8 ways good corporate governance creates company value04 Mar 2019
Regional Head of our AMEA Business Development, Nousrath Bhugeloo, examines the key benefits of good corporate governance and how it has become a pre-requisite to reaping investor confidence and unleashing shareholder value.
Defining corporate governance
Put simply, corporate governance is a framework by which a company is controlled and directed in the most effective way. It involves a set of relationships between a company’s management, its board, its shareholders and other stakeholders.
While the drive for good corporate governance is generally associated with publicly listed companies, the governance benefits to non-listed companies are less often talked about – in many countries, national codes of corporate governance set out practices and standards that are desirable but not mandatory for non-listed companies.
With non-listed companies as the main component of a nation's economic fabric, the role of good corporate governance in enhancing shareholder and investor value should not be minimised.
Benefits of good corporate governance
Good corporate governance builds trust and predictability, hence generating comfort to investors – a consideration manifest in the ESG requirements (Environmental, Social, Governance) of a growing number of Private Equity funds across the world, particularly in impact funds.
In practice, how does good corporate governance contribute to building value?
- Risk mitigation – An effective corporate governance framework helps to mitigate risks, providing shareholders in non-listed companies with the comfort that although their exits may be difficult, their interests will be safeguarded by the board and management. A good governance framework will also induce reflection on exit strategies, giving additional comfort to prospective shareholders deciding whether to invest in the company.
- Improved capital flow – An increase in confidence by investors and banks in the company due to robust financial management reporting will not only improve access to capital, but also minimise both cost of capital and cost of equity, resulting in an optimised capital flow. Deciding on an appropriate capital structure is thus a key element of good corporate governance. Transparency, especially regarding everything of interest to investors, will command a lower risk premium, therefore lowering the cost of capital and equity.
- Reputational boost – Transparency in a company’s internal policies, control mechanisms and how it deals with its suppliers, vendors, media, staff and government bodies will boost its reputation and thus its brand value.
- More effective, better decision-making – Good corporate governance also aims at a faster decision-making process by establishing a clear delineation of roles between owners and management.
- Improved reporting – Improved reporting on performance in turn leads managers and owners to make more informed and fact-based decisions, leading ultimately to improving sales margins and reducing costs.
- Focus on compliance – Good corporate governance will adequately rest on policies requiring the company to stay compliant with local laws and regulations; it will synchronise risk management and compliance to ensure the company has proper control mechanisms, meets its objectives and operates efficiently in terms of people, processes, technology and information.
- Higher staff retention – An increase in staff retention and motivation can be expected, especially from senior staff, when the company has a well-defined and communicated vision and direction. A focus on the company’s core business will also make it easier to penetrate the market and attract the interest of shareholders. Additionally, millennials – now the largest single group on the labour market in many countries – tend to rank an organisation’s commitment to responsible business practices highly in their employment choices.
- Limitation of disruptive behaviour and conflicts of interest – By establishing rules to reduce potential fraud and malpractices amongst employees; and avoiding conflicts of interest namely through minority shareholders being given their share of voice by being represented by independent directors.
Over recent years, empirical evidence has emerged showing a correlation between corporate governance and stock market performance of listed companies (information more accessible). In non-listed companies, private equity investors typically show a greater appetite for companies more prone to embracing good corporate governance standards and practices.
Today, applying the principles of corporate governance has become a pre-requisite to reaping shareholder confidence and unleashing shareholder value. Increasingly, investors will be assessing the governance capital of target companies as closely as they scrutinise its technological and human capital. Good corporate governance also helps companies to weather the consequences of an economic downturn with more agility.
Through the use of International Financial Centres, we provide governance and board services to companies wishing to build enterprise and shareholder value. You can learn more about those services here.