Corporate Governance rating. By Dario Lo Turco and Karina Katrysh

Transcription

1 Corporate Governance rating By Dario Lo Turco and Karina Katrysh

2 AGENDA Introduction to CGR CGR Agencies CGR Relevance CGR Criticisms Conclusion

3 What is CGR? Corporate Governance The system by which corporations are directed and controlled Corporate Governance Rating The valuation of those systems done by several organizations Characteristics: CG Ratings are set by different independent rating agencies CG Ratings are valuated by investors when taking investment decisions

4 Why is CGR important? The rising importance of good governance (OECD principles) Higher concern regarding CG quality. The recent corporate scandals

5 Potential users of CGR Governance consulting firms Small investors Executive search firms Accounting firms Institutional investors

6 Why are institutional investors the primary users of CGR? Destruction of the bank myth Growing awareness of fiduciary duty mainly among institutional investors

7 AGENDA Introduction to CGR CGR Agencies CGR Relevance CGR Criticisms Conclusion

8 CG Rating Agencies Institutional Shareholders Service (ISS) Governance Metrics International (GMI)

9 is a leading provider of proxy voting and corporate governance services to institutional investors ISS governance scoring tools ISS Corporate Governance Quotient, 2002 Government Risk Indicator (GRID), 2010 ISS QuickScore since 2013

10 is a quantitatively-driven data solution designed to identify governance risk within portfolio companies.* ISS Governance QuickScore is designed to help institutional investors: identify and monitor potential governance risk drill down on companies with governance risk identify companies with which to engage on governance issues access detailed data to inform their own investment models advance compliance on mandates *Institutional Shareholder Services Inc. ISS Governance QuickScore, January 2013

11 ISS Governance QuickScore Coverage 4,100 companies in 25 markets, the largest 3,000 U.S. and 250 Canadian companies plus UK, Europe, Japan and Asia Pacific companies

12 ISS Governance QuickScore Metodology A quantitatively-driven approach Governance attributes Company level deciles scores A regionalized scoring approach Anglo Region United Kingdom, Australia, Ireland and New Zealand Asia Pacific Region Hong Kong and Singapore Western European Region Belgium, Luxembourg, Netherlands and France Nordic Region Denmark, Finland, Norway and Sweden Southern European Region Italy, Spain, Cyprus and Greece Germanic Region Germany, Austria and Switzerland

13 Scoring Process Step of corporate governance factors by which to measure governance-related risk (Category Pillars and regions) Step 2 Step 3 Analysis of the correlation for each governance factor with 16 commonly utilized performance and risk factors grouped into 4 measures: Market (2 factors), Profitability (9 factors), Risk (2 factors), and Valuation (3 factors).

14 Performance Category Market Performance Measure Industry Adjusted TSR1Y Tobin's Q Profitability Cash Flow Return On Investment (CFROI) Dividend Growth 1Y Step 4 EBITDA Margin Free Cash Flow to Sales Net Profit Margin Return on Assets (ROA) Return on Equity (ROE) Return on Invested Capital (ROIC) SaleGrowth1Y Risk Volatility Z score Valuation Price to Book Ratio Price to Cash Flow Ratio *Institutional Shareholder Services Inc. ISS Governance QuickScore, January 2013 Price to Earnings Ratio

15 Hypothetical Example of Raw Scoring, Normalization and Decile Scoring Output Rating Category Raw Points Governance QuickScore Board Audit Shareholder Rights Compensation Total There are a total of 181 factors analyzed under Governance QuickScore, with the specific factors under analysis varying by region.

16 was formed in 2010 through the merger of three independent companies The Corporate Library (1999) was a leading independent provider of research and ratings designed to help institutional investors evaluate corporate governance practices as an element of overall investment risk. GovernanceMetrics International (2000) developed indepth coverage of governance risk profiles of 4,200 companies, including the complete MSCI World Index and extensive Emerging Market coverage. Audit Integrity (2002) developed Accounting and Governance Risk (AGR ) ratings for approximately 18,000 public companies worldwide.

17 GMI Environmental, Social and Governance (ESG) ratings GMI Accounting and Governance Risk (AGR) ratings Forensic Alpha Model (FAM)

18 GMI Environmental, Social and Governance (ESG) Ratings Key characteristics Fall ,000 companies worldwide 150 carefully selected risk factors organized into six categories two forms: as percentile scores ranging from 1 to 100, and as a letter grade ( A to F )

19 GMI Accounting and Governance Risk Rating Key characteristics 19,000 companies worldwide based on discrete risk factors organized into categories such as revenue recognition expense recognition asset-liability valuation governance risks and high-risk events two ways: as a percentile score ranging from 1 to 100, and in corresponding categories ranging from Conservative to Very Aggressive

20 AGENDA Introduction to CGR CGR Agencies CGR Relevance CGR Criticisms Conclusion

21 Relevance of CG Ratings Corporate Governance Criteria Rights and duties of shareholders Range of takeover defences Disclosure on corporate governance Board structure and function CG Ratings assesses the position of a shareholder in a company in terms of rights and obligations shows an objective mathematical approach for checking the probability to resist a hostile bid assess the level of transparency on a company s corporate governance assesses the accountability, independence and functioning of the governing bodies

22 Good CG Rating Vs. Weak CG Rating improves profits and increases company valuations greater access to financing lower cost of capital better performance more favourable treatment of all stakeholders poor firm performance risky financing patterns makes firms susceptible to macroeconomic crises

23 Shareholders (Majority and Minority) Majority Shareholders To understand how management is promoting the interests of the shareholders. To understand the relative degree of transparency at a firm To guide existing and new investments: both strategic and portfolio investment Minority Shareholders To appreciate how management treats minority shareholders visa -vis majority Creditors (Counterparties, Investors, Lenders) To use as a guide or as conditionality for lending decisions To understand how management promotes the interests of financial stakeholders To guide rollover or new lending decisions

24 Board Directors To understand the relative standing of existing governance practices as a form of self assessment To use as benchmarks for improvement To reduce directors liability insurance premia To provide additional information to attract new directors to join the board To help orient new directors about a company s governance processes Managers To understand the relative standing of existing governance practices To use as benchmarks for improvement To communicate governance standards as an investor relations tool (annual reports, websites, advertising, etc)

25 AGENDA Introduction to CGR CGR Agencies CGR Relevance CGR Criticisms Conclusion

26 CGR Criticisms How reliable is the underlying theory of CG, in particular the relation between good CG practices and higher performance? Are the cultural and contextual differences between companies, taken into consideration by CGR agencies? There is a correlation between the different ratings system?

27 CGR Criticisms CGR & Stock value Good governance practices Higher stock value Focus on short or long-term stock performance? There is an ideal time frame?

28 CGR Criticisms Definition of good Governance What is good Governance? What factors constitute good Governance? How should factors be weighted?

29 CGR Criticisms Ratings value The value of the ratings were confirmed by studies sponsored by CGR agencies CGR have either limited or no success in predicting firm performance Little correlation among the different rating agencies Uniform scale for assessing a firm s governance ISS changed recently it s rating system

30 AGENDA Introduction to CGR CGR Agencies CGR Relevance CGR Criticisms Conclusion

31 Conclusion How reliable is the underlying theory of CG, in particular the relation between good CG practices and higher performance? Not 100% reliable. Are the cultural and contextual differences between companies, taken into consideration by CGR agencies? No, they are not. There is a correlation among the different ratings system? Recent studies showed small correlation.

32 Conclusion Different studies in Corporate governance rating and firm performance lead to different results CG rating can not give an accurate forecast about firm performance Investors should not base entirely on commercial CGR in their investment decision More time needs to be invested into the perfection of governance rating databases Need for greater use of qualitative research method, like directors interviews

33 THANK YOU!

34 References Barrett, Annalisa, Paula Todd, Christa Schlaudecker, and Towers Perrin. "Corporate Governance Ratings.", CDF Corporate Governance Committee, v_ratings3-05.pdf Brown, Matthew S. "The Ratings Game: Corporate Governance Ratings and Why You Should Care.", December Foerster, Stephen R., and Brian C. Y. Huen. "Does Corporate Governance Matter to Canadian Investors?, Richard Ivey School of Business The University of Western Ontario London, Ontario, Canada, N6A 3K7, 9 May

35 References Gawer, Joseph Corporate Governance Scores and Long Term Performance, December governance_scores_and_long_term_performance_2013_gawer.pdf GMI Ratings website, Institutional Shareholder Services Inc. ISS Governance QuickScore, January Keisuke Nitta. Corporate Governance Rating (CGR)- A More Efficient Approach to Corporate Monitoring, Financial Research Group, Khanna, Vikramaditya. "Corporate Governance Ratings: One score, two scores, or more? University of Pennsylvania Law Review,Vol. 158: 39 PENNumbra,

36 References Mine Ertugrul and Shantaram Hegde. Corporate Governance Ratings and Firm Performance Provided by Financial Management, pages , Robert Daines, Ian Gow, David Larcker. Rating the Ratings: How Good are Commercial Governance Ratings? Provided by Rock Center for Corporate Governance at Stanford University, Working Paper Series No 1 and Stanford University School of Law, Law & Economics Research Paper Series, Paper No. 360, Standard & Poor s Corporate Governance Scores and Evaluations, Corporate%20Governance%20Scores.pdf