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The directors' cut: Indexing governance

When John Connolly took over the top spot at proxy advisory firm Institutional Shareholder Services last March, he observed that "shareholders and companies are transforming corporate governance in the way that they talk to each other about risk and value."

When John Connolly took over the top spot at proxy advisory firm Institutional Shareholder Services last March, he observed that "shareholders and companies are transforming corporate governance in the way that they talk to each other about risk and value." Now he's getting ready to introduce something new into that conversation.

Last month Connolly teamed up with Mark Makepeace, CEO of London-based indexing giant FTSE Group, to announce a series of global corporate governance indexes -- the first such international benchmarks -- based on criteria that include executive compensation, board independence and audit processes. Following a "soft launch" test period that is expected to last through March, FTSE and Rockville, Maryland­based ISS plan to begin publishing six indexes covering some 2,300 companies in 24 countries.

The broadest-based of the benchmarks consists of about 1,360 large- and midcap companies in developed markets; others are broken out by country or region. More sectors will follow later this year. Investors will be able to track global, regional and industry sector trends in corporate governance and create customized benchmarks to compare governance and stock performance. They will also be able to see how individual companies stack up against industry averages, because FTSE will post company scores on its Web site.

"This puts corporate governance squarely in the context of how portfolios are managed," says Connolly, who joined the proxy advisory firm after a stint working for IBM's consulting business.

Makepeace, the founder of FTSE, which is jointly owned by Financial Times Group and the London Stock Exchange, says the indexes and underlying company ratings will create "a level of transparency that we've never seen before, and it's what the marketplace has told us it is looking for." The company scores are based on ISS's corporate governance quotient, which was introduced in 2002 and is currently available only to paying subscribers.

Makepeace concedes that transparency may not go over well with companies that have below-par CGQs.

"We have notified 2,000-plus companies of their results, and before we publish we'll give them every opportunity to tell us where they disagree," he says. "We believe it will raise standards and be a powerful tool for companies as well as investors -- they too will be able to make objective market and peer comparisons."

The new venture's rankings may also prove valuable to analysts and academics who are trying to better understand how -- or whether -- governance correlates with stock performance. "We definitely will contribute to those discussions," says Makepeace. "But it will be an evolutionary process. We don't have all the answers."