Leadership

Commercial Governance Ratings in Question

By Jessica Stillman

Updated on: July 8, 2008 / 2:25 PM EDT / MoneyWatch

The Find: Governance advisory firms claim they can predict the future performance of a public company by analyzing public data, but new research claims the value of their ratings is dubious at best.
The Source: A study by Stanford law and business faculty.

The Takeaway: Faculty members at the Rock Center for Corporate Governance, a joint center of Stanford Law School and the Stanford Graduate School of Business, examined more than 15,000 ratings of 6,827 public companies from 2005 to 2007. The researchers looked for correlations between the ratings of commercial governance advisory firms like Institutional Shareholder Services, or ISS, and five metrics of governance performance: restatements of financial results, shareholder lawsuits, return on assets, a measure of stock valuation known as the Q Ratio, and Alpha -- a measure of an investment's stock price performance on a risk-adjusted basis.

Considering the value of ISS rose from $45 million to $544 million between 2001 and 2006 you could be forgiven for expecting great things from its ratings. But when the researchers had a look they found "no significant correlation between its Corporate Governance Quotient (or CGQ) ratings and any of the five metrics." Competitor firms Audit Integrity, Governance Metrics International (GMI) and The Corporate Library (TCL) fared slightly better, but their ratings only showed a weak correlation to some of the variables.

Professor Robert Daines acknowledges that the results of the study are bound to be controversial, noting:

Ratings and proxy recommendations... are watched closely by the financial press and generally are seen as quite credible. Indeed, board members of rated firms spend significant amounts of time discussing the ratings and attempt to bring governance practices in line with the standards of the watchdogs.

The full text of the study is available at the Rock Center website.

The Question: Have we been hoodwinked?

(Image of rating scale by leafar., CC 2.0)