United States: Avoiding GRIdlock: Living with the New RiskMetrics Matrix

Last March, RiskMetrics Group, formerly Institutional Shareholder Services (ISS), launched Governance Risk Indicators" (GRId), its new governance-related risk evaluation program. GRId consists of a matrix of 65 to 95 weighted questions that define RiskMetrics' view of what constitutes good governance for public companies. GRId replaces RiskMetrics' Corporate Governance Quotient (CGQ), which is being phased out.

Methodology

GRId evaluates a company by comparing the company's governance practices to RiskMetrics-defined best practices for the country in which the company is located (unlike CGQ, which compared a company's governance practices to peer group practices). GRId's methodology is tied to RiskMetrics' benchmark proxy voting policies and is expected to be annually updated in conjunction with policy updates.

At the core of GRId's methodology is a battery of questions addressing four areas of governance: Audit, Board Composition, Shareholder Rights and Compensation (there are 63 questions for U.S. companies). Each category is divided into subsections, and questions and subsections are weighted differently based on the company's geographic market. Answers to questions are based on disclosures in the company's public filings and scored on a scale of "-5" to "5". (A "0" represents a neutral score, suggesting that the company meets market standards.) Scores are then calculated and reported as "concern levels" of low, medium or high on RiskMetrics' proxy analyses.

Implementation

GRId initially covers approximately 8,000 global companies, of which approximately 6,400 are U.S. companies, with the balance coming from the U.K., France, Germany, the Netherlands and Sweden. RiskMetrics expects to expand GRId to cover additional countries later in the year.

GRId's "One Size Fits All" Approach

While GRId incorporates a multi-factor approach to governance, it is not nearly as nuanced as the analysis a company should undertake when developing a fully integrated approach to governance, which involves balancing the needs and objectives of the company's various constituencies, as well as long- and short-term perspectives on the issues confronting the company. For example, in developing a company's governance policies and programs, the company's board of directors should consider a broad spectrum of factors, including the company's business, its industry and competitors, its geographic market, potential unfriendly acquirers, the regulatory environment and the competing interests of its various constituencies. Because every company's circumstances are unique, a "one size fits all" approach often is inappropriate.

Yet, a "one size fits all" approach is precisely what RiskMetrics attempts to impose with GRId. For example, GRId evaluates each company's governance practices only against the RiskMetrics-defined best practices for the applicable geographic market, and does not consider a company's particular circumstances or industry practices, risks associated with a company's failure to retain senior management or an untimely takeover attempt, or how a company's overall approach to enterprise risk management affects its governance processes. In addition, GRId's expression of rankings as absolute "concern levels" based on what largely amounts to a "check the box" scoring system may encourage some companies to adopt RiskMetrics-defined best practices in order to increase GRId scores, and not because they support the company's overall governance program. Moreover, a company's failure to make a disclosure in its public filings about an issue that is significant to its GRId score may result in a low score for that question, even if the company had adopted a RiskMetrics "best practice" for that issue.

Given RiskMetrics' current influence with institutional investors, however, many companies may feel pressure to automatically fall into step with the GRId matrix, rather than pursuing a more thoughtful approach. While companies should give weight to RiskMetrics' views, they also should recognize that GRId is based solely on the institutional shareholders' perspective. Rather than basing governance programs solely on GRId, companies should take a broader view when determining a fully integrated approach to governance. And although GRId will now be a factor, companies should not blindly follow the RiskMetrics model, but rather, should continue to consider the full range of issues and interests when striking the right balance in their governance processes.

Resources

RiskMetrics has made available an information webpage regarding GRId, which includes a 193-page technical document, online and telephone support, a "frequently asked questions" link, an example of a GRId company profile and a sample data feed file. The webpage also contains a data verification site through which companies can verify data used for their GRId evaluations and request corrections. If errors are identified, a corrected RiskMetrics report will be published as long as the shareholder meeting date has not passed. The website address is http://www.riskmetrics.com/grid-info .

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