Does corporate governance improve company performance?

10 Nov 2023 | Data is not evidence

Corporate governance…can genuinely add value for business.

I was delighted to see a company’s study reach this conclusion. Corporate governance is my main research topic; I’m a Fellow of the European Corporate Governance Institute, and at the time I was Academic Director of the LBS Centre for Corporate Governance. The study’s subtitle was ‘A proven link between effective corporate governance and value creation’ (my emphasis) and the contents page suggests that they found ‘the holy grail’. A summary of the study boasted that ‘there has never been conclusive proof…until now.’

And the results indeed seemed conclusive: ‘Companies with the strongest governance practices achieve total shareholder returns of 8.5x the initial investment.’ By buying companies with good governance, you’d not just double your money — you’d more than octuple it (if that’s even a word).

But all the company did was find a correlation between corporate governance and performance — which is far from causation. There are two rival theories. The first is reverse causality. Perhaps poorly-performing companies have to focus on fire-fighting; only once a company has a rosy future outlook can it turn its attention to longer-term issues such as governance. The second is omitted variables. Something entirely different, such as having a great CEO, could improve both governance and performance, rather than the former causing the latter.

What was striking is that the link between corporate governance and performance had already been shown by many studies published in the top scientific journals. But the company’s study measured corporate governance by its own Corporate Governance Index. So, to tout their own index, they pretended that this question had never been explored before, and claimed ‘conclusive proof’  when they didn’t even have evidence. They had data, but data is not evidence when it’s consistent with rival theories.

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