Every governance discussion I have ever attended in a chief executive's office has eventually come round to the same question. The CEO asks it differently in London than in Riyadh, differently in Frankfurt than in Mumbai, but the structure is identical: am I paying for theatre or am I paying for something?
The honest answer is yes, but. Yes, the evidence supports the proposition that good governance pays, in measurable ways, across a range of jurisdictions and time periods. But the evidence is messier than the activists pretend, and the largest single channel through which governance pays is one that is hard to measure on a quarterly basis.
Four channels through which governance pays
The cost of capital. Companies with stronger governance are perceived by investors as lower-risk and accordingly pay less for their equity and their debt. McKinsey, in surveys conducted across more than a decade, found global institutional investors willing to pay premiums of between ten and forty per cent for well-governed companies, with the highest premiums in markets where governance protection is otherwise weak.
Operational performance. Companies with better governance make better decisions: they catch problems earlier, allocate capital more rigorously, replace failed executives faster. Gompers, Ishii, and Metrick found that a long-short portfolio buying companies with strong governance generated abnormal returns of about 8.5 per cent a year. Later studies found smaller effects — the market learned.
Crisis resilience. This is the channel for which the evidence is most consistent. Knight and Pretty tracked companies that suffered crisis events and found that better-governed companies exceeded their pre-crisis trajectory by about thirteen per cent twelve months out. Less well-governed companies were still fifteen per cent behind. A spread of nearly thirty percentage points, on the same shock, attributable to the quality of the board.
Durability. Well-governed companies last longer. They survive the founder's exit, the regulator's investigation, the bad year in the cycle. Durability is hard to capture in a five-year regression, but it is the point of governance: to ensure there is a company in the next quarter that is worth running.
The strongest single piece of evidence
The Hawkamah ESG Index for the Pan-Arab region, maintained since 2007 in partnership with S&P, has shown that its constituent companies outperformed the underlying Pan-Arab benchmark by a cumulative seventy-five per cent. In a region where the conventional wisdom is that governance is a cost rather than a benefit.
The companies in the top quartile of disclosure are not the companies that obscure and outperform. They are the companies run by people who think governance is the price of doing business at scale, who recruit better directors because the better directors will not join a company they cannot understand.
This article is adapted from The Director's Craft by Peter Burchardt. Read the full chapter in the book →