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Musk’s Contempt For SEC Signals Significant ESG Risk To Tesla Investors

11 December 2018Old Mutual Wealth
Chris Potgieter, Head of Old Mutual Private Client Securities

Chris Potgieter, Head of Old Mutual Private Client Securities

Elon Musk may have settled his fine with the United States Securities and Exchange Commission (SEC), following charges of securities fraud earlier this year. However, the Tesla CEO didn’t miss the opportunity to announce his explicit contempt for the so-called watchdog over Wall Street, saying “I want to be clear: I do not respect the SEC”.

According to Chris Potgieter, Head of Old Mutual Private Client Securities, Musk’s disregard for the shareholders of Tesla presents a risk to the long-term sustainability of the company. “While the news that Musk was permitted to remain CEO of Tesla initially came as a relief to many investors, his recent erratic behaviour and the apparent inability of the Tesla board of directors to rein him in may be cause for concern,” he says.

Potgieter says that “key man risk” – the risk of losing one individual who is core to the operation of the business – is often problematic for successful start-ups as they mature into listed companies. “If you think of how a company like Tesla came to be, it was up to an individual to have a vision and to sell that vision to angel or venture capital investors. By making their companies their own and running with their ideas, these individuals have been critical factors in their success. I don’t think you can avert that, because, ultimately, people buy people,” says Potgieter.

“However, companies do not stay start-ups forever. Tesla is now a major listed company, with 8 000 employees. The business has been scaled and is affecting the lives of many, many people – employees, those using its products and services, and shareholders invested through a public market. At some point, governance does become a critical factor,” says Potgieter.

He explains that the strength of the executive board is an important aspect of governance – one of the three pillars of a company’s environmental, social and governance (ESG) profile. “The depth, diversity and experience – and the independence - of a board are all criteria believed to indicate a quality company, because a strong board of directors is able to help management navigate a company through the harshest of times,” says Potgieter.

He explains that the key purpose of a board is to ensure that the company's affairs are conducted ethically by holding management and board members accountable, while meeting the appropriate interests of its shareholders and other stakeholders.

“According to a study of Thomson Reuters ESG dataset by Bank of America Merrill Lynch, companies with high ESG scores had lower subsequent price and earnings volatility than companies with low ESG scores. The study revealed how diverse executive boards – an indicator of strong management – between 2005 and 2016 had higher subsequent 1-year return on equity (ROE) than companies with less diverse boards nearly every year over the same decade,” says Potgieter.

“Musk’s contempt for Tesla shareholders is not a new phenomenon. It was also apparent the day he described the questions by Wall Street analysts’ – representing the interests of investors – at a recent meeting as ’dry ‘, ’boring ‘and ’boneheaded’.

“In my opinion, this was a watershed moment for Tesla – an incident that strongly resembles the moment Jeff Skilling, the CEO of Enron and once darling of Wall Street, insulted an analyst for asking why Enron refused to provide a balance sheet prior to a shareholder meeting,” says Potgieter.

He explains that investors should consider the non-financial indicators, such as governance, to be just as meaningful as financial indicators when measuring performance. ESG scores are an integral part of good risk management and should be scrutinised as much as balance sheets and earnings statements, because they are one of best predictors of long-term sustainability and company performance.

“While the clean-energy electric-car maker is a company any socially responsible investor should love to invest in, the lack of action taken by the board in response to Musk’s recent behaviour highlights a potential problem with the company’s management and presents a significant governance risk to investors,” concludes Potgieter.

 

 

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