Shared Knowledge

In the complicated world of corporate governance ratings, discussions of databases, cooperation and information sharing are in the air. Two leading academic institutions and some of the most powerful players in the governance rating business are involved or have given public encouragement to the creation of an independent information resource – something that could transform the use and influence of corporate governance ratings. For some, including Gary Lutin, an investment banker at New York-based Lutin & Company, this can’t happen soon enough. Lutin, who conducts shareholder forums on corporate control matters, has been encouraging the idea of a governance database since the middle of last year. ‘There’s always been concern about having sufficient access to corporate governance information, but this was heightened when the Investor Responsibility Research Center was bought last year,’ he comments. In July 2005, when Institutional Shareholder Services (ISS) bought IRRC, which only provided research and not opinions, some in the industry felt a crucial governance resource had been lost. ‘IRRC was viewed as a communal information source, like an academic institution,’ says Lutin. ‘When ISS bought it, it focused everyone’s attention on the fact that it was now under the control of a commercial entity.’ According to Lutin, this led to discussions about the necessity of creating a new communal information center, one that would contain a database of accurate information while improving efficiency, reducing costs and increasing the use of governance data for as many users as possible.

Relying on the academics

One idea is to establish an entirely new academic institute, and a pair of prestigious universities have done just that. On March 6 of this year, Stanford Law School launched the Arthur and Toni Rembe Rock Center for Corporate Governance – the first of its kind on the west coast. Headed by professors Robert Daines and Joseph Grundfest (a former SEC commissioner), the school studies issues such as shareholder rights, the future of the auditing industry and international governance. The Stanford center also announced that it will launch an open-source database, providing information about the governance characteristics of major companies. This information, which will be free and accessible to all, will allow users to generate avariety of governance scores. Stanford launched a similar databasefor securities class-action data about a decade ago and is preparing to launch one for intellectual property litigation information. ‘We’re fairly far down the road with our plans for the corporate governance database,’ says Grundfest. ‘We have financing in place and are doing some interesting research into a variety of initiatives.’ He notes, however, that it is still too early to talk about any specifics of the database, but says it will be of broad interest. ‘It will be helpful to investors, corporations, regulators, policymakers and the press.’ According to Grundfest, the information in the database will most likely come directly from corporations themselves. ‘Any other method would be incredibly expensive,’ he explains. Three months after Stanford launched its center, Yale University opened the Yale Center for Corporate Governance and Performance (YCCGP) on June 12. Ira Millstein, senior partner at international law firm Weil, Gotshal & Manges and senior associate dean for corporate governance at Yale School of Management, serves as director. At the inauguration the following day – during a panel discussion involving ISS CEO John Connolly, Glass Lewis CEO Greg Taxin and Proxy Governance founder and CEO Steve Wallman – talk turned to the possible creation of a communal information resource. Those attending the meeting say Connolly offered to help establish a common database and agreed to assume leadership and offer Yale the opportunity to host the project. In discussions after the panel session, Taxin apparently agreed to support the establishment of the database, while Wallman chose to reserve judgment. Connolly and Taxin were not available to comment for this article. ISS, however, sent a statement about the Yale discussion: ‘During the Yale corporate governance forum, ISS CEO John Connolly said that enormous progress has been made by institutions and corporations in understanding the value of corporate governance. He went on to suggest that proxy advisors come together to collaborate on an industry-wide initiative that would provide critical insight into the most important issues facing investors.’ No further information was given on what such an initiative might involve. Millstein says he is still keen to work with ISS and Glass Lewis to create a governance database. ‘Yale is known as a convener of people. We’re renowned for bringing parties together and providing a locale for discussion,’ he comments. ‘We would be happy to host a meeting with ISS and Glass Lewis to determine how to put a database together. As soon as we hear from them, we’re prepared to work with them.’ The National Association of Corporate Directors (NACD) had also been looking into creating a governance database, but stopped when it saw what Stanford was launching, says Peter Gleason, COO and director of research for NACD. The murky world of rating agencies Preliminary documents from January 2006 regarding the planning stages of a Yale-affiliated database outline the reasons such a resource is seen as necessary by supporters: ‘While there has been recent and significant attention to strengthening corporate governance in the United States, there is not presently an independent organization dedicated to ensuring that shareholders have reliable, independent and analytically secure information on which to base decisions about proxy voting and related issues.’ One problem, according to supporters of a governance database, is that governance information is often accessed via potentially biased sources. ‘Many of the concerns center around the commercial interests that are perceived in the way information is processed by rating agencies,’ says Philip Armstrong, head of Washington, DC-based Global Corporate Governance Forum, an initiative of the World Bank and the Organization for Economic Co-operation and Development (OECD). The lack of transparency is also a cause for criticism, with many calling for rating agencies to display the same level of openness they demand of listed companies, including disclosing how they arrived at a rating and how they weight different criteria. Mark Hoffman, Seattle-based partner at DLA Piper Rudnick Gray Cary and chair of the firm’s public company and corporate governance practice, says clients sometimes want to better understand a governance rating. ‘With ISS, for example, it’s not always clear which CGQ [corporate governance quotient] components matter most, so clients will call saying they don’t understand why their rating is lower than their peers’ ratings.’ ‘In conversations with ISS and Proxy Governance, we’ve told them they have to articulate how they reached their recommendations and who made them,’ adds Tom Lehner, director of public policy at the Business Roundtable. Another problem can be inaccurate data used to achieve ratings. Sometimes this is due to an error on the part of companies, and sometimes the rating agencies make mistakes. For Hoffman, errors can occur when agencies use the wrong state of incorporation for a company or fail to take into account the nuances of state law. ‘In Washington, for example, companies are not allowed to opt out of the corporate takeover statute, but sometimes this is not recognized by rating agencies,’ he says. Although much of the raw data used in ratings is publicly available, its inaccessibility to non-professional investors also draws criticism. ‘For retail investors and academics, it’s fairly expensive to get hold of the corporate governance information, so currently relatively few access it,’ says Ken Bertsch, senior vice president and director of corporate governance at Moody’s Investors Service. ‘Some aca- demics might, but it’s still a challenge for them to search through all the pieces. A database that made information more widely available would have a very positive impact on the market.’ Bertsch adds that if people had easier access to corporate governance information, it could reduce the number of errors, too. ‘With increased human analysis, unintentional and intentional mistakes on the part of companies are more likely to be caught,’ he says. A wide range of benefits One aim of a governance database would be to collate much of the standard information required by various parties, increasing efficiency on all sides. The factual data – for example, board composition – is something everyone shares. The four main proxy advisors and researchers all independently acquire the same information. Howard Sherman, co-founder and chief operating officer at GovernanceMetrics International (GMI), agrees that there could be improvements to the current system of data collection. ‘GMI spends a huge amount of time reviewing corporate filings, news sources, web sites and stock exchange data to profile each company in our database,’ he says. ‘There’s a fair amount of data that is very specific and standard and is just pulled from company logs. If there was a way to quickly access that data, and if enough information was included in such a database, then that would be very interesting to us as a way of making our processes more efficient.’ One example of such a database is the London Stock Exchange’s Corporate Responsibility Exchange, launched in late 2004. This online tool allows companies to put all of their corporate responsibility information – from a range of different departments – in one place and meet the needs of various rating systems all at once. So far, more than 100 companies have signed up, according to an LSE spokesperson. The benefits of a database to the academic world are also currently being discussed by various interested parties. ‘There’s still a lot of inconclusive research about corporate governance coming out,’ says George Dallas, managing director and global practice leader of the governance and advisory services unit at Standard & Poor’s. ‘Paper A will say one thing; paper B will say the opposite. We need more evidence than we currently have. Right now it seems there are more opinions than facts about corporate governance.’ It would also be a way to encourage academics to do more comparisons between companies, uncover commonality or delve into any regional differences. According to Sherman, increased resources for academics would help those on the receiving end of inquiries, too. ‘We probably receive more e-mails requesting information from academics, professors and PhD students than anyone else,’ he says. The benefits to companies, of course, would also be numerous. A database could be a valuable tool, from a company perspective, for benchmarking one’s own practice against immediate peers. Companies could mine the information and use it to build their own understanding of what the metrics are and how they fit into their sector. The potential time-saving benefits of an information database will no doubt be of interest to every overworked corporate secretary as well. Companies already have significant SEC disclosure requirements and are inundated with questionnaires from a range of different groups often asking about the same issues. In addition, when information used by these groups is wrong, companies have to spend even more time correcting it. ‘The people I’ve talked to on the corporate side about this have been among the most enthusiastic supporters,’ adds Lutin.