Benchmarking for Stronger Corporate Governance Practices
Investors are increasingly focusing on long-term value creation for their shareholders and stakeholders as compared to simply tracking short-term financial performance. This is why efforts are being made in many countries around the world to measure and quantify a company’s practices in non-financial areas such as corporate governance.
Take for instance, the CEO of Blackrock, who in his annual communication to CEOs of S&P 500 companies last year asked them to articulate a clear strategy for longer-term value creation, and to explicitly affirm the strategy that has been approved by their board. For the current year, his call in this "new world", was to further emphasize the importance of corporate governance, including Environmental, Social and Governance (ESG) factors which have become imperative in influencing the long-term value of firms and protecting the interest of investors.
The growing importance of non-financial information such as ESG is broadening the scope of financial and regulatory reporting for the CFO. It is also expanding the CFO’s role as a partner to the CEO in executing strategy through decision-useful disclosure. The importance of non-financial parameters is growing for investors, which is demonstrated by the fact that nearly $20 trillion investments were made worldwide in 2014 incorporating non-financial information, such as ESG, into investor’s strategies.
Can one really measure non-financial information such as the factors affecting ESG? There have been several efforts in this area – and one such tool is a corporate governance scorecard. A scorecard is a
quantitative tool to measure the compliance of governance practices as compared to a benchmark.
How does a corporate governance scorecard help?
In today’s era of globalization, this tool has become critical for investors to measure the state of corporate governance in a company and help make an informed investment decision. Investors can gather a lot more intelligence regarding the policies and practices, ethical conduct, and understand the tone at the top; providing deeper insights than mere financial numbers.
Scorecards even assess a company’s governance practices, track the progress over time and compare different companies and even groups of companies –across industries and across countries. Scorecards encourage implementation of codes and standards by benchmarking companies and countries over time.
The first scorecard was developed by the German Financial Analysis and Asset Management Association (DVFA), a society of investment professionals in Germany comprising about 1,400 individual members representing over 400 investment firms, banks, asset managers, consultants and counselling businesses. The scorecard was meant to provide financial analysts and investors with a practical tool for evaluating the governance of listed German companies. In addition, it served as a tool to measure the compliance level of listed companies with the German Corporate Governance Code.
For companies, this tool can help to analyze governance practices and identify shortcomings against locally defined standards or generally accepted international standards of best practices. Scorecards can help them to improve their governance standards as the ultimate outcome should be to improve operational performance and lower risks. This can translate into setting of realistic expectations for the coming year and generate incentives for reform, help direct change, and set in motion a process of continual improvement.
ASEAN countries had been using this scorecard since as early as 2006-07. In these countries, the scorecard has been used by regulators, individual companies, institutional and international investors, and independent analysts and Institute of Directors/Institutes of Corporate Governance. The ASEAN Corporate Governance Scorecard of 2012-13 reported that maximum companies in Malaysia scored ranging from 50-59 with just a single company scoring above 90. In the following year’s report of 2013-14, the number improved to 11. This clearly shows that having the scorecards in place led to a mindset change making them more competitive for achieving higher level of governance.
What would such a scorecard mean for companies in India? Is there more work for management, more information that needs to flow from CFO to CEO and then to the Board! Does this mean more disclosures need to be made to shareholders and regulators, beyond the existing sea of information that fall under mandatory reporting?
The answers to these questions may be a yes but in the long term, the need will be more strategic rather than being driven by compliance. It will help them strengthen global competitiveness, have strategies and objectives that can be measured, and increase their ability to attract better quality long-term investors, establish partnerships that will add more long-term value to the companies. We hope that investors, insurance companies, regulators and above all individual companies in India will take up the use of corporate governance scorecard more seriously to protect the long-term interests of all stakeholders.