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GMI Releases New Global Governance Ratings

Improvements Seen Following Enactment of SOX, But Risks Remain

New York, September 7, 2004. GovernanceMetrics International (GMI), the corporate governance research and ratings agency, today announced new ratings on 2,588 global companies. Twenty-six companies – twenty American, five Canadian, and one Australian - received scores of 10.0, GMI’s highest rating. As a group, these companies outperformed the S&P 500 Index as measured by total returns for each of the last one, three and five year periods by 4.9%, 8.3% and 10%, respectively, as of August 31, 2004. Similar out-performance results were achieved when measured against the MSCI World Index. Gavin Anderson, GMI’s CEO said, “This suggests a correlation between corporate governance practices and portfolio returns when measured across a number of variables and across a multi-year period.”

Mr. Anderson noted that U.S. companies overall had improved ratings over the past two years, with their global average rating rising from 6.5 to 7.2. “The enactment of Sarbanes-Oxley in 2002 has led to continued improvements in the level of practice and transparency in the United States, but one should not be complacent; governance risks certainly do remain despite changes in the broader corporate governance climate,” said Mr. Anderson.

The Sarbanes-Oxley Act has had clear effects on the levels of behavior and disclosure when comparing GMI’s newest ratings release to the first release in December 2002. Among the more positive changes in the U.S. are:

- 95% of companies now report having a qualified financial expert on their audit committee versus 65% in 2002

- 73% have hiring policies concerning employees or former employees of auditor firms versus 14% in 2002

- 51% of companies have adopted auditor personnel rotation policies versus 8% in 2002

- 83% of audit committees now perform self-evaluations versus 17% in 2002

In addition to changes from legislative initiatives, there have been several other improvements in governance in U.S. boardrooms over the past two years. For example:

- 90% of companies now have board evaluation policies versus 35%

- 80% of companies now provide director training versus 14% and

- 11% of companies paid their auditors more for non-audit fees than for audit related fees versus 48% in 2002

Mr. Anderson noted that “as a whole, Sarbanes-Oxley appears to be having its desired effect with increased levels of audit committee accountability, auditor independence, and better transparency, but compliance with Sarbanes-Oxley policies is not the be all and end all in determining what constitutes sound corporate governance. When looking at other aspects of a company’s governance profile such as the presence of material related-party transactions, dual class voting structures and lack of independent board leadership, one can still wean insights into potential governance risks.”

In the matter of independent board leadership, advances are being made, but U.S. companies still have a long way to go. The difference between the U.S. and U.K. in this area is noteworthy. Presently, 95% of rated companies in the U.K. have separated the Chairman and CEO roles, but only one-third of rated companies in the U.S. have done so. In December 2002, 22% of U.S. companies had separated the Chairman and CEO roles. Other companies are attempting to address this issue by naming a “lead non-executive director.” The percentage of U.S. companies naming a lead director increased from approximately 13% to 42% in the period from December 2002 to August 2004. However, nearly a quarter of these non-executive chairman and lead directors can not be classified as independent under GMI standards.

“Related-party transactions are an interesting aspect to investigate since they can be a strong signal into a company’s governance practices and sense of propriety,” said Mr. Anderson. Approximately 35% of U.S. companies examined by GMI report a related-party transaction involving the Chairman, CEO, President, COO or CFO or a relative thereof. In contrast, 11% of European companies engaged in such related party transactions. For U.S. companies with dual class voting mechanisms where insiders control shares with superior voting rights, this number is notably higher (46%). Mr. Anderson indicated that “this finding is not surprising given that at these companies, shareholders are unable to wield any influence given the disproportionate voting power held by insiders. Indeed, Paul Gompers of Harvard in a recent study titled, Incentives vs. Control: an Analysis of US Dual-Class Companies, concluded that “the more control that insiders have, the more they can pursue strategies that are at the expense of the outside shareholders.”

Among the more conspicuous transactions in the past year are:

- An NYSE company whose President’s son controls a company where sales to his father’s employer have accounted for up to 50% of revenue in the past three years.

- An NYSE company where the CEO is also Chairman of another company which is 30% owned by family trusts that he is a trustee and beneficiary of. Both companies are part of partnerships that sell property to the NYSE company. Transactions last year were in excess of $83 million.

- A NASDAQ company where three directors are employees of a company that has invested in a significant customer of that same NASDAQ company.

Noteworthy Country Ratings

On a national level, U.S. companies had the highest overall average rating of 7.23, followed by Canada (7.19), United Kingdom (7.12) and Australia (6.73). At the other end of the scale, Greek companies had the lowest overall average rating at 2.93 followed by Japan at 3.57. In Europe, companies from Belgium (4.52), Portugal (4.55) and Denmark (4.60) had the lowest overall average ratings. Twenty-five companies received GMI’s lowest overall global rating of 1.0. Thirteen of the 25 are located in Japan, 4 in Greece, 3 in Belgium, 2 in France, and 1 each in Denmark, New Zealand and Hong Kong.

With this release GMI also initiated governance ratings on companies operating in both Hong Kong and Singapore with 44 and 48 companies under coverage, respectively. The overall and section ratings for these two markets is disclosed below. The below average overall ratings reflect the fact that disclosure in these two markets is relatively scarce. Among the best practices in these countries are that all related-party transactions above a certain amount must always be approved by shareholders and in Singapore, shareholders must approve overall directors’ fees. On the other hand, in both markets, voting is by a show of hands unless the company expressly calls for all votes to be counted and in Hong Kong, some of the largest companies boast boards where share ownership among directors and officers is nonexistent.