The Benefits of Good Corporate Governance

A recent IFC publication “Practical Guide to Corporate Governance: Experiences from the Latin American Companies Circle” provides very useful lessons on why corporate governance is important to business performance and what companies can do to improve their governance. The guide focuses on 14 Latin American firms that are members of the so-called Companies Circle launched in 2005 to provide private sector input into the work of the Latin American Corporate Governance Roundtable. The member companies have demonstrated commitment to good corporate governance practices and in this guide they share their experiences.

From initial motivation for undertaking corporate governance reform through tangible benefits that it brings, the journey that businesses make to achieve change is not always easy. But the rewards are there to compensate for the efforts – and they are equally applicable around the world.

Key areas discussed in the guide where improved corporate governance can help include: accessing capital or reducing the cost of capital; facing and responding to external market pressures; balancing (sometimes) diverging shareholder interests; resolving governance issues in family-owned businesses; ensuring company sustainability; and, achieving better operational results.

The benefits are real and measurable. For one, good governance leads to higher market valuation. Buenaventura, a Peruvian company, managed to improve its corporate governance and the CEO estimates that these improvements resulted in an additional 20 percent increase in market valuation. Better corporate governance also decreases the cost of capital and helps to attract and retain shareholders. Credit Suisse raised its valuation of Brasil Telecom from “hold” to “outperform” because of governance improvements.

Empirical evidence shows that Companies Circle members, due to their focus on improved corporate governance, produced substantially better operational and market results than other Latin American companies. Their profitability reflected by average ROE (Return on Equity) of 21.7 percent from 2005 to 2007 was higher than other firms in the same period (16.7 percent). Companies Circle members also pay more dividends, which helps attract additional investors, and have better access to credit at a lower cost.

The report concludes that investors buying Companies Circle member stocks on December 31, 1997, on December 31, 2008 would have five times more equity than a similar investment in all Latin American companies. These tangible benefits also suggest that good governance helps enterprises through difficult economic times like the current financial crisis, since well-governed companies tend to deliver not only higher but also more sustainable value.

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