A Bad Rating for the Raters

Short of direct shareholder activism, one of the most common methods used to promote corporate governance reform is the creation of rating systems. The notion is that companies will institute changes to rectify a bad rating, or else they will be pressured to do so by institutional shareholders that use the evaluations in their investment decisions.

For this to work, the rating systems need to be able to identify corporate governance shortcomings in a coherent way and be consistent in their evaluations. One might think that the diagnosis is a straightforward matter and that the challenge lies in getting companies to change. Yet a new report issued by the the Rock Center for Corporate Governance at Stanford University apparently finds a wide degree of variation among the ratings offered by different services.

I say “apparently,” because the report, despite being described in some detail in an article posted today by Fortune magazine (which presumably received an advance copy), has not appeared on the Center’s website as of this writing.

According to Fortune, the study found that the ratings of a given company by the leading services—RiskMetrics Group’s ISS Governance Services, The Corporate Library, GovernanceMetrics International (GMI) and Audit Integrity—can vary wildly. For example, pharmaceutical giant Pfizer is said to have received a perfect score of 100 from ISS at one point but a less impressive D from the Corporate Library at the same time. Lockheed Martin got 9.5 out of 10 from GMI but the worst possible grade from the Corporate Library.

Fortune quoted study co-author Robert Daines as saying that “[good] governance is a little bit like porn. I can spot it when I see it, but it is hard to say what it is.” If that’s the case, perhaps institutional shareholders should stop paying hefty fees to the rating services and use their own judgment—or else rely on corporate accountability groups with clear principles rather than black-box systems to determine what’s wrong with the way companies are run.

UPDATE: I’ve now learned that the Stanford study is available online here.

3 thoughts on “A Bad Rating for the Raters”

  1. The ranking and ratings done by most consultants are point analyses whose results are dependent more on methodology assumptions and statistical methods than anything else. That’s why their results look like scattershot.

    The “know it when I see it” comment about good corporate governance is another way of saying that measuring it requires a social evaluation – not just a report on who did what to whom and when – but some serious application of the “wisdom of the crowds”.

    To your final point – in principle, assessing good corporate governance by aggregating the views of informed shareholders and citizens results in a more realistic measurement of company’s reputation than the sort of “black box” analyses that seem to dominate the dialogue today.

    Think about the specific case of executive pay. A company’s pay consultants analyze the subject to death, providing all kinds of technically detailed reports. But then the shareholders look at the pay numbers and go ballistic. Whose “measurement” of the company’s reputation is more realistic??

  2. Pay consultants answer to the CEOs and the boards that hire them. If pay were set by shareholders, it would be considerably lower, and certainly wouldn’t go up when the company’s performance metrics are going down.

    To act as if these consultants simply disagree with shareholders is to miss the larger point — the consultants are effectively “hired guns” who know they will never get hired again if they recommend a lower and much more realistic pay level for the CEOs who sign their checks.

  3. Countercorp: The fact that pay consultants answer to CEOs and boards is so well known as to be obvious. The point of Phil’s post and my comment was that collective assessments – particularly by involved shareholders – are likely to be better measurements of what is and isn’t good corporate governance than the analyses of most any consultant or black-box wielding firm. Do you agree with that?

    I would really like to see you guys a) take a constructive position that is actually related to the thread of discussion, and b) use your real names in your posts.

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