How Corporate Governance Affects the Financial Performance of Companies
Corporate governance affects the financial performance
of companies through several channels, the most important of which are:
1. Expanding access to external financing sources.
Effective application of corporate governance principles leads to facilitating access to capital markets and increasing the credit rating of the company by eliminating the two most important barriers to accessing external finance (the inconsistency of information between financiers and borrowers due to poor accounting; non-discloser of the important information and neglecting interested parties associated with the company). Companies with an effective corporate governance system can increase investor confidence and increase the firms' access to capital, therefore improve their financial performance.
2. Increasing the company's value.
Investors usually pay higher prices for purchasing company shares that have effective adherence to corporate governance principles, since it protects their rights, especially the rights of small investors, not to mention ensuring good regulation of relations between investors, the board of directors and managers. This leads to a decrease in the cost of capital.
Effective corporate governance systems also provides direct economic benefits to companies, which makes them more profitable and competitive.
3. Crisis reduction.
Weak investor protection makes net cash flows more sensitive to events with a negative impact. As investor risks increase, the cost of capital increases accordingly. Therefore, investors, as a rule, follow corporate governance principles as key criteria in the process of making investment decisions, as they reduce the risk of crises and (to some extent) maintain the financial performance of the company even in times of crisis.
4. Improving stakeholder relationships.
When the relations between stakeholders are clear, based on transparency and each stakeholder fulfills his obligations, this will inevitably lead to company improvement, maximizing the wealth of shareholders, improving their activities, as well as a good economic impact on the community in which the company operates.
5. Improving administrative efficiency.
An effective system of corporate governance provides the necessary incentives for the board and management to achieve goals that meet the interests of the company and its shareholders. Thus, board members and managers are constantly stimulating work in the interests of the company, which has a positive effect on its financial performance.
Igor Todorović (2013. Impact of corporate governance on performance of companies, Montenegrin Journal of Economics, Vol. 9, No. 2, pp. 47-53.
The Organization for Economic Cooperation and Development, Practical Guide to Corporate Governance, 2009.