October 05, 2009
Corporate Governance Ratings
Posted by Gordon Smith

Last Friday Rob Daines presented his paper (with Ian Gow and David Larcker) entitled Rating the Ratings: How Good are Commercial Governance Ratings? at the BYU Finance Department. I had seen this paper floating around, but I hadn't taken the time to read it until the seminar.

Wow! This paper is terrific.

The authors examine Audit Integrity, RiskMetrics (previously Institutional Shareholder Services), GovernanceMetrics International, and The Corporate Library and find little support for claims that these ratings can accurately predict future performance, risk, and undesirable outcomes such as accounting restatements and shareholder litigation.

In one sense, this is not surprising, given that the agencies generate dramatically different ratings for many firms. On the other hand, you might wonder, as I did, why firms buy these ratings. According to Rob, the answer seems to be twofold: the ratings can serve as a form of insurance in litigation (providing evidence of diligent investigation) and purchasing the ratings gives firms access to the underlying data, which may be valuable.

Highly recommended.

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