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When It’s Governance That Creates Value

The Observatory on Corporate Governance Excellence in Italy, established by The European House – Ambrosetti with the aim of coming up with concrete proposals for improving the corporate governance of Italian companies, conducted the third edition of a survey of a qualified sample of national and international institutional investors who manage overall more than 4.4 trillion euros, asking them in particular what criteria they adopted in selecting potential targets to invest in.

When It’s Governance That Creates Value

When It’s Governance That Creates Value

by Valerio De Molli and Marco Visani

Read the Sole 24 Ore article

Why should a company ensure separation between ownership and control, equip itself with a competent board of directors, ensure a remuneration system that orients toward the right behaviors, provide for effective risk management and professionalize the organization? Why, in short, should a company adopt a good corporate governance system?

A first answer could be, very briefly, that this ensures effective, efficient management. Although this explanation may seem simplistic at first sight, it needs to be examined from several angles.

First of all, an effective governance system is one of the main investment selection criteria used by market institutional operators.

In 2017, the Observatory on Corporate Governance Excellence in Italy, established by The European House – Ambrosetti with the aim of coming up with concrete proposals for improving the corporate governance of Italian companies, conducted the third edition of a survey of a qualified sample of national and international institutional investors who manage overall more than 4.4 trillion euros (a figure that is almost seven times the capitalization of all companies listed on the Italian stock exchange), asking them in particular what criteria they adopted in selecting potential targets to invest in.

Quality of the governance system is the third investment criteria after quality of management, i.e. the top resources that lead the company, and company fundamentals, linked substantially to the business, geographic markets of reference, sales channels and efficiency.

So governance counts. A lot.

In the future, the quality of corporate governance, together with the level of social and environmental responsibility, will become an ever more important criterion in institutional investors’ evaluation process. Attracting private capital is even more important for a country like Italy, which above all has very strong budget constraints and therefore can’t leverage public investments to relaunch growth and employment.

Very succinctly, if a company wants to benefit from private investments, it must give itself an effective, efficient governance system: this goes for the big listed companies but perhaps it is even more important for small and medium-sized enterprises, which would thus succeed in diversifying their sources of financing away from Italy’s typical bank-centered financing.

Secondly, a good corporate governance system increases the probability that a company attain value creation performance that is higher than its competitors. For each Italian company listed in the FTSE MIB, Mid Cap and Star segments, the Observatory of The European House – Ambrosetti regularly monitors the relationship between positioning in the Index of Governance Excellence (EG Index), a complex indicator with more than 30 considered parameters which summarizes the quality of a company’s corporate governance, and performance in terms of relative Total shareholders’ return (Tsr). Tsr measures the yield of the capital invested by a shareholder over a certain period, taking into account the distribution of dividends in the same time frame. For this purpose, 443 companies listed in Italy, France, Germany, Spain and the U.K. were analyzed. The relative Tsr was then calculated with respect to a European peer reference group for each company of the sample in order to sterilize the trends of the various sectors.

From our analysis it emerges that, in more than 70% of cases, consistency is found between the positioning on the EG Index and that for relative Tsr: the companies that invest in the quality of corporate governance are those that have greater probabilities of outperforming their European competitors. This evidence, confirmed in the last four years in which the analysis was carried out, is true for all stock exchange segments (FTSE MIB, Mid Cap, Star). In sum, companies that have a good positioning in terms of governance system quality outperform their competitors, while companies that are at the bottom of the EG Index classification have high probabilities of recording lower Tsr results than competitors.

For example, if attention is focused on the major listed companies in Italy, that is, those belonging to the FTSE MIB segment, it is observed that in 77% of cases there is consistency between positioning within the 2017 EG Index and the ranking for relative Tsr. So, what are the areas that companies should focus on most in order to improve their governance systems, and what are the areas that companies should pay most attention to in order to create more value and attract more investments?

  • Equip themselves with an adequate board of directors possessing the appropriate professionalism and skills, which allows constructive debate aimed at making the best decisions.

  • Have a planning, control and risk management system that enables companies to govern growth more effectively.

  • Put in place a remuneration system aligned with the company strategy, which allows orienting the right behaviors towards long-term value creation and attracting the professional expertise required.

  • Define adequate policies for attracting the best talent.

  • Establish clear, transparent methods for defining objectives and communicating results.

“Good governance” therefore not only makes companies more attractive to potential investors, but also ensures sustainable growth and, over the long term, guarantees the company’s continuity and value creation.

Not by chance, the “mantra” of The European House - Ambrosetti is: without investment there are no jobs, without jobs there is no growth and without growth there is no future.


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