Credit: Kurt Schacht, Managing Director, CFA Institute
Mention the term corporate governance, and for most people it will evoke academic, legal, and technical matters too mundane to address in typical securities analysis. Because of this perhaps, the issue is not top of mind for most investors.
But it should be.
There is a direct correlation between corporate governance and corporate performance. The better the internal controls and procedures by which individual companies are managed, the better the performance. The weaker these controls are, the weaker the performance.
In their study, Corporate Governance and Firm Performance, professors Lawrence Brown and Marcus Caylor, found that companies with top governance rankings had returns on equity 9.2% higher than industry averages, net profit margins 46.0% better than industry averages, and sales growth 3.5% greater than industry averages.
While this impact on performance is not lost on investors, appreciation is still evolving. It was perhaps higher in 2005 when CFA Institute published the inaugural edition of its corporate governance manual, called The Corporate Governance of Listed Companies. At that time, corporate governance failures at WorldCom and Enron, among others, cost investors billions, and roiled global equity markets.
The second edition of The Corporate Governance of Listed Companies was published following governance breakdowns at Bear Stearns and Lehman Brothers. While the results were the same — investor losses and roiling markets — this second failure of governance was far more costly and far more perilous. The liquidity of the Federal Reserve together with the full faith and credit of the United States government were needed to cure the impacts of poor governance.
It is therefore hoped that with the recent publication of the third edition of The Corporate Governance of Listed Companies — which is freely available to investors — CFA Institute is not presaging another round of governance crises like those that have occurred in the past.
While the art and science of corporate governance has advanced over the past decade and capital markets appear relatively calm, there are nonetheless important governance issues that deserve the attention of investors, regulators and C-suite executives. Chief among these are the integration of environmental social issues into governance structures and the emergence of dual-class shares.
This latter issue, in particular, has the power to sow disorder with effects that are difficult to completely comprehend until it is too late. Specifically, there are a number of large, powerful technology companies largely under the control of few, and in some cases just one, shareholders as a result of dual-class structures. In other words, these companies’ principals are largely unaccountable to their shareowners should strategies, operations, or public views turn sour.
A governance failure at any of these companies could provoke crises ranging from international politics, to privacy, to the underpinnings of our democracy.
So, yes, corporate governance is an important subject, but not just for investors. The updated version of The Corporate Governance of Listed Companies does not provide a set of best practices, or even take a position on the best corporate governance structures for investors. Instead, its purpose is to alert investors — and policymakers — to the primary corporate governance issues and risks affecting companies and to highlight some of the factors investors should consider when making investment decisions, all before it is too late.
To download the Corporate Governance of Listed Companies click here.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
