Good governance can improve performance

Feb 27 2008 by Nic Paton Print This Article

Corporate governance is not generally thought of as something that sets pulses racing, but a new British survey has argued that firms with the best records on this issue produce 18 per cent higher returns.

The research by the Association of British Insurers has also found that breaching governance best practice – what's known as a "red top" by the ABI – can also reduce a company's return on assets by an average of 1 percentage point a year.

It's not just in the P&L that poor corporate governance can have a startling effect.

Shareholders investing in poorly governed companies also by and large suffer from lower returns, said the association.

The ABI calculated that £100 invested in a company with no corporate governance problems led to an average return of £120.

But the same amount invested in the worst governed companies returned just £102.

The analysis of 654 UK FTSE All-Share companies from 2003 to 2007 also found that the worst offending companies, or those that breached guidelines in every year examined, underperformed the average industry-adjusted return on assets by between three and five percentage points a year.

There was also found to be a time lag of two to three years between any breach and the impact on performance.

Other findings included a nine per cent reduction in share volatility in well-governed companies against their poorly governed counterparts.

And the ABI concluded the balance of the boardroom was crucial to success in corporate governance.

The more non-executive directors on a board the better the performance, by and large, it found.

But there was also an important corollary: too great a number of non-execs was also linked to a fall in profitability.

ABI director of investment affairs Peter Montagnon said: "Our growing database has enabled us to look at the impact of corporate governance over a period of time.

"Our members' interest in governance has always been driven by their desire to generate value for policyholders over time. The results confirm our belief that good governance produces better returns with less volatility – something that long-term savers need," he added.

The latest research is a bigger version of a similar survey carried out by the ABI this time last year.

That survey looked at 14 firms in the FTSE All-Share Index that had all issued more than one red top, and found 11 had underperformed.

Similarly, those who's boards were populated solely by executives rather than non-executive directors, were more likely to see their share price fall as a result, it concluded.