Recent UK study considers what is good governance and how is it measured

Stimulate debate and create a deeper understanding of what good governance is and how it is measured.

The Great Governance Debate – Towards a Good Governance Index for Listed Companies
UK Institute of Directors in association with Cass Business School, June 2015

An ongoing study from the UK Institute of Directors (IoD) and Cass Business School seeks to stimulate debate and create a deeper understanding of what good governance is and how it is measured - with a view to creating a reliable corporate governance (CG) index. A full report is expected to be published later this year.

The study examines the corporate governance practices of the 100 largest companies listed on the London Stock Exchange.

The study’s methodology is unique and was designed to overcome the “tick-box approach” to measuring corporate governance practices. In addition to objective factors frequently used to judge corporate governance, the study considers the external perceptions of business practitioners through a survey mechanism. These factors are combined into a predictive model that aims to assess how corporate governance practices of one company may be assessed based on the ratings of another.

The researchers identified 53 instrumental factors for the study in order to assess corporate governance and also understand the business environment of the companies. These factors were grouped into six areas: board effectiveness; audit and risk/external accountability; remuneration and reward; shareholder relations; stakeholder relations; and business environment.

Reflections on the research and the usefulness of a CG Index

The IoD’s study raises interesting questions about how effective an index-based approach is in assessing and measuring corporate governance and corporate performance.

There are a number of well-established academic and proprietary corporate governance indexes. These include: the Khanna Corporate Governance Index (2001); the Klapper and Love Index (2002); the Black, Jang and Kim Index (2003); the Gompers, Ishii and Metrick Index (2003); the FTSE-ISS Corporate Governance index (2005); and the Ananchotikul Corporate Governance Index (2008). Stock exchanges in Brazil, China, Italy, Mexico, Peru, South Africa and South Korea also use their own CG indexes.

While some studies have pointed to an association between the use of a corporate governance index and market valuation, a clear relationship is yet to be established.

Ken Olisa, Chairman of the advisory panel for the report, says “One of the key findings of our new research is that no one factor dictates whether a company is well run… It is simply not correct for a company to say that because they have ticked certain boxes, they show good governance.”

“We believe that corporate governance cannot be assessed using straightforward tick-box approaches, such as measuring how a company scores against an arbitrary list of factors.”

“Governance is all about behaviours; and behaviours – whether individual or collective – are hard to reduce to a coherent framework connecting a small number of factors” says Mr Olisa. “An individual director’s behaviour is driven by a host of different factors, some physical, some chemical, and some inexplicable.”

The IoD study hopes that its findings will help produce a more reliable corporate governance index in the future – serving as a useful tool both within firms as well as for investors and stakeholders in identifying future company performance.

“The ultimate test of the quality of a CG index is its usefulness to both investors and to stakeholders in identifying future company performance”, says Professors Volpin and Clare of the Cass Business School. They describe a reliable corporate governance index as “the Holy Grail of governance research”.

Mr Olisa says that “there were, and will continue to be, widely divergent views about how far any index can capture the essence of governance.”