Putting a value on board governance

Abstract

board governance fad is being kept alive by a bunch of consultants and academics...there is no evidence that board governance matters to shareholders. When I see some evidence, I'll take this more seriously. says the CEO of a Fortune 500 company - and he is not alone in his skepticism. Though there are some CEOs who firmly believe in the importance of good board governance and have taken steps to strengthen their company's governance processes, many others remain doubtful about the benefits of taking action. So many other things matter more - competitors, financials, marketing - board governance is just not on my screen, said one CEO. Another argued, Fund managers are very short-term oriented; not much use talking about boards with them it's too long-term an issue. To try and ascertain the real worth of good governance, McKinsey, in conjunction with Institutional Investor, Inc., conducted a survey of over 100 major investors, CEOs, and senior executives. According to the survey findings, good governance practice really does make a difference a difference that many investors are willing to pay for. (See the boxed insert for details of the survey.) Just how much is good corporate governance worth? We asked investors to compare two well performing companies (such as those with consistent profits and number one or two in terms of market share) and state whether they would pay more for the stock of one of these companies if it were well governed. Two-thirds of the investors said they would [ILLUSTRATION FOR EXHIBIT 1 OMITTED]. As one respondent put it: Companies with good board governance practices have a shareholder-value focus. Among those willing to pay more for good governance, the average premium specified was 16 percent. However, a minority of those investors who said they would pay more felt the actual premium was hard to quantify. based on the entire survey group, including those who said they would not pay more, the average premium was 11 percent [ILLUSTRATION FOR EXHIBIT 2 OMITTED]. Exhibit 3 Financial improvements equivalent to an 11% increase in share price Example company An 11% increase in stock price would $ million be equivalent to: Revenue 1,000 Increasing EBIT 11% or $11 million forever COGS 600 Increasing sales $110 million forever SGA 300 Reducing COGS 2% forever EBIT 100 Reducing SGA 4% forever An 11 percent increase in share price would equate to an increase in earnings before interest and tax (EBIT) of 11 percent in perpetuity. To put that figure into perspective, consider the scope and intensity of effort that would be required to earn a similar increase through measures such as cost cutting or higher productivity (Exhibit 3). Who cares most about good governance? If it is clear that many investors are willing to pay significantly more for the stock of companies that have good governance practices, how can those investors be identified? The survey reveals three key variables that influence the importance certain investors place on good governance: Portfolio turnover. Investors with lower turnover ratios in their portfolios governance most [ILLUSTRATION FOR EXHIBIT 4 OMITTED]. They hold stocks longer and believe good governance will help improve performance in the long term. Asset management philosophy. Investors who pursue a value strategy (for example, those who invest in undervalued companies with low price/earnings ratios and/or stable companies with regular dividends), are more willing to pay for good governance than those who pursue a growth strategy (for example, those who pick companies with high price/earnings ratios in the hope the companies will grow) [ILLUSTRATION FOR EXHIBIT 5 OMITTED]. Sixty percent of the investors who said they would pay more for good governance described themselves as investors. …

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