NEW YORK-A strong correlation exists between poor corporate governance and the spate of debt downgrades to junk-bond status and, conversely, a link is emerging between socially responsible company practices and rating stability, said Diane Keefe, manager of the $19 million Pax World High Yield Bond Fund.
“From what I have observed, there certainly is a correlation. One of theories is that qualitative factors about corporate management may add value to investment research,” she said during a June 19 conference call.
The fund, now in its third year, screens companies according to criteria that include corporate governance, employee diversity and environmental protection. It outperformed high-yield bond fund indices in 2000 and 2001, she said.
So far this year, however, the Pax World High Yield Bond Fund is a bit behind its peers, largely because of its investment in cable TV operator Adelphia Communications Corp. Earlier this month, Adelphia fired Deloitte & Touche, its auditor, after discovering that past audits overlooked questionable arrangements allowing company founder, John J. Rigas, and his family to use corporate accounts for themselves and run up $3 billion in debt.
“Adelphia slipped through. It passed our social screen because it doesn’t sell porno through cable TV,” Keefe said.
This year through June 17, Standard & Poor’s Corp. has downgraded into the high-yield or junk-bond range some $47 billion of debt issued by 30 companies. In a conference call June 20, Ed Emmer, executive managing director of corporate and government services, said S&P will now “devote a lot more resources to accounting and financial disclosure and corporate governance and place a lot more emphasis on liquidity and ratings triggers.”
Pax World High Yield Bond Fund has avoided or exited early some of the other high profile, high flyers whose debt ratings and reputations lately have crash-landed amid allegations of improper or questionable accounting and corporate governance practices, including Qwest Communications Inc., WorldCom Inc., the Williams Companies Inc. and Tyco International Ltd.
Qwest, which recently replaced Joseph Nacchio, its chief executive officer, had renewed his five-year contract within the last year, even as “some began to suggest the company booked fiber swaps in the last few weeks of each quarter to boost results,” Keefe said.
“It’s difficult to address accounting issues when the board does not act in the best interest of all stakeholders.”
The $400 million in personal loans that WorldCom’s board of directors gave to Bernard Ebbers, now former chief executive, “was an early sell signal that most ignored,” she said.
The fund did not invest in Tyco because of its weapons-related businesses. Pax World High Yield Bond Fund also declined to invest in Williams because the company did not pass its environmental screening criteria.
Besides the New York Stock Exchange move to require independent boards of directors and the Securities and Exchange Commission plan to require CEOs and chief financial officers to sign their companies’ financial statements, Keefe said other measures are necessary.
“The independence of auditors is key and has not been established. We need to create incentives for long-term wealth accumulation (by top executives) and to create a threat to their personal wealth if their business collapses,” she said.
