Fiction of Ratings

By Ramesh Akkineni

from an article in Financial Express

Standard & Poor’s has recently announced that it is getting out of the business of rating on corporate governance in the US. It competed well by quickly developing a corporate governance score (CGS) service and emerged as the leader. The rating model was based mainly on the assumptions implicit in the OECD principles on corporate governance.

Since its announcement of the service in 2000, several companies around the world subjected themselves to this rating, many from the emerging markets, particularly Russia. It launched its services in the US in 2002 and the first company that announced its CGS publicly was the Washington-based Federal National Mortgage Association (Fannie Mae), the US’s largest housing finance company, that scored nine out of 10. Andria Esposito, managing director for governance services at Standard & Poor’s, New York, reportedly commented at that time: “Fannie Mae is not only demonstrating its own strong governance practices, but is also showing leadership in the US with regard to providing greater openness and disclosure about its corporate governance standards.”

Subsequent to the dramatic ratings and announcements, Fannie Mae was caught in a vortex of scandals related to accounting, compensation, and other governance issues. Standard & Poor’s lowered the score to seven and then to six. Finally, it has announced withdrawal of the score, as well as the service itself, for the US companies. Some have speculated on additional considerations behind the decision, such as poor revenues in this line of business in the US due to the preoccupation with the Sarbanes-Oxley legislation, which may have crowded out the luxury of corporate governance ratings.

It may be a matter of time before many companies and agencies give up corporate governance rating for reasons of weak validity or cost-effectiveness. About 30 months back, I had cautioned through this paper that corporate governance ratings at this point are akin to partying hurriedly in a bikini. First, the ratings do not yet have a clear objective in relation to capital markets. This is unlike in credit rating, for which there are clear objectives for the rating agencies, the rated companies and the public dealing with such companies.

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