Checkbox approach to CG doesn't work

Wharton accounting professors David Larcker, Irem Tuna and Scott Richardson say the check-box approach to CG doesn't work, because companies and their situations are too diverse. "The recipe book is big, and there's a different recipe for each company," Richardson notes. Even worse, the professors say, are consultants and ratings services that use formulas - which they typically refuse to reveal - to boil down a company's CG to a single number or grade.

Yep.

"Lots of people are coming up with G. scorecards," Larcker explains. "They're coming up with best practices and selling this stuff. As far as we can tell, there's no evidence that those scorecards map into better C. performance or better behavior by managers."

Larcker, Tuna and Richardson tried to create a magic formula of their own. But no matter how they sliced and diced G. data (consisting of more than 30 individual measures) on more than 2,100 public companies, they couldn't find one. The three professors have released their findings in a working paper titled, "Does CG Really Matter?" The title is intentionally provocative. They do think CG matters, but after puzzling over reams of company numbers, they are not confident that anyone can measure whether one firm's G. is better than another's at least, not by using typical metrics.

As they say in their paper, "Our overall conclusion is that the typical structural indicators of CG used in academic research and institutional rating services have a very limited ability to explain managerial decisions and firm valuation."

CG pays

A new study released today by GovernanceMetrics International shows corporations that are rated highest for governance practices have delivered superior investment returns.

GovernanceMetrics International said its latest data on 2,588 global companies found that 26 companies receiving the highest score of 10.0 outperformed the Standard & Poor's 500 stock index total return by 10 percent over the last five years.

Over a three-year period the companies outperformed by 8.3 percent and over one year they outperformed by 4.9 percent. The 26 companies included 20 American companies, five Canadian and one Australian.

GMI said the companies also outperformed when measured against the Morgan Stanley Capital International World Index.

"This suggests a correlation between CG practices and portfolio returns when measured across a number of variables and across a multi-year period," GMI Chief Executive Gavin Anderson said in a statement.

Anderson said that U.S. companies as a group had improved ratings over the past two years, with the average rating rising to 7.2 from 6.5. He attributed the better showing in part to the Sarbanes-Oxley Act, a U.S. law that required a series of accounting and CG reforms.

The report said that 95 percent of U.S. companies now say they have a qualified financial expert on their audit committee, compared with 65 percent in an earlier study in 2002.

Nearly three-quarters have hiring policies concerning employees or former employees of auditor firms compared with only 14 percent in 2002.

Just over half of the companies have adopted a policy on rotation of audit personnel compared with 8 percent in 2002.

A big majority of audit committees, 83 percent, now perform self-evaluations compared with 17 percent in the earlier study.

In other changes, 90 percent of companies now have board evaluation policies versus 35 percent in 2002. Director training is provided by 80 percent of companies compared with 14 percent in the earlier study. Only 11 percent of companies say they are paying auditors more for non-audit work as opposed to audit-related work, down from 48 percent in 2002.

The study found that U.S. companies have also improved in independent board leadership, but are behind the UK.

GMI said 95 percent of rated companies in the UK have separated the roles of chairman and chief executive, while only one-third of rated companies in the United States have done so. In the earlier study, 22 percent of U.S. companies had separated the chairman and chief executive roles.

Comparing nations, U.S. companies had the highest overall average rating, 7.23. Canada was second with a 7.19 score, followed by the UK with a 7.12 rating and Australia with 6.73.

Greek companies had the worst overall average rating, 2.93, followed by Japan, with 3.57.

Examples of the 26 companies with the highest rating included Eastman Kodak in the United States, Suncor Energy in Canada and Westpac Banking in Australia.

The GMI rating system uses hundreds of data points that fall into the broad categories of board accountability, financial disclosure and internal controls, executive compensation, shareholder rights, ownership base and takeover provisions, corporate behaviour and social responsibility.