GovernanceMetrics International
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GMI Study Shows Utilities Lead Other Industries In Corporate Governance Practices But Still Face Major Challenges
Utilities Will Need Stronger Boards in the Face of Deregulation and Increased Pressure for Delivery Improvements
New York, October 21st, 2003 GovernanceMetrics International(GMI), an independent governance ratings agency, today published a report showing that the utility industry leads all other industries in corporate governance practices, but that there is a wide disparity in scores among individual utility companies.
The study concluded that given the critical challenges of the industry’s regulatory environment and increased demand for delivery improvements, many utilities lack the board oversight to ensure that they will succeed.
“It may surprise some that the utility industry scored highest on average in overall governance,” said Gavin Anderson, GMI's Chief Executive Officer. “But this industry traditionally has faced more stringent regulation than others and regulation is about accountability. Our ratings help determine whether a company has a culture of accountability, transparency and integrity.”
“Some utilities have become infamous for negligence,” he added. “And while many of the world’s 90 largest utilities have leadership that is well-diversified, knowledgeable of regulatory issues, and capable of addressing the critical challenges that the industry faces, a number don’t.”
Utilities earned higher average ratings than other industries for six out of seven GMI governance categories: board accountability, shareholder rights, remuneration, market for control, ownership base and potential dilution, and corporate behavior.
Overall, however, utilities earned a lower than average governance rating in the category of financial disclosure and internal controls. This underperformance is attributed to recent high levels of debt resulting in a high relative number of debt downgrades, numerous accounting-based investigations at U.S. utilities, and over three times the rate of recent earnings restatements among the utilities sector than in the entire GMI universe.
Recent events such as massive blackouts in the northeastern U.S. and Italy, Enron failures, and California outages, as well as regulatory and public scrutiny, underscore the need for sound corporate governance practices at utilities, which are vital to the infrastructure of the United States, as well as other nations.
Key findings of the GMI study are:
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Analysts say some utilities have not learned their lesson: Some
utilities still engage in opaque accounting disclosures and lackluster
governance standards. Analysts see a higher premium on governance in the
utilities sector than only a year ago, and expect companies with clearer
financials and better governance to outperform.
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Many utilities still have high levels of debt: Although utilities
typically have high levels of debt, those with higher governance ratings have
suffered fewer debt downgrades. Companies with higher governance ratings tend
to also have higher debt levels perhaps suggesting that good governance
practices registers with lenders.
- Utilities face major challenges: The industry has undergone drastic change in the last 10 years, following decades of relative predictability. More change is likely to come from regulation, the rebuilding of the U.S. utilities infrastructure, increased customer demands, the growing need for environmentally friendly energy, and other challenges. GMI research has shown that independent, knowledgeable boards with the power to effect change at a utility will reward shareholders to a far greater degree than boards without these characteristics. Not all utility boards are equipped, however, to navigate these new challenges.
Utilities vs. Other Industries
GMI’s study was based on global ratings of 1,000 U.S. and 600 non-US companies from 15 countries. The study utilized GMI's rating system, which incorporates hundreds of data points across seven broad categories of analysis. GMI rates companies from 1.0 (lowest possible score) to 10.0 (highest). The firm also utilizes a “red flag” alert to identify areas it believes investors should pay particular attention to.
Among all rated industries, utilities performed highest globally with an average rating of 7.0. It was followed by energy (6.9) and insurance (6.8), industries that also historically have been highly-regulated. Industries that performed lowest were construction (4.9), autos (5.6) and media (5.8).
American and British utilities generally had the highest governance ratings, while the lowest were in Japan and continental Europe, which have far lower governance standards. All of the top 10 companies operate in the U. S. and received scores between 9.0 and 10.0, GMI’s highest rating.
Pinnacle West earned GMI’s highest possible governance rating of 10.0, due to the utility’s recently published, highly detailed governance guidelines; a generous array of rights afforded to company shareholders; the low dilution level for executive stock options; and an outstanding environmental management system.
Of the 90 utilities it rated, GMI red-flagged 21 or nearly 25%. Of these, 11 were U.S. companies, six were European, three were Japanese, and one was Australian. U.S. companies were the only utilities flagged for financial disclosure or internal control issues, underscoring the need for tighter accounting controls among U.S. utilities.
The lowest rated utilities were Kansai Electric Power and Chubu Electric Power of Japan, each of which earned ratings of 2.5 for failure to disclose governance policies and poor shareholder voting rights. The lowest U. S. performers were Westar Energy and Dynegy, which have been the subject of criminal investigations.
European and other non-U.S. companies fared better than U.S. companies in financial disclosure, corporate behavior and social responsibility.
Of all the challenges utilities face, legislative and regulatory initiatives may have the greatest effect. Government regulation has traditionally played a large role in the governance of all utilities due to their importance to the economy and reluctance to allow power resources to be left solely to open market variances.
In the U.S., the Federal Energy Regulatory Commission (FERC), which regulates electric and gas utilities, has managed industry restructuring since the Energy Policy Act of 1992. Impending legislation – such as Congress’s potential repeal of the Public Utility Holding Company Act (PUHCA), which limits how utilities can invest in other non-utility related ventures – and demands by consumers and regulators for market reform, will increase the need for boards to understand their companies, the industry and the political landscape. While governance measures on financial reporting requirements have been published via Congress’ Sarbanes-Oxley Act and the SEC, federal requirements have not been promulgated by regulators such as FERC.
“The governance practices of utilities companies today are better than one might expect,” Anderson said, “but the regulatory framework for change is immense, and if there was ever a time when the industry needed strong leadership and boards it is now.” GMI’s report of the utility industry can be obtained by contacting Lourdes Gomez at lgomez@gmiratings.com. It is priced at $3,500.
About GovernanceMetricsInternational
GovernanceMetricsInternational (GMI) is the only independent corporate governance ratings agency focusing on corporate accountability issues on a global scale. Its ratings are based hundreds of data points per company and cover seven broad categories of analysis. Ratings criteria are based on a number of well-regarded global corporate governance codes, including those developed by the Organisation for Economic Cooperation and Development (OECD).