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Governance and Financial Results in a Time of Crisis

The shareholder activist crowd would like you to believe that good corporate governance practices, as defined by people like Lucian Bebchuk and ISS, are correlated with positive financial results.

Jeff Lipshaw is a self-admitted skeptic:

Back when I was fighting the governance wars from the inside, arguing from the board’s standpoint why having poison pills and classified boards made sense (at least in the right hands), there were several studies done linking good governance to share performance, the most famous being the Gompers/Metrick/Ishii study.  I was not (and am not) statistician enough to know if the study was good; all I can say is that my intuition was and is that things like technology, cost productivity, barriers to entry, business savvy, and things like that would have a lot more to do with share price than whether there was a poison pill or the shareholders had the right to call a meeting. 

As the author of a book on corporate governance, it’s in my financial interest to think governance matters. And I in fact do think so. Yet, I’m also confident that Jeff’s right about what matters most.

Interestingly, Jeff’s done some back of the envelope calculations that lend credence to his argument:

What occurred to me was the question whether, if I had a portfolio of the “best governed” companies on October 9, 2007, at the very height of the stock market, and kept that portfolio unchanged for one year, how would it do?  Given that I performed this little empirical study from the laptop in my den, don’t have the individual governance scores on any survey (CGC from ISS, or whatever GovernanceMetrics puts out), and couldn’t do the regressions and correlations even if I did (but I did leave a phone message for Bill Henderson), I simply went to the website of IR Global Rankings, and took the thirty companies it ranked best in corporate governance practices (listed below the fold), found their historical closing stock prices on Yahoo! Finance for each of October 9, 2007 and October 9, 2008, assumed a portfolio of one share of each, and looked at how the portfolio performed.  (Other methodology disclosures also below the fold).

Here are the results:

Decline in “good governance” portfolio:  50%

Decline in S&P500 Index Fund 42%

Decline in NYSE Composite Index Fund 43%

Decline in Dow Jones Industrial Average 39%

Within the good governance portfolio, every stock declined.  The best performers were Bayer AG (17% decline), Procter & Gamble (12% decline), and Global Payments (11% decline).  The worst performers were ICA (93% decline), Wachovia (93% decline), Banco BPI (71% decline), and Life Time Fitness (70% decline).  (I did not check to see if these numbers were adjusted for splits, but I assume so.)

But you’d still be better in index funds than picking stocks based on the IR Global Rankings of good governance practices.