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August 19, 2003
Corporate Governance Ratings Take Different Approaches to Produce Similar Results
    by William Baue

GovernanceMetrics International rates corporate governance in relation to other companies, while Institutional Shareholder Services rates in relation to market indexes.

Late last month, GovernanceMetrics International (GMI), an independent corporate governance rating agency based in New York City, released its ratings for more than 1,000 US companies and more than 600 companies from fourteen other countries. Seventeen companies, including ChevronTexaco (ticker: CVX), ExxonMobil (XOM), Eastman Kodak (EK), McDonald's (MCD), Occidental Petroleum (OXY), and Praxair (PX) earned perfect scores of 10 (on a scale of 1 to 10) in GMI's overall global ratings.

This does not mean that these companies have "perfect" corporate governance in an absolute sense, but rather that they have best practice on governance, according to GMI. Whereas other ratings measure corporate governance, social, or environmental performance against a set standard or benchmark, GMI rates each company's governance in relation to other companies' governance.

"We wanted to capture the reality of the marketplace rather than some theoretical gold standard in the belief that institutions who are our subscribers want to deal in the real world," said Gavin Anderson, GMI's CEO. "The bar is set by companies that embrace the highest standard of behavior."

GMI assigns 16 different ratings to companies, including a global rating that compares each company to the entire universe of 1,600 companies and a home market rating that compares companies to their national compatriots. Ratings also compare companies to their same-sector peers.

"Our system utilizes asymmetric geometric scoring (AGS), which in effect magnifies the record of 'outliers,'" said Mr. Anderson. "This includes both those with the very best practices, who are then rewarded more, or those with the worst, who are penalized accordingly."

Institutional Shareholder Services (ISS), which provides institutional investors with proxy voting and corporate governance services, launched a research tool in June 2002 that similarly rates governance. However, ISS's Corporate Governance Quotient (CGQ) rates in relation to set benchmarks, not to other companies' corporate governance performance. ISS also says that its system accurately reflects reality.

"We peg our ratings to market indexes and industry peer groups because that's how analysts typically look at the data," said Cheryl Gustitus, vice president of communications at ISS.

The CGQ rates more than 5,400 US companies and 2,000 non-US companies in relation to their appropriate benchmarks, such as the S&P 500 and the MSCI World Index. While CGQ analyzes 61 data points, GMI analyzes almost ten times more, or 600 data points.

GMI and CGQ divide their metrics into a similar number of categories (seven and eight, respectively) that overlap on such issues as executive and director compensation, takeover provisions, and ownership. However, GMI includes a specific category for corporate behavior and social responsibility, issues that CGQ leaves untouched.

GMI scores companies relationally not only at the final stage of evaluation, but throughout the rating process as well. As an example, a hypothetical "HighRated Company" could receive a 6.0 rating in shareholder rights in its home market yet still receive a perfect 10.0 overall home market rating. That is because a 6.0 rating in the shareholder rights subcategory actually compares very favorably to other companies' performance, and therefore does not bring down the overall rating.

Considering the degree of controversy surrounding some of the corporate governance practices of companies such as ChevronTexaco and ExxonMobil, investors may be surprised at their "perfect" scores. Both companies have CEOs that also hold the position of chairman of the board, a practice that many corporate governance advocates spurn.

"While we believe that the chairman and CEO roles should be separate, the fact that ExxonMobil and ChevronTexaco haven't split those roles doesn't necessarily represent a huge risk to the investor from a governance perspective, with all the other metrics considered," said Mr. Anderson.

Interestingly, GMI and CGQ's different rating systems sometimes generate consistent findings.

"We have a relatively high rating on ExxonMobil as well," Ms. Gustitus told

ExxonMobil earned a score of 92.5 out of 100 in relation to the S&P 500, and a 99 against its peer group.

"The company has made substantial changes in their governance practices; before it made those changes, it didn't see those scores," Ms. Gustitus explained.


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