Recent research by Goldman Sachs JB Were (GSJBW) has confirmed that the long-standing correlation between good governance and good shareholder returns has held up well during recent market volatility and over the longer term (8 year) investment cycle.  In particular, executive remuneration maintained its place as the most significant indicator of good governance among the factors used.

This is consistent with earlier research noted by Guerdon Associates last year (see HERE)

Based on over 8 years of data GSJBW conclude:

(1) Stock selection which includes reference to corporate governance measures has provided good returns for investors and, significantly, performed well during the global financial crisis (GFC); and

(2) Corporate governance-based stock analysis can help improve investment returns irrespective of whether investors are pursuing a broader environmental, social and governance (ESG) improvement program in individual stocks

GSJBW assessed the alpha performance (against a passive index) of a hypothetical portfolio weighted on governance measures over three performance periods:

• Long term (8 years)
• From 31 July 2008 until their last portfolio rebalance on 31 May 2009 (which included the most intense period of the GFC)
• The current period’s portfolio from May 2009

The corporate governance ratings are supplied by Regnan and updated roughly twice per year.  Stocks are rated 0 (poor) through to 5 (good) for a number of governance sub categories as follows: 

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

These are weighted to form an “Overall” governance rating (also 0–5).
 
The sample comprises 163 companies.

GSJBW rebalanced the portfolio according to the ratings each time new Regnan data is issued. 

Since August 2001 the long term performance of the portfolio to the end of August 2009 is strong, with cumulative excess returns above the index returns for each of the following measured categories (factors) of: 

• Remuneration +46.1%
• Board Skills +31.1%
• Audit +27.3%,
• Overall Board +27.2%
• Overall Governance +17.6%

The charts below plot the performance history for each governance sub-category on an average basis and a median basis.
 
The average basis shows the magnitude of returns, while the median basis identifies how consistent the performance is throughout the portfolio (i.e. that it is not driven by a small number of stocks with extreme returns).  Both charts show strong cumulative performance for each of the corporate governance sub-categories, except Accounting.

Hence remuneration provided the best long term indicator out of all the governance measures for good relative shareholder returns.

Performance of the portfolio during the full term to May 2009 (i.e. 31 July 2008 to 31 May 2009) when the GFC was at its most intense provided a strong return and good performance:

• Board +8.4%
• Board Skills +8
• Overall Governance +7.6%
• Audit +6.7%
• Remuneration +6.0%
• Accounting -0.3%

In the very short term the results are not as supportive.  But it is difficult to draw any conclusions with short term data.  GSJBW’s current corporate governance portfolio since Regnan re-issued the ratings in May reveals the following performance: 

• Board Skills -0.6%
• Board -1.0 %
• Overall Governance -2.3%
• Remuneration -4.4%
• Audit -4.5%
• Accounting -4.8%

While negative so far, GSJBW believes the noise from the strong rally and reporting season is having an impact.  Notably, on a median basis, all factors except Accounting have continued to outperform.

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