Does BBR render CGR and CGI DOA? Or, no matter what the evidence, is it all CYA?

• Author: Kaback, Hoffer
• Position: QUIDDITIES

ARE CORPORATE GOVERNANCE "indices" valuable ... or meaningless? Do so-called governance "best practices" lead to better corporate performance ... or are they not worth a John Nance Garner bucketful of warm p--? Should directors cut their consciences (and practices) to fit this year's governance fashions ... or should they stand tall and refuse to do so?

The commercial rating services answer these three questions by claiming that their proprietary formulae for weighting governance practices yield a valuable tool for investors. (And, plainly, their substantial customer base votes with its pocketbook on this assertion.)

Very different answers are given in an October 2007 paper by Professors Sanjai Bhagat, Brian Bolton, and Roberta Romano (BBR). Titled "The Promise and Peril of Corporate Governance Indices," it was written for the European Corporate Governance Institute (and can be downloaded at www.ecgi.org/wp).

BBR's principal points include:

1. Those who sell governance ratings and evaluation services to investors assert that earlier academic studies demonstrate a causal, statistically significant connection between governance indices and corporate performance.

2. BBR's analysis shows, on the contrary, that there is "no consistent relation between the academic and related commercial governance indices and measures of corporate performance."

3. Regulators should not mandate specific governance practices but should encourage flexibility. In other (my) words: Corporate governance indices (CGI) and corporate governance ratings (CGR) are bunk.

4. The single characteristic of outside board members' stock ownership is a better proxy for good governance than CGI/CGR insofar as such ownership relates to (a) future accounting earnings and (b) firing the CEO after bad performance.

5. Indices that weight individual governance practices overlook the issue of interaction among practices and that practices may be substitutes (rather than complements).

6. There are differences between relating governance to (a) stock returns and (b) accounting earnings.

7. "Comply or explain" regulatory regimes (as in Canada) create an unhealthy and inappropriate incentive for companies to conform to governance checklist-ism; better would be disclosure without comparisons to a purported standard.

8. Purchasers of CGR services may not themselves even believe that such ratings have predictive or analytical value; they may instead be engaged in CYA activity as fiduciaries.

9. BBR's two...