GovernanceMetrics International
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March 3, 2008
GMI Releases New Ratings for All Rated Companies
Dear Colleague,
This is to let you know that GMI has just released new ratings and rating reports for our entire universe of 4,165 companies, including nearly 600 from emerging markets. Clients will see the new information the next time you log onto the GMI subscriber site. FTP sites will be updated overnight to reflect the new ratings data.
We also wanted you to know that clients who access GMI Rating Reports over Bloomberg are now able to access GMI Rating Files directly over their Bloomberg Professional Services platform as well. We made these arrangements with Bloomberg to help our clients integrate governance factors into their portfolio screens, a process that is becoming increasingly mainstream.
Governance and Performance at Top-Rated Companies
Our experience, and a growing body of research, suggests that investors who put in the time will find that governance analysis is a helpful tool to assess potential risk and to gain additional insights into investment opportunities. For example, only one percent of our total research universe achieves an overall global rating of 10.0, the highest assigned by GMI. Today’s release includes 42 top-rated companies, representing Australia, Canada, Ireland, Netherlands, the UK and the US. Total shareholder returns for these companies averaged 13.9 percent in calendar 2007, compared to 11.8 percent for the MSCI EAFE Index. Annual total returns for these companies averaged 22.2 percent for 2005, 2006 and 2007, compared to 20.7 percent for the MSCI EAFE Index for the same three-year period. While not proof positive, this does suggest that governance quality can affect pricing in today’s global markets.
Here is a small sample of some of the companies we are watching:
Apollo Group, Inc. (NASDAQ: APOL)
Apollo has consistently received low ratings from GMI and currently has a global rating of 3.0 and flags in four out of six research categories. The company continues to be worth watching, as it recently disclosed an interesting change in executive remuneration. Previously, Apollo used other for-profit education providers as its peer group for comparison of executive pay. It switched to an eclectic group of companies that are “similarly-sized, highly-successful service-based businesses whose executives possessed: sophisticated brand management experience; significant marketing/advertising experience (including the use of the Internet); experience with large employee populations; Internet related content and transaction experience; nationwide retail presence; and consumer, rather than business, service experience.” The company explained that it “is the largest publicly held, for-profit provider of education in the country and much larger than its public company competitors. While the Compensation Committee examined data from the education group peers, it determined that it was more appropriate to benchmark compensation for executive officers against companies that were similar in size when compared to revenues and market capitalization.”
This occurred after the Compensation Committee was revamped following problems the company had with options backdating, which surfaced a couple of years ago and included favorable exercise prices. The new committee also decided to review the peer group. While we understand the logic, it is worth noting that the new group does not include any of its natural competitors, and of the twelve companies chosen, nine have CEO’s in the Forbes’ Top 500 highest compensation list.
Public shareholders might complain about this, but they cannot vote. Apollo’s voting rights rest solely with the Class B shareholders, Acting Executive Chairman Dr. John G Sperling and his son, Peter V. Sperling. Dr. Sperling is the highest paid executive at Apollo and also controls the election of all directors, including those on the Compensation Committee. The board of Apollo did invite public shareholders to an annual meeting recently to receive the results of the Class B shareholders’ annual meeting (i.e. to be told who the directors are), view a presentation on the company’s business and raise questions. However, shareholder resolutions are not invited.
APOL has recently been the subject of an award of up to $277M (depending on the final calculations) by a Federal jury in a case involving alleged misleading of investors regarding a negative Department of Education report that stated that the company had recruiting practices that breached federal regulations. The company was sued in a shareholders law suit and is expected to appeal.
Ping An Insurance (Group) Co. of China Ltd. (HKEx: 2318)
Ping An is the number two Chinese life insurer by premiums after China Life. Ping An plans to raise close to $20 billion in coming months. Since the company disclosed the outlines of its fundraising plan - potentially one of the world's largest - it has weighed heavily in the country's already-wobbly stock markets and attracted official criticism. Speculation is intense over what will happen on March 5, when Ping An shareholders are scheduled to vote. Increasingly, the planned offering is shaping up as an important test of investor resilience in China and of how the government plans to handle a recent sharp downturn in what previously had been one of the world's best-performing markets.
Ping An is currently rated 3.5 overall by GMI, considered to be below average on our rating scale of 1.0 to 10.0. With the stakes this high, how this company is governed would seem to have enormous implications for investors, and the Chinese market at large.
Allco Finance Group Ltd. (ASX: AFG)
Allco is an Australian company now in serious difficulty due to exposure to structured securities. The company announced that it was not going to pay a half or full-year dividend this year. Allco is under a financial cloud as it seeks to restructure itself, drastically reduce head count and restructure its debt facilities, which are coming to maturity.
In its latest financials, Allco’s current liabilities have risen from A$200M for its financial year ending June 30, 2007 to $2.3B for the half year ending December 31, 2007. CEO Mr. David Clarke is reported to have said that the company’s banks could require it to repay A$900 million in senior debt within 90 days, a demand the company would find "very difficult" to meet. Allco’s shares dropped 64% on the day this information was announced. The company is now moving quickly to sell assets to shore up its balance sheet.
GMI has had concerns about Allco since it was first rated. It has extensive related party transactions and limited disclosure of its committee charters and other company policies. Its Executive Chairman sits on the Human Resources and Remuneration Committee. Even before the latest revelations, Allco’s global rating in the area of Financial Disclosure and Internal Controls was in the bottom 10% of Australian companies covered by GMI.
Allied Irish Banks plc (Dublin Stock Exchange: ALBK)
On the positive side, Allied Irish Banks plc (“AIB”) offers an interesting story about risk and controls systems. Early this decade, AIB had a familiar-sounding problem with a rogue trader and other substantial internal controls issues. It conducted a thorough investigation and appears to have learned from these by appointing a new Chief Risk Officer and encouraging employees to speak up about problems. The investigation was independently reviewed by a former Governor of the Central Bank of Ireland.
AIB shows its seriousness about its controls systems by having the former President of the Institute of Chartered Accountants in Ireland (and Joint Chairman of the Joint Ethics Board of the Institute of Chartered Accountants in Ireland, Scotland and England and Wales) as its Audit Committee chair.
This attitude appears to have borne fruit, with AIB announcing solid annual results for 2007 despite problems elsewhere in the banking sector. Its total impairment adjustment for structured securities was a comparatively small €39 million in total (€25M in subprime, €11M in CDO’s and €3M in other asset-backed securities). While other banks in Europe and the United States have been writing off billions, AIB has looked solid by comparison.
AIB has an overall global rating of 10.0, and 10.0 in the area of Financial Disclosure and Internal Controls.
The New York Times Company (NYSE: NYT)
The New York Times Company (NYSE: NYT) says it will meet with director nominees put forward by a dissident shareholder group. The meeting could be a first step toward a decision to recommend a vote for some of the group's nominees. Such a decision could avert a threatened proxy fight by the shareholders, Harbinger Capital Partners and Firebrand Partners, which recently disclosed they had raised their stake in the publishing company to 19%.
NYT has a dual class voting system. Holders of Class A Common Stock, the publicly traded shares, elect 30% of the board, while Class B Shares, 88% of which are held by the Sulzberger family's 1997 Trust, elect 70% of the board. This puts NYT in a small minority, with only 43 companies of the S&P 500 deviating from a one share, one vote standard. This is down from 60 in December 2002, when GMI first started rating the S&P 500.
With NYT as a backdrop, we thought it was worth taking a look at what else has changed within the S&P 500 over the last five years, and what has not. Board leadership has been one of the areas most subject to change. In December 2002, 381 (76%) of the S&P 500 had a combined Chair / CEO, compared to 296 (59%) today. Only 52 (10%) had a designated "lead" or senior non-executive board member in December 2002, compared to 304 (61%) today.
We also found a shift away from staggered elections (“classified boards”) and towards annual elections, with roughly 80 (16%) of the S&P 500 companies making the change over the last five years. Today, 293 (59%) hold annual elections.
One of the most dramatic changes has been in how US company directors are elected. In contrast to the US, where GMI recorded no companies with a majority voting policy in December 2002, majority voting is a longstanding legal requirement in Australia, the UK and a number of other markets. GMI now tracks 275 (55%) companies within the S&P 500 that use some form of majority voting in the election of directors. One of the most recent additions is NYT itself – the company announced the change on February 21.
The most dramatic change was in the number of companies where non-executive directors have a formal session without the executive members at least once a year. 87 (17%) of the S&P 500 reported doing so in December 2002, compared to 488 (98%) today. In addition, 231 (46%) of the S&P 500 report today that it is the board's policy to hold non-executive sessions before or after every board meeting, time permitting, up from just 28 (6%) in December 2002.
To no one’s surprise, the pace of reform with respect to executive remuneration seems slower. We looked at companies which have a clause in the employment contract of the CEO and/or key executives or as part of the company's published policies or bylaws providing for a claw back of any bonuses, options and/or other compensation based on accounts that end up being restated at a later date. No such clauses existed among S&P 500 companies in December 2002; today 64 (13%) of the S&P 500 disclose a claw-back provision. We also looked to see whether “innovative” option plans had taken hold the last five years, specifically looking at companies where a portion of executive stock option grants include premium-priced options or indexed options, companies that require financial performance hurdles be achieved before some stock options may be exercised, or companies that require executives already holding a certain amount of company stock pay a premium to exercise additional stock options. 62 (12%) of the S&P 500 have at least one of these features in place today, compared to 22 (4%) in December 2002.
Corporate governance is an ongoing, evolutionary process, and it’s good to see movement towards best practice among many S&P 500 companies. NYT’s move to majority voting is a clear reflection of this trend. It will be interesting to see what else, if anything, NYT decides to do in this environment.
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