Time and money spent improving governance doesn’t improve shareholder value, says Stanford study

In a study titled “Who’s Watching the Watchdogs?” that “is likely to be controversial,” Stanford said Monday it has found evidence that “questions the value of the ratings” of all four of the major shareholder advisory firms, according to a press release put out by the Rock Center for Corporate Governance, made up primarily of faculty from both the Stanford Law School and its Graduate School of Business.

These firms claim they are “able to predict future performance by performing a detailed analysis encompassing many variables culled from public sources,” according to the release, a claim the study tends to debunk.

“Everyone would agree that corporate governance is a good thing. But can you measure it without even talking to the companies being rated?” asks David Larcker, co-director of the Rock Center, in the release. “There’s an industry out there that claims you can. But for the most part, we found only a tenuous link between the ratings and future performance of the companies.”

That advising institutional investors has become big business is illustrated in the release by fact that Institutional Shareholder Services, “the best known of the advisory companies, was sold for a reported $45 million in 2001. Five years later, ISS was sold again; this time for $553 million to the RiskMetrics Group. The enormous appreciation in value underscores the importance placed by the investing public on ratings and advisories issued by ISS and its major competitors, including Audit Integrity, Governance Metrics International and The Corporate Library.”

The study, which examined more than 15,000 ratings generated for 6,827 separate companies from late 2005 to early 2007, attempted to correlate ratings issued by the advisory firms to five measures of governance: financial restatements, shareholder lawsuits, return on assets, a measure of stock valuation, and a measure of an investment’s stock price performance.

It characterized the results it found for ISS as “particularly shocking,” as it found no links between their ratings and any of the measures listed above.


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