May 8, 2016

The Kenyan investing public has recently lost roughly Kshs 264.3 bn across various companies. As discussed in our Focus of the Week on Corporate Governance in Kenya, most of the losses appear to have been driven mainly by a failure of corporate governance. The losses are shown in the table below:

Source: Cytonn Investments

Corporate governance constitutes the mechanisms, processes, and relations through which companies are controlled and governed. Corporate governance is founded on the pillars that businesses have to practice accountability to stakeholders, fairness, have transparency in business activities and exhibit independence in decision making of the board. The benefits of good corporate governance are numerous as (i) it protects the interest of the investing public, (ii) improves access to funding at better costs, (iii) reduces risks of corporate crisis, (iv) improves firm valuation and share price performance, and (v) generally improves the performance of the entire firm and enhances sustainability.

Having highlighted the challenges the market is facing, we decided to take the next step to produce an actionable index that market participants, whether investors, companies or regulators, can rely on to factor corporate governance in their decision making.

We did research on various corporate governance indices (CGI) around the world and extracted 25 metrics that can be used to evaluate corporate governance in an organization. We ultimately used 24 of the metrics, and dropped one, litigation against a company, because we could not find sufficient and reliable litigation data.

Based on these 24 metrics, we collected data and created a score for all listed companies with at least Kshs 1.0 bn in market capitalization. The data and score for each of the listed companies was shared with the Chief Executive Officer of each of the companies for their reaction. What is interesting is that companies that rank high on CGI are also very open and responsive; of the top 10 rankings by CGI, 80% (KCB Group, Safaricom, Stanchart, Kengen, Jubilee, Barclays, Bamburi, DTB and I&M) responded to the request to confirm their data and scoring, demonstrating their openness and responsiveness to the investing public. We have released all the data collected to develop this report so that it can be reviewed and critiqued by interested parties.

Key highlights of the findings include:

1. There is a strong correlation between corporate governance and returns. The top 25 companies in the Cytonn CGI have delivered an absolute return of approximately 55.6% over the last 5 years compared to the bottom 25 companies, which have delivered an absolute return 9.1% per annum of the last 5 years.

2. Gender diversity is also directly correlated with stock returns. The top 25 companies by gender diversity have delivered and 5-year absolute return of 42.4% compared to 25.6% delivered by the bottom 25 companies

3. Ethnic diversity is also directly correlated to stock returns as evidenced by the top 25 companies on ethnic diversity delivering a 5-Year absolute return of 52.9% compared to 12.5% delivered by bottom 25 companies.

4. The top two companies, KCB Group and Safaricom, have come out publicly in support of a transparent and open private sector devoid of corruption.

*We have excluded agricultural stocks due to their repricing as they were priced due to their Real Estate holding

Please find on this link, the Cytonn Corporate Governance Index.

The results demonstrate that good corporate governance is essential to well-functioning and vibrant financial markets; And vibrant financial markets are essential to funding economic growth, which in turn creates jobs and raises the standards of living for Kenyans. Consequently, good corporate governance is a national imperative and we have a choice: we either focus on it and get it right for the benefit of all Kenyans, or give it lip service for the benefit of a few unscrupulous players. We hope that the Cytonn CGI will make its contribution towards improving corporate governance in Kenya and ultimately, deepening capital markets, funding growth and improving the standards of living.

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Disclaimer: The views expressed in this publication, are those of the writers where particulars are not warranted- as the facts may change from time to time. This publication is meant for general information only, and is not a warranty, representation or solicitation for any product that may be on offer. Readers are thereby advised in all circumstances, to seek the advice of an independent financial advisor to advise them of the suitability of any financial product for their investment purposes.