Governance key to better valuations: Crisil

Investors put a premium on firms with better governance standards, says a Crisil study

Companies with better governance practices enjoy a premium in the financial markets and thus can significantly improve their market valuations, according to a study by Crisil, a rating agency.

The study, conducted over a three-year period beginning 2000-01, pointed out that the strength of stakeholder relationships plays an important role in determining the quantum of governance premium enjoyed by companies.

"The results of the study are in line with other studies that showed that corporate governance standards influenced valuations in companies more in the emerging markets than in the developed ones," a Crisil release said.

The agency conducted the study on 40 leading companies which account for a significant proportions of the Sensex and Nifty.

The study entails tracking the correlation between the quality of corporate governance practices and governance premium, which is defined as the ratio of a company's growth-adjusted PE (price-to-earnings) ratio to the sector's average.

The study found that while a composite score based on traditional governance practices and stakeholder relations showed a co-efficient of correlation of 0.56 with the governance premium, a score on traditional governance alone showed a correlation of 0.47.

"This highlights the importance of creating value for a company's stakeholders and the fact that investors recognise and reward such value creation," said Ajay Dwivedi, Head-Ratings Criteria and Product Development.

Crisil has analysed governance premium of 40 companies after dividing them in four categories on the basis of their composite score on governance and strength of stakeholder relationship.

The analysis, which showed a sharp differentiation in the governance premium at varying levels of governance, demonstrated that the governance premium enjoyed by the companies was highly sensitive to governance standards.

Crisil used its proprietary governance and value creation criteria in arriving at the composite governance and stakeholder relationship scores.

This involved adding scores on certain parameters that measure the strength of stakeholder relationships to traditional governance scores.

To access traditional governance, Crisil used scores on corporate governance assigned by CLSA India to a sample of Indian companies between 2001 and 2003.