The value of a company increased by 4 percent for each attribute of better governance that the firm implemented, according to a working paper, "Did New Regulations Target the Relevant Corporate Governance Attributes?" by Reena Aggarwal and Rohan Williamson, who are both professors at the McDonough School of Business at Georgetown University.

"The bottom line is we came to the conclusion that there is a very strong positive relationship between firm value and corporate governance," Aggarwal told a Feb. 15 webcast hosted by the ISS Center for Corporate Governance.

By adopting 10 more governance attributes, firms increased their value, as measured by Tobin's Q, by an average of 40 percent, the study found. "That has statistical significance, which becomes economically significant," Aggarwal said.

The average Tobin's Q ratio for the sample was 1.13. Tobin's Q is the market value of the firm divided by its book value on a replacement cost basis. The study examined a total of 64 governance attributes, using ISS Corporate Governance Quotient data on 5,300 companies.

Even before the passage of the Sarbanes-Oxley Act of 2002, the market put a premium on companies that voluntarily adopted good corporate governance practices, the Aggarwal-Williamson study found. Since the law took effect, firms that have adopted good governance practices beyond what was mandated have received higher valuations, the researchers found.

"Firms that voluntarily go beyond the mandatory requirement in adopting good corporate governance practices enjoy higher market valuations," Aggarwal said.

Aggarwal, who is also a visiting professor of finance at the Sloan School of Management at the Massachusetts Institute of Technology this year, spoke on a panel moderated by Stephen Deane, director of the ISS center. The panel also included Gavin Grant, director of global corporate governance research at Deutsche Bank, and John Deosaran, ISS vice president for corporate ratings. The webcast can be downloaded for replay at: http://www.issproxy.com/cgq_webcast/index.jsp

Governance Is a "Leading Indicator"
"We agree with the findings that the market has found a way to differentiate between the stocks of well-governed and the poorly governed companies," Grant said about the Aggarwal-Williamson paper. "But to us, it was unclear whether investors were reacting to events and therefore losing performance, or whether they were correctly anticipating the price implication of governance events and therefore being ahead of the curve and adding potentially to their portfolio returns."

Over the past four years, Deutsche Bank has developed a model that offers investors ways to integrate corporate governance into investment decision-making by linking a quantified measure of governance risk to traditional equity valuation metrics. The bank has applied this model in research on markets in North American and Europe in published reports entitled "Beyond the Numbers," and will shortly issue a similar study of Asian markets.

Grant said Deutsche Bank analysts look for companies that introduce board-related corporate governance improvements. They also track these companies' announcements of share buybacks, sell-offs of underperforming assets, and the redeployment of capital to more profitable businesses. The market generally picks up on the capital reallocation, and puts a premium on the stock price, Grant said.

"We believe that corporate governance is actually the leading indicator to that capital reallocation by introducing better directors and improved corporate governance standards at the board level," Grant said.

Deosaran said that recently there has been considerably more research, both survey and quantitative analysis, as investors seek to understand the link between governance and performance. He pointed to a recent article by Jay W. Eisenhofer and Gregg S. Levin of the law firm of Grant & Eisenhofer, in the Sept. 23 issue of Corporate Accountability Report, published by the Bureau of National Affairs. The article, "Does Corporate Governance Matter to Investment Returns?" reviews some two dozen recent studies on this topic.