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 The Corporate Library’s Governance Ratings and Equity ReturnsKimberly Gladman, CFA, Ph.D., Director of Research and Risk Analytics

Execuve Summary 

A recent study of investment applicaons for The Corporate Library’s governance rangs shows outperformance

in 2003-2010 for three hypothecal por�olios benchmarked to the Russell 1000. The highest level of

outperformance—275 annualized basis points—was found for the por�olio applying the strictest governance

screens. Performance aribuon indicates that 121 basis points of the annualized outperformance for this

por�olio was stock-specific and hence directly aributable to the rangs. Approximately 74 addional basis

points resulted from differenal industry weighngs produced by the applicaon of rangs standards to

each company on an absolute (not “best-in-class”) basis. Por�olio standard deviaon was comparable to the

benchmark, and tracking error was 3.3 percent. The por�olio outperformed the benchmark in over 60 percent

of the test months, and had an informaon rao exceeding 0.8.

Growth of $1 Billion Invested 

The chart below shows the growth of $1 billion invested in each of the three por�olios vs. the Russell 1000 (in

blue), with the por�olio using the strictest governance screens shown in dark red.

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The Corporate Library’s Governance Risk Rangs

The Corporate Library’s governance risk rangs seek to idenfy companies where a divergence between the

interests of management and shareholders may be placing investment value at risk. The rangs process has

two parts. First, a database algorithm scores each company’s governance by assigning or deducng points

for a range of data items related to board composion, execuve compensaon, takeover defenses, and

accounng compliance. Second, a rangs analyst researches each company and adjusts the automac scores

where appropriate. To ensure consistency across me and among analysts, a detailed protocol containingextensive decision rules guides this qualitave research. On a quarterly basis, The Corporate Library’s senior

staff, including specialists in board pracces, takeover defense, and compensaon, review and if necessary

suggest amendments to this research protocol. It thus represents the firm’s evolving collecve intelligence and

expert opinion on how best to idenfy governance-related investment risks.

The rangs process is enrely boom-up and evaluates each company individually (not on a “best-in-class”

basis). As a result, if what The Corporate Library believes to be poor governance pracces are widespread

in a parcular industry, a large proporon of the companies in that industry will receive low rangs. The

Corporate Library’s rangs are from A to F, corresponding to a scale from low to very high risk. This overal

rang is comprised of individual component rangs for board, compensaon, takeover defense and accounng

compliance, which are also expressed in leer grades corresponding to risk levels. Board and compensaonscoring components together make up the majority (about 80 percent) of the overall scoring system.

The Quantave Services Group Study 

Commissioned by The Corporate Library and conducted by Quantave Services Group, the current study

covered the period from July 2003 to February 2010 and modeled three por�olios. All por�olios were based

on the Russell 1000 but excluded the following companies: 1) those whose overall governance The Corporate

Library rated D or F (the green “TCL” line in the chart above); 2) those rated D or F in overall governance

as well as both board and compensaon (this “Long Only Inclusive” por�olio is represented by the bright

red “LOI” line); and 3) those rated D or F in either overall governance or board or compensaon (this is the

“Long Only Exclusion” por�olio, represented by the dark red “LOE” line above). For each case, the simulaonassumed market-cap weighng, quarterly rebalancing, and reinvestment of dividends at each quarter-end. It

also incorporated market-impact transacon costs for a por�olio size of $1 billion. The third por�olio showed

strongest outperformance and is the main focus of this report. In what follows, it will simply be referred to as

“the por�olio.”

Por�olio Characteriscs

On average, the por�olio excluded about half the benchmark names and had annual turnover of 65 percent

corresponding to an average holding period per company of 1.5 years. In comparison to the benchmark, the

por�olio had a somewhat smaller weighted average market-cap ($42 billion vs. $79 billion) and a slight growthlt (P/E rao of 20.3 vs. 18); it was also persistently underweight in financials and energy and overweight in

technology stocks. These differenal factor exposures were much diminished when the por�olio was compared

to the benchmark on an equal-weighted basis, demonstrang that the market-cap weighng played a large

role in their creaon.

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© 2009 The C orporate Library, LLC. All rights reserved. No part of this publication may be reproduced, republished, altered, posted, transmitted,

or distributed without writt en permission from The Corporate Library, or, in the case of photocopying, under the terms of a license issued by The

Corporate Library.

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Performance

Annualized performance for the por�olio was 6.91 percent, compared to 4.16 percent for the benchmark,

producing an annualized outperformance of 275 basis points and cumulave outperformance approaching 25

percent. Standard deviaon was 22.29 percent (vs. 21.84 percent for the benchmark). Tracking error was 3.3

percent, the informaon rao was 0.82, and outperformance was seen in 61 percent of test months. Forty-

four percent, or 121 bps, of the 275 annualized bps of acve return was stock-specific, and another 74 bps are

aributable to the financial industry underweight produced by the applicaon of rangs standards to each

company on an absolute (not “best-in-class”) basis.

Conclusion

Previous research on the relaonship of governance rangs systems to investment performance has shown

mixed results, and the significance of parcular governance features to equity returns is widely debated. The

current study, however, suggests that The Corporate Library’s rangs system—focused on the idenficaon of

agency problems rather than supposed best pracces—can contribute significantly to alpha generaon.

For more informaon

• Request the full study here or call (207) 874-6921

• Request a free trial of Board Analyst® and gain access to The Corporate Library’s Risk Rangs

• Speak to The Corporate Library team about how you can incorporate our Risk Rangs into your

investment decisions: click here or call (207) 874-6921