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Non-Financial Concerns Matter to Investors

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Swiss Finance Institute
Tuesday, October 3, 2017 - 09:00

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From Enron to Bernie Madoff, the corporate world has witnessed some major corporate scandals over the last few years. The common denominator of any scandal is a decline in investors’ trust. In this month’s edition of SFI's Practitioner Roundups, we  look at two different elements―managerial honesty and corporate governance―that are of importance to investors and influence their investment decisions.

Do investors care about managerial honesty?
Increased regulation has sought to eradicate corporate fraud and managerial misconduct. But is further regulation really needed to improve management ethics, or do investors promote honest corporate cultures anyway by making investment decisions based on perceived managerial honesty?

SFI Prof. Rajna Gibson Brandon of the University of Geneva, Dr. Matthias Sohn of Zeppelin University, Prof. Carmen Tanner of the University of Zurich, and SFI Prof. Alexander F. Wagner of the University of Zurich employ experimental research to answer this question. The experiment shows that many participants place ethical considerations above financial returns. A total of 60 percent of the participants invested with CEOs who did not engage in upwards earnings management and thus passed on the opportunity to earn a significantly higher bonus. Investors consider such CEOs as more honest. The results apply for pro-social investors and investors with a pro-self orientation, but the motivations for their choices differ. Pro-self investors value managerial honesty as a signal of the credibility of a CEOs’ future financial returns announcements, whereas pro-social investors base their decisions on moral values and are largely insensitive to financial returns. «Essentially, firms might be able to benefit from a lower cost of capital through perceived honesty as some investors seem willing to accept lower returns in exchange for the lower risk they bear,» states Prof. Rajna Gibson Brandon. Prof. Alexander F. Wagner adds: «Deception risk is a major concern for investors. When creating portfolios for their clients, banks should incorporate the important role of managerial honesty as a safeguard against this risk.»

Incorporating corporate governance factors into investment decisions
Corporate scandals illustrate why investors must look closely at the way in which companies are structured and controlled. «Analyzing a company’s corporate governance is an effective way for investors to assess the quality of a company, and in particular its long-term managerial alignment with their own interests,» says Christine Schmid, Credit Suisse’s Head of Investment Solutions. But how do investors incorporate such factors into their investment decisions?

A recent Credit Suisse Research Institute Report reveals that an investment strategy may reward investors when it focuses on well-governed companies in sectors where governance is particularly important. Investors might invest in long–short portfolios based on going long on the top 10 percent of companies versus shortening the bottom 10 percent when looking at the governance score within each sector. Investors should focus on well-governed companies in sectors where governance has moved from being relatively unimportant to being in sharper focus, perhaps due to regulatory changes or similar pressures. As indicated by specific shifts that occur from time to time—e.g., at Volkswagen in 2015—a shift in governance can be an early warning sign. Such cases serve to reinforce the necessity—and the benefits—of investors considering aspects of corporate governance in their investment strategies.

Read the full version of the October issue of SFI’s Practitioner Roundups, here.

Interested to find out more?

  • To learn more about «What really motivates people to be honest in business», watch SFI Prof. Alexander F. Wagner’s talk featured on, here.
  • To learn more about corporate governance, consult the SFI White Paper «Corporate Governance: Beyond Best Practice» or the Credit Suisse Research Institute report «How Corporate Governance Matters».
  • To refresh and deepen your corporate governance knowledge and leadership skills, consult details of our CAS in Banking with a focus on Corporate Banking, here.