What you need to know: A new rating system that breaks companies’ corporate governance scores down into separate categories will be implemented beginning in March.

What you need to do: Companies will need to consider the implications of this new assessment, since it may highlight deficiencies in individual categories, and should verify RiskMetrics’ data as soon as they receive notification of their ratings from RiskMetrics.

RiskMetrics Group, which provides proxy research to institutional investors, recently announced that it would be replacing its Corporate Governance Quotient rating for public companies with a new Governance Risk Indicator. The transition by RiskMetrics to the Governance Risk Indicator will occur in early March when the new Governance Risk Indicator will be included in RiskMetrics proxy research reports for companies with annual meetings after late March.

What will the new Governance Risk Indicator look like? Unlike the CGQ, which was a single, numerical corporate governance rating for the entirety of governance matters faced by a public company, the new Governance Risk Indicator will consist of separate ratings in four governance categories:

  • Board
  • Audit
  • Compensation
  • Shareholder rights

Ratings in each category will be determined based upon a lengthy set of specific metrics established by RiskMetrics. The Governance Risk Indicator rating for each category will be on a stoplight system: red for high concern, yellow for medium concern and green for low concern.

While the CGQ was a relative rating based on two S&P classifications – size and industry – the new Governance Risk Indicator is an absolute rating based on what RiskMetrics believes to be best practices, though it will incorporate differences for local market nuances.

Similar to the CGQ, the Governance Risk Indicator will be derived from a series of questions or data points relating to a company. RiskMetrics has indicated that it will issue a technical document in the near future that will provide the means to replicate Governance Risk Indicator assessments of risk across the four key areas for any company.

Practical guidance for companies

  • While the substance is the same, the change in form matters. While the substance of the questions asked by RiskMetrics under the new Governance Risk Indicator may end up being similar to that of the prior CGQ, having separate ratings for the four governance areas will highlight deficiencies that RiskMetrics perceives in any one area. For example, many companies with “good” corporate governance may receive a “high concern” or “medium concern” rating in the area of shareholder rights due to common public company practices, such as a limited ability of shareholders to call special meetings, shareholders being precluded from acting by written consent or a super-majority vote being required to approve mergers or business combinations. Board and Corporate Governance Committees will want to think about what their rating will be in each of the four categories and the implications for the company.
  • Companies should verify the data used by RiskMetrics. RiskMetrics has indicated that companies will receive an alert from RiskMetrics’ data verification site to review their information once it is available. There will be limited time to review and update this data before the 2010 proxy research reports are issued by RiskMetrics.
  • This is not a change in RiskMetrics’ voting policies. Though it represents a change in how RiskMetrics presents the corporate governance information, the adoption of the Governance Risk Indicators is not a change in RiskMetrics’ underlying voting policies. According to RiskMetrics, the new ratings are simply meant to increase transparency and better align the presentation with its voting policies.