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McKINSEY QUARTERLY PUTTING A VALUE ON CORPORATE GOVERNANCE Robert F. Felton - Alec Hudnut - Jennifer van Heeckeren 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 stock of one of these companies if it were well governed. Two-thirds of the investors said they would. 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. Who cares most about good governance? The survey reveals three key variables that influence the importance certain investors place on good performance: Portfolio turnover. Investors with low turnover ratios in their portfolios value governance most. They hold stocks longer and believe good governance will help improve performance in the long term. Asset managment 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). Client base. Investors who manage money for high net worth individuals, endowments, foundations, and public pension funds are more willing to pay for good governance than those who manage money primarily for corporate pension funds. Three reasons why investors care There are three main reasons why investors will pay a premium for good governance. Some believe that a company with good governance will perform better over time, leading to a higher stock price. This group is primarily trying to capture upside, long-term potential. Others see good governance as a means of reducing risk, as they believe it decreases the likelihood of bad things happening to a company. Also, when bad things do happen, they expect well-governed companies to rebound more quickly. Still others regard the recent increase in attention to goverance as a fad. However, they tag along because so many investors do value governance. As this group sees it, the stock of a well-governed company may be worth more simply because governance is such a hot topic these days. Governance matters more in some circumstances than in others Another essential question is, "When is good governance important?" Respondents felt it was most important during crises, or when CEOs might be tempted to spend too freely unless constrained by a strong board (for example, in a declining industry with high cash flows). By contrast, governance is perceived as least important in highly competitive industries, where market pressures keep CEOs on their toes more effectively than any board ever could. The value of governance is no longer a question of faith Believing in the value of corporate governance should no longer be a question of faith. Some investors will pay a significant premium for good governance. And though it is more important in some circumstances than in others, and more important to managers of some types of funds than others, it remains clear that good board governance can serve as a tool for attracting certain types of investors, as well as influencing what they will pay for stock. Given that many investors do care about board governance, what action can companies take to improve their own practices? A good first step would be for senior executives, investors and board members to learn how to talk together about substantive governance issues in a productive way. The survey indicates that a much broader consensus exists on board issues between management and investors than has typically been portrayed, and that there are likely to be opportunities for much productive discussion. ABOUT THE AUTHORS ABOUT THE RESEARCH
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