Importance of good governance in driving investor returns

From September 2018, companies listed on AIM will be required to apply a recognised corporate governance code. Judith MacKenzie explains the importance of good governance and the crucial role it plays in driving investor returns.  

As we await the result of the Financial Reporting Council’s overhaul of the UK Corporate Governance Code, it is worth noting that change will not just be restricted to companies listed on the main market. From September, smaller companies listed on AIM will also be required to apply a recognised corporate governance code for the first time.

However, most small and mid-sized companies are likely to find the UK Corporate Governance Code unsuitable to their size and stage of development. In fact, research indicates that around 400 companies on AIM currently refer to the Quoted Companies Alliance (QCA) Corporate Governance Code, which is specifically tailored for companies at the smaller end of the market cap spectrum. It includes 10 corporate governance principles that companies should follow, and step-by-step guidance on how to effectively apply these principles and adopt best practise. We fully support this code - it is no coincidence that companies with a strong culture of corporate governance can deliver better performance. And we welcome initiatives that drive an efficient, effective and dynamic management framework that can allow those companies to deliver long-term shareholder value.

At Downing, we expect our investee companies to apply rigorous and effective corporate governance and have directors who understand their duties and are familiar with their legal responsibilities. These can be demanding – directors are accountable for the culture, foresight and success of the company, and must act in the best interests of the company to benefit current and future shareholders.

Competent boards should be regular constructive challengers to management teams. They should also help develop strategy and long-term objectives, monitor performance, ensure the build-up of necessary assets, skills and capable management, and lead in setting a culture of integrity.

We hold significant positions in companies that have competent management, growing markets, sound and often transformational strategies, good margins, healthy operating cash flows and who appreciate the support and influence our board offers. Where key qualities are lacking, we encourage the necessary strategic action or improvement in performance. This provides confidence that over the long term, intrinsic value will become evident and our investments will either be revalued or the companies acquired.

The crucial role played by good corporate governance was demonstrated recently by one of our holdings that has been less successful in meeting the above criteria. We took a board seat, suspecting that governance could be improved, and the structure of our investment has allowed us to drive change throughout the business. Board members and top management were changed, the business refocused and we now believe that the company should generate a gain for shareholders in due course.

Correct governance of companies is critical to corporate health and investor confidence. At the core of good governance is directors actively ‘directing’, striving for the success of the company, overseen by nominated advisers who should be doing more than going through the motions, and by the LSE AIM team that should monitor with determination.

As the UK faces an uncertain future, good corporate governance will become ever more important, and will be a valuable contributing factor in creating and growing successful UK companies.

‍Judith MacKenzie

Partner and Head of Downing Public Equity

Board member, Quoted Companies Alliance