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How much is good governance worth? These days, corporate chieftains, shareholder activists, and academics are hotly debating that question. Even as funds such as TIAA-CREF and the California Public Employees' Retirement System (CalPERS) seek to impose boardroom guidelines on companies such as H.J. Heinz Co., critics of the somewhat rigid rules say they're trying to do the impossible. Investors simply can't tally the benefits of a strong board of directors, in part because what goes on inside the boardroom is invisible to outsiders.

But as the battle over boardroom standards heats up, institutional shareholders and governance gurus are gathering evidence to prod often reluctant chieftains and their directors into reform. A number of recent studies show that well-governed companies not only make more money than the poorly governed, but investors are likely to give them a higher stock market value.

In one yet-unpublished study, Yale University economist Paul W. MacAvoy looked at the performance of 275 companies ranked on governance by CalPERS in 1994. Those that CalPERS considered well-governed boasted an extra 1.5% to 2% on average in annual returns to shareholders. ''Over a decade, we're talking about returns of 15% to 20% more to shareholders,'' says MacAvoy. Another study of 205 corporations in 14 industries by professors at the University of Pennsylvania's Wharton School found that companies with ''ineffective governance structures'' often rewarded their CEOs excessive pay in relation to performance.

But perhaps the most compelling evidence that good governance pays off comes from a McKinsey & Co. study. Investors were asked how much they would be willing to pay for shares in two well-performing companies. The difference between the two theoretical companies: Only one of the boards followed good governance practices, such as having a majority of outside directors.

The investors surveyed--50 institutional money managers who together oversee assets worth $840 million--told McKinsey they would fork over an average premium of 11% for the stock of the company with good governance practices. Perhaps more telling, chief executives and directors were willing to pay an even higher premium. Directors said they would pay about 14% to 15% more, while CEOs said they would ante up an extra 16%. ''This is the first time anyone has demonstrated that investors place a high value on good governance,'' says Ira M. Millstein, the governance guru. ''We'll be able to use this study to convince boards to become more pro-active.''

Applying the study's numbers to Heinz would suggest that the company's market value would grow $1.6 billion if investors thought it was well-governed. That's hardly chump change. McKinsey estimates that Heinz would have to increase its pretax profits by more than $140 million annually to gain 11% in stock price.

HYPOTHETICAL. Why the big jump? Some investors surveyed said they believed that good governance would help boost performance over time, bringing a higher stock price. Others felt good governance decreases the risk of bad news--and when trouble occurs, they rebound faster.

Of course, McKinsey's numbers are based on a hypothetical; there's no telling whether investors would make the same decisions if they had money on the line. And in real life, so many disparate factors go into assessing a stock's value that it's impossible to put a price tag on a well-run board. Even staunch supporters such as Millstein caution that guidelines and policies offer no guarantees. He concedes that the best standards in the world won't do much good if directors don't take their responsibilities seriously. Nevertheless, without the ability to peek inside the boardroom, investors will have to settle for the next best thing: measuring a company's commitment to governance via the independence, quality, and accountability of its board.

By John A. Byrne in New York

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Updated Sept. 4, 1997 by bwwebmaster
Copyright 1997, Bloomberg L.P.
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