Good corporate governance pays

New research from the ABI (Association of British Insurers) shows that companies with the best corporate governance records have produced returns 18 percent higher than those with poor governance. It was also revealed that a breach of governance best practice (known as a red top in the ABI’s guidance) reduces a company’s industry-adjusted return on assets (ROA) by an average of 1 percentage point a year. For even the best performing companies, (those within the top quartile of ROA performance), that equates to an actual fall of 8.6 percent in returns per year.

The research also shows that shareholders investing in a poorly governed company suffer from low returns. £100 invested in a company with no corporate governance problems leads to an average return of £120 but if invested in the worst governed companies the return would have been just £102.

Other key findings include:
- The worst offending companies, which breached guidelines in every year examined, underperformed the average industry-adjusted return on assets by 3- 5 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

- The volatility of share returns is 9 percent lower for well-governed companies than poorly governed companies.

- The balance of the board is crucial. More non-executive directors on a board improves performance, though too great a number is linked to a fall in profitability.

- Companies that receive a red top for pre-emption rights issues see a large negative impact on performance, with an annual decrease of 3 percentage points of industry-adjusted ROA. (Pre-emption is the right of existing shareholders to be offered shares at a time of new share launches, to prevent them having their holdings diluted).

The research examined 654 UK FTSE All-Share companies from 2003 to 2007 using unique governance data from the ABI’s Institutional Voting and Information Service (IVIS). The service issues colour coded guidance to highlight breaches of governance best practice, with red being the most serious.

Read the report (PDF).

•Date: 4th March 2008• Region:UK/World •Type: Article •Topic: Operational risk
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