Standard & Poor’s has updated its guidance related to its methodology for evaluating enterprises’ management and governance - a component used by S&P in assessing enterprises’ overall creditworthiness. Such new guidance updates S&P’s 2008 and 2011 guidance related to its management and governance evaluation methodologies. The new guidance is effective immediately.  

An enterprise’s credit rating is based on an evaluation of both its business risk profile and financial risk profile. S&P’s evaluation of management and governance credit factors generally impacts the business risk profile component of such credit rating. S&P’s new guidance reorganizes and integrates the methodology used in evaluating management and governance, which had been evaluated separately, to more accurately reflect the reality that an enterprise’s board of directors oversees management and is primarily responsible for deficiencies in management’s “strategic positioning, risk management and organizational effectiveness”.  

An evaluation and scoring of management now includes a clearly itemized analysis of strategic positioning, risk management/financial management and organizational effectiveness, with each such criterion including specific subfactors for further transparency. Governance is also evaluated and scored pursuant to several specific subfactors, including those related to board effectiveness, management culture and internal controls. The analysis of the governance credit factors interplays with the management credit factor analysis in that the former is intended to reflect an “adjustment” to, and “constraint” on, the evaluation of management.  

Each management subfactor is scored as positive, negative or neutral, while each governance subfactor is scored as negative or neutral. Scoring of management and governance is evidence-based and, if no evidence is available, a neutral score is given for the respective subfactor, provided that key management and governance information has not been deemed withheld, in which case a negative score for such subfactor may result. A negative score in any management or governance subfactor indicates a “material deficiency” in the management or governance of the enterprise.  

The management and governance subfactor scores are aggregated to arrive at the overall score awarded to management and governance as a component of the enterprise’s business risk profile, which, as noted above, is combined with its financial risk profile to result in the designated credit rating for the enterprise. Scoring of management and governance is made on a scale of weak, fair, satisfactory or strong, depending on the mix of positive and negative management scores and the existence and severity of governance deficiencies.

S&P’s updated criteria for evaluating management and governance is intended to enhance transparency in such evaluation, as opposed to providing any new, or substantive changes to existing criteria for evaluating management and governance. As such, the enumerated credit factors and related subfactors merely articulate how management and governance are scored, and thus are not expected to impact any existing credit ratings, but will be integrated into S&P’s reviews going forward. Further, S&P’s updated management and governance methodology is intended to incorporate its initiative in recent years to apply the analysis of enterprise risk management to nonfinancial companies. For a more in-depth discussion of ERM and S&P’s review of ERM and application to nonfinancial companies, please see our July 2010 advisory, “Standard & Poor’s Clarifies ERM Analyses for Nonfinancial Companies,” which can be found here.

A focus on management and governance credit factors is not limited to those companies seeking to obtain or maintain a credit rating, but instead is in the realm and responsibility of all companies. The SEC, stock exchanges and others require certain disclosures and compliance measures with respect to management and governance matters. As such, although a company may not have credit rating needs, the guidance with respect to management and governance credit factors provided by S&P contains useful considerations for most companies, particularly those subject to the oversight of the SEC and the scrutiny of investors.

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The above is a summary only and is intended to describe the current S&P guidance relating to its management and governance credit factors methodology; the full texts of the November 2012 S&P guidance on such methodology can be found here and here.