Conflicts of Interest in Advisory Firms
BNET columnist Jessica Stillman penned an intriguing post last week calling a new Stanford study noting the dubious claims of shareholder advisory services that they can predict future performance of companies. The report, issued by the Rock Center for Corporate Governance, run jointly by Stanford law and graduate business schools, reached its conclusions after examining 15,000 ratings of 6,827 public firms from 2005 to 2007.
The study took an especially close look at Institutional Shareholder Services, the Rockville, Md.-based firm that surveys around 38,000 shareholders meetings each year. ISS, now owned by RiskMetrics Groups, Inc. of New York, uses a series of metrics to rate corporate governance, including financial restatements, shareholder lawsuits, return on assets and others.
Like competitors such as Glass, Lewis & Company in San Francisco, ISS weighs on various proposals from shareholders and candidates for directorships. As shareholder democracy issues gain more currency, firms such as ISS seem to have more relevance since they present themselves as knowledgeable and unbiased sources of good info. What's more, they have their own bells and whistles through which they can divine a company's future, or so they claim.
The Stanford study, however, throws cold water on the conceit that governance advisers are rocket scientists. There's another little problem as well: conflicts of interest.
ISS and its president John M. Connolly have been constantly criticized for apparent conflicts of interest. As Robert D. Hershey Jr. wrote in the New York Times a couple of years ago: "ISS draws fire for both setting governance standards and helping corporate clients meet them, provoking criticism that it profits handsomely from a possible conflict of interest. It (ISS) says it has strictly separated these functions in order to eliminate conflicts." Another Times business reporter, Gretchen Morgenson, has regularly trashed I.S.S in her columns, saying it acts both as an auditor and consultant.
Gee, isn't it funny that the big accounting firms got into big trouble a few years ago for profiting from a very similar situation. They vetted financial reports of companies while selling them consulting services, with the idea being, (wink wink) that if you play ball on hiring our consultants, we'll play ball on your screwy, dishonest financial statements. Big Accounting was forced to spin off its consulting units as part of the post Enron and WorldCom house cleanings.
Another scary thing about governance advisers is that they seem to get fewer. In 2005, ISS, for instance, bought Washington, D.C.-based Investors Responsibility Research Center and last year I.S.S. itself was picked up by RiskMetrics.
And, there's the perennial problem of Big Think with these groups. Organizations such as I.S.S. seem to think that they can guru their way through disparate companies without actually dealing with them from the inside.
Anyway, my guess is that the Stanford folks are on to something. What do you think?