We should be thankful that stock analysis is generally quantitative. The net profit margin is net profit divided by revenue. A company’s gearing is the ratio of debt to equity. Corporate governance, on the other hand, is a little trickier to gauge.

How do you assess the independence and objectivity of a company’s board of directors? And how to judge the aptness of a chief executive’s remuneration? As shareholders, we are the owners of these companies. We are the bosses of the bosses (in theory, at least) and we deserve to know how our companies are run - because when they are governed poorly, things tend to blow up.

So why does looking at board structures, considering executive compensation and the rest of it sometimes feel like an afterthought? It is an important part of not just the risk equation, but also the potential reward.

‘Good’ corporate governance and why it matters

Studies have repeatedly drawn a link between superior corporate governance and positive share price performance. A study in 2007 found that the best-governed companies (according to the ISS Corporate Governance Quotient, which rates publicly traded companies in terms of the quality of their corporate governance) generated returns on equity 23.8% better than those of poorly governed companies during the year reviewed (‘Corporate Governance Study: The Correlation between Corporate Governance and Company Performance’, Brown and Caylor, 2007).

This makes sense given that a good corporate governance system should 1) mitigate conflicts of interest among stakeholders (especially between managers and shareholders), and 2) ensure that the assets of the company are used productively and in the best interests of the investors and other stakeholders (‘do you really need the corporate jet for that, Dave...’).

Other responsibilities include: describing the rights of shareholders; defining manager and director governance responsibilities to stakeholders; ensuring fair treatment between stakeholders, and promoting transparent and accurate disclosures concerning trading operations, risk, and financial position. We can get a reasonable impression of corporate governance by looking at a company's annual reports.

What to do now

Steps you can take to gauge the quality of a company’s corporate governance include investigating the following:

How is the Board composed and are members sufficiently independent? Looking at the annual reports, the Board profiles on the company’s website, and doing a little googling can help here. Is the Board professional or does it look like an old boy’s club? Do members…

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