Corporate Governance Development in the UK and Continental Europe

Article excerpt

The potential onset of 'corporate governance fatigue' is a risk for all publicly listed companies, which needs to be resisted strongly. The commitment of corporate Boards to fairness, transparency and accountability has an appreciable effect on whether the greatest practicable enhancement is achieved over the period of their shareholders' investment.

Classically, corporate governance is divided into four main pillars: Board independence, shareholder treatment, information disclosure and executive remuneration. Constant themes are the protection of shareholder rights (including the equitable treatment of all shareholders), timely and accurate disclosure of information (to analysts and investors), strategy and monitoring of the Board and the supervisory involvement of non-executive directors.

So why is corporate governance so important? Put briefly, without investor confidence, markets will not thrive. This is the case whether instances of poor governance have arisen from corporate failure, companies have been run poorly, there has been unjustified remuneration or simply lack of transparency and disclosure.

The corporate governance 'roll of shame' over recent years is geographically dispersed. Examples include:

* U.S. (WorldCom, Tyco and Enron) France (Vivendi)

* Netherlands (Ahold)

* Italy (Parmalat)

* Germany (Volkswagen)

* Japan (Mitsubishi)

* South Korea (SK Group, Daewoo)

Generally though, commentators agree that the position is improving. A recent study of 2,500 international companies by GovernanceMetrics International found that the Sarbanes-Oxley reforms have led to a 10 percent improvement in the corporate governance performance of large U.S. companies compared against their foreign counterparts. However, Sarbanes-Oxley has certainly had its critics in terms of the cost of compliance (particularly regarding the controversial Section 404, which requires outside accounting firms to vouch for the reliability of a company's internal control systems) and the often argued 'governance imperialism' which impacts foreign-owned companies listed in the U.S.

There has also been considerable progress on pay disclosure. The U.S., Canada, UK, Ireland, France, Italy, the Netherlands and Sweden now all have mandatory disclosure. In addition, "holdouts" like Germany are coming slowly into the fold.

The European Commission has also made progress, with last year's recommendations on directors' remuneration and independent directors. The Commission argues that it is not part of an embryonic European code, and is not a response to Sarbanes-Oxley, but to the needs of European investors. The 'Father of European Governance' Jaap Winter, says that, "Convergence should probably be stimulated, but we should be sensitive to differences that still exist and are relevant." Indeed, a recent ABI/Deminor study showed that one-third of Europe's 300 biggest companies still fail to abide by "one share, one vote."

The 2002 McKinsey Study showed that investors are generally prepared to pay a premium for a well-governed company. Despite some earlier studies not finding a connection between better corporate governance practices and higher corporate performance, the picture that emerges from some recent studies supports the attractive working hypothesis that such a link exists. Let us look at four research exercises, namely:

* The Deutsche Bank 2004 Study "Beyond the Numbers"

* The 2004 FTSE/ISS Study

* The Economist Intelligence Unit Study

* The GovernanceMetrics International Study

The Deutsche Bank Study concluded that, "The assessment of corporate governance standards is a valid measure of equity risk. There is a clear link between corporate governance assessment and share price volatility, corporate profitability and share price performance." An example is that for the FTSE 350, there is a positive relationship between historic corporate performance assessment and return on equity (ROE). …