Calculative Ideas, Calculative Devices, and Calculative Agents:
How Sell-Side Financial Analysts Have Incorporated Ideas of Corporate Governance
into Investment Analyses
Zhiyuan (Simon) Tan1
Department of Management
King’s College London
Franklin-Wilkins Building
150 Stamford Street
London SE1 9NH
Tel: 0044-(0)2078483626
E-mail: simon.z.tan@kcl.ac.uk
Paper submitted to
the Interdisciplinary Perspectives on Accounting Conference (2012)
1
This paper is based on my doctoral thesis that I completed at the London School of Economics. The financial
support from the Department of Accounting at the LSE is acknowledged. I am grateful to Peter Miller for his
academic support throughout this study. Earlier versions of the paper have been presented at the Accounting,
Organisations and Society Seminar at the LSE, The 2011 British Accounting and Finance Association Annual
Conference, and The 34th European Accounting Association Annual Congress. I also wish to thank colleagues at
King’s College London, particularly Richard Laughlin and Jill Solomon, for their useful comments on the
manuscript.
1
Calculative Ideas, Calculative Devices, and Calculative Agents:
How Sell-Side Financial Analysts Have Incorporated Ideas of Corporate Governance
into Investment Analyses
Abstract
Since the turn of the century, as an important component in the investment chain, some sellside financial analysts have started exploring the integration of corporate governance into
investment analyses. This emerging form of economic calculation in financial markets is
considered in this paper as being constituted by an ensemble of calculative ideas, calculative
devices, and calculative agents. The paper traces ideas, ideals, and aspirations articulated in
financial markets and the wider economy that have shaped the concrete work of analysts.
These include ideas related to the potential link between corporate governance and the
financials, the ideal of incorporating governance issues into investment analyses, and the
perception among financial market participants that analysts could play an important role in
linking governance to the financials. These constitute the ‘programmatic’ dimension of the
corporate governance integration. This paper also attends to the tools and devices deployed
by analysts, and these constitute the ‘technological’ dimension of the integration. Corporate
governance scores, portfolio analyses, event analyses, regression analyses, ‘governance-toprofitability’ analyses, ‘governance-to-valuation’ analyses, and the various graphs
operationalise the idea that corporate governance and the financials are potentially linked,
and help fulfil the objective of bringing corporate governance into investment analyses.
Nevertheless, it is the analysts who elaborate upon ideas and rationales surrounding corporate
governance integration, and who meanwhile deploy concrete devices and instruments to
render the integration possible and operational. In light of the notion of ‘carrier’, this paper
suggests, as calculative agents, analysts assemble the programmatic dimension of corporate
governance integration with the technological aspect, and translate calculative ideas into
calculative devices.
2
1.
Introduction
Corporate governance failures, such as Enron, WorldCom, and Parmalat, which took place in
the early 21st century, shook the global business landscape. Since then, corporate governance
has been perceived explicitly as ‘an area of risk’ that could have material impacts on
corporate financial performance and shareholder value (Dallas & Patel, 2004; Dallas, 2004;
Solomon, 2010). Integrating corporate governance into the investment decision making
process has come to be viewed as an ideal to be sought and an agenda to be promoted by
constituents of the investing public (e.g. The UN Global Compact, 2004, 2005, 2009; The
UNEP FI, 2004). However, a common and consistent understanding of how to incorporate
corporate governance in asset management, securities brokerage services, and the associated
buy-side and sell-side research functions does not appear to exist (The UN Global Compact,
2004: 1). Various participants in financial markets, including fund managers, brokers, and
buy-side and sell-side financial analysts, are in the process of exploring ways in which
corporate governance may be integrated into the investment decision making process. The
integration of corporate governance into investment analyses may be viewed as an emerging
form of economic calculation in financial markets.
Among those financial market participants who are attempting to bring corporate governance
into the investment decision making process, sell-side financial analysts are considered to be
‘the specialists’ (The UN Global Compact, 2004). Sell-side financial analysts work in the
equity research divisions of brokerage firms. Traditionally termed as ‘equity research
analysts’, they specialise by industry sectors, analysing companies within a specific sector,
offer investment recommendations to investors, and concentrate mainly on the financial and
operational aspects of corporations (Gullapalli, 2004). During the past decade, some equity
research analysts in the US and the UK have evaluated companies beyond the financials (e.g.
firm profitability, stock price performance, and equity valuation) to consider the governance
of corporations. They approach governance issues primarily on an individual and piecemeal
basis within the industry sector teams to which they belong. In parallel, major brokerage
houses such as Deutsche Bank, Citigroup, Goldman Sachs, JP Morgan, Merrill Lynch, and
UBS, among others, have established dedicated research teams within their equity research
divisions to focus attention on examining corporate governance and other extra-financial
issues. Analysts employed in these teams are sometimes called corporate governance
analysts, socially responsible investment (SRI) analysts, or environmental, social, and
governance (ESG) analysts. These ‘non-equity-research analysts’2 (analysts hereafter) may
not normally value stocks or directly offer investment recommendations. However, they have
taken the initiative to explore systematically the integration of governance issues into
investment analyses and exerted great effort to demonstrate the importance of corporate
governance in determining shareholder value to investors. These analysts can be considered
as the pioneers in the field of corporate governance integration. This paper focuses
specifically on the attempt made by some of these ‘non-equity-research analysts’ to explore
the integration of corporate governance into investment analyses by investigating how
integration is performed, and the role these analysts play in this emerging form of economic
calculation3.
Since both equity research analysts and ‘non-equity-research’ analysts work in the equity research divisions of
brokerage firms, or on so-called ‘sell-side’, they can all be thought of as ‘sell-side financial analysts’.
3
In addition to corporate governance, environmental and social issues are considered as being needed to be
taken into account in the investment process. These so-called ‘ESG’ issues are covered by analysts to varying
degrees (EAI, 2008). These three categories of issues appear to be examined separately by most analysts. Even
2
3
To inform the empirical analysis, this paper refers to the conceptualisation that economic
calculation is constituted by both ‘programmatic’ and ‘technological’ dimensions, and the
ensemble formed between the two (Mennicken, Miller, & Samiolo, 2008; Miller, 2008a,
2008b; Power, 1997). The corporate governance integration explored by analysts, it is argued,
is attached to and shaped by certain idealised and normative elements being widely
articulated in financial markets and the wider economy. These include ideas and discourses
related to the potential link between corporate governance and the financials that have been
promulgated since the 1980s; the ideal of bringing corporate governance into asset
management, securities brokerage services, and buy-side and sell-side research functions that
surfaced from the early 21st century; and the perception among financial market participants
that analysts could and should be actively incorporating governance criteria into investment
analyses. These ideas, discourses, and perceptions, taken together, constitute the
programmatic dimension of the governance integration explored by analysts. However, these
programmatic and discursive elements are made operable by the material tools and devices
that analysts deploy. Corporate governance scores, portfolio analyses, event analyses,
regression analyses, ‘governance-to-profitability’ analyses, ‘governance-to-valuation’
analyses, and the various visual devices operationalise the idea that corporate governance and
the financials are potentially linked. They help fulfil the objective of bringing corporate
governance into investment analyses and articulate corporate governance as a risk factor in
the investment process. Nevertheless, it is the analysts who adopt and elaborate upon ideas
and rationales surrounding corporate governance integration, and who meanwhile create and
deploy concrete devices and instruments to render the integration possible and operational. In
light of the notion of ‘carrier’ drawn from neo-institutionalism (Sahlin-Andersson & Engwall,
2002; Scott, 2003; see also Czarniawska & Joerges, 1996; Czarniawska & Sevon, 2005), this
paper suggests that the role played by analysts in their exploration of integrating corporate
governance into investment analyses is one of assembling programmatic dimension of this
particular form of economic calculation with technological aspect, and of translating
calculative ideas into calculative devices. As an emerging form of economic calculation in
financial markets, the corporate governance integration explored by analysts is constituted by
an ensemble of calculative ideas, calculative devices, as well as calculative agents.
This paper draws on a diverse set of textual documents as empirical materials. It is considered
elsewhere that through the deployment and elaboration of a particular language or
vocabulary, ideas, ideals, and aspirations take shape within “government reports, White
Papers, Green Papers, papers from business, trade unions, financiers, political parties,
charities and academics” (Miller & Rose, 1990: 4). Accordingly, to trace ideas, ideals, and
aspirations articulated in financial markets and the wider economy that shape the corporate
governance integration explored by analysts, this paper utilises publicly available documents
issued by national and international governmental and non-governmental organisations as
well as by investment institutions in financial markets, selected financial newspapers and
magazines, textbooks of corporate governance, and academic and practitioner publications on
corporate governance. Special attention is paid to the reports issued by the UN Global
Compact. These are the few yet important official documents that have articulated explicitly
the idea and aspiration of integrating governance issues into the investment process. To
examine the concrete work undertaken by analysts, this paper makes use of their written
when combined analyses of environmental and social issues appear, corporate governance is often excluded
from these analyses. This paper focuses specifically on corporate governance, which is the first among ESG
issues that analysts employed in brokerage firms have attended to – e.g. analysts at Deutsche Bank started its
corporate governance related research back in 2000.
4
reports. It concentrates mainly on analyst reports that consider the link between governance
issues and the financials, and that document the corporate governance integration explored by
analysts. These reports were obtained from the Investext Plus database that was available
initially from the British Library until early 20094. Five reports written by analysts based in
the US and the UK before 2009 are considered relevant to this study. This number of relevant
reports is relatively small, given the infancy of corporate governance integration at that time.
Analysts who produced these reports were employed mostly by specialised corporate
governance, ESG, or SRI teams at brokerage firms when these reports were written. These
analyst reports provide a window through which the translation of calculative ideas into
material and concrete devices may be looked at. Particularly, this paper attends to the
narratives, tables, lists, charts, figures, and graphs which constitute the reports.
The rest of the paper is organised as follows. The next section introduces the notions of
‘programmatic’, ‘technological’, and ‘carrier’, and related theoretical underpinnings that help
make sense of the economic calculation under investigation. The paper then traces ideas,
discourses, aspirations, and ideals that can be considered to shape the corporate governance
integration explored by analysts. Next, the paper examines the concrete work conducted by
analysts that operationalises corporate governance integration and attends to ways in which
analysts as calculative agents translate calculative ideas into calculative devices. The final
section summarises the paper and provides some concluding comments.
2.
Theoretical lenses
Economic calculation has been an object of enquiry in the sociological analysis of the
economy since the late 1970s (Mennicken et al., 2008; Miller, 1994). Attempts have been
made to investigate the conditions, capacities, and consequences of various forms of
economic calculation functioning in economy and society. Scholars from different
disciplines, including those within accounting, have come to demonstrate that the operation
of particular ways of calculating and techniques of calculation is implicated within specific
organisational, institutional, and cultural settings (e.g. Burchell, Clubb, Hopwood, & Hughes,
1980; Cutler, Hindess, Hirst, & Hussain, 1978; Hacking, 1975; Hopwood, 1983). Some
scholars have focused on the interrelations among economic calculation, economic policy,
and economic discourse (e.g. Burchell, Clubb, & Hopwood, 1985; Miller & Rose, 1990;
Thompson, 1986; Tribe, 1978). It has been argued that economic policies and categories of
economic discourse shape techniques of economic calculation, and calculative practices
“would have significance and meaning only through the discursive formation within which
they emerge” (Miller, 1994: 15). Reciprocally, economic discourse is said to be made
operable through various calculative practices, and techniques of economic calculation
constitute the means and instruments through which policy objectives are to be realised.
Particularly, the roles of economic calculation in general, and of accounting in particular, in
making possible the governing of economic life, have been suggested in a Foucauldian
perspective of the ‘governmentality’ literature (Miller & Rose, 1990; Miller & Rose, 2008;
Rose & Miller, 1992). According to this literature, a range of authorities that seek to act upon
the actions of others set out their aspirations and objectives in a particular language that
represents the domain to be governed in a way that the domain is rendered amenable to
4
The British Library terminated its subscription to Investext Plus in early 2009.
5
government. The term ‘programme’ has been advanced to refer to this “discursive nature of
modes of governing, the conceptualising and imagining of the economic domain and its
constituent components and associated problems as something that could be acted upon and
calculated” (Miller, 2008b: 8-9). Meanwhile, ‘technologies of government’ are deployed to
intervene upon the objects that are of concern to the authorities. Technologies are considered
to be the devices and instruments that operationalise aspirations and act upon others,
including various techniques of economic calculation (Miller, 2008b: 9). In short, calculative
technologies, such as accounting, are mobilised by political programmes for intervening upon
economic life.
This conceptualisation of the governing of economic life has informed studies of accounting
as social and institutional practice (e.g. Mennicken, 2009; Miller, 1991; Miller & O'Leary,
1987; Neu, Gomez, Graham, & Heincke, 2006; Power, 1997; Robson, 1991, 1994; see also
Chapman, Cooper, & Miller, 2009). Accounting, as a particular form of economic
calculation, has been viewed as having both programmatic and technological dimensions.
The ‘programmatic’ (or ‘normative’) dimension relates to “the ideas and concepts which
shape the mission of the practice and which […] attach the practice to […] broader policy
objectives” (Power, 1997: 6). The ‘technological’ (or ‘operational’) aspect refers to “the more
or less concrete tasks and routines which make up the world of practitioners” (ibis: 6). These
two dimensions of accounting are considered to go hand-in-hand, with each being the
condition of operation for the other (Mennicken et al., 2008; Miller, 2008b: 25). For instance,
the technique of discounted cash flow was called upon to help facilitate better investment
decisions in the hope of achieving ‘economic growth’ in Britain in the 1960s (Miller, 1991).
The language of ‘efficiency’ was central to the ambitions of standard costing to transform
British enterprises in the early decades of the 20th century (Miller & O'Leary, 1987). Also, the
rise of Russian auditing practices was conditioned by, and implicated in, the wider transition
from a planned to a market economy in Russia in the early 1990s (Mennicken, 2009).
In the past decade or so, although the roles of the calculative infrastructures that shape and
make markets, hierarchies, contracts, organisations, and networks have come to be addressed,
the programmatic dimension of economic calculation is not always considered (Mennicken et
al., 2008; Miller, 2008a, 2008b). Instead, economic sociologists, especially those who have
shown increasing interest in financial markets (e.g. Beunza & Stark, 2004; Callon, 1998;
MacKenzie & Millo, 2003), have made a ‘technological turn’ in economic sociology
(Mennicken et al., 2008). This ‘technological turn’ attends specifically to the ‘technological
infrastructures’ of economic calculation, its material and mundane instruments and
procedures. Callon and Muniesa (2005: 1245), for instance, argue that economic calculation
“is distributed among human actors and material devices”, where ‘material devices’ include
tools, equipment, technical devices, and algorithms. Recently, the notion of ‘market devices’
has been formulated to refer to material instruments, models, and tools that represent and
intervene in the construction of markets (Muniesa, Millo, & Callon, 2007). Furthermore, in
the field of social studies of finance, the ‘technicality’ and ‘materiality’ of financial markets
have been emphasised. Scholars have examined technical systems and concrete and material
practices of trading and risk management in financial markets (e.g. Beunza, Hardie, &
MacKenzie, 2006; Hardie & MacKenzie, 2007).
Given the conceptualisation formulated by scholars associated with the ‘governmentality’
literature that economic calculation is constituted by both programmatic and technological
aspects, the ‘technological turn’ in economic sociology has been criticised for its neglect of
the programmatic dimension, and its failure to address the linkage and interdependence
6
between programmes and technologies. As Miller (2008a: 53 & 57) suggests, the emphasis
on the material reality of calculation “has not been matched by a similar concern with the
‘programmes’ or ‘ideas’ that articulate, animate and give significance to particular ways of
calculating”, and therefore has “resulted in a neglect of the overall ensemble of calculations,
inscriptions, tactics, strategies and aspirations”. When studying economic calculation, it is
further proposed, programmes and technologies, rationales and devices, or ideas and
instruments need to be conjointly analysed, and the linkage and interplay between the two
dimensions be attended to (Mennicken et al., 2008; Miller, 2008a, 2008b). The present paper
seeks to build on and extend this line of conceptualisation by examining both programmatic
and technological aspects of an emerging form of economic calculation in financial markets,
namely, the integration of corporate governance into investment analyses explored by
analysts. It investigates the tools and devices deployed by analysts, as well as the idealised
schemata, aspirations, ideas, and discourses that have shaped and given significance to the
concrete tasks that analysts have performed.
However, viewing economic calculation as being constituted by programmatic and
technological dimensions tends to ignore the role played by agents who perform the
calculation. Indeed, it is the calculative agents who make reference to and elaborate upon
calculative ideas and rationales, and who, at the same time, create and deploy concrete
devices and instruments to make calculation possible and operational. The calculative agents
can be viewed as linking and assembling the programmatic dimension of a particular form of
economic calculation with the technological aspect, and as translating calculative ideas into
calculative devices (Czarniawska & Joerges, 1996; Czarniawska & Sevon, 2005; Latour,
1987). To make sense of this role played by calculative agents, this paper refers to the notion
of ‘carrier’ drawn from neo-institutionalism. Carriers5 are considered to play significant roles
in framing, packaging, and circulating ideas (Sahlin-Andersson & Engwall, 2002: 8). When
ideas are adopted or spread, they are unpacked, edited, re-interpreted, and transformed by
carriers. As Scott (2003: 879) further emphasises, carriers are “[…] mechanisms that
significantly influence the nature of the elements they transmit”. The form, focus, content,
and meaning of the original idea are constantly subject to modification and transformation by
carriers. Particularly, abstract ideas are often materialised, inscribed, and turned into objects
that can be seen and touched (Czarniawska & Joerges, 1996; Czarniawska & Sevon, 2005).
In this way, economic calculation could be viewed as a process of materialisation of
calculative ideas, in which calculative agents actively turn ideas and rationales into
calculative devices. Accordingly, this paper pays special attention to the translation,
performed by analysts who act as calculative agents, of ideas and rationales surrounding
corporate governance integration into material tools and devices. It seeks to shed new light on
the issue of calculative agents ‘carrying’ calculative ideas, rationales, and discourses, and
turning them into material devices. It aims to demonstrate that economic calculation is
constituted by calculative ideas, calculative devices, as well as calculative agents.
3.
Articulating corporate governance integration: ideas, discourses, and broader
aspirations
They are also termed ‘translators’ (Czarniawska & Sevon, 1996), ‘knowledge entrepreneurs’ (Abrahamson &
Fairchild, 2001), ‘teachers of norms’ (Finnemore, 1993), ‘editors’ (Sahlin-Andersson, 1996), and ‘others’
(Meyer, 1996).
5
7
During the past three decades or so, ideas and discourses related to the potential link between
corporate governance and the financials have been articulated in at least three aspects of
institutional life: academic research, public policy making, and institutional investment. From
the early 21st century, the idea and ideal of incorporating corporate governance and other
extra-financial issues into the investment decision making process started to emerge within
the institutional investment community. This section traces these ideas, discourses, and ideal
which, it is considered, constitute the programmatic dimension of the integration of
governance issues into investment analyses explored by analysts.
3.1
Academic research6
The first academic study of the relationship between corporate governance issues and the
financials can be traced back to 1955 when Stanley Vance related type of board structure to
corporate performance (Vance, 1955, 1978). Subsequent studies of this relationship followed
in the 1960s and the 1970s, and were conducted mostly by Vance (e.g. 1964, 1968, 1977,
1978)7. It was not until the 1980s that academic studies of the link between corporate
governance and the financials started to gain momentum. Since then, a number of these
studies have focused on board composition and board leadership structure, and explored the
relationships between these aspects of corporate governance and the financials. As Dalton,
Daily, Ellstrand, and Johnson (1998: 269) put it:
“There is a distinguished tradition of conceptualization and research
arguing that boards of directors’ composition and leadership structure
(CEO/chairperson roles held jointly or separately) can influence a variety of
organisational outcomes. This attention continues to be apparent in the
academic literature.”
These studies have contributed to the academic debate over mechanisms of corporate control
between agency theory and stewardship theory given the separation of ownership and control
in modern corporations8. Studies informed by agency theory suggest that outside director
representation and firm performance are positively correlated (e.g. Baysinger & Butler, 1985;
Ezzamel & Watson, 1993; Schellenger, Wood, & Tashakori, 1989). In contrast, research
informed by stewardship theory proposes that inside directors are associated with higher firm
performance (e.g. Kesner, 1987). Nevertheless, some research does not find statistically
significant correlations between board composition and firm performance (e.g. Chaganti,
Mahajan, & Sharma, 1985; Daily & Dalton, 1992; Kesner, Victor, & Lamont, 1986; Zahra &
Stanton, 1988). Mixed results have been obtained from academic studies of the relationship
between some aspects of corporate governance, such as board composition, and corporate
performance. Nevertheless, the burgeoning of these studies in the last two decades of the 20 th
6
This section does not intend to provide a detailed review of academic studies of the relationship between
corporate governance and corporate financial performance. Instead, it aims to trace academic ideas and
discourses related to the potential link between corporate governance and the financials that have been
articulated in academia in the past few decades.
7
However, see Pfeffer (1972).
8
These two theoretical frameworks have informed academic research that seeks to discover the link between
corporate governance and the financials. It is beyond the scope of this paper to discuss them in detail. For an
overview of agency theory, see Jensen and Meckling (1976). For stewardship theory, see Donaldson and Davis
(1991).
8
century shows that the potential link between corporate governance and the financials was
perceived widely as a significant issue in the academic world at that time.
Since the 1990s, academics have also focused on the impact of shareholder activism as a
mechanism of corporate governance on firm financial performance. ‘Shareholder activism’ is
referred to by the European Corporate Governance Institute as “[…] the way in which
shareholders can assert their power as owners of the company to influence its behaviour”9. As
will be further discussed in section 3.3, shareholder activism assumes that strong monitoring
of corporate behaviour by shareholders will potentially contribute to the financials of
corporations in a positive manner. Some academics, such as Solomon and Solomon (2004:
113), explicitly endorsed this perception:
“An essential issue in the whole debate about shareholder activism and the
role of institutional investors in corporate governance is whether or not such
intervention results in higher financial performance in investee companies.
[…] There is certainly a perception among the institutional investment
community that activism brings financial rewards, as more efficient
monitoring of company management aligns shareholder and manager
interests and therefore helps to maximize shareholder wealth.”
Like the results from other studies of the relationship between some aspects of corporate
governance and the financials, evidence from academic research on the impact of shareholder
activism on corporate performance and investment returns has been largely mixed (Solomon
& Solomon, 2004: 113). For instance, Nesbitt (1994) found that shareholder activism has a
significantly positive impact on the financial performance of companies targeted by the
California Public Employees’ Retirement System (CalPERS). In contrast, Faccio and Lasfer
(2000) argued that pension funds in the UK do not add value to the companies in which they
hold large stakes. Nevertheless, exploring the link between shareholder activism and the
financials has been placed firmly onto the agenda for academic research.
Since the early 21st century, the availability of commercial corporate governance ratings has
expanded the scope of academic research on the relationship between corporate governance
and the financials. These ratings have been provided by the GovernanceMetrics International
(GMI), Institutional Shareholder Services (ISS), the Corporate Library, and the Corporate
Governance Service Department at Standard & Poor’s, among others. These rating
organisations have claimed to develop independent governance ratings, although the accuracy
and reliability of the ratings and the independence of the rating organisations have been
subject to scrutiny (Brown, 2004; Snyder, 2008). With these ratings, academic scholars have
explored the relationship between the overall quality of the corporate governance procedures
of a firm, presumably captured by the single governance metric, and corporate performance.
For instance, Brown and Caylor (2004) documented that corporations with the higher
industry-adjusted Corporate Governance Quotient (CGQ) scores issued by the ISS are
associated with better 3-year, 5-year, and 10-year shareholder returns, higher profits, lower
stock price volatilities, and higher dividend payouts and yields. However, Daines, Gow, and
Larcker (2009) reported that there is no significant correlation between the CGQ scores
issued by the ISS and some basic performance metrics, such as restatements of financial
results, shareholder lawsuits, return on assets, stock valuation, and risk-adjusted stock price
performance. Epps and Cereola (2008) also found no statistical evidence suggesting that the
9
See http://www.ecgi.org/activism/index.php.
9
operating performance of firms is related to their ISS corporate governance rating. Similar to
prior academic research, this line of enquiry has produced rather mixed results. However, the
agenda for exploring the relationship between corporate governance and the financials has
been consolidated further within the academic community thanks to the emergence and rapid
growth of corporate governance ratings. The idea that corporate governance and the
financials are potentially linked has, once again, been articulated and reflected upon in the
academic world.
3.2
Public policy making
Ideas and discourses related to the potential link between corporate governance and the
financials have appeared in the public policy making arena approximately since the 1980s. In
the US, corporate governance reforms initiated by the Securities and Exchange Commission
(1980) and the American Law Institute (1982) in the early 1980s were informed by the idea
that corporate governance and the financials are potentially linked. As Baysinger and Butler
(1985: 103) pointed out explicitly:
“[… T]he [corporate governance] reform movement is based on the idea
that shareholder welfare is enhanced by boards of directors which are
capable of monitoring management, rendering independent judgments on
managerial performance, and meting out rewards on the basis of these
evaluations. All else equal, firms with more independent boards should
perform better; changes in board composition toward the reformers'
prescriptions should improve performance.”
Since the late 1980s and the early 1990s, corporate governance has been made visible as an
issue in the UK, US, and global business community. This was triggered arguably by the
outbreak of a few corporate scandals, such as Bank of Credit and Commerce International
(BCCI) and Maxwell, and the Asian financial crisis. Corporate governance has been placed
onto the agenda for intervention, scrutiny, and reform. Starting with the Cadbury Report
(1992), a series of corporate governance codes, principles, and standards have been
developed and enacted on both sides of the Atlantic and transnationally. These formal
corporate governance documents issued in the 1990s can be argued as being formulated in
light of the belief that corporate governance and the financials are potentially linked. For
instance, when setting out the responsibilities of the board, the Organisation for Economic
Co-operation and Development (OECD) stated in its Principles of Corporate Governance
(OECD, 1999: V) that:
“Together with guiding corporate strategy, the board is chiefly responsible
for monitoring managerial performance and achieving an adequate return
for shareholders, while preventing conflicts of interest and balancing
competing demands on the corporation.”
It appears that an assumption underlying the statement above is that a responsible corporate
board can effectively monitor the actions of managers, which can in turn potentially bring
about enhanced investment return to shareholders. In other words, the idea that a responsible
corporate board can contribute positively to firm performance seems to underlie the
Principles issued by the OECD. Similarly, it has been considered that the Hampel Report
(1998), issued by the Committee on Corporate Governance in Britain, was informed by the
10
idea that active institutional shareholders can contribute positively toward the financials of
corporations:
“Pension fund trustees were targeted by the report [i.e. the Hampel Report]
as a group who needed to take their corporate governance responsibilities
more seriously. […] It is clearly an implicit assumption of the Hampel
Committee and other proponents of shareholder activism that institutional
investors’ intervention in investee companies produces higher financial
returns.” (Solomon & Solomon, 2004: 51 & 131)
Despite the increased scrutiny of corporate governance processes, the scandals and failures
continued. The outbreak of a series of corporate failures in different geographical
jurisdictions of the world in the first few years of the 21st century, such as Enron, WorldCom,
Global Crossing, and Parmalat, further increased the salience of the issue of corporate
governance. A new wave of governance reforms has taken place, arguably in response to the
outbreak of these scandals. The idea that corporate governance and the financials are
potentially linked continued to underlie policy documents issued at that time. For instance, it
was stated in the Higgs Report (2003), which concerned the role, independence, and
recruitment of non-executive directors, that:
“Good corporate governance […] is an integral part of ensuring successful
corporate performance, but of course only a part. It remains the case that
successful entrepreneurs and strong managers, held properly to account and
supported by effective boards, drive wealth creation. […] The nominations
[of board members] and appointments process is crucial to strong corporate
performance as well as effective accountability.”
Furthermore, after the outbreak of the corporate scandals in the early 2000s, the OECD called
for a survey to assess the Principles of Corporate Governance (OECD, 1999) originally
issued in 1999 before it considered updating and revising the Principles. In the report that
documented the survey, the OECD stated that it reviewed and summarised a body of
“empirical work showing the importance of corporate governance in determining company
performance and economic growth” (2004: 4). This suggests that the idea that corporate
governance and the financials are potentially linked was not alien to the notion of corporate
governance adopted by the OECD, even if this idea might not explicitly inform the process of
assessing and revising the Principles.
3.3
Institutional investment
The potential link between corporate governance and the financials has also been identified
and articulated by institutional investors, particularly in conjunction with their activism
towards corporations that appeared from the mid-1980s and rapidly flourished in the 1990s10.
10
Before the mid-1980s, individual activists and religious groups in the US had challenged corporations on
specific social or moral issues (Hendry, Sanderson, Barker, & Roberts, 2007). Shareholder activism by
institutional investors, particularly by self-managed public pension funds, emerged first in the US in the mid1980s (Gillan & Starks, 1998; Hendry et al., 2007). From the early 21st century, especially in Britain, the socalled ‘new shareholder activism’ by mainstream institutional investors (e.g. wholesale and retail asset
management companies, pension funds, and the investment arms of life assurance companies) started to surface
(Hendry et al., 2007). This paper concerns activism exerted by institutional investors.
11
Shareholder activism, as Smith (1996: 227) pointed out, aims “[…] to bring about changes in
the organisational control structure of firms […] not perceived to be pursuing shareholderwealth-maximising goals”. The formation of the Council of Institutional Investors (CII) in the
US in January 1985 marked the beginning of shareholder activism by institutional investors
(Gillan & Starks, 1998). The Council was formed in an attempt on the part of large public
pension funds to lobby for shareholder rights and hold investee companies accountable. In the
first few years after the formation of the CII, public pension funds in the US exerted their
activism to address issues such as the repeal of anti-takeover amendments, changes in voting
rules, and increased board independence (Gillan & Starks, 1998). Shareholder activism has
become a mechanism of corporate governance that can potentially contribute to the governing
of corporate behaviour.
One primary assumption underlying shareholder activism is considered to be the promotion
of ‘sound’ governance practices as a means to improve corporate performance and
shareholder returns (e.g. Eisenhofer & Levin, 2005). It is believed that by engaging actively
in overseeing the management of corporations, institutional investors would be able to press
for good governance practices, which it is hoped would in turn translate into improved
financial performance and enhanced investment returns. In other words, ‘active’ shareholders
have considered that corporate governance and the financials are potentially positively linked,
and that improved governance practices could lead to enhanced financial performance. As
Dale Hanson, former chief executive of the California Public Employees’ Retirement System
(CalPERS), a pioneer of shareholder activism, stated:
“CalPERS has no motives other than to improve corporate performance so
that investment value is increased […]. We seek a return to corporations
being accountable to their shareholders. If accountability exists, we are
confident that corporate performance will follow.” (Hanson, 1993)
The comment below by Alastair Ross Goobey, former chief executive of Hermes Pensions
Management in Britain, further elucidated that shareholder activism can potentially add to
investment return, and reinforced the idea that corporate governance and the financials are
potentially positively linked:
“We see corporate governance not as a moral crusade, but as part of our
fiduciary duty to our clients in identifying the business risks, financial and
non-financial, to enhance our investment process accordingly […] Hermes
believes that an active shareholder involvement can help release the higher
intrinsic value of the company.” (Quoted in Sparkes, 2002)
Some institutional investors have engaged in intensive shareholder activism by investing in
companies known for their weak governance practices, with a view of forcing them to
improve their corporate governance, and thereby achieving enhanced returns. Lens Ltd.,
which was established by Robert Monks and Nell Minow in the US in 1989, represented one
example of these investment institutions. Lens invested in companies such as Sears and
Eastman Kodak that had weak governance structures, negotiated with them, and effected
changes within the companies. This engagement with initially poorly governed companies
was reported as having resulted in substantial increases in share valuation (Solomon, 2010).
In 1998, Lens joined forces with Hermes, a major UK institutional investor, and founded
Hermes Lens Asset Management Company in partnership with the British Telecom pension
scheme. This investment institution adopted the same principle, namely, taking stakes in
12
underperforming companies and engaging in shareholder activism to press for change. Again,
excess investment returns were reported to have been generated (Solomon, 2010). The
success of these cases of intensive shareholder activism gave support to the view held by
active institutional investors that corporate governance and the financials are potentially
positively linked.
Institutional investors have appeared to be even more concerned about corporate governance
after the outbreak of a series of corporate scandals in the early 2000s (Tricker, 2009; Young,
2003). They have also perceived more strongly the potential link between corporate
governance and the financials. According to a survey conducted by McKinsey & Company
(2002), investors believed that corporate governance can make a difference to the bottom line
of a company, i.e. corporate financial performance. It was reported that the majority of
investors surveyed would be prepared to pay 12% more for the shares of a well-governed UK
company, and 14% more for the shares of a well-governed US company, compared to the
shares of companies with similar financial performances but poorer governance procedures.
As Mallin (2004: 74) commented on the survey results:
“It is […] the investor’s perception and belief that corporate governance is
important and that belief leads to the willingness to pay a premium for good
corporate governance.”
Almost at the same time, i.e. since the early 21st century, an increasing number of
institutional investors have come to view corporate governance, which is part and parcel of
the notions of ‘ESG’ (environmental, social, and governance) and ‘EFIs’ (extra-financial
issues)11, as potentially having material impact on corporate financial performance and
shareholder returns over the long term12 (e.g. EAI, 2004). For instance, in its Global
Principles of Accountable Corporate Governance, the CalPERS stated that it
“[…] believes that environmental, social, and corporate governance issues
can affect the performance of investment portfolios (to varying degrees
across companies, sectors, regions, and asset classes through time.)”
(CalPERS, 2009: 17)
Other financial institutions within the investment community have also echoed institutional
investors regarding the potential link between corporate governance and other extra-financial
issues and long term corporate financial performance and investment returns. For instance,
fund management firms, insurance companies, and investment banks that took part in the
Financial Sector Initiative Who Cares Wins overseen by The United Nations Global Compact
claimed:
Generally speaking, ‘EFIs’ embraces more elements (such as intellectual capital, wider elements in the supply
chain, e.g. suppliers, products and services) than ‘ESG’ which basically includes environmental, social and
governance issues.
12
This has been considered as being triggered by the increasingly widespread adoption of the idea of ‘socially
responsible investment’ (SRI) in the institutional investment community in the US and the UK (Solomon &
Solomon, 2004; Sparkes, 2002). SRI used to be a fringe activity carried out by a small number of unit trusts and
mutual funds. Since the late 1990s, it has become an important consideration by mainstream institutional
investors (Sparkes, 2002). The umbrella terms ‘ESG’ and ‘EFIs’ have been adopted mostly by members of the
institutional investment community to capture factors that are considered as having material impact on long term
firm financial performance and investment returns. These terms, while increasingly being used in institutional
investment, tend to be referred to less often by academics or public policy makers.
11
13
“[… We] are convinced that in a more globalised, interconnected and
competitive world the way that environmental, social and corporate
governance issues are managed is part of companies’ overall management
quality needed to compete successfully. Companies that perform better with
regard to these issues can increase shareholder value by, for example,
properly managing risks, anticipating regulatory action or accessing new
markets, while at the same time contributing to the sustainable development
of the societies in which they operate.” (The UN Global Compact, 2004: i)
Institutional investors and fund managers not only have further articulated the idea that
corporate governance and the financials are potentially linked. They have also taken one step
further, as compared to academics and public policy makers, to explicitly call for the
integration of corporate governance and other extra-financial issues into asset management,
securities brokerage services, and the associated buy-side and sell-side research functions. As
Kay Carberry, Assistant General Secretary of the Trade Union Congress (TUC) and director
of the TUC Superannuation Society in Britain, pointed out:
“There is a growing recognition amongst pension funds and fund managers
that the management of extra financial or intangible issues by companies is
essential for their long-term performance […] Without comprehensive
analysis of these issues, investors will continue to base investment decisions
on a partial view.” (Quoted in EAI, 2005)
The incorporation of corporate governance into the investment decision making process has
been thought of as being able to help realise and achieve certain broader aspirations and
objectives in economy and society. For instance, it was suggested that:
“[…] a better consideration of environmental, social and governance factors
will ultimately contribute to stronger and more resilient investment markets,
as well as contribute to the sustainable development of societies.” (The UN
Global Compact, 2004: i)
Taking corporate governance criteria into account and integrating them into the investment
decision making process has become an ideal to be sought and an agenda to be pursued
within the institutional investment community. Nevertheless, a consistent understanding of
how to incorporate governance issues into asset management, securities brokerage services,
and buy-side and sell-side research is not considered as having been developed (The UN
Global Compact, 2004: 1). How corporate governance could and should be integrated into
investment analyses is yet to be explored by fund managers, brokers, and buy-side and sellside financial analysts. Among these actors in the investment chain, financial analysts who
work on the so-called ‘sell-side’ have been regarded as “the specialists best placed to show
how ESG issues impact company and investment value” and to explore ways in which
corporate governance could be integrated into investment analyses (The UN Global Compact,
2004: 37). These analysts have also been encouraged
“[…] to take an active role in testing and refining the investment rationale
for ESG integration in research and investment decisions [… to] further
develop the necessary investment know-how, models and tools in a creative
and thoughtful way [in order to] better deal with qualitative information and
14
uncertain impacts related to ESG issues” (The UN Global Compact, 2004:
ii, 10 & 28)
Furthermore, fund management firms and the asset management departments of investment
banks that constituted the Asset Management Working Group (AMWG) under the United
Nations Environment Programme Finance Initiative (UNEP FI) also strongly requested
brokerage firm analysts
“[…] to identify specific [corporate governance and other extra-financial]
criteria likely to be material for company competitiveness and reputation
[… and] to the extent possible to quantify their potential impact on stock
price.” (The UNEP FI, 2004: 4)
3.4
Linking the three aspects of institutional life
In the past three decades, ideas and discourses related to the potential link between corporate
governance and the financials have been articulated in arenas of academic research, public
policy making, and institutional investment. Each of these aspects of institutional life no
doubt has its own objects of concern and modes of operation. Actors within each locale,
namely, academics, public policy markers, and members of the institutional investment
community respectively have their own distinct ambitions, goals, and work agendas.
Nevertheless, over the last thirty years, they have come to share a common belief that
corporate governance and the financials are potentially linked. They have articulated almost
at the same time the significance of corporate governance in determining financial
performance and shareholder value. The three aspects of institutional life can be viewed as
having come together and formed a ‘loosely functioning ensemble’ (Miller & Napier, 1993:
643) that helps to rationalise the integration of corporate governance into the investment
process. The three locales are not understood to be mutually exclusive. Instead, they can be
considered as being linked to each other with movements and developments in one locale
having shaped those in the others. For example, the assessment by the OECD of its Principles
of Corporate Governance in the late 1990s has been informed by academic research on the
relationship between corporate governance and the financials. New developments in the
institutional investment community, such as the emergence of shareholder activism and
corporate governance rating, have expanded the scope of academic studies of the link
between governance issues and the financials. Since the early 21st century, the agenda for
integrating corporate governance, which is part and parcel of the notions of ‘ESG’ and
‘EFIs’, into the investment process has been articulated explicitly and widely within the
institutional investment community. Corporate governance integration has come to be seen as
an ideal to be sought, and attached to some broader aspirations in economy and society.
Analysts have been considered as having a crucial role to play in exploring ways in which
governance issues may be incorporated into investment analyses. All together, these ideas,
discourses, and aspirations have come to condition the corporate governance integration
explored by analysts, and endow the concrete tasks and routines performed by analysts with
broader meaning and wider significance.
4.
Operationalising corporate governance integration: tools and devices
15
An agenda for exploring ways in which corporate governance may be integrated into
investment analyses has been advanced by non-equity-research analysts based in some US
and UK brokerage firms. In the process of exploring this integration, ideas and discourses
related to the potential link between corporate governance and the financials widely
articulated in various locales are being further ‘carried’ by analysts and translated into
material forms. Additional tools and devices have also been created and deployed by analysts
to attempt to combine the governance assessment of a company with its broader investment
thesis. These tools and devices appear to help achieve the objective of incorporating
governance issues into the investment process.
4.1
The agenda of analysts for exploring corporate governance integration
Consistent with the perception that a consistent approach to incorporating corporate
governance and other extra-financial issues into the investment process has not yet been
formulated (The UN Global Compact, 2004: 1), analysts have considered their work in
corporate governance integration as exploratory in nature. They have proffered an agenda for
exploring ways in which governance issues may be integrated into investment analyses:
“In our research we identify some of the potential implications of corporate
governance to the investment process. […] We identify the facts and
behavioural differences impacting a company’s governance standards and
explore ways to integrate them into the investment process in a systematic
way.” (Grandmont, Grant, & Silva, 2004: 6)
The agenda proposed by analysts for exploring the integration of governance issues into
investment analyses and what they seek to achieve are aligned closely with the expectations
that other financial market participants have placed on analysts and their role in corporate
governance integration (e.g. The UN Global Compact, 2004, 2005, 2009; The UNEP FI,
2004). Meanwhile, the work performed by analysts tends to be shaped and influenced
strongly by ideas related to the potential link between corporate governance and the
financials that have been articulated widely by academics, public policy makers, and
investment institutions. As revealed from the reports produced by analysts, ideas related to
this potential link appear to be augmented and further ‘carried’ by analysts themselves. For
instance:
“[… We] believe that the quality of corporate governance can affect the
volatility of the price of risk, at the level of market, sector, and company,
and therefore, can affect the performance of investment portfolios.”
(Hudson & Morgan-Knott, 2008: 3)
Other analysts, such as Grandmont, Grant and Silva (2004: 14), expressed a similar view:
“We hypothesize that corporate governance standards affect the way a
company is run and, consequently, its profitability. It is logical to predict
that companies and boards that are focused on maximizing shareholder
value tend to be better run and have better returns.”
16
Furthermore, as consistent with the views of some commentators (Dallas & Patel, 2004;
Dallas, 2004), corporate governance has been perceived by analysts as a risk factor in the
investment process. As Hudson and Morgan-Knott (2008: 17) emphasised:
“[… C]orporate governance is potentially a significant source of risk at the
level of country, sector, and company.”
This perception of corporate governance as a risk factor has also been held by other analysts,
such as Grant (2005: 1):
“It is now increasingly accepted that corporate governance and extrafinancial risk metrics encompassing environmental and social factors are
components of a company’s equity risk premium […] Incorporating these
risk metrics [for which corporate governance is a part] into the investment
decision-making process is a necessary – and ultimately – profitable step
for portfolio managers.”
Ideas related to the potential link between corporate governance and the financials and the
belief that corporate governance as a risk factor needs to be considered, it can be argued,
rationalise the investigation undertaken by analysts into how governance issues could be
integrated into investment analyses. However, the potential link between corporate
governance and the financials has not been accepted at face value by analysts. Instead, some
analysts have expressed their mis-trust in the link. For instance, Hudson and Morgan-Knott
(2008: 4 & 15) stated that they
“[…] do not believe the governance rating would necessarily explain
potential performance in isolation […I]t is unlikely to be very easy to make
a direct association between governance and share price performance.”
As a consequence, to pursue the agenda for exploring the integration of corporate governance
into investment analyses, first of all, some analysts attempt to further examine the
relationships between corporate governance and various financial metrics, even though these
associations have been studied intensively by others, including academics13. With some of
these relationships being ascertained by analysts themselves, analysts explore ways in which
corporate governance criteria could be considered in relation to the financials in the
investment decision making process. Some analysts set out this logic explicitly:
“We quantify and measure corporate governance standards and explore the
relationships between corporate governance and risk (e.g. volatility) and
their implications for profitability, stock price performance and equity
valuation. With these links we can start to evaluate companies and equity
portfolios by comparing their inherent corporate governance risks.”
(Grandmont et al., 2004: 6)
4.2
Quantification of corporate governance
13
Although analysts are aware of academic research into the link between corporate governance and the
financials, they tend to undertake their own investigation into this link.
17
Before focusing on the link between corporate governance and the financials, first of all,
analysts attempt to get corporate governance issues quantified and measured. Some analysts
have made use of the quantification provided by corporate governance rating organisations,
such as the GovernanceMetrics International (GMI). Others, however, have developed their
own quantification and measurement of the governance procedures adopted by companies.
To quantify corporate governance issues, for instance, some analysts focused on corporate
governance factors that “[…] represent international best practices as well as being indicators
of equity risk” (Grant, 2005: 5). They identified a total of 50 corporate governance factors
and treated them as 50 data points. Each data point was weighed depending on whether it was
considered by analysts as a ‘primary’, ‘secondary’, ‘tertiary’, or ‘information’ issue of
corporate governance best practice (see Table 1 and Table 2). For example, according to
Table 1, ‘Independent Chairman’ is treated as a ‘primary’ issue. A ‘primary’ issue, according
to Table 2, is referred to as “a deliberate stance to disadvantage minority investors or a factor
identified as price/valuation sensitive”, and is given ‘3x weight’ in the process of generating a
corporate governance score for a company. For each company that analysts examined, an
overall assessment score was generated. This score was presented on an absolute scale that
ranges from 0% to 100%14. For example, Burberry was given a score of 38%, while a score
of 82% was given to BHP Billiton Plc (Grant, Grandmont, & Silva, 2004: 17 & 31). This
indicates that the governance system of BHP Billiton Plc appears to be superior to that of
Burberry by 44%. In addition to measuring absolute standards of corporate governance, the
change in the quality of the governance procedures of companies over time has also been
considered. Such change is measured by the momentum score. It was generated, as
mentioned very briefly by analysts in their report, through “[…] compare[ing] each
company’s underlying current governance data to its own available historical data”
(Grandmont et al., 2004: 9).
------------------------------------------------------------------------------------Insert Table 1 about Here
------------------------------------------------------------------------------------------------------------------------------------------------------------------------Insert Table 2 about Here
------------------------------------------------------------------------------------Quantification of corporate governance is an essential step towards the examination of the
link between corporate governance and the financials and the combined assessment of
standards of corporate governance and firm financial performance conducted by analysts.
Particularly, without quantifying corporate governance issues, statistical analyses on the
relationship between corporate governance and the financials cannot be performed. Through
the mechanisms of quantification, qualitative information about corporate governance is
transformed into quantitative information, and differences between the governance
procedures adopted by companies are transformed into magnitude and rendered
commensurate, and a common metric, namely, the corporate governance score is generated15
(cf. Espeland & Stevens, 1998).
14
Analysts did not describe in their reports how they actually derived the absolute scores based on the 50 data
points and the weights. This, however, does not affect the empirical analysis here. For this paper, it is the
mechanism adopted by analysts of quantifying corporate governance issues that is of interest.
15
Quantification of corporate governance by other financial market participants, such as corporate governance
rating organisations, has been debated and criticised over the past few years (e.g. Daines, Gow, & Larcker,
18
4.3
Ascertaining the link between corporate governance and the financials
Due to their mis-trust in the perceived link between corporate governance and the financials,
some analysts have examined and attempted to ascertain this link. By doing so, analysts
further ‘carry’ ideas related to the potential link between corporate governance and the
financials, and translate these ideas into a set of tools and devices. These tools and devices
render the link between corporate governance and the financials newly visible, material, and
somehow factual.
In order to assess the link between corporate governance and the financials, some analysts
have performed ‘portfolio analyses’ that are considered to be:
“[…the] us[ing of] financial metrics to compare best from worst performers
for a given set of […] corporate governance criteria against existing stock
portfolios. The comparison helped [with] evaluat[ing] the financial impact
of chosen criteria […].” (The UNEP FI, 2004: 7)
Some analysts, for instance, constructed two equally weighted portfolios from US S&P500
stocks based only on corporate governance criteria (Grandmont et al., 2004; Grant, 2005;
Grant et al., 2004). The first portfolio consists of stocks of companies with above average16
absolute corporate governance scores and positive momentum scores between 07/02/2001
and 30/06/2003, while the second portfolio includes stocks of companies with below average
absolute corporate governance scores and negative momentum scores in the same period17.
These analysts plotted the price performances of the two portfolios over the two-year period
in a graph (see Graph 1). This graph reveals that the portfolio which consists of stocks of
companies with above average absolute corporate governance scores and positive momentum
scores (blue trajectory) has a higher average market price than the other portfolio (red
trajectory) over the two-year period. Based on this, analysts claimed:
“[C]ompanies with above average assessment & positive momentum
outperformed those with below average assessment & negative momentum
[…] with a [price] performance differential spread between the portfolios of
18.9% [… I]nvestments in companies with the highest quality of
governance structures and behavior have significantly outperformed those
with the weakest governance” (Grandmont et al., 2004: 10).
------------------------------------------------------------------------------------Insert Graph 1 about Here
------------------------------------------------------------------------------------By constructing two portfolios based only on corporate governance criteria, tracking their
price performances, and revealing the price performance differentials through a graph, the
2010). It is beyond the scope of this paper to examine this issue in detail.
16
This ‘average’ is the average corporate governance absolute score computed by analysts for companies in the
US S&P500 index.
17
When a company receives a positive momentum score, it means that it improves its governance standard over
time. When a negative momentum score is given, it implies that the governance standard of a company
deteriorates.
19
link between corporate governance and share price performance has been constructed as a
fact. The way in which the perceived link between corporate governance and share price
performance could be assessed has been transformed. More specifically, this link has been
rendered newly visible, material, and tangible.
Portfolios constructed based on corporate governance criteria have also been deployed by
analysts in ‘event analyses’. Grant (2005: 16), for instance, has investigated whether
companies in the UK FTSE350 index announcing positive governance reforms around the
annual general meeting (AGM) date would outperform companies disclosing deteriorating
standards of corporate governance. He built two equally weighted portfolios for companies
“with the most identifiable momentum – top and bottom 5% of [the UK FTSE350] index”18.
By plotting the price performances of these portfolios in a graph (see Graph 2), Grant (2005:
17) argued that the portfolio of companies disclosing deteriorating governance standards
(grey trajectory) underperformed the portfolio of companies announcing highly positive
governance reforms (blue trajectory) over the 90-day analysis period around the AGM date.
------------------------------------------------------------------------------------Insert Graph 2 about Here
------------------------------------------------------------------------------------In this case, another fact is constructed, namely, changes in the governance practices adopted
by companies can have an impact on share price performance. This fact is constructed
through the building of two portfolios based only on corporate governance criteria, the
tracking of their price performances over time, and the visualisation of the price performance
differentials in a graph. Once again, analysts have translated abstract ideas related to the
potential link between corporate governance and the financial into concrete and tangible
devices. These ideas have, once again, been transformed into a material and newly visible
form.
Analysts have also attempted to assess the link between corporate governance and the
financials in a statistical manner through ‘regression analyses’. Similar to academic
researchers, analysts have made use of regression analyses to assess the relationships between
standards of corporate governance achieved by companies that are presumably captured by
the corporate governance scores and various financial metrics such as share price
performance, valuation, and accounting performance (Hudson & Morgan-Knott, 2008: 15).
Some analysts argued that “[…] corporate governance standards affect the way a company is
run and, consequently, its profitability” (Grandmont et al., 2004: 14). Accordingly, they
focused on the relationship between corporate governance and profitability for companies
within the UK FTSE350 index. Three measures of profitability were considered: ‘Return on
Equity’ (ROE), ‘Return on Assets’ (ROA), and ‘Earnings Before Interests, Tax, Depreciation
and Amortisation Margin’ (EBITDA Margin). The quality of the governance procedures
adopted by companies was measured by the absolute corporate governance scores that these
analysts have developed. In order to investigate the relationship between firm profitability
and corporate governance in a statistical manner, these analysts ran regressions for the two
variables, with profitability being the dependent variable and corporate governance being the
independent variable. The regression model, simply speaking, appears to be:
18
This means that one portfolio comprises stocks of companies whose momentum scores are higher than those
received by 95% of the companies in the UK FTSE350 index, and the other portfolio includes stocks of
companies whose momentum scores are lower than those received by 95% of the companies in the same index.
20
Profitability =  +  Corporate Governance +  19
These analysts found that the corporate governance scores received by companies are
positively correlated to all three measures of profitability. For instance, for the relationship
between ROE and corporate governance, the regression result is ROE = 0.2518Corporate
Governance + 0.1128, where the coefficient for the independent variable is positive
(Grandmont et al., 2004: 14). The relationships between each profitability measure and
corporate governance were also represented in graphs. As revealed from the graph that
depicts the result of the regression between ROE and corporate governance (see Graph 3), the
regression line is upward sloping. This further confirms that ROE and corporate governance
tend to be positively correlated. With the deployment of regression analyses, the link between
firm profitability and corporate governance is established numerically and statistically. This
link has also been visualised with the regression lines being plotted in graphs. In this way,
another new visibility of the link between corporate governance and the financials has been
created. Ideas related to the potential link between corporate governance and the financials
have once more been translated into a material and tangible form.
------------------------------------------------------------------------------------Insert Graph 3 about Here
------------------------------------------------------------------------------------However, the link between corporate governance and the financials cannot always be
established as originally expected. For instance, although corporate governance and the price
earnings ratios (P/E) have been perceived to be positively correlated, Walker (2008: 1) noted
that:
“[…] within the UK life insurance sector there appears to be a decreasing
relationship between the governance rating and price earnings ratios (P/E),
although there is no statistically significant data to back up this
conclusion.”20
The results from the investigation of the link between corporate governance and the
financials have been viewed by analysts to be sector-specific. They also depend on the level
of analysis, namely, individual firm level, industry level, or market level. The examination
conducted by some analysts of the association between corporate governance and stock
valuation for companies within the US S&P500 index clearly demonstrates this. Three
measures of valuation were considered: Price to Earnings, Price to Book Value, and Price to
Cash Flow. The relationships between each of these measures and standards of corporate
governance presumably captured by the corporate governance scores developed by these
analysts were studied. These analysts noted that:
“[…] while for the Food & Staples Retailing sector the relationship shows
that companies with higher governance standards trade at higher valuation
multiples, the same cannot be said for the Capital Goods sector.”
(Grandmont et al., 2004: 22)
19
As compared to those models developed by academics, analysts deployed a rather simplistic model. Analysts
did not comment on the validity of this model in their report. It appears that analysts have concentrated
exclusively on the relationship between firm profitability and corporate governance and excluded any other
variable.
20
Walker (2008) examined only seven UK life insurance companies.
21
When summarising the results from their regression analyses (see Table 3), Grandmont et al.
(2004: 23) further concluded that:
“[…] there is no US market-wide correlation between corporate governance
and equity valuations.”
-------------------------------------------------------------------------------------Insert Table 3 about Here
-------------------------------------------------------------------------------------In short, not all perceived relationships between corporate governance and financial metrics
can be established or ascertained. Nevertheless, analysts still believe that corporate
governance has “[…] an impact on corporate results and longer term equity performance”
(Grandmont et al., 2004: 24). Those relationships between corporate governance and various
measures of the financials that have been ascertained by analysts appear to reinforce the idea
that governance issues are needed to be incorporated into the investment process. Although
the links established by analysts seem to be fabricated in some cases, these links appear to
help justify and rationalise the integration of governance criteria into investment analyses.
Furthermore, the lack of correlation between corporate governance and market valuation of
stocks for companies in some industries has been considered by some analysts as being
induced by the inability of investors to incorporate governance assessments into valuation
models on a timely basis due to lack of efficient and effective tools (Grandmont et al., 2004:
24). It is somehow for this particular reason that these analysts have claimed to develop
certain frameworks that may help portfolio managers and investors to “incorporate
governance systematically throughout stock selection” (Hudson & Morgan-Knott, 2008: 1).
4.4
Combining corporate governance with the financials
Analysts attempt to combine assessments of corporate governance and the financials mainly
on a case-by-case basis. For each case, analysts examine the corporate governance standard
of a company in relation to its broader investment thesis driven by profitability, equity
valuation, and stock price performance. The general principle is to seek an alignment between
the governance assessment of a company and its broader investment thesis.
Such an alignment occurs, according to analysts, when a company whose corporate
governance rating is above sector average achieves above sector average profit, market
valuation, and stock price performance, or vice versa. For such an ‘alignment’, the
governance standard of a company can be considered as being consistent with its financial
performance. When the financials of a company and its governance profile are not seen as
being in line with each other, as suggested by analysts, further investigation will be needed to
determine whether or not the company is worthy of being chosen for investment. The
principle of ‘alignment’ is informed largely by the positive link between corporate
governance and the financials that has been perceived strongly by analyst and other financial
market participants, or that has been ascertained by analysts. This principle is adopted
irrespective of how the governance assessment is performed, i.e. either by corporate
governance rating organisations or by analysts themselves. Analysts Hudson and MorganKnott (2008: 23), who have drawn upon the corporate governance ratings provided by the
GMI, stated that:
22
“[… We] look for an alignment between the overall governance rating
according to GMI, and the broader thesis driven by fundamentals,
valuation, and/or share price performance, as appropriate.”
Hudson and Morgan-Knott (2008) have provided illustrations of the combined analysis of
corporate governance and the financials by focusing on companies in the beverage sector. It
was noted that Britvic was given high scores by the GMI. From a purely financial
perspective, DeRise (2008, quoted in Hudson & Morgan-Knott, 2008), an equity research
analyst who values stocks, suggested that “Britvic is cheap and defensive”. Accordingly,
Hudson and Morgan-Knott (2008) considered the governance assessment provided by the
GMI for Britvic as aligning with its broader investment thesis. They viewed the relatively low
level of governance risk for Britvic indicated by the GMI rating scores as being in line with
the ‘buy’ recommendation offered by DeRise. As Hudson and Morgan-Knott (2008: 23)
commented:
“Britvic is not only “cheap and defensive”, but also brings the additional
comfort of a strong governance profile.”
Nevertheless, inconsistencies between corporate governance assessment and broader
investment theses appear. While Carlsberg was given very low scores by the GMI, DeRise
(2008, quoted in Hudson & Morgan-Knott, 2008) still recommended investors to buy its
shares. DeRise provided a justification for his ‘buy’ recommendation which Hudson and
Morgan-Knott (2008) endorsed and re-produced in their own report:
“Though Carlsberg has a low governance rating, we continue to recommend
the stock as Buy. […] we believe Carlsberg's growth story from S&N cost
synergies and ongoing restructuring of the “old” Carlsberg business is
compelling and not factored into the current share price.” (DeRise 2008,
quoted in Hudson & Morgan-Knott, 2008)
Analysts have demonstrated that the combined assessment of corporate governance and the
financials is pursued on a case-by-case basis. Aligning the corporate governance assessment
of a company and its broader investment thesis with each other is a fundamental principle.
This principle has been viewed by analysts as being operationalised with the consideration of
the merits of individual situations.
A more or less similar approach is adopted by other analysts in their exploration of
integrating corporate governance into investment analyses, but with some additional tools and
devices deployed. For instance, Grant et al. (2004) have explored and demonstrated ways in
which corporate governance information could be used in conjunction with financial
information in the selection of stocks for investment:
“Our objective is to incorporate the corporate governance risk factor into
the investment decision making process. Therefore, we add corporate
governance information as a further layer to traditional fundamental
analysis in order to select stocks for inclusion (or exclusion) from
portfolios. We contend that adding corporate governance to traditional
fundamental analysis allows us to more accurately estimate the potential
risk-reward of a security. […] This analysis allows us to identify companies
23
whose governance-valuation-profitability measures are, in our view,
inappropriately priced by the markets, allowing us to generate long and
short stock ideas.” (Grant et al., 2004: 57)
The ‘governance-valuation-profitability’ analyses involve combined assessments of either
corporate governance and firm profitability, or corporate governance and equity valuation.
They are performed with the deployment by analysts of some representational devices, such
as the ‘governance-to-profitability’ and ‘governance-to-valuation’ graphs. These graphs
represent the relationship between the corporate governance standard of a company and its
profitability or valuation in relation to that of the other company in the same industry.
For instance, analysts Grant et al. (2004) adopted the ‘Governance-to-profitability’ analyses
to compare the investment potentials of two stocks of companies from the general retailers
sector, namely, Signet Group Plc and Burberry Group Plc. Using ‘Return on Assets’ (ROA)
as a measure of profitability, these analysts developed a ‘corporate governance vs. ROA’
graph (see Graph 4). The horizontal axis of this graph indicates the governance scores that
analysts have issued to companies in the general retailers sector, and the vertical axis
measures the ROA of these companies. The horizontal line in the middle (left half in red and
right half in blue) indicates that the average ROA for companies in the general retailers sector
was approximately 10% in 2003. The vertical line in the middle (upper half in blue and lower
half in red) indicates that the average corporate governance score for this sector was roughly
54% in 2003. Since standards of corporate governance and ROA were perceived to be
positively correlated, analysts considered that a company whose corporate governance score
is above the sector average would have an above sector average ROA, and that it would
appear in the top right rectangle of the graph. A company whose corporate governance score
is below the sector average would be expected to have a below sector average ROA, and it
would appear in the bottom left rectangle. For these two scenarios, the corporate governance
assessment and the broader investment thesis can be thought of as aligning with each other.
When a company appears in the top left or the bottom right part of the graph, analysts tended
to view the governance assessment of this company and its broader investment thesis as being
inconsistent.
------------------------------------------------------------------------------------Insert Graph 4 about Here
------------------------------------------------------------------------------------According to Graph 4, Signet Group Plc is located in the top right rectangle. This suggests
that the governance standard of Signet was consistent with its profitability measured by ROA
in 2003. Both the governance score received by Signet and its ROA exceeded the respective
sector averages. However, Burberry Group Plc appears in the top left part of the graph. This
indicates that the governance standard of Burberry and its investment thesis related to
profitability did not align with each other in 2003. The quality of the governance procedures
of Burberry was significantly below the sector average, although Burberry achieved an above
sector average ROA in 2003. Together with the similar insights revealed from the other
‘governance-to-profitability’ analyses that utilised ‘Return on Equity’ (ROE) and ‘Earnings
Before Interests, Tax, Depreciation and Amortisation Margin’ (EBITDA Margin) as
measures of profitability, Grant et al. (2004: 64) noted that:
“[…O]n a governance-to-profitability measurement Signet Group Plc
shows similar profitability measures to Burberry Group Plc while enjoying
24
much better governance standards. In other words, when compared to
Burberry Group Plc, Signet Group Plc offers similar levels of profitability
for a lower corporate governance risk.”
Based on the ‘governance-to-profitability’ analyses, between Signet and Burberry, analysts
suggested that Signet shall be the target for ‘long investing’ and Burberry for ‘short
investing’21. This investment strategy is further reinforced by the results of a series of
‘governance-to-valuation’ analyses. Grant et al. (2004) considered three measures of equity
valuation: ‘Price to Earnings’ (P/E) ratio, ‘Price to Cash Flow’ (P/CF) ratio, and ‘Price to
Book Value’ (P/BV) ratio. The logic behind the ‘governance-to-valuation’ analyses is exactly
the same as that for the ‘governance-to-profitability’ analyses. The ‘governance-to-valuation’
analyses reveal that, for both Signet and Burberry, their corporate governance standards were
inconsistent with their share valuations in 2003. As Grant et al. (2004: 65) further explained:
“[…] Signet Group Plc trades at a significant valuation discount to the
sector on a P/E and P/BV basis while enjoying a much lower governance
risk factor than the average company in the sector. Conversely, Burberry
Group Plc trades at valuation rates that are much richer than the sector
average while having a higher corporate governance risk than the sector
average.”
As demonstrated by analysts, on the basis of the results generated from the ‘governancevaluation-profitability’ analyses, investors who ‘long’ the shares of Signet Group Plc and
‘short’ those of Burberry Group Plc would potentially make a profit. This investment
strategy is informed simultaneously by the corporate governance assessment and the broader
investment thesis. In particular, the ‘governance-to-profitability’ and ‘governance-tovaluation’ analyses and graphs bring corporate governance information and financial
information together, and render the integration of governance criteria into investment
analyses possible and operational. These tools and devices help realise the ideal of integrating
the category of corporate governance into the investment decision making process. Both the
governance and the financials of companies are inscribed into a form that companies as
potential investment objects could be focused on, discussed, compared, and subsequently
acted upon. The ‘governance-to-profitability’ and ‘governance-to-valuation’ analyses and
graphs enable corporate governance risk to be assessed within centres of investment decision
making (cf. Latour, 1987; Rose & Miller, 1992), where the investment potentials of
companies could be assessed, and where investment decision making could possibly be
facilitated. These analyses and associated graphs, however, are developed and put into place
by analysts who have taken the initiative to seek to bring corporate governance and the
financials together. The idea of integrating corporate governance into investment analyses has
been operationalised, and been translated by analysts into material, tangible, and concrete
devices.
4.5
Summary
For ‘long investing’, according to Grant et al. (2004), the stocks of a company with an above average
governance assessment, improving momentum, and low valuation will be bought by investors. For ‘short
investing’, investors may sell the stocks of a company whose governance risk is high (i.e. below average
assessment with declining momentum) and that trade at valuation premiums.
21
25
Some analysts have proposed an agenda for exploring the integration of corporate governance
into investment analyses. They have created and deployed a bundle of tools and devices to
get corporate governance quantified, ascertain the link between corporate governance and the
financials, and seek to incorporate governance risks into investment analyses. Analysts have
translated ideas and discourses pertaining to corporate governance integration into material,
concrete, and tangible devices. Analysts have also served as a link between the two
categories, namely, corporate governance and financial performance, bringing them together
in the investment process.
Analysts have explored and demonstrated different ways in which combined analysis of
corporate governance and the financials could be performed. The question of whether these
mechanisms for corporate governance integration will be taken up subsequently by
institutional investors and fund managers is beyond the scope of the present study to address.
Nevertheless, the work performed by analysts in the field of corporate governance integration
has been recognised. For instance, in a recent report issued by The United Nations Global
Compact (2009), titled “Future Proof? Embedding Environmental, Social and Governance
Issues in Investment Markets”, analysts were praised for their achievement
“[…] in developing the analytical frameworks and demonstrating the
rationale for [corporate governance] integration in investment research […
analysts] have demonstrated that quantifying financial impacts of
[environmental, social, and governance] issues, in spite of their often
uncertain and long-term character, is absolutely within the reach of the
analysts’ profession.” (The UN Global Compact, 2009: 8 & 23)
5.
Discussion and conclusion
This paper has focused on one important component in the investment chain, namely, sellside financial analysts, that has been considered as having a crucial role to play in the
integration of corporate governance into the investment process. Some of the ways in which
some US and UK based corporate governance/ESG/SRI analysts based in the equity research
divisions of brokerage firms have explored the integration of governance issues have been
discussed in light of theoretical concepts of ‘programmatic’, ‘technological’, and ‘carrier’. As
an emerging form of economic calculation in financial markets, the integration of corporate
governance into investment analyses has been viewed as being constituted by an ensemble of
ideas, discourses, tools, devices, as well as calculative agents. Calculative ideas, calculative
devices, and calculative agents are equally important components of the particular form of
economic calculation under investigation here. In particular, analysts, it is argued, play an
important role in carrying calculative ideas surrounding corporate governance integration that
have been widely articulated in financial markets, and in turning them into calculative
devices.
The concrete tasks and routines performed by analysts in their exploration of corporate
governance integration have been a focus of the present study. In particular, this paper has
examined some material and concrete tools and devices deployed by analysts to make the
integration of governance issues into investment analyses possible and operational. These
include: corporate governance scores, portfolio analyses, event analyses, regression analyses,
‘governance-to-profitability’ analyses, ‘governance-to-valuation’ analyses, as well as various
26
visual devices. These tools and devices have transformed ways in which a domain could be
looked at and examined (cf. Latour, 1987; Rose & Miller, 1992). More specifically, these
tools and devices have been considered as allowing the link between corporate governance
and the financials to be established and ascertained. This link, originally perceived to be
potential and hypothetical, is rendered newly visible, material, calculable, and factual.
Furthermore, corporate governance, which appears to be concealed in traditional investment
analyses, is revealed and brought together with the financials in the integration. The
‘governance-to-profitability’ and ‘governance-to-valuation’ analyses and graphs deployed by
analysts make visible corporate governance as a risk factor in the investment decision making
process. In short, the present study does not deny the ‘materiality’ and ‘technicality’ of
economic calculation (Muniesa et al., 2007). Instead, it adds to the economic sociology
literature by further emphasising the role of the ‘technological infrastructure’ for a particular
form of economic calculation.
This paper has gone beyond examining the ‘technological’ dimension of the corporate
governance integration explored by analysts to have attended also to its ‘programmatic’
aspect. This relates to ideas, discourses, ideals, and aspirations that shape the concrete tasks
performed by analysts and endow the technical work conducted by analysts with broader
meaning and wider significance. This paper has documented that ideas and discourses related
to the potential link between corporate governance and the financials have been articulated in
academic research, public policy making, and institutional investment in the last two decades
of the 20th century. From the early 2000s, the idea that corporate governance needs to be
considered in asset management, securities brokerage services, and buy-side and sell-side
research functions started to surface. This paper has also noted that the integration of
corporate governance into investment analyses has come to be viewed as being attached to
some wider objectives and aspirations in the economy that it can help achieve. For instance, it
is considered that combining governance issues with the financials in the investment process
can potentially “contribute to stronger and more resilient investment markets” (The UN
Global Compact, 2004: i). In short, programmatic and technological dimensions of corporate
governance integration, it is argued, go hand in hand here as elsewhere, with each dimension
being the condition of operation for the other (cf. Mennicken et al., 2008; Miller, 2008b: 25).
The conceptualisation that economic calculation is constituted by both ‘programmatic’ and
‘technological’ dimensions was initially advanced by accounting scholars who are informed
by the Foucauldian perspective of the governmentality literature (Mennicken et al., 2008;
Miller, 2008a, 2008b; Power, 1997). This paper has extended this conceptualisation by
investigating programmes and ideas, as well as technologies and instruments, pertaining to an
emerging form of economic calculation in financial markets. It has demonstrated how
scholars in economic sociology and social studies of finance could borrow conceptual lenses
from their counterparts in social studies of accounting in order to understand the preconditions and implications of a particular form of economic calculation (cf. Mennicken et
al., 2008; Vollmer, Mennicken, & Preda, 2009).
Departing from an examination of programmatic and technological aspects of a particular
form of economic calculation, this paper has taken one step further to have addressed the role
played by calculative agents. In exploring ways in which corporate governance may be
integrated into investment analyses, it is indeed the analysts who elaborate upon ideas and
rationales surrounding corporate governance integration, and who meanwhile deploy concrete
devices and instruments to render the integration possible and operational. To make sense of
this more or less transformative capacity exerted by analysts, this paper has referred to the
notion of ‘carrier’ (Sahlin-Andersson & Engwall, 2002; Scott, 2003; see also Czarniawska &
27
Joerges, 1996; Czarniawska & Sevon, 2005). In light of this conceptual lens, analysts have
been thought of as serving as a link between programmatic dimension of corporate
governance integration and technological aspect, and as translating calculative ideas into
calculative devices. More specifically, analysts have been viewed as ‘carrying’ ideas related
to the potential link between corporate governance and the financials as well as the idea of
incorporating governance issues into the investment decision making process. However,
analysts have materialised these ideas, and inscribed them into objects that are sufficiently
tangible to be seen and touched (cf. Czarniawska & Joerges, 1996; Czarniawska & Sevon,
2005). The material and concrete tools and devices that analysts have created and deployed
can even be conceptualised as ‘technologies of carrier’ with which carriers edit, modify,
transform, and re-present calculative ideas, rationales, and logics (cf. Sahlin-Andersson &
Engwall, 2002: 16). In short, the conceptualisation that economic calculation is constituted by
‘programmatic’ and ‘technological’ dimensions tends to downplay the role of calculative
agents. This paper has explicitly brought calculative agents back within the study of
economic calculation and advanced a mediating role that they can play between the two
dimensions.
This paper has important implications for future research. First, the paper has concentrated
mainly on ‘non-equity-research analysts’ who appear to be the pioneers for exploring and
demonstrating how governance issues may be integrated into investment analyses. The extent
to which and how the output generated by these analysts will be utilised by their counterparts
in the equity research divisions, namely, equity research analysts, for formulating investment
recommendations, as well as by institutional investors and fund managers for making
investment decisions require further investigation. More generally, how these different actors
interact in the field of corporate governance integration is an interesting issue to be addressed
in future research. Second, this paper has examined both programmatic and technological
aspects of the corporate governance integration explored by analysts. Future research may
investigate in what ways the technologies deployed by analysts change the contents of the
programmes that these technologies have come to connect with; how specific tools and
devices deployed by analysts potentially impact upon those ideas and aspirations that gave
significance to corporate governance integration in the first place; and whether analysts
develop new tools and devices, and to what extent and how new technologies and new
programmes possibly co-emerge. Third, although it has been recognised that the integration
of governance issues into investment analyses is “absolutely within the reach of the analysts’
profession” (The UN Global Compact, 2009: 23), the extent to which and ways in which
analysts have developed a system of knowledge and expertise in this new field may deserve
further systematic enquiry. The extent to which the corporate governance integration
performed by analysts represents an expansion of their expertise and knowledge claims may
also be conceptualised in future studies (cf. Abbott, 1988). Additionally, future research
could possibly explore the extent to which the analyst profession has become a ‘hybrid’
profession (Kurunmäki, 2004), and the process through which they have borrowed and
adapted tools for integrating governance criteria into investment analyses that may well be
developed initially by other professional groups. Lastly, this paper has described three aspects
of institutional life in which ideas related to the potential link between corporate governance
and the financials have been articulated: academic research, public policy making, and
institutional investment. Like analysts, academics, public policy makers, and institutional
investors can possibly be thought of as carriers of calculative ideas. Future research could
investigate in detail how these different carriers interact with each other and how a discursive
field for articulating the potential link between corporate governance and the financials has
formed and transformed over time (cf. Sahlin-Andersson & Engwall, 2002).
28
Table 1
Figure 13: Governance factors segregate by Pillar and degree of significance
Director Independence
Information Disclosure
Chairman
Information
Directors state compliance with Combined Code
CEO
Secondary
Individual directors attendance is disclosed
Secondary
Primary
Secondary
Independent Chairman
Primary
Compensation /policy changes fully explained
Number of board members
Tertiary
Fully independent audit com w/ at least 3 memb
Number of independent directors
Primary
Total non-audit fees as % of total fee
CEO other directorships/positions
Secondary
Number of audit committee meetings last FY
No director attends more than 4 board meetings
Secondary
Audit Com has right to engage outside advisors
Directors attend more than 4 boards
Secondary
Audit Com includes at least 1 financial expert
Secondary
Number of board meetings in last FY
Secondary
Primary
Secondary
Tertiary
Tertiary
Political contributions (GBP)
Information
Number of directors with 9+ years tenure
Tertiary
Process for board appraisal is disclosed
Secondary
There is a named senior independent director
Tertiary
Process for succession planning is disclosed
Secondary
% independence: Audit, Nom., Remun. Comt.
Primary
Transparent recruiting system for new directors
Secondary
Shareholder Treatment
Corporate Compensation
Each ordinary share has equal voting rights
Primary
CEO appointment year
Information
Other share type
Tertiary
CEO's last FY salary
Information
Secondary
CEO's last FY bonus
Information
Primary
CEO's other emoluments
Information
There is no controlling shareholder
Secondary
CEO's share option gains
Information
No persons have right to designate directors
Secondary
CEO's LTIP gains
Information
Authorised/Issued shares
All directors face election every year
All new LTIPs/ESOs are put to vote
Tertiary
CEO's pension gains
Information
All voting conducted equitably and by poll
Tertiary
CEO total compensation
Information
Issued shares under option
Primary
All components of salary are fully disclosed
Secondary
Directors required to build up sig. equity stake
Directors interests
No director has a contract in excess of 1 year
Secondary
Comp. liability on termination of contract stated
Tertiary
Primary
All directors with 1+ year of service own stock
Secondary
Secondary
Maximum potential awards are disclosed
Tertiary
Source: PIRC, Deutsche Bank estimates and company data
Modified from: Grant, Grandmont & Silva (2004: 38)
29
Table 2
The Hurdle for Primary, Secondary and Tertiary Issues of Corporate Governance
Best Practice
Primary issues
3 x weight
A deliberate stance to disadvantage minority investors or a
factor identified as price/valuation sensitive
Secondary issues
2 x weight
A failure to follow international best practice standards
Tertiary issues
1 x weight
A failure to follow pro-active corporate governance policies
Information issues
no weight
Of relevance to institutional investors but not scored
Modified from: Grant, Grandmont & Silva (2004: 37)
30
Table 3
Figure 34: Governance impact on equity valuation, by S&P 500 sector
P/E
P/BV
P/CF
Semiconductors & Semiconductor Equipment
Positive
Positive
Positive
Food & Staples Retailing
Positive
Positive
Positive
Materials
Positive
Positive
Positive
Technology Hardware & Equipment
Positive
Positive
Positive
Retailing
Positive
Positive
Positive
Food Beverage & Tobacco
Positive
Positive
Positive
Software & Services
Positive
Positive
Negative
Telecommunication Services
Positive
Neutral
Negative
Utilities
Neutral
Neutral
Neutral
Consumer Durables & Apparel
Neutral
Neutral
Negative
Commercial Services & Supplies
Negative
Neutral
Neutral
Pharmaceuticals & Biotechnology
Negative
Positive
Negative
Capital Goods
Negative
Neutral
Negative
Energy
Negative
Neutral
Negative
Media
Negative
Neutral
Neutral
Health Care Equipment & Services
Negative
Negative
Negative
Source: Deutsche Bank Securities Inc. estimates and company information
Modified from: Grandmont, Grant, & Silva (2004: 23)
31
Graph 1
Source: Grandmont, Grant, & Silva (2004: 10)
32
Graph 2
Source: Grant (2005: 17)
33
Graph 3
Source: Grandmont, Grant, & Silva (2004: 14)
34
Graph 4
Source: Grant, Grandmont, & Silva (2004: 64)
35
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