United States: Global Demand Rises For Corporate Governance Indices

Corporate scandals and emerging market corporate governance concerns have lead to an increase in the use of global good-company guideposts, adding new complexity to the investor relations function.

As a result of the up tick in corporate scandals in the first half of the decade, the global investment community has turned to indices and governance services that identify well-governed companies and attempt to draw a parallel between corporate governance and equity performance.

The push to highlight good governance isn't just as a result of U.S. scandals. Singapore-based China Aviation Oil earlier this month issued suspension sentences to its chief and four top officials after management was charged with fraud and dishonesty.

The increase in demand for such indices can also be related to increases in cross-border investment. Large global institutional investors recently have taken significant positions in Asian and Eastern European companies.

Though some have questioned a correlation between governance and equity performance in developed capital markets, recent events around the long touted contrarian example, Omaha, NE-based Berkshire Hathaway Inc., may provide latent evidence that a correlation does, in fact, exist.

Berkshire Hathaway's past Corporate Governance Quotient (CGQ) issued by Rockville, MD-based Institutional Shareholder Services (ISS) had been low--around 5 out of 100--even as it was virtually scandal free as a stalwart creator of shareholder value. The eventual impact of its governance practices only recently have been brought into question as Berkshire Hathaway got caught up in the New York-based American International Group Inc. (AIG) saga.

However, the relationship between governance and performance might be strongest in emerging markets. Emerging market company information is typically sparse and information channels often rife with dubious insider self interest. The tenets of good governance, such as independent boards of directors and audit, may better serve shareholder value in situations where such disciplines may be lax.

As the investment community looks more to these indices, investor relations practitioners will need to follow governance models as they evolve. Reputation risk, investor lawsuits, and other legal concerns mount with every change in a highly watched index.

For example, ISS and FTSE International began a partnership last year to further study correlations between corporate governance and performance through the FSTE/ISS ratings. Though, according to the two partners, their model has produced findings that indicate "structure and independence of the board" and "shareholder rights and protections" have the highest weights in governance standards, this will change as markets change.

Those companies not addressing in investor communications the ways in which they compare to accepted indices are open to criticism that they failed to meet a corporate governance standard.

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