If you care what’s hot in the consulting biz, forget sensitivity training, time management, zero-based budgeting, management by objectives, diversity training, business process reengineering, knowledge management, convergence or the ‘new economy’. The hottest thing is corporate governance.
In the last six months I have received brochures and e-mails from over 70 firms claiming to be specialists in governance. Their slick materials trumpet expertise in director training and preventive structures for boards. Several are rushing to set up as the Consumer Reports of good governance with their own ratings. While Consumer Reports is non-profit, consultants are very much for profit.
Interestingly, the revered and objective non-profit experts in this field – ranging from the Investor Responsibility Research Center (IRRC) to the National Association of Corporate Directors (NACD), the Conference Board and the Council of Better Business Bureaus – have avoided the lure of ratings and consulting. Also notable: IRRC was the previous employer of several governance consultants.
Consultants often suffer from the now all too familiar odor of embedded conflicts of interest in their own businesses. Unlike Consumer Reports, JD Power, Epinions.com, Edmunds or the Academy Awards, these governance raters seem to think its okay to ‘consult’ for the same companies they ‘independently evaluate’.
Ironically, this practice faintly echoes two of the greatest governance problems now prohibited under Sarbanes-Oxley and the global settlement with major Wall Street firms, respectively. One is the forbidden practice of accounting firms serving as public auditors over the integrity and accuracy of firms that are also major clients of their consulting businesses. The other is analysts pumping up stocks that have investment banking relationships with their firm.
While these governance consultants denied these conflicts when I first raised them in the press in March, major firms have since addressed the issue in very different ways. The following month Institutional Shareholder Services (ISS), the influential proxy advisor, published its board members which include a few of its competitors, along with a statement regarding conflicts of interest.
In short, ISS says it will not sit on both sides of the table – advising institutional investors on how to launch a proxy battle while advising the target firm’s management on how to beat such efforts. ISS claims to have created its own separation of roles through separate staffs and physical separation – similar to the Chinese wall once lauded by some securities firms. Strangely, there appears to be no such Chinese wall protecting ISS’s governance consulting services from conflicts with its governance ratings.
ISS’s competitor, GovernanceMetrics International (GMI), seems to repudiate ISS policies (although its COO was formerly the CEO of ISS). GMI says it ‘will not provide corporate governance consulting services to any company that is part of our research universe or is expected to become part of that universe within twelve months.’ Then, to make sure ISS feels the slap, GMI adds, ‘To do so would impinge on our reputation for independence and credibility.’ Strangely, though, GMI offers two levels of ratings: ‘basic ratings’ for non-clients and ‘comprehensive ratings’ for firms that pay a fee – hence clients.
Most importantly, do these governance rating systems work? A month after the fanfare of launching its new Corporate Governance Quotient (CGQ), ISS proudly suggested Adelphia’s fraud might have been predicted based on its pre-scandal CGQ rating. ISS didn’t do so well when it came to waving red flags ahead of other cases of massive fraud, however. According to ISS’s analysis of HealthSouth, for example, the company outperformed 64.3 percent of S&P 500 companies in terms of governance.
Firms that Fortune magazine’s 10,000 experts rate highest like Wal-Mart, UPS, Southwest Airlines, Dell, eBay, Goldman Sachs and Starbucks are all shockingly in GMI’s ‘below average’ categories. They rate much lower than firms recently embroiled in governance controversies like Citigroup, Xerox, EDS, HealthSouth, Merrill Lynch, AOL TimeWarner, AMR and Tenet Healthcare.
In fact, while ISS and GMI analyze many sensible dimensions, many others like the presence of the former CEO on the board and the number of outside directors have no solid support to show they lead to more diligent directors or better performance.
The Corporate Library, another ratings firm, collects a tremendous amount of data but avoids the lure of remunerative conflicting consulting services. It also avoids simplistic quantitative ratings. Like a good financial analyst, it analyzes the facts first and then provides a qualitative grade from A to F. HealthSouth, for instance, previously scored an F for governance.
