More Rules, Higher Profits

New research shows that good governance practices may reduce your cost of capital.

All too often, the drive for corporate-governance -6.reform feels like a costly exercise in wishful thinking. After all, can you really find a strong correlation between a mandatory retirement age for directors and a bigger net profit margin?

You can, as it happens. A growing body of research suggests that the governance practices promoted by such proxy groups as Institutional Shareholder Services (ISS) and the Investor Responsibility Research Center are indeed associated with better corporate performance and a lower cost of capital. One 2003 study by researchers at Harvard University and the Wharton School found that companies with greater protections for shareholders had significantly better equity returns, profits, and sales growth than others. A more recent study, by ISS, found that companies that closely follow its governance advice have higher price-earnings ratios.

Figure 1.1 Financial management on the organization chart

*ln response to heightened concern over shareholders' interests, a growing number of companies have placed shareholders in a box above the board of directors on their organtzation chart.