AB: Governance Matters - The Proof Is in the Proxy
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Insights
Examining the correlation between corporate governance and stock performance is a important aspect of market analysis. The concept of 'governance' here refers to the set of rules, practices and processes by which a company is directed and controlled. Good governance can lead to more transparency, reduced risk of fraud and better decision-making, all of which are attractive to investors. In turn, this can translate into higher investor confidence and potentially higher stock prices.
While the study refers to historical data, it's important to note that past performance is not always indicative of future results. However, the consistent underperformance of companies with poor governance scores suggests that governance can be a reliable indicator of a company's operational effectiveness and risk management. Investors might use this data to guide investment decisions, favoring companies with strong governance frameworks.
It's also worth considering the role of proxy voting as a tool for shareholder engagement. By actively participating in corporate governance through proxy votes, investors can influence company policies and advocate for changes that may lead to better performance. This proactive approach is increasingly valued in the investment community, as it aligns with the growing emphasis on environmental, social and governance (ESG) factors.
The linkage between governance and stock returns is a significant factor that financial analysts must consider when evaluating investment opportunities. The entrenchment index mentioned in the study provides a quantifiable measure of governance quality. A lower E-index indicates better governance, which the study correlates with higher firm value and returns. This is a critical insight for portfolio management, as it suggests that incorporating governance analysis into stock selection could enhance portfolio performance.
However, it's essential to scrutinize the methodology of such studies to ensure the robustness of the conclusions. The time frame and the market conditions during the study period can influence the results. For instance, governance might play a different role in market downturns compared to bull markets. Therefore, while governance is a key factor, it should be one of many considerations in a holistic investment strategy.
Furthermore, the impact of governance on stock returns may not be immediate. Investors with a long-term horizon may benefit more from this correlation than short-term traders. This is because governance improvements often take time to materialize in financial performance. Analysts must balance the urgency for returns with the patience required for governance-related investments to bear fruit.
The findings from AllianceBernstein emphasize the importance of governance in corporate performance. Corporate governance experts often assess a company's board structure, shareholder rights and transparency to determine the quality of governance. These elements are important in preventing conflicts of interest and ensuring that management acts in the best interests of shareholders.
It's also important to recognize that governance goes beyond compliance with regulations. It involves creating a culture of accountability and ethical behavior that can contribute to the company's long-term success. Companies that score well on governance metrics are often perceived as more resilient and better equipped to handle crises.
Investors are increasingly considering these non-financial factors as part of their investment criteria. The trend towards sustainable investing is pushing companies to improve their governance standards, as poor governance can lead to reputational damage and financial loss. The research presented here reinforces the narrative that good governance is not just a moral imperative but also a financial one.
Our research shows a correlation between strong governance and higher stock returns.
NORTHAMPTON, MA / ACCESSWIRE / March 20, 2024 / AllianceBernstein
Bob Herr| Director of Corporate Governance-Responsibility
Ryan Oden| Research Analyst-US Growth Equities
Investors have long theorized that companies with poor corporate governance practices may be more prone to mismanagement and weak returns. To investigate further, we've looked inward to a key data source: our proxy votes.
Specifically, we draw a correlation example between governance and returns through AllianceBernstein's (AB's) proxy-voting track record in recent years. We think proxy voting is one of the most expressive tools investors can use to communicate a view on the quality of a firm's governance, providing that it's based on careful analysis and accountability, not a rubber stamp.
Specifically, leveraging proxy voting and direct engagement* with companies can help to improve them, ideally resulting in better long-term outcomes. Several studies, which include our own findings, have made this connection much more apparent.
The Governance-Return Nexus
In one study, professors at Harvard Law School constructed an entrenchment index, or "E-index," based on six key governance provisions. Their findings linked poorer E-index ratings with reductions in firm value and returns across US equities from 1990 to 2003.
More recently, S&P Global found that, between 2000 and 2017, companies in the bottom quartile of S&P Dow Jones Indices' Governance Scores underperformed those in the top quintile by about
Inspired by these observations and our own experience, we built an internal study to determine if a similar association exists between our proxy-voting record and returns. We found that on average companies for which we voted against management on any number of proposals later underperformed those with which we were more strongly aligned.
Standing Up for Governance-One Company at a Time
Evaluating governance isn't a one-size-fits-all proposition. We utilize a proprietary proxy-voting policy to vet each company's alignment with our basic expectations, followed by a collaborative review process that leverages analyst expertise and engagement data. This two-pronged approach enables us to incorporate company-specific fundamental insights to implement more constructive voting strategies.
When we surmise a company's governance practices aren't supporting our clients' best interests, we may vote against management to signal our objection. For instance, seeing internal accounting problems, we may record our opposition to the chair of the audit committee; if executive compensation is misaligned with performance, we vote against it. Some governance issues may warrant a stance against the specific board member(s) responsible-also known as an "accountability vote."
Entered into Evidence, Thousands of AB Proxy Votes
Within this backdrop, our study retraced approximately 34,000 shareholder meetings, consisting of votes on more than 266,000 individual proposals across global firms from 2018 through 2022. Then, we linked each proxy vote to the company's total stock return the following calendar year.
To help categorize our degree of alignment with management, we grouped the companies into equal-weighted baskets based on our number of votes against management (VAMs). For example, zero VAMs may reflect stronger alignment based on what we believe is sound governance and oversight across the firm. One VAM indicates a single "no" vote on any of the proposed matters, from capitalization and audits to compensation and director elections. Two VAMs reflects our disapproval on two such measures and so forth.
Zero VAMs occurred in
We found that zero-VAM companies-those we fully supported-outperformed those in the other VAM baskets by at least 250 basis points per year. We observed this general trend among similarly sized peers and across most-but not all-sectors and regions. For the five-year period, the average annualized return for zero-VAM companies was
Mind over Matter-Proxy Voting Should Be Thoughtful
Proxy voting should be more than a compliance exercise. It's a fundamental tool in active management, empowering investors to sway companies from pitfalls that can impede long-term performance. In matters of governance especially, we've found that well-thought-out proxy votes can make a positive impact on important business decisions, from leadership and disclosures to compensation and capitalization.
Landon Shea, Proxy and ESG Engagement Associate at AB, and Peter Højsteen-Ljungbeck, ESG Data Research Associate at AB, were instrumental in the research that formed the basis for this blog.
*AB engages issuers where it believes the engagement is in the best interest of its clients.
The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AB portfolio-management teams. Views are subject to revision over time.
Learn more about AB's approach to responsibility here.
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SOURCE: AllianceBernstein
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FAQ
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