Read All About It – Counting the cost of poor corporate governance

What does 8.5% look like on a balance sheet or a valuation? Basically, it’s headline news.

Post Brexit, Sterling plunged 8% against the euro and 13% against the dollar, marking its worst daily fall on record — exceeding the 4.9% fall during the Black Wednesday of 1992. When Deutsche Bank’s shares fell by 5% in June 2016 on the increasing risk of US regulatory action; everyone noticed and commentators amplified concerns about the health of the bank. The value of Deutsche has fallen further since.

So why are Boards so seemingly sanguine about the 8.5% more they could earn for their shareholders if they tidied up their corporate governance?

The evidence is not new

As far back as 2003, three leading economists with the National Bureau of Economic Research noted that strong Boards and independent directors protecting shareholder rights delivered shareholder returns which were 8.5% higher than those where shareholder governance was weaker.

The value of those same firms, measured using the Tobin Q methodology (market value/Book value) was correspondingly 8.5% higher.

To quote Paul Gompers, Joy Ishii, and Andrew Metrick, an 8.5% increase in both shareholder returns and company valuation. Companies with weak corporate governance ‘earned significantly lower returns, were valued lower, had poorer operating performance, and engaged in greater capital expenditure and takeover activity’.

The authors are careful to say they aren’t making any claims about the direction of causality between corporate governance and corporate performance; shareholders clearly benefit from effective corporate governance, but the fact remains that too many Boards are still failing to grasp a win that promises short term gain and long term benefits.

Whilst the corporate governance codes provide the blueprint for effective board governance, in our experience, many companies and consultants focus too much on being able to demonstrate compliance, rather than demonstrating the effectiveness it delivers.

What Board Matters International suggest

With disruption all around, shareholders, boards, regulators and funding partners should strengthen their foundations by critically examining the effectiveness of corporate governance in their company. They should do so with the same level of scrutiny that they would apply to the company’s market effectiveness and profit performance, and ask themselves the following three core questions.

1. Is the Board evaluation objective?  No manager would ever approve a salary increase or performance bonus based solely on the outcome of his employee’s self-assessment.  Employers know that employees tend to “talk-up” achievements and ignore or minimise failures and slow to criticise. Therefore, whilst self-assessment is important, a true view of performance requires input from an independent third party.  Who undertook the last evaluation of your board?
2. Does your Board evaluation give you real insight? Unfortunately, too many Board Evaluations concentrate solely on the extent to which processes are in place and working. Examples being “Are Board papers distributed in time?”, “Is the amount of time given to agenda items adequate?” and “Do you have terms of reference for Board Committees?”. These measures are important but they tend to be quantitative. Real insight into Board Governance effectiveness requires qualitative analysis of both board processes and more importantly the interaction between and the overall skill set of the Board.  Was it worth the time and money to get a completed checklist?
3. Does your Board have the right skills today to match what the business needs tomorrow? The pace of change in all business sectors continues to accelerate. Bernard Byrne, Chief Executive Officer of AIB Bank in a recent interview with Donal O’Donovan, Deputy Business Editor of the Irish Independent identified that in order to compete with the plethora of non-traditional entrants to financial services that “Banks needed to invest in new technologies and new sectors……..that it had not done in the past”. Although delivery of this strategy will require the acquisition of additional business capability into the business, Boards also need to consider whether their own skills sets are appropriate for the future shape of their business. Too often Board evaluations are backward looking, and do not properly assess the degree to which the current skills set of the Board are appropriate to match the future strategy of the business.

Disclaimer

The views and opinions in this article are views and opinions of Board Matters International, save where quoted and referenced. They should not be taken to represent any express or implied views of any organisation, client or connection of Board Matters International or its partners.

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