Does Corporate Governance Matter?
"Corporate governance is not acknowledged enough when it works well, though it is frequently assailed when it fails dramatically," says Michael O'Sullivan, Credit Suisse's Chief Investment Officer, International Wealth Management, in a new report launched in Davos by the Credit Suisse Research Institute.
Good Governance Pays
An independent board, strong controls, transparency and shareholder rights generally increase market value. But precise impacts of 'good governance' can be hard to pin down. Exact linkages to share price are not often obvious, governance is more important in some periods than in others, and it affects some industries more than others.
An examination of some 1200 companies by Credit Suisse analysts Giles Keating and Antonios Koutsoukis shows that in some sectors a focus on corporate governance can reward investors with market outperformance. Usually it's a few-points advantage in valuation, which can make a significant difference over time. Some industries are more sensitive to good practice ‒ namely telecoms, basic materials, oil and gas, and financials. As Credit Suisse Group's Chairman Urs Rohner notes: "Robust corporate governance is a must in any industry, and for banks in particular." Other sectors, particularly consumer goods and services, technology and healthcare, may prioritize good governance, but this does not necessarily help them to outperform the market. Governance's influence on value also fluctuates. It seems to be more important when times are bad, and less so when times are good.
Work in Progress
'Seems' is the operative word here, because governance and its effects are not a settled science. Definitions are still in development, and precise causes and effects are often not easy to find or to generalise. Current definitions used by Keating and Koutsoukis comprise four themes: independence of the Board of Directors; equity and transparency of pay; checks, balances and democracy of corporate control; and conservativeness of accounting. These are broken down further into 96 factors. Accounting, for example, is rated according to how aggressively revenues and expenses are recognised, or how quickly goodwill is amortized. Keating and Koutsoukis found that these factors can relate to share performance, but not always as expected. Clearly, more work in understanding governance is needed, says Michael O'Sullivan: "Investors need a better understanding of sectors where, and periods when, corporate governance can significantly aid their decision-making."
Governments on Governance
While investors and financiers are building this understanding from the bottom-up, governments are trying the same from the top-down. Furthest along, says Bob Parker, Senior Advisor in Investment, Strategy and Research at Credit Suisse, is the United Kingdom's Financial Reporting Council (FRC). Its 'Stewardship Code' lays out seven principles of how asset managers must behave toward the companies in which they own shares. These revolve around disclosure and cooperation, rather than secrecy and conflict. Since its introduction in 2010, Parker adds, similar codes have been adopted in most Western countries with large, public equity markets. Meanwhile, academics are also trying to define governance. As the report explains, there is already wide scholarship on the subject.
Money Managers Take Note
This is apparent to asset managers, whose awareness of governance, contends Bob Parker, is rising in two ways. First, they are ever more inclined to step in and take the reins themselves. Activist hedge funds, for example, are on the rise, and they have substantially outperformed more passive peers in the past 6-7 years. Second, money managers are paying more attention to the impact of governance: who, what, when and where. A key tool is Credit Suisse's HOLT governance scorecard, which assesses and compares 20,000 US and European companies based on 13 governance-relevant criteria such as the level of transparency of corporate pay and the balance between short- and long-term performance measurement.
Down The Chain
A final angle of governance switches focus from investors, regulators and managers to the supply chain, i.e. how well governed are suppliers and customers. This can be critical, says the report.
Using PEERs, another tool developed by Credit Suisse, analysts Julia Dawson and Richard Kersley found that good governance leaders tend to demand high standards from their business partners, including both suppliers and customers, and can thus act as multipliers of best practice. As Michael O'Sullivan concludes: "With profit growth slowing, credit spreads higher and interest rates rising, corporate governance will become an even more important factor for investors."