Investors, customers, communities, employees, and other stakeholders will seek the economic high ground and support those firms that demonstrate alignment with their goals. The last place owners expect their companies to be featured in on the front page of major financial dailies. Usually front page corporate news is not good. Often focusing on traumatic events, management is routinely challenged for having allowed or even actively promoted poor, questionable, or even illegal performance.

Moreover, long-term consistent high performance is a challenge at which few firms excel. In the dynamic fast moving world in which global firms operate it is difficult to grease all the corporate wheels operationally. Differing cultures, societal norms, and financial metrics conspire to challenge the capabilities of even the most experienced executive. Organizational structuralists have long understood the need to localize and focus segments of large multi-faceted global organizations. Over time a complex set of policies and procedures sought to ensure accountability and compliance with laws and norms of ethical behavior. Much like back office accounting and human resource systems, these guidelines were seen as a cost of doing business.

This need not be the case. When governance is codified and focused to meet the trials facing the twenty-first century firm, the evidence suggests value can be derived. Value is two-fold. Immediate and sustained assurance that employee wrongdoing is restrained is coupled with the development of a long-range reputation. Studies have shown that strong governance can effect abnormal returns on average, 8.5 percent per year.(1) Given recent equity performance, this is not an insignificant amount (the number in this study is statistically significant).

Far from a drain on managerial resources, is there any other single year-on-year activity that will drive this level of equity performance? Logically, since the board and the CEO are charged with growing shareholder returns it stands to reason that actions that generate high returns would place high in the executive portfolio.

Specifically, firms with weaker shareholder rights have higher capital expenditures coupled with lower sales growth and lower profits all the while making more acquisitions. The math is quite simple – greater cash outflow and less cash inflow. Moreover, since many acquisitions are dilutive and required significant executive attention, the geometric effect of cash neutral to decline and inattention to current operations is predictable and measurable by The Street. Even accretive acquisitions place a near-term strain on the organization.

Shareholders and regulators are expecting better governance and firms must take these concerns seriously. Shorted sighted management will balk offering a host of excuses. When driven by near-term bonuses, they may be right. On the other hand, the long-term value of stock options will be greater when good governance is part of the competitive arsenal.

Notes:
(1) Gompers, Paul A., Ishii, Joy L., and Metrick, Andrew. (2001, July). Corporate Governance and Equity Prices. http://icf.som.yale.edu/Conference-Papers/Fall2001/gov.pdf