Despite changes in corporate law and the introduction of the code, ownership of Mexican public firms is still heavily concentrated and this presents incentives that harm the three principals of good governance: transparency, balance of power, and accountability. Having said this, we also need to acknowledge the increasing importance of private equity and institutional investment among the newer public firms. The presence of this type of block holders should improve the quality of governance due to an increase in accountability and power balance. The caveat here is that the number of firms that go public in Mexico is low even for emerging markets; according to Rivas and Adamuz (2017), in a study using 63 developed and emerging countries Mexico ranks 48th in terms of IPOs/population during 2001 to 2014. Among the large emerging economies that fare better than Mexico are China, Chile, Croatia, Turkey, Brazil, Indonesia, Philippines, South Africa, India, and Russia.
The presence of women directors in our sampled firms is remarkably low (6 percent: Table 6.1) not only for social responsibility reasons but also for informed decision making at the board level; women take buying decisions of many kinds of products so firms need a minimum quota of gender representatives both at the board and TMTs. An average of 6 percent (Table 6.1) of international experience is low for a country with the size of trade that Mexico has. Diversity can have positive effects on board performance. A growing body of research suggests that board member diversity brings unique perspectives to boards and contributes to build social capital (e.g., Arfken, Bellar, and Helms 2004; Rivas 2012b). Diversity can also enhance a board’s independence of thought (Adams and Ferreira 2009). Other specific areas to improve include:
- A)Committees. By having, on average, a number slightly above legal requirements (2), it could be that committees in Mexico are seen more as a bureaucratic procedure rather than a vehicle for improving governance quality. If, for example, a firm is committed to improve the legitimacy of its independence level, a nomination committee that recruits, evaluates, and proposes candidates for the board is destined to play a pivotal role (EY-ICSA 2016).
- B)Training. This is a recommendation that comes from a Deloitte 2018 survey of board members. New members need to learn not only about their board duties but also about the businesses that the firm does. An ideal training for board members could then include meetings with clients, suppliers, top managers, and facility inspections.
- C)Tenure. According to Granovetter (1985), human beings are not only rational and self-interested actors that make decisions independently of others. Rather, we are all embedded in relationships that inform our decisions so it is harder to remain independent as time passes. It is true that relationships do not determine individual actions but they do inform and add value to them through the transfer of fine-grained information, trust and joint problem solving. Hence, serving time of board members should not exceed a limit. In our analysis we find that this figure is high: average tenure at S&P firms is 8.2 years (Spencer Stuart 2017) versus 10.7 years for Mexico. An avenue to decrease it could include a retirement age policy. Among Fortune 100 firms, 72 years is the norm (EY 2015).
- D)Board evaluations have grown in importance (from 57 percent in 2008 to 75 percent in 2016). Most annual reports do not disclose the type or period where they were performed. Anecdotal evidence points to these assessments as being performed on an irregular and sometimes informal basis. According to the OECD Board evaluation report (2018), It is recommended that they are done periodically, comprehensively, supervised by a specific individual or board committee and disclosed in a formal manner in order to increase their potential contribution to governance effectiveness.
- E)CEO and TMT succession plans. As with board training, this constitutes an area of opportunity; sixty-two percent of surveyed firms do not have one in place. Compensation procedures for top managers and board committees are also needed (Deloitte 2013). These processes could potentially be a task for a compensation/human capital board committee.
- F)Increase in transparency of top-level compensation and nomination practices. According to the CFA Corporate Governance Manual (2018), the disclosure of executive pay sheds light on a board’s stewardship of firm assets. This disclosure allows investors to assess whether compensation practices are reasonable in light of their reported performance. One way to implement this could be using an independent board committee (compensation/human capital/nomination) that designs and proposes for board approval a system of TMT - board compensation and recruitment. A simplified version—for clarity purposes—could then be disclosed to shareholders in the annual report - meeting.
- G)Duality. CEO duality occurs when the same person holds the CEO and chair roles. In stable periods, independence between the chairman and CEO roles contributes to improved accountability in the boardroom since the board is expected to monitor top managers. It has been argued that if the CEO also chairs the board, there might be a conflict of interest in the board’s monitoring of the TMT (Monks and Minow 2008). Duality is in fact forbidden by law in the United Kingdom but it is a widespread phenomenon in Mexico where 44 percent of firms exhibited this trait in 2016. Research has shown, however, that duality can help to overcome crisis faster; CEO duality becomes beneficial as concentrated power allows the firm to respond more rapidly to a crisis (Dowell, Shackell, and Stuart 2011). But, in contexts with low institutional quality and financial market development, CEO duality could deter firm performance (Mutlu et al. 2017). Thus, given the above-mentioned arguments CEO duality should be evaluated carefully.
- H)Functional background diversity. A diverse board is less susceptible to “groupthink” (Barkema and Vermeulen 1998). Although it is related to task conflict, it improves performance on cognitive tasks (Jehn, Northcarft, and Neale 1997). Functionally diverse teams may be better linked into external networks, allowing them greater access to information (Milliken and Martins 1996). One way to increase diversity could be setting quotas for the most important background profiles -finance, operations, production, and technical- these quotas could also be aligned with corporate objectives such as entering a new country or industry.
- I)Age. Firms could try to better match board entrants so that there are “cohorts” of director age. Setting limits to tenure and establishing a retirement age could aid a process of achieving board age diversity. Hacksoon and Chanwoo (2010) found that age diversity at the board level positively affects firm valuation. On the other hand, groups characterized by diversity in age may find it difficult to communicate, conflict is more likely, and social integration harder to achieve. A younger board takes more risk, innovates more, and has higher levels of energy (Barker and Mueller 2002).
- J)Meetings. Boards in Mexico hold the number of meetings that are legally required (4). Many strategic decisions are made during board meetings. It is true that a board should avoid implementing strategies and a high number of yearly meetings could be a signal of this behavior. As mentioned earlier, for S&P 500 firms in the US, the average is 8.2 meetings, which is more than double the Mexican average of 4. This lower result could be related to the high ownership concentration and low level of board independence exhibited in the country. Thus, it is possible that several boards in our sample could be acting more in an advisory than in a fiduciary role and, because of the oligopolistic nature of Mexican markets (COFECE 2018) where firms are able to charge premium prices due to their market dominance, controlling shareholders could feel that a board adds limited value to firm performance.
Overall, corporate governance practices in Mexico compare to those of OECD countries but fare below its average. Thus, we can conclude that Mexico needs to improve its governance practices if it truly aspires to become a developed economy or even a leader of emerging country practices.
A key regulatory issue that Mexico needs to address is the update of the Law of Mercantile Societies from 1934 so that it is consistent with the 2005 law of security markets. Most countries from the civil law tradition had this same problem but have managed to address it in recent years. Among those countries are Spain, Italy, Brazil, Colombia, and Chile. Until this matter is resolved, private firms in Mexico will not be required to have a board that follows global best practices. Hence, the regulatory framework in Mexico needs to be consistent in order for corporate governance best legal practices to permeate and contribute to improvements.
Because of the high level of ownership concentration, regulators should consider restricting pyramidal structures and the issuance of shares with restricted voting rights (currently at a threshold of 25 percent). Why? Because freely allowing this exacerbates the problem of control by few and ownership by many. Policy makers should consider that restricted voting rights create principal–agent problems where the principal (owner) is not able to exercise part of his/her rights and the agent (CEO) can distinguish between a “first” and “second” class of firm owners. A one share–one vote policy has been a practice consistent with sound corporate governance practices. Hence, regulators should reconsider the existing forms of equity issuance and decide if they enhance corporate governance practices.
Following the study of Machuga and Teitel (2009), policy makers should also consider redefining board independence to make it more rigorous and establishing a maximum number of directorships an individual board member can hold. Substitute board members is also a practice in Mexico that should be forbidden. Even if a substitute board member is as capable as the regular one, how can they follow pending issues that have been discussed in previous meetings? How can he/she earn minority shareholders’ trust?
Babatz-Torres (1997) argues that Mexican law protects minority shareholders on the surface but needs to be much more specific to serve their interests against potential lawsuits from majority owners. Chong and López-de-Silanes (2007) mention that the country has reformed its securities laws but also agrees with the low degree of shareholder protection diagnosis.
As mentioned earlier, professionalizing board members would also help. Director institutes can play a key role in expanding the pool of competent candidates from which to select directors. This has proved to be a valuable resource in Brazil with the Brazilian Institute of Corporate Governance (IBGC) that was formed as a nonprofit organization in 1995 to improve the quality of directors and governance practices.
Private dispute resolution procedures are currently being tested in the Sao Paulo Stock Exchange. These mechanism between firms and shareholders could be promoted by creating professional shareholder arbitration panels and persuading firms to include this resource in their by-laws.
Another potential best practice is to include a minimum of corporate governance standards for firms that wish to be eligible for pension fund/institutional investments. It requires that companies establish mechanisms to ensure the protection and equitable treatment of shareholders. This has been done in Colombia where it is probably too soon to find its results.
Mexican firms that aspire to improve their governance practices could also partner with institutional investors as evidence shows that their presence can be an effective remedy to principal–principal problems of expropriation in family-controlled firms, especially in the absence of a market for corporate control (Young et al. 2002; Agrawal and Knoeber 1996).
In our results from the Expansion 500 data, we show that the highest performing group in terms of ROE are multinational subsidiaries (18 percent) followed by state-owned entities (13 percent) and domestic firms (9 percent). Because most domestic firms are family firms, our results could be suggesting that most family firms would indeed benefit from limiting family interaction to ownership and board representation as argued by Bennedsen, Pérez-González, and Wolfenzon (2010). Successful family firms then need to become experts in corporate governance, fully assuming their ownership responsibilities. Family executives should be the exception and not the norm among family firms. Good corporate governance principles should clearly establish the requisites for family members to become executives in the firm.
Finally, we need to keep in mind that the quality of written law and regulation is only one side of the coin. Good corporate governance also relies on business practices, compliance, and enforcement. A key challenge for policy makers in Mexico is to improve the enforcement of the existing laws and—where necessary—improve laws and regulations.