Could Better Governance Lead to Higher Valuations?
Investors across the world study every aspect of a business before deploying capital. However, one of these aspects has been somewhat overlooked: corporate governance.
Defined as the structure of rules, practices, and processes used to direct and manage a company, corporate governance seems to have an underrated impact on business valuation. In fact, 94% of buy-side analysts and investors said governance had an impact on their valuation of an investment prospect, in a survey conducted by Rivel Research. They also said better governance could justify a premium of up to 10% on the company’s market value.
Researchers May Elewa and Wafaa Salah applied this thesis to public companies. Data gathered on stocks listed on the Egyptian Stock Exchange during 2007-2014 revealed that stronger governance, clearer rules and better transparency from leadership significantly boosted stock prices. However, governance had little to now impact on trading volume. Their paper was published in the International Journal of Accounting and Financial Reporting in 2016.
Recently, examples of bad governance leading to bad outcomes have emerged. The founders of ride-sharing and co-working startups Uber and WeWork were both ousted due to failures in governance. Both companies were embroiled in scandals during their founder’s tenure. WeWork’s valuation dropped from $47 billion to $2.9 billion over the course of its founder’s public relations nightmare. Meanwhile, Uber’s value declined 15% as a result of its founder’s scandals in 2017, according to The Information.
Corporate governance issues are further complicated when family is involved. While family-controlled businesses have unique strengths, they also often fall prey to issues such as “highly-concentrated ownership, poor transparency and absence of accountability and fairness principles that led to abuse of minority shareholder rights,” according to the OECD.
Resolving these issues and cementing good governance could potentially unlock additional wealth for shareholders across the board.