The value of good corporate governance

No sooner has the FRC has closed for submissions for on how well the Combined Code is working, than 3 surveys highlight the value of good corporate governance for issuers.

The Financial Reporting Council has been inquiring over the last few weeks into how well the Combined Code is working. Largely, the responses made public (from the IRS, the ABI, PIRC and others) have highlighted that in the two years since the Combined Code was introduced, the climate of communication has improved hugely.

Not that everything is perfect; the ABI’s survey showed inconsistent compliance, and concerns remain among investors that companies are defaulting to a minimum compliance rather than explaining.

However for issuers who have yet to be convinced that the time, effort and expense in complying with best practice is a wise investment, 3 surveys have been released which shed light on how companies with good corporate governance increase total returns to the investor.

First, companies with better corporate governance have lower risk, better profitability and higher valuation. More specifically, these well-run companies outperform poorly governed firms in return on investment, annual dividend yield, net profit margin, and price-to-earnings ratio.

These are among the findings of the forthcoming "Corporate Governance Quotient 3.0 Research White Paper," by Daniel Cheng, director of ISS' Quantitative Models Group, and Yi-Yen Wu, a senior analyst in that group. Applying more than 4,000 statistical tests, the researchers examined the correlation between ISS' Corporate Governance Quotient (CGQ) ratings and 16 financial performance metrics from 2002 to 2004 for more than 5,200 U.S. companies.

Next, in September, Governance Metrics International(GMI),the corporate governance research and ratings agency, announced new ratings on more than 3,200 global companies. Thirty-three companies, including twenty-two American, seven Canadian, two Australian and two British, were rated 10.0, GMI’s highest rating. As a group, these companies outperformed the S&P 500 Index as measured by total shareholder returns for each of the last one, three, and five-year periods ending September 1, 2005, providing excess returns of 11.40%, 6.09% and 15.19% respectively relative to the index. GMI ratings and company reports are used by pension funds, investment advisers, mutual funds, banks, insurance underwriters and regulators to assess governance risk, as well as corporate advisory firms and corporate issuers to benchmark performance and conduct peer comparisons.
However a contrarian view was shown in a new study by Marathon Club, which develops approaches to long-term pension fund investment, and the University of Bath. The study showed that there was a significant scope for improving corporate governance and corporate responsibility practices.
More than 80% of investment professionals support the promotion of good corporate governance and corporate responsibility, but only half believe it should be integrated into fund manager selection and review processes.
The survey, which polled more than 100 investment professionals, revealed a strong belief that good governance was an opportunity rather an obligation.
More than 88% of respondents said good governance helped manage a fund's investment risks and long-term return prospects and 80% said good corporate responsibility would help too.
Respondents said they would be keen to integrate corporate governance and corporate responsibility factors into buy/sell decisions and core investment processes with much less support of using a specialist index or screening.
Do these surveys point conclusively to a direct connection between excellence in corporate governance and total returns to the investor? Almost certainly not; after all companies well run in corporate governance, are likely to be well run in other areas.