Goldman Sachs J B Were (GSJBW) recently updated their analysis of the correlation between governance ratings and share price performance.  They concluded three things:

(1) On balance, superior corporate governance provided strong returns for investors, even during the recent period of market volatility
(2) Corporate governance analysis can improve investment returns even for those not pursuing a broader Environmental, Social and Governance (ESG) agenda
(3) However, for those who are looking to “mainstream ESG” as part of their investment process, corporate governance should be a linchpin of broader ESG analysis.

We are not convinced that strong correlation results can justify their conclusion that “superior corporate governance provided strong returns for investors “. Correlation does not, in most studies, prove causation, although it can be inferred if other factors are present.

Not particularly emphasised in their research is that positive remuneration governance rating is far and away the best correlate with long term share price performance success. 

This article summarises their research.

GSJBW’s ESG research is focused on quantitatively measuring how ESG issues can impact on company valuation and investment returns.  They tested a range of ESG factors and had previously established a good correlation between, among other things, corporate governance ratings and share price performance.

CGI Solutions provided GSJBW with an update of their governance ratings used for the analysis.  CGI Solutions rate stocks 0 (poor) through to 5 (good) for a number of governance sub categories as follows:

• Audit Quality (independence, strength of process)
• Overall Board (skill mix and structure)
• Board Skills
• Remuneration (clarity of policy, reasonableness of policy, size)
• Accounting (clarity/reasonableness of policy around abnormal items)

These are weighted to form an “Overall” governance rating (also 0–5).  Ratings are issued twice per year – roughly August and March.  CGI Solutions’ currently rates 156 companies. 

The latest update from CGI Solutions was interesting because it covered a time of significant market volatility – from November 2007 to March 2008.  With a significant part of the longer term test since 2001 being in low volatility bull market conditions, GSJBW were interested to see what contribution the corporate governance strategies made in the very different conditions of recent months.

Good governance strategies did well, as the figures in the 1st table below indicate.

It makes intuitive sense that the lower risk attributes offered by better governed companies would contribute to good performance in such a volatile period, where investors became increasingly risk averse.  This is also true given some of the key market themes were governance related – for example, a focus on related party transactions and also directors’ shareholdings, with questioning around the levels of margin lending.  GSJBW calculated the performance of a strategy of investing long in good governance and selling short poor governance from 31 July 2007 (their previous data update) to 31 March 2008.  The results were strong for most of the governance strategies.  They found the following excess (above passive index) returns achieved over the most recent period of volatility on companies with a positive governance rating in the following areas:

The results over the long term were more pronounced and telling. 

GSJBW applied almost 7 years of back history for corporate governance. The latest results add to the previously strong performance history since inception in August 2001. The long term cumulative returns (excess above a passive index return) since August 2001 are illustrated in Figure 1 below and presented in Table 2.

 

Figure 1: Long term excess returns by governance factor 1/8/01 to 31/3/08 (source GSJBW Research)

Based on these results, GSJBW concluded that corporate governance analysis could help improve investment returns.  This is irrespective of an investor’s individual views on whether they want to pursue a broader ESG agenda.

GSJBW’s conclusion is that governance investing was clearly useful through this period, and is likely to continue to be useful while uncertain market sentiment persists.

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