Watching the directors | The Corporate Library scrutinizes corporate boards to uncover companies at risk

Even before crusading New York Attorney General Eliot Spitzer in October 2004 charged insurance broker Marsh & McLennan with rigging bids and receiving kickbacks from insurers, Portland-based The Corporate Library had serious concerns of its own about the company. Last year, the independent research firm's Board Analyst tool, which grades corporate boards on how effectively they protect shareholders' interests, had given Marsh's board of directors a D overall ˆ— which included an F for its CEO compensation practices.

The way The Corporate Library sees it, excessive CEO pay is just one hint that a board isn't willing or strong enough to stand up to management, and thus may be falling behind in other areas of proper corporate governance. Now, in light of Spitzer's allegations and a subsequent Business Week article claiming that Marsh operated under an "arrogant" and "secretive" corporate culture overseen by a board that included six members directly involved with running the company or its subsidiaries, that D grade looks prescient.

Of course, an overpaid CEO or a board filled with management's golf buddies doesn't automatically add up to a high-profile corporate scandal. But that kind of cronyism is among the business-as-usual conflicts of interest that The Corporate Library has been working to eliminate since Cape Elizabeth investor, entrepreneur and former Senate candidate Bob Monks founded the company in 1999 with attorney and shareholder activist Nell Minow. What began as the research arm of Monks' and Minow's hedge fund has grown to a 32-employee firm that's compiled a database of corporate governance information on 2,000 publicly traded companies.

Along the way, editor and chairman Nell Minow has become TCL's public voice, routinely sought out by journalists to comment on the latest allegations of corporate misdeeds and preach the importance of good governance. "I want to make it so humiliating to do [corporate governance] badly that it's just easier to do it the right way," says Minow, who works from her home in McLean, Va. "I want directors to say, 'The CEO is putting pressure on me to raise his pay package, but Nell Minow is going to kill me if I do that.'"

Though Americans have loved the spectacle of public humiliation since the days of scarlet letters and stocks (the wooden kind), TCL's goal isn't to knock down corporate leaders out of spite. Instead, the company's mission is to improve corporate governance practices and thereby protect the shareholders who often end up paying for management's mistakes and excesses. To that end, TCL's products are designed to help clients ˆ— primarily institutional investment firms, insurance companies and executive search firms ˆ— analyze corporate governance issues as a risk factor before deciding whether to invest in or do business with a company.

But with the collapse of Enron, WorldCom, Adelphia and others showing just how costly bad corporate governance can be, TCL's niche has become increasingly crowded, including decades-old proxy research firms such as the Investor Responsibility Research Center, which counsels investors on corporate governance issues and director votes, and newer research firms such as New York-based Governance Metrics, which also attempts to score companies based on corporate governance practices. Facing that competition, Monks, Minow and CEO Karen Lowell, who took the top job at The Corporate Library in October 2003 after serving as the company's COO, are trying to focus on the products that will both differentiate the company's role within the corporate governance niche and create a profitable business. "There's no shortage of ideas around here," says Lowell. "My job as CEO is to say, 'Does it have commercial value?'"

Making a connection
Since the collapse of the technology stock bubble in 2000, academics and researchers increasingly have attempted to pin down the connection between good corporate governance and stronger companies or better stock market performance. For example, a Drexel University study released last October found that when a majority of a company's outside directors sit on three or more corporate boards ˆ— making them, presumably, too busy to focus on any one company ˆ— the company's market-to-book ratio, which compares the company's total stock value to the value of its assets, is on average 4.2% lower than that of companies with more dedicated boards. "Good governance is not just a fad, it goes right to the heart of value creation," says Jeff Ptak, a senior mutual funds analyst with independent investment research company Morningstar in Chicago. "The Corporate Library has really been in the forefront of getting that notion out there."

That's because Monks (who was traveling in England when this story was reported and was unavailable for an interview) and Minow have been agitating for better corporate governance for 20 years, starting in 1985 at Monks' proxy services firm Institutional Shareholder Services, which consults with large, institutional shareholders on key corporate votes. The pair had met when both were working for the U.S. government: Minow ˆ— the daughter of former Federal Communications Commissioner Newton Minow, who famously called television a "vast wasteland" ˆ— worked at the Office of Management and Budget at the time when Monks oversaw the government employees' pension system for the Department of Labor.

Growing out of their work with ISS, Monks and Minow in 1991 put their theories on corporate governance to the test by creating the LENS fund, a hedge fund that attempted to turn underperforming companies around by goading boards and managers to adopt good corporate governance policies. Between 1995 and October 2000, the LENS fund delivered an average annual return of 34.4%, compared to the S&P 500's 21.0% average annual return.

Monks and Minow sold the LENS fund to the British investing firm Hermes in 2000, but just before that transaction the pair spun off the fund's internal research arm as The Corporate Library. "I look at it like a rocket ship, where one stage falls off at a time," says Minow. "[Being an independent research firm] is what we wanted to do all the time, but the world wasn't ready for us then. I'm not sure it's ready for us now."

Since then, TCL has assembled a database of corporate governance information by culling information from Securities and Exchange Commission documents and other publicly available information, and setting its 17 analysts ˆ— who don't come from traditional financial backgrounds, but instead have strong research and computer skills ˆ— to work interpreting the data. In 2003, it used that analysis to launch its flagship product, the Board Analyst. The online tool lets clients view letter grades for board performance based on the following key metrics: CEO compensation, which TCL says should be tied to the company's performance; use of "independent" directors, who do not have a mangement role in the company or outside business relationships with it; shareholder responsiveness, which measures the board's track record for implementing shareholder recommendations; and takeover defenses, which are policies that ideally give shareholders a strong voice in approving any takeover bids. "We don't call our analysis staff 'data-gatherers' because they are analysts," says Lowell. "They are constantly looking at the data for anomalies."

To complement its rankings, TCL also offers a Board Interlocks tool, which uses hub-and-spoke graphics to show which other boards a company's directors serve on. And it's recently developed a corporate governance screening tool that lets clients use corporate governance data alongside more traditional investing or financial metrics to rank companies.

Together, these products have landed TCL between 200 and 300 customers, who subscribe on a per-user basis to the individual pieces or the full menu. That structure means TCL clients can pay anywhere from $3,000 a year for single-user access to the Board Interlocks tool, to $100,000 for an enterprise-wide subscription to all of TCL's offerings. (Individual investors concerned about purchasing a particular stock also can purchase TCL's reports on individual companies for $75 apiece.)

Information is oxygen
At least one client, Chubb Insurance, said it decided to subscribe to the Board Analyst over products offered by "dozens" of companies peddling corporate governance products precisely because of Board Analyst's opinion-heavy reports. Chubb is using the tool to help decide whether to offer potential clients director and officer insurance policies, which essentially protect those individuals from lawsuits stemming from corporate mismanagement, says Tony Galbane, a senior vice president and Chubb's D&O underwriting manager. "[TCL's] tool brings to the assessment a bias that is deeply rooted in a cynicism about excessive compensation," says Galbane. "I agree with their basic premise: that you start by looking at the money and the behavior goes with it."

Another of TCL's clients, the giant pension-fund manager California Public Employees' Retirement System, uses a custom-developed database from TCL to help with its shareholder activism campaigns. Screening the stocks in its portfolio against TCL's corporate governance metrics is one of the methods CalPERS uses to identify underperforming companies, which the fund then works with on specific performance or governance improvements. "We use The Corporate Library database because it's an indication of the tone at the top," says Mary Morris, an investment officer in CalPERS' corporate governance unit.

Even with The Corporate Library's existing client base, Lowell admits that so far the company hasn't made a strong sales push. That's because until recently it didn't feel the products were ready for a mass effort. Instead, the firm relied on a limited amount of direct sales and word-of-mouth publicity ˆ— largely driven by Minow and other TCL staffers' quotes in the media ˆ— to attract potential clients.

Now, though, Lowell is developing a new sales and marketing strategy that will identify events and conferences at which TCL wants to have a presence, and the industries that represent the most fertile territory for its sales staff. Alongside the pension fund managers, insurers and executive search firms the company already serves, Lowell is eyeing foundations and endowments, plaintiffs' law firms that take on shareholder suits, and individual departments within large corporations, such as human resources departments that handle executive and director compensation. She plans to implement that strategy early this year.

At the same time, TCL is looking at the countless ways it can parse its corporate governance data and develop new products, such as effectiveness ratings for individual board members, not just entire boards. A new regulation requiring mutual fund managers to disclose how they voted in shareholder proxy situations has allowed TLC to develop a tool that would let investors to judge their mutual fund holdings based on the fund manager's decisions on corporate governance issues.

TCL also is working to develop a "Corporate Governance Index," which would assemble a list of companies whose governance practices meet TCL's standards. That way, institutional investors concerned about protecting their shareholder rights or rewarding companies for good governance practices would have a ready-made list of investments. In fact, Monks already is helping test that model through RAM Trust, the Portland-based money management firm he founded in 1969. In 2003, Monks and Ram Trust's chief investment officer John Higgins launched an experimental fund that invests in well-governed companies; its performance could help show whether TCL's ratings ˆ— and, in turn, a future corporate governance index ˆ— predict good or bad stock performance, says Lowell.

Despite an interest in helping create investment vehicles, both Minow and Lowell say they have no intention of TCL actively managing money itself. Likewise, Minow says the firm won't stray into the world of shareholder activism, preferring instead to provide the data and opinions that inspire others to take action. (Minow and Monks, however, still occasionally advocate for shareholder rights on their own.)

That's because Minow sees information as the oxygen of financial markets. And even as The Corporate Library works to help stamp out laissez-faire corporate practices, Minow is convinced its information-based business model won't become obsolete. "No matter how many structural reforms are adopted, and no matter how smart people get about these issues," Minow says, "there will always be a job for people who interpret data and provide insights."