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Alex Todd’s Comment on: Corporate Governance Ratings: Rating the Raters by Kimberly Gladman

Alex Todd’s Comment on:  Corporate Governance Ratings: Rating the Raters by Kimberly Gladman

My research supports your conclusion that “good governance can’t guarantee high stock returns, and that even bad governance won’t always make a company blow up anytime soon”. I would only add that I don’t believe there are inherently “good” or “bad” corporate governance practices. Instead, I believe there are corporate governance styles that better support different performance objectives and others that may be counterproductive.

I wrote about this in an article entitled “Corporate Governance Best Practices: One size does not fit all” (see http://trustenablement.com/local/Corporate_Governanc_Best_%20Preactices-mar08_icsa_intnl.pdf ). It’s interesting to note that using corporate governance practices data from April 2008, I recently traced the stock performance of a small sample of the 7,000+ companies in my model to see how each corporate governance style performed during the two years of the recession. I was surprised to learn that issuers with a “management influenced” board style significantly outperformed the others. Why? Apparently, because, as per my article, they were associated more with cash distributions to shareholders (read dividends) than any other performance measure. I also found it interesting that the worst performing style was the “management controlled” board, which most corporate governance experts would agree is an example of “bad” corporate governance practices. However, it’s not the “bad” corporate governance practices of these companies that are the cause of their stocks’ under-performance. Instead it is their vulnerability to business cycles, since “management controlled boards” were otherwise found to be associated with superior revenue growth, which was difficult to sustain during the recession. Incidentally, “management controlled boards” were also overwhelmingly the most likely to have been delisted during this two-year period.

My takeaway from this research is that corporate governance styles are a better indicator of expected business performance, not only stock valuations. Although one of these styles, the “trusted board style”, was originally found to be associated with higher valuations (share prices), it’s stocks underperformed during this economic downturn. Instead, it was the dividend-paying shares of the issuers governed by “management influenced” boards that were best suited for this economic downturn. Value investors may therefore want to take a closer look at companies with a “trusted board style” or those that exhibit the “bad”, “management controlled board” style during the current economic recovery.

There is no absolute “good” or “bad” in corporate governance. There are only more and less appropriate governance styles for achieving different business objectives at different times.

Corporate governance is more about strategy than it is about religion. One size does not fit all.

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