GOOD CORPORATE GOVERNANCE vs SHAREHOLDER VALUE?

Accountancy SA,  May 2007  by Abdo, Andrew,  Fisher, Greg

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In the past 10 years, interest in corporate governance has grown tremendously. Corporate scandals, environmental concerns and globalisation have all played their part in causing shareholders and the public to question and consider how companies should be governed.

South African Chartered Accountants [CA(SA)] have long been viewed as custodians of corporate governance. Inherent public expectation centres on the responsibility of auditors and accountants to ensure transparency and fairness in reporting performance and management philosophies. As deemed custodians of such a high expectation, CAs(SA) can fulfil both the role of hero, and the role of villain in the eye of the public.

"It was the best of times, it was the worst of times, it was the age of wisdom, it was the age of foolishness... 'Charles Dickens, A Tale of Two Cities

The CA(SA) as a hero prevails in the best of times. The times of great results, excellent governance and general stakeholder delight. The hero offers world class best practice reporting, provides the wisdom and guidance on policy issues and prevails as an independent opinion to the directors.

In the worst of times, the CA(SA) is the villain and is blamed for large corporate governance failures, frauds and stakeholder deception. When the news of Enron, Regal Bank and Fidentia hit the press, the opening declaration from the bloodthirsty public was heard in unison: "Where were the auditors?"

As a primary custodian of corporate governance in South Afria, we as chartered accountants should consider how much progress has been made in respect of corporate governance practices in this country, and whether corporate governance practices and disclosure create shareholder value in the long term?

Research indicates that corporate governance should be viewed by investors as a component of equity risk. Emerging economies carry an element of uncertainty for investors that can be mitigated at a company level if good governance practices are employed. Recently, the McKinsey Consulting Group found that investors in certain emerging market countries would pay a premium of 23% and 28% for shares in a company with "good" corporate governance.

While many academics have identified that sound corporate governance practices will reduce the risk of corporate failure, the question that remains is whether an investment in sound corporate governance practices by a company results in an actual increase in shareholder value.

RESEARCHING CORPORATE GOVERNANCE AND SHAREHOLDER RETURNS

Actual corporate governance practices of a company are difficult to measure objectively because many such practices take place behind close doors. It is, however, possible to measure the level of corporate governance disclosure for listed companies, as this information is typically disclosed in the annual report. In order to research corporate governance disclosure in annual reports of listed South African companies, a measure termed the "G-Score" has been developed. The "G-Score" is a composite gauge of 29 governance disclosure factors, encompassing seven categories: board effectiveness, remuneration, audit ft accounting, internal audit, risk management, sustainability and ethics. These factors were selected after careful analysis of the principles outlined in the King Il report and other relevant governance practices from around the world.

The intention in conducting the research was to measure corporate governance disclosure (i.e. "G-Score") against shareholder returns for companies listed on the JSE. To provide for a cross-section sample of companies, nine sectors were selected for testing. Ninety-seven companies were sampled and scored for governance disclosure using the "G-Score" framework in two periods, 2003 and 2005. The share price for these ninety-seven companies was tracked over the same periods to ascertain if there is any relationship between corporate governance and shareholder returns disclosure.

RESULTS AND ANALYSIS

The data revealed a wide range of corporate governance disclosures in South Africa. The highest recorded "G-Score" was 91% and the lowest was 20%. The average "G-Score" across all ninety-seven companies over the period under review was 61% but there were definite outliers highlighting that certain companies had exceptionally poor corporate governance disclosure. A comparison of the scores from the initial assessment in 2003 and the second assessment in 2005 showed a general improvement in the level of governance disclosures for the sample over time, indicating that to some extent, directors and . auditors are improving the corporate governance practices within South African listed entities over time.

Table 1 indicates the minimum, maximum and average governance score for each JSE sector examined. These results highlight the discrepancies that exist in the level of corporate governance disclosure between companies in certain sectors of the South African economy. The governance scores were derived by taking a simple average for the 2003 and 2005 assessment periods. These results are disclosed on a sector by sector basis, with the highest scoring sector being the banking and life insurance sector. This could highlight the role that independent regulators (such as the South African Reserve Bank) play in fostering a culture of disclosure and transparency.