Revisiting the Link Between Governance & Performance

In a CG Newsletter two years ago, I discussed the relationship between corporate governance and financial performance in the hospitality industry. By comparing a company's stock appreciation, growth in earnings and EBITDA to our Governance Index, I concluded that there was only a minor connection between the two. More recent studies such as "Corporate Governance and Equity Prices" by Gompers, Ishii and Metrick, have concluded that companies with a strong governance index had higher values, profits, sales growth, lower capital expenditures and made fewer acquisitions. While we both compared metrics such as:

• The size, makeup, and independence of the board
• Committee structure and effectiveness
• The presence of interlocks, insider participation, and related transactions
• Fundamental commitment to pay-for-performance

Gompers focused on the takeover vulnerability of a company. They concluded that the more accessible a company was to a takeover (strong shareholder rights) the better the governance and the performance. In contrast, when management could easily block a takeover attempt (weak shareholder rights) the company's financial performance trailed the market. In evaluating the relative strength of shareholder rights, Gompers compared the following additional metrics:

• Antigreenmail provisions that decreased shareholder rights
• Blank Check Preferred Stock that allowed boards to delay takeovers
• Business Combination regulations that imposed a moratorium on certain transactions
• Bylaw and Charter amendments that limit shareholder actions
• Cash-out laws that allow shareholders to sell to a "controlling" shareholder
• Classified or Staggered board terms that make it difficult to takeover a board
• Change-In-Control provisions that make acquisitions more expensive
• Director Indemnification contracts that shield directors from liability
• Cumulative Voting & Secret Ballot provisions that increase shareholder rights
• Directors' duties provisions that allow directors to consider other constituencies besides shareholders
• Fair-Price provisions that limit the range of prices a bidder can pay in two-tier offers
• Golden Parachutes offered to executives without shareholder approval
• Pension Parachutes that prevent an acquirer from using surplus cash in a pension fund to finance acquisition
• Poison Pill provisions that allow the board to dilute the acquirers voting power
• Special Meeting limitations that delay proxy votes
• Supermajority voting requirements that delay or defeat takeover attempts
• Unequal Voting rights that give some shareholders preference over others
• Written Consent limitations that delay actions by acquirers.

It is clear that good governance makes for good corporate citizens but now there is financial motivation. If you want to outperform the competition, make sure your corporate governance is unassailable.