S&P and Moody’s Corp. accounted for around 83% of all credit ratings, the SEC said this month in its second annual examination of nine firms in the industry. (This article is the first of a two-part series that will discuss Moody’s next.) Each of the larger agencies did not appear to follow their methodologies and certain policies in determining certain credit ratings, the SEC found. On a brighter note, the regulator also said that with one exception, all nine agencies appropriately addressed its recommendations in 2011.
But the SEC also found various problems, ranging from inconsistent disclosure about methodology to directors not actively exercising their required oversight duties. Each of the agencies could strengthen its internal supervisory controls, the SEC said. For some, the regulator recommended changes in areas such as staff resources and oversight in the determination of ratings.
In the case of McGraw-Hill, oversight problems blatantly exist even in the senior ranks. For example, some directors on the board likely suffer from conflict of interest. Seven of McGraw-Hill’s directors have served more than a decade, including Robert P. McGraw, Pedro Aspe, Winfried Franz Wilhelm Bischoff, and Sidney Taurel, according to the company’s most recent proxy filing. The long-tenured directors make up the majority or chair four of the five standing board committees at McGraw-Hill. While we recognize the benefits of experience, we feel directors should have relationships that are distant enough for objectivity, as we noted in July.
In part due to such issues, McGraw-Hill is rated “D” on its environmental, social and governance (ESG) risk overall. Its financial statements reflect an AGR ® score of 24, indicating higher accounting and governance risk than 76% of comparable companies.
Some fallout from the risk is readily manifest. For example, the company’s board of friends and family awarded chairman and CEO Harold W. McGraw III $8.74 million in fiscal 2011, well over three times the median pay for the company’s other named executive officers. His compensation includes costs associated with his use of sleeping quarters in the McGraw-Hill building and his travel in company cars and aircraft – even to board meetings for ConocoPhillips and United Technologies Corporation. While some of these expenses may be more work-related than others, they are not directly tied to company performance, making it harder to explain what they do for investors. This suggests that the board has given Mr. McGraw the freedom to prioritize his own needs ahead of his staff, customers and investors, and he has seen fit to use it.
Meanwhile the others in the company are looking to Mr. McGraw as their leader and example. He makes decisions that impact every person at McGraw-Hill, fostering a culture that can make the kinds of mistakes the SEC described in its recent report. If Mr. McGraw can do whatever he wants, why not anybody else?