ISS used its influence twice in takeovers involving Irish firms but noteveryone is happy to take its advice. Andrew Hill and Tony Tassell report

Rockville, Maryland is an unlikely addition to Capitol Hill and Wall Street on corporate America's map of where to lobby.

But over the past 18 months, companies, financial institutions and shareholder activists have beaten a path to the city to talk to Institutional Shareholder Services (ISS), the proxy advisory group based there.

The small, privately-owned company, founded less than two decades ago, considers the attention a tribute to the success of its strategy - based on making recommendations on shareholder votes and proxy and bid battles - and an invitation to expand further.

ISS has come to the attention of Irish shareholders in two recent takeover battles. In July 2002, it backed Madison Dearborn's €3.7 billion buyout of Jefferson Smurfit and earlier this year it advised shareholders in Riverdeep to accept the $376.3 million O'Callaghan/McDonagh backed Hertal offer.

The offer, which had been criticised by domestic analysts, was seen as fair "in light of the multiples on offer in its sector" by the stock.

Both companies had significant presence in the United States - in the case of Smurfit, 55 per cent of its shareholders were based there - adding to the impact of the recommendations.

More recently it hit the headlines after it came out on the wrong side of the GlaxoSmithKline "platinum parachute" row.

As shareholders rebelled against the severance package proposed should the British company's US-based chief executive be fired, ISS demurred, saying it thought the amounts involved were relatively inexpensive. Despite the support of ISS, the a.g.m. voted down the deal.

The move also pitted it against Britain's National Association of Pension Funds, a strong voice in British corporate governance, with which it last week joined forces to make recommendations on votes at British company meetings.

ISS has faced criticism, both of its methodology and of the conflict that might arise in courting corporate clients while offering an objective judgment on important shareholder votes.

Mr Jamie Heard, ISS chief executive, dismisses that concern. He points out that the group is regulated by the Securities and Exchange Commission and works to a very strict code of conduct aimed at preventing conflicts.

He denies that ISS's aggressive promotion of its new rating - the corporate governance quotient - increases the risk of conflict. "Plenty of companies who don't pay a nickel to ISS have improved their scores by changing their governance, so the idea that the only way to improve your score is to pay ISS is flat wrong," he says.

There is also some concern that if ISS corporate governance criteria become the benchmark for US companies, they may distort the aims of the Sarbanes-Oxley corporate reform act and other official codes of practice.

Ms Beth Brooke, Ernst & Young's global vice-chairwoman of strategy, says the act's emphasis on the work of the audit committee could be undermined by ISS's stricter rules. "ISS's policy takes away some of the audit committee's oversight responsibility and it could potentially damage audit quality," she says.

ISS says it is gratified by the number of companies striving to comply with its stricter tests.

Corporate clients account for about 15 per cent of ISS business and the group has a separate arm to serve the corporate market. It offers advice on corporate governance and executive and director pay, and is pushing hard to expand the use of its "corporate governance quotient" - a rating companies can use to assess their performance against peers.

ISS competes in an increasingly crowded market with governance ratings offered by Standard & Poor's, GovernanceMetrics and - from next week - the Corporate Library, the shareholder research group. But so far, it is the ISS rating that companies, eager to put recent scandals behind them, are boasting about.

That has fuelled the concerns of some critics, such as Ms Sarah Teslik, executive director of the Council of Institutional Investors, which represents 130 US corporate, public and union pension funds.

She says the council works well with the ISS on most issues, but "we have been troubled sometimes with ISS selling services to both sides on the deal".

Mr Heard defends the group's business model and points to a strict code aimed at avoiding conflicts. He says some rivals charge companies six-figure sums for their ratings. ISS clients only pay if they use its governance benchmarking tool, which costs $10,000-$18,000 depending on company size.

ISS's growing influence was highlighted last year, when it advised shareholders to support the Hewlett-Packard bid for rival computer maker Compaq when the vote seemed evenly split. Shareholders narrowly backed the deal, although ISS was embarrassed later when its director of US research, who wrote the crucial Hewlett-Packard report, resigned after admitting he had lied about having a law degree.

Mr Richard Ferlauto, a former ISS analyst and now director of investment policy with the American Federation of State, County and Municipal Employees, estimates that at companies with big institutional shareholdings, an ISS recommendation can swing between 15 and 20 per cent of the vote.

For instance, a change in ISS's opinion may have drained support from a proposal last month to introduce performance-related stock options at General Electric. The same proposal garnered about 30 per cent of the vote in 2002, when ISS backed it. But, based on its own criteria, ISS said GE had "cleaned up its act" on equity-based pay by this year, and advised shareholders to oppose the motion. The vote slipped to 15 per cent, despite support from Calpers, the big California pension fund.

ISS says such changes are always based on company behaviour, measured against the voting policies in a 750-page ISS manual that shareholders, companies and their advisers can consult.

Although the switches in opinion irritate shareholders and companies, many are reluctant to attack ISS openly because they need to curry favour with its analysts.

Says one activist fund manager: "Just because there's criticism from both sides doesn't mean that it all evens out and the result is that ISS is objective."

"No-one I have spoken to in Britain feels comfortable with the process," adds a corporate governance expert at a leading British institution. "If you do a straight calculation of how many analysts they have to cover 20,000 companies, then you get an idea of how good the analysis is."

Mr Heard says ISS is pumping investment into both technology and personnel. Sophisticated software often carries out the basic analysis of companies' regulatory filings and the 60 senior analysts do in-depth reports only on the few critical cases. "We're getting quite a lot of bang for our buck," he says.

What is clear is that, as the focus on governance and shareholder votes increases, ISS is likely to come under greater pressure to compromise its principles. Mr Patrick McGurn, ISS special counsel, says this year ISS had "more dialogue" with companies about its policies. "The stakes are higher," he says.