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Good corporate governance generates financial returns

02 Dec 2019

Corporate governance has been a hot topic of discussion in Australia for many years – spearheaded by Royal Commissions, drilled home by corporate law changes to charge company directors with more responsibilities, and demanded by consumers and shareholders holding companies to a higher standard of behaviour and transparency.

In this day and age, good corporate governance is simply good business.

Everyone can agree that an effective Board and leadership team protects business from the vagaries of fluctuating markets and evolving legislation. It will help to attract and retain people who want to work with a company that is not only performing well, but also lives up to shared core values. And of course we increasingly see that customers and clients will reward companies that have similar values and strong governance processes in place – and can evidence them. Conversely, companies which experience governance failures see a direct cost in terms of reputation and declining share price.

Good corporate governance can drive tangible returns for business.

Our colleagues at Grant Thornton in the UK have produced an incredibly valuable report – ‘Getting smart about governance and its link to financial performance’ – which draws on 10 years of data from the FTSE350 to draw, perhaps for the first time, a clear link between good corporate governance and financial performance.

The debate can now progress beyond the cost of governance and evolve instead to how governance drives value for shareholders and other stakeholders.

While this data is UK specific, the similarities between the Australian and UK markets: our corporate structures, as well as attitudes and community expectations from consumers and shareholders, would suggest we could expect similar results here.

 

Some of the key results were:

2x

The total shareholder return delivered by governance leaders is double that delivered by companies scoring lowest for quality of governance

43%

Governance leaders had an EBIT 43% higher than those companies with the weakest governance practices

2x

Governance leaders are twice as likely to stay in the FTSE 350 as companies with the weakest governance practices

25%

Those with strongest governance practices are 15% less financially leveraged and have 25% more liquidity

One of the key reasons for these results is that a company with good corporate governance helps to foster a corporate decision-making environment with clear purpose and strong strategic intent. Any risks that are taken are managed appropriately in support of business strategy and long-term value creation. These businesses tend to be more agile, responsive and have higher levels of trust within the organisation which improves operational efficiency. The system works and generates value.

Six areas of strong governance

The research analysis found that corporate governance leaders (those in the top quartile of the Grant Thornton UK Corporate Governance Index[i]) scored high in six key areas:

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Clarity and connectivity

Understand your business model. Know how your company makes money and articulate this clearly enough to draw a direct link between it and your strategic objectives, values, risks and rewards.

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Culture integration

Define and articulate your culture. Be clear about values and behaviours and identify the key metrics you will use to monitor success in embedding that culture into your decision-making framework.

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Board effectiveness

The composition of the board should reflect the company’s strategic priorities markets and risks. Create an environment which leverages diversity to build a broad skill set in your key decision makers.

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Succession planning

Identify the skills you will need to deliver future strategy and take time to develop future leaders at senior management level and below. Outline how succession planning interventions are improving diversity.

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Risk management

Anticipate and understand the principal risks to realising your strategy and purpose, provide detailed disclosure on them to your decision makers and plan the appropriate level of mitigation.

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Internal controls

Understand your controls framework and how it operates to manage all principal risks (not just financial). Develop a system to regularly monitor the effectiveness of your controls and maintain consistent controls across divisions.

For anyone looking at how to improve corporate governance in their organisation, this report is a valuable read not only on the different ways to embed a culture of good governance, but to also demonstrate to your business the value that can be created from good governance practices.

[i] Grant Thornton UK have tracked over 500 FTSE 350 companies across ten different industries for the past 17 years, this is called the Grant Thornton UK Corporate Governance Index.

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