According to Governance Metrics International (GMI), "the most important investing lesson of the 21st century is that traditional measures for evaluating risk are inadequate." The financial world has witnessed numerous corporate failures over the past few years, some of which have been linked to governance, environmental and accounting scandals. According to GMI, these companies include:
- News Corporation (NASDAQ:NWS)
- Massey Energy (NYSE:MEE)
- Lehman Brothers (OTC:LEHMQ)
- Bear Stearns
- Sino Forest (OTC:SNOFF)
So why did many analysts overlook the problems with these companies until they were rocked by scandal?
A recent report by GMI suggests that, "despite a growing body of evidence that ESG (author's note: ESG = Environmental, Social, Governance) factors can affect company valuations and the cost of capital in both the equity and fixed income markets, these factors often remain overlooked in traditional valuation models." In other words, fundamental analysis alone doesn't recognize and address risks that are buried in the footnotes to financial statements, left off balance sheets or embedded within corporate culture.
To address this knowledge gap, GMI released its Initial Risk List of ten companies it believes warrant further investigation for various ESG risks:
|Company ||Ticker ||Industry|
|Apollo Group, Inc||APOL||Personal Services|
|Comstock Resources, Inc||CRK||Oil/Gas E&P|
|EZCORP, Inc||EZPW||Consumer/Financial Services|
|News Corporation||NWSA||Media Diversified|
|SandRidge Energy Inc||SD||Oil/Gas E&P|
|Scientific Games Corp||SGMS||Casinos/Gaming|
While it doesn't suggest these companies are at any imminent risk, GMI's complaints range from voting control to environmental disclosure to director tenure to regulation risks to compensation. Details are available in the report (pdf).
While GMI raises some important criticisms, I have personally seen mixed results from stock selection based on various measures of corporate citizenship. Nevertheless, GMI's arguments may warrant a healthy dose of skepticism.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
Additional disclosure: This is not advice. While Plan B Economics makes every effort to provide high quality information, the information is not guaranteed to be accurate and should not be relied on. Investing involves risk and you could lose all your money. Consult a professional advisor before making any investing decisions.