North America, Australia head ratings, Japan bottom, most of Europe lags

12 February 2004

Canada, the United States and Australia top the league table for good corporate governance, while Japan, Greece, Austria and Portugal are firmly anchored at the bottom, according to new ratings on 2100 global companies published by GovernanceMetrics International (GMI), a corporate governance research and ratings agency.

GMI's rating system incorporates hundreds of data points across six broad categories of analysis: board accountability, financial disclosure and internal controls, executive compensation, shareholder rights, ownership base, takeover provisions, plus corporate behavior and social responsibility.

An interesting feature of these findings is that three out of the top four countries rely on well honed codes rather than detailed legislation, while many of the worst performers are in the European Union. Japan's poor performance also sends a major signal to the Tokyo Stock Exchange and Japanese regulators. Small numbers cannot explain its performance, as its businesses represented one tenth of the total.

The companies rated were based in 20 of the OECD's major countries, but in some of the nations only a small number of companies featured. For example only two companies featured from Austria and only four from Belgium.

Most of the best-performing companies - scoring the highest possible mark of 10 - were from the United States, but other top performers included Westpac, an Australian bank, and Vodafone, a British mobile phone company.

The country league table, with average and above average shaded:

Source: Governance Metrics International (2004)

Gavid Anderson, president and CEO of GMI, cautioned against assuming there were no corporate governance problems in the highest rated countries:

"While US, Canadian, UK and Australian firms had higher average scores than others, it would be a mistake to conclude that there was little governance risk in companies from these markets. Indeed we are still seeing practices in companies in all four markets that warrant significant shareholder concern.

"Two examples are a US concern which claims it does not control its overseas operations despite controlling 85% of the voting power of the entity. This same company has had two earnings restatements and its outside auditor recently resigned over management misrepresentations of related-party transactions. In the second example, the chairman of a Canadian company, who controls the company with a special class of shares, received almost $25 million last year in special fees for 'business consulting and development services.'

"Certainly in the latter case, investors have become much more familiar with this kind of activity in the last few months as managements at some controlled companies enriched themselves at the expense of both shareholders and bondholders."

As part of its rating process, GMI identifies issues of concern to investors and "red flags" companies that are undergoing regulatory investigation, have high potential options dilution, unequal voting rights or other practices that represent additional risk to equity or debt holders. Parmalat was one such company GMI flagged in July of last year, months before the Italian company imploded and became Europe's Enron. In its current universe GMI has issued red flags at 675 companies. The market sectors with the highest percentages of red flags are Technology (56%), Media (50%), Telecommunications (45%) and Healthcare (39%). In addition, GMI identified 211 companies that have taken an unusual and non-recurring charge of 5% or more of revenues in the last year, 190 companies that have been cited or found guilty for a breach of law involving non-accounting issues, and 189 companies that have been subject to a regulatory investigation for a material issue other than an accounting matter.

Another area of concern is compensation. While 1,835 companies covered by GMI had a compensation committee, in 414 cases an executive seat on the compensation committee. In 59 instances, it was the CEO.

Of particular interest today also is director independence, and the question of whether board leadership comes from a combined Chairman/CEO or an independent Chairman or lead outside director. In this latest ratings release, GMI found that in just the last six months there has been a significant shift.

While the total number of independent directors increased marginally from 56.1% to 57.5%, the number of combined Chairman and CEO positions fell from 47.3% to 41.6%, the number of independent chairman grew from 13.2% to 21.2% and the change in the number of lead directors jumped from 23.3% to 33.4%. Fifty percent increases in six months is a very significant change and were found not only in the United States, but also in Europe and Australia.

Summing up Anderson described the results as "another example of a growing body of research suggesting a correlation between corporate governance and portfolio returns when measured across a number of variables and across a multi-year period."

And another study published here the same day found companies with poor corporate governance not only have lower stock market returns, but are also less profitable, riskier and have lower returns on equity and investment than companies with stronger governance, a new study has found.

The study, conducted by Georgia State University accounting professor Lawrence D. Brown, confirms earlier surveys reported by Corporate Governance adopting another angle, and suggesting businesses that took the subject seriously did better. The weight of opinion now seems firmly convinced corporate governance equates with corporate health.

The Georgia study, funded by a grant from Institutional Shareholder Services and using that organisation's own rating system, found that those companies with weak governance paid lower dividends. In Professor Brown's assessment the composition of boards was the most significant factor in the corporate governance equation.

In numerical terms the Georgia study found those at the bottom of the governance pile had returns on equity 4.86% below average, while those at the top had returns 19% above their industry-adjusted average.

Links for further details on this study:
GMI press release February 9, 2004
Institutional Shareholders Services (ISS) press release