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2 July 2008
Lifting the Lid: New study takes aim at governance grades
Source: www.reuters.com
By Martha Graybow
NEW YORK, July 3 (Reuters) - The corporate watchdogs that assess how companies are run have just been given their own report card from a group of academic critics who say the services have a long way to go to provide meaningful governance ratings.
Governance ratings -- which look at issues such as board independence and executive pay -- became a hot business after the Enron fraud and other accounting scandals. Subscribers include investors, insurers who write policies for boards of directors and lawyers. But critics say it is hard to take the reports seriously because the ratings can vary widely depending on who is doing the scoring.
Now, the new study by Stanford University''s Rock Center for Corporate Governance questions whether ratings provided by firms such as RiskMetrics Group Inc (RMG.N: Quote, Profile, Research, Stock Buzz) and GovernanceMetrics International have any real value.
It concludes the ratings are not closely linked with a company''s future financial performance or whether the company is likely to be hit with shareholder lawsuits or accounting problems. The study''s authors also suggest that, while governance is important, companies that change their practices to boost their grades might not want to bother.
The raters are the equivalent of "the 2,000 pound, good governance gorilla, and they have a lot of pull in the market," said Robert Daines, a Stanford professor and one of the study''s authors.
"Our paper suggests that their rankings don''t produce useful information," he added.
Governance research firms have taken issue with the study, saying it only looked at a limited time frame and that ratings are not designed to be the only factor investors consider.
The study, a working paper yet to be published, is called "Rating the Ratings: How Good Are Commercial Governance Ratings?" It analyzed whether the 2005 governance scores for more than 6,500 companies forecast company outcomes such as lawsuits or financial restatements in 2006 and 2007.
Overall, it found, "the level of predictive validity for these ratings are well below the threshold necessary to support the bold claims made for them" by the ratings firms.
"I''m not sure you can draw any real conclusions from what they ended up testing," said Howard Sherman, chief executive officer of GovernanceMetrics.
He said his firm sees a key correlation between a company''s governance practices and its cost of capital -- a metric that "was not at all part of this analysis."
Richard Bennett, CEO of the Corporate Library, also questioned how the study was carried out.
"We are only getting and better and better," he said. "The study is kind of old at this point."
A spokeswoman for RiskMetrics, Sarah Cohn, said its governance ratings are not meant to forecast a company''s future performance at all.
"It''s a comparative tool, not a predictive tool," she said.
In the case of RiskMetrics, the Stanford study also found there was little relation between its governance ratings and another service the company offers providing recommendations to shareholders on things such as how to cast their ballots in board of director elections.
The CEO of another firm cited in the study, Audit Integrity''s Jack Zwingli, thought the research was valuable, but he hoped Stanford would do it again with more complete data.
Investors concerned with governance issues have said before that governance ratings themselves cannot be accepted at face value, in part because the scores can vary so widely among firms because they use different methodologies.
The Stanford study cites a number of inconsistencies in the 2005 ratings it analyzed, such as poor ratings given to General Electric Co (GE.N: Quote, Profile, Research, Stock Buzz) and AT&T Inc (T.N: Quote, Profile, Research, Stock Buzz) from the Corporate Library while at the same time they received top scores from RiskMetrics.
Discrepancies have emerged more recently, such as reports on brewer Anheuser-Busch Cos Inc BUD, whose governance has been put in focus after its board spurned a takeover offer. The company received an "F" rating -- the worst possible -- in 2007 from The Corporate Library, while its latest RiskMetrics rating ranked it better than 75.4 percent of S&P 500 Index companies and better than 91.9 percent of peers in its sector.
"We found little agreement as to what counted as good or bad governance. These are not small companies that they are disagreeing on," Daines said. "These are big, prominent, really well-covered firms." (Editing by Andre Grenon)
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