Friday, May 14, 2010

Governing The Governors

In a previous post, we discussed the potential pitfalls of investing in companies with poor corporate governance structures. But how can an investor protect himself? There are two basic ways. First of all, the investor can become knowledgeable about what makes for good corporate governance, and then study up on each company in which he is interested in order to make sure it follows practices in accordance with sound corporate governance. The second method is to take advantage of the information published by the companies that specialize in rating and reporting on the governance practices of public companies.

A full discussion of what makes for good corporate governance is beyond the scope of what can be provided in this one article, and we have covered some of the basic points in previous articles on corporate governance. Therefore, this article will focus on what's available for those interested in pursuing the second method.

Governance Metrics International (GMI) is a company that has developed a proprietary corporate governance rating model that it has applied to over 4000 companies. The premise behind the company is that firms with superior corporate governance practices generate superior returns. GMI can be contacted for those who wish to receive a sample report.

Standard and Poor's also produces a Corporate Governance Score (CGS), based on the following criteria:
  1. Ownership structure
  2. Shareholder rights
  3. Transparency and disclosure
  4. Board effectiveness
Based on how a company is rated in the above four factors, it is given a CGS rating between 1 and 10. A sample report of S&P governance can be viewed here.

While it's easy to gloss over corporate governance elements, the wisest investors always keep them top of mind. With the first rule of value investing being "Never Lose Money", ensuring sound corporate governance practices can increase the likelihood of being able to follow that rule successfully.

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