Study hits governance ratings’ effectiveness

Corporate governance ratings have little success in predicting the performance of a company, according to a study by faculty members at the Arthur and Toni Rembe Rock Center for Corporate Governance, a joint center of Stanford Law School and the Stanford University Graduate School of Business.

The study “casts strong doubt upon the value and validity of the ratings of governance advisory firms” — RiskMetrics Group, Audit Integrity, Governance Metrics International and The Corporate Library — “that compile indexes to evaluate the effectiveness of a publicly held company’s governance practices,” according to a statement from Rock Center about the study.

Robert Daines, Stanford Law School professor, co-director of the Rock Center and an author of the study, said in an interview the research looked largely at the firms’ 2005 ratings to assess how well they predicted outcomes in subsequent years.

“Our results indicate that the level of predictive validity for these ratings are well below the threshold necessary to support the bold claims made for them by these commercial firms,” the study said.

Howard Sherman, president and CEO at GovernanceMetrics, said the study “used a limited time frame. … It isn’t long enough to draw any meaningful conclusions. More importantly, they didn’t use the entire set of GMI ratings. Our clients, based on their renewal rates, clearly find value from what we provide.”

“I’m reluctant to comment on the study because I haven’t reviewed it in any depth,” said Richard A. Bennett, CEO at The Corporate Library. “But I will say the study did find our ratings were predictive of accounting restatements and … of superior operating performance and discovering alpha” in investment portfolio returns.

James A. Kaplan, chairman, Audit Integrity, said in a statement, “The study represents an interesting overview with respect to governance ratings. Audit Integrity’s top-rated performance in the study is due to the breadth of our data and the fact that our analysis relies solely on quantitative techniques.”

Sarah Cohn, RiskMetrics spokeswoman, said in a statement, “The depth and scope of the Stanford study is quite limited. In fact, we were surprised to learn that the findings are based on such a limited data set and time horizon.”