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Good governance rewarded by markets, says IMD study
Lausanne, Switzerland (ots) - New research has uncovered consistent evidence of how good corporate governance is recognized and rewarded by the markets. A commonly-held assumption is that costs of voluntarily adopting and implementing better governance practices outweigh benefits to a company.
But a study by IMD business school, suggests market prices positively reflect such a move. The finding is of particular significance amid growing pressure to embrace new regulations and promote transparency to prevent another financial crisis.
Professor Arturo Bris, one of the study's authors, said: "We're witnessing a period of increasing regulation designed to avoid the failures of the past.
"It's generally assumed good governance has to be imposed or recommended from the outside because the costs are greater than the benefits. Our study demonstrates this isn't necessarily the case - in fact, the voluntary adoption is rewarded almost immediately by the markets."
To investigate the value of voluntarily adopting good corporate governance the study exploited an organizational feature of the London Stock Exchange (LSE).
For almost two decades companies incorporated outside the UK were permitted to feature in the LSE's overseas segment via two distinct processes. The first method, culminating in an official listing, is a procedure that is still used today and is initiated by the firm itself deciding to list its shares in the UK. This involves abiding by a strict set of rules laid down by the Financial Services Authority, as well as being monitored by its offshoot, the UK Listing Authority. The second process, the Stock Exchange Automated Quotation International market - or SEAQ-I - was discontinued in July 2004 and demanded far less scrutiny.
Only an application by a single LSE trading member was necessary for a firm to be traded on a specialized platform - even without the company's own approval.
The study examined data relating to hundreds of firms listed on the LSE or traded on SEAQ-I to determine the stock price reaction around listing/trading days. It discovered companies enjoyed an average stock price increase of 3.81% during 20 days around the day they earned a regular listing on the LSE. By contrast, stock returns for firms traded on SEAQ-I - in other words, firms not embracing good governance - fell by an average of 0.038% in the same period.
Co-author Professor Salvatore Cantale said: "Since both listings are in the UK, we have to look for the key differentiator between the two approaches.
"The inference is that it's the decision to list voluntarily and all this entails - specifically, a willingness to be scrutinized and monitored by the regulators.
"Knowing this, we can see the unwillingness of a company or a board to comply with good governance is usually the result of selfish behavior. We argue that in such instances the most effective approach for regulators is not 'comply and explain' but rather 'comply or else'."
IMD, a business school in Lausanne, Switzerland, is a world leader in executive education. www.imd.org
Arturo Bris and Salvatore Cantale are finance professors at IMD.