Good governance delivers real benefits

We are witnessing a period of ever-growing financial regulation and new governance rules aimed at promoting transparency and avoiding the failures of the past.

The intention is to prevent the world being plunged into another financial crisis as a consequence of inadequacies in how companies are run.

Few could sincerely question the nobleness of this effort, not least amid the current economic climate, yet it is by no means a campaign that is universally welcomed. The mere encouragement of better practice, let alone its legislation, is innately difficult, and many firms make little secret of the fact that they view it as an invasion of their privacy.

Extensive research has frequently highlighted the reluctance of boards to improve corporate governance when they are free to choose not to do so. The traditional assumption is that changes have to be imposed or recommended from the outside, since the costs of implementing them outweigh any benefits a company might derive.

Regulators in some countries, including Brazil, Canada, Hong Kong, Malaysia, South Korea, South Africa and the UK, favour a ‘comply or explain’ regime. Rather than establishing binding laws, they set out a code: listed companies must either adhere to it or explain publicly why they do not. This sometimes makes for what might be termed a rather liberal accord.

Other nations – chief among them the US, in the form of the Dodd-Frank Act – prefer a ‘comply or else’ philosophy. The more leeway is afforded, perhaps understandably, the less inclined towards acquiescence a board may feel.

Consider, for example, the phenomenon of staggered boards, the arrangement by which only a fraction of a board of directors’ membership is elected each year. A recent study suggests 60 per cent of US companies employ this stratagem, which just happens to be one of the most effective anti-takeover devices ever conceived. Although the percentage has declined of late, even Dodd-Frank does not prohibit its use, which remains prevalent among American firms in spite of destroying value for shareholders.

A devil’s advocate may well contend that boards and corporations have yet to be presented with any meaningful evidence that the self-motivated embracing of good governance practices delivers real, tangible benefits to a firm or its shareholders. In light of this, the argument might go, why should they change their behaviour?

The International Institute for Management Development (IMD), a business school based in Lausanne, Switzerland, recently exploited an interesting organisational feature of the London Stock Exchange (LSE) to investigate the value of voluntarily adopting better governance.