After the scandals at Enron, WorldCom, Adelphia Communications, Arthur Andersen and a host of other U.S. firms, a number of credit rating organizations, along with a handful of other business research groups, are now offering up opinions, ratings and other barometers on the effectiveness of corporate governance at a variety of U.S. companies. In the past year, Standard & Poor’s (S&P), the long established credit rating organization, as well as Institutional Shareholder Services (ISS), a well-known provider of proxy voting research, have both become sources for corporate governance information.

Certainly, the form and nature of the corporate governance “scoring” systems differ from firm to firm. For the moment, ISS and S&P appear to be generating more buzz, as established companies laying the groundwork for this new rating process. ISS began providing its “Corporate Governance Quotient (CGQ)” for a fee to subscribers in June 2002, while S&P offered U.S. corporate governance “scores” in October of the same year, but only at the behest of the ranked company or a shareholder (upon company approval). The company itself or the vested interest, such as the shareholder, foots the bill for S&P’s services. Both ISS and S&P take into account such things as ownership structure, auditing procedures (internal and external), and board independence, when assessing the appropriate level of corporate governance controls at a company.

ISS provides two scores of between 0 to 100 percent, with the first based on an indices ranking against other comparable companies, segmented as S&P LargeCap 500, MidCap 400, SmallCap 600, or Russell 3000 companies. ISS provides a second score, or “CGQ,” relative to the industry type, such as banking or automotive. In contrast, S&P offers an overall score of between 1 (poorest) to 10 (best), with four sub scores, all between 1 and 10 as well, in the areas of ownership structure and influence; financial stakeholder rights and relations; financial transparency and information disclosure; and board structure and process. ISS derives its “quotient” from publicly available data, including financial statements and press releases, while S&P obtains its data from confidential company interviews and data, in addition to publicly filed financial documents and other materials. (ISS’s analysis method negates the need for company permission, while S&P’s process requires they seek the company’s permission. S&P must obtain private data to complete its work.)

In addition to ISS and S&P, two established business research organizations, the Corporate Library and the Investor Responsibility Research Center (IRRC), are also selling to subscribers their versions of corporate governance rankings for U.S. companies, based on publicly available data. Both organizations rate companies against other companies, using a variety of differing benchmarks and factors, including industry type, company size, etc.

A relative newcomer in the corporate research field, GovernanceMetrics International (GMI), began a similar service three years ago. GMI lists its initial subscribers as mostly institutional investors. An overall score is provided, from a low of 1 to the highest of 10, based on a myriad of factors, including board accountability, financial disclosure, internal controls, shareholder rights, and executive compensation. All ranked companies are scored against the entire universe of companies rated by GMI. Scoring can take the form of a basic rating, based on publicly available information, or a more comprehensive rating, derived from public and private company information. A comprehensive rating requires the analyzed company’s cooperation and a fee from the same company, similar to the S&P process.

The emergence of the various corporate governance scoring services initially caused quite a bit of media hubbub, particularly the announcement of S&P’s initiative. The interest appears to have died down in recent months as corporate scandal news has subsided. However, as more investment firms, like Smith Barney and Prudential Financial, are now using the “CGQ” from ISS in their equity research, the concept of corporate governance scores is expected to gain more momentum.

Another well-respected entrant in the game may soon generate additional interest in the use of corporate governance “rankings”. In an interview with Knowledge@Emory this month, Mark Watson, vice president-corporate governance in the credit policy group at Moody’s Investors Services, announced that the credit rating agency has plans in the works to provide a written opinion on the corporate governance initiatives at a limited number of companies. While details are still sketchy, Watson notes, “We will offer an opinion on about 100 or so companies, specifically those that are some of the largest issuers of debt. This will be made available to the people who buy our service. The form is still taking shape, but it may be a two to three page written assessment.”

David Wessels, professor of finance at Emory University’s Goizueta Business School, believes that if and when this sort of corporate governance analysis tool becomes more standardized and available on a wider and more public basis, it could be particularly useful for current and potential investors alike. “This research is simply too time consuming for most investors to do on their own,” he notes. “If the rating agencies are able to build a critical mass of rankings, then this could give the individual investor a useful barometer on one key factor that might lead to strong future performance.”

Wessels notes that such well-known and deep-pocketed firms as S&P and Moody’s could provide significant influence to make this sort of “scoring” a more routine and expected part of the financial analysis and risk assessment process. However, Andrew Ward, assistant professor of organization and management at Goizueta, cautions that the measurement derived is only as good as the information it is based on. Obviously, says Ward, the scoring completed with inside and more detailed information will provide a much more accurate picture of the level of corporate governance controls in place than the scoring done with publicly available documents only.

The process of rating, if done well, could offer a company an objective opinion on internal controls, and, in turn, might lead to corrective measures when flaws in procedures are discovered. “When the rated company buys the service and wants an outside firm to do the rating, then the directors and officers are privy to information that they wouldn’t otherwise have,” Ward adds.  Corporate boards of directors are increasingly operating in a climate of fear, after many highly publicized legal square-offs between inside executives, regulators, and shareholders.  Hence, outside directors may be keenly interested in having an objective review of the internal controls in place at the company, says Andrea Esposito, head of S&P’s Americas governance services in their corporate governance group.

Esposito notes that the S&P scores garnered through their interactive corporate governance scoring service comes from an in-depth analysis of inside corporate information. For now, the company has the option to make a score public. Esposito adds, “We only do corporate governance scores by request of the company or investor. We need to have the participation of the company to do it, as it is a fully interactive process.”

S&P looks at three years worth of board and committee minutes, in addition to other confidential information and financial statements. The analysis also includes interviews with the chairpersons of all the major corporate committees, generally all of the independent directors and the executive management (such as the CEO, CFO, etc.), the head of investor relations, external and internal auditors, and sometimes even block or large shareholders.

To date, Esposito says that about 80 companies from across the globe have obtained a corporate governance score from S&P, though she is not at liberty to reveal how many of these are U.S.-based concerns. However, Esposito notes that according to federal regulations, if a company agrees to undergo a corporate governance scoring at the request of a shareholder, then the information would need to be made public, so there would be no unfair advantage given to anyone based on insider information.

Professor Ward sees the current beginning steps towards corporate governance scores as a “good move,” adding that it is especially “important to have this information from credible sources, such as ratings agencies, bringing their help to bear on the matter.” He envisions that as these rankings become a more public and accepted measurement, they could soon influence a company’s stock price or price of their bonds. Additionally, continued pressure from shareholders and the various stock exchanges to improve internal controls at publicly traded firms may soon necessitate that companies make this type of information public, says Ward. “It may take some time, but we will eventually get there,” he adds.

A few companies are choosing to reveal their scores, and this may soon promote further interest in the process. In January, Fannie Mae became the first U.S. company to obtain and then reveal the corporate governance score given to it by S&P. Of course, with a 9 out of a possible 10, it was a no-brainer that the nation’s largest provider of housing finance would provide the details on its near-perfect score. According to a press release from S&P, such things as “shareholder-friendly provisions that allow owners to convene special shareholder meetings” and “a highly independent board” earned Fannie Mae the high marks.

In February, Agilent Technologies received favorable “CGQs” from ISS. The maker of scientific instruments and analysis equipment added the information to its website, under the heading of “social responsibility,” almost as a seal of approval. (The company received a 92.2 percent “CGQ” against the industry index, outperforming 92.2 percent of the companies in the S&P 500. They also earned a 98.3 percent against the peer group index, surpassing 98.3 percent of the companies in the technology, hardware and equipment category.)

For those businesses with less than favorable scores, notes Professor Wessels, market pressure may eventually force them to reveal their scores. Those that refuse to provide the information may eventually be seen as “hiding something.” A poor score that is revealed may be less damaging than one that is hidden, especially if the company’s leadership is proactive in announcing the corrective actions being taken to “up” their score.

(June 2003)