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We are all hypocrites on corporate governance

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Even as politicians gouge each other’s eyes out they all agree on the importance of education. Likewise in the corporate and investing world: I bet you’ve never met anyone who says governance doesn’t matter.

Is that right, though? Or is it just that a global complex of directors, trustees, headhunters, consultants and money managers has its nose so deep in the sound governance trough that uncomfortable truths are ignored?

Such as the news this week that the boss of LVMH, one of Europe’s most successful public companies — whose family controls almost two-thirds of the voting rights — proposes to nominate two more of his sons on to its board. Or that the S&P 500 has just racked up five days on the trot of all-time highs, despite the fact if you turn over the business cards of almost half of its chief executives they read “Chair” on the other side.

European firms wouldn’t dream of combining the two roles. Investors and experts on management and control reckon there is nothing worse. Yet the biggest European stock in the MSCI World index is ranked 20th. Every firm above Nestlé is American.

And some of the very largest of these US companies have terrible governance. The dual-share structures of the likes of Meta and Alphabet laugh in our faces. Sure you can own a slice, but that doesn’t equal a say in how the business is run.

Elon Musk is jealous and on Wednesday said dual shares would be an “ideal” way for him to have even more control over Tesla. With shares in the electric-car maker up 820 per cent in five years, few shareholders would disagree.

Indeed even one of the looniest governance structures ever couldn’t hamper arguably the most significant and successful new company since Apple last year. Open AI has a non-profit charity sitting above a for-profit holding company. Obvs.

Investors may know bad governance when they see it, but who cares when there’s money to be made? More than $40bn of overseas money has poured into Japanese stocks over the past 12 months, according to exchange data, despite a spider web of cross-shareholdings and other travesties of governance.

Likewise foreign direct investment into Saudi Arabia almost quadrupled between 2011 and 2021. And while a net $80bn flowed out of Chinese equity and bond portfolios last year, according to data from the Institute of International Finance, more than $200bn went into other emerging markets, none of which is a governance posterchild.

While equity investors ignore bad governance when it suits them, the irony is they don’t need to. Academic studies of governance and shareholder returns struggle to find a definitive positive relationship — let alone causation. Indeed, a Journal of Corporate Finance paper in 2022 showed that poor governance stocks have actually outperformed good ones since 2008.

Even with practices we consider no-brainers, such as independent board members to improve the monitoring of executives and prevent conflicts of interest, evidence of a relationship with performance is weak.

Certainly the 11 independents on Enron’s 14-member board didn’t help much. Almost half of WorldCom’s were outsiders too, as many academics have noted. An influential paper by James Coombs of Florida State University concludes that CEO power simply overwhelms board independence.

Of course there will always be governance horror shows. Volkswagen’s slump under control between the Porsche-Piëch family and the State of Lower Saxony “beggars belief” according to a veteran fund manager. And is it right that Exxon has just filed a lawsuit to block a shareholder climate resolution?

Then again, Germany’s two-tier system, with separate management and supervisory boards, is held in high esteem by governance groupies. So is the fact that employees are represented. What rank is the country’s biggest stock in the MSCI World? 60th.

Whether governance matters or not has become even more important in recent years as it makes up a third of environmental, social and governance investing. And whereas there is much disagreement around “E” and “S”, few people question sound governance as a worthy goal.

And yet the most comprehensive long-run analysis I’ve seen of ESG scores versus returns — by Rómulo Alves, Philipp Krüger and Mathijs van Dijk — shows no relationship at all, be it across regions, time periods or ESG constituents. Indeed the statistically weakest of the three weak relationships was governance.

The reality is there are as many ways to run a company as there are companies. We should celebrate this diversity and let caveat emptor prevail. 

stuart.kirk@ft.com

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