Who's watching the
A new study from
Stanford University questions the reliability of corporate-governance
James Bandler and
June 26, 2008: 11:50 AM EDT
(Fortune Magazine) -- Since
the Enron scandal, a coterie of corporate-governance firms has emerged as
standard-bearers for shareholder rights. In addition to acting as quote
machines, the firms - which include the Corporate Library and RiskMetrics
Group's ISS Governance Services - are also big businesses that sell, among
other things, ratings that say whether a company is well governed or not.
But a new study from
Stanford University's law
and business schools gives mostly dismal grades to four of the biggest
rating services: ISS, the Corporate Library, GovernanceMetrics International
(GMI), and Audit Integrity.
Statistical tests run by
the Stanford academics found little or no correlation between the different
services' ratings. Pfizer (PFE,
for instance, earned a perfect "100" from ISS in 2005, but a "D" from the
Corporate Library. Lockheed Martin (LMT,
scored a 9.5 out of ten from GMI, but Corporate Library gave it its worst
possible grade, an "F."
ISS has a separate and
powerful proxy advisory service. Its ratings are posted publicly on Yahoo
Finance; companies, fearing the scrutiny of shareholder activists or the
wrath of the raters, sometimes do pirouettes to improve scores.
No sophisticated investment
manager relies on ratings alone. But the Stanford team found very little or
no statistical evidence of links between the ratings and company
performance, undermining the firms' very raison d'ętre. Some did better than
others: GMI predicted companies' restatements better than its peers. But
ISS's main rankings, the study found, predicted nothing but future lawsuits.
On average, its top-ranked companies were more likely to have class-action
lawsuits than its lowest-rated companies.
A tool, not a talisman
The firms say other studies
show their ratings can identify investment opportunities and risks. "The
fact that our primary customers are investment managers suggests they are
finding value in what we deliver," said Howard Sherman, CEO of GMI. Patrick
McGurn, special counsel at ISS, said the study used the wrong kinds of
metrics and should have looked at more than one year of ratings data - and
points out that the ratings are "a tool, not a talisman," and not meant to
act as a predictor of performance. The Corporate Library declined to
comment; the CEO of Audit Integrity praised the study.
But the Stanford findings
reinforce a growing sentiment that governance ratings are an art, not a
science. "It points out that there's no grand unified theory of corporate
governance," says Cary Klafter, vice president of legal and corporate
affairs at Intel.
A few years ago, ISS docked
Intel's score because the law firm where a member of the Intel board's
nominating committee worked had done legal work for Intel (INTC,
Klafter called the ratings adjustment - Intel's score fell by multiples of
ten, then shot back up after the director switched to a different committee
- "amazingly overblown" and said it suggested the irrelevance of the number.
All this is not to say that
governance doesn't matter; it may just not be easily quantifiable. "[Good]
governance is a little bit like porn," says Robert Daines, one of the
authors of the study and co-director of Stanford's
for Corporate Governance, referring to Supreme Court Justice Potter
Stewart's famous comment about recognizing obscenity. "I can spot it when I
see it, but it is hard to say what it is." Even ISS's McGurn says he hopes
research like the Stanford study will lead to more attention to governance.
That is happening:
Researchers at the
Rock Center are trying to find a way to make hard-to-collect governance data
available for free. Let a thousand ratings services bloom.
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