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Corporate governance: Mary, Mary…

Robert Bruce

One of the joys of journalism is to take the contrarian view. If the whole
media world is banging on about how the youth of today is going to hell in a
handcart via alcopops and worse, then it always raises the spirits, if that is
the right phrase, to point out some happy part of society where all is going
well despite the nanny state’s warnings.

And so it goes with corporate governance. The veteran financial journalist
Anthony Hilton, whose daily column in the London Evening Standard has
always revelled in appearing on panels as the person who thinks corporate
governance is a dangerous distraction. His performances on such occasions are
legendary and much enjoyed. I have always tended to take the opposite view, but
we argue about it and then shake hands.

But it looks as though he has, through the recent research published by the
Association of British Insurers, reached a conversion about corporate
governance. The research was entitled Governance and Performance in
Corporate Britain
and Hilton devoted part of his daily column to it on
publication. This is how he started: “There are some of us who have always
thought the main purpose of the drive to improve corporate governance was not to
improve company performance, but to help fund managers avoid the embarrassment
of investing in companies that went bust. Policy was skewed towards risk control
rather than growth. Equities were required to behave like bonds, but still
deliver excess returns.”

And it has to be said that the Hilton view had many adherents. It was a
question of how well the way a business was run connected with how it was
structured. Running a successful business requires risk-taking, bravery, good
luck, a better understanding of your markets than your competitors and more. If
you take a dim view of corporate governance, all you can see is a growing
bureaucracy which not only inhibits nearly all of those things, but also turns
into a sort of out-of-control creeper, a deadly nightshade slowly strangling the
life out of an enterprise and its ability to grab business opportunities.

This sort of argument chimes with many mainstream worries in society as a
whole – the erosion of personal responsibility, the futile objective of
eliminating risk, the transfer of blame. It is no wonder that the concept of
corporate governance has been taken seriously for so long.

There is also another reason. Although people intuitively felt an effective
corporate governance structure must strengthen a company, there were few
indications in the research undertaken that showed, unequivocally, that this was
the case. Many surveys hinted it probably was. But there was always a whiff of
wishful thinking attached to the results.

But the ABI study has probably changed all that. At the outset, it admits the
same problems of doubt. “The ABI’s leading role in corporate governance stems
from our members’ belief that well-governed companies will produce better
returns for shareholders over time,” it says. “Long-term value creation matters
to insurers because their holdings are long-term in line with their liabilities.
Yet, while this has prompted us to undertake serious dialogue with companies and
considered voting, the causal relationship between governance and value creation
has never been demonstrated.”

This time, that has changed. And it has probably changed because the
principles of good corporate governance have evolved – or morphed beyond
recognition with so much input and interpretation. It is no longer a recent
innovation. It has become the established default culture. The ABI study showed
something new. “One important conclusion, not highlighted in other research, is
that good governance reduces volatility of returns”, it says. “Moreover, good
governance is also a precursor to good performance rather than vice versa.”

What has happened is that the ABI now has web-based data stretching back for
a good period, and it has spotted a direct link – proving their original manifes
to. Companies that received what the ABI terms a ‘red-top alert’ from them
warning about a serious governance transgression are less profitable and
generate less value over time for shareholders than other companies. And over
the years that followed, they produced a lower return on assets and a poorer
share price performance.

But there is also contrary evidence, muddying the waters. The corporate
governance movement has not made life easier for the board of directors. Rather,
the opposite. Boards that failed to live up to the required standards of
corporate governance found that, far from producing a more successful company,
they were scrambling about dealing with all sorts of other problems. As the ABI
points out: “The volatility of share returns is 9% lower for well-governed
companies than poorly governed companies.” And as Anthony Hilton put it: “Taken
as a whole, the conclusion seems inescapable. Despite scepticism from people
like me, good governance makes a difference.”

Who’d run a FTSE company?

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