Do You Know Your Corporate Governance Score?

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Earlier this year, Institutional Shareholder Services (ISS) — the largest and most influential proxy advisory firm — unveiled its Governance QuickScore rating system. Your company should review its QuickScore rating as soon as possible and ensure it’s based on accurate data, due to the significant impact governance issues can have on investor decisions.

Measuring risk

QuickScore, which replaces ISS’s Governance Risk Indicator (GRId), is a quantitatively driven data solution designed to identify governance risk within portfolio companies. It covers the 3,000 largest U.S. companies (by market capitalization), as well as several other global regions.

In computing a company’s QuickScore, ISS examines correlations between governance factors and key financial metrics, giving greater weight to the factors with the highest correlation. The financial metrics are based on the “16 most common performance and risk factors” grouped into four measurement categories: market (2 factors), profitability (9 factors), risk (2 factors) and valuation (3 factors).

The corporate governance factors consist of between 40 and 80 that the ISS deems the most critical to measure corporate governance-related risk. Subject companies are evaluated based on whether they meet, exceed or fall short of market best practices for each relevant factor. The actual number of factors analyzed varies by region, but each falls under one of the following four categories: board structure, compensation/remuneration, shareholder rights and audit practices.

Keep in mind that ISS doesn’t disclose the relative weight given to each governance factor. Also, it’s not entirely clear how ISS analysts evaluate whether a company meets, exceeds or falls short of a particular best practice. Therefore, it may not be apparent how a particular factor affects your company’s final score. For example, a board’s proportion of independent directors is thought to have a big impact on company performance. Will a company with one nonindependent director receive a substantially better score than a company with two?

Everything’s relative

Companies receive scores, on a scale from 1 (lowest risk) to 10 (highest risk) for each of the four corporate governance categories. They also receive an overall score. 

In computing these scores, ISS takes a company’s raw scores and converts them into a 1-to-10 score based on its ranking relative to other U.S. companies. Note, however, that ISS ranks the 500 largest U.S. companies separately from the next 2,500 companies. Because QuickScores are relative, a company that has adopted many or most governance best practices may still find itself with a score that’s average or below average.

How to check your score

You can find your company’s score by visiting issgovernance.com. The page also provides instructions for obtaining a log-in ID for ISS’s complimentary Data Verification. This tool enables you to review, verify and provide feedback on data used to determine your company’s QuickScore.

Review your QuickScore carefully for inaccuracies in any of the underlying data and submit corrections to ISS. Be sure to investigate any potentially serious governance issues that QuickScore has marked with a red flag. These red flags indicate factors that have had a significantly negative effect on your company’s score. As the 2014 proxy season approaches, your QuickScore report also can help you identify corporate governance practices with room for improvement.

Keep things in perspective

It’s important to know your company’s QuickScore, especially since investors are likely to use this tool in comparing different companies’ governance practices. But be careful not to overreact. While a poor score in a particular area may prompt you to re-evaluate your company’s practices, you should continue to make governance decisions based on the best interests of your company.

QuickScore rating factors

Each of the several dozen factors Institutional Shareholder Services considers when determining a company’s Governance QuickScore falls into one of the following categories and subcategories:

1. Board structure: board composition, composition of committees, board practices, board policies and related party transactions.
2. Compensation/remuneration: pay for performance, nonperformance-based pay, use of equity, equity risk mitigation, nonexecutive pay, communications and disclosure, termination, and controversies.
3. Shareholder rights: one share / one vote, takeover defenses, voting issues, voting formalities and other issues.
4. Audit practices: external auditor, audit and accounting controversies and other audit issues.

Copyright © 2013 Thomson Reuters / BizActions.