Friday, October 10, 2008

Financial Crisis, Governance, and Stock Performance

Posted by Jeff Lipshaw

I was working away this morning and trying not to look at the Dow when a thought struck me.  Back when I was fighting the governance wars from the inside, arguing from the board's standpoint why having poison pills and classified boards made sense (at least in the right hands), there were several studies done linking good governance to share performance, the most famous being the Gompers/Metrick/Ishii study.  I was not (and am not) statistician enough to know if the study was good; all I can say is that my intuition was and is that things like technology, cost productivity, barriers to entry, business savvy, and things like that would have a lot more to do with share price than whether there was a poison pill or the shareholders had the right to call a meeting.  Moreover, I'm not sure how you would factor out those differences among companies other than to say it all evens out in a big enough sample.  As I said, I'm not statistician enough to do the work myself.

What occurred to me was the question whether, if I had a portfolio of the "best governed" companies on October 9, 2007, at the very height of the stock market, and kept that portfolio unchanged for one year, how would it do?  Given that I performed this little empirical study from the laptop in my den, don't have the individual governance scores on any survey (CGC from ISS, or whatever GovernanceMetrics puts out), and couldn't do the regressions and correlations even if I did (but I did leave a phone message for Bill Henderson), I simply went to the website of IR Global Rankings, and took the thirty companies it ranked best in corporate governance practices (listed below the fold), found their historical closing stock prices on Yahoo! Finance for each of October 9, 2007 and October 9, 2008, assumed a portfolio of one share of each, and looked at how the portfolio performed.  (Other methodology disclosures also below the fold).

Here are the results:

Decline in "good governance" portfolio:              50%

Decline in S&P500 Index Fund                            42%

Decline in NYSE Composite Index Fund               43%

Decline in Dow Jones Industrial Average             39%

Within the good governance portfolio, every stock declined.  The best performers were Bayer AG (17% decline), Procter & Gamble (12% decline), and Global Payments (11% decline).  The worst performers were ICA (93% decline), Wachovia (93% decline), Banco BPI (71% decline), and Life Time Fitness (70% decline).  (I did not check to see if these numbers were adjusted for splits, but I assume so.)

But you'd still be better in index funds than picking stocks based on the IR Global Rankings of good governance practices.

The IR Global top ranked companies were Nexen, Royal Philips, Telekom Austria, Bayer, Infosys, Procter & Gamble, Deutsche Post, Satyam, Total, GE, Totvs, Norsk Hydro, ICICI Bank, Banco BPI, Wachovia, Bursa Malaysia, Global Payments, Kotak Mahindra Bank, JDS Uniphase, Perdigao, Deutsche Telekom, Life Time Fitness, Grasim, BASF, Indra, Pengrowth, Masisa, IC RUSS-INVEST, Hysan, ICA.  I could not find quotes over the full time period for Masisa and IC RUSS-INVEST, so they are not included.  Kotak and Grasim had Berkshire Hathaway-like stock prices, so I divided them by 10 and 100, respectively, so as not to weight the portfolio unduly.  I used a NYSE common stock or ADR price if it was available; otherwise, I used the price on the main exchange on which the shares of the company were traded.

The portfolio was fairly well diversified geographically:  North America - 8, Europe - 10, Asia-Pacific - 7, Latin America - 3.  Of the 28 companies, 7 were financials.  The remainder were split among industrials, telecom, technology, oil & gas, and consumer goods and services.

My data is here.

http://lawprofessors.typepad.com/legal_profession/2008/10/financial-crisi.html

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Comments

Do you have any comparable data for share performance versus "technology, cost productivity, barriers to entry, business savvy, and things like that"? Given the heavily psychological regime the credit markets are seeing currently, is there still a good case to be made for connecting fundamentals and market performance in any way?

Maybe, like me, you think that "real economy" fundamental stuff matters. In that case, maybe the best course is not to invest in stocks at all.

Posted by: A.J. Sutter | Oct 12, 2008 7:48:41 AM

Interesting question. Yes, I think business fundamentals matter to share price, but only in the long term, and it's really hard to predict on a company by company basis. The accepted wisdom is that VCs first and foremost make bets on industries, and then try to select the best managements and technologies within industries.

Diversification, not avoidance, I think.

Posted by: Jeff Lipshaw | Oct 12, 2008 10:52:31 AM

interesting article about Financial Crisis

Posted by: Daniel | May 13, 2009 3:48:43 AM

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