Corporate Governance Screen Updates

NEW! 2005 Data Released for KLD STATS

Customizing Social & Environmental Restrictions
to Meet Your Exact Needs

Corporate Governance Screen Updates

         KLD has expanded its corporate governance research to include new ratings on transparency, accounting, and political accountability, and moved its coverage of tax disputes and controversies to Community. KLD's coverage as of January 2006 includes more than 700 new ratings entries in profiles of nearly 600 of the 3,000 US companies on which we report.

Why The New Ratings Categories

         Considered as an investment, political spending can bring high payoffs through laws and regulations that enhance corporate profits, but it can carry an extremely high risk to a company’s reputation and regulatory risk. The DeLay and Abramoff scandals highlight the controversial subject of corporate involvement in public discourse.

         Shareholders filed more than fifty shareholder resolutions demanding disclosure of political spending in 2004 and 2005. In December 2004 Morgan Stanley became the first major US Corporation to respond to shareholder pressure, agreeing to publish its soft money contributions and have board level oversight of its political involvement. In 2005 Johnson & Johnson, Schering-Plough, Coca Cola, PepsiCola and Eli Lilly all followed suit.

         KLD’s Political Accountability rating evaluates a company’s involvement in political controversies, as well as their transparency in reporting political activity to the public. In separate reports, Sustain-Ability and the Center for Political Accountability argued that corporate involvement in public policy as a business practice must be transparent to shareholders.

         Accounting and Transparency are two areas that KLD formerly reported on in its “Corporate Governance Other Concern and Other Strength” rating, but SOCRATES users can now view them as separate indicators of the state of a company’s corporate governance.

         On the one hand, outstanding transparency through CSR reporting may signify strong governance, particularly as to environmental and social issues. On the other hand, repeated problems with accounting, such as financial restatements or government investigations may suggest a fundamental problem with a company’s corporate governance.

         In the past, KLD covered tax disputes as a corporate governance and financial concern. KLD has now moved this coverage to community and expanded the coverage to highlight the community implications of tax controversies, particularly in negotiations with local governments concerning tax breaks, subsidies and job creation.

Rating Methodology

         To rate each company’s political accountability KLD partnered with the Center for Political Accountability, a nonpartisan nonprofit organization, to collect publicly available information on political spending. KLD also sent a detailed survey on the governance of political involvement to over 3,000 US companies, researched companies’ websites, and spoke directly with dozens of company representatives.

         For its transparency rating, KLD analyzes companies on the quality of reporting on their environmental, social and governance factors through CSR reports, the GRI, CERES and OneReport.

         KLD reports on accounting controversies that the SEC or other government agencies have targeted for fines and formal or informal investigations regarding irregularities. KLD also tracks financial restatements, shareholder related lawsuits and executive turnover.

         For more information on KLD’s Corporate Governance ratings changes, see the press release at: http://www.kld.com/newsletter/archive/press/012306KLDExpandsCGScreens.html

NEW! Diversity Trends Within the S&P 500

A Quick Look at Diversity Trends within the S&P 500 Over the Past Decade (1994-2004)

         Given the advances in diversity over the course of the past ten years, one would assume that diversity numbers within large corporations have also improved. This assumption can be confirmed using KLD data. In 1994, approximately 25.6% of the companies listed on the S&P 500 had a KLD concern for non-representation. In 2004, just 11.4% of companies on the S&P 500 had qualified for the concern, a decrease of over 55%. KLD defines non-representation as companies with no women on the board of directors or among senior level managers.¹

         The biggest drop in companies with no female representation occurred between 1994 and 1995, when the percentage decreased from 25.6% to 17.4%. Interestingly, the number of companies with a KLD concern for diversity controversies rose significantly during that same time period, rising from four in 1994 to 20 in 1995.

         From 1996-2004, the number of companies with a non-representation concern continued to decrease for a couple of years, then remained relatively steady, with fluctuations of about 2% year to year both up and down. 2005 was the first year where the percentage dropped below 10%.

         During this same time period, 1996-2004, the number of companies with a controversies concern continued to increase significantly, rising from 24 in 1996 (4.8%), to 84 in 2005 (16.8%). The biggest increase occurred from 1997-1998, and then each year from 1999-2002. KLD assigns a diversity controversies concern if a company has either paid substantial fines or civil penalties as a result of affirmative action lawsuit, or has otherwise been involved in a controversy related to affirmative action issues.

         In other indicators of diversity, companies that qualified for a KLD strength for board diversity increased from 6.4% of the S&P 500 in 1994, to 22.6% in 2004. Companies qualifying for a promotion strength for women and minorities in executive level positions increased from 20.6% of the companies in the S&P 500 in 1994 (up from 17% in 1993), to 34.2% in 2004.

About KLD STATS

         KLD STATS is a historical statistical summary of KLD’s in-depth research available in SOCRATES and KLD PASS. It has been published annually since 1991 to give users the ability to analyze trends in the social and environmental performance of corporations.² At the end of each year, KLD takes a snapshot of corporate social performance of all companies within KLD's company profile universe. KLD creates a statistical summary of the in-depth profiles providing a "yes/no" answer for all of KLD's social ratings. KLD will be releasing the 2005 KLD STATS data in February 2006.

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¹ For 1991-2000, KLD has research available for approximately 660 companies on the S&P 500®, and the KLD DS 400 Index. Data for the 1,100 companies on the Russell 1000® and the KLD DS 400 Index are available for 2001 and 2002. Data on the Russell 3000, the S&P 500, and the DS 400 are available for 2003 through 2005.
² KLD attempts to take into consideration the presence of minorities within the board and upper management, but this data is much more difficult to find, and companies are often reluctant to release the ethnicity of their officers and directors.

Customizing Social & Environmental Restrictions
To Meet Your Client's Needs

Applying social restrictions, and how you can work proactively with clients
to minimize portfolio impact.

         The year past saw a number of large, well known and widely held companies fall under seemingly unrelated controversial involvement reports.

         Names such as Yahoo! Inc., Coca-Cola Company, Starbucks Corporation, and Bellsouth Corporation raised more than a few questions about the feasibility of applying broad, undefined social restrictions for such categories as gambling, alcohol, and adult entertainment.

Applying Social Restrictions - Know Your Options

         Social investors comprise a broad range of investors with widely different social mandates. It is important to educate yourself on your options, and set a screening strategy up front.

         When it comes to defining involvement in a particular issue, many clients are willing to compromise somewhat. This allows for investment in companies where involvement is minor or indirect.

         In order to tailor the research to the needs of such a diverse group, KLD decided the involvement reports needed to be flexible enough to allow clients to dictate how strict the screens could be.

         To that end, KLD created numerous sub-categories of involvement, to allow clients to customize their restrictions.

         For example, the adult entertainment report includes companies identified as "providers," companies that offer adult content through cable services such as pay-per-view or premium channels. This type of involvement is indirect and accounts for very little revenue. In the S&P 500, almost 40% of telecommunications companies in the utilities sector have some involvement in cable operations that offer adult content, leaving fewer investment options.

         A client wishing to restrict involvement in alcohol or tobacco may be comfortable screening out manufacturers of the product, while allowing investment in companies that own or are owned by companies involved with that product, or companies that sell the product in their stores.

         "A classic example I use is Kraft, which is on both the alcohol and tobacco reports due to the 85% stake in the company that Altria owns. Kraft itself does not have any involvement in either of these products," says Darragh Gallant, KLD's Manager of Client Services. Some clients will decide to screen out Kraft to avoid investing in a company whose revenues partially flow to Altria, while other clients will consider Kraft an acceptable investment because it does not have any involvement in either tobacco or alcohol.

         Setting a revenue threshold is another common way of employing a social restriction, while still being able to invest in many of the large companies that are listed on the involvement reports for minor involvement.

Avoiding Misunderstandings

         The best strategy for investing managers when employing social restrictions is to go over the proposed screening criteria issue by issue with a client, being as clear as possible about the parameters the client wishes to implement. Outlining distinctions between different types of "acceptable" involvement will help avoid confusion or misunderstandings later on.

         Clients applying a 5% revenue threshold for military weapons involvement should not be surprised that General Electric Company passes this weapons screen. For large companies like GE, a small percentage of revenue could still amount to billions of dollars. In this case, clients can opt to add another qualifying screen to set a revenue cap to catch significant players.

         As KLD's manager of client services, Ms. Gallant says she takes time working with investment managers to help them implement their clients' social restrictions. Often it is a matter of exploring all of the different sub-categories of involvement, and deciding which ones make sense to restrict given each client's mandates.

         "It's not unusual for investment managers to have a variety of social mandates on individual accounts. It is really important to establish each investor's tolerance level for each of the different involvement issues up front, and work out the best strategy for applying those tolerances."