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Watching the Watchdogs

Aug 14, 2008
Since the days of Enron and the other corporate debacles that rang in the beginning of the new millennium, a huge industry has grown up that purports to provide independent judgments on the quality of corporate governance. The industry is dominated by four firms, the best known being Institutional Shareholder Services (ISS). It was sold in 2001 for a reported $45 million.

By tweaking numbers available through SEC filings and other public sources, these companies come up with ratings that they claim can predict future performance of the companies. Problem is, they don’t. In a recent study by the Stanford Graduate School of Business entitled, “Rating the Ratings: How Good Are Commercial Governance Ratings?,” the authors conclude that they aren’t very good at all. The study looked for correlations among the ratings of four leading watchdog companies and five basic performance metrics: restatement of financial results, shareholder lawsuits, return on assets, and some things called the Q Ratio and Alpha which only someone who spends 24/7 wringing money out of the stock market can understand. They found slight to no correlation among the elements, and practically no agreement among the leading companies’ ratings (many of the same corporations were rated by more than one watchdog).

So why then did a company that sold for $45 million in 2001 manage to get itself sold again in 2006 for over half a billion dollars, despite the fact that its product is, well, worthless? I guess it just proves that, even in the heady regions of high finance, there’s one—or two—born every minute.
tags: Business | Economics

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