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Unravelling the Impact of Corporate Governance on Performance

According to the OECD Principles of Corporate Governance, Corporate governance involves a set of relationships between a company’s management, board, shareholders and stakeholders. In one study, S&P Global (2019) found that companies with low Governance Scores underperformed those with top quintiles by about 2% annually between 2000 and 2017 in the S&P Dow Jones Indices.


Using a sample of US firms, research by Alali, F., Anandarajan, A. and Jiang, W. (2012) finds that firms characterized by stronger corporate governance have a significantly higher credit rating and that this association is accentuated for smaller firms relative to larger firms. They find that an improvement in corporate governance is associated with an improvement in bond rating. To help guide you through the AGM season, we are exploring the link between proxy voting rights, shareholder structures, and their impact on overall governance performance.


Keywords: proxy voting rights, shareholder structures, governance performance, AGM


Key findings:


·       Stringency in Antitrust Laws Testing Governance Resilience


·       Governance Performance Improved by Proxy Voting Schemes Could Enhance Firm Values


·       Shareholder Structures’ Impact on Governance Performance Varied


·       Board Leadership Structure and Risk Oversight Crucial to Compliance and Firm Performance


·       Best Practices for Governance Structure - Lessons Learned from Sustainability Reports



Stringency in Antitrust Laws Testing Governance Resilience


Policymakers around the world increasingly call for strengthening antitrust laws. For instance, Apple (NASDAQ: AAPL) shares slumped to a 4-month low (March 4, 2024) after the European Commission fined it over €1.8 billion for abusing its dominant position in the market to distribute music streaming apps to iPhone and iPad users (‘iOS users') through its App Store. This is illegal under EU antitrust rules. In addition, shares of Apple fell 4% on March 21, 2024, after the company was hit with an antitrust lawsuit by the U.S. Department of Justice (DOJ) for “monopolisation or attempted monopolization of smartphone markets.” The push for more stringent antitrust laws raises questions about the impact of such reforms on firms.


In a research paper authored by Chen Lin, Ross Levine, and Wensi Xie (2021), using firm-level data from 99 countries over the 1990-2010 period, the research discovered that valuations rose after countries had more stringency competition laws. The effects are larger among firms with more severe pre-existing agency problems: firms in countries with weaker investor protection laws, with weaker firm-specific governance provisions, and with greater opacity. The results suggest that antitrust laws that intensify competition exert a positive influence on valuations by reducing agency problems.


Recent news has brought attention to corporate governance and its role in ensuring fair competition in the market. The intersection of antitrust law and corporate governance can be seen in scenarios where corporate decisions and policies might have implications for market competition. Recent charges against Apple in different regions highlight the firm's anti-competition strategies which are being scrutinized under antitrust laws. It is important for companies to have good corporate governance practices that oversee business strategies and help ensure compliance with regulatory developments such as antitrust laws to prevent legal penalties and damage to reputation.


Proxy Voting Rights and Governance Performance


The study by Gompers, Ishii, and Metrick (2003) reveals that firms with stronger shareholder rights, which can be seen as a proxy for better governance practices, tend to have higher firm value, higher profits, higher sales growth, lower capital expenditures, and make fewer corporate acquisitions.


Based on their findings, an investment strategy that focused on buying firms with the strongest shareholder rights and selling those with the weakest rights would have yielded abnormal returns of 8.5% per year during the sample period. This suggests that the market recognizes and rewards firms with better governance practices, as reflected in their proxy voting rights.


The study's results support the notion that good corporate governance, as indicated by proxy voting rights, is positively correlated with superior firm performance. This correlation is evident through various performance metrics, including firm value, profitability, and growth. The research implies that investors can potentially use governance-related information as a predictive tool for investment decisions and that firms with better governance practices are likely to outperform their peers.


Kalay, Karakaş, and Pant’s recent paper provide evidence that the market values voting rights, implying that investors are willing to pay a premium for the ability to influence corporate governance. The study's methodology and findings suggest that there is a quantifiable link between proxy voting rights and governance performance, which in turn can affect overall firm performance. The increase in the value of voting rights around critical governance events underscores the importance of shareholder voting as a mechanism for ensuring good governance practices that contribute to firm value.


A study by Bob Herr & Ryan Oden from AllianceBernstein L.P. shows a correlation between strong governance and higher stock returns, indicating that companies with robust corporate governance practices may be less prone to mismanagement and could potentially yield better returns. This aligns with the findings of Kalay, Karakaş, and Pant, reinforcing the notion that effective proxy voting rights can lead to improved governance performance and, consequently, enhance firm performance.


Shareholder Structures and Governance Performance


Pyles, M.K., & Wang, W.’s research (2014) found that firms with higher levels of executive stock options and less earnings management are more likely to exhibit return improvement following firm underperformance. This suggests that aligning the interests of shareholders and executives can facilitate improvement in stock performance.


However, they found little evidence of an association between board independence (control mechanism) and performance improvement. This implies that the control mechanisms in corporate governance may not result in measurable improvement in stock performance.


In simpler terms, the study found that when a company’s stock is not doing well, it’s more likely to recover if the company’s executives have a lot of stock options (which gives them a personal stake in the company’s success). But having an independent board of directors doesn’t necessarily lead to improvement.


In conclusion, both proxy voting rights and shareholder structures play significant roles in shaping a company's governance performance. However, the effectiveness of these mechanisms depends on various factors, including the level of shareholder participation and the degree of information available to them. It's also worth noting that the relationship between these elements and governance performance can vary across different companies and sectors.


Board Leadership Structure and Risk Oversight


Recent revisions to Corporate Governance Codes globally have focused on enhancing transparency, accountability, and risk management. For instance, the UK’s 2024 revision of its Corporate Governance Code has introduced significant changes, particularly in the area of internal controls. In particular, corporate boards are now required to make an annual declaration on the effectiveness of their company’s material internal controls, covering financial, operational, reporting, and compliance controls. The board’s responsibility has been expanded to not only establish but also maintain the effectiveness of the company’s risk management and internal controls framework.


There’s a new emphasis on governance reporting to focus on board decisions in the context of the company’s strategy and objectives, aiming to avoid generic reporting and enhance transparency in exercising shareholder rights. This aligns with the global trend towards more detailed and strategic reporting to provide stakeholders with a clearer understanding of a company’s governance practices and decision-making processes.


Besides internal control, global leaders have been updating corporate governance codes spinning around topics on transparency & reporting, and corporate social responsibility, with a focus on management bodies, shareholders, and other stakeholders.


The EU policymakers have set sight on digital company law, transparency, and sustainability due diligence, with new rules enabling companies to use digital tools in company law procedures and providing strong safeguards against fraud and ensuring that company information in business registers is reliable and up-to-date.


China’s amendments to its PRC Company Law in 2023, which will be effect from 1 July 2024. The amendments focus on enhancing shareholder rights, increasing director and management accountability, and reinforcing the capital contribution obligations of shareholders. The latest Mandatory Sustainability Reporting Guidelines for Listed Companies also stress the need for governance disclosure over sustainability management structures and oversight, in addition to anti-bribery and antitrust disclosures.


Companies should consider reviewing their board leadership structure and board risk oversight disclosures. They can look at the disclosures made by their peer companies and best practices on material topics to assess whether they provide more detailed insights on these topics. By doing so, companies can identify ways to enhance their disclosures while meeting compliance demands.


Hacking group, Lapsus$ claims it gained internal access to the system privileges of Okta, the San Francisco-based company that manages user authentication services for thousands of corporate clients. This led Okta, Inc. (formerly Saasure Inc.) shares to fall 4.8% as the market opened in New York on March 22, 2022. What started as a data breach issue has expanded to encompass management structure, procedures, and safeguard concerns—issues that are all related to corporate governance.


Technology evolves rapidly, and cyber threats perhaps more so. Nasdaq pointed out that amid a volatile environment, cybersecurity remains a prime risk, exacerbated by a surge in criminal activity. Moreover, the fallout from incidents is burgeoning concerning financial and reputational consequences.


It is critical that boards receive the right information around cyber risk to effectively synthesize and action their fiduciary responsibilities. Static analyses of today’s risk are less helpful than establishing a regular flow of information to the board that supports cybersecurity investment decisions based on business, operational, and financial considerations.


Case Studies for Best Practices of Governance Structure


According to the OECD Principles of Corporate Governance, corporate governance provides the structure and systems through which the company is directed its objectives are set, and the means of attaining those objectives and monitoring performance are determined. Well-designed corporate governance policies can play an important role in contributing to the achievement of broader economic objectives and three major public policy benefits. They help companies to access financing, particularly from capital markets. By doing so, they promote innovation, productivity and entrepreneurship, and foster economic dynamism more broadly.


And for those who provide capital, either directly or indirectly, good corporate governance serves as an assurance that they can participate and share in the company’s value creation on fair and equitable terms. It therefore affects the cost at which corporations can access capital for growth.


Case Study – ASML Holding N.V.


The MSCI Governance-Quality Indexes (the ‘Indexes’) aim to reflect the performance of a strategy that seeks to capture both the financial and corporate governance aspects of Quality investing. The MSCI Governance Metrics model is based on a set of governance and accounting key metrics organized into four themes: Board, Pay, Ownership and Control, and Accounting.


As one of the top ten constitutes in the MSCI Governance-Quality Indexes, ASML Holding N.V. has gained a triple A (ESG Leader, last updated on Jun 2023) compared to its industry peers on Corporate Governance issue, which evaluates the impact companies’ ownership, boards and compensation practices have on investors.


ASML’s stock performance in 2023 has been strong, with a total return of 52.67% over the past 12 months, outperforming the S&P 500’s return of 32.75%. The company’s outperformance in 2023 could be attributed to many factors, one of which could be the contributions from its corporate governance practices detailed in its annual report 2023, which focuses on responsible and transparent governance, along with its ESG Sustainability strategy, may have positively influenced investor sentiment and, consequently, their stock valuation.


ASML has a two-tier board structure, consisting of a Board of Management responsible for managing the company, and an independent Supervisory Board which supervises and advises the Board of Management. For the fulfilment of their duties, the two Boards are accountable to the General Meeting, the corporate body representing our shareholders.


Source: from ASML ANNUAL REPORT 2023.


Evidence suggests that the two-tier board structure can offer several advantages:

  • The supervisory board provides an additional layer of oversight, which can help prevent management misconduct and ensure that the company is being run in the best interests of the shareholders.

  • With separate boards, the roles and responsibilities of management and oversight are more clearly defined, which can improve accountability and transparency.

  • The company's supervisory board is composed of non-executive directors who can provide independent judgment, creating a non-biased decision-making process.


However, it’s important to note that the effectiveness of a two-tier board structure can vary depending on how it is implemented and the specific context of the company.


The design of a suitable board structure is a key aspect of good corporate governance. Amongst others, research by Martin Gelter and Mathias Siems (2021) finds that the two-tier model companies tend to be larger, older, more complex and more diverse (e.g., in terms of female or foreign board membership).


Its Supervisory Board meets the gender quota of the Dutch gender diversity bill, as both men and women are represented on the Supervisory Board by at least 3 out of 9 members. (4F:5M) Since no seats are taken by women on the Board of Management, the company has updated 2022, the Board of Management Diversity Policy and set a gender balance target for the Board of Management to 2026 have at least one female and at least one male Board of Management member. ASML also set a goal for the total inflow of women and the inflow of female leaders (JG 9+) of 24% in 2025. The Supervisory Board included performance metrics aimed at improving the representation of women in senior leadership in the Board of Management's long-term incentive as well. The company’s Remuneration Committee also set ESG metrics as part of executive remuneration.


It is worth noting that 76% of Standard & Poor’s 500 companies used at least one metric for ESG performance when creating executive incentive plans last year (2023), a jump of 14 percentage points since 2020. The share of U.S. companies using climate and environmental metrics in incentive plans has surged to 44% from 12% during the past three years. Willis Towers Watson (WTW, 2024) derived these data on U.S. companies from proxies filed from October 2022 through September 2023.


Furthermore, ASML’s commitment to transparency in its governance practices, as evidenced by detailed annual reports and AGM documentation, helps build trust with investors. The company’s AGM provides a platform for shareholders to ask questions and vote on important company matters, fostering a sense of involvement and ownership.


In addition, ASML’s General Meeting (AGM) is held at least once a year and generally takes place in Veldhoven, the Netherlands. Starting from 2023, shareholders had the option to attend the 2023 AGM in person in Veldhoven or virtually.


ASML’s hybrid meeting format and the streamlined proxy voting process make participation more accessible, potentially leading to broader shareholder engagement. Its hybrid AGM 2024 is coming with an agenda including explanatory notes and a detailed manual with FAQs for virtual participation and voting support. This reflects ASML’s commitment to leveraging technology for inclusive shareholder engagement.


These practices contribute to a robust governance framework that can be emulated by other organizations aiming to enhance their corporate governance and shareholder relations. Adopting such practices can lead to improved trust and transparency, ultimately benefiting stock performance and valuations.


The interconnection between proxy voting rights, shareholder structures, and governance performance is complex yet pivotal for asset managers in pursuit of governance alphas. By understanding these links, asset managers can better navigate the US market to pinpoint stocks that not only promise robust returns but also exhibit sound governance practices.

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