Savvy investors know that the difference between the next Apple and the next Enron is in how well the business can handle financial, resource, and capability stresses
A World Bank white paper showed an 8% bump in share price following an announcement of governance improvement in the media. The take-away from this is: Promote your good governance.
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As we continue our examination of the benefits of good enterprise compliance systems, here's one that usually gets overlooked: building shareholder value. It's really the most important benefit of all, because the true mission of any business is to increase the wealth of its shareholders (owners) by paying dividends and/or causing the share price to increase. Shareholders should earn a higher return than they could if they were invested in other assets having the same amount of risk.
A new look at shareholder value
The key drivers of shareholder value are revenue, operating margin, tax rate, capital expenditure, working capital, cost of capital, and commercial sustainability. The reason that shareholder value strategy has failed in the past is due to the pursuit of one driver to the detriment of another. Typically, people see their choice as revenue vs margin, or working capital vs cost of capital, or tax rate vs capital expenditure. The people who see things this way often are lower-level managers who don’t understand that you improve margins through efficiencies, not by cutting back.
The primarily neglected driver is commercial sustainability. A good governance framework supports it through risk management, planning and review, and real-time KPI feedback. Therefore it can be used to avert unforeseen negative impacts on other drivers.
Good governance as a marketplace differentiation
With the bounce in the stock market this year, investor interest quickly moved from bargain hunting to the desire for secure holdings. Investors still hold a fear of bubble stocks. Knowing that the sharp growth comes with economic recovery, they see opportunities. But they also know there are risks that some stocks will invariably collapse under that stress. The difference between the next Apple and the next Enron is in how well the business can handle the financial, resource, and capability stresses.
There is no better time for companies to promote their good corporate governance as a point of differentiation in the marketplace. Attracting solid, long-term investors lifts a company’s share price. With increased market capitalization comes improved gearing, which in turn enables increases in capacity. That, in turn, breeds economies of scale, resulting in greater market share. And so the cycle goes.
The link to share price
A 2009 World Bank white paper on Tangible Benefits of Good Governance is emphatic about the direct relationship between share price and good governance. On weighted average, share prices for companies with a reputation for good governance performed 17% better than their Index. Even more interesting is that the report shows an 8% bump in share price following an announcement of governance improvement in the media. The take-away from this is: Promote your good governance.
Similar results from Latin America were found in studies from the Association of British Insurers and from Goldman Sachs JB. The latter's 2005 study concluded: “We believe…results… show a good relationship between corporate governance ratings and share price performance for FY06…[and] we are impressed by their robustness and consistency.”.
Good governance is about having strong management systems that replace hope with knowing. Contrary to popular belief, good governance supported by good tools, makes a business more flexible and able to anticipate and take advantage of new opportunities (see previous blog). The result is commercially sustainable cost saving, business growth and improved shareholder value.