South Africa is ahead of many countries in terms of corporate governance. Not only was the country at the forefront of factoring ESG issues into its exchange listing requirements, it now requires integrated corporate reporting.
In a previous global market strategy report, Cornerstone Capital Group examined the significance of governance for country equity valuations using both “top‑down” (governance at the national level) and “bottom up” (governance at the corporate level) metrics — see Gauging Governance Globally: Macro and Micro Metrics, September 15, 2014. We highlighted that a multiple regression generated an R-squared of 0.16 between equity valuation at the country level and four measures of governance:
- The World Economic Forum’s Corporate Governance
- The World Bank’s Ease of Doing Business Index.
- Transparency International’s Corruption Perceptions Index.
- The World Bank’s Worldwide Governance Indicators.
Source: Cornerstone Capital Group.
We then took a weighted average of the four macro governance measures to rank the eight regions / countries in our regional strategy model in terms of a composite governance score. The rankings (from best to worst): (i) Australia; (ii) U.K.; (iii) North America; (iv) Japan; (v) Europe ex the U.K.; (vi) Latin America; (vii) Emerging Asia; (viii) the Central and Eastern Europe, Middle East and Africa (CEEMEA) region.
In terms of the CEEMEA region, the country with the largest weight in the MSCI Emerging Markets EMEA Index is South Africa — a 45% weight as of April 2015. Other countries with large weightings include Russia (23%), Poland (9%) and Turkey (8%). Figure 1 illustrates that, if South Africa is treated as a standalone country, it ranks much higher than either (i) the CEEMEA region as a whole or (ii) three European countries: Portugal, Spain and Italy.
A few points to note:
- The scores for the regions in Figure 1 are based on the weights of the component countries in the relevant MSCI index. So, even though South Africa has a much bigger weight (45%) than Russia (23%), the extremely poor scores for governance in Russia (and the mediocre scores for Poland and Turkey) mean that the CEEMEA region as a whole ranks last in our governance composite.
- Our governance composite is calculated by weighting the four measures of governance outlined above. The WEF Corporate Governance rank gets the heaviest weight given its relatively strong correlation with country P/Es. Despite its low R-squared, we included The World Bank’s Worldwide Governance Indicators because a statistical analysis reveals that a four-variable model is more statistically significant than a three-variable model (i.e., one that excludes the World Bank Worldwide Governance indicators).
- Figure 1 illustrates that South Africa ranks very well for governance at the corporate level — i.e., the World Economic Forum’s Corporate Governance score and the World Bank’s Ease of Doing Business Index — but not as well at the national level i.e., the Corruption Perceptions Index and the World Bank’s Worldwide Governance Indicators. That South Africa ranks well for governance at the corporate level is not that surprising.
The Evolution of World Class Corporate Governance in South Africa
Following the publication of the King III Report on Corporate Governance in 2009, the JSE mandated the disclosure of sustainability information starting in the 2010 financial year and subsequently mandated the disclosure of integrated reporting starting in 2011. Landmark events in the evolution of corporate governance in South Africa were the King I Report on Corporate Governance in 1994 and the King II Report on Corporate Governance in 2002 (both named after retired Supreme Court judge Mervyn E. King (See Professor King’s article in this issue.) While neither of these reports specified mandatory requirements for companies, their guidelines were selectively adopted by the Johannesburg Stock Exchange (JSE) as listing requirements (See “The Johannesburg Stock Exchange: Integrating Sustainability” article in this issue).
- Companies are mandated to disclose their policies in relation to a series of ESG issues as well as to report on the actions that they take to achieve the objectives of their policies. (However, it should be noted that no specific guidelines have been provided, or standards set, to require disclosure along a specific set of metrics.)
- Integrated reports must describe the value creation process inside an organization and discuss a company’s impact on stakeholders as well as the strategies for mitigating any potentially negative impacts on society.
ESG reporting was widespread among many of the large firms in the economy even before the recently mandated disclosure of sustainability information. Following the initiatives outlined above, corporate governance is now widely considered to be world-class in South Africa.
Michael Geraghty is the Global Markets Strategist for Cornerstone Capital Group. He has over three decades of experience in the financial services industry including working as an investment strategist at UBS and Citi.