VALUING VIRTUE
More and more investors believe corporate governance plays a key role in driving financial performance. Can the link between the two be measured?
By Jennifer Morris

Ask Matthew Panikar about the importance of good corporate governance and he has no doubts. As chairman of the European operations of Reliance Industries, a US$4.3 billion Indian petrochemicals company, and head of the firm's finance and investor relations divisions, he has had to tap the international capital markets many times over the past decade. He insists that good governance has helped him do so.

The link between the two wasn't always as clear. When he began working for Reliance in 1992, the firm was largely unknown outside its home market of India. As such, persuading investors to back Reliance's ambitious expansion plans was certain to be tricky. To help address that challenge, Panikar decided to meet with corporate governance gurus in Europe and the US in order to benchmark his firm against the highest standards available. "We wanted investors to know that we had their best interests at heart," says Panikar.

It proved to be a wise move. With a string of capital-raising exercises successfully under his belt - including US$450 million of global depositary receipts and US$804 million of bonds - Panikar is in no doubt that his attention to corporate governance has reaped rich rewards. "Once investors knew that we took good governance seriously, they were very keen to get their hands on our stock," he smiles.

This is a lesson not lost on Benjamin Cohen, CFO of Accor, the E6 billion (US$5.2 billion). French hotel and travel services group. "We have to look after our shareholders as well as we look after our [hotel] guests," he replies.
It's an attitude that has won him many friends in the investment community. When he launched an exchangeable bond in March this year, for example, the issue was 2.5 times oversubscribed, encouraging Cohen to increase it from E368m to E433m.
However, ask Cohen to elaborate on whether there is concrete evidence to prove the relationship between good governance and financial success and he has no firm figures. "The link is impossible to measure exactly," he concedes, "but I'd say it's very positive."

Cohen's conundrum is far from unique, for corporate governance is a slippery term at the best of times. Nonetheless, more and more investors in Europe agree that taking steps to improve governance has a long-term, positive impact on a firm's bottom line. It's that belief that has sparked a number of initiatives to try to measure both what constitutes good governance and how that affects corporate performance.

Setting Standards

Take the recent efforts of DVFA, the German capital markets association. In June this year, it published a "Corporate Governance Scorecard" for the first time. Based on input from German fund managers, academics and analysts, the scorecard "crystallizes corporate governance standards", says Christian Strenger, one of the authors of the scorecard and director of DWS, Germany's largest pension fund with E99 billion of assets under management.

Though a number of organizations, such as the OECD and the European Association of Securities Dealers, already issue guidelines in this area, Strenger contends that they leave something to be desired by, in particular, not addressing country-specific, cultural criteria. DVFA's does. So, for example, its scorecard looks at board independence because it's an area that corporate governance activists in Germany are deeply concerned about. However, if there were a French version of the scorecard, Strenger says he would put more emphasis on voting rights.

Strenger is confident that, given the caliber of the contributors, DVFA's scorecard will set national standards in Germany and greatly influence which companies can attract capital because of their corporate-governance records. "Investors have to bite, not just bark," he says. To help them decide when to bite, the scorecard's criteria include areas such as board independence and management compensation. It then recommends a percentage weighting for each element, although investors are encouraged to adapt the scoring system to reflect their own particular priorities.

Say shareholder rights account for 20 percent of the overall scorecard. Based on that weighting, DVFA's scorecard asks a series of questions: are all shareholders treated equally in the case of share repurchases? As soon as pre-conditions are fulfilled, can voting rights be exercised via the Internet? And so on. Investors respond yes, no or partially, and then a point system is applied to the answers and added into a total score.

Talk of the Town?

Strenger hopes that the scorecard will spark a trend. The DVFA is already talking with capital markets associations in France, the UK and the US, and he believes other countries in other parts of the world, including Asia, will follow suit eventually. His actions are certainly attracting attention, and not just among the investment community. Ralf Brammer, CFO of AWD Holding, a 530 million deutsche mark (US$235 million) German financial-services firm, keeps a copy of the scorecard on his desk. Brammer, who was head of investor relations at DaimlerChrysler until April this year, is preparing to float AWD in November and he's made good governance a priority.

"Having clear corporate governance rules makes us a more efficient company," he says. To help ensure that AWD sticks to the guidelines, Brammer has just hired a compliance officer who reports directly to him. "We're sending a strong signal to the capital markets that this code is a tool and a commitment, not just a piece of paper," he states.

Premium Power

And mounting evidence suggests he is right to do so. Take the survey released in June from McKinsey & Company, the global consulting group. The study asked 200 institutional investors - with a combined spending power of US$3.25 trillion - if they would pay more for the stock of a well-governed firm. More than 80 percent of the respondents said they would be prepared to pay a premium for stock if a firm demonstrates an ability to, among other things, maintain a majority of outside board directors with no management ties, hold formal evaluations of directors' performances, ensure that a large proportion of directors' pay is in the form of stock options, and provide investors with easy access to information.

That's good news for companies that are already doing all these things, says Paul Coombes, director of McKinsey's London office and author of the report. For one thing, their cost of capital will be lower. "Companies that fail to [improve corporate governance] will find themselves at a competitive disadvantage when it comes to attracting capital to finance growth," he says.

Jennifer Morris is a staff writer at CFO Europe, CFO Asia's sister publication.