Discerning the Relationship Between Governance and Success


Not long ago, I pointed to Eric Jackson's Breakout Performance blog post on the correlation between the makeup of a company's board of directors and that company's level of success, both in terms of revenue and in terms of reputation. This week, along a similar vein, Motley Fool contributor Chris Jones discusses the link between a company's corporate governance practices and its stock prices. Generally, he says, there is a wealth of evidence that companies with good governance practices yield better returns for their investors.


Jones points to three specific examples of said evidence:


  1. A 2001 study out of Harvard and the University of Pennsylvania revealed that when participants bought shares in companies with strong protections on shareholder rights, and sold shares in companies that did not have strong protections, the return was 8.5 percentage points per year above the market average.
  2. In further dissecting the results of the above study, researchers from Institutional Shareholder Services and Georgia State University found that the companies with the best governance practices yielded "higher average returns on equity by 23.8 percent.
  3. The CFA Institute maintains that there is a direct relationship between good governance and higher valuations of companies.


All that said, of course, good governance practices don't guarantee high stock prices (a.k.a. success), and high stock prices don't necessarily translate to a good corporate governance quotient. But it's a good place to start for investors who are a bit gun shy given the current economy.


The lesson for businesses is simple: If your stock prices, valuations and/or returns on equity aren't as high as you'd like, take a good hard look at your corporate governance practices. Chances are you'll find room for improvement.