Investment: Good corporate governance (CGC) poses some interesting challenges for the marketer, but it also has benefits by maximising value. How can this be achieved in a customer-centric way?

Corporate governance is of great interest to investors, and it will influence their decisions in putting money into a company or, as shareholders, in leaving it there. Investors will pay a premium to invest in companies that prove a higher standard of governance . What can the marketer do to influence this premium to the benefit of the listed company and its shareholders? The answer is not straightforward and poses an interesting challenge for the marketing profession.

The conventional role of marketing addresses one group of stakeholders – customers. Indeed, the classic definition of marketing is about anticipating, identifying and satisfying customer needs profitably. The marketer controls all aspects of the product market match, including the pricing, so that the company can create the maximum value for the customer and consequently extract the maximum profit from the relationship. In this context the shareholder is merely the passive recipient of value.

The investor as customer

However, investors in publicly quoted companies are also stakeholders who, like customers, have needs to be satisfied both to attract them and to retain them. Like the customer, the equity investor has an expectation of value. This expectation is made up of two elements, dividend income and increase in share price. Share price performance is usually the primary source of value sought by the experienced investor. If we consider the investor as the potential customer in search of value through his investment, the company becomes the product. Investors compare one company with another just as the customer compares one product or service with another.

A key aspect of governance

The one variable where the marketers can have the most effect is in how the company presents itself – the product. Get this right and they can exert the maximum leverage on the most critical variable – the share price. The presentation of the ethos of corporate governance is central to this, but one aspect exerts more leverage than any other. It is the strategic capability of the company. This is the system by which a company builds, shapes and then uses it resources and strengths to drive value, sustain profits and achieve growth.

Traditional equity investment research relies extensively upon the quantitative analysis of financial results – the past. Analysis of the past can only provide a partial view of the ability of a company to perform in the future. The book value of a company accounts on average for less than 20% of its market value. The other 80% or more reflects the belief investors have in the capacity of the management to keep producing better results. Traditional research's pre-occupation with the past gives investors limited assistance in interpreting the future. Analysts talk about 'liking' the management of one company more than another. This is insufficient. The general communication of corporate governance, and in particular of a company's strategic capability, offers more predictive possibilities of likely future value.

Proof of concept?

The chart indicates the potential. The Strategic Capability Index comprises twelve companies whose presentation of this key aspect of corporate governance in their 2003/4 annual reporting narratives indicated they were the most strategically capable in the FTSE100, and eight who were similarly the most strategically challenged. The capable companies have outperformed the FTSE100 by 34.92% over thirty-three months through comparatively better PE ratios and earnings growth. This 2004 analysis also validates the findings of earlier US research. Eminent accounting academic Professor Christina Botosan’s 1997 research used rigorous statistical analysis to demonstrate that lower equity capital cost [higher share price] accrued to high disclosing companies, and, particularly, to those with a lesser analyst following.

Extending Botosan’s research, the Financial Accounting Standards Board concluded that companies lightly followed by analysts, and disclosing the most, enjoyed a nine per cent reduction in their cost of equity capital. Standard & Poors more recently undertook a study of the world’s 1,500 most liquid companies, covering the UK and US as well as other global markets. They concluded that: “Most telling are the findings that suggest that companies which voluntarily disclose more in their annual reports command a higher stock price … Companies that distinguish themselves by disclosing more information lower their market risk and therefore their cost of capital.

A basis for comparable evaluation

If marketers are to use corporate governance effectively in this manner then they need a reliable system that enables comparability between companies. FutureValue offers one interesting and innovative method derived from the methodology that produced the index shown in the chart above. In preparing annual reporting documents, UK-listed companies are expected to comply with the provisions of the 'Operating and Financial Review' (OFR) Reporting Statement and discuss, among other things, how their thinking and planning for the future will build upon both past and present achievement. These strategic capability-related criteria of the OFR best practice guidance provide the basis for evaluating each company’s narrative commentary, thereby ensuring consistency and comparability across all companies.

The FutureValue technique scours all non-financial narrative sections of annual reporting documents in which OFR-related commentary appears. For each company it identifies relevant content, allocating it to one of four factors: strategic capability; objectives and strategy; performance and KPIs; future factors and risk; and, the non-balance sheet resources and strengths of the business. Researchers then evaluate to a template and score each factor. How a company presents its overall narrative and how well it articulates the content are equally fundamental to the document's overall effectiveness. So, the evaluation also allocates points for communication and for coherence respectively. An un-weighted average of the scores for all these six factors combines in an overall rating for the company that is discussed in a standard 5-page Report. In 2006, top quartile companies scored in excess of 7.1. Second quartile companies score 5.6 or better.

In summary, equity investors, like customers, have needs to be satisfied. Like customers they make comparison between 'products' – listed companies. They pose a challenge to marketers in listed companies because it is difficult to exert control over the marketing variables of the investment product market. The communication of strong corporate governance enhances the product and will influence pricing – the share price. Strategic capability is the key component of corporate governance that arguably has the most impact on pricing – the share price.

¹ Roberto Newell and Gregory Wilson, 2002 "A premium for good governance", McKinsey Quarterly, Number 3
² FTSE350, January 2006 – Market to book ratio average
³ Christina Botosan, 1997. “Disclosure Level and the Cost of Equity Capital” The Accounting Review 72 (July): pp 323-349
⁴ Financial Accounting Standards Board. 2001 “Improving Business Reporting: Insights into Enhancing Voluntary Disclosures” Steering Committee Report Appendix B: pp 35-37
⁵ Standard & Poors. 2002 “Transparency and Disclosure: Overview and Methodology of Study Results”
⁶ http://www.futurevalue.co.uk
⁷ Accounting Standards Board, January 2006 'Reporting Statement 1'

By Ian McDonald Wood

For more information contact Ian McDonald Wood:
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