Rating Management Behavior and Ethics: A Proposal to Upgrade the Corporate Governance Rating Criteria

By Vo, Thuy-Nga T. | Journal of Corporation Law, Fall 2008 | Go to article overview
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Rating Management Behavior and Ethics: A Proposal to Upgrade the Corporate Governance Rating Criteria


Vo, Thuy-Nga T., Journal of Corporation Law


I. INTRODUCTION
II. CORPORATE GOVERNANCE RATINGS
   A. Growth of Governance Rating Agencies
   B. Governance Rating Process
      1. Rating Scales
      2. Rating Criteria
   C. Influence of Governance Ratings
      1. Wide Range of Clients and Users
      2. Deep Impact on Governance Practices
III. DISCONNECT BETWEEN GOVERNANCE RATING CRITERIA AND CORPORATE
  PERFORMANCE
   A. The Lack of Correlation Between Rating Criteria and Corporate
     Financial Performance
   B. The Lack of Correlation Between Rating Criteria and Management
     Behavior and Ethics
IV. CONNECTING GOVERNANCE RATING CRITERIA TO CORPORATE PERFORMANCE
   A. Management Behavior and Ethics Affect Financial Performance
   B. Employees as a Source of Information About Management Behavior
     and Ethics
   C. Benefits of Employee Assessments as a Corporate Governance
     Rating Criterion
   D. Conducting Employee Assessments
V. CONCLUSION

I. INTRODUCTION

Corporate governance rating agencies currently do not, but should, include in their rating criteria an employee assessment of managerial behavior and ethics. Governance rating agencies strive to distinguish themselves from their competitors by establishing governance rating criteria that are indicative of whether directors and officers are serving shareholder interests instead of management prerogatives. Adding a rating criterion that is based on a company's implementation of, and the results from, periodic assessments of managerial behavior and ethics would provide insight into whether the company's directors and officers are performing their responsibilities to advance shareholder interests.

Governance rating agencies are for-profit providers of corporate governance ratings. These governance rating agencies have experienced tremendous growth in size as well as influence during the past decade. There is a wide range of users and uses for the corporate governance ratings. Some of the users include investors, insurance companies, financial and securities analysts, lawyers, accountants, financial institutions, and the rated companies themselves. These users utilize the data compiled and the ratings assigned by governance rating agencies to make investment and voting decisions, determine premiums, prepare financial and stock reports, provide governance advice, determine credit risk, and benchmark governance practices. Knowing that there is a broad base of clients for and users of corporate governance ratings, public companies pay close attention to the governance ratings assigned to their companies by governance rating agencies. The rated companies strive to adopt governance practices advocated by governance rating agencies in order to garner favorable governance ratings.

Governance rating agencies develop rating criteria that mirror disclosure obligations and operational measures required under law or for listing on stock markets. Rating agencies also establish standards of governance that extend beyond legal and listing requirements or dominant corporate practices to include governance mechanisms that may not be prevalent but that are perceived by rating agencies to be conducive to enhancing directors' and officers' performance of their responsibilities to advance shareholder interests.

Empirical evidence has not established a strong correlation between corporate financial profitability and the structural mechanisms relied upon by rating agencies in their rating systems. The rating criteria also do not provide assurance that officers and directors of the corporation are performing their respective responsibilities of management and oversight. The lack of strong linkage between governance rating criteria and corporate performance, financial or otherwise, may be due to the rating agencies' focus on observable, structural mechanisms as indicators of corporate conduct. Structural mechanisms such as board composition and charter provisions neither indicate the board's fulfillment of its responsibility to monitor managerial performance nor ensure management's fulfillment of its responsibility to apply fundamental business precepts.

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