Polish your presentation: you're being rated; A number of ratings services have sprung up in recent years to rank companies on their corporate governance--a key criteria for investors. But companies have little control over the process, and may not particularly care for the outcome.

Public companies are fully accustomed to being rated by securities analysts--in fact, many would love more coverage than they're getting these days. But getting rated on their corporate governance is a lot newer idea. While not as high-profile or as meaningful as analyst ratings, these rankings are a corporate equivalent of cod-liver oil--something that may not taste good but is supposed to be good for you.

Without a doubt, the notion of producing corporate governance ratings would have been a non-starter a decade ago. Governance wasn't in the headlines then; apart from dealing with activists focused on, say, social responsibility or board-composition issues, companies didn't face a lot of outside pressure about how they governed themselves. But the scandals that have erupted in the past five years have heightened the attendant scrutiny on governance and boards of directors, and brought demands from investors to know what--and how well--companies are doing.

The governance-ratings process is a lot different from analysts' modeling, and companies have less control over the resulting message. As practiced by Institutional Shareholder Services (ISS), whose Corporate Governance Quotient (CGQ) is the leading index in this area, the ratings are produced by data-crunchers working solely with public information supplied by the companies via their websites, proxies, Securities and Exchange Commission (SEC) filings and other sources. ISS analysts don't go to the companies to seek additional information.

ISS launched its CGQ service in 2002, hard on the heels of the collapse of Enron Corp. and amid the accounting scandals at Worldcom Inc. and Tyco International and the formulation of the Sarbanes-Oxley Act. The Rockville, Md.-based ISS, whose principal clients are institutional investors such as pension and mutual funds, found that there was a hunger for data about which companies might have governance deficiencies and, as a result, represent investment risks.

"We had a lot of institutions using us for proxy voting and research who said they wanted to learn if: one, there could be any indication of implosions that were likely; and two, if there was any way to look at companies across industries on a consistent basis," says John Deosaran, vice president of corporate ratings for ISS.

Currently, ISS has governance ratings out on a huge universe of public companies--over 8,000, with 5,300 of those in the U.S. Most of the rest are in Europe, Canada and Asia. It divides the U.S. rankings into four principal groups: companies in the S & P 500 (large cap), S & P 400 (mid-cap), S & P 600 (small cap) and the Russell 3000. Public access to the ratings is free via the ISS website or through Yahoo! Finance, which carries the ratings in its profiles of individual companies. Canadian companies are drawn from the S & P/TSX Composite Index; other international organizations are listed on the MSCI EAFE and the FTSE All-World indexes.

The CGQ uses 63 different variables for U.S. companies and 55 for foreign entities. Those are divided among eight basic categories, which carry different weightings: board of directors, audit, charter and bylaw provisions, anti-takeover provisions, executive and director compensation, progressive practices, stock ownership and director education. "Some of the variables are reviewed together under the premise that corporate governance is enhanced when selected combinations of these variables are adopted," ISS says.

Each of the variables has positive or negative implications. All are revalidated several times a year and rescored, using new information (such as from news reports). Companies are given a percentage score running up to 100 percent, both for their index group and for their industry. Deosaran says that while companies have free access to the ratings and can submit new data, ISS doesn't actually contact them to discuss any possible changes.

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Private companies are excluded from the rankings, though Deosaran says ISS has been looking at rating private companies that have filed registration statements to go public. "The biggest type of issues there are disclosure-related--what kind of information becomes available on the registration statement," he says.

Plenty of Company

The notion of rating governance has proven a popular one, and has drawn a number of other providers around the world:

* The Corporate Library--Founded by activist investors Robert Monks and Nell Minow, this organization offers a subscription service with governance ratings centered on "board effectiveness"--a composite of 10 different variables, such as board composition, accounting and shareholder responsiveness--and board risk, both rated on a school-type scale from "F" up to "A." A percentage number is also assigned to "best practices" compliance ratings, which the firm says correlates to "compliance with a simplified list of commonly recognized best practices, based primarily on the OECD [Organization for Economic Co-operation and Development] model."

Currently, the Corporate Library is providing governance data and analysis on more than 4,000 U.S. companies through its Board Analyst Pro product. Its universe is a bit different: the Fortune 1000, Russell 3000 (new this year) and Domini 400, a small-cap index. The product also offers "one-click" access to SEC filings, charters and bylaws, governance policies, shareholder proposal history, etc.

* GovernanceMetrics International (GMI). An independent agency, it offers paid subscribers ratings on companies on a scale from one to 10. Since beginning with ratings of Japan's Nikkei 225 index in May 2003, GMI has grown to encompass a global portfolio of companies. Like ISS, it provides ratings on the S & P large cap, mid-cap and small cap stocks, as well as the Russell 1000 and Toronto's TSX. It also provides extensive ratings in Asia and Europe.

"GMI's premise is straightforward: companies that emphasize corporate governance and transparency will, over time, generate superior returns and economic performance and lower their cost of capital," the company says. "The opposite is also true: companies weak in corporate governance and transparency represent increased investment risks and result in a higher cost of capital."

* The "Expert RA--RID" Consortium. The Expert Rating Agency and the Russian Institute of Directors have developed national ratings of corporate governance to assign a complex indicator of corporate governance quality in Russian joint-stock companies.

According to the consortium's website, the ratings "take account of practically all of the companies that are of interest to portfolio investors." At the end of January 2005, National Ratings of Corporate Governance were established for 150 Russian issuing companies--in effect, the majority of companies whose securities are traded on the stock exchanges.

* Moody's Investors Service. Moody's doesn't issue ratings per se, but since 2003 has produced reports with governance implications on some 300 U.S. and Canadian companies. The intent, says Kenneth Bertsch, managing director of Corporate Governance Analysis, is to analyze whether certain governance parameters--compensation, takeover defenses, the independence of the board, etc.--could impact the company's credit ratings. Reports aren't publicly posted, but are issued to customers.

Bertsch says that Moody's analysts go through public documents and also talk with the companies, largely to try to determine if governance could be a positive or negative factor with respect to credit risk. "We'd want to look at compensation--is it irrationally high?" he asks. "There could certainly be a linkage to credit risk there. And are their metrics understandable?"

In a written report, Moody's argues that "after controlling for a variety of firm characteristics, including industry effects and long-term ratings, we find that large, positive, unexplained bonus and option awards are predictive of both default and large rating downgrades ... Larger-than-expected compensation may also be correlated with high levels of credit risk if it signals weak oversight from the board of directors."

Moody's differs from ISS, Bertsch notes, in that its focus is not on shareholders but bondholders. With that, he says, its analysts' views on issues like option usage and takeover defenses like poison pills are often different. "Sometimes we like [defenses]," he says, while ISS generally scores them as negatives.

Company Reaction

Not surprisingly, company reaction to the ratings varies widely. Some with strong scores have chosen to promote those; others, often with lower scores, frequently offer warnings about misinterpreting the ratings.

After all, it's been pointed out time and again that Enron had a strong code of ethics, and ostensibly, good governance. It's the way in which policy is rolled out into practice where the truth about governance really lies, and there may be nuances that a number can't capture, no matter how thoroughly it's generated.

"We've heard a ton, and it runs the gamut," says Deosaran. "Nobody really likes to be rated. No one wants negative grades to be disseminated.

"When the product was first launched, there was a lot of reaction around, 'Who are you to be rating me?' Now, there is a tendency to look at the CGQ as something that is not threatening, and occasionally to highlight what they are doing. We do see companies at the very top seeking to reprint or use their score" for marketing or promotion purposes.

One of those making note of its ratings is MBIA Inc., a worldwide financial guarantor. On its corporate website, MBIA notes its first-place ranking among S & P 500 companies on the CGQ (see table), as well as a 2005 Global Rating of 9.5 out of 10 and a Home Market score of 10 out of 10 for corporate governance by GovernanceMetrics International.

Another corporation posting its governance ratings is the CIT Group, which notes on its website that it is rated by ISS, GMI, Moody's and The Corporate Library. Those ratings are generally strong, although the Corporate Library results are probably closer to average.

However, CIT reminds page viewers that "the published corporate governance ratings, grades and evaluations reflect the opinions of those organizations and are not recommendations to buy, sell or hold any of CIT's securities." It adds that "CIT does not pay a fee to any of the investor services organizations listed below in connection with their issuance of corporate governance ratings."

Intel Corp. is in the more cautionary camp. The giant chipmaker doesn't publish its scores, even though they are quite high on ISS' CGQ--85.2 percent for the S & P 500 and 98.7 percent for the semiconductor sector.

"Intel neither recommends the use of these ratings scores to its investors, nor seeks to dissuade its investors from taking the scores into account. We do not publish these scores, which vary over time," the company notes on its website. "Please note that any opinions, estimates or forecasts regarding Intel's corporate governance practices or the historical or predicted performance of Intel made by those firms are theirs alone and do not represent opinions, forecasts or predictions of Intel Corporation or its management."

Many rated companies have cared enough, however, to take advantage of the capability to go onto the CGQ website and submit new information, with the idea of boosting their ratings. That process is free--a company needs simply to call and request a password from ISS. Deosaran says that since the ratings format was revised last September, some 450 to 500 companies have submitted updates.

Institutional investors, hungry for governance information, are more likely to take the numbers at face value and accept the growing evidence of a linkage between good governance and stronger financial performance. Actually, Deosaran says there appears to be a shift in emphasis taking place among ISS clients.

"The early adopters were looking for something that would give them a clear indication of troublesome companies," he says. "Over the last eight months, there's been a shift in how they are viewing the data." Instead, investors are asking, "Can I use governance scores and the underlying data as performance indicators?"

"We've recently had a number of managers looking for companies scoring at the industry average or just below on governance issues," Deosaran says. "They seem to believe that over time, given enough activism, those companies that do well in a lot of other areas but under-perform in the CGQ will be pushed to improve--and then the market will reward those companies."

One clear result shows up readily on many corporate websites: a listing of company governance policies and charters for bodies like the compensation committee. Those don't necessarily move the needle on the ratings, but they can help persuade investors that a company is serious about governance and is willing to spell out how it deals with the subject.

RELATED ARTICLE: takeaways

* Since 2002, a number of governance ratings sources have sprung up, chiefly to help institutional investors judge public companies' governance effectiveness.

* The largest of these providers, Institutional Shareholder Services, rates more than 8,000 companies around the world and makes the ratings free to the public.

* The ratings draw from publicly available data, available through sources such as SEC filings, company websites, proxies and the like.

* Companies' reactions to the ratings vary. Some have promoted them, especially top ratings, while others have urged investors to be cautious about accepting them.

BEST AND WORST CGQ SCORES

Top 5 Companies      Score

MBIA Inc.            100
Tenet Healthcare      99.8
H.J. Heinz            99.6
National City Corp.   99.4
Campbell Soup         99.2

Bottom 5 Companies   Score

Maxim Integrated       1
PMC-Sierra             0.8
Monster Worldwide      0.6
Dillard's              0.4
Rowan Cos.             0.2

Source: ISS CGQ, Jan. 12, 2006