoil as the company tries to move past the incident and recover its reputation.

Our screen yields 210 companies that could carry additional #MeToo risks. While the sample size of affected public companies currently is too small to provide a robust statistical analysis, the companies on the list should at least give investors pause on whether the market is mispricing the potential corporate governance risks of a harassment or discrimination incident. What other metrics could we incorporate into a negative screen to perhaps build a more robust model?

Building a Better Model

What are additional variables and factors that could help develop a better quantitative metric?

• Founder Age. Men over 55 have shown a larger implicit gender bias, and evidence should build over longer tenures where there is misappropriate behavior. The watchlist has a median executive age of 60 years old compared to a median executive age of 55 years old for S&P 500 companies.

• Very Large Insider Ownership. Concentrated ownership may weaken board structures, rendering them ineffective to create change or oust an executive.

• **Sexual Harassment Claims by Industry**. Industry type could also be a factor to consider if an industry typically has higher rates of harassment and misconduct. Additionally, large gaps in employee compensation by gender could indicate whether gender discrimination already exists.

• Board Independence**.** In many instances, the board of founder led companies is an extension of the founder, potentially creating a conflict of interest. Censible’s analysis of board independence demonstrated that founder led U.S. companies typically have 80% independent directors while companies on the watchlist have a median of 60% independent directors. Screening for "friends on the board", i.e. personal relationships and business contacts of founders, could be an additional factor to detect conflicts of interest.

• Independent Chairman. Could a founder serving as the chairman of the board suggest a higher incidence of wrongful conduct? 70% of the watchlist, including Wynn Resorts and Guess?, have founders serving as the chairman.

• Rate of Progress. In 2017, a record high of 36% of board seats were filled by women. Companies that currently lack executive gender diversity, but show commitment to improving the status quo, may have a reduced risk of an incident occurring.

As we mentioned in Part I, the market seems to be pricing a 20% haircut in valuation if a sexual misconduct or harassment incident occurs. Should the companies on our watchlist trade at lower multiples than peers? Should the put options for these companies have a higher implied volatility and positive skew? At what point does the benefit of outperformance by a founder in the executive seat become outweighed by increased concentration risk by his or her behavior? These are some questions and ideas that could help further refine a quantitative metric for #MeToo risks, and how a metric could be integrated into more traditional financial modeling and valuation.

So is ESG-related analysis simply a "feel good" metric, acting as a barometer for social impact? Or, is it something that all investors should include in the investment decision process? In Part III, we will explore why it is not such a black or white issue, but rather a natural evolution in approaching long-term investment objectives to help mitigate risks, assess investment opportunities as well as a means to incorporate a more personalized approach to values-based investing.

Companies Screened for MeToo Risks