Does Good Governance Mean Better Returns?

We take a look at the returns of companies that score well for governance risk

Sunniva Kolostyak 16 January, 2023 | 9:16AM
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Performance is often cited as part of the win-win with environmental, social and governance (ESG) investing. In short: you can do good, and enjoy good returns in the process.

This week on, we're devoting our coverage to the "G". So do companies with good governance return more? What are the long-term implications? And how do you even measure governance in the first place?

To better understand the relationship between governance risk and performance, we have turned to our data. Morningstar Sustainalytics measures a number of ESG risks, tracking over 13,000 of the biggest businesses in the world – including their governance. What are these companies returning?

What we’re looking at in particular is governance risk – more specifically, the degree to which a company’s value may be at risk driven by governance factors. Corporate governance is a foundational element in Sustainalytics' ESG risk ratings and reflects the company's conviction that poor corporate governance poses material risks for companies.

In order to measure this, Sustainalytics issues governance risk scores, which summarise companies' "unmanaged governance risk exposure" after considering how it approaches risk.

The outcome is displayed as a number between 0 and 100, though most scores range between 0 and 25.

Lowest Governance Risk

Let’s start with a look at the stocks with the "best", or lowest, governance risk. At the top of the list we find Biffa (BIFF) with a governance risk score of 2.63. The waste management company, which we will look in depth at later in the week, is particularly strong in terms of ownership and shareholder rights, remuneration and board structure, according to Sustainalytics.

Sustainalytics also assesses a company’s corporate governance structures, practices and behaviours by looking at six 'pillars': board integrity and quality, board structure, remuneration, shareholder rights, financial reporting and stakeholder governance. On these measures Biffa is one of the best companies on the London Stock Exchange.

Together with Polymetal (POLY), Biffa is one of only two companies in the top 10 for low governance risk that have an overall ESG risk rating of Medium. The rest all have lower risk; RS Group (RS1) has the lowest overall with a "Negligible" rating.

If we take a look at returns among the low-risk companies, Biffa is the one with the best one-year return, managing to gain 16.30% in a year where most markets failed. Annualised over 10 years, however, RS Group wins out – so is there something to be said for low risk? (Biffa only listed on the LSE in 2016 and a 10-year number is therefore unavailable.)

Highest Governance Risk

At the other end of the spectrum, there are overall ESG risk scores of Medium or High. This is unsurprising, as governance risk can impact Sustainalytics' final number (with notable exceptions: the LSE itself has a low ESG rating but a relatively high governance risk score).

While all of the companies at this end operate in financial services, it’s IntegraFin (IHP) with the highest rating at 15.83%. It also has one of the worst one-year returns, losing 43.79%. The FTSE 250-stock listed in 2018 and managed to more than double its share price from IPO to the end of 2021, but it has since plummeted.

The best performer in the group is undoubtably Bank of Georgia (BGEO) with its 73.80% gain over the past year, and 11.46% year-on-year performance over the past 10 years.

As a whole, most of the stocks in the universe had positive returns over the past 10 years, irrespective of governance risk. In a scatterplot of risk versus returns, the companies create somewhat of a pyramid shape, where most stocks hover around a governance risk of 5 and a single-digit return. Financial services is by far the sector with the highest governance risk, while the two stocks with the highest returns both belong to the consumer cyclical category.

What About Long-Term Performance?

Sorted by long-term performance, JD Sports (JD.) does best. Over the past 10 years, the sportswear retailer has returned 35.64% on average every year, about 4% more than the runner-up Games Workshop (GAW). Most of this list did not have a good 2022 – Ocado (OCDO), for example, is down 54.83% over the past one year. But the online grocer, once an investor favourite, is still one of the best-performing stocks the UK has in the long term.

One company has done well both this year and over the long term is advertiser 4imprint (FOUR), up 60.14% over the year and 29.36% over 10 years annualised.

Only one of these high performers has a double-digit governance risk score: Hutchmed (HCM), which also happens to have a high ESG risk rating. Two more are rated Medium, while the rest have low risk. As mentioned, the London Stock Exchange (LSEG) has a low ESG risk rating, while its governance risk score is only about 1.5 lower than Hutchmed's.

If we only saw this list, it would be easy to jump to a conclusion that yes, the lower the score, the higher the likelihood of a better long-term return. But the spread in the scatterplot would also argue a similar story on both ends of the spectrum.

Whether there is a link between the two or not, a well-run company that manages its risk well is about more than getting the best return. Having the right corporate structures in place builds trust, so investors know they’re investing in a company that values its employees and business partners, promotes transparency, and utilises its shareholder rights.

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The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

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Sunniva Kolostyak

Sunniva Kolostyak  is data journalist for

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