The Great Governance Debate – Towards a Good Governance Index for Listed Companies
Institute of Directors & Cass Business School, 2015
32 Pages Posted: 11 Dec 2020
Date Written: June 1, 2015
A reliable corporate governance (CG) index – a combination of individual governance indicators capable of measuring the overall quality of a firm’s governance – is regarded as the Holy Grail of governance research. Ideally a CG index would measure all of the characteristics that matter for corporate outcomes, and would be a valuable tool for informing both CG decisions within firms and investment decisions across firms.
Over the past 20 years, academics and practitioners have made several attempts at producing CG indices, so far with limited success. Existing indices have often been criticised for adopting a ‘kitchen sink’ approach to the problem by simply combining large numbers of indicators (typically between 50 and 100) using an arbitrary weighting scheme to produce CG index scores for companies.3 Several critics have also argued that the ‘tick-box approach’ used to compile the basic CG databases for such indices can easily be gamed by companies. Such gaming can render them uninformative over time.
The ultimate test of the quality of a CG index is its usefulness to both investors and to other stakeholders in identifying future company performance. By and large, existing indices continue to fail this test: they often do not identify the best-performing companies and in some cases fail to detect the worst-performing ones.
The Institute of Directors, in partnership with Cass Business School and Z/Yen, is taking on this challenge. In this document we present two important innovations. First, we use a new list of indicators that are not simply related to compliance with the UK CG code. Although the emphasis is on public information, crucially, we do not only rely on the information disclosed in annual reports. Second, the weights assigned to the individual components are inferred on the basis of surveys of customer, investor and employee assessments of the quality of the corporate governance regime of the rated companies. This methodology automatically adjusts for the perceived importance of different governance mechanisms and implicitly creates a link between the index and firm performance. This could also significantly reduce the scope for gaming and preserve the relevance of an index over time.
We believe, therefore, that these approaches could produce a more reliable index in the future, which will help us all learn what works and does not work in corporate governance.
Keywords: Governance, Corporate Governance Index
JEL Classification: G30 - General
Suggested Citation: Suggested Citation