Ronna Abramson

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These Software Makers Treat Their Owners Well

Ronna Abramson

When it comes to good corporate governance, Intuit and Microsoft rank high among software stocks, while i2 Technologies and Ariba are among the worst.

Admittedly, the ranking draws from a limited sample: the 10 software stocks covered by Salomon Smith Barney. The investment bank released the list on the occasion of adding ISS's so-called corporate governance quotient, a measure of a company's corporate governance policies based on 51 variables, to its research notes.

The value of the measure? Software analyst Heather Bellini suggests in her note introducing the metric that it can be useful in assessing risk. Salomon, the first investment bank to add the rating to its research, was unavailable for comment on the move.

A low ranking could tip investors that they should look deeper into a company to determine whether it has the right checks and balances in place, said Pat McGurn, vice president and director of corporate programs at ISS. Investors also use the rating to select companies in their portfolio as targets for shareholder activism campaigns, he said.

Meanwhile, a comparison of the software companies' corporate governance ratings to their stock performance this year found a correlation only at the top and bottom of the list.

McGurn said ISS has tried to weigh the variables that contribute to the corporate governance quotient so that it correlates to long-term performance. But "there are always anomalies," he acknowledged. "There are some companies that you get exactly what you expect: bad governance and bad performance." But there's also the case of the badly governed company that performs well, he added.

Many of the companies plagued by corporate scandals did not rank well, Bellini said in her note. For instance, Adelphia had a corporate governance quotient of 16, Worldcom 11 and Enron 42. The number reflects the percentage of companies the firm outperformed in the relevant benchmark index (a rating of 95 means that the firm outperformed 95% of the companies in the relevant benchmark index).

In addition, ISS ranks the companies relative to their industry group. In the case of the companies followed by Bellini, that would be the software and services industry group.

So what distinguishes the companies at the top from those at the bottom? Companies such as Intuit, Microsoft and Siebel Systems have a board controlled by a majority of independent outsiders; a compensation committee composed solely of independent outside directors; a CEO who serves on the boards of two or fewer other companies; directors who receive all or a portion of their compensation in stock; and non-employee directors who do not participate in the company's pension plan, according to ISS and Salomon.

Companies at the bottom of the list, such as Ariba, i2 and Informatica, had some things in common, too: They allow their boards to amend bylaws without shareholder approval, they permit option repricing without shareholder approval, and they deny shareholders cumulative voting rights, which let individual investors apply all their votes to a single director.

In addition, the low-ranking companies had a classified board, which means the directors serve staggered terms, making it more difficult to launch a proxy fight. i2 also has a poison pill in place that is not approved by shareholders, requires a 67% vote to amend certain provisions of the bylaws or charter, and its outside board members meet only when the CEO is present.

Some of the same policies exist at the companies at the top of the list. Intuit, one of the few software stocks to post gains since the beginning of the year, has a former CEO on the board, stock-based incentive plans that have been adopted without shareholder approval, no term limits for directors and no cumulative shareholder voting rights.

But Intuit's positives far outweigh such negatives, according to ISS. They include an audit committee composed of only independent outside directors; a full board that is elected annually; a mandatory retirement age of 72 for directors; board members with the authority to retain outside advisers; a simple majority vote to amend the charter or bylaws; a prohibition on option repricing without shareholder approval; and a board-approved CEO succession plan.