Sunday Brunch: sizing up good corporate governance

Sunday Brunch: sizing up good corporate governance

Improving overall corporate governance can improve valuation, but what should we be looking for?

In a recent edition of 'What Caught Our Eye' we discussed a meta analysis from Nguyen and Dao from Hanoi University that looked at the impact of improving overall governance on stock valuations compared with improving liquidity - often achieved by listing a company's shares on a liquid exchange with lots of traded volume.

'Liquidity' = a measure of how easily a stock (or any asset) can be bought or sold quickly without having a big impact on the stock price.

'Spread' = the difference between the bid (the highest price someone wants to pay to buy a stock) and the ask (the lowest price a seller will sell the stock). The smaller the spread, the more liquid the stock.

They found that improving overall governance had a positive impact on valuation. In fact it had a bigger impact on valuation than improving liquidity. The chart below illustrates this.

(Chart by Joachim Klement, source Nguyen and Dao, 2022)

What the chart also reveals from the study is that improving overall governance had a much bigger impact than individual governance measures alone - for example, simply increasing the size of the board. In fact in this case it had 3x the impact.

So we need to think about governance of organisations, or 'corporate governance' holistically and it raises a broader question: what makes up good 'corporate governance'?

And before that, what is 'corporate governance'?

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What is 'corporate governance'?

Let's start by looking at a few different definitions starting with a basic high level one.

The Cambridge Dictionary definition of 'corporate governance' is the "way in which a company is managed by the people who are working at the highest level in it."

The Chartered Governance Institute UK & Ireland describes corporate governance as:

"... the way in which companies are governed and to what purpose. It is concerned with practices and procedures for trying to ensure that a company is run in such a way that it achieves its objectives."

Chartered Governance Institute UK & Ireland

They go further to say that from a shareholder’s perspective, "corporate governance can be defined as a process for monitoring and control to ensure that management runs the company in the interests of the shareholders." They also highlight that there are other groups, including employees, customers and the general public who will an interest in how a company acts.

The Corporate Governance Institute goes further to say that the purpose of good governance is ...

" ensure that businesses have the appropriate decision-making processes and controls to ensure that all stakeholders’ interests (shareholders, employees, suppliers, customers and the community) are balanced."

Corporate Governance Institute

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