Majority of the World’s Corporations Don’t Get Corporate Governance Right

Study Offers New Insight into Post-Enron Era of Corporate Governance
with Most Either Investing Too Much or Too Little

Bethlehem, PA, January 4, 2010 — New research from Lehigh University finds that the majority of the world’s corporations implemented corporate governance measures without taking into account the financial and legal systems of the country in which they operate, and in turn, negatively impacted the firm’s performance.  In fact, the authors found that over the period studied as many as 66 percent of the world’s corporations either invested too much or too little in corporate governance based on the financial and legal system in which they operate.

Anne Anderson, associate and a chaired professor in finance, and Parveen Gupta, professor and department chair in accounting at Lehigh University’s College of Business and Economics, studied 1,732 firms representing 22 countries before co-authoring this groundbreaking research study on corporate governance and firm performance.

This research, published in the January issue of The Journal of Contemporary Accounting and Economics, is the most comprehensive of its kind to explore the intersection of a country’s financial structure and its legal system-and how this intersection impacts a firm’s governance behavior and its financial performance. The research has earned international accolades for its insight into corporate governance, including the prestigious Vernon Zimmerman Best Paper Award at the 20th Asian-Pacific Conference on International Accounting Issues in Dijon, France, last year.

“We wanted to take a hard look and question the traditional thinking that if you implement good governance than you increase the value of the firm,” said Gupta.  “Indeed, we found that this was not the case overall. Rather, only when you match the level of corporate governance with the financial and legal systems at hand did an increase in performance occur.”

The authors found that high levels of corporate governance do not need to be implemented in every jurisdiction and a “one-size-fits-all” approach simply doesn’t work for companies attempting to align their governance structure to enhance their firm’s performance.

This study also suggests that some of the world’s corporations may have gone too far in aggressively implementing governance restrictions to better protect their shareholders, customers and employees in reaction to the Enron, WorldCom and other such scandals.

“When a significant problem arises, most companies begin imposing additional governance mechanisms without thinking,” said Anderson. “It’s a knee-jerk reaction. They believe they need to be visible and quickly show their commitment to change to contain the damage. The problem is, they enact the wrong measures, and that makes for a very costly mistake.”

The authors created a two-by-two matrix juxtaposing legal structures (civil law vs. common law systems) and financial systems (market based vs. bank based) and reviewed 60 governance-related measures (from an international data-set maintained by Risk Metrics) organized into eight broad categories: boards, audits, charters, states of incorporations, compensation, qualitative reviews, ownership, and education.

As part of their assessment, the professors examined firm-specific operating variables, stock market performance and a calculation called Tobin’s Q – all together these assessments helped to provide an approximate value of a firm.

The authors found that a firm’s value is positive when corporate governance is matched with the financial structure and legal systems of the country, and is negative when it is not.

“For the Bank/Civil system we believe too much governance is redundant and thus a negative investment, but for Market/Common system higher levels of governance are better,” said Anderson. “In other words, overshooting in the bank/civil structure is not good and undershooting in market/common is not good.”

To illustrate the point, the authors report that in a review of 2003-2005, they found that in the Bank/Civil system, on average, as many as 66 percent of companies overshot, and in the Market/Common as many as 53 percent of companies undershot on corporate governance.

What this suggests, said the authors, is more than ever before, companies need to do a better job of studying their options before implementing governance for governance sake. According to the authors there are a variety of reasons as to why this is the case.

“If you are a country where capital allocation takes place primarily through the banks, it’s important to know that when banks loan money, they typically put a member of the bank on the board of that company,” said Gupta. “Because the banks become an insider and have access to all the information, there is not a need for additional control mechanisms – these measures can be duplicative and redundant in this case. However, in a common law, market-based system, there is no dominant financier, so you do need these external systems to protect the assets.”

A highly-customized approach to corporate governance strongly enhances a company’s Return-On-Investment, according to the authors.

“Our advice: Be judicious and aware of your environment. Be careful and consider where you operate,” said Anderson.

CONTACT:

• Dina Silver Pokedoff, APR
• Director of Media Relations, Lehigh University
• dis204@lehigh.edu
• 610-758-6656

Tags: corporate governance, lehigh university, press release, study