A DISCUSSION OF CURRENT EVENTS AND EMERGING RISKS AFFECTING FOURTH DISTRICT FINANCIAL INSTITUTIONS
Corporate Performance: The Governance Factor
by Kimberly Ortiz, Examiner
Strong corporate governance is essential not
only for operating
Periodically, McKinsey Quarterly surveys investors to quantify whether they are willing to pay more for the stock of a well-governed company than they are for shares of a company with similar financial performance but poor governance practices. A 1996 survey found that 66 percent of respondents were willing to pay a premium for the shares of well governed companies,1 and by 1999, over 80 percent of respondents were willing to do so.2 Although the 1999 survey did not address why more respondents were willing to pay a premium, the stock performance of companies with poor governance practices over the past two years leads us to believe the figure may be even higher in today's environment.
It is interesting to note that in 1999, respondents, on average, were willing to pay 18 percent more for the stock of a well-governed U.S. company and 28 percent more for the stock of a well-governed company in Venezuela. The survey concluded that investors were willing to pay a smaller premium for well-governed U.S. companies because they believed that many domestic companies had "already addressed fundamental governance issues."
A Process for Improvement
Although most companies conduct annual employee evaluations to assess their performance and effectiveness, it is not yet commonplace for directors and boards to do so. However, because of today's corporate environment, boards of directors should anticipate closer examination as to how they measure their performance and, ultimately, the effectiveness of each director.
Self-evaluation is one of the best methods for boards of directors to identify their strengths and weaknesses and to improve their performance and effectiveness. The self-evaluation process should encompass two steps. Because each director has an equal fiduciary and legal responsibility, the first step is to provide for an assessment of each director. The second step is to evaluate the board of directors as a whole in order to assess how the group functions together.
When instituting a self-evaluation process for the entire board of directors, boards may wish to consider a number of topics when evaluating their process and structure (see table).4
In addition to evaluating the board's process and structure, self-evalation should be used to determine whether the board is meeting their goals and objectives. Because goals, objectives, and board processes differ among companies, the evaluation criteria should be established by the board and based on their duties.
Korn/Ferry International's 2002 survey found that 37 percent of boards already have a formal process for evaluating their performance. With evidence that investors are willing to pay a premium for companies with good governance practices, shareholders could see improved returns as a result of board self-evaluations and subsequent corrective actions.
3. See Korn/Ferry International, U.S. 29th Annual Board of Directors Study.
İFederal Reserve Bank of Cleveland