Improve your governance and boost your share price

Hong Kong company executives worried that a mid-cycle slowdown will eat into their share price performance next year can take heart. There is an easy way that they can not only improve their returns in 2011, but improve them while reducing the amount of risk their shareholders run.

Normally, of course, higher returns tend to be associated with running greater risks. But the risk-return relationship doesn't always hold true. According to a new study by a group of Hong Kong academics, local companies can both improve their share price performance and lower the risk run by investors by improving their standards of corporate governance.

At first that might sound like old news. After all, analysts have long equated higher standards of corporate governance with better investment returns. But previous studies have tended to look only at the level of a company's governance, not whether it is improving or deteriorating.

The distinction is important. A snapshot study that assesses the standard of a company's corporate governance at only a single point in time will always be open to question. It cannot convincingly show a causal link between governance and performance.

After all, a company that earns handsome profits may be able to afford better standards of corporate governance as a bolt-on luxury. There is nothing to show that higher standards actually drive better performance.

Yet the new study by Cheung Yan-Leung and Tan Weiqiang, of Baptist University and Aris Stouratis, of City University, goes a step further.

The three academics examined corporate governance standards among members of Hong Kong's main stock indices, compiling a scorecard based on information available to ordinary investors, such as disclosure standards, the number of independent directors and whether shareholders can vote on directors' pay.

Some of their results mirror the findings of earlier studies. For example they find that companies with high concentrations of controlling family ownership tend to be badly governed, and that the share price performance of badly governed companies tends to be poor.

However, more importantly they also track how changes in governance affect share price performance and risk levels over time. For example, they show that some companies have proved more willing to change than others, with family-controlled companies slower than their more widely held competitors to improve governance standards.

Yet those companies that do introduce changes to raise their corporate governance scores are richly rewarded by the market, enjoying a stronger subsequent share price performance and lower levels of risk. What's more, the greatest gains and the biggest risk reductions are shown by those companies making the biggest improvements from the lowest base.

That should be encouraging. It implies a genuine cause and effect relationship, with improvements in governance standards driving both stronger returns and reductions in risk.

Unfortunately, there are indications that corporate Hong Kong may be heading in the wrong direction. In the past, Hong Kong's business executives and regulators have typically congratulated themselves for operating one of the strongest corporate governance cultures in Asia.

However, in the latest survey of regional standards compiled by the Asian Corporate Governance Association (ACGA) and published in September, Hong Kong's rating actually fell compared with the previous survey conducted in 2007, with the city surrendering its top slot to Singapore (see the first chart).

Although the ACGA praises the Securities and Futures Commission for pressing ahead with more rigorous enforcement, it criticises Hong Kong's government for backsliding on reform. The government, it concludes, 'displays an ambivalent attitude towards corporate governance and is more concerned about short-term expansion of the stockmarket in which it is a substantial shareholder'.

Meanwhile at the company level, although Hong Kong boasts paragons of corporate governance like Li & Fung and HSBC, it is clear that many local corporations are reluctant converts to the cause. According to the ACGA report's co-publisher, brokerage house CLSA, Hong Kong companies remain weak in several key areas, including their governance discipline, the independence of their boards and their green and social credentials (see the second chart).

Company bosses should make a firm New Year's resolution to tackle these failings in 2011. After all, it's an easy way to boost their performance in what promises to be a tricky year.