Rating the Ratings: How Good are Commercial Governance Ratings?
Stanford Law School; Stanford Graduate School of Business
Ian D. Gow
Harvard University - Accounting & Control Unit
David F. Larcker
Stanford University - Graduate School of Business
December 1, 2010
Stanford Law and Economics Olin Working Paper No. 360
Rock Center for Corporate Governance at Stanford University Working Paper No. 1
Journal of Financial Economics (JFE), Vol. 98, No. 3, 2010
Proxy advisory and corporate governance rating firms play an increasingly important role in U.S. public markets. Proxy advisory firms provide voting recommendations to shareholders on proxy proposals and sometimes take an active role persuading management to change governance arrangements. Corporate governance rating firms provide indices to evaluate the effectiveness of a firm's governance and claim to be able to predict future performance, risk, and undesirable outcomes such as accounting restatements and shareholder litigation. We examine these claims for the commercial corporate governance ratings produced for 2005 by Audit Integrity, RiskMetrics (previously Institutional Shareholder Services), GovernanceMetrics International, and The Corporate Library. Our results indicate that the level of predictive validity for these ratings are well below the threshold necessary to support the bold claims made for them by these commercial firms. Moreover, we find no relation between the governance ratings provided by RiskMetrics with either their voting recommendations or the actual votes by shareholders on proxy proposals.
Number of Pages in PDF File: 76
Keywords: corporate governance, governance ratings
JEL Classification: G34, M41, M43, K22
Date posted: June 27, 2008 ; Last revised: September 28, 2013
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