The general perception is that it is too early to expect investors to differentiate between Indian companies on account of corporate governance -- after all, the country's related listing requirement (clause 49) only took effect in 2000.

But a new study by Standard & Poor's shows that in fact there is a link -- in India at least -- between corporate governance and market value, suggesting investors do take it into account when deciding where to put their money. The Satyam Computers fraud that emerged in January, for example, certainly focused a great deal of attention on this area.

The study shows that the corporate governance score obtained once a year from the S&P ESG India Index -- which rebalances annually on January 1 -- has a significant and positive link to company-level performance. Better governed firms command a higher market valuation; for every 1 point increase in the governance score beyond 45 (out of 100), a company's market value rises by 3%.

Such firms are also less leveraged, have higher interest coverage ratios, provide a higher return on net worth and capital employed, and their profit margins are relatively more stable, says S&P. Their price-to-earnings ratios and dividend yields are also higher.

The S&P ESG India Index, launched in January 2008, is a measure of environmental, social and corporate governance at Indian companies -- the only one of its type for any country.

However, S&P and its Indian subsidiary, Crisil, are working with several stock exchanges to create a similar ESG index, says Sunil Sinha, New Delhi-based head and senior economist at Crisil. "As and when reasonable time series data relating to corporate governance of companies listed on these stock exchanges become available, we may explore the possibility of such a study," he says.  

For the new report, S&P used corporate governance scores from the S&P ESG India Index for a four-year period from 2005-2008 for nearly 300 companies. The scores aggregated factors including: shareholder capital; shareholder rights; financial information; operational, board and management information; board and management remuneration; corruption; leadership; and business ethics.

Though these results are preliminary, they are significant in at least three ways, says the report. First, they suggest that investors are using the information available on governance practices to differentiate between companies. As a result, companies have an interest in improving governance -- as well as publicising the measures that they take -- since this will contribute to an improvement in their market valuations.

Second, only companies above a certain threshold of governance level trade at a premium. The existence of this 'threshold' effect provides a rough benchmark for mandatory disclosure requirements to be set by a regulator. S&P says further examination will help to identify the kinds of behaviour and disclosures on which investors place the highest premium.

Third, to the extent that global investors put a premium on corporate governance practices, their strategies may have some positive spill-over effects on domestic investors who may be trying to replicate them. This aspect may support an argument for regulatory mechanisms that encourage such investors, says S&P.