Corporate executives and directors are meeting in Toronto this week at the second Corporate Governance Conference to discuss igniting more passion in the boardroom. One idea they might explore is whether there is demand for corporate governance rating agencies.

Corporations pay for independent analysis of themselves from credit rating agencies. They pay for this service because it creates value in the form of easier access to financing. The success of any new agency that rates corporate governance would depend on whether this service creates value for public companies and their shareholders.

Evidence suggests this is in fact the case. A study by McKinsey and Company found evidence of a link between the quality of governance and shareholder value. Surveys of investors in both developed and emerging market economies revealed that over 80 percent of investors were willing to pay a premium for shares in well-governed companies. The premium ranged from 18 percent in the US and UK to over 25 percent for some emerging market economies such as Indonesia and Venezuela.

A new working paper by Professors Gompers and Ishii at Harvard and Metrick from the Wharton School of Business shows that investing in well-governed companies pays off. The study revealed that abnormally high returns could be generated by a portfolio of stocks in companies where governance and shareholders rights were relatively strong in comparison to management power.

Companies might also find governance ratings helpful in stemming the increasing tide of regulation over their continuous disclosure (information that companies disclose on an ongoing basis). Securities regulators have been increasing their scrutinization of not only regulatory filings, but in the case of the OSC, any tidbit of disclosed information they can find through their new Continuous Disclosure (CD) Review Program. In addition, securities commissions have been introducing new rules expanding the depth and scope of disclosure requirements including non-GAAP financial data and even the content of audited financial statements themselves.

Given rising concern over accounting and auditing practices in the wake of the Enron collapse, it is likely that the trend towards more regulation will continue. However, regulation is a vastly inferior to governance as a line of defense against inadequate disclosure. Governance and disclosure are mutually reinforcing. Timely and accurate disclosure of information by companies improves governance by allowing shareholders to use that information in reviewing management performance. Good governance practices contribute towards ensuring the quality of information disclosure.

A well-governed company will make the information needs of its shareholders its priority in determining what to disclose. In contrast, a heavily regulated company focuses on compliance, making sure they won’t get themselves in trouble with the regulators.

Regulators and self-regulatory organizations are paying greater attention to the importance of good governance, both in Canada and elsewhere. Recently, a Joint Committee on Corporate Governance, sponsored by the TSE, CDNX and CICA, released the Saucier Report. The Committee’s mandate was to recommend how Canada should respond to new governance requirements on the NYSE and Nasdaq that emerged from the Blue Ribbon Committee on Audit Committee Effectiveness in the US.

The Saucier report indicated that corporate governance practices had improved in many Canadian companies. However, based on a survey of current practices, and other factors, it concluded that there is room for improvement and made several recommendations to further improve the quality of governance in Canada, such as extending governance disclosure requirements to some CDNX-listed companies, but it also recognized the limitations of regulation as a tool to foster good governance.

By establishing governance agencies, the private sector can take a leading role in further promoting the quality of corporate governance. A rich clientele exists for this service from companies that have already recognized the shareholder benefits to governance. For these companies, the incentives to show off the quality of their governance have never been greater.