The Limitations of Governance Ratings
As governance ratings have become ubiquitous, they have also attracted an increasing about amount of attention, not all of it positive. As I noted in a prior post (here), one academic study questions the "predictive validity" of the governance ratings. A more recent academic study questions the applicability of uniform governance standards to disparate companies.
In any April 2009 paper entitled "Elusive Quest for Global Governance Standards" (here), Harvard Law Professor Lucien Bebchuk and Hebrew University of Jerusalem Professor Assaf Hamdani question whether the effort to establish uniform governance metrics suffers from a "basic shortcoming"; that is, the authors question whether certain corporate arrangements counted as good governance should be considered equally valuable for all companies.
In particular, the authors contend that the value of certain arrangements "depends considerably on companies’ ownership structure" and that "measures that protect outside investors in a company without a controlling shareholder are often irrelevant or even harmful when it comes to investor protection in companies with a controlling shareholder."
In elaborating on this perspective, the authors note that in the U.S. most public companies lack a controlling shareholder, by contrast to companies outside the U.S. that often have a controlling shareholder. Given the absence of a controlling shareholder, "for anyone approaching governance arrangement from a U.S. perspective finds it is natural to assume that the arrangements governing control contests are a key element in the governance of public companies." This kind of bias results in a preference for governance arrangements that, for example, relate to takeovers and proxy fights. However, for companies that have controlling shareholders, "the presence of arrangements providing protection against a hostile takeover or a proxy fight is neither good nor bad, but simply irrelevant."
In view of these differences deriving from this important ownership distinction, certain governance practices, the authors suggest, should be weighed in assessing governance according to whether or not companies have a controlling shareholder.
The authors reviewed the governance rating methodology of three governance rating systems: RiskMetrics’ Corporate Governance Quotient (CGQ); and two measures developed by academics, the Anti-Self-Dealing Index and the Anti-Director-Rights Index. The authors conclude that presumptions built into the measures reflect a "failure" to "properly take into account the relationship between ownership structure and corporate governance," which "substantially undermines the indices’ ability to serve as effective metrics for the quality of the governance at firms or countries worldwide."
The authors are not against the development of governance metrics; as they put it, they "do not question the feasibility of developing a methodology for large-scale governance assessments." Rather they argue that commentators and practitioners should "develop separate systems – one for controlled and one for widely held firms," so that the rating methodology "fits the company’s ownership structure."
The authors’ analysis makes an important contribution for the understanding and use of the now ubiquitous governance measures. In particular, it may be critical for those relying on these measures to understand their limitations in certain contexts. By the same token, it is worth emphasizing that the limitations the authors cite will be most relevant in connection with companies outside the Unites States. The authors apparently do not question the general usefulness of the measures for U.S.-domiciled companies that lack a controlling shareholder (or for that matter, for any company lacking a controlling shareholder).
The more interesting question may be whether or not there are other limitations on the one-size-fits all approach to corporate governance measurement. I have often been concerned that governance metrics applicable to larger companies may not be as applicable to smaller companies, or that governance requirements best suited for mature companies may not be the same as those suited, say, for a developmental stage company. I have also often wondered whether the standards should be applied the same to all companies in all industries.
All of which to me suggests that there could be room for additional research along the lines undertaken in this study, to examine whether or not there may be other ways in which governance metrics should reflect separate methodologies for assessing different categories of companies.
He’s At It Again: Some readers may recall the recent post (here) in which I reported on the lawsuit that purported to be brought on behalf of Bernard Madoff by federal prison inmate Jonathan Lee Riches against Brittney Spears. As reported in a May 23, 2009 article in the Spokane Spokesman-Review (here), Riches has now filed another lawsuit in the Eastern District of Washington seeking an injunction to stop the Guinness Book of World Records from naming him as the person who has filed the most lawsuits in the history of mankind. A copy of Riches’ latest complaint can be found here.
Riches contends that the Guinness Book plans to print false information about him, among other things apparently by undercounting the number of lawsuits Riches claims he has filed. He also objects to the names the Guinness Book intends to call him, including "Johnny Sue-nami," "Sue-per-man," "the Patrick Ewing of Suing" and the "the Lawsuit Zeus." He says that these phrases "hurt my feelings and violates my civil rights."
Riches filed his case in the Eastern District of Washington despite the February 23, 2009 order (here) entered in that court by Judge Justin Quackenbush, in a case in which Riches had sued the Peanut Corporation of America claiming to have been poisoned with Salmonella-tainted peanut butter. In the order, Judge Quackenbush had admonished Riches that his "ability to file future cases in this court will be enjoined" if Riches continue to filed cases that fail to state a claim or that are "deemed frivolous or malicious."
Among other things, in his latest lawsuit, Riches claims that the Guinness Book has "no right to publish my work, my legal masterpieces." Riches prior lawsuit targets include among others Somali pirates, Plato, Nostradamus, George Bush and New England Patriots Coach Bill Belichick. (Riches undoubtedly filed the Belichick lawsuit to prove that not all of his lawsuits are frivolous.) In his latest complaint, Riches says he has also sued Black History Month, the president of Iran and butter substitute "I Can’t Believe It’s Not Butter!"
Riches also asserts that "when I get out of prison, I’m going to start a Lawsuit 101 shop and teach Americans how to file pro se lawsuits." He also said "I will sell Jonathan Lee Riches T-shirts" saying "Watch out what you do, or I’ll sue you."
Hat tip to the Overlawyered blog (here) for the link to the Spokane Spokesman-Record article.
The concerns you raise about ownership characteristics in your latest posting on corporate governance ratings struck a particularly positive chord among the analysts at The Corporate Library. Drawing the distinction between companies with a controlling shareholder and those more widely held has been an integral part of our corporate governance ratings since their inception in 2003.
Of the 3,381 companies in our present coverage universe, 360, or 10.6%, have a controlling shareholder block. While the ratings of all the companies we cover involve a manual review, controlled companies by far require the most in-depth study. One size clearly does not fit all when it comes to corporate governance. Companies with controlling shareholders are particularly complex and diverse in their various approaches to shareholder representation and management oversight. Indicators of possible self-dealing are especially important at these firms, and are regularly highlighted in our ratings and analysis.
Current letter-grade ratings for this group range from a low governance risk B to a very high governance risk F. In the context of securities class action litigation, however, controlling shareholders rarely sue themselves, so our more specialized SLRA ratings apply a very different weighting for the presence of a controlling shareholder block, and nearly all of these companies have been assigned a low risk rating. To our knowledge there were only a couple of such cases in our coverage universe over the past two years, and at least one, against Calamos Asset Management, was ultimately dismissed.
I should also note here that the author of the study you cited, Lucian Bebchuk, is a member of The Corporate Library's Advisory Board.