Rating the Ratings: How Good are Commercial Governance Ratings?

76 Pages Posted: 27 Jun 2008 Last revised: 28 Sep 2013

Robert Daines

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

Date Written: December 1, 2010

Abstract

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.

Keywords: corporate governance, governance ratings

JEL Classification: G34, M41, M43, K22

Suggested Citation

Daines, Robert and Gow, Ian D. and Larcker, David F., Rating the Ratings: How Good are Commercial Governance Ratings? (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. Available at SSRN: https://ssrn.com/abstract=1152093 or http://dx.doi.org/10.2139/ssrn.1152093

Robert Daines

Stanford Law School ( email )

559 Nathan Abbott Way
Stanford, CA 94305-8610
United States
650-736-2684 (Phone)

Stanford Graduate School of Business ( email )

655 Knight Way
Stanford, CA 94305-5015
United States

Ian D. Gow

Harvard University - Accounting & Control Unit ( email )

Soldiers Field
Boston, MA 02163
United States
6174956530 (Phone)

David F. Larcker (Contact Author)

Stanford University - Graduate School of Business ( email )

Graduate School of Business
518 Memorial Way
Stanford, CA 94305-5015
United States
650-725-6159 (Phone)

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