Author Archive | James McRitchie
The US Securities and Exchange Commission voted to approve five members of a new national accounting oversight board to be headed by ex-FBI-CIA chief William Webster whose only experience in accounting, as far as we know, was heading the auditing committee of U.S. Technologies, now bankrupt and facing fraud accusations. Shortly before Webster was appointed he told Harvey Pitt but Pitt chose not to tell the other four commissioners prior to their vote.
Webster edged out the much better qualified pension fund chief John Biggs, who would have done much to restore trust. The vote was 3-2. Webster becomes the first chairman of the Public Company Accounting Oversight Board, expected to get up and running early next year.
In addition to Webster, the commission approved former CalPERS attorney Kayla Gillan; accountant and former SEC general counsel Daniel Goelzer; former congressman Willis Gradison; and SEC Enforcement Division Chief Accountant Charles Neimeier. Continue Reading →
How the Corporate Landscape Is Changing. CFO.com outlines the prospects for pages of corporate governance reforms.
Providence Capital to another institutional shareholders meeting. This one will focus on Healthsouth (NYSE: HRC). Items on the agenda include Medicare issues, current leadership and business strategy, the Company’s corporate governance and the host of lawsuits recently filed against and on behalf of the Company. Shareholders can attend in person or via teleconference. Tuesday, October 1, 2002
Time: 4:15 pm (EDT)
Place: Providence Capital, Inc.
730 Fifth Avenue
New York, New York 10019
RSVP at 212-888-3200
Securities and Exchange Commission Chairman Harvey Pitt proposed changes to proxy rules in a speech before the Council of Institutional Investors. Pitt suggested eliminating SEC rule 14a-8(i)(7). This rule allows companies to omit from their proxy statements shareowner proposals that deal with “ordinary business,” or matters that are of concern to management, not shareowners. (see SEC Chair Proposes Eliminating Ordinary Business Exception in Proxy Rules, SocialFunds.com, 9/25/02)
Alaska Permanent Fund Corp. Corporate Governance Forum, 10-11:30 a.m., Egan Library in Juneau. Public invited. Details: (907) 465-2047.
According to a recent Harris Interactive poll commissioned by the Calvert Group found that 32% of investors with employer-sponsored retirement plans say that their plan offers an SRI option. 68% of investors with such an option choose it. 74% of respondents whose companies do not offer an SRI option for their retirement plan said they would invest in one if offered. On the other hand, only 41% were aware that SRI mutual funds exist – and of these, just 25% actually invest in at least one SRI mutual fund.
“No one can legislate, or by rule-adoption, mandate honesty,” Grasso told the Council of Institutional Investors. “What we can do, what we must do … is send a very powerful message. The system isn’t broken.” Forbes reported that pension fund managers didn’t buy it. “Tough talk and rule proposals have not halted the market decline or alleviated the worries of individual investors whose retirement savings are at stake.” (NYSE chairman faces heat from U.S. pension fund managers, 9/24/02)
CorpGov Classes Grow
More universities are recognizing the importance of corporate governance. The Executive Development Center in the Office of Extended Studies at California State University San Marcos offers a course on “Corporate Governance: Building Better Businesses Through Better Boards,” beginning Oct. 15. Panelists will lead students through a three-hour class that meets one night each week for five weeks. The course covers board leadership, strategy, structure, operations, oversight, financial and accounting models and ethical and legal issues.
The University of Technology Sydney, in Australia, has established a Centre for Corporate Governance to address weaknesses within the corporate sector.
Underfunded Pension Funds
Standard & Poors noted that the average funding ratio of corporate defined benefit plans stood at 94% at the beginning of July, compared with a 100% funding level at the end of 2001 – and noted the funding level may have declined another 4-5% since then. The following companies account for $37.5 billion out of a total funding shortfall of $65.4 billion :
- General Motors
- Exxon Mobil
- Delta Air Lines
- United Technologies
- Northwest Airlines
State pension plans report with more of a significant time lag. Wilshire Associates forecasts that underfunded retirement systems will grow from 51% to 75% of systems when 6/30/02 reports are available and analyzed. (S&P: Pension Pressures May Push Public Funds, Plansponsor.com, 9/24/02)
Support for SEC Petition No. 4-461 and Variations Grows
Support for our petition to open the corporate proxy to shareholder nominations and elections continues to grow.eRaider, for example, has now followed suit with their own petition and I expect there will be several more. Electronic comments to the SEC that specifically mentionRulemaking Petition File No. 4-461 in the subject line of an e-mail to Mr. Jonathan G. Katz appear to get posted to an SEC comment page in about a week. If you mail a comment and it doesn’t get posted, please let us know.
I have reason to believe that leaders from organizations as disparate as the AFL-CIO and the Business Roundtable might support the petition if the threshold were set at something like the 13D level of 5%. I would encourage everyone to suggest their own amendments to our petition. Please do so formally to the SEC, either by commenting on our petition or submitting one of your own so that your views will be heard and considered.
Investors dumped $49 billion in mutual funds during July and another $5.8 billion in August, according to Lipper. Harvey Pitt’s 9/23 Remarks Before the Council of Institutional Investors’ Fall Conference that he has asked staff to consider eliminating the “ordinary business exception” indicates a willingness to consider major changes to restore investor confidence. At the core of making “shareholder suffrage a reality,” as Mr. Pitt termed it, are the rules that govern board elections. CII took a stand years ago against broker voting. I hope they will lead the movement to resurface that issue and I hope they widen their vision to include the central issues of shareholder nominations and access to the company proxy.
CGF Report Carves New Niche
I’ve mentioned it before, but Maureen Nevin Duffy’s new publication, Corporate Governance Fund Report, has quickly become an invaluable service to those of us who are “pushing back” to restore trust in capital markets. Her reporting on Proactive Investors is outstanding.
In “Who’s Hot in September? – Andrew Shapiro,” Duffy reports his most recent innovation is being appointed to “Board Observer” status at Earl Scheib. Another first, as far as we know. Shapiro shares the same trading restrictions as Earl Scheib directors and basically will act much like a board member but without the vote and without the liability. We’re waiting to see what he will do at Arlington, where he is Chairman of the board’s Corporate Governance Committee. (In the interest of full disclosure, the editor of CorpGov.Net is a limited partner investor in a fund managed by Lawndale Capital Management, LLC.)
Duffy also discusses what governance leaders thought of the agreement between Computer Associate’s and Sam Wyly’s Ranger Governance. She takes you behind the scenes in what Guy Wyser-Pratte calls the “German Enron” (Babcock Borsig), reviews Ralph Whitworth’s success at ousting Tyco directors and even keeps us informed of what’s happening in Brazil at the Sao Paolo Stock Exchange. Observing that “reforms are spreading through Corporate America faster that the Dow is dropping,” Duffy predicts “we’re going to see dramatic changes in investor involvement, on the scale of the consumer movement of the 60’s and 70’s.” As more read the Corporate Governance Fund Report, her predictions could become self-fulfilling prophecies.
Class-Action Suits Up
Millions of angry investors have lost billions and there are many to blame: corporations, fat-cat executives, boards, lawyers, accountants and financial advisers, investment bankers and analysts. Enron and its executives have been hit by 45 securities lawsuits, Adelphia by 56 and Tyco by 60. The potential legal fees are staggering. In the suit against Enron and its Wall Street advisers, some experts estimate claims could exceed $30 billion. Last year, the average class-action settlement in securities cases jumped to $17.2 million, up from an average of $14.1 million in the previous five years, according to a study by PricewaterhouseCoopers (PwC).
Lawsuits targeting banking and brokerage firms have jumped to 12% of the total this year, up from 2% last year, according to PwC. In a highly unusual incentive program, CalSTRS and two other large California pension funds have offered to pay their lawyers higher fees in a case against WorldCom if they can substantial contributions from former CEO Bernie Ebbers or 14 other executives. Executives almost never pay a penny of their own money and pushing for them to do so usually drags out the settlement process. In a study of a dozen $100 million-plus class-action settlements since 1995 by Joseph Grundfest, a Stanford University Law School professor, only two included contributions from executives, representing a fraction of the total settlements. Here’s hoping the percentages rises quickly. For more information, see the Securities Class Action Clearinghouse.
Koppes Joins IRRC Board
Richard H. Koppes, former Deputy Executive Officer and General Counsel of CalPERS and currently with Jones, Day, Reavis & Pogue, has joined the board of the Investor Responsibility Research Center. Mr. Koppes also serves as Co-Director of the Executive Education Programs at Stanford Law School, and does private consulting for corporations. Koppes is recognized internationally as a leading expert in corporate governance, especially in the role of pension fund investors in corporate governance and fiduciary duties. Mr. Koppes served as a member of the NY Stock Exchange Board of Governors’ Legal Advisory Committee from 1994 to 1997, is a member of the American Society of Corporate Secretaries, the Council of Institutional Investors, the Advisory Board of the National Association of Corporate Directors, the Blue Ribbon Commission on Board Evaluation of the NACD, the American Law Institute, and the International Bar Association where he serves as Vice Chairman of the Corporate Counsel Committee of the Section on Business Law. He is the founder, past president and current administrative officer of the National Association of Public Pension Attorneys. IRRC’s research, software products and consulting serve a wide range of clients including some of the largest institutional investors in the world, as well as corporations, law firms, and socially responsible organizations. Although somewhat dated, we interviewed Koppes as he transitioned from CalPERS in July 1996.
On Wednesday, October 2, the Japanese Chamber of Commerce and Industry of New York, in collaboration with Michael Solomon Associates, is sponsoring a half-day symposium that will examine the changing corporate governance environment in the U.S. and Japan from the viewpoint of corporations, institutional investors, and legal and academic experts.
Holly Gregory (Weil, Gotschal & Manges) and Bruce Aronson (Columbia Law School) will discuss the changing regulatory environment in a panel moderated by Satoru Murase (Bingham McCutchen Murase). In the second panel, moderated by Hugh Patrick (Columbia University), Carolyn Brancato (Conference Board) and Hideji Tanaka (Cerberus Capital Management) will discuss how corporations in both countries are responding to pressure to improve their governance practices.
The role public pension funds and other institutional investors are playing in promoting better governance practices will be discussed by Peter Clapman (TIAA-CREF) and Yasuhiro Fujii (Ministry of Health and Welfare). The luncheon keynote speaker will be John Towers, the vice chairman of State Street Corporation, who will provide a perspective on these issues from one of the largest investment management firms in the U.S. Contact Leslie Brown of the JCCI at (212) 246-8001 or[email protected].
4th Annual Triple Bottom Line InvestingConference 2002
When: 7 & 8 November 2002
Where: Hotel Le Plaza, Brussels, Belgium
The theme for this year’s conference is SRI and Governance. In addition, there will be analyst meetings where leading multinationals from various sectors will present their sustainable performance for the last year and their strategy for the coming year. 24 workshops and 105 speakers, TBLI is truly the leading SRI learning and networking event of the year. Call Netherlands + 31 (0) 20 428 6752 or email: [email protected]
Strategic Summit on Auditing and Governance in the New Era of Accountability
When: December 9-12, 2002
Where: The Embassy Suites Hotel, New York City
Fees: Summit: $1095, Summit after 12/2: $1195, Workshops: add $450 each
More Info: MIS Training Institute
SEC to Require Mutual Fund Disclosure of Votes?
Staff members at the SEC are expected to propose that mutual fund and other investment managers be forced to say publicly how they vote their shares in corporate proxy fights. Mutual fund managers push for openness from companies in which they invest while, at the same time, battling similar initiatives to bring more disclosure to the fund industry itself.
The proposed rule will be considered at an open meeting Thursday. In addition to requiring disclosure of their proxy-voting records, investment managers would be mandated to disclose the policies and procedures they use to determine how to cast their votes. The SEC will set a public-comment period on the rule proposal, normally at least a month. Then, before taking a final vote on the matter, the commission will spend a few additional months reviewing the comments, which may result in modifications to the original rule proposal.
Mutual funds hold about $3 trillion in stocks, about 21% of the U.S. stock market on behalf of 93 million investors, and are often the largest stakeholders in public companies but only a few SRI funds disclose their votes. Fund companies are worried about offending corporations which subscribe to their 401(k) retirement plans.
The SEC’s disclosure on the subject consists of a two-paragraph news digest item published recently. It says the SEC is considering requiring mutual funds and certain other investment companies and advisers to disclose the “policies and procedures” they use to determine how to vote proxies. Additionally, it might require “management investment companies to file with the commission, and make available to shareholders, their proxy voting records.”
Update 9/20: The SEC’s proposal would require mutual fund companies to
- disclose their proxy voting guidelines;
- provide a full listing of their voting record twice a year to the SEC;
- discuss and disclose proxy votes inconsistent with the Fund’s voting guidelines and
- disclose to shareholders the availability of information about its proxy
voting policies and procedures, as well as its voting record.
The Commission proposal will include the requirement that mutual funds make their voting records available, upon request, within 3 working days, to any investor seeking that information. The information will also be made available on the SEC website on the EDGAR Filing System. Posting the guidelines and voting results on a mutual fund’s website is optional and at the discretion of the Fund company. It was not mandated that votes be posted on fund company websites. The rules for investment advisors are tailored to the “customized” nature of their investment advisory mandates. A 60 day comment period is likely to begin shortly. The new rules would be a tremendous victory for corporate governance advocates. At CorpGov.Net we have been pushing for voting disclosure since the inception of our internet site in 1995. Scandals do provide opportunities.
Domini Social Investments was the first mutual fund company to start publishing its proxy voting guidelines in 1996 and its proxy voting record in 1999. A few other SRI firms followed suit, including Pax World Funds in May 2000, MMA Praxis in October 2000, the Calvert Group in April 2001, and Citizens Funds in September 2002.
Providence Capital to Hold Disney Meeting
Providence Capital, a corporate governance reform advocate will hold a meeting open to Disney shareholders on Sept. 17 in New York. “In view of Disney’s recent stock performance, we believe the board would welcome the views of its largest stockholders prior to instituting changes in the company’s governing body,” said Providence Capital President Herbert Denton. (Disney suffered a 22% decline this year) The purpose of the meeting is “to provide a forum for Disney’s major shareholders to discuss their views on a number of critical issues which have undermined investor confidence in Disney’s stock.”
Providence spokesman Jay Hill, who recently endorsed our Petition for Democracy in Corporate Elections (SEC Rulemaking Petition File No. 4-461), said his company is a relatively small institutional shareholder, owning less than 1 percent of Disney’s outstanding shares. He said the company organized the meeting because of its past emphasis on corporate governance issues, which have included meetings about troubled conglomerate Tyco International Ltd. and ICN Pharmaceuticals, where dissident investors forced founder Milan Panic to step down after a proxy fight in May.
For additional information on the meeting, please contactJay Hill, Providence Capital, Inc., 730 Fifth Avenue, Suite 2102, New York, New York 10019 RSVP at 212-888-3200 Fax: 212-888-3203.
AFL-CIO Office of Investment Seeks Financial Initiatives Coordinator
The AFL-CIO Office of Investment is seeking qualified candidates for the position of Financial Initiatives Coordinator. Workers’ retirement savings constitutes the country’s largest single source of investment capital. The Office of Investment seeks to promote the interests of worker-beneficiaries in the capital markets by leading shareholder initiatives, advocating for effective legislative and regulatory reform, and supporting active ownership and corporate governance reform strategies of worker pension and benefit funds.
Recent office initiatives include shareholder proposals to enhance board of director accountability, promote auditor and analyst independence, reign in excessive executive pay and encourage the adoption of ILO labor standards; shareholder campaigns to oppose re-incorporations in Bermuda and the re-election of Enron directors to other public company boards; and multi-pronged efforts to defend and strengthen defined benefit plans and the Social Security system in order to protect workers’ retirement security.
As a member of senior staff, the Financial Initiatives Coordinator will:
- Design and oversee highly skilled, multi-disciplinary research and campaign teams for capital market initiatives, including shareholder campaigns, corporate governance projects, proxy contests by worker funds, and public policy and research initiatives.
- Identify capital market intervention opportunities for worker funds, conduct supporting research, including the preparation of detailed corporate critiques, and develop and implement effective initiatives.
- Identify key public policy and legislative issues, and formulate capital market advocacy strategies.
- Implement departmental projects, including production of specialized analyses, reports, speeches and testimony, and preparation and staffing for conferences and meetings.
- Work with pension fund trustees, investment managers, investment bankers, and financial industry organizations to implement initiatives.
- Masters degree or higher in relevant field, with law or MBA degree strongly preferred. Must be published on relevant subject mater in a reputable publication (candidates will be required to produce a portfolio of published articles).
- Demonstrated competence in corporate finance and governance, including familiarity with securities laws and rules and regulations, and pension and benefit issues, including ERISA; quantitative and qualitative research, including financial analysis, industry research, corporate research and issue research; researching and writing high quality reports that will withstand significant legal, media, public, legislative, regulatory and business scrutiny and criticism.
- Excellent writing skills, political and organizational skills, and the ability to work well with others.
- At least seven years relevant work experience.
Send your resume and a writing sample to Michael Garland, AFL-CIO Office of Investment, 815 16th Street NW, Washington, DC 20006 or fax it to (202) 508-6992.
Deloitte & Touche Provides Online Learning Opportunity
DeloitteLearning provides a valuable online corporate goverance training curriculum available for free to anyone who registers on the site. We’ve added their listing to ourClasses page. Courses include:
- Capital Markets Overview
- Complex Financial Instruments
- Executive Compensation
- Information Technology for Executives
- Privacy and Data Protection
- The Securities and Exchange Commission
Expensing Options Inevitable
A recent survey by Mercer Human Resource Consulting found that 8% of US employers believe that option expensing will be mandated within five years. Only 37% have formally considered the issue at the executive or board level. Only 5% plan to lobby actively against option expense recognition. (see Coming: No Option on Options, CFO.com, 9/6)
Corporate Governance Goes Mainstream
CBSMarketWatch carried a series of articles on corporate governance. Shareholders strike back, credits Walter Hewlett with starting “a war that has spread to every boardroom in corporate America.” After providing some background, the article concludes, there is no shortage of proposed solutions to fix corporate governance practices.
“They include creating an independent office of the chairman to restrict CEOs from wielding too much influence; banning directors from selling stock while serving on the board; formal nominating committees to select directors; and mandatory boardroom peer-reviews.
What investors are likely to see is a tighter definition of independent directors, compensation committees run by directors unaffiliated with the company, a greater number of outside directors sitting on boards, and continuing education requirements for boards.
More controversial regulatory reforms — such as stockholder approval of all stock option plans and limiting the influence of CEOs on boards — will be more difficult to get accepted, corporate governance experts predict.”
Small investors: Little clout on boards reviews the responsibilities of boards and what small shareholders can do. The average board has eight directors. “Last year, directors spent an average of 175 to 200 hours at each board they served, according to the NACD. Public companies pay them from an average of $45,000 for small companies to an average of $152,000 for the top 200 U.S. companies in salary and stock options, the trade group said. And directors of most for-profit companies don’t have term limits.”
The article provides an example of a shareholder activist. Jill Ratner, who heads the Rose Foundation for Communities and the Environment, sought to curb Maxxam’s logging practices. Even with the backing of major pension funds, it’s almost impossible to change the board, she found out.
The list of shareholders cost her $1,000. Then she then hired an attorney to draw up a proxy statement and card for an expensive mailing to each stockholder urging them to vote for her slate of directors. “The three proxy battles she waged failed by voting margins of 78 percent to 97 percent.” The article goes through a number of tactics but in the end appears to conclude that the best course for small investors is to sell.
A commentary, More disclosure, not regulation, is what’s needed, by Nell Minow offers more hope. As we press for changes, she suggests we keep the following three caveats in mind:
- Structural solutions are easily subverted. Tinkering with the definition of “independent director” or removing non-independent directors on various committees will have no real impact. “Independent” can mean “indifferent.” While it is tempting to impose new requirements about who should be on what committees and how many meetings they should have, that would have little impact on substance.
- Consider the law of unintended consequences. We do not want to turn minimum standards into safe harbors. We have to be careful in crafting the listing standards so that instead of imposing obstacles to innovation, they reward it. The best way to address these two concerns is to change the rules on disclosure rather than structure.
- The third caveat is that all of the reform proposals I have seen so far focus on what I call the “supply side” of corporate governance, on what corporations must do. We must consider these issues from the perspective of the “demand side” to make sure that barriers to shareholder oversight are eliminated.
- Companies should be required to include their corporate governance policies and conflict-of-interest policies in their proxy statements. If they waive those policies at any time, that should be disclosed, along with the reasons for the waiver.
- Institutional investors should be required to disclose their proxy voting policies, any votes cast contrary to those policies, and all votes in contested elections. Their votes should be kept confidential until after the date of the meeting at which they are cast, so that management can’t coerce them into changing.
In EMC activist gets post-Enron boost, Tim Smith of Walden Asset Management, credits the change in mood since Enron with his ability to win majority support for a resolution that calls on the company to put more independent directors on its board.
The legacy: a fair share of victories recounts the history of shareholder activism and includes a timeline of important events. Crashing the party highlights some of the “big moments” at annual meetings this year. Stung by critics, Disney reforms board recounts how Disney is finally getting the message by making a number of reforms and by hiring Ira Millstein, noted attorney and corporate governance expert, to help guide them. Teamwork of dubious value discusses a mechanism used to “foster teamwork among the highest ranks of a corporation” the office of the chairman that includes the chairman, chief executive, president and the vice chairman in a structure that allowed for “power and responsibility sharing.” In acutuality, it appears more likely to reduce checks and balances, as well as accountability. The series of articles includes filmclip interviews wth Harry Snyder of the Consumers Union who puts his faith in lawsuits and with Charles Elson, director of the University of Delaware’s Center for Corporate Governance, who see market forces ralling the needed reforms.
The series ends with Are shareholders the problem?Marjorie Kelly, editor of Business Ethics magazine and author of The Divine Right of Capital. “Under the current rules of governance, as long as he didn’t get caught, Enron CEO Ken Lay had a fiduciary duty to lie, cheat and steal in the name of the shareholders, she says. because maximizing shareholder value is the only principle corporations understand.” Kelly argues that corporate boards that represent only shareholders are like feudal societies that only served the interests of the aristocracy. “People say we need better alignment” between management and shareholder interests, Kelly says. “I say no, that’s the problem.” Paying managers in stock increases the incentive for them to cook the books or to engage in shortsighted behavior that might boost the stock price now while eroding the long-run value of the company.
Hats off to MarketWatch.com for a fine series of articles.
Back to the top
Improvement Would Pay Dividends in in Thailand
A study of the 100 largest companies listed on the Stock Exchange of Thailand found that companies with strong corporate governance practices have higher market valuations. Many Thai companies have ample room for improvement, particularly in the areas of minority shareholder rights, management oversight and incentives, and disclosure. A Mckinsey report suggests that Thailand’s government and regulatory authorities could help by providing corporate governance rules, incentives, and educational efforts.
SEC Adopts Rules
Members of the SEC voted to require companies to file annual 10-K reports 60 days after the end of the year, instead of 90 days, and quarterly 10-Q reports 35 days after the end of each quarter, instead of 45 days. The SEC also voted to:
- Require corporate officers to disclose any purchase or sale of their company’s stock within two days.
- Require that CEOs and CFOs certify the accuracy of their financial reports. (SEC speeds up reporting, CNN, 8/27/02)
Issues in Corporate Governance: Bloomberg Roundtable
Raymond Troubh, interim chairman of Enron, Charles Elson, director of the Corporate Governance Center at the University of Delaware, and Damon Silvers, associate general counsel for the AFL-CIO, talk with Bloomberg’s Mark Jaffe about the impact of new corporate governance rules on companies’ boards of directors. Damon Silversvoiced his opinion that shareholders representing 5-10% should be allowed to nominate board members and those nominations should appear on the corporate proxy. Elson favors, instead, an easier takeover process for replacing inefficient boards. Troubh wants more in the way of forensic accounting. Listen to the Bloomberg Roundtable.8/23/02
Directors Go Back to School
Back to School, but This One Is for Top Corporate Officials, reads the article’s headline in the 9/3/02 New York Times. It’s not reassuring to learn that only 20% of the class of “about 80 officers and directors from companies including Pfizer, McDonald’s, Motorola and Dow Chemical” knew the definition of “retained earnings — undistributed earnings that have not been paid out to stockholders or transferred to a surplus account.” Still, it’s good to know that more directors are getting an education. For information on similar programs, see oureducation page.
Two courses focusing on leadership and business ethics, both from an Islamic perspective, will be taking place in Dubai in October. The courses have been organised by the Middle East offices of the Institute for International Research (IIR) in Dubai. “In the light of recent financial scandals, we are noting an increased interest in the issue of corporate governance from companies operating on Islamic principles,” said IIR event organiser Chris Mullinger. “Both the Leadership and Motivation and the Business Ethics courses have been designed for Muslims and non-Muslims in business. They will provide direct, practical guidance to executives and key workers in a Muslim organisation as well giving expatriate executives of multinational companies valuable insights into working in Muslim countries and with Muslim companies.”
Proxy Season Roundup
NACD publication, Director’s Monthly, reports the message from this proxy season was loud and clear – “put more independent directors on boards, let shareholders vote on executives’ pay and severance packages and don’t allow a company’s auditor to do consulting work with the firm.
The new winner this year was the “auditor conflict” resolution, which asks companies not to hire the same accounting firm for audit and non-audit services. This labor resolution at 12 companies won an average of 29.8% of the vote, with the vote at PG&E coming in at 46.5%.
At Mentor Graphics, investors approved – by a margin of 57% – a resolution by TIAA-CREF asking the company to put all stock plans with material dilution to a shareholder vote.
John Chevadden’s resolution at Airborne on their poison pill garnered 91.4% of the vote. Seventeen out of 100 social proposals won votes exceeding 15%. “High vote-getters focused on human rights, equal employment and global warming. For a full roundup, see IRRC Tally Shows Record Support for Shareholder Proposals in 2002.
Canadian corporations faced fewer shareholder proposals, according to Fairvest’s Corporate Governance Review. In 2001, 12 companies included a total of 39 shareholder proposals, compared to 16 companies and 63 resolutions in 2000. As Fairvest wrote their June/July edition in 2002, 13 companies accounted for only 28 shareholder proposals. The five big banks accounted for 21 of all shareholder proposals.
At the Hudson’s Bay Company 36.8% of voted shares supported a shareholder proposal calling on the company to reflect the International Labor Organization’s Fundamental Principles on Rights at Work in its Company Code of Vendor Conduct and standard purchase contracts. The level of support is high, considering that the Caisse de depot et placement du Quebec, which holds more than 10% of outstanding shares, abstained from voting on the proposal.
The identical proposal at Sears Canada, which is 55% owned by Sears in the U.S., garnered only 6.3% support, whereas in the U.S., the same proposal got 9.35% of shares voted.
Arianna Huffington joins those calling for mutual funds to meet their fiduciary responsibilities by becoming active in corporate governance. Mutual funds: Corporate crime’s lumbering, narcoleptic giant, 8/26/02.
The California Court of Appeals set oral arguments for 11/13 on a lawsuit blocking pay hikes for 10 CalPERS internal portfolio managers as well as for board members themselves. Last October, a Superior Court judge ruled that the System attempted to circumvent state. CalPERS appealed the ruling. State Controller Kathleen Connell, who refused to grant the pay increases, sued CalPERS for issuing the checks directly.
Standard & Poor’s is surveying corporate pension plans to get a handle on their unfunded liabilities. S&P sent out 700 surveys as part of a broader move to better factor in unfunded liabilities of corporate pension plans when rating companies’ debt. Early indications show that pension plans of manufacturing companies have been hardest hit because the number of retirees receiving benefits often outnumber the amount of employees still working. One warning that a company is having trouble with its pension fund is when it uses the proceeds of a securities issue to help cover the unfunded portion of its pension plan. (S&P Surveys Companies To Factor Pension Plans More Heavily In Ratings, 9/4/02, Institutionalinvestor.com)
The 8/19 version of Investment News included an interesting interview with Jamie Heard, the CEO of Institutional Shareholder Services Inc. See One on One: “We have a huge problem now – the public mistrust of corporate America.” From the Archives search function near the bottom of the page, search Jamie Heard.
A study by the National Whistleblowers Center found that about half of whistle-blowers who expose workplace wrongdoing experience are fired. Others face harassment, or unfair discipline.
Richard Grasso, head of the New York Stock Exchange and an outspoken advocate of corporate governance reform, d failed to disclose his stock ownership properly to financial regulators for five years. Grasso, a director of Computer Associates, didn’t file reports with the SEC over the past five years that noted company stock awards. Neither did Former US Senator Alfonse D’Amato, another Computer Associates director.
eRaider joins move to petition the SEC to mandate that public companies place the names of all legitimate director candidates on ballots distributed to shareholders,similar to that submitted by McRitchie and Greenberg. Additionally, they will ask the SEC to disallow broker votes, ban the use of corporate funds for campaigning for any candidate and strike down unreasonable qualification tests for director candidates.
Research by the Institute for Policy Studies found that CEO pay at 23 companies under investigation for accounting irregularities earned 70% more than the typical CEO at a large company. They banked an average of $62 million from 1999 to 2001, compared with $36 million for the remaining 300+ CEOs in the survey. [The (Fat) Wages of Scandal, BusinessWeek, 9/9/02]
The contribution of the CEO’s reputation to the corporate brand has increased 20% from 1997 to 48% today, according to research by Burson-Marsteller. (Director’s Monthly, NACD, 8/02)
Chief executives at five of the six leading Wall Street banks hold one or more outside corporate directorships, in some cases on the boards of companies that have a close banking relationship with their firms, according to an informal survey by AFX Global Ethics Monitor.
A survey conducted by the Investor Responsibility Research Center found that 72% of the $5.7 billion in fees paid by 1,200 public companies to their auditors in 2000 was for nonaudit services. The Sarbanes-Oxley Act will place new restrictions on the services that auditors can provide for their clients and will establish an independent board to oversee the industry for the first time in its history. The New York Stock Exchange will prohibit auditors of listed companies from serving on the boards of clients for five years. Nasdaq-listed companies will be prohibited from hiring former auditors at all levels for three years. (No More Mr. Nice Guy, CFO.com)
Building Public Trust: The Future of Corporate Reportingby Samuel A. DiPiazza and Robert G. Eccles argues the restoration of trust requires a drastic overhaul corporate reporting.
Corporate Boards: New Strategies for Adding Value at the Top by Jay Alden Conger, et al argues that, with technology at the heart of 21st-century business, corporate directors need to recognize the value of knowledge as a strategic asset, putting their focus on meeting not only the demands of shareholders but also those of stakeholders, including employees and the global communities in which they operate.
Takeovers, Restructuring, and Corporate Governance by J. Fred Weston, Juan A. Siu, Brian A. Johnson provides a conceptual framework.
Reinventing Your Board: A Step-By-Step Guide to Implementing Policy Governance by John Carver, Miriam Mayhew Carver outlines effective board decision making and offers practical advice on such matters as setting the agenda, monitoring CEO performance, defining the board role.
A Theory of the Firm: Governance, Residual Claims, and Organizational Forms by Michael C. Jensen examines the forces, both external and internal, that lead corporations to behave efficiently and to create wealth.
Business: The Ultimate Resource by Perseus Publishing is an ambitious compendium of essays, biographies, and source materials. With over 2,000 pages, it weighs a ton, so don’t plan on taking it the beach. Includes:
- Original best-practice essays from over 150 of today’s thought leaders
- Profiles 100 influential business pioneers and management thinkers (few in the area of corporate governance)
- Summaries of 70 most important business books (again, short on corporate governance)
- Over 300 practical checklists, covering many areas of management and career development
–A world business almanac covering more than 150 countries, all 50 US states, and 24 industries
–A dictionary of 6,000 business terms
–A list of 3,000 information sources (books, journals, Web sites and organizations), covering 115 topics
Business: The Ultimate Resource doesn’t compare withCorporate Governance (International Library of Critical Writings in Economics), but the price is hard to beat, especially if you can get it used. I’ve got both on my shelf.
The Audit Committee: Performing Corporate Governanceby Laura F. Spira argues that the audit committee is an arena where members can form and strengthen shifting and fragmentary networks with each other and with the external auditors.
How Governments Privatize: the Politics of Divestment in the United States and Germany by Mark Cassell argues that privatization must be understood as a political and administrative puzzle rather than simply an exercise in economic efficiency. He studies two successful divestment agencies, the U.S. Resolution Trust Corporation and the German Treuhandanstalt. 0878408797 (case : alk. paper) (American governance and public policy series: American governance and public policy.
Transformational Boards by Byron Tweeten offers an engagement framework for board leadership designed to help boards lead their organizations through times of change.
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Board Services Grow
Houlihan Lokey Howard & Zukin introduced a new Board of Directors Advisory Service to support outside directors with their increasingly demanding fiduciary duties. Houlihan Lokey will assign a team of investment bankers to provide information, analysis and advice to board members. The Service will review information supplied by clients, analyze the companyís financial situation and stock performance, track institutional investor and market analyst views on the company, review accounting issues, coordinate other board advisors and facilitate communication between the board and management. “By providing an independent source of information, analysis and advice, this service will allow directors to effectively spend their time on important corporate issues and, at the same time, facilitate communication between the board and management,” a spoksman said.
Tip of the Iceberg
How Companies Lie: Why Enron Is Just the Tip of the Iceberg, by A. Larry Elliott and Richard J. Schroth, contend that “gamesmanship has replaced business management competence as executives and their boards have focused on managing the stock first, the business second and strategic value last.” The authors argue for greater SEC authority to review corporate books and accounting practices. At bottom, however, the burden is on investors to display a healthy skepticism toward all financial reports. (Ed., such skepticism might lead investors to take a stronger role, for example, in choosing the company’s auditor) They focus on five areas for reform:
- Accurate and verified communications
- Full disclosure of conflicts of interest
- Real-time accounting and real-time reporting
- Straightforward accounting rules
- Real accountability by executives.
SEC Petitioned to Strengthen Environmental Disclosure
Led by the Rose Foundation for Communities and the Environment, foundations with more than $3 billion in aggregate invested assets petitioned the SEC on 8/21/02 to improve requirements for accurate and consistent disclosure of environmental risks.
To clarify the intent of the SEC’s material disclosure requirements and help ensure compliance with existing material financial disclosure requirements, the foundations urge the Commission to adopt the standards for estimation and disclosure of environmental liabilities developed by the American Society for Testing and Materials International (ASTM).
“These standards, which were developed by a consensus process conducted by one of our nation’s leading engineering organizations, provide guidance to companies for the accurate estimation of environmental liabilities and explicitly require reporting companies to aggregate environmental liabilities to determine whether they exceed the SEC’s materiality threshold. The ASTM’s development of these standards has been backed by the insurance industry, in response to the current paucity of information about the financial significance of environmental liabilities.
Disclosure consistent with the ASTM standards would provide investors with standardized information critical to their evaluation of the financial risk associated with a company’s environmental liabilities. Complete and accurate disclosure of financially material environmental risk furthers the Commission’s mission of protecting investors and the public and protecting and restoring public confidence in our markets and in publicly traded companies.”
The petition was signed by the following:
- Alaska Conservation Foundation
- As You Sow Foundation
- Beldon Fund
- Bullitt Foundation
- Columbia Foundation
- Compton Foundation
- Conservation Land Trust
- Deep Ecology Foundation
- Educational Foundation of America
- French American Charitable Trust
- Gaia Fund
- Richard & Rhoda Goldman Fund
- Gordon Lovejoy Foundation
- First Nations Foundation
- Needmor Fund
- Andrew Norman Foundation
- Jessie Smith Noyes Foundation
- Rockefeller Family Fund
- Rose Foundation for Communities & the Environment
- San Francisco Foundation
- The Seventh Generation Fund for Indian Development, Inc
- Surdna Foundation
- The Tides Foundation
- Wallace Global Fund
- Weedon Foundation
- William B. Wiener, Jr. Foundation
- Wilburforce Foundation
This is an important step forward for activism among foundations and, if enacted, will do a great deal to ensure environmental liabilities are reflected in share price. When that happens, we expect corporations will be much better environmental stewards and there will be a stronger correlation between environmentally responsible business practices and corporate profits. According to a 1998 study by the Environmental Protection agency, nearly three-quarters of companies who were fined more than $100,000 for environmental violations failed to tell the SEC in their annual filings.
We urge readers to support this petition by writing to Mr. Jonathan G. Katz, Secretary, U.S. Securities and Exchange Commission, 450 Fifth Street, N.W., Washington, DC 20549 or e-mail Mr. Katz at [email protected], indicating that you support the petition to improve requirements for accurate and consistent disclosure of environmental risks submitted by the Rose Foundation for Communities and the Environment and others.
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Profits Down, CEO Pay Up
Even as corporate profits fell 13% in 2001, CEO pay rose by 7%, according to a survey by consulting firm Mercer.
The survey, which looked at 350 of America’s largest corporations, found hat the rise in pay was mainly due to stocks and stock options. In 2001, stocks made up 59% of top executives’ pay, up from 57% in 2000 and 44% in 1997, according to the Mercer report.
CEOs at 23 corporations under investigation for improper accounting pocketed $1.4 billion, or an average of $62 million each, in the last three years. Meanwhile, their companies’ stock values plunged $530 billion, or about 73% of their total value, and their companies laid off a total of 162,000 workers.
Those are key findings in the ninth annual CEO compensation survey of large public companies by United for a Fair Economy and the Institute for Policy Studies.
Additionally, corporate profits reported to the Internal Revenue Service fell from $660 billion in 1996 to $658 billion in 1998, while profits reported to shareholders rose from $753 billion to $817 billion over the same period. (see Statistics on CEO compensation show opposite of pay for performance, 8/26/02, The Kansas City Star)
16 Companies Missed SEC Deadline
The results are in, and 16 of the 691 companies required to certify their financial statements with the SEC by August 14 failed to comply. (The rest must certify by December).
Delinquent companies include: ACT Manufacturing, Adams Resources & Energy, Adelphia Communications, Alaska Air Group, CMS Energy, Consolidated Freightways, Dynegy, Enron, Gemstar-TV Guide, IT Group, McLeodUSA, Mirant, Qwest Communications International, LTV and TruServ. Only IT Group didn’t at least file an excuse.
The SEC has not yet decided what it will do to punish the companies that failed to comply with the certification order.
Jump in Board Turnover Expected
The boardrooms of Fortune 1000 companies could see a director turnover of as much as 50% over the next year, according to executive recruiter Christian & Timbers. “We are getting flooded with calls for board searches as more and more executives ask to be rotated off,” said Christian & Timbers Chairman and CEO Jeffrey Christian. “Many do not want to return to the board.” Christian said that in the post-Enron corporate culture, many directors regard the risk of serving on a board as not worth the rewards.
Recent governance reforms, such as the Sarbanes-Oxley bill, have also increased the overall responsibility of directors, with new requirements for paperwork, conference calls, and committee meetings. Roger Raber, president of the National Association of Corporate Directors, said the average yearly commitment for each board seat is 175 to 200 hours, up from 100 to 125 hours in 1999, often compelling director who once sat on three boards to choose only one.
Stephen Mader, president and chief operating officer of Christian & Timbers, believes the turnover is ultimately positive. “To us this is really a constructive process,” said Mader, “We think that it will open the door for many better motivated directors. Boards are going to have a much better profile of members.” (thecorporatelibrary.com, 8/14)
Momentum For Expensing Options Grows
No, the major high-tech firms haven’t endorsed expensing options, but they have started to bend. TechNet, a Palo Alto based trade association, whose 250 members include Intel, Microsoft, Oracle, Cisco Systems, and Hewlett-Packard, is considering a new proposal put forth by Intel: “quarterly impact sheets” detailing the number of option grants, the timetable for exercising them, and the potential effect on the corporate bottom line. The group is also considering requirements that executives hold options for five years before exercising them and restrictions on executives’ ability to sell shares.
CFO.com says “the group’s new tactic represents a tacit acknowledgment by the technology industry that support for expensing options among accounting industry groups like FASB, lawmakers on Capitol Hill, and institutional investors has reached a critical mass.” CFO.com reports that at least 76 public companies, including General Motors, General Electric, Merrill Lynch, American Express and Home Depot have announced that they will expense options in their next fiscal year. (Will Tech Companies Join the Options Parade? 8/26)
However termed, when done for tax avoidance, companies should be called on it. The August 19th issue of Pensions&Investments carried an editorial objecting to Phi Angelides’ recent efforts to have CalSTRS and CalPERS divest stocks of companies that move corporate registration offshore to avoid US corporate income tax. Pension&Investments argues these firms are simply using legal means to avoid double taxation, once in the country in which profits were earned and again in the US.
The editorial argues that moving to Bermuda simply puts US firms on an equal footing with foreign competitors and increases their ability to continue employing thousands of US workers. “Mr. Angelides either too thick to understand this…” should be using his clout to lobby to eliminate the double taxation of foreign earnings.
While it is true that corporate income tax laws could use a makeover, the picture painted by the editorial falls far short of realism. Companies not only avoid double taxation but can shift their debt disproportionately to their U.S. subsidiary and then deduct interest payments from taxes. As reported in the Washington Post, Stanley Works predicted its move to Bermuda would cuts its taxes by $30 million a year. Only $7 million was due to taxes on foreign income.
It is entirely appropriate that public pension funds avoid investments in companies that avoid paying the taxes that support pension fund members and the state budget. Public pension funs should no more tolerate such blatant tax avoidance by firms in their portfolio than unions should support companies that lock their members out of work.
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Broker Voting Issue Continues
The New York Times carried an article recently that called to the importance of proxy voting. The author, Gretchen Morgenson, praised the New York Stock Exchange for submitting new rules to the SEC requiring all listed companies to put proposed stock option plans to shareholder votes. However, brokerage firms are still free to vote for shareholders on many important issues:
- election of auditors and directors,
- proposals to increase the number of shares authorized for issuance,
- social issues, and
- compensation schemes that are not related to stock options.
How significant are broker votes? ADP Corporation, which practically has a monopoly on tabulating proxy votes, says that 23% of the votes in the most recent proxy season were cast by brokerage firms that lacked instructions from the true owners of the shares.
As expected, small shareholders with a 1,000 shares or less voted least frequently, 41.5% of the time. But institutional holders (which estimated were those with more than 50,000 shares) who have a fiduciary duty to vote, only voted 72% of the time.
“As long as brokerage firms vote the shares with management, the opposition of shareholders to an issue raised in the proxy will be overridden. The current broker-vote rules, combined with investor apathy, mean that shareholder votes are unlikely to represent what most of the owners want in contested situations.” Those of advocating more democratic corporate governance need to continue to press to eliminate broker voting, except for the purposes of obtaining a quorum. (See “Pick Up the Proxy, Fill It Out and Exert Some Control,” 8/25)
Mutual Fund Industry Calls for Expensing Stock Options
Reality is setting in. The Investment Company Institute, the national association of mutual funds, urged the Financial Accounting Standards Board (FASB) to adopt accounting standards requiring companies to treat stock options as an expense and ensuring uniformity in how those options are valued.
“The mutual fund industry, on behalf of millions of individual investors, invests nearly $4 trillion in equity and fixed-income securities issued by U.S. corporations. Expensing stock options will benefit investors and enhance our nation’s reputation for having the most rigorous accounting and disclosure standards in the world,” said Institute President Matthew P. Fink. (seepress release and letter of 8/21/02)
CalPERS Adopts Conflict of Interest Reforms
The California Public Employees’ Retirement System (CalPERS) adopted reforms at the urging of state Treasurer Philip Angelides that will require banks to root out potential conflicts of interest if they want to do business with the largest US public pension fund. CalPERS will give “significant consideration” to the reforms in hiring money managers to pick stocks and bonds, though it won’t necessarily make the reforms a condition of hiring.
The principles call for brokerages to separate analyst pay from investment banking revenue, create a committee to review and approve all stock recommendations and ask brokerages to disclose whether they have been paid by companies they research. Ted White, director of corporate governance at CalPERS, said staff will send a copy of the guidelines to money managers asking them how they will comply.
The rules were drafted jointly by officials from California, New York and North Carolina in response to recent disclosures of conflicts of interests among investment houses. For example, Pacific Corporate Group, which advised CalPERS to invest more than $750 million in Enron, also earned fees from Enron for locating investors. (see CalPERS rules to prevent conflict of interest , SFGate, 8/20 and CalPERS Adopts Reforms on Conflicts, LA Times, 8/20)
Open Ballot Movement Grows: Holy Grail of Corporate Governance in Reach?
The 8/19 issue of Pensions&Investments includes an article entitled “Wisconsin fund could lead charge for open balloting” by Barry B. Burr. “The State of Wisconsin Investment Board may make open access to corporate proxy ballots – allowing shareholders to place candidates for directors on the ballots – one of its key corporate governance focus issues for the next proxy season.”
The article goes on to mention a call by the Social Investment Forum to the SEC to consider a two candidate minimum and to develop a way for corporations to include shareholder nominees (see nyseletter.html). It also mentions the rulemaking petition to the SEC to require shareholder-nominated director-candidates to appear on the corporate proxy ballots, which I submitted, along with Les Greenberg and the Committee of Concerned Shareholders.
Although Patrick McGurn of Institutional Shareholders Services is quoted in Pension&Investments saying ballot access is “the Holy Grail of corporate governance,” he also points out that “you don’t want 1,000 names on the ballot” and the “feasibility of the idea depends on the details.”
Charles Elson of the University of Delaware’s Center for Corporate Governance says “the solution is an independent nominating committee and independent directors.” TIAA-CREF’s Kenneth Bertsch says they’re interested in hearing ideas but it’s not clear “democratic style election(s) would be worth the conflict and confusion.” Richard C. Ferlauto, of the American Federation of State, County and Municipal Employees says the 2003 season presents an opportunity to rise the issue of “access to the corporate proxy ballot.”
I wish SWIB and AFSCME luck with any plans to raise the issue at individual firms during the next proxy season. I’ll certainly be voting with them but I fear the SEC will simply write a lot of no action letters because of the very rule we have petitioned to change – Rule 14a-(8)(i)8, which prohibits resolutions relating to elections.
Pat McGurn is right, details need to be worked out concerning just how shareholders should get access to the ballot. Our petition could have suggested rules requiring that nominees show the support of shareholders holding at least 1% of the firm. Of course, McGurn could then come back and say you don’t want 100 names on the ballot either. We’re hoping SIF’s letter and our formal petition will result in a flood of letters, cards and e-mails to the SEC, not only supporting shareholder access to the corporate ballot, but also providing detailed suggested amendments. Our petition is one of the opening salvos but it’s a formal request, which I believe requires formal consideration and response by the SEC.
When starting negotiations I don’t think its a good idea to raise the bar too high. That’s why we left the threshold just where it is for resolutions. We generally don’t see 1,000 resolutions on each corporate ballot, although we might get a dozen on some next year.
I think this could be a great debate and I hope some of the ideas spill over into civic elections. If we’re afraid of too many candidates, one way to make the elections more workable would be to institute Instant Runoff Voting. Using IRV there are no wasted votes because you rank the candidates and your votes for losers are instantly reallocated until a consensus winner is chosen. With IRV you could have voted Nader, for example, without throwing the election to Bush.
As C. Russel Hansen, Jr. points out is his August newsletter from theboardplace.com: “None of the current regulatory proposals changes “who effectively nominates or can veto a director candidate (the CEO), who controls the preparation of the proxy statement (the CEO/CLO), who manages the election meetings and voting process (the CEO/CLO), who effectively determines or can veto director compensation (the CEO), who cuts the director compensation checks (CEO/CFO), who cuts the expense reimbursement checks (CEO/CFO), who cuts the checks to the auditors (CEO/CFO), who cuts the checks to the audit committee advisors (CEO/CFO), who develops the budget, including the piece dealing with board expenses (CEO/CFO) or who procures and pays for the D&O insurance (CEO/CFO).”
Hansen ends his article on “CEO-Centric Boards After the Sarbanes-Oxley Act of 2002” with the following: “…as long as (1) a director’s election, compensation and protection remain in the hands of (or at least preventable by) the CEO, (2) the CEO performs his or her side of the unwritten covenant to nominate, elect and protect, (3) the board likes it like that, (4) the board looks to management to staff the board and committee workload and (5) the underperforming board dragon looks dead, then Sarbanes-Oxley-NYSE-Nasdaq leave the CEO-centric board very much alive and quite well — indeed healthier than ever.”
Shareholder access to the company proxy is as close as we can get at this point to the Holy Grail. Write Mr. Jonathan G. Katz, Secretary, U.S. Securities and Exchange Commission, 450 Fifth Street, N.W., Washington, DC 20549 or e-mail Mr. Katz at [email protected], indicating that you support the petition for democracy in corporate elections submitted by the Committee of Concerned Shareholders and James McRitchie, Rulemaking Petition File No. 4-461. Let him know of any amendments you favor. Or, write supporting the SIF letter of 7/24/02. Don’t let the momentum die.
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What You Must Know About Corporate Governance
This book is timely, coming on the heels of the 2002 King Report (King II) and of an increased interest in corporate governance as a result of Enron, Global Crossing and other failures due to corruption and incompetence. From the forward, “If South African companies are to compete for international capital and if much needed jobs are to be created through increased direct foreign investment, behaviour in our boardrooms must be beyond reproach.” The 2000 McKinsey & Company study is cited to reinforce the message that more than 80% of global institutional investors are willing to pay a premium for shares in well-governed companies.
In about 150 pages, corporate managers, secretaries, board members, advisors and investors get a tidy summary of the most essential principles and practices of corporate governance, with a focus on South Africa but with a great deal of applicability in any country using an Anglo-American model (here termed the Anglo Saxon model). The book weaves its tale around King II, which was made public in March of 2002.
After a brief introduction, focusing on the historical development of the corporation, corporate governance (mostly citing the eminent R. I. Tricker), as well as Cadbury and King reports, the book addresses “Strategy and Its Implementation.” Here, the authors point out the duties of executive management vs. those of the board, ensuring the strategy is well formulated and executed. Wixley and Everingham stress the importance of have an independent board with a variety of perspectives “so that a disinterested voice will be heard on any subject of importance.”
The book moves from there to:
- selecting board members,
- expected behavior of individual directors,
- duties of directors and how they function as a group,
- board committee structures,
- financial reporting and communication,
- assessment of risk and internal controls,
- accountability re financial information,
- reliability via external audits and internal audits,
- non-financial information and
- applicability to the public sector.
Each chapter includes relevant examples from real life. Although the authors closely follow the King report, they do not hesitate to provide advice on controversial subjects not addressed by those reports, such as advocating that options not be repriced and that by should be expensed. “Our view is that the interests of good corporate governance would be well served by accounting for the cost of share options granted as an expense in the company’s income statement.”
Perhaps unique to the King Report, among corporate governance standards, is its treatment of the HIV/AIDS pandemic, recommending that each company describe their strategy, plans and policies. What You Must Know About Corporate Governance is written by Tom Wixley and Geoff Everingham, published by Siber Ink, Cape Town, South Africa, 2002.
Corporate Attorneys Owe Duty to Shareholders, Not Management
In a speech to the American Bar Association’s Business Law Section, SEC Chair Harvey Pitt said, “Outside auditors owe a duty to shareholders and the investing public to assure that a company’s financial reports are reliable and truthfully prepared. Similarly, lawyers who represent corporations serve shareholders, not corporate management.” “This should be self-evident,” he noted. “But recent events indicate some corporate lawyers have lost sight of this axiom, a form of professional blindness that isn’t new….” (see Corporate Attorneys Have Role Similar to Auditors, Says Pitt, CFO.com, 8/13/02)
Profit From Vice
Mutuals.com launched the Vice Fund, a no-load mutual fund described as the “first and only open-end mutual fund to invest primarily in “socially irresponsible” industries,” such as alcohol, gambling, tobacco and the weapons industry. In SEC filings the Fund contends that companies in these industries, if managed correctly, will continue to experience significant capital appreciation during good and bad markets. According to the Vice Fund, over the five-year period June 30, 1997, to June 30, 2002, an individual simply investing 25% into each of the alcohol, tobacco, gaming & casino, and aerospace/defense sectorswould have outperformed the S&P 500 index (earning 52.96% versus 11.83%, according to the firm).
Cross My Heart and Hope to Die
That’s what Nell Minow calls the new SEC requirement. Corporations have long been liable for penalties for knowingly filing false or misleading material information. This time, of course, corporate executives really mean it.Just the same, criminal charges will still require proof the officer “knowingly” submitted false reports, which is no different from current law. A recent article Motley Fool article walks readers to the new requirement. See “CEOs Signed. So What?” The SEC says that nearly all of the 697 companies that were ordered to file certified statements about the accuracy of their financials met their 8/14 deadline. More than two-dozen companies failed to certify fully or asked for postponements.
By the end of the year, all 14,000 companies overseen by the SEC must certify their financials, including foreign issuers of debt and equity, under provisions of the recently signed Sarbanes-Oxley Act, which will become effective by 8/29. The typical D&O policy has a dishonesty exclusion, which means that insurers do not have to pay on behalf of a director if he/she is proven to have committed fraud. However, insurers may still have to pay defense costs up until the point that any fraud is actually proven. It is only at that point that insurers can try to claim the money back from a director found guilty of fraud. Expect insurance costs to rise.
Kill the Corporate Dividend Tax
I don’t often favor lowering taxes on corporations, but this idea looks good. It comes from Jeremy Siegel, author ofStocks for the Long Run: The Definitive Definitive Guide to Financial Market Returns and Long-Term Investment Strategies, Andrew Metrick and Paul Gompers. Since interest costs, but not dividend payments, are deductible, management is inclined to raise debt and retain earnings. This tax treatment and CEO dependence on option-based compensation schemes contributed to capital gains, not dividends becoming the preferred source of shareholder return.
If dividends were deductible and retained earnings expensed, corporations would be motivated to pay profits out as dividends. The incentive to take on massive debt, risking bankruptcy, to gain a tax deduction and build management’s power base would be reduced. The emphasis on dividends, rather than capital gains, would reduce use of stock options. Here, I’ll add my two cents, if stock options were also required to be expensed, awards to management and employees would soon be made in shares, rather than options…thus, to some extent, aligning the interests of shareholders, management and employees.
Siegel, Metrick and Gompers also note eliminating the corporate tax on dividends would reduce the number of firms who seek to re-incorporate outside the US in order to shield foreign-earned income US taxes, since they could avoid taxes on foreign-earned income simply by paying out their profits as dividends. Their proposal would also reduce the propensity to over-allocate company stock in employee 401(k) plans since all dividends, not just those in such plans, would be deductible.
Caveats: The authors envision greater use of dividend reinvestment plans (DRIPs), subject to the personal income tax. Secondary offerings would become more common source of raising capital. Firms with good investment prospects would find easy access to additional capital if they released adequate information about expansion strategies.
Although corporate tax revenue be reduced, some losses would be recouped through increased personal taxes on dividends. Additionally, if their corporate dividend exemption idea is adopted, they favor eliminating all other corporate tax credits. “Elimination of these loopholes would not only simplify the corporate tax but should sharply reduce corporate influence-peddling and lessen some of the all-too-cozy ties between politicians and big business.” (A Simple Solution to Stock Market Woes: Kill the Corporate Dividend Tax,[email protected] Newsletter, 8/14-27/03)
Banks Sold the Ponzi Schemes
Wall Street banks sold public investors – especially pension funds, a bill of goods – $20 billion worth of “investment grade” WorldCom bonds that protected the banks from their own credit exposure are now worthless. Read more at the Corporate Governance Fund Report, where Institutional Investors are “Pushing Back.”
Fred S. Golden has joined the Corporate Governance Network. His firm, Verificaiton Specialists, can can lead you through the maze of requirements and regulations that now govern the Audit Committee, especially as a result of the new Sarbanes-Oxley Act.
DB Plans Drop 6%, DC Plans 8%
Pensions&Investments reports that defined benefit plans kissed goodby to $208 billion and defined contribution plans $98 billion since September 30th due to the falling market. Defined contribution plans were harder hit because they had a higher percentage of their funds in equities (61.7% v 56.9%). Corporations will no longer be able to carry pension plan funding on the back of investment returns.
Forget about global warming and sweatshop labor. This year’s crop of shareholder resolutions is all about excessive chief executive pay and squeaky-clean accounting. The new battleground is corporate governance…making sure company executives don’t cook the books and enrich themselves at the expense of shareholders. We can expect much more of the same next year.
Several comentators on the NYSE amendments pointed out that “the election of directors is currently not a democratic process. This is problematic, as directors represent shareholders, not management. In only the rare circumstances of proxy fights do shareholders get to vote in competitive Board elections. In the current system, the directors nominate and elect one another, with shareholders playing a passive role of rubberstamping nominees.” (Adam Kanzer, General Counsel & Director of Shareholder Activism, Domini Social Investments LLC) We’re starting to get a few signatures for our petition in support of Democracy in Corporate Elections. Activism pays.
Cood Governance Pays in Italy
Does good corporate-governance pay? A new stock maket, he STAR exchange, launched in April 2001 by Italy’s Borsa Italiana for companies that follow a strict set of governance requirements provides more evidence that it does. Listed companies must have a minimum number of independent, nonexecutive directors; ensure that the compensation of managers and directors reflects their performance; and adhere to rigorous disclosure requirements. Companies on the STAR exchange outperformed those on the main board by 16.5% and had a weighted average market-to-book ratio of 3.8, compared with 2.1 on the main exchange. (The McKinsey Quarterly, 2002 Number 3)
Shift to Quality and Away from Risk Means Shift to SRI
The Social Investment Forum and fundtracker Lipper indicate that US investors are pulling money out of most mutual funds but are increasing allocations into socially responsible investment (SRI) funds. Between January and June 2002, SRI fund assets grew 3% while US diversified funds averaged a 9.5% loss. When the S&P 500 lost over 13% in June and diversified funds suffered net redemptions of $13 billion, SRI funds saw net inflows of $47 million.
“The market faces a real crisis of credibility caused, in part, by a seemingly endless procession of corporate scandals,” according to Social Investment Forum President Tim Smith. “Socially and environmentally responsible mutual funds use their influence to promote more corporate responsibility through resolutions, dialogue and encouraging reforms in corporate governance. When you combine that far sighted leadership with good relative performance, screened funds are an increasingly attractive alternative for many of the nation’s investors.” The public is searching for quality and lower risk; 13 of 18 socially or environmentally responsible funds with at least $100 million in assets achieved top performance rankings from Morningstar and/or Lipper for the one and three year period ending June 30, 2002. (Investors Continue to Put Money into SRI Mutual Funds 8/1/02)
Yet even SRI funds are getting nailed. It is one thing for a fund to determine whether a company is, say, a weapons maker. It is quite another to detect whether a company is quietly playing games with its numbers. Better screens are needed. Not everyone can agree that making weapons isn’t socially responsible. However, most would agree that accounting fraud and excess CEO pay shouldn’t fit into the SRI mold.
Computer Associates Sued for Paying Greenmail
Chevra Machzikai Torah, a Brooklyn, New York-based non-profit organization, filed a lawsuit against Computer Associates International and its directors, seeking a refund of the $10 million paid to dissident investor Sam Wyly to call off his proxy fight. The suid claims CA’s 12 directors breached their fiduciary duty in the pay-off agreement, which stipulates that Wyly must not launch another bid for a CA board seat for 5 years. The suit alleges that the payment was made so the existing directors and managers can keep their jobs. It damaged CA’s share price as well as its reputation. (News Briefs,The Corporate Library, 8/6/02)
India Places Last
A McKinsey & Co. survey of 188 companies from a cross-section of emerging markets placed India last in terms or transparency. The survey looked at the emerging economies of India, Malaysia, Mexico, South Korea, Taiwan, and Turkey. South Korea earned the highest score as the emerging market that had adopted the highest quality corporate governance rules or guidelines. Malaysia topped the list with a score of 81 in disclosure and audit quality. (News Briefs, The Corporate Library, 8/6/02)
Questioning the Call for More Shareholder Power
In a recent posting with the above title, Russell Mokhiber and Robert Weissman take a page from Marjorie Kelly’s excellent book, The Divine Right of Capital. “A common diagnosis of the current scandals is that they can be traced to company executives’ ability to function with little accountability to shareholders. An alternative view is that the problem was that executives were thinking too much about what shareholders want.” No, shareholders didn’t want CEOs to rob them blind, but they did want share prices pumped up, “especially in the short term.” That assessment is on target, especially for many mutual funds with high churn rates.
“People are saying we need to align executives closer to shareholders,” Kelly says. “I believe their alignment was too close. We need a corporation that is accountable to someone besides shareholders.” To me, that would be society, enforced by governments. That’s what laws are for…they need to be enforced.
Kelly’s book contains many interesting ideas; Mokhiber and Weissman focus on “time-limited shareholding.” Shareholder control would be progressively transferred to employees, a public entity or a non-profit enterprise. Although they admit, such an idea is “far from immediate enactment,” they see possibilities in coming bankruptcies. (see Questioning the Call for More Shareholder Power, Russell Mokhiber and Robert Weissman)
I’ve long been a huge fan of expanding employee ownership and greater participation by employees in decision-making. At almost every opportunity, I remind readers that firms with these characteristics grow about 10% faster every year than the norm. We’ve built in employee ownership when restructuring through bankruptcy before, as in the Chrysler bailout; we could do it again. There may be cases where progressively transferring control of a corporation to a public entity makes sense, such as with private toll roads and sport arenas. However, keeping the bulk of a corporation’s shares available to the market also has advantages, such as liquidity and the ability to raise capital. In addition, if functioning properly, there are great advantages in having independent outsiders on the board of directors and the profit incentive is a great motivator.
The recent corporate implosion was not due to over-alignment between shareholders and management. Instead it was built on accounting gimmickry embodied in stock options. Because of business pressure on the FASB in the mid-nineties, the cost of stock options resulted in a 9% overstatement of earnings by the S&P 500. Among information technology firms in the S&P 500 the average overstatement due to the cost of options was 33%. Options are not an alignment between shareholders and managers. They are a usurpation of power in the form of heads I win, tails you lose. Options are a one way street, with plenty of upside potential but no downside risk. They motivate CEOs and other executives to undertake risky ventures and aggressive accounting practices. Long term value is out the window when all they need is a timely spike in the value of stock.
A study of 10 different industries by Jack Dolmat-Connell, a principal at Clark/Bardes Consulting, found that companies in which executives had large shareholdings performed significantly better that those in which ownership was small. “Southwest Airlines had high stock-ownership levels and good performance, while Delta Airlines had low ownership and poor performance. Likewise, Dell Computer had high ownership and good performance, while Apple Computer (Steve Jobs owns all of two shares in the company) had low ownership and much poorer performance.” (see Pay for Nonperformance?, CFO.com, 8/1/02)
Contrary to Kelly’s assertion, shareholders don’t have too much power; they have too little. It was the Business Roundtable, an association of CEOs, not shareholders, that lobbied Congress to keep options “free.” It was CEOs, not shareholders, who have controlled corporate boards…even those with “independent” boards. Allow shareholders to use the company proxy to nominate and elect directors and we’ll see the beginning of truly independent boards. Require options to be expensed and we’ll see those independent boards move away from compensating CEOs with options and towards granting restricted stock. (see below, Options: Expensing and Restricting) (Sign Petition in support of Democracy in Corporate Elections. See our press release: Petition for Democracy in Corporate Elections)
Options: Expensing and Restricting
Citigroup has become the latest company to jump aboard the expensing bandwagon. Reports are they will begin expensing all stock options to management, employees and corporate directors in January, reducing next year’s earnings by 3 cents a share. When fully phased in over the next five years, it should cost about six cents a share.
Citigroup also announced that the bank’s CEO, Sanford Weill, and CFO, Todd Thomson, have personally certified the bank’s financial statements, thus meeting an SEC requirement that 900 of the nation’s biggest companies officially sign-off on a company’s books by August 14.
One of our readers, Thomas Ernst Huenefeld of Cincinnati, writes that sales of stock from exercised options by top executives need to be restricted until after they leave the company. He suggests they only be allowed to sell sufficient shares to pay their income taxes, until ninety days after they leave the company. (They wouldn’t be restricted from selling shares which they acquired in the open market.)
Mr. Huenfeld’s idea is excellent, although I’d favor even a longer restriction on sales…say two years after they leave. This would align the long-term interests of CEOs and shareholders, CEOs would place a greater emphasis on succession planning and we would expect a reduction in accounting trickery, since final compensation would be, at least in part, dependent on the next administration.
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AFL-CIO Supports Worker Access to Corporate Ballots
During a July 30 rally outside he New York Stock Exchange, AFL-CIO President John J. Sweeney announced the organization’s agenda, which calls for putting workers first, holding CEOs accountable, putting integrity back into the markets and ending corporate corruption of politics. “CEOs should no longer have access to company funds to run candidates for their board while worker funds have to spend their own money to elect independent directors.”
We hope the AFL-CIO will urge its members to support the Petition for Democracy in Corporate Elections.
“Cliff Notes” on Corporate Responsibility by Newsbatch
Can’t keep up with all the news? A summary on Corporate Responsibility has been added to Newsbatch.com. The summary provides an in depth account of the major recent scandals, discusses proposals for reform and the extent to which the recent legislation passed by Congress has enacted these proposals.
Mckinsey & Company’s Latest Global Investor Survey, July 2002
Corporate governance remains of great concern for institutional investors, according to the 2002 Global Investor Opinion Survey released by McKinsey & Company, with strengthening the quality of accounting disclosure as the top priority.
Corporate governance is at the heart of investment decisions
- Investors state that they still put corporate governance on a par with financial indicators when evaluating investment decisions.
- An overwhelming majority of investors are prepared to pay a premium for companies exhibiting high governance standards. Premiums averaged 12-14% in North America and Western Europe; 20-25% in Asia and Latin America; and over 30% in Eastern Europe and Africa.
- While the relative significance of governance appears to have decreased slightly since 2000, this highlights that (i) many countries have implemented governance-related reforms that have been welcomed by investors, and
(ii) more than 60% of investors state that governance considerations might lead them to avoid individual companies with poor governance with a third avoiding countries.
Financial disclosure is a pivotal concern
- In pursuit of better accounting disclosure, investors resoundingly express support for the introduction of a single unified global accounting standard, with 90 percent favoring such a move. However, investors are split down the middle on the preferred standard.
- Investors are unified on expensing stock options in P&L statements, with over 80 percent supporting such a change.
Reform priorities focus on rebuilding the integrity of the system
- Investment behavior is affected by a broad spectrum of factors, not just those at the corporate level. The quality of market regulation and infrastructure is highly significant, along with enforceable property rights and downward pressure on corruption.
- After strengthening corporate transparency, investors believe companies should create more independent boards and achieve greater boardroom effectiveness through such steps as better director selection, more disciplined board evaluation processes and greater time commitment from directors.
- Specific policy priorities include strengthening shareholder rights, improving accounting standards, promoting board independence and tighter enforcement of existing regulations.
How International Are European Boards?
Based on the 101 responses received so far, the preliminary findings of the study are:
- About 20% of executive and non-executive board members are not nationals of the country of incorporation;
- Swiss and Dutch respondents have the most international boards, while German and Italian respondents are the least international;
- About 15% of companies that responded have a non-domestic CEO; 10% a non-domestic Chairman;
- Non-domestic CEOs and Chairmen are found most often among Swedish respondents;
- In contrast all the CEOs and Chairmen of the German and Italian respondents are domestic.
See presentation by André Sapir, Member, European Commission Group of Policy Advisors, at the ECGI launch, Tuesday 15 January 2002 at La Maison de l’Europe at the Bibliothèque Solvay, Brussels.
Petition for Democracy in Corporate Elections
The Petition seeks to create corporate democracy and true accountability. Petitioners ask the SEC to amend its Rule 14a-8(i) so that ALL Shareholders, using the Shareholder Proposal process, will be able to nominate Director-candidates and the names of those Director-candidates must be placed on the corporation’s ballot.
The myth is that the Management reports to the Board. The reality is that the Board reports to the CEO. Strengthening the definition of “independent” Directors will have little impact, as long as they owe their positions to the CEO.
A corporation’s ballot is paid for with assets belonging to ALL Shareholders. Yet, under current Rule 14a-8(i), ONLY the names of Director-candidates nominated by the corporation appear on the corporation’s ballot. Shareholders are denied equal access to the ballot. Instead, Director-candidates nominated by Shareholders must go through an extremely expensive proxy solicitation process.
The present system is rife with conflicts of interest. Since Directors are beholden to Management and/or fellow Directors for their position, they will most likely not ask the “tough questions” of Management, even though they owe a fiduciary duty to Shareholders to ask those questions.
An investor from Germany recently summarized the current system. “When I have started to invest in the USA about 3 years ago I was sure that elections of directors are fair. … So when I have discovered that elections of directors of USA public companies are not democratic I was very surprised and disappointed. … This is EXACTLY how voting in communist countries worked. Everyone could vote, but there was just NO CHOICE of candidates. The point was not how to be elected, but how to get on the election list. With this system no changes were possible, so there was no motivation to improve the governance.” (Emphasis in original.)
The major barrier to democratic corporate elections is the fact that, under present SEC Rules, only the names of those persons nominated by the corporation are required to appear on the corporation’s ballot. The Committee of Concerned Shareholders and James McRitchie have petioned the SEC to amend Rule 14a-(8)(i)(8) to require that ALL nominees for Director positions, who meet the other legal requirements, be included in Corporate proxy materials.
Entrenched Managers and Directors will only improve corporate governance when they can be held accountable, e.g., voted out of office and replaced with Directors chosen by shareholders. Please join with us in this request to Jonathan G. Katz, Secretary, U.S. Securities and Exchange Commission. Please e-mail Mr. Katz at [email protected], indicating that you support the petition for democracy in corporate electionssubmitted by the Committee of Concerned Shareholders and James McRitchie.
SRI Funds Take Hold
Investor interest in socially responsible investment funds (SRIs) is running high. According to fund research company Lipper, overall, stock funds experienced outflows of $12.7 billion in June (net after new money is invested and redemptions are made). Yet, SRIs had inflow of $47 million during the same month.
Calvert will soon be screening model for corporate-governance problems, using data compiled by Institutional Shareholder Services. ISS ranks major companies on 51 separate measures from compensation to anti-takeover pills and independence of boards. Those with the lowest scores will be avoided.
Along with labor unions and pension funds, SRIs are quickly becoming the most active in the use of shareholder resolutions. Walden Asset Management’s resolution at data storage company EMC to make its board more independent, won support from 56% of votes cast in 2002, vs. an average 22.5% support for this type of proposal last year. (Not So Bad at Do-Gooder Funds, BusinessWeek, 8/1/02)
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Last Chance to Comment on NYSE Proposed Changes to Listing Standards
The New York Stock Exchange released recommendations from its Corporate Accountability and Listing Standards Committee, which propose new standards and changes in corporate governance and disclosure practices of NYSE-listed companies.See press release. See written comments. Write to help restore investor trust and confidence. Comments are due on August 1st. Below is this editor’s comments.
Dear Ms. O’Neill, Mr. Levin, Mr. Panetta, & Mr. McCall:
This is to support the New York Stock Exchange’s (NYSE) proposed changes to its listing requirements and to suggest additional changes to enhance corporate governance standards.
I am an individual investor and the editor of Corporate Governance, an Internet publication at Corpgov.Net, which I established in 1995 to provide research and advice to governments, boards, unions, institutional investors and individuals on improving corporate governance.
NYSE Proposed Changes
Shareholder Votes on Equity Compensation & Broker No-Votes: I strongly support the NYSE’s proposal to require shareholder votes on this highly contentious issue. The right to vote is an important democratic right. However, the proposal would be improved by prohibiting all broker votes on any subject unless the broker receives prior instruction from their customer. When companies need shareholder approval, management has come to rely on broker votes because, unfortunately, brokers tend to blindly vote on the side of management.
Board Independence: I support your recommendation that independent directors must comprise a majority of board members. However, the proposal could be substantially strengthened by joining with me in petitioning the SEC to permit shareholders to use Shareholder Proposals for the purpose of electing directors.
Directors do not become independent just because they have no economic ties to the company beyond their job as a director. Disinterested outsiders can mean uninterested outsiders. The key is not “independence, ” arbitrarily defined, but whether a director’s interests are aligned with the shareholders. If a director is to represent the interests of shareholders, they must share those interests. Moreover, they must be intimately familiar with those interests. Put simply, they must be shareholders, nominated and elected by and accountable to shareholders.
Additional Areas for Consideration
1. Listed companies should be required to include their corporate governance policies and conflict of interest policies in their proxy statements. If they waive those policies at any time, that should be disclosed, along with the reasons for the waiver.
2. Any online proxy voting system should be required to include all proxies circulated by all parties. Both sides in a proxy contest should have access to the cheaper and more accurate system for counting votes available through ADP. All votes should be counted the same way, especially if there is any form of shareholder initiative, from a proposal to a contest.
3. Social and environmental risk should be classified as “material” and be mandated for disclosure to protect investors from the adverse impact of undisclosed liabilities, obligations, and impairments. Research demonstrate a link between financial performance and environmental performance. Outstanding cases/complaints, and number of aggregate violations found by the National Labor Relations Board, Department of Labor, Equal Employment Opportunity Commission and the Office of Federal Contract Compliance Programs should also be included.
4. Require options to be expensed. Options are a form of compensation that clearly have value. A representation of that value should not remain hidden in the footnotes of financial statements. In the year 2000 options resulted in a 9% overstatement of earnings by the S&P 500. Among information technology firms in the S&P 500 the average overstatement due to the cost of options was 33%. The total cost to shareholders was $284 billion in dilution.
5. Split the roles of chair and CEO. How can the board act independently if the CEO sets the agenda? The “lead director” concept was a half way measure that appears to confuse many and hasn’t caught fire. A McKinsey survey of more than 180 US directors representing 500 companies suggested that more than two-thirds believe the board should split the role of chief executive and chairman. Let’s give them what they want and need to do their jobs.
Thank you for this opportunity to share my views on the NYSE proposals.
Corporate Governance Fund Report Debuts
The Corporate Governance Fund Report (CGFR), a monthly newsletter that track funds and investments aimed at improving or rewarding the corporate governance practices of the invested companies, emerged in July with a free trial offering. The editor/publisher is Maureen Nevin Duffy, perhaps best known as the founding editor of the Journal of Performance Measurement. The debut issue discusses Herbert Al Denton, who led dissidents at ICN Pharmaceuticals’ shareholder vote – a 3 – 1 landslide. (In the interest of full disclosure, the Editor of CorpGov.Net is an ICN shareholder.) The issue also discusses Guy Wyser-Pratte’s recent initiatives at German engineering/defense contractor Babcock Borsig, Brazilian activists and funds. Most interesting to this reader was the most comprehensive list of proactive investors’ funds worldwide that I have seen.
CGFR’s mission is to “follow and analyze the activities of investors seeking better Corporate Governance. These investors are agents for change, whether they bear the label ‘active investors,’ ‘relational investors,’ ‘value investors,’ ‘proactive investors,’ ‘head bashers’ or ‘institutional investors.’ They pack the potential of restoring trust in our capital markets. They are Pushing Back!” We look forward to Ms. Duffy’s future reports from the front lines.
Angelides Take Another Bold Move
Congressional efforts to stop tax evading corporations from moving offshore have stalled. Yet, California’s Treasurer Phil Angelides won’t be deterred. He announced that his office will no longer invest in US companies that move to offshore tax havens. Angeledies also urged CalPERS and CalSTRS to divest $752 million worth of investments from such expatriates. “These are American companies doing business in this country, living here, enjoying all the fruits, yet they do not want to abide by our rules. Where does it stop?”
While Angelides has taken a bold step; is it the right one? True, governments and government employees shouldn’t be supporting companies that undermine our tax base. Selling off these firms makes news when the action is taken but this step should be a last resort. We won’t have as much influence with expatriate firms when we aren’t shareholders.
CalPERS and CalSTRS shouldn’t be bullied into selling. They should submit shareholder resolutions or bylaws amendments to every expatriate firm in their portfolios to require them to move back. They should work with the Council of Institutional Investors, the Social Investment Forum and other investor groups to ensure our voices are heard. Additionally, they should more fully utilize their own internet sites. Every member should be able to track their individual portfolios online and should receive advice from CalPERS and CalSTRS concerning how to vote on upcoming corporate proxies.
Hush Money Draws Attention to Greenmail
One early morning in 1984 California Treasurer Jesse Unruh read that Texaco had repurchased almost 10% of its own stock from the Bass brothers at a $137 million premium so that Texaco’s top brass could avoid loss of their own jobs in a takeover. That action stirred resentment and woke a slumbering giant. The California Public Employees Retirement System began its long involvement with corporate governance issues.
Computer Associates denies their recent payment of $10 million to Sam Wyly is greenmail because they didn’t buy his stock; he simply agreed not to wage a proxy fight. Whatever it’s called, it’s still stealing from shareholders to entrench management. This time shareholders are already awake. The Sarbanes bill is only the opening shot; let the shareholder revolution begin!
IOSCO Recommends OECD Principles for Emerging Markets
The Emerging Markets Committee of the International Organisation of Securities Commissions (IOSCO) has recommended that its members foster good corporate governance through legislation, regulations and codes of good practices using the OECD’s “Principles of Corporate Governance” as a benchmark.
- Read the IOSCO press release.
- Read the speech made by Bill Witherell, OECD Director for Financial, Fiscal and Enterprise Affairs, at IOSCO 2002, Istanbul, 24 May 2002: Corporate Governance and the Integrity of Financial Markets: Some Current Challenges.
- More information on corporate governance at the OECD
Consult the 2nd Edition of the Corporate Affairs Newsletter, offering articles on the launch of the White Paper on Corporate Governance in Russia and insights on accounting and audit conflicts. The newsletter also provides information on the corporate governance programme in Romania.
Six Ways to Improve Corporate Governance
Republicans and Democrats are stumbling all over each other to show who can be toughest with corporate “wrongdoers.” The Senate and House have passed competing legislation calling for everything from 20-year jail terms and extended statutes of limitations to new accounting rules and oversight boards. Many of the reforms are good but others are more for show. The 20-year jail terms, for example, will require proving intent to defraud and you can bet the defendants will have some of the best lawyers money can buy. Here’s a list of six reforms, the first has been widely discussed but many of the others have received too little consideration.
- Require stock options to be expensed. Expensing options is supported by Federal Reserve Chairman Alan Greenspan, Senator John McCain, Citigroups’s Sanford I. Weill, billionaire investor Warren Buffett and the several of the companies on whose boards he sits, such as Coca-Cola and the Washington Post.
Unions, representing groups ranging from sheet-metal workers to the Teamsters, have filed 11 shareholder resolutions focusing on expensing stock options that will be voted on from September to November. This fall’s action is a practice run for 50 and 60 companies to be targeted next year. It is a winning issue for unions, a losing one for those seen as “fat cat” CEOs.
Options are a form of compensation that clearly have value. A representation of that value should not remain hidden in the footnotes of financial statements. In the year 2000 options resulted in a 9% overstatement of earnings by the S&P 500. Among information technology firms in the S&P 500 the average overstatement due to the cost of options was 33%. The total cost to shareholders was $284 billion in dilution.
“How many legs does a dog have if you call the tail a leg? Four. Calling a tail a leg doesn’t make it a leg,” said a wise Abraham Lincoln. Shareholder activist Robert Monks has related this analogy for years and it still holds up; our accounting standards recognized the truth.
The culture of greed has overcome even our youngsters. A Junior Achievement survey, reported in Across the Board, found that 34% of teenage girls believe they will be earning $1 million/year by the time they are 40. Among teenage boys, it was 65%. In actuality, less than 5% of households have a $1 million in total assets, let alone earning that much every year. It’s the lottery/options/superstar mentality…let’s get back to reality.
If shareholders had a larger role in setting the pay of corporate executives, we would see greater use of restricted stock that can’t be sold until at least two years after the executives leave office. This form of golden parachute would only pay off only if the CEO has laid a firm foundation for the firm’s long term future, instead of simply concentrating in jacking up stock prices so they can cash out options in any given quarter.
- Permit direct nomination of board members by shareholders. The current process, where shareholders coercively ratify incumbent nominees is plainly not an “election.” Running an independent nominee or slate using the solicitation process is prohibitively expensive, except in the most unusual circumstances. Why should shareholders be required to run candidates by paying for an expensive solicitation, while current management uses our funds to tout their candidates on the company proxy?
The current system is worse than voters trying to run a state government by proposition. We need our own elected leaders on corporate boards. The idea of requiring a majority of “independent” directors is a half way measure. Historically, the chief executive serves as the chief recruiter for board vacancies. Board members can be “independent” and still owe their jobs to the CEO; that’s not independence. Board members who are actually nominated and elected by shareholders will be accountable and will, in turn, hold the CEO accountable. (see“Independent” Directors = Oxymoron)
- Require institutional investors to report their voting policies and their votes in corporate elections. In 1988 the Department of Labor (DOL) set forth the opinion that, since proxy voting can add value, voting rights are subject to the same fiduciary standards as other plan assets (see “Avon” letter). The same standards of trust law also hold for mutual funds, as clarified by SEC Chair Harvey Pitt, in a letter dated 2/12/2002. However, if votes are not disclosed, how can these standards be enforced? How do we know when the money managers are voting in our interest if we never know how they vote?
- Split the roles of chair and CEO. How can the board act independently if the CEO sets the agenda? The “lead director” concept was a half way measure that appears to confuse many and hasn’t caught fire. A McKinsey survey of more than 180 US directors representing 500 companies suggested that more than two-thirds believe the board should split the role of chief executive and chairman. Let’s give them what they want and need to do their jobs.
- Election reform via instant runoff voting (IRV). Government elections need to be reformed if business is to shift its focus from earning the most money possible for CEOs to maximizing total returns. Doubling prison terms for dishonest CEOs means little if none are convicted. Big government can’t balance big business because both major parties will remain beholden to their largest contributors. Voting for third party candidates is wasting your vote. IRV would encourage candidates take real stands on the issues because voters would be voting for their favorite candidate without fear of wasting their vote or helping elect their least favorite candidate.
Less than half of those eligible vote in presidential elections. During off years, only about 35% vote. In last December’s special election in San Francisco less than one in six registered voters participated. The poor and middle class feel disenfranchised. In plurality voting systems, typical in the US, candidates can win with less than a majority when there are more than two candidates running for the office. IRV ensures that the winner enjoys true support from a majority of the voters, rather than from a simple plurality.
Used for major elections in Australia, Ireland, Great Britain, and soon in San Francisco, IRV accomplishes the goals of a traditional runoff election in one efficient round of voting. Voters indicate both their favorite and their runoff choices by ranking candidates in order of preference. If no candidate wins a majority of votes, the first-choice preferences of the last-place candidate’s supporters are eliminated and their second choices are used instead. If there still is no majority winner, the first choices of those voting for the next-to-last candidate is discarded in favor of their second-ranked choices, and so on, until a majority winner is determined. (see the Center for Voting and Democracy)
- Eliminate broker voting. Currently, if shareholders don’t vote their proxies within 10 days of the annual meeting, their brokers will vote for them…always in favor of management’s recommendations. The Council of Institutional Investors has opposed the use of broker votes for anything except achieving a quorum for a shareholder meeting and has urged the SEC to prohibit broker voting without client instructions. When will the SEC listen? Its time we all urged this action.
Conflict of Interest at CalPERS
CalPERS directors are involved in potential conflicts of interest that threaten to erode the fund’s sterling image, according to a report by Sharon L. Crenson of the Associated Press. Five members of the board owned stocks also held by CalPERS in 2001, according to the latest state records. Three board members have received thousands of dollars in political campaign contributions from companies CalPERS invests in. I say that even though CalPERS is one of the best, there’s much more beneath that surface. Keep digging. (see Potential Conflicts of Interest at Nation’s Largest Public Pension Fund, 7/16)
Many retirement plan sponsors don’t believe or don’t realize that they are responsible for their plan’s investment performance. Surprise! You may find yourself facing personal liability if participant investments turn out badly. Members of corporate pension committees and plan sponsors who – in light of the recent Enron controversy and other litigation — are concerned about their responsibilities under ERISA might consider signing up for a class.
In the latest issue of Ralph Ward’s Boardroom Insider, Ralph gives thanks that he hasn’t spoken to any international groups on corporate governance for a few months. When he did so in India earlier this year, post-Enron comments could be summed up as “How dare the US try to tell us how important good governance is.” Ralph notes that “in less than a year, US corporate governance has gone from a light shining on the hill of global commerce to become an ‘ugly American’ outrage, calling into question a decade of economic growth.”
He concludes that “America has always been, for good or ill, a nation based on pushing the envelope. The good side of this has been a willingness to gamble on creating wholly new industries, and personally staking everything on an entrepreneurial pipe dream — to create fortunes out of nothing. Yet the dark side has also been a talent for creating fortunes out of nothing — and skipping town with the cash before anyone got wise.”
Of course, many on the speaking circuit, Ralph included, are not out to impose America’s values on others. Certainly, I don’t feel in a position to do so. First, I can barely keep up with cutting edge developments in the US, let alone all the other countries of the world. I try to point to some of our successes, failures and what we are working on to push the envelope. My hope is that by sharing, others can learn from our experience.
And, of course, we can learn from the experience of others. Asian corporate governance, especially in Korea, appears to have taken a great leap forward as a result of reforms put in place after the 1997-98 financial crisis. This is reflected in a healthier market. Morgan Stanley’s Far East Index (ex-Japan) gained 8.9% in US dollars so far this year, whereas the Dow and S&P 500 have dropped 12% and 19.8% respectively.
Let’s look at another indicator, financial leverage. Salomon Smith Barney recently reported that in Asia the ratio of average credit to gross domestic product fell from 123% in 1997 to 114% in 2001. In the US, it has gone from 204% in 1994 to 288%.
Kwong Ki-Chi, chief executive of the Hong Kong Exchanges, told a business seminar recently, “There is now some suggestions in the U.S. that the share option scheme should be approved by the shareholders.” “In Hong Kong, we already require share options to be approved by shareholders.” Of course, use of options isn’t as pervasive in Asia, so CEOs are less prone to take a short-term view for personal gain.
If there is an “Ugly American” phenomenon, based on the arrogant imposition of American systems of corporate governance, surely recent events have humbled the perpetrators. Surely we have much to learn from each other. (Statistics taken from a 7/11 Reuters report entitled “Asia no longer ‘bad boy’ of corporate governance, by Sabyasachi Mitra.)
The Worsening Crisis of Confidence on Wall Street: The Role of Auditing Firms
A new study of the above title by Weiss Ratings found that auditing firms gave a clean bill of health to 94% of the public companies that were subsequently cited for accounting irregularities. The companies in the survey dropped from a total peak market value of $1.8 trillion to only $527 billion, an aggregate shareholder loss of almost $1.3 trillion. Of the Big Five firms, PricewaterhouseCoopers came out best.. (Survey: Auditors Don’t Spot Problems, CFO.com)
ICGN Urges Action
The International Corporate Governance Network (ICGN) whose members hold more than $10 trillion in assets — calls for:
- more board independence as a way to improve transparency and protect shareholder interests
- full publication of the salaries, short and long-term incentives and other benefits for all main board directors
- shareholder vote on remuneration at companies’ annual meeting
- rein in the use of options because they tend to reflect more general economic conditions rather than management.
“Investor inactivism has been an aider and abettor in what has happened,” Peter Clapman, ICGN chairman and senior vice president of the College Retirement Equities Fund (TIAA-CREF) says. “If an investor thought previously that corporate governance did not have to affect the bottom line or fund performance, that view has been dashed now.” (Investor Group Seeks Cuts In Executive Compensation, WSJ, 7/11/02)
The President’s long awaited speech called for stricter enforcement, tough penalties and more disclosure. He called the Senate “to act quickly and responsibly so I can sign a good bill into law” but, according to the Wall Street Journal, his “aides suggest they’re hoping to water down whatever passes.”
Tough talk, but he failed to address many of the most basic issues, such as expensing options. Individual investors were told to take proxy voting more seriously but Bush didn’t say anything about the fiduciary duty of institutional investors to disclose their proxy policies and votes. Small individual investors aren’t going to police corporate “wrongdoers.”
Stocks began the day higher but sank steadily after Bush’s speech. Will his tough talk stave off more sweeping reforms? That seems to have been the purpose but we may be on our way to our first corporate governance led recession, if the bleeding doesn’t stop. Moral exhortations to CEOs won’t work, especially coming from a president who refused to make the record of his own transactions at Harken and the SEC investigation public. (see Bush Crackdown on Business Fraud: Is Sure Signal That New Era Is Here (WSJ Online, 7/10/02, and discussion forum) Learn more about the first MBA White House at George and Dick’s Amazing Corporate Misadventures and Bush: Corporate Confidence Man.
New Corporate Paradigm?
After Enron, WorldCom and dozens of other frauds, the time may be ripe for a new corporate paradigm. Certainly, mistrust of the current system is at an all time high…at least during my 54 year lifetime. Marjorie Kelly’s The Divine Right of Capital offers insights in a readable style (favorably compared to Tom Paine by one prominent reviewer) and the beginnings of a viable alternative. Instead of maximizing the return to shareholders, corporations should be maximizing total return…a concept we have been advocating here at CorpGov.Net since 1995. Total return here implies the long term efficient use of all resources, both natural and human. Of course, at the heart of the efficient use of resources is the need to recognize humanity as part of nature, not separate from it.
The aim of her book is to start a dialogue about the “core problem of capitalism.” Bloated CEO pay, sweatshops, stagnant wages, corporate welfare, environmental indifference and, I would add, the unraveling of political democracy, are all symptoms. “They spring from a single source: the mandate to maximize returns to shareholders.” Kelly argues that “this mandate amounts to property bias, which is akin to racial or gender bias. It arises from the unconscious belief that property owners, or wealth holders, matter more than others.” We have yielded control to an economic aristocracy.
“Civilization has crossed a great divide in history, from monarchy to democracy. But we have democratized only government, not economics. Property bias keeps our corporate worldview rooted in the predemocratic age.”
Corporations used to be chartered for social purposes, as well as to bring a profit to investors. Today they seem out of control. Too many are focused on pumping up the price of their stock, rather than creating real value. Most of the enormous wealth generated by corporations is channeled to a very small number of investors. Kelly points out that between 1976 and 1997 the top 1% doubled their share of household wealth in the US from 20% to 40%.
Contrary to popular opinion (I wonder if most people really are this misinformed), “investing” in the stock market is really speculating; 99% of the money invested in stocks simply represents a bet on future growth. The stockholder isn’t providing capital to a company but is buying shares from another stockholder, gambling that the price will rise. Only about 1% of stock sold (mostly during initial public offerings) actually finds its way to the corporation itself. The vast majority of corporate capital comes from retained earnings, not from the sale of stock.
A more accurate description of “investors,” according to Kelly, would be “extractors.” Most investors contribute nothing to the company. Instead, they are buying the right to extract wealth from it. Looking at the other stakeholders, such as suppliers and the community, one group stands out…employees. Employees and investors and present an interesting comparison.
Employees typically invest a great deal in the companies they work for in terms of what Margaret Blair calls “firm specific human capital.” They develop knowledge and skills, much of which is specific to their individual firm’s operations. In addition, employees often have 401(k) or other investment plans that are overweighted in their employer’s stock. In contrast, most shareholders have a relatively small proportion of their investments in any one company because they recognize the reduced risk of a balanced portfolio.
The fiduciary duty of directors is to maximize the wealth that can be extracted from the corporation by shareholders, typically in the form of dividends, buy-backs or increased share value. Fundamental to standard operating procedures is the idea of minimizing expenses such as wages and income to employees. Even though employees have a greater stake in the coporation’s success, they have no formal say as employees in corporate governance…no vote for the board of directors. Kelly argues employees are not treated as corporate citizens, in the current model, but as subjects. In today’s paradigm, you either own property or you essentially are property.
Kelly gives the interesting example of St. Lukes, an ad agency spun out of Chiat/Day where employees refused to be sold with the company. Without its employees, the ad agency was worthless, so the new owners sold out to employees for $1 and a percentage of profits for seven years. (see The Ad Agency to End All Ad Agencies, FastCompany.com)
Although we have made some progress in addressing racism and sexism, we’ve only scratched the surface of wealthism. There wasDorr’s Rebellion in 1842. But since owning property was largely abolished as a requirement for voting, the issues surrounding wealthism have largely gone unaddressed.
Kelly argues the socially responsible investment movement, while in the right direction, doesn’t go far enough, since outperforming other investments is still the measure of success. In her vision, other measures matter…good wages, schools and a healthy environment. Wealthism is the key to many separate problems, just as sexism and racism are key in resolving many others.
Kelly argues that efficiency is best served when gains go to those who create wealth. Indeed, almost all the studies I have read conclude that democratically run companies, where decision-making and profits are shared, are better at producing wealth than the typical corporate model, which more closely resembles a dictatorship. Diversity and democracy pay, but most of those who run corporations and many shareholders are not interested in creating wealth most efficiently. They are happy to settle for less efficiency, if it will disproportionately increase their own power and wealth.
Kelly’s revelation that stock trading doesn’t raise corporate capital isn’t new. In 1967 Louis Kelso and Patricia Hetter wrote, “less that half of one percent of aggregate new capital formation during the eleven years 1955-1965 came from newly issued stocks, while 99.5% was financed through internal sources and through issuance of debt securities that in due course must be repaid from internal sources.” (Two-Factor Theory: The Economics of Reality. See also Democracy and Economic Power) Kelso, and his longtime ally Senator Russell Long, truly made a difference through the invention and popularization of employee stock ownership plans (ESOPs). Today, 8.8 million employees participate in 11,000 plans with assets valued at 400 billion. Want more information on how ESOPS can be made even more productive through employee involvement? Contact the National Center for Employee Ownership (NCEO).
Maybe Kelly’s book and her energy can help take these prior efforts to the next level. Some of her more interesting ideas include the following:
- Create a Federal Employee Ownership Corporation to promote employee ownership like Fannie Mae and Freddie Mac promote home ownership.
- Require a majority vote of workers for mergers, acquisitions or hostile takeovers.
- Bar corporate felons from federal contracts. The Clinton administration enacted a rule to bar recidivist businesses with a record of breaking labor or environmental laws from getting government contracts. The Bush administration overturned it immediately on taking office. Kelly suggests the idea be extended to include a ban on campaign financing and lobbying for such corporate offenders.
- Reaffirm the right of the people to revoke corporate charters.
A word of caution; I’ve met corporate governance scholars who have read Kelly’s book and refuse to even discuss it because the book doesn’t fit the current paradigm. I, for example, have spent years believing that if employees would just take more control of their pension funds, corporate executives would be held accountable to standards that more closely reflect our long term interests. Sure, 10% of the wealthiest families may hold 62% of the value of all pension accounts (they did in 1992), but many average Joes and Janes at least have some voice in how this money is invested and how companies owned by their pension fund are governed. Some, like the members of CalPERS, have a direct vote in elections for board members. Others vote for union officials who sit on pension fund boards or appoint those who do. Such votes aren’t in proportion to holdings, so pension funds tilt more towards democracy than traditional shareholdings.
How do I reconcile Kelly’s vision with mine? We’re both headed down a road in the same basic direction to a more efficient model of corporate governance. No one has a monopoly on how to get there but working together should make the going a little easier for all of us.
Speak Loudly and Carry a Small Stick
Gorge W. Bush is “deeply concerned” and will “hold people accountable,” but his words provide the reassurance of an accounting certification by Arthur Andersen. Six months since the president promised “a lot of government inquiry into Enron,” we’re getting a prominently billed speech on corporate governance. As Frank Rich noted in a New York Times editorial, “Playboy has done a better job of exposing the women of Enron than the Bush administration has done at exposing its men.” “The sight of a corporate crook being led away in handcuffs, Giuliani-style, would do far more to restore confidence in Wall Street than any more presidential blather.”
Why the slow pace in locking up America’s corporate “wrongdoers?” Frank Rich thinks it has something to do with the fact that several of those who profited from Enron work at the White House. Fellow Times editorial writer Paul Krugman, notes that Bush profited by exactly the same accounting misdeeds at Harkin as were used by Enron a decade later. (Yes, Arthur Andersen was the accountant.) (see Succeeding in Business, NYTimes, 7/7/02)
“WorldCom is a political boon to the president because it allows him to moralize about epic-scale crime without mentioning Enron, Halliburton or Harken,” writes Rich. The rise of Enron and the corrupt Bush presidential dynasty have been compared to that of the Harding administration’s Teapot Dome scandals.
Bush has already voiced opposition to expensing stock options, one of the simple fixes endorsed by Alan Greenspan and Warren Buffett. His Treasury Department, according to Newsweek, is hard at work stifling legislation that would end offshore shelters that allowed Enron (with 800-plus such entities) to evade taxes in four out of five years.
I look forward to his major address to the nation on corporate governance issues. Unfortunately, just when the country is looking for a Teddy Roosevelt to “speak softly, but carry a big stick,” we’re likely to witness just the opposite. (All the President’s Enrons, Frank Rich, NYTimes, 7/6/02)
Nader Offers to Organize Individual Investors
People want to make corporate bosses to pay back their ill-gotten billions to laid-off workers and pensioners. “They want to see these corporate crooks convicted and sent to jail,” Nader said. HE offered to help organize individual investors to pressure the White House, Congress and the Securities and Exchange Commission to bring justice and honesty back to the market. “Greed, unrestrained by the rule of law, knows no boundaries,” he said. “Greed has pushed the envelope.”
Nader called on the SEC to reopen its 1991 investigation into President Bush’s insider sale of $850,000 worth of Harken Energy shares in June 1990, just two months before the shares plunged. See White House defends Bush SEC filing. He also suggested other top executives in the administration, including Vice President Dick Cheney, should abe investigated by the SEC for contributing to accounting irregularities.
For reform to be meaningful, it must restore real independence to corporate auditors and must create a strong and independent oversight body for the accounting industry, Nader said. (Nader calls for investors movement: Rationale is to give the little guy a ‘seat at the table,’ CBS.MarketWatch.com, 7/5/2002)
Cracking Down on Corporate Crime
First, the Federal Bureau of Investigation should be required to compile an annual report on corporate crime in American, to accompany its current Crime in the United States report, which is unfortunately confined to street crime.
Second, the federal government should refuse to do business with companies that are serious and/or repeat law breakers, as well as deny other privileges (for example, granting broadcasting licenses) to corporate criminals. This would involve some new or strengthened laws and regulations, as well more stringent enforcement of debarment, contractor responsibility and good character laws now on the books. States and local governments should adopt similar measures.
Third, whistleblowers and private citizens should be able to enforce laws regulating corporate conduct. One way to facilitate this enforcement approach would be to expand and creatively adapt the False Claims Act, which currently enables whistleblowers to initiate lawsuits against entities which have defrauded the government, and which reclaims for the government every year hundreds of millions of dollars stolen by unethical contractors. (Russell Mokhiber and Robert Weissman)
Investment Bankers to Meet New Requirements
California Treasurer Phil Angelides called on investment banking firms and money managers to follow new conflict-of-interest guidelines or face the loss of billions of dollars in government investment business. Investment bankers must sever links between their corporate business deals and their payments to stock analysts; they must create a review committee to approve all research recommendations; and they must monitor their own progress. Money managers who provide advice to the California Public Employees’ Retirement System and the California State Teachers’ Retirement System will have to follow the guidelines if the boards of the pension funds agree.
“CalPERS and CalSTRS lost $850 million on WorldCom alone,” Angelides said. “These are not sustainable losses.” The investment protection principles are patterned after a May agreement between Merrill Lynch & Co. and New York Attorney General Eliot Spitzer following allegations that that company’s investment advice was tainted by conflicts of interest. Angelides oversees California’s $50 billion Pooled Money Investment Account, which is the checking account for state government and more than 3,000 local jurisdictions.
CalPERS Calls Members to Action
CalPERS is urging its 1.3 million members and all investors to push passage of S 2673, the Investor Protection Act of 2002. CalPERS posted sample letters for organizations and individual investors to fax to their Senators on its Shareowner Forum. “There is currently a crisis of confidence with the accounting industry,” said James E. Burton, Chief Executive Officer for CalPERS. “The independence of accounting firms that audit financial statements of public companies must be beyond reproach. The conflicts of interest that are prevalent throughout the accounting industry have fueled the erosion of investor confidence. Nothing but a ‘bright-line’ ban will end the inherent conflicts created when an external auditor is simultaneously receiving fees from a company for non-audit work,” Burton said.
A review of 1,200 U.S. companies in the System’s stock portfolio during the 2002 proxy season indicated that more than half of the audit firms’ revenues were derived from non-audit services.
“We consider this unacceptable and a significant impediment to objective and independent auditing,” added Burton. The Act also calls for creating an oversight board for regulating accounting firms that audit public companies that would represent the interests of investors, and those whom investors rely upon. CalPERS believes that this new body must have the power to investigate, adjudicate and discipline the industry through authority set by Congress, as well as have an independent funding mechanism. CalPERS has estimated that its unrealized and realized stock and bond losses in WorldCom total more than $580 million.
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Booking fees associated with its use of third-party network services and facilities as capital expenditures, instead of expenses, was a $3.85 billion fraud. Obviously, civil and criminal penalties for committing accounting fraud are not strong enough to deter such crimes. Will an SEC call for CEOs and CFOs of large companies (revenues totaling more than $1.2 billion) cure the problem? I doubt it. In spite of the Enron debacle, the SEC continues to allow corporate management to exclude from the proxy a proposal for shareowners to select the auditor by vote. The SEC deems auditor selection to be an “ordinary business” decision that shareowners should not consider undertaking.
“The wider implications of the WorldCom debacle will not be shrugged off so lightly,” says Tom Holland. Foreign investors owned $1.75 trillion in US equities, nearly 13% of the outstanding capitalization, as of March 2002. During the last 3 months global capital flows have pushed up the yen by nearly 12% against the dollar. “Even if only a small percentage of that capital is reallocated to Asia, the effect on relatively illiquid regional currencies and stockmarkets could be significant.” (World Con, Far Eastern Economic Review, 7/11/2002)
But taking money overseas may yield no better results in the long run. A research paper by Christian Leuz, Dhananjay Nanda, and Peter Wysockia studying investor protection regulations in 31 countries shows that accounting abuses such as self-dealing are far worse in Continental Europe and Southeast Asia than in the US. (Feeling Burned by Accounting Scams in the U.S.? Just Look Overseas, [email protected] Newsletter)
Joint Venture Consequences
Unocal will stand trial late September for alleged human-rights abuses committed by the government of Burma, the oil giant’s joint-venture partner in the development of a gas field. “Companies are going to have to take more account of the social consequences of their operations,” says Stephen Davis, who editsGlobal Proxy Watch. “We’re asking for $1 billion,” says Terry Collingsworth, head of the International Labour Rights Foundation, which filed the case against Unocal.” “Unocal’s involvement in Burma acts as a poison pill,” says Simon Billenness, a consultant to U.S.-based Trillium Asset Management. “Unless a company adopts a human-rights policy that is transparent, you’re going to face greater risk of damage to your business, your stock price, your image and your brand.” (The Era of Responsibility, Far Eastern Economic Review, 7/11/2002)
Banking Governance Questioned
Mike Mayo, an analyst at Prudential Financial, says four out of five chief executives at the 30-odd banks that he examined are also their chairmen. One out of four board members has a financial relationship with his bank. At FleetBoston Financial and SunTrust, only half of the directors can be considered independent. Of the fees banks paid to external auditors, 70% were for services other than auditing, such ad providing consulting and tax advice. (A murky sort of pond life, 7/4/2002,The Economist)
Only 20% of CFOs in a recent survey were found to be Certified Public Accountants; 35% had MBAs, and 5% had both qualifications. Only 1% of high-school students want to major in accountancy, compared with 4% in 1990. According to a recent article in The Economist, “an accountancy training encourages respect for numbers; an MBA breeds creativity.” Maybe its time to get back to counting beans. Their advice? “Appoint a CFO old enough to remember the trade.” “Bring in a foreigner. ‘In Britain, finance directors seem to be more loyal to their practice than to their firm,’ observes Frank Schroeder. Now president of DBM Europe, a human-capital consultancy.”
Unfortunately, “Chief executives clearly want a CFO who will be part of the team. If he isn’t, he goes. A survey by CFO magazine in 1999 found that 39% of chief executives had fired their last CFO, and 75% had hired the current incumbent—40% of them within the previous three years.” And from Nell Minow comes the advice for audit committees to hold at least some meetings without the CEO and take part in hiring and firing of CFOs. If CFOs were required to be CPAs, just as a general counsel must have passed the bar, the numbers might be presented more honestly. (Too creative by 50%?, 7/4/2002)
Martha Stewart Isn’t Alone
George W. Bush “has more familiarity with troubled energy companies and accounting irregularities than probably any previous chief executive,” according to Chuck Lewis of the nonpartisan Center for Public Integrity. As reported in the Wall Street Journal on March 4, 2002, Bush sold off two-thirds of his stake in Harken Energy, for $848,000 (about four times bigger than the sale that has Martha Stewart in hot water). The law required prompt disclosure of insider sales but Bush neglected to report his transaction to the SEC for 34 weeks.
According to Paul Krugman’s recent OpEd piece in the New York Times (Everyone Is Outraged, 7/2/2002), “an internal SEC memorandum concluded that he had broken the law, but no charges were filed. This, everyone insists, had nothing to do with the fact that his father was president.”
It took Nixon to go to China. Maybe Bush, Cheney and Pitt have the insider knowledge it takes to stop accounting fraud and corporate crime. For more, see Bush Family Value$, September/October 1992, Mother Jones and Bush And The Corporate Crime Wave: Part of the Solution or Problem? File Under “Takes One to Know One.” June 27, 2002, The Daily Enron.
Bush may be calling for reform but he is unlikely to call for severing links between investment bankers and analysts, strengthening auditor independence by banning consulting for accounting clients, or requiring that options be expensed. Without these reforms, let alone opening up the board nomination process, investors aren’t likely to head back into the market.
Public confidence in Big Business is at its lowest since 1981, according to the latest Gallup Poll. Bruce Nussbaum, writing for BusinessWeek says that “a growing buyers’ strike in the stock market, the flight of money into housing, and the rising price of gold all indicate that the early stages of a panic may be building… if the corporate crime wave leads people to pull back from the stock market, the economy could sink into a double-dip recession.”
“Markets can work only if information is honest, rules of the game are clear, and people follow them. Realizing that this isn’t the case today has left many Americans doubting their own futures and jeopardizing the future of the economy.” (Can Trust Be Rebuilt?, BusinessWeek, 7/8/2002)
Governance Leader, TIAA-CREF, Faces Shareholder Resolutions
Based on longstanding dissatisfaction with TIAA-CREF’s weak external and internal corporate governance policies, the attachedshareholder resolution requesting a shareholder vote on separation of the CEO and Chairman of the Board positions has been submitted to TIAA-CREF. Additionally, a secondParticipant Proposal has been submitted concerning issues related to social and environmental responsibility, proxy voting and governance efforts. No decision has been made as of July 2nd regarding whether TIAA-CREF will omit or include the resolutions in its fall proxy material. Like corporate shareholder resolutions, those to mutual funds are advisory but can send a strong message. (The hyperlinks have been added by James McRitchie, Editor, Corpgov.Net, in order to provide readers additional information.) To discuss the 1st proposal, contactDavid E. Ortman. To discuss the second, contact Curt Verschoor.
Governance & SRI Resolutions Get Votes
The central corporate governance issue is conflicts of interests by auditors. So far this year, 12 resolutions addressing the issues have received an average 30% support. Union funds initially submitted 29 auditor proposals, with 17 filed by the Carpenters. First out of the box was Walt Disney, in February, where 41% of voting shareowners supported the proposal. That strong showing early on led at least 11 companies to agree to new policies in order to have proposals withdrawn. Pacific Gas & Electric shareowners registered the highest vote, at 47% of votes cast.
“Golden Parachutes,” lucrative separation packages for executives, have received an average 40% support, based on results from 13 of the 19 golden parachute resolutions voted so far, up from last year’s average of 31% on 13 such resolutions. Board independence proposals also getting 29%, up 23% last year.
Votes for SRI proposals are up, as well. In each of the last 2 years, less than 15 of more than 150 social and environmental proposals received more than a 15% vote. This year, 17 resolutions have already so, with only 100 taken up so far.
Fall From Grace
The United States runs a huge trade deficit, which has been covered by a net inflow of $1.3 billion in foreign investments every day, according to Edmund L. Andrews, in writing for the New York Times. (U.S. Businesses Dim as Models for Foreigners, 6/27/2002) The dollar has been falling in relation to the Euro and Yen but Andrews says the more enduring impact may be a revolt against the “American model,” which “emphasizes bare-knuckle competition, aggressive deal making, a high level of public disclosure and fantastic rewards for executives who deliver the goods.”
“European leaders are also pushing for greater acceptance of their auditing rules, known as the international accounting standards, as an alternative to American rules. The great virtue of the international accounting standards, which all European Union companies will have to adopt by 2005, is that it is a simple and fairly compact list of basic principles. The American system, by contrast, is made up of volumes and volumes of decisions reached over the years on the finest nuances and shadings of every issue.” A survey by UBS Warburg and the Gallup Organization found that only 32% of European investors now rank the United States as the most attractive market in the world.
A recent survey by the Pew Research Center for the People and the Press found that President Bush’s approval rating on the economy had slipped to 53% from 60% in January. Only 30% of the public sees the economy improving over the next 12 months, down from 42% a year ago, and a third said the president was doing all he could to improve economic conditions, down from 48% six months ago.
After a year of successful cooperation with three of the six biggest German asset managers, the Association of Institutional Shareholders (VIP) is now able to expand their activities to the whole of Europe. As a first step to global and cross border transparency VIP made up a list of the dates of the annual general meetings of all EuroStoxx companies for the years 2002/2003. The second step will be completing it with all DJSI dates. This chronological and alphabetical list will be regularly updated according to the latest information at vip-cg.com.
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CalPERS Fails to Act on Expensing Options
“Stock options should not be treated as a business expense,” California’s Governor Gray Davis told the Silicon Valley Manufacturing Group at their board meeting in San Jose. (Davis backs tech firms on options, SFGate.com, 6/13) No Davis doesn’t hold much influence with the SEC or the Financial Accounting Standards Board (FASB) but he does appoint two members to the 13 member CalPERS Board and two officers of his administration also sit on the Board. A week later members of the CalPERS Board took up the issue and delayed any action to endorse or reject expensing stock options until August.
The Council of Institutional Investors, an association of some 120 public, corporate and Taft-Hartley pension funds with assets of $1 trillion, which CalPERS helped to found, threw its support behind expensing options back in March. Federal Reserve Chairman Alan Greenspan cautioned that failure to expense stock options has “introduced a significant distortion in reported earnings, one that has grown with the increasing prevalence of this form of compensation.”
A growing number of editorials in the business press, such as Fortune magazine, have called for expensing options. Standard and Poors announced recently that when it computes core earnings, it will deduct stock options as compensation expense. The International Accounting Standards Board (IASB) is likely to weigh in on the expensing side as our Financial Accounting Standards Board did before Congress interfered at the request of CEOs and Silicon Valley years ago. CalPERS should be taking the lead on this issue. Instead they are hiding.
Options are a form of compensation that clearly have value. A representation of that value should not remain hidden in the footnotes of financial statements. On average options overstated earnings among the S&P 500 by 1% in 1995 when CorpGov.Net went online. In 2000 options resulted in a 9% overstatement of earnings by the same group and among information technology firms in the S&P 500 the average overstatement due to the cost of options was 33%. The total cost to shareholders was $284 billion in dilution.
“How many legs does a dog have if you call the tail a leg? Four. Calling a tail a leg doesn’t make it a leg,” said a wise Abraham Lincoln. After the accounting disclosures of Enron, Global Crossing, Tyco and now WorldCom, the investing public deserves the truth. Ignoring the cost of options doesn’t mean they are not an expense. Let’s hope CalPERS comes to its senses, even if we have to wait until after the elections.
Writing for Directors & Boards, Martin T. Sosnoff, Chairman of Atalanta/Sosnoff Capital, says “Enron ain’t the problem.” (Spring 2002) “Over the past decade there was a landslide transfer of wealth from public shareholders to corporate managers.” Enron is the tip of the iceberg.
The great surge in productivity gains of the back half of the nineties was probably a scam. “After you make adjustments for too liberal assumptions on pension fund rates of return, factor in take-a-bath plant closings, the capitalization of R&D and huge inventory of write-offs, and low salaries to balance the options substitution, it looks as if earnings for the S&P 500 Index grew at their long-term pace of 5%, not the 10% that was reported.”
Sosnoff says the country “needs a swelling populist rage against managements’ venality comparable with the vilification of the trusts, typified by John D. Rockefeller Sr.” “Where’s the Teddy Roosevelt in the wings holding a big stick and ready to pounce.”
Can CalPERS Afford to Throw Stones?
Christopher Palmeri’s article with the above title inBusinessWeek (6/24) raises the issue that CalPERS knew about Fastow’s self-dealing partnerships but didn’t blow the whistle on him or Enron. There has been a spate of resignations at CalPERS, which has underperformed in comparison with other funds. However, his primary focus is on conflicts of interests by board members and those who appoint them, as well as the move to socially responsible investing (SRI).
Should CalPERS have reported Fastow? Undoubtedly. Maybe if those favoring SRI had been more fully in control, they would have. Too often fiduciaries take the attitude that yes this guy is a crook, but he’s our crook and he’s making money for us. Those favoring SRI are more likely to take the long term view. We’re all better off in the long run if crooks are in jail.
Yes, political contributions are troublesome and the potential payoff of a $100 million investment in return for a relatively small political donation continues to be problematic at CalPERS and in the other halls of government. Every time a department awards a contract, every time the legislature passes a bill, we can speculate about the influence of political contributions. And we should. It is obvious to all the money plays too big of a role in politics. At least CalPERS is run by a board that operates, to a large extent, in the open, rather than by a single elected official, as is the case with many pension funds in other states.
If Palmeri’s wanted to raise questions about CalPERS’ governance, why didn’t he discuss board members who leave the board and after a year lobby in order to obtain huge placement fees? One such former board member was recently reelected. Maybe he’s trying to renew his influence so that he can once again try for those fat placement fees when his term is up.
Why didn’t Palmeri discuss board members that simultaneously serve on other private investment boards? Does due diligence on one board serve the other equally? Which board comes first with regard to fiduciary duty? If he wanted to get into good governance practices, what about questioning value of having members serve on a board for more than 30 years? Can such directors still be considered independent? CalPERS has had more than one in this situation.
Is it good governance to have a board member in charge of a $150 billion fund who has declared bankruptcy not once, but twice? One CalPERS board member served as head of the investment committee while declaring bankruptcy twice. California’s Probate Code, which generally governs trustees, says that the office of a trustee that has declared bankruptcy is declared vacant. Is CalPERS above the law? Is it good governance to have voting rules which don’t provide for runoff elections and allow candidates to be elected with as little as 5.5% of the vote, as has happened at CalPERS. I don’t understand why Mr. Palmer failed to mention these issues that seem so much easier to fix than the question of political contributions.
With regard to SRI, CalPERS has been too timid. Had they gotten out of tobacco stocks years ago, as the lawsuits were taking hold, Angelides’ strategy would have been brilliant, financially as well as socially. True, blacklisting several emerging market countries has been widely criticized but not because people think CalPERS would make as much money in the short run wherever it can.
The criticism I heard over and over again while attending a meeting of Asian Development Bank was that CalPERS shouldn’t write off whole countries when there are good companies within those countries with excellent corporate governance practices that can set an example. Why write off India, for example, when Infosys has governance practices that are at least as good as many companies in the US. CalPERS needs to refine its policies to include company rankings as well as country rankings. That way, they will not miss excellent investment opportunities. At the same time, they will encourage individual firms operating in developing countries to adopt good corporate governance standards to attract foreign direct investment. (In the interest of full disclosure, the editor is an Infosys shareholder.)
That’s the title of Fortune’s June 24th article on how to bring back investor confidence through 7 suggested reforms:
- Earnings- trust but verify. Git rid of so-called proforma earnings; report real results. Expense options, stop the abuse of restructuring charges. Include pension costs but not pension income. The quality of earnings should be graded by auditors.
- Rebuild the Chinese wall. Enact regulations that forbid analysts from being involved in banking deals; let them evaluate companies only after they have gone publie.
- Let the SEC eat what it kills. The SEC has 100 lawyers to study the disclosure documents of 17,000 public companies. SEC examiners are paid 25 – 40%less than those of other federal agencies. Employee turnover is 30%/year. Yet, the SEC took in $2 billion, 5 times their entire annual budget. Congress should stop diverting their money to other uses.
- Pay CEOs, yeah – but not so much. Stock options should be expensed.
- Fire the chairman of the bored. Fortune’s writers praise the NYSE’s proposed reforms. The requirement that outsiders on the board meet regularly without management “will have a huge impact.”
- Put the “public” back in IPO. “For every dollar startups raised in 1999 and 2000, they paid 58 cents in a combination of fees and forgone proceeds.” The solution has been out there since 1998 when W. R. Hambrechtbegan auctioning IPOs on the Internet. Shares go to the highest bidder and the “IPO slush fund, that big pool of money that feeds all the corruption, evaporates.”
- Shareholders should act like owners. 75 mutual funds, penisons and other institutions control $6.3 trillion…44% of the market. “Real reform is only a proxy vote away.” They then reference the next article, “Investors of the world unite!” That article, by Marc Gunther, weaves the story of activism by institutional investors around the central figure of Robert A.G. Monks and does a great job of presenting the struggle through his efforts. “The so-called elections of corporate boards are mostly a sham, and will remain so until dissidents can get access to the company proxy statement to challenge the management slates.” Hopefully, Monks, John Bogle and others will help create a culture of ownership responsibility.
Would Institional Investors Create Better Corporate Governance?
Be careful what your wish for, says BusinessWeek’s John A. Byrne in “Investor Power Has Its Downside, Too” (7/1/02). “Why? For starters, the focus on quarterly numbers would become even more intense.” Shareholder turnover jumped from 12% in 1960 to 98% most recently. Institutional investors made “maximizing shareholder value” the prevailing principle of American business. Byrne argues that shareholders hardly made a peep about the runup in CEO pay and stock dilution as long as prices were going up.
Byrne has a point, but positive directions from such efforts are most likely to come from public pension funds, index funds and SRI funds who tend to be long term holders.
Capital Stewardship Certificate Program
The Center for Working Capital and the National Labor College are offering a certificate program in capital stewardship. The program has four classes. Introduction to Capital Stewardship provides an overview of key concepts, laws and policies. Fiduciary Duties outlines the legal duties of trustees regarding pension fund management. Investment Strategies grounds trustees in the fundamentals of investment decision-making while emphasizing investment techniques for highroad economic strategies. In the final class, Active Ownership and Corporate Governance, trustees will gain a thorough understanding of the benefits of active ownership through proxy voting and monitoring corporate governance. Trustees and plan professionals will explore avenues for maximizing long-term value through corporate governance. This is a great program for union activists who are either pension fund trustees or are hoping to be a trustee. Learn more.
4th World Congress on Environment Management
We understand the 4th World Congress on Environment Management held in Palampur from 7-9 June 2002 on “Sustainability through Good Governance” was a success despite adverse publicity in the international media about the impending nuclear conflict between India and Pakistan. The conference had several outstanding speakers from overseas and was attended by over 400 business leaders, government ministers, policy makers, CEOs, directors and senior managers of public private sector and multinational companies, NGOs and environmentalists. His Holiness the Dalai Lama inaugurated the Congress and presented the Golden Peacock Environment Management Awards.
The conference adopted a “blueprint for action” referenced as the “Palampur Declaration on Sustainable Development.” According to UN Report on Human Development (1998), the income ratio between 20% of the world’s poorest and 20% richest was 1:30 in 1960. It increased to 1:61 in 1990. In 1999 it was 1:74 and today it stands at 1:87. According to the Congress, “poverty is the single largest barrier to sustainability.” Partners in Action for Sustainability (PIAS) is one initiative adopted in the Declaration. The PIAS task will be to disseminate good work done by companies and thus provide role models that we badly need and at the same time encourage companies to seek 3rd party certification to ISO 14001.
Women on Board
The current [email protected] Newsletter contains a discussion by a panel of women executives (scroll down). Sally W. Stetson, president of the Forum of Executive Women, cited statistics showing that the percentage of Fortune 500 corporate boards with at least one woman grew from 63% in 1993 to 84% in 1999. However, women held just 11.2% of total board seats. Why? According to Deborah M. Fretz, CEO of Sunoco Logistics Partners, its because “CEOs go after other CEOs of publicly traded companies.” Maybe stacking the board with CEOs should be considered another conflict of interest, since each member of such a board has a vested interest in raising CEO compensation.
Trade Unions Call for Sustainable Development
Trade unions issued a challenge that could result in one of the biggest ‘grass-roots’ initiatives on sustainable development to date. It may involve millions of workers around the world in joint actions to implement needed changes in their workplace and communities. The proposal to initiate an international program of “Workplace Assessments’ could bring unions and employers together in action plans for change on water and energy uses, transportation, toxic substance and wastes, public and occupational health, as well as participation and basic security.
“We look forward to the day when workers can engage their employers in joint action to set common targets, monitor progress and implement change on broad range of issues,” said Ms. Ching Chabo from the International Confederation of Free Trade Unions’ Asia Pacific office. (Unions issue challenge to UN “Sustainable Development” Meeting, 28/5/2002)
Short Term Efficiencies = Long Term Inefficiencies
The stock market is becoming more efficient over the short term and less efficient over the long term, according to some experts, as reported in Pensions&Investments. Albert S. “Pete” Kyle of Fuqua School of Business, Duke University, says “the market is getting more and more efficient over very short periods of time, over a day or week or month” because more people are trying to make money off price discrepancies through hedge funds. Barr Rosenberg, chairman of AXA agrees because managers face increasing pressure for short term results. Hedge fund assets have grown 1,500% in the last 10 years to $563 billion.
Peter L. Bernstein, a consultant, thinks investors are still driving while looking through the rearview mirror and Robert D. Arnott, managing partner of first Quadrant Corp. is quoted, “I would bet very, very long odd that the risk premium in the next 20 years will not be even as half as large as what we saw in the last 20 years.” (Time is of the Essence, 6/10/02)
Short Term Thinking and CEO Pay
Many CEO’s and board’s are not creating value on a medium term basis and investors would be better off investing in T-bills, according to Mark Van Clieaf of MVC Associates International. His analysis finds that 35% of S&P 500 firms failed to return an after tax profit agreater than the cost of capital over 5 years. In an analysis of the proxy statements of the complete S&P 500 he found that the duration of time over which CEO performance was measured was only 1-year for 55% of the firms. Are they really trying to create long term value?
Fidelity To Fight Excessive CEO Pay
Fidelity Investments, which oversees $800 billion in assets is reviewing how to use itsballots in shareholder votes to protest outsized corporate pay packages, according to Mr. Roiter, Fidelity’s general counsel. Fidelity is considering token gestures such as withholding its votes for corporate directors that have approved excessive executive compensation plans. However, in accordance with a longstanding policy, it probably won’t disclose how it votes, so the effort, while a step in the right direction, will not have as much impact as it could.
In the past Fidelity’s votes against management’s recommendations often involved stock-options plans. The company usually objects to plans that dilute the shares outstanding by more than 10% at large companies or more than 15% at smaller companies. CEO pay increased 535% since 1990, far surpassing the 297% gain in the S&P 500 stock index, the 116% jump in corporate profits and the 32% bump up in workers’ pay, according to Legg Mason Value Trust manager Bill Miller who has joined with CalPERS in withholding support from directors to protest specific corporate practices, such as hiring auditing firms that also do consulting work for a company. (see Fidelity Uses Voting Threats To Fight Excessive CEO Pay, WSJ, 6/12/02)
Gregg Li Joins NETwork
Gregg Li, the Chief Architect of G. Li & Company Ltd., has joined the Corporate Governance NETWork. Mr. Li has over 20 years of experience in the Pacific Rim. He has served as a troubleshooter for the US Federal Government, as a regional internal consultant for American Express in East Asia, as a development consultant for the Vocational Training Council (VTC) in Hong Kong, as an external consultant to the former Coopers & Lybrand MCS Asian operation, and has headed a management think-tank at the University of Hong Kong during the period of Hong Kong’s handover to China. Other principals with the firm include
- Robert Tricker, an honorary professor at the University of Warwick, Exeter, and Hong Kong.
- Anthony Siu, engineer, venture capitalist, management consultant, and business angel.
- Alfred Ho, 30 years in management and organizational development.
Governance and Junk Bonds
Poor corporate governance practices are strongly correlated to U.S. firms getting downgraded to junk bond status, according to Pax World High-Yield Fund manager Diane Keefe. Participate in a briefing at 1:30 p.m. EDT on Wednesday, June 19, 2002 by calling 1-800-966-6338 at 1:25 EDT and asking for the “Pax” or “junk bond” call. The live, two-way phone-based telenews event (with Q&A) will focus on the raft of “fallen angels” — investment grade companies on the cusp of being downgraded to high-yield status but already trading at “junk” levels. Ms. Keefe will discuss the bonds of Tyco, Qwest, E-Trade, Adelphia, WorldCom and a number of other firms.
Pax World High-Yield Fund bills itself as the only socially responsible junk bond mutual fund in the United States. Can’t make it? A streaming audio replay of the call will be available on the Web as of 6 p.m. EDT on June 19, 2002.
CFO.com posted an interesting article on 6/6 entitled “Whose Company Is It, Anyway?,” which dicusses some of the changed proposed by NYSE and Nasdaq. However, the bulk of the article centers on the suddenly increasing number of organizations that have recently come out with governance metrics. Standard and Poor’s Corporate Governance Score (CGS) and Institutional Shareholder Services’ (ISS) Corporate Governance Quotients (CGQ). The Corporate Library and GovernanceMetrics International will release a governance metrics later this year.
No, the rating systems won’t be perfect, Enron might have scored high, but credit rating systems also evolved. “If investors are to take such governance ratings at face value, they must be convinced that the providers of the scores are on the side of shareholders — and not corporate clients,” says CFO’s Jennifer Caplan. The ever quotable Nell Minnow doesn’t see this as a big problem. “I am confident that the market will determine which information is really useful,” she predicts. “It’s like buying a tip-sheet at the race-track. After a while, you learn which ones really work.” It could make the difference between gamboling and investing.
Owners Must Step Up to the Plate
In “The Value of Trust” (6/6/02), The Economist raises three main investors concerns:
- the role of the research that is published by investment banks;
- the way in which shares in IPOs are allocated; and
- the use of accounting rules to mislead investors.
Although the article explores several reforms, at bottom “governance is unlikely to improve much until the institutions that own large chunks of corporate America start acting as real owners, by keeping a sharper eye on their boards and their management.”
Again in “Under the Board Talk” (6/13/02) “shareholders should play a bigger role in the selection of directors.” The Economist also calls for “separating the job of chief executive from that of chairman.” Shareholders should steer board recruitment away from the tiny pool of CEOs of other firms. “Why not trawl more widely, among academics and public servants?”
Finally, in “Designed by Committee,” The Economist notes that “the most powerful catalyst for change ought to be the big institutional investors that have their own fiduciary duty to protect their investors. Right now, these institutions are busily blaming boards for recent wrongs. But this seems rather convenient. One of the more interesting features of the assorted revelations now scandalising the market is that many of them are hardly news….As part of its reforms, the NYSE proposes to give shareholders more opportunity to monitor and participate in governance. This includes allowing them to vote on stock and stock-option plans for bosses, and making companies disclose codes of business conduct and ethics on their websites. In Delaware, judges seem more willing to put their faith in the judgment of sophisticated institutions, and may increasingly throw open contentious issues to a vote. When it comes—as it inevitably will—the next wave of corporate scandals might put institutions, not boards of directors, in its crosshairs.”
Chinese Court Sends Mixed Message
Shenzhen court’s verdict on 6/4 sends a mixed message re investor rights. In Fountain Corp. vs. Caijing magazine, Pu Shaoping and the Stock Exchange Executive Council a Chinese listed company took a media organization to court to defend its reputation. The court ruled that Caijing was guilty of defaming Fountain Corp. because of what the court deemed to be an inaccurate paragraph in a Caijing exposé. At the same time, however, the judgment broke ground in upholding what it said was the media’s “right to expose, comment, criticize, and monitor negative phenomena in society”–as long as the reporting is accurate. (see Wielding a Double-Edged Sword, Far Eastern Economic Review, issue dated 6/20)
The following technology trends were noted by Broc Romanek, Director of Marketing for RR Donnelley Financial and Editor-in-Chief of RealCorporateLawyer.com. I summarized from the Spring issue of the Corporate Secretary (a publication of the American Society of Corporate Secretaries). Sign up for Romanek’s E-Zine and stay informed.
- Online Proxy Fights used internet-based solicitation strategies last year at Travis Street partners LLC, Pioneer Group, ICN Pharmaceuticals, Luby’s and Goldfield Corporation, as well as during the Hewlett-Packard Compaq merger. Dissidents used web sites and message boards extensively to access “street name” holders.
- Electronic Stockholders’ Meetings. Inforte, a small company located in Chicago but incorporated in Delaware, held the first annual meeting exclusively in virtual reality on the internet. 5500 registered and beneficial holders attended. It was cheap; Inforte spent only $2,000 for the webcast through PR Newswire and for an election inspector. I doubt if many will follow suit but simulcasting is likely to grow rapidly.
- Electronic Offerings. A variable annuity offered by The American Life Insurance Company was probably the first to not also be available on paper. The SEC declared the registration statement effective on October 25th. We can expect more.
- Electronic Delivery and Voting. Online voting caught up with telephone voting and can be expected to pass it during the 2002 proxy season.
- Not so FreeEDGAR. Many EDGAR-based services started changing subscription. (see EDGAR,FreeEdgar.com, 10kwizard.com, Section16.net,TheCorporateCounsel.net, RealCorporateLawyer.comand TheCorporateLibrary.com).
- Regulatory Changes. SEC proposal that companies post disclosures on corporate web sites at same time they are filed and increased use by the SEC of their own site.
- Director Communications. More companies are utilizingextranets for their boards and committees to communicate with management and each other. See RecordCenter andBoardVantage for off the shelf systems.
- Online Education. Some state bar associations claim over 10% of their members have earned CLE credit online or through a CD-ROM. Additionally,
NYSE Rule Changes in Works
New York Stock Exchange announced new rules for improving corporate governance for NYSE-listed companies. The draft rules, which must be approved by the Securities and Exchange Commission, require listed companies to:
- maintain a majority of independent directors on their boards and refine independence to require “no material relationship with the listed company either directly or as a partner, shareholder or officer of an organization that has a relationship with the company” (current rules say that a listed company must have an audit committee that includes at least three independent directors.);
- conduct regular meetings among non-management directors,
- shareholders owning 20% or more of the company’s shares may not vote on audit committee matters, and
- get investor approval for all equity-based compensation plans (current rules require shareholder approval of only those stock plans where officers and directors may participate). The is probably the portion of the proposed rules most likely to change do to pressure (see below). The draft rules also state that brokers can vote their clients’ shares only on such proposals after checking with them first (I say, why not just eliminate broker voting altogether?).
NYSE Governance Rules Have Activists Salivating, says Diane Hess of TheStreet.com. “These rules accomplish, in one fell swoop, what shareholders have been striving for,” Nell Minow is quoted as saying. Peter Clapman, senior vice president of TIAA-CREF, the largest pension system in the world, says the guidelines would “remove barriers to effective communications” and “harmonize relationships.” The Business Roundtable has already come out against the NYSE’s proposal for shareholder approval for all plans, saying it could end up reducing the number of options and stock granted to rank-and-file employees because of the additional costs of shareholder approval. Significant changes…definitely, but certainly not everything desired by shareholder activists. Investor approval for all equity based compensation plans is the most radical of the ideas but it probably wouldn’t be as hard for management to take as expensing options.
Ditto Nasdaq, but Less
Nasdaq Stock Market, Inc. announced key rule changes approved by its board on May 22, 2002. These proposed rules will soon be published in the Federal Register, be subject to comment periods, and could be implemented later this summer. Further corporate governance reforms will be examined at the next meeting of the Nasdaq Listing and Hearing Review Council in San Francisco June 26-28. They include:
- a majority of independent directors on corporate boards;
- compensation committees composed solely of independent directors;
- a cooling-off period during which former auditors would be precluded from serving on corporate audit committees;
- expanding the scope of audit committee authority;
- strengthening continuing education for directors;
- increasing the use of corporate codes of conduct and compliance methods to support them; and
- mandate non-U.S. companies to disclose if they have received waivers of corporate governance standards through a new SEC disclosure requirement.
The rule filings, to be submitted to the SEC now, concern the following subjects:
- Stock Option Plans. Require shareholder approval for all plans in which officers and directors participate. Although existing exemptions for inducement grants to new executive officers and tax qualified, nondiscriminatory plans such as Employee Stock Ownership Plans (ESOP) were retained, the new rule does not include the so-called “treasury share” exception that would permit a company to use certain repurchased shares to fund options to executive officers without prior shareholder approval.
- Independent Directors. The definition will be extended to prohibit any payments, other than for board service, including political contributions, in excess of $60,000 and will extend to receipt of such payments by a family member of the director. Furthermore, a director will not be considered independent if the company makes payments to a charity where the director is an executive officer and such payments exceed the greater of $200,000 or 5% of either the company’s or the charity’s gross revenues.
- Disclosure of material information will be harmonized with the SEC’s full-disclosure rule to facilitate disclosure by issuers using Reg FD methods such as conference calls, press conferences and Web casts, so long as the public is provided adequate notice and granted access.
- Related Party Transactions. A company’s audit committee or a comparable body of the board of directors must review and approve all related-party transactions.
- Explicit Prohibition on Misrepresenting Information to Nasdaq. A material misrepresentation or omission by an issuer to Nasdaq may result in the company being delisted.
CEO/Chair Split Favored
The demise of Enron has triggered a spate of criminal investigations and lawsuits against companies and directors, spreading “angst and paranoia through boardrooms.” A McKinsey survey of more than 180 US directors representing 500 companies reveals that just under 40% were not confident they had processes in place to control potential conflicts of interest and even more thought they were not prepared to deal with risk management issues such as assessing the impact of pay on performance. The survey suggested that more than two-thirds believe the board should split the role of chief executive and chairman. (Financial Times, Enron’s Demisse has Taken the Shine Off Boardroom Tables)
Our 15 minutes of fame came on June 4, 2002 when Paul Krugman’s editorial “Greed is Bad” brought CorpGov.Net to the attention of thousands of New York Times readers.
Krugman points out that “distrust of corporations threatens our still-tentative economic recovery; it turns out greed is bad, after all. But what will reform our system? Washington seems determined to validate the judgment of the quite apolitical Web site of Corporate Governance (corpgov.net), which matter-of-factly remarks, ‘Given the power of corporate lobbyists, government control often equates to de facto corporate control anyway.'” No, we’re not all that apolitical. This is not a situation which we embrace, only the current reality.
As Krugman’s editorial indicates, corporations show no signs changing their ways. “Who will save that malfunctioning corporation called the U.S.A.?” Only the owners of corporations have that power. The most fundamental reform needed is to eliminate the SEC prohibition against using the shareholder resolution process to nominate directors but owners so far aren’t demanding that kind of power. Currently, shareholders can only nominate candidates by paying for an expensive solicitation, while the current management uses company funds, our money, to elect their own candidates. A democratic election process would bring about a real shareholder revolution and fundamental improvements in corporate governance. Other reforms simply treat the symptoms of a failure in democracy.
Global 100 Names ISS to Gadfly List
CFO Magazine’s The Global 100 lists a fairly arbitrary but not unreasonable 100 “major influencers” on global business by category: Raters & Regulators, World Players, Politicians, Taxmen, Exchange Masters, Bankers, CEOs, Investors, Lawyers, Risk Managers, Gadflies, Thought Leaders, and the Rest. There are some of the usual suspects and some surprises. What I don’t understand is the Gadfly label applied to ISS.
“Gadflies” are various types of insects that bite or annoy livestock. But here it is the second definition that obviously applies; “a person who stimulates or annoys, especially by persistent criticism.” Neither definition is particularly flattering but in the corporate world it is generally applied to the Gilbert brothers, Evelyn Davis and others whose shareholder proposals are strictly precatory.
As Robert Monks has eluded, although individually they are often ignored, together gadflies irritate the individual animals and sometimes the herd enough to get them moving. Included in the Global 100 are Toshiaki Murakami M&A Consulting in Japan and David Webb, Editor, of Webb-site.com in Hong Kong. Both have shaken up their respective markets. Murakami’s campaign to open up the value of cash-rich apparel maker Tokyo Style Co. has the look of an American style corporate raider. Webb’s attempt to advance minority shareholders’ interests in Hong Kong-listed companies through his HAMS proposal was recently rejected by the government. Maybe the gadfly label is appropriate to them and even to Mark Mobius, who is termed the “dean of emerging markets investing.” Each has obvious respect but their victories have been limited to date.
However, I’d draw the line at including Institutional Investors Services in this category. “When ISS talks, people listen,” CFO indicates. No kidding; if CEOs and other corporate officers don’t listen, they’ll soon find themselves out on the street. ISS was already responsible for 20% swings in proxy voting. Now they have launched a new service that will initially rate all companies in the Russell 3000 Index and will eventually extend coverage globally. The ratings are scored from 1 to 100, with 100 being a perfect score, and are based on seven aspects of corporate governance:
- board structure and composition,
- charter and bylaw provisions,
- laws of the state of incorporation,
- executive and director compensation,
- qualitative factors, including financial performance,
- D&O stock ownership, and
- director education, from an accredited program, including those offered by the National Association of Corporate Directors, the University of Wisconsin/State of Wisconsin Investment Board, the Wharton/Spencer Stuart Directors’ Institute, Dartmouth’s Center for Corporate Governance, and the Stanford Directors’ College.
Companies will be scored individually and will be ranked relative to their peer groups. If ISS is a gadfly, who is the 800 pound gorilla?
Errosion of Investor Confidence
Growing mistrust due to a steady stream of accounting scandals, poor corporate governance and conflicts of interest are is taking a toll. The S&P 500 has lost 7% this year while the Nasdaq composite lost 17.2 percent of its value and is trading 68% below its 2000 peak. The number of investors who say it’s a good time to invest has dropped to levels not recorded since September 2001, according to a monthly Gallup poll. Dubious accounting practices topped the list of concerns.
David M. Blitzer, chief investment strategist at Standard & Poor’s, said investors appeared deeply frustrated today. The New York Times quotes him as saying, that investors “want a sense that it is a fair game and that everybody has an equal chance to win or lose. People seem to feel that for the matter to be settled, somebody is going to have to go to jail.”
Average daily trades at Charles Schwab in April came in at 192,900, down from 235,000 a year earlier and a high of 420,100 trades daily in March 2000. Moody’s, tracking the first five months of 2002, Only 21% of respondents expect higher incomes in six months, according to Moody’s. That is below the 25.7% average from 1996 to 2000 and below the 23.9% of a year ago. (What If Investors Won’t Join the Party? NYTimes, 6/2)
Annual Reports Continue Spin
Despite the call for improved disclosure, annual reports look like business as usual, according to a report by Reuters. “Most corporate reports have become an exercise in spin, offering cheery photos of balding executives with big smiles and reams of only thinly interpreted, financial boilerplate.” Maybe we’ll see better reports next year if the SEC adopts new rules requiring more and timelier reporting on accounting policies and trades.
“Companies will wait for more guidance from the SEC and the exchanges before they do anything more than they absolutely, positively have to,” says Nell Minow, editor of The Corporate Library. “They still just haven’t learned that the one who provides the best, clearest, most accessible information wins.” (U.S. corporate reports yet to heed Enron’s lessons, 5/31)
7-9 June 2002 in Palampur, Himachal Pradesh (India). The Congress will be inaugurated by Noble Laureate His Holiness the Dalai Lama. Help create a blueprint for good corporate governance which creates long term value for all stakeholders by mobilizing not only the physical capital but also the human capital, social capital and natural capital.
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Monitoring By Shareholders Pays
Research by Peter Wright of the University of Memphis, Mark Kroll of Louisiana Tech University, and Detelin Elenkov of the University of Tennessee, Knoxville recently found that in actively monitored companies, CEO pay raises connected to major acquisitions tend to reflect improved company performance. In laxly monitored companies, they tend to reflect little more than increased corporate size.
The findings are based on an analysis of corporate acquisitions between 1993 and 1998 that involved publicly owned firms and met a number of conditions. One condition was that the merger had to boost the acquirer’s revenues by 10% or more. Another was that the same CEO had to be in place the year before and the year after the acquisition. Still another was that the acquiring firm did not undertake another acquisition in the same year or during the following year. To make the final cut for the sample, the acquiring firms had to be clearly in one group or the other — actively monitored or passively monitored. How they were classified depended on whether they were above or below the median in terms of 1) number of stock analysts following the company, 2) percentage of ownership by activist institutions, and 3) proportion of independent board members — that is, board members not employed by the company or beholden to it in some other way.
For the group of actively monitored companies CEO pay was significantly related to both a rise in stock price upon announcement of the acquisition and an increase in the firm’s return on equity during the following year. Thus, CEO pay boosts reflected both the stock market’s approval of the acquisition and the subsequent enhancement of the company’s bottom-line results. They were not influenced, however, by the extent of the firm’s revenue growth deriving from its greater size.
For the passively monitored companies, however, the findings were the reverse: increases in CEO pay bore no significant relationship to either of the performance measures but only to the amount of increase in corporate size. They concluded that lax monitoring encourages top executives to “adopt acquisition strategies in order to enhance their own rewards.” In contrast, “for firms with vigilant external monitoring activities, changes in CEO compensation will be directly associated with returns accruing to their shareholders due to acquisitions.” (June/July issue of the Academy of Management Journal)
Enron Amusement of the Month
Accountants at Arthur Andersen knew Enron was a high-risk client even back in 1995. Testifying in court earlier this month, partner James Hecker said he wrote a parody back then to the tune of the Eagles hit song Hotel California which included the following: “They livin’ it up at the Hotel Cram-It-Down-Ya, When the [law]suits arrive, Bring your alibis.” (From Business Ethics magazine’s online news report, BizEthicsBuzz. Subscribe free.)
Four Ideas for Reforming Corporate Governance After Enron
Reprinted with permission from the author, Marjorie Kelly, Editor and Publisher, Business Ethics magazine.
The picture on the front page of the New York Times in early May was memorable: five Enron directors with hands upraised, swearing to a Senate subcommittee they were not responsible for the company’s collapse. Pathetic as they seemed, they were telling the truth. Corporate directors are not in any real sense “directing” companies. And that’s the problem.
In a telling moment before the subcommittee, the directors confessed they “had no inkling that Enron was in troubled waters until mid-October 2001” – right before the house of cards collapsed. This may seem unconscionable negligence, but it is more fundamentally a result of the design of corporate governance. Boards of directors don’t govern because all essential governance happens before the board meets. State law mandates directors must act in the best interests of the corporation and its shareholders, which courts interpret to mean maximum share price. So as long as share price remains high, directors feel confident. Yet it was precisely the hyper-inflation of share price that destroyed Enron.
Post-Enron, it’s clear that pursuit of profits must stay within ethical bounds, and that executives and shareholders may not enrich themselves by extorting the public or employees. Toothless codes of ethics like Enron’s are no help. Ethical concerns must grow teeth – which means biting into reform of corporate governance. While most proposals for reform today merely tinker at the margins, some get to the heart of the matter. Below are four of the best.
- Ensure auditors really audit by making them fully independent.
Instead of having companies be the “bosses” of their own auditors – selecting and paying the firms they want to work with – a Corporate Accountability Commission could assign auditors and pay them from fees assessed on companies. That’s the proposal of Ralph Estes, emeritus professor of accounting at American University, in his proposed Corporate Accountability Act. The commission would be empowered to expand reporting requirements beyond stockholder needs to encompass data needed by other stakeholders – such as pollution emissions, wages and benefits paid, and corporate welfare received.
- Bar law-breaking companies from government contracts.
Earlier this year, both Enron and Arthur Andersen were suspended from contracting with the federal government. Yet suspensions like these remain far too rare, as companies with far worse records still feed at the government trough in massive amounts. Lockheed Martin, for example, has an outrageous 63 violations and alleged violations, yet its 1999 government contract awards totaled $14 billion. “There’s no reason to be giving a contract to a repeat violator,” says Rep. Carolyn Maloney, a New York Democrat on the House Government Reform Committee, who plans to introduce legislation requiring a central database of contractor violations.
Ultimately, contract suspensions or debarments should be required for companies who face more than one criminal conviction or civil judgment in three years – that’s the recommendation of the Project on Government Oversight (POGO) in its May report “Federal Contractor Misconduct.” Companies like Boeing with $14 billion in federal contracts, Raytheon with $8 billion, and General Electric with $1.6 billion, all have two dozen or more violations and alleged violations. If they faced threat of contract suspension, ethics would become a genuine bottom-line concern – which is the only way to make ethics real to these folks.
- Create a broad duty of loyalty in law to the public good.
Today a corporate duty of loyalty is due only to shareholders, not to any other stakeholders, and Enron behaved accordingly – using tricks to drive electricity prices up 900 percent in California and thus fuel a spike in the company’s share price. Such piracy against the public good would be outlawed under a state Code for Corporate Citizenship, proposed by Robert Hinkley, formerly a partner with the law firm Skadden, Arps, Slate, Meagher & Flom. His change to the law of directors’ duties would leave the current duty to shareholders in place, but amend it to say shareholder gain may not be pursued at the expense of the community, the employees, or the environment. (For an article by Hinkley in Business Ethics, seewww.DivineRightofCapital.com/change.htm.) A group has formed in Minnesota to pursue passage of the new law there, led by John Karvel.
- Find truly knowledgeable directors: Employees .
If we’re tired of boards with no “no inkling” of what’s going on, we should seek directors who have a clue. Who better than the people who work at a company every day? As directors, employees would be concerned with the long term and not next quarter. Since we don’t import people from outside the U.S. to govern the nation, why import people from outside companies to govern them? If the problem is that CEOs will appoint cronies, make board elections a real horse race: allow persons to self-nominate and run, being elected one by one, not as a slate. In short, get some real governance going. If Sherron Watkins had been on the Enron board, the whole scandal might have been averted.
Asian Development Bank Forum on Corporate Governance in Asia
As part of the Thirty-Fifth Annual Meeting of the Board of Governors of the Asian Development Bank a Forum on Corporate Governance in Asia was held in Shanghai, People’s Republic of China, on May 11 2002. The forum invited internationally known scholars and practitioners to share their views on the key challenges on improving corporate governance in Asia. As the final speaker, I was invited to offer my views on the shareholder activist movement and on good corporate citizenship. I would advise interested readers to contact the other panelists directly for information concerning their excellent presentations.
Dr. Shamshad Akhtar, Director of the Governance, Finance and Trade Division, East Asia and Central Asia Department of the Asian Development Bank acted as the moderator and graciously introduced the panel, summarized and added important points of her own.
Emeritus Professor Wolfgang Kasper, from the University of New South Wales and Senior Fellow at the Center for Independent Studies, asserted that universal, rather than case specific, rules of corporate governance inspire trust and lead to lower transaction costs, innovation and growth. But, he reminded us, the opportunism of managers and politicians will only be curbed when good rules are enforced effectively and consistently.
Professor Jinglian Wu is a Senior Research Fellow, Development Research Center of the State Council Professor of Economics, Graduate School of Chinese Academy of Social Sciences, a member of the Standing Committee of the Chinese People’s Political Consultative Conference, and is Chief Economist, China International Capital Corporation Limited (CICC). Professor Wu reminded us that even large dominate economies like the PRC need to improve corporate governance if they are to continue to attract enough Foreign Direct Investment to underwrite future growth. He expressed disappointment in China’s failure to move forward with a proposal to privatize state companies by turning over stock to support pensioners. China needs to implement laws and regulations that will provide the necessary incentives for management and will protect the rights of small/public shareholders.
George Dallas, Managing Director with Standard & Poor’s, informed us that his firm has developed a service that evaluates corporate governance practices. The corporate governance scores they assign will be an important new tool for investors in calculating potential risk. These scores will also provide an important source of objective feedback for companies and countries wishing to see where they stand relative to others on a global basis.
Dr. Nik Ramlah Nik Mahmood, Director of Policy & Development Division with Malaysian Securities Commission, described several innovations in Malaysia such as the new KLSE Listing Requirements for mandatory accreditation and training of directors.
Professor Larry Lang, Chair of Finance at the Chinese University of HK, used humorous examples of corporate governance incompetence from Hong Kong, China and other Asian countries and discussed improvements needed.
Post-Enron Observations on Corporate Governance
Quite frankly, Enron has left American investors scared and distrustful. The watchdog systems designed to protect us failed and that failure was widespread, extending to investment banking, auditors, regulators and business leaders in general, none of whom acted to prevent the actions that led to Enron’s fall. Take a look at the last two covers of BusinessWeek, our most popular business magazine. One headline reads, “The Crisis in Corporate Governance,” the other “Wall Street: How Corrupt is it?” There is a growing realization that the system is broken. To fix it, we need to reduce conflicts of interest and we need greater democracy both at the top, in the accountability of boards and CEOs, and at the bottom in the form of increased ownership and participation by employees.
There is no question that globalization of capital is on the rise. Countries and companies that seek to attract investors will need to attain ever higher scores by rating systems, such Standard & Poor’s, if they are to obtain low cost financing. Long term investors will seek markets where their legal rights are known and protected and where those using their money can be held accountable.
US investors are even more sensitive to issues such as fraudulent financial reporting, conflicts of interests and lack of auditor and director independence since the demise of Enron, once our 7th largest company. Countries with political stability, transparent accounting practices, shareholder rights, as well as employee protections, will attract long term investors who are willing to pay a premium for shares in well-governed companies.
Let’s examine the recent decision by CalPERS to pull out of several Asian markets. It wasn’t an aberration. I’ll talk about how standards at CalPERS are likely to change over time and I’ll close by noting some of what I see on the horizon.
You’ll have to be the judge of how these developments will impact Asia. The problems we face are different. In the US ownership is widely dispersed. That leaves management in control. Shareholders can loose everything if the CEO is unethical. In Asia, there is usually a dominant shareholder (either the state or a family). The problem is how to guarantee the investments/rights of minority shareholders. US industries are increasingly based on intellectual capital, while yours are more dependent on attracting cash investments. But knowledge work isn’t confined to office workers and even capital intensive industries benefit by putting all the brains of their employees to work. America and the emerging markets of Asia would benefit from something of a convergence and in greater democracy.
The Decision by CalPERS
CalPERS, the California Public Employees Retirement System, has assets of over $150 billion. As was widely reported in February, they announced they would be pulling out of several emerging markets: Indonesia, Malaysia, Thailand and the Philippines on ethical grounds.
Their standards assign a 50% weighting for the following factors:
- political stability
- financial transparency
- labor standards
The other half of the review is based on:
- market liquidity and volatility
- market regulation and investor protections
- capital market openness
- settlement proficiency
- transaction costs
Their investments in Asian emerging markets were relatively small to begin with: under $100 million each in Indonesia, the Philippines and Thailand, with a little more in Malaysia. So, was it important?
Yes, without a doubt, CalPERS is a leading indicator of policies that will eventually apply to a larger segment of US investors, and to others around the world well. I understand that each of the affected countries sent delegations to Sacramento, California to plead with CalPERS to reverse their decision. At an April 19th meeting, the Filipino delegation, led by their Secretary of Finance Jose Isidro Camacho, succeeded in convincing CalPERS that it meets their guidelines. They’ll be taken off the blacklist next week.
Pension funds in the US hold a little over 25% of our market. They tend to be long term investors (holding stock for 7-8 years), while most mutual funds turn over their portfolio’s at a rate of 85% a year. CalPERS doesn’t sell when the market goes down or another type of investment comes into fashion. Many pension funds, like CalPERS, are controlled in part by labor unions and their members. At CalPERS, members directly elect almost 1/2 the board. 20-30 years ago union members started waking up to the fact that our pensions were often invested in companies with “unfair” labor practices that were undermining our jobs or, in the case of public funds, the taxbase that pays for our jobs.
At about the same time, our Department of Labor issued a directive that required pension funds to pay attention to how their votes cast in corporate elections. DOL required that proxies be voted in the interest of plan beneficiaries, not the money managers.
During the last ten years, unions and their pension funds have become the leading proponents of shareholder resolutions. Unions know how to organize winning campaigns at shareholders meetings, in the press and with the public. Our pension funds are becoming a more important organizing tool than the threat of a strike.
Typically, large pension funds like CalPERS have used a strategy of buying a little of almost the entire listed market and holding. When company performance lags over a long period, CalPERS doesn’t sell because selling would only drive the price of their large holdings down further. Instead, they work with other investors to target those companies for change. They negotiate with management. If that doesn’t work, they file resolutions to encourage more independent boards and other best corporate governance practices. Sometimes they’ve backed dissident slates … voting out board members and CEOs.
Another fast growing segment of the US market is SRI (socially responsible investment) funds. Religious and other nongovernmental organizations led the way in making corporations and the public more aware of social impacts. Churches began introducing resolutions at shareholders meetings, for example to get Dow Chemical to stop producing napalm when we were at war with Vietnam, and later to get Nike to improve labor conditions at their factories. Mutual funds catering to SRI investors developed screens for whatever they thought was sinful or unethical – tobacco, unfair labor practices pollution, etc. Typically, they don’t buy shares in companies that try to profit from activities they don’t approve.
The U.S. leads the way in “ethical investing” with $2.03 trillion invested in a “socially responsible manner” in 2001, or 10 percent of the $19.9 trillion funds managed. However, Britain and Germany have in the past two years issued laws requiring pension funds to state their position on social, environmental and ethical issues. I understand that France is set to follow suit.
A month or so ago, the Chairman of the Securities and Exchange Commission (Mr. Pitt) clarified in writing that the same policy that applies to pension funds (proxies must be voted in the best interest of shareholders, not money managers) also applies to mutual funds (which hold almost another 25% of the market). This will put some pressure on all funds to examine their voting practices.
Pension funds are becoming more like SRI funds. Members of employee/labor influenced funds, such as CalPERS want them to reflect their values. They are starting to screen out markets and companies that don’t provide minimum protections to investors…of the kind Mr. Dallas has described, and they are doing it first primarily in emerging markets, where risks are perceived to be the greatest. But this trend will probably extend to domestic markets as well.
We’ve already seen evidence of the shift to SRI considerations when CalPERS sold off its tobacco stocks. Sure, they wanted to avoid the risks inherent in tobacco lawsuits but many members of the system are public health workers who want better alignment between their values and the practices of their pension fund. During the day, we’re working to convince kids not to start smoking and to help adults quit. Our pension fund shouldn’t be investing our money to bet against our success at work.
CalPERS should have either sold its investments in Enron much earlier or should have used its corporate governance clout to change their behavior. Enron was a known tax dodger and they helped bring about an energy crisis in California. It is not in the best interest of public employees to invest in companies that avoid taxes or that manipulate markets to defraud consumers. As public employees, we depend on taxes and we spend much of our working lives trying to get companies to obey both the letter and the spirit of the law.
As governments and market forces institute reforms, CalPERS and other funds will get more sophisticated in their approach. Country ratings should be used in tandem with corporate ratings. Combining the country’s score with a given company’s score would more accurately measure risk. CalPERS would still invest substantially more in countries with transparency, political stability and good labor practices. However, exceptional corporations in difficult environments would not be completely out of bounds. CalPERS practices engagement in the US market; many of us believe it should do the same in emerging markets.
On the SRI side. Mutual funds are using more sophisticated screens. Instead of banning entire industries, more are moving to eliminate the worst offenders or invest in companies with best practices. This will be combined with corporate governance and social activism, resulting in a double payoff; better economic returns and social reforms.
Here’s an example. Innovest, an investment advisor, found that the top half of firms ranked by environmental sensitivity outperformed the bottom half by up to 21.8% over a two year period, depending on industry. Their Eco-enhanced S&P 500outperformed the actual index by 11% over the same period. SRI funds and pension funds like CalPERS will use Innovest’s information to screen out the worst offenders and enhance their return.
At the same time, social activists, such as the Rose Foundation for Communities and the Environment, are drawing attention to a 1998 study by the US Environmental Protection Agency that revealed 74% of companies failed to meet SEC disclosure requirements regarding environmental liabilities that exceed $100,000. Only once in the past 25 years has the SEC taken action to enforce the disclosure of environmental liabilities. The Rose Foundation wants the SEC to require that companies aggregate environmental liabilities so that more must report….and it is leading a movement to have the law enforced. Enforcing the law will further improve the return of investments in companies that are already acting more responsibly.
Enron and the events of 9/11 are accelerating a merger of interests between the worlds of corporate governance and social resolutions. This season finds “crossover” resolutions that fuse corporate governance and social issues. Examples include resolutions asking for increased racial and gender diversity on corporate boards, and those asking for executive compensation to be linked to corporate social responsibility. Robert Monks, prominent in corporate governance, is now working in conjunction with the ExxonMobil campaign to address global warming and split the CEO and Chair.
Enron and Arthur Anderson have raised the stakes. The SEC has traditionally banned shareholders resolutions on such “ordinary business” practices as choosing an auditor. But many now see that “voting mindlessly with management is no longer classified as the responsible thing to do.” (as SIF Chairman Timothy Smith recently noted)
As I have mentioned, the law requires pension funds to vote shares in the best interest of beneficiaries. However, that law has never been enforced. Now we have a pronouncement by the head of the Securities and Exchange Commission that the same fiduciary law applies to mutual funds; voting rights must be treated as an asset, not as a mechanism for money managers to get more business at the expense of shareholders.
Enforcement won’t happen until it is easy to recognize how to vote in the best interests of shareholders. That’s where research findings will come into play. Disclosure should also be required. How can we hold our pension and mutual fund fiduciaries accountable unless we know how they vote?
We’re going to see more reports that point to the need for greater democracy and eventually the laws requiring votes to be cast in favor of pension fund beneficiaries and mutual fund owners will be enforced.
“Corporate Governance and Equity Prices” is the title of a study by Paul A. Gompers, Joy L. Ishii, Andrew Metrick, published in August 2001 supports the need for greater democracy at the top…to reduce management entrenchment.
They used 24 corporate governance provisions to build a proxy for shareholder rights. These fall broadly into the categories of
- tactics for delaying hostile takeovers,
- voting rights,
- director/officer protections
- state laws
They looked at 1,500 firms and found a striking relationship between corporate governance and stock returns. Firms in the lowest decile of the index (strongest shareholder rights…the democracy portfolio) earned 8.5% higher returns than firms in the highest decile of the index (weakest shareholder rights…the dictatorship portfolio) during the 1990s. Furthermore, they found that weaker shareholder rights are associated with lower profits, lower sales growth, higher capital expenditures, and a higher amount of corporate acquisitions. Pension and mutual funds that vote in favor of weakening shareholder rights could now face legal action.
Other studies demonstrate the need for greater democracy at the lower rungs of the corporate ladder are equally, if not more, important. Firms with significant employee ownership and participation in decision making grew 8 to 11% faster than their counterparts (NCEO, 1986). The GAO found that such firms experienced a 52% higher annual productivity growth rate.
In the U.S. tangibles contributed by capital, such as property, plant and equipment, accounted for 62% of the total value of mining and manufacturing firms in 1982 but only for 25% more recently. Intangibles contributed by employees, such as labor, patents and trademarks, now contribute 75% of the total value.
A 1998 report, “Corporate Governance: Improving Competitiveness and Access to Capital in Global Markets,” written by an advisory group to the OECD (led by Ira Millstein), concluded: “The more important human capital is to a business, the more those investors should stand to gain – or lose – and the greater voice they should have in governing it.”
Those who vote against measures designed to empower workers will in the not too distant future face lawsuits for not voting in the interests of shareholders.
Alan Greenspan, Chairman of our Federal Reserve Board,recently addressed the need to restore public trust in the governance of corporations after Enron. His is a pessimistic assessment of the situation. According to Greenspan, the “CEO-dominant paradigm, with all its faults, will likely continue to be viewed as the most viable form of corporate governance for today’s world. The only credible alternative is for large–primarily institutional–shareholders to exert far more control over corporate affairs than they appear to be willing to exercise.” Further, “if the CEO chooses to govern in the interests of shareholders, he or she can, by example and through oversight, induce corporate colleagues and outside auditors to behave in ways that produce de facto governance that matches the de jure shareholder-led model.”
It is unfortunate that Mr. Greenspan appears to place more importance in appearances than in reforms that would give shareholders more real rights. Mr. Greenspan is probably correct in his short term assessment of the politics of the situation but institutional investors have made a difference and will again. One area where they’ve made an enormous difference is in CEO pay…but in the wrong direction.
CalPERS had helped set up the Council of Institutional Investors, whose members control well over a trillion dollars in assets. They wanted to be able to communicate more freely with each other concerning corporate governance issues but an SEC rule required them to file a lot of paperwork and made strategizing on corporate campaigns impractical.
At the time, there was a large public outcry about CEO pay and the fact that it kept rising, even when company profits fell. In order to get a change in the SEC rules, CalPERS and others agreed to support the more popular notion that executive pay should be linked to performance. Unfortunately, that language was poorly crafted and the unintended result was that while workers’ pay rose 28% in the 1990s, CEO pay rose 443% and there doesn’t seem to be much of a correlation between performance and compensation. Now CEOs are earning 500 times what their workers make and CEOs are still getting raises when their companies underperform.
Lesson: Watch out for unintended consequences.
So, what reforms are on the horizon? Here are a few.
- Transparency. We will continue to work for transparency in all aspects of corporate operations, including disclosure of off-balance sheet debt and offshore tax havens.
- The Audit. The integrity, independence and reputation of the audit must be restored. Auditors won’t also be able to serve as the firm’s a business consultant and should be rotated periodically.
- Campaign Finance Reform. Corporate donations corrupt the one-person one vote system of political democracy. We’re making strides but money will find other routes.
- Boards of Directors. Boards will be closely monitored for independence, diversity, interlocking positions and conflicts of interest. CEOs shouldn’t chair Board of Directors.
- Executive Compensation. Pay shouldn’t be so linked to share and option price that executives put their own short-term gain over the long-term health of the company. Stock options should be expensed. In 2000, the net profits of Standard & Poor’s 500-stock index companies would have been 9% lower reported, according to Bear, Stearns & Co.
- Professionals. Too often accountants and attorneys represent senior management, not the company. Professional organizations must do a better job through education and discipline to minimize these abuses.
- Role of Stock Exchanges. The New York Stock Exchange and NASDAQ should impose stronger standards for director independence and education, shareholder approval for all material equity plans, and policies that seek out conflicts of interest.
Unlikely Anytime Soon, But Sorely Needed
- Tax Policies. We need to encourage long-term ownership… perhaps through increase in short-term capital gains tax.
- The law should require that employees get to elect the trustees for their 401(k)s and pension plans; it’s a simple matter of democracy and controlling our destiny.
- Broker voting should be eliminated. Currently, if shareholders don’t vote their proxies within 10 days of the annual meeting, their brokers will for them…always in favor of management’s recommendations.
- Board elections. The SEC prohibition against using the resolution process to nominate directors must go. The only way shareholders can run candidates is to pay for a solicitation, while the current management uses our funds to tout their candidates on the company proxy. When this prohibition happens, you’ll know the shareholder revolution has been finally won.
Thank you for the opportunity to address such a distinguished audience. If any of you are ever in Sacramento, California please look me up. I’ll take you to lunch. In the meantime go to CorpGov.Net on the Internet and drop me an e-mail. Let’s keep in touch.
Institutional Investors Roundtable
Nicholas Brady, chairman of Darby Overseas Investment, Ltd. and former secretary of the US Department of the Treasury from 1988 to 1993 under presidents Reagan and Bush, indicated that China must address its nonperforming loans and develop and credit culture. He led off the discussion with seven points learned in resolving the savings and loan industry crisis.
- The health of the banking sector is key to economic recovery and development.
- The cost of fixing the crisis increases over time.
- Regulatory measures that undermine the banking system must be addressed.
- No single solution is appropriate for all countries.
- The most essential ingredient is political courage.
- No help will come from the economic interests that caused the crisis.
- Be bold; time is your enemy.
Robert D. Hormats, vice chairman and managing director of Goldman Sachs (International) and former assistant secretary of state for economic and business affairs, discussed the fact that corporations and governments would be rated on risk factors. He suggested the possibility of Fannie Mae type institutions to pool together nonpermforming loans. Hormats stressed the need for more Asian firms to increase the proportion of outside directors, deal fairly with minority shareholders and reduce conflicts of interest.
Barry Metzger, of Coudert Brothers and formerly General Counsel of the Asian Development Bank, commented on Enron/Anderson. Even in the best systems there will be Enrons because of greed. Accountability will come about through fines, awards of damages and jail. Institutional investors have a responsibility to help address the need for stronger contract rights to protect their investments. When questioned about the environment, he responded by nothing the big race won’t be for dollars but for talent and talented people want to live in a healthy environment. Javed Hamid of the World Bank added that companies who meet World Bank environmental standards and corporate governance best practices find that the extra due diligence reduces risk and adds value to the bottom line.
Hubert Neiss, chairman of Deustche Bank’s Asia Pacific Head Office and formerly with the International Monetary Fund, indicated banking reforms are needed, along with further deregulation, transparency and governance reforms. The latest global slowdown did not result in a major financial crisis in Asia due previous actions, such as:
- Expansionary fiscal policies.
- Structural reforms.
- Flexible exchange rates.
- Foreign exchange reserves had built up.
- The U.S. Recovery was driving up Asian exports and he projected a further rise.
Mark Mobius, president of Templeton Emerging Markets Fund, pointed to the need for organizations in other countries to duplicate the work of Professor Ha-sung Jang and the People’s Solidarity for Participatory Democracy (PSPD) organization in Korea go rotect minority shareholders’ rights and foster transparent corporate governance.
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A major study from Claros Consulting will show that ExxonMobil’s attitude towards global warming could cost the company’s shareholders billions of dollars in coming years. The Claros Consulting report finds that ExxonMobil’s climate-change strategy involves unnecessary risks and missed opportunities – and is helping its competitors more than ExxonMobil itself. Commissioned by shareholder activist Robert A.G. Monks, CERES and Campaign ExxonMobil, the study also details the five steps shareholders can take to encourage ExxonMobil management to act responsibly on climate change. The release of the report comes about one month before ExxonMobil shareholders will vote on two related resolutions at the company’s annual stockholder meeting on May 29, 2002. Speakers during the live, two-way media briefing (including Q&A) will be:
- Shareholder activist Robert A.G. Monks, publisher of RAGM.com and founder of Institutional Shareholder Services.
- Report author Mark Mansley, Claros Consulting of London, England.
- Peter Altman, national coordinator of Campaign ExxonMobil.
- Ariane van Buren, senior project manager of the Sustainable Governance Project at CERES.
TO PARTICIPATE: A live, two-way telenews media briefing will take place at 1-800/966-6338 (or 1-415/217-0050 outside the U.S.) at 1:30 p.m. EDT on May 2, 2002. Ask for the “ExxonMobil study” or “global warming” call. To ensure that you hear the media briefing from the beginning, make sure to call in by 1:25 p.m.
CAN’T PARTICIPATE?: A streaming audio recording of the news event will be available on the Web as of 6 p.m. EDT on May 2nd at www.hastingsgroup.com/shareholderstudy.html.
FOR MORE INFORMATION, CALL: Stephanie Kendall, 703/276-3254 or [email protected].
Options Aren’t Free
Stock options accounted for 58% of CEO pay at big American companies last year and diluted corporate equity at America’s top 200 corporations by 16.4% of total shares outstanding as of 2000. Accounting treatment of options has overstated profits by a little over 10% in 1998 but this has risen to an average of 19.7% in 2000 and a staggering 72.8% in the case of information-technology companies. Unlike wages and other benefits, options are not subtracted from current earnings. President Bush’s suggestions for improving corporate governance avoided the issue. But the International Accountancy Standards Board will produce a new draft standard on options in the autumn. According the The Economist, “There are no good arguments for continuing to pretend that options cost nothing. The rules should at last reflect reality.” (An expense by any other name, 4/4/02)
According to a report by Bloomberg News, Andersen’s apparent unwillingness to sound warnings about Enron’s financial health was not unusual. In 54% of the 673 largest bankruptcies of public companies since 1996, auditors provided no warning in annual financial statements before the bankruptcy filing. System Software Associates, for example, was given a clean audit, even though the company was being investigated by the SEC for alleged accounting fraud.
Investors lost $119.8 billion in the 10 largest bankruptcies following audits that raised no concerns. Bloomberg also noted that Andersen actually issued audit warnings before bankruptcies more often than any of the Big Five accounting firms. Bloomberg also found that auditors are much more likely to raise concerns with small rather than large companies. The implication: professional services firms don’t want to risk losing big accounts by issuing warnings. In the 50 largest bankruptcy cases since 1996, only 14 of those companies received an auditor’s caution letter. Auditors issued caution letters to 70% of the 50 smallest companies that declared bankruptcy. (seeTeetering on the Brink at CFO.com)
Survey Results on Board Compensation
BoardSeat, a Silicon Valley search firm that specializes exclusively in board director and advisory board searches and consulting, published a report on the compensation and administration of boards of directors and advisory boards of venture capital-backed companies. Call 415-648-0808 to order. A few highlights are as follows:
- 68.8% of companies that had raised $10 million or less have an advisory board as compared with only 37.5% of companies that had raised $50 million or more. There is a wide range in the number of advisors retained by companies, with the average advisory board size being about five members.
- 84% of companies compensate independent directors with stock options only
- Only 6.6% of companies compensate investors for sitting on the board of directors
- 38% of companies have no independent directors
- Just over half the companies surveyed hold directors and officers’ insurance
- 73% percent of very early stage companies hold monthly board meetings
CalPERS Focus List
CalPERS’ new Focus List consists of only five companies. They include: Lucent Technologies of Murray Hill, New Jersey; NTL, Inc. of New York, New York; Qwest Communications of Denver, Colorado; Cincinnati Financial Corporation of Cincinnati, Ohio; and Gateway Computers of San Diego, California. However, CalPERS is closely monitoring four other companies. Possible actions regarding the companies will be disclosed throughout the proxy season.
“Focus List” companies were selected from the pension fund’s investments in more than 1,800 U.S. corporations, and was based on the companies’ long-term stock performance, corporate governance practices, and an economic value-added (EVA) evaluation. EVA measures a company’s after-tax net operating profit, minus its cost of capital. By using EVA and stock performance, CalPERS has pinpointed companies where poor market performance is due to underlying financial performance problems as opposed to industry or extraneous factors.
Gateway Computers, for example, has some of the worst performance in its industry. The California developer of desktop and portable personal computers underperformed all comparison indices and its direct competitors last year. The company turned in a loss of 55% for the one-year period ended 12/31/01 and showed little profitability between 1998 and 2000. An EVA evaluation performed for CalPERS by Stern Stewart & Associates revealed that Gateway’s cumulative EVA for the three-year period was a negative $141 million.
Gateway’s poor governance practices include a lack of complete independence on the company’s audit and nominating committees, a classified board and a recently adopted poison pill. The CEO and Chairman Theodore Waitt also chairs the Nominating Committee. Gateway has not answered requests from CalPERS to meet, citing that letters take a month to read and are responded to if they are “worthy.”
CalPERS filed a shareholder proposal to declassify Gateway’s Board and require annual elections of all directors. It also filed the same proposal at NTL, Inc., but given the company’s restructuring, a vote may never come to pass.
CalPERS is also outraged at recent reports that Qwest’s Chief Executive Joseph P. Nacchio received a $1.5 million bonus last year and a $24 million cash payout, during a period when the company is cutting jobs and its performance has fallen. “These decisions demonstrate blatant disregard for shareholders,” said Mark Anson, CalPERS Chief Investment Officer. “We have lost complete confidence in Qwest’s management and board.”
Qwest also has a number of egregious conflicts of interest. There have been multiple reported business transactions between Qwest and the Anschutz Company, where Qwest’s Chairman and Founder Phillip F. Anschutz also sits as a director and Chairman. CalPERS plans to vote against any Qwest director up for re-nomination this year.
NTL, Inc. has corporate governance issues that show particular disregard to its shareowners. The owner and operator of broadband communication networks has underperformed its peers by approximately 292% for the five-year period ended 7/31/01 and has underperformed the broad market by nearly 144%. NTL also recently announced a massive debt-for-equity swap that CalPERS believes will severely impact common stock holders.
NTL’s Board does not allow shareowners to call special meetings, has re-priced options in recent years for a handful of executives, and is replete with interlocking directors.
Lucent Technologies is refusing to adopt a shareholder proposal to declassify its board that passed by a shareholder majority vote last year. CalPERS has already voted against Lucent compensation committee directors Paul A. Allaire and John A. Young for awarding the company’s former CEO, Richard McGinn, an excessive severance package.
Cincinnati Financial Corp. is also on the list for poor corporate governance pitfalls. More than half of Cincinnati Financial Corporation’s Board is comprised of inside or affiliated directors.
A PricewaterhouseCoopers survey reported in Investor Relations Business found that, although institutional investors hold 60% of the shares at most major companies, they don’t wield much influence. Of company executives surveyed, 34% said the influence of institutional investors is neutral and over a quarter said they have no influence at all! The vast majority put this down to good investor relations – keeping institutional investors informed about long-term strategies. The 10 largest institutional investors typically own 27% of large firms; the top 5 own just under 20% and the largest holds a 9% stake. (IRB, 4/22/02, Many Institutions Take a Back Seat)
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Kennesaw Weighs in on Corporate Goverance Reforms
Enron, Global Crossing and other recent debacles have stirred a great deal of thinking in recent months. Kennesaw State University’s Corporate Governance Center released a set of17 principles “to advance the current dialogue and to promote investor, stakeholder, and financial statement user interests.” Dana R. Hermanson, Director of Research, notes “we believe that these principles should be at the heart of current efforts to reform corporate governance and financial reporting in the wake of the Enron disaster.” Paul D. Lapides, Director of the Corporate Governance Center indicates the principles are offered “to promote investor, stakeholder, and financial statement user interests.” Most of the recommendations are fairly standard fare for post-Enron reviews (directors should be independent, audit firms should perform no consulting for audit clients, etc.) but several are either long overdue reforms or are building cutting edge consensus:
- The current GAAP financial reporting model is becoming increasingly less appropriate for US public companies. The industrial-age model currently used should be replaced or enhanced so that tangible and intangible resources, risks, and performance of information-age companies can be effectively and efficiently communicated to financial statement users.
- The roles of Board Chair and CEO should be separate.
- Analysts should not be compensated based on their firms’ investment banking activities.
- Corporate management should face strict criminal penalties in fraudulent financial reporting cases. The Securities and Exchange Commission should be given the resources it needs to effectively combat financial statement fraud.
The Center draws on a distinguished list of staff, fellows and advisors. Their major strengths in the area of accounting are getting a lot of attention as a result of Enron.
Corporate Boards Should Focus on Performance, Not Conformance
After the corporate governance revolution of the 1990s that led to a new era of accountability to shareholders, the Enron debacle has brought new attention to the role of corporate boards and governance. Board members increasingly realize the need to act more vigorously to hold managements accountable. They are more likely to actively probe areas such as conflicts of interest and compensation of top executives. At the same time, however, would-be reformers must guard against going too far and imposing rules that tie managements’ hands.
These were some key issues that Wharton professors and a former CEO of Campbell Soup discussed at a session on corporate governance in Philadelphia as part of the Wharton Fellows program.
Proxy Voting Is a Fiduciary Duty, Pitt Says
The head of the Securities and Exchange Commission, Harvey Pitt, has asserted that money managers should view their corporate proxy votes as a fiduciary duty in a private letter to a former affiliate of LENS. The letter was in response to a 1988 request for guidance. In the letter Pitt explained that “an investment adviser must exercise its responsibility to vote the shares of its clients in a manner that is consistent with the general antifraud provisions of the Advisers Act, as well as its fiduciary duties under federal and state law to act in the best interests of its clients.”
“We have asked every SEC chairman since 1988 about this” and delivered each a copy of the 1988 letter, recalled Nell Minow, a former Lens principal who now runs the Corporate Library. Investment managers “are going to have to justify every [proxy] vote they make,” Ms. Minow said. “The fact that management recommends it won’t be enough.” The move will certainly be used by activists to persuade mutual funds and others to vote in the best interests of fund holders. Let’s hope it has an impact similar to DOL’s Avon Letter of February 23, 1988. (WSJ, 3/21)
Reforms Needed Post-Enron
Joan Bavaria, President and CEO of Trillium Asset Management, founding Chair of CERESand co-founder the Social Investment Forum recently offered Ten Responses to the Enron Crisis for Socially Responsible Investors, summarized and annotated here as points 1-10. Appearing before the House Financial Services Committee Subcommittee on Capital Markets, Insurance, and Government Sponsored Enterprises, Peter Clapman, senior vice president and chief counsel for corporate governance of pension and financial services provider TIAA-CREF commented on five major areas in need of reform, summarized here as points 11-15. Since many more reforms are needed, I took the liberty of adding four of my own recommendations.
- Transparency. We need to continue to work for more transparency around all aspects of corporate operations. “Transparency” of the future will include more disclosure of such items as off-balance sheet debt and secret off-shore tax havens. A coalition known as the Corporate Sunshine Working Group is pushing the Securities and Exchange Commission to require greater disclosure from companies on their environmental liabilities. CERES and the GRI have made gigantic strides around the environment and other sustainability issues.
- The Audit. The integrity, independence and reputation of the audit must be restored. We must fight against the conflict of interest inherent when the auditor also serves as a business consultant.
- Ed. note: One of the more innovative approaches to ensure auditor independence was introduced at Fleetwood Industries by Mark Latham of the Corporate Monitoring Project. Latham’s proposal would let shareowners vote to select the auditor, not just ratify a firm selected by the board of directors. Latham believes competing to please shareowners rather than directors who often serve at the pleasure of management, would create “new pressure for higher standards and tougher audits.”
- Off Balance Sheet Transactions. Socially responsible investors might consider careful scrutiny of the balance sheet as part of routine social analysis, looking for signs of off-balance sheet or hidden transactions. Responsible companies have nothing to hide.
- Campaign Finance Reform. Once campaign finance reform legislation has passed, socially responsible investors should begin to ask companies for information on their contributions, even if they are channeled to obscure non-profits in lieu of political parties or politicians.
- Boards of Directors. Boards should be closely monitored for independence, diversity, interlocking positions and conflicts of interest. Board compensation should not be so excessive as to discourage questions and dissonance in Board meetings. The CEO of a company should not also chair the Board of Directors.
- Executive Compensation. Top managing executives’ pay should not be so linked to the short-term valuation of shares and options to tempt managers to foreclose on the future of a company for the benefit of their short-term enrichment. Shareholders should continue to advocate more balanced compensation plans. According to United for a Fair Economy, after nearly two decades of real wage declines, workers’ pay rose 28% in the 1990s (before adjusting for inflation). Meanwhile, CEO pay has rose 443%.
- Ed. note: An increasing abuse is the use of zero-cost collars to hedge their bets on stock options. As Charles M. Elson, director of the University of Delaware’s Center for Corporate Governance: “It’s like a baseball player betting on the other team. If the executive is collaring, shareholders should be aware of it.” Hedging undermines the purpose of performance-based pay, since it cuts the risk of ownership. Unlike an outright sale of stock, investors rarely learn of hedging transactions because they are reported to the SEC on Form 4, and are rarely filed electronically. They’re not included in other company filings, such as the proxy or 10-K reports. Most services that provide insider-trading data to investors fail to pick up such transactions.
- Ethics Policies. Internal ethics statements and policies should be scrutinized, disclosed and discussed at shareholder and Board meetings. Mere disclosure does not guarantee compliance. We can ask companies how they monitor internal compliance.
- Tax Policies. The SRI community should put its weight behind all efforts to increase the short-term capital gains tax or otherwise change the tax structure to encourage long term ownership of stock. The short-term focus of Wall Street causes honest corporate managers to eye Wall Street minute by minute when they should be looking out for the long-term welfare of their company.
- Ed. note: I’d like to see the SRI community also taking shareholders actions to encourage corporations to pay their taxes or even screening out investments in habitual tax evaders. Enron not only avoided paying income taxes in four of the last five years (they paid $17 million in 1997), using almost 900 subsidiaries in tax-haven countries and other techniques, it also collected $381 million in tax “refunds.” They wiped out much, if not all, of their tax liability despite reporting nearly $2 billion in profits from 1996 through 2000. That’s not a good SRI record as far as I’m concerned. From 1995 to 2000, corporate earnings jumped by more than a third, but taxes rose by only about 17%. The tax code has become so riddled with loopholes that tax avoidance has become a profit center of its own. Reforms are desperately needed.
- Renewable Energy. Socially responsible investors should continue to advocate sustainable sources of energy. Distressingly left out of most of the public debate around Enron, energy issues sit at the heart of both this scandal and the terrorist acts of the fall. This country is dependent on external sources for what remains the essential plasma of our economy and life style. There has been a distressing step backwards away from support of alternative clean fuels.
- Sustainable Investments. The SRI community should advocate legislation that requires pension managers to ask companies in which they invest for long-term planning that addresses sustainability issues (environment, human rights, community interaction).
- Conflicts of Professionals. Too often accountants and lawyers ostensibly representing the company, in fact, wind up representing only its senior management such as at Enron. Professional organizations must do a better job through education and discipline to minimize these abuses.
- Regulation of Accounting Profession. An independent board should oversee the accounting profession with its own funding source and with the legal authority to enforce rules and impose sanctions for wrongdoing. TIAA-CREF also favors periodic rotation of a company’s auditors and not using the same firm for accounting and consulting services.
- Executive Compensation. Reforms are needed to require that the cost of stock options be reflected in financial statements and that shareholder approval for dilutive stock option plans be in place.
- Role of Stock Exchanges. The New York Stock Exchange and NASDAQ must be an important engine for change. The exchanges must impose stronger standards for director independence and education, shareholder approval for all material equity plans, and policies that seek out conflicts of interest.
- Education of Directors. Not all individuals are qualified to be directors in today’s complex market place simply because they are asked to serve. Audit Committee directors only recently had to meet a standard of financial literacy — literally the ability to understand a financial statement. Compensation committee directors often do not take a proactive role on behalf of the company because they lack an understanding of issues and do not hire independent consultants when needed. Stock options overuse and abuse stems from the inadequate performance of many compensation committees and the board as a whole.
- Options. Their costs need to be not only reported but expensed. If the estimated cost of options were taken as an expense against earnings in 2000, the net profits of Standard & Poor’s 500-stock index companies would have been 9% lower reported, according to Bear, Stearns & Co. Properly accounting for options is not easy but ignoring their costs is the wrong solution.
- Employees should get to elect the trustees for their 401(k)s and pension plans; its a simple matter of democracy and controlling your destiny.
- Voting. Broker voting should be eliminated. Currently, if shareholders don’t vote their proxies within 10 days of the annual meeting, their broker will vote for them…always in favor of management’s recommendations. Second, institutional voting must be in the investors interest. Since 1988 Department of Labor has held that voting rights must be voted in the interests of members and beneficiaries, not plan sponsors. That rule should be enforced and extended to mutual funds and other institutional investors. The rule should also require disclosure. How can we hold our pension and mutual fund fiduciaries accountable unless we know how they vote? Third, not really a reform but we need a third-party provider to consolidate the voting advice of CALPERS, Calvert, Citizens, Domini Social Investments, Meritas Mutual Funds, MMA Praxis, Pax World Fund and others who will surely follow.
- Board elections. The SEC prohibition against using the resolution process to nominate directors must go. The only way shareholders can run candidates is to pay for a solicitation, while the current management uses our funds to tout their candidates on the company proxy.
Poor Showing for India
Indian blue chips garnered poor ratings in a Standard & Poor’s survey of transparency and disclosure at 350 prominent Asian and Latin American companies. The survey awarded 10 possible points on a basis of 98 information attributes grouped into 3 categories: financial transparency and information disclosure; investor relations and ownership structure; and, board and management structure and processes. Nineteen out of the 43 Indian companies surveyed, including Hindustan Lever, Hindustan Petroleum, ITC, the State Bank of India, and Reliance Industries, received a score of 4. Six Indian firms, including Mahanagar Telephone Nigam Ltd., Reliance Capital, Sterlite Industries, Raymond and Silverline Technologies, each scored 3, while Cipla walked away with a paltry 2. Conversely, Infosys Technologies and SIS scored 7, a score which no other Indian corporations equaled. (The Corporate Library)
Shareowner Action Center updated for 2002
SocialFunds.com recently updated its online Shareowner Action Center with new information from the Investor Responsibility Research Center. The new IRRC Proxy Voting Checklistprovides summary information on all corporate social policy shareowner resolutions filed in the United States for the 2002 proxy season. Issues raised in these resolutions address energy and the environment, fair employment, global labor standards, executive pay, board diversity, and a host of other issues. The IRRC checklist includes the company name, annual meeting date, resolution subject, and sponsor (including resolutions withdrawn or omitted). To date, the IRRC Proxy Voting Checklist includes 271 resolutions filed with 177 US companies for 2002, by far the largest list available on the Internet without charge.
I only wish they had included resolutions on all issues. I’ve always believed that corporate governance defenses, which aim to further entrench management, should also be of interest to those concerned with social issues. If we spent more effort addressing the root of the problem, undemocratic corporate governance, we wouldn’t have so many symptoms to deal with.
The checklist in the Shareowner Action Center will be updated with voting results in early June. For more immediate information, contact IRRC.
Federal Class Action Suits Surged in 2001
Post-Reform Act settlements average almost $25 million, up from $8 million Pre Reform Act, and rise significantly if an accounting firm or underwriter is also a defendant.
The 327 federal securities class action litigation suits filed in 2001 represent a 60% increase over the number of filings in 2000, and the companies sued lost a total of more than $2 trillion in market capitalization during the class periods, a 157% increase from the market capitalization loss during the class periods for the 204 companies sued in 2000, according to the figures released by the Stanford Law School Securities Class Action Clearinghouse in cooperation with Cornerstone Research. The 327 cases do not include an additional 138 securities class actions filed in 2001 alleging fraud in the IPO underwriting process with no additional allegations. The IPO cases were analyzed separately.
Earnings Overstated by $130 Billion
US firms may have overstated their earnings by $130 billion, according to the London-basedCentre for Economics and Business Research (CEBR), which believes that accounting practices are “less rigorous” in the US than they are “elsewhere.” “There is a systematic bias toward making profits look rosier than the underlying economics might suggest,” according to DEBR Director Mark Pragnell. Investor Relations Business (IRB) 3/11, carries an interesting commentary on the report and notes, “if the report’s claims about corporate overstatements are correct, the Dow Jones Industrial Average’s current range of 7,500 to 9,500 is some 2,000 points higher than they should be.” Pragnell attributes the source of the problem, in part, to the link between executive pay and performance.
Worried? You could sell your stock or resign from the board but you might do better by reading Zabihollah Rezaee’s timely book Financial Statement Fraud: Prevention and Detection. This will be especially helpful to boards of directors and audit committees so you’ll know when accounting practices are going over the line.
In 1999 the Committee of Sponsoring Organizations of the Treadway Commission (COSC) identified 300 public companies involved in alleged financial statement fraud. They found CEOs and CFOs linked in 83% of the cases. Most had been audited by one of the Big Five. Enron and a skeptical market call for more conservative reporting. Rezaee takes you through familiar cases such as Waste Management and Sunbeam but also goes to the cutting edge of electronic reporting using XBRL taxonomy, which enables online and real-time disclosure of financial information…thus, providing a tremendous aid in addressing the SEC’s Fair Disclosure regulation. Equal and simultaneous access, I hope that’s where we’re headed.
In the meantime, Mr. Rezaee reminds us to:
- Employ senior execs who are knowledgeable about financial reporting.
- Directors need to pay special attention to pressures caused by pay for performance incentives.
- Develop and attitude of professional skepticism.
- Pay close attention to integrity and reputation issues.
- Monitor opportunities and motivations for management to override internal control structures (don’t waive your ethical code like the Enron board did).
- Appoint knowledgeable, experience, and independent directors
Another good source for insights on the subject is Ralph Ward’s Boardroom Insider. Ralph reminds us that even “America’s gold standard of supermarket tabloid trash,” the National Enquirer, recently featured “Enron: Adultery, Greed, How they ripped off Americans!” Accounting fraud is right up there with two headed space monkeys. Of course, its also grabbing headlines at C-SPAN, CNN and CNBC. The latest issue gives the following advise on outside auditors
- Is the outside audit firm performing any of the inside audit functions, and if so, how many? Enron has been slammed for farming out many of its internal audit tasks to outside auditor Arthur Andersen, but such contracting is not uncommon. In the future, though, such an arrangement, which pretty well lets auditors audit their own work, will be outside the pale.
- Does the audit firm perform any other consulting work for the company? Ask your inside auditors about the various formulas used to calculate how much consulting work is too much, but be aware that the rules here are shifting overnight. Barbara Hackman Franklin, one of America’s most respected audit committee pros, reports that one of her boards had a rule that any consulting expenditure with the audit firm over $500,000 required board approval. Just 6 months ago this limit would be considered fairly strict, but at the audit committee’s February meeting the approval threshold was lowered – to zero. Any expenditure now requires board pre-approval.
- Major corporations have long had a revolving door between the outside auditor and inside staff positions, with audit partners easing directly into high-paying jobs with the company. While this offers nifty career options, it weakens auditor independence. More companies now head off temptation by banning the hiring of partners or managers of the audit firm who worked with company accounts. Usually this limitation is for a set period of time, typically 3 years.
- Of course, coziness between the auditor and the company can be more inbred. Carol Zacharias, of CNA in New York, recalls the case of a company that engaged a Big 5 audit firm when it went public in 1971, and used the same auditor for the next 3 decades (also hiring its CFO and accounting chief from the same firm). The familiarity seems to have bred contempt, however – the company was socked with a multimillion dollar SEC fine a few years ago for overstating income. Moral of the story – term limits for auditors (anywhere from 3 to 7 years) may be a wave of the future.
- Here’s one often overlooked conflict, says Zacharias. Does the outside audit firm’s own retirement plan hold stock in the company? This sounds like a whole barrel of conflicts, yet it is not uncommon, especially with some young venture firms (the ones who most need an independent eye on their accounts).
M&A Consulting Battles for Independence at Tokyo Style Corporation
M&A Consulting, whose mission is to unlock value with effective corporate governance and to promote shareholder value in the Japanese market, submitted a second shareholder proposal to Tokyo Style Corporation (TSE 8112), nominating two candidates as independent directors. This proposal is in response to the company’s failure to respond to their initial proposal dated January 31, 2002, which requested that they produce their own candidates for independent directors.
Predicting Key Shareholder Reaction
Identifying and understanding important investors can help predict the direction of share prices, according to a recent study reported in The McKinsey Quarterly, 2002 Number 2. Just as it is possible to know and predict your customers well, because there are only so many of them, it is also possible to predict stock price movements since the average firm there is a maximum of only 100 current and potential investors that significantly influence share prices. By identifying these critical individual or institutional investors and their motivations, executives can predict how they will react to announcements—and more accurately estimate the direction of stock prices.
Investors who have weight and a propensity to throw it around can reasonably account for at least 1% of a stock’s trading volume for a given quarter. Once a company has identified each of its primary movers, the next step is to profile all of them, describing how they make decisions. “What does the investor want to invest in, using what valuation methodologies? How is it likely to react to events or to data, which after all can be interpreted in many ways? Are its investments subject to any constraints, such as their size and frequency? Second, the profile should describe each investor’s views on issues that the company might face.”
Of course data gathering for such analysis must be done with great care since SEC regulations prohibit companies from disclosing material information to some but not all investors. “Typically, indirect questions work best,” seems like an understatement. Companies adopting such a strategy will stop viewing the market as a monolithic adversary. Instead of asking why the market moved, “they should pinpoint who bought, who sold, and why.” Think of your company as a private company and you’ll immediately see the need to understand your owners.
Will investor relations units head the call of authors Kevin Coyne and Jonathan Witter? If they do, they will take on a newly strategic role, testing major plans for their effect on share price and suggesting modifications to bring the plans into better alignment with the views of key shareholders. (see What makes your stock price go up and down)
Chevedden Puts TRW on the Spot at Annual Meeting
From the TRW annual meeting proxy dated March 4, 2002: The Company received a letter from a shareholder indicating his intention to request a vote at the annual meeting of shareholders for the Company to report, orally and in writing, at the annual meeting and in the next Company news release after the annual meeting the following information:
- the identity of Directors who have philanthropic links to the Company, quantifying these philanthropic links and reporting whether such Directors are also members of the Audit Committee;
- the attendance of Directors at the annual meeting of shareholders;
- whether the Company’s independent auditors perform audit consulting services and the categories of other consulting services the Company’s independent auditors perform, including the percentage of their overall fee for each category representing more than 10 percent of their annual fee; and
- the topics and outcome of any Rule 14a-8 proposals, including challenges by the Company of such proposals to the Securities and Exchange Commission.
If any of these matters properly comes to a shareholder vote at the meeting, the holders of the proxies solicited by this proxy statement intend to exercise their discretion to vote against any request for reports on these matters and against modifying the Company’s existing policies and practices on the matters to which the proposal relates.
In addition to taking a position of nondisclosure, management scheduled the meeting for 8:30 AM on April 24. According to John Chevedden, “an 8:30 start is a good way to discourage attendance: Force all local shareholders to fight rush-hour traffic and make sure that all out-of-town visitors spend a night in Cleveland.” John, why not stay two nights? Take in the 2nd City Student Improv at Kennedy’s Theatre where audience members are encouraged to yell out suggestions for the scenes and be a part of the show. Let’s see what they can do with topics from the TRW meeting.
Further Disclosure for Options
Starting in April, companies must include tables in their 10-K reports disclosing information about all employee stock option plans. In the past, only plans voted on and approved by shareholders had to be disclosed, and then only in footnotes. Now, companies will have to include tables identifying the number and weighted average exercise price of outstanding options; warrants and rights; and the number of securities available for future issuance under existing equity base compensation plans. The requirement certainly falls far short of a proposal by the International Accounting Standards Board to expense stock options but it is a move in the right direction.
Denton’s Providence Capital Turns Up Volume
Providence Capital’s corporate governance seminar entitled “Good Governance Pays” was well attended by a virtual whose who in the field. Professor Gompers’ study, “Corporate Governance and Equity Prices,” was well received. Providence’s small private investment portfolio returned more than 29% last year. “After Enron, the institutional investor community can no longer count on regulators, boards, lawyers, auditors or credit rating agencies,” Denton said. “They can’t rely on those folks. They have to rely on themselves by sponsoring their own director nominees.”
Companies targeted by Providence face the threat of a shareholder resolution urging the redemption of poison pills adopted without shareholder approval, a Denton-backed board slate, and a “director nomination by-law amendment.” Directors who refuse to heed a majority shareholder vote to dissolve a poison pill would be later disqualified as a director.
The bylaw amendment will likely face a legal challenge before it even came to an annual meeting vote but if it flies “the subject matter it would open up to shareholder action would be voluminous,” according to Pat McGurn, director of corporate programs at Institutional Shareholder Services. Look also for a rise in activity from Ralph Whitworth’s Relational Investors and Andrew Shapiro’s Lawndale Capital.
Corporate Governance Developments and the New Tools of Governance
The 1st International Conference on Corporate Governance: Corporate Governance Developments and the New Tools of Governance, will mark the official launch of the Centre for Corporate Governance Research at the Birmingham Business School, University of Birmingham, Edgbaston, Birmingham, UK. There will be specially invited sessions from keynote speakers, including Ariyoshi Okumura from Japan and Howard Sherman from the US; and presentation of papers by leading academics in the field including Marco Becht. Sir Adrian Cadbury will be attending the event as the External Advisor to the Centre for Corporate Governance Research.
Papers are invited on issues relating to any field of corporate governance. Possible topic areas may include boards of directors, executive remuneration, corporate governance ratings systems, internet and corporate governance, electronic voting, institutional investors, developments in corporate governance codes, etc.
Date: Tuesday 9th July 2002. Conference Fee per Delegate: £140 fee includes lunch and refreshments, and a set of conference papers.
Death Threat for Whistle Blower
Liu Shuwei, a researcher at the prestigious Central University of Finance and Economics in Beijing, reportedly blew the whistle on Hubei Lantian Co — a producer of fish and lotus root. Revenue seemed unusually high and the government had no record of some claimed assets. She wrote a brief article for publication in an “internal” magazine for bankers with a circulation of just 180, recommending they shut off credit to the company. Shortly afterwards China Construction Bank, Bank of China and others followed her advice.
Then she was served her with a writ for defamation and received dozens of death threats. Lantian apologized to investors in a public announcement. Apparently, 10 officials have been questioned in an investigation into whether the company had provided false financial information. The defamation case was postponed indefinitely. Lantian could be a test case for a new judicial decision allowing shareholders to sue companies for releasing false information. CITIC Industrial Bank and Minsheng Bank are suing for nonpayment of $16 million in loans after banks froze the company’s accounts. The case may not have the impact of Enron but it has drawn attention to poor accounting practices in China.
In an appearance before the Senate Banking Committee, Federal Reserve Chairman Alan Greenspan said “even though Enron was a great tragedy for a number of people, especially the employees who worked there, it probably has created a positive set of forces to improve corporate governance.” “I think we are going to find it was a net plus to our economy,” if corporate rules were improved as a result.”
Triple Bottom Line Simulation
Increasing evidence demonstrates that socially responsible investing (SRI) generates returns at least comparable to traditional investing. On 5/21/01, more than 40 institutional treasurers and investors met in New York City to participate in the Triple Bottom Line Simulation Conference. Five of their peers, institutional investors like themselves, presented case studies on actual social investments of more than $100 million. Next, socially responsible investment firms presented the products to be considered for the simulation. Finally, the large investors sat down and created five portfolios of social investments.
Each portfolio focused on a different aspect of socially responsible investing: social screening, shareholder activism, community development, and social venture capital, while one portfolio followed general SRI investing guidelines. Groups then divided the funds in each portfolio, allocating percentages to equity, fixed income, alternative investments, and cash. Once they chose the actual investments comprising their portfolio, they were ready to commence the simulation. All five simulations so far are outperforming the financial benchmarks. seeInstitutional Investors Try Their Hand at Socially Responsible Investing at SocialFunds.com.
Who Is To Blame For Outrageous Executive Pay?
According to Frank Glassner CEO, Compensation Design Group, it’s a combination of institutional investors, Congress, corporate governance activists and the media. Institutional shareholders see the corporation’s main purpose as maximizing shareholder returns and profits, emphasizing short-term profits rather than the long-term health of the company.
Legislation enacted by Congress to deal with excessive executive compensation tied the deductibility of executive compensation to a pay for performance. Again, emphasizing short-term profitability and stock performance. CEO pay soared with stock prices. The “eagle eye of corporate governance activists and the omnipresent role of the media” simply add fuel to the fire.
Glassner believes corporations must correct their ambitious need to push short-term stock prices and institutional shareholders should back off. Management should be “more sensitive to the hardships you are asking your employees to endure… some type of sacrifice in today’s environment is a must.” “One less Barbie Dream House isn’t going to hurt anyone.” If the rank-and-file has to make financial sacrifices, so should the company management. In turn, when the company experiences increased profitability, all levels of the organization should share the wealth in one way or another.
“When Chairman Pitt said that the SEC will act in cases where executives collect from illusory gains but do not ‘suffer the consequences of subsequent restatements, the way the public does,’ he could have been speaking directly to Kenneth Lay himself. With Enron, plenty of innocent people were hurt and lives were ruined.” “Enron and Global Crossing have been a slap in the public’s face,” said Glassner. “Allowing those executives to walk away with the cash would be the equivalent of letting a bank robber keep the stolen proceeds and lecturing him to ‘never, ever, rob a bank again.'”
Good Governance Pays
Providence Capital will host a corporate governance seminar entitled “Good Governance Pays” in New York City on Friday, March 8, 2002 at 10:00 AM at the Peninsula Hotel (700 Fifth Avenue at 55th Street). The session will highlight the growing awareness of corporate governance’s impact on stock price performance. The seminar will also discuss how the institutional investor community is reacting to corporate governance post-Enron and effective tactics for promoting shareholder-friendly corporate governance at publicly traded corporations.
“In the last couple of years there have been many companies that have ignored majority shareholder votes on non-binding proposals concerning poison pills, staggered boards and other corporate governance matters. Examples include Merck, Albertson’s and Electronic Data Systems Corporation,” said Herbert A. Denton, President of Providence Capital. “When companies routinely reject shareholder wishes, institutional investors need to consider alternative tactics, including submitting an alternative slate of director nominees.”
The discussion will be open to the media and members of the institutional investor community. A Q&A session will follow the presentation. Presenting will be Mr. Denton, and Paul A. Gompers, Professor of Business Administration and Director of Research at Harvard Business School. Professor Gompers co-authored a recent study entitled “Corporate Governance and Equity Prices.” The study found that, from 1990 through 1999, investments in well governed companies responsive to shareholder interests outperformed – by over 900 basis points per year – investments in companies structured to resist change.
Participants can register to attend in person by calling (212) 888-3200 and asking for Ester Done. In addition, a live conference call will be available by calling (785) 832-1077. To view PowerPoint presentation and to read the study, go to providencecapitalnyc.com.
Summary of the Recommendations
2nd International Conference on Corporate Governance
Despite the threat of an impending South Asian war, the conference sponsored by the World Council for Corporate Governance was attended by 416 business leaders and policy makers from 20 countries. There was a consensus that corporations must recognise that globalisation offers them both the strength and opportunity to usher in a just and conflict free world for their own security, survival and sustainability. Corporate governance must integrate the issues of environmental and social responsibility for sustainable wealth creation. It was felt that a free market is meaningless without internalisation of true costs. Economic costs must reflect the full ecological costs; Also valuing true worth of the earth was the only hope of bringing the 3 billion poor in the market economy and help them reap the benefits of globalisation and bridge the widening gap between the world’s poor and rich.
The launch of Indian Sustainability Movement planned on 5th June 2002 in New Delhi to synchronise with World Environment Day is to sensitise the government and business on the enormous business opportunity in restructuring the economy on renewable fuels and innovating products and services to make them environmentally sustainable.
The launch will be followed by a 3 day Environment Congress beginning in Palampur (HP) on 7 June 2002 and incorporating International Mountain Convention to coincide with International Year of Mountains 2002. It will focus world attention on the plight of mountain people, creating sustainable livelihoods for them and protecting and promoting their unique heritage and culture. The theme of the Congress is “Sustainability through Good Governance”. The output of these discussions will be presented to the 3rd International Conference on Corporate Governance to be held in New Delhi on 27th and 28th September 2002.
- Corporations must recognize that globalisation offers them both the strength and opportunity to usher in a just and conflict free world for their own security, survival and sustainability.
- The scope of Corporate Governance should be enlarged to encompass Good Governance in all its aspects taking cognizance of the political, administrative, economic, social and judicial environment in which they function. Board of Directors ought to balance the interests of capital providers with those of other stakeholders and aim for a long term and sustained business success. Good Corporate Governance ought to create value for all stakeholders including society at large.
- As the Enron debacle indicates, a good corporate governance code is no guarantee of good corporate governance. There needs to be stricter monitoring and enforcement of laws, as well as punishment for corporate scams to ensure that those who violate the public trust do not go without penalty. Along with a requirement of disclosures and accountability, laws should be amended to mete out swift and deterrent punishment to the offenders.
- There needs to be a separation of the role of Chairman and CEO and greater scrutiny of CEO by the Board of Directors.
- There should be a clear separation of the audit and consulting functions. These should in no circumstance be done by the same organization.
- Corporate Governance ought to cover disclosures on Environmental and Social responsibility.
- Sustainability ought to be the end game of business. No business activity that jeopardizes the ability of future generations to meet their own needs should be permitted.
- There is a need for economic costs to reflect full ecological costs. Accounting practices need to ensure that environmental costs are properly internalized.
- There needs to be greater recognition of the importance of intellectual and reputational capital and the tectonic shift in public values with the onset of knowledge economy.
- Rapid obsolescence and irrelevance are the two greatest risks to corporations in the knowledge economy. Governments and businesses need to collaborate to provide incentives for innovations of new business designs and products with least impact on environment.
- A primary goal of good corporate governance ought to be to foster a culture of creativity, innovation and entrepreneurship to protect the business from irrelevance and obsolescence. It should aim to leverage the intellectual capital to serve the unarticulated customers and untapped markets.
- There needs to be greater awareness of the need for Corporate Social Responsibility. An Award to recognize achievements of Corporate Social Responsibility as distinct from the existing award on Excellence in Corporate Governance will be a good way to encourage corporate role towards society.
- It is unpractical to hold non-executive Directorship or Directorship in ten and more companies. The rules for Directorships need to be amended so that the number of directorships a person can hold is less then ten.
- It is vital that a minimal training programme be designed and organized for Directors, both Executive and Non-executive, covering key aspects of good corporate governance and director responsibilities – statutory, environmental and social. There should be a compulsory induction programme for institutional nominees.
- Corporations should continuously internalize the evolving best practices in corporate governance.
- To strengthen Boards of Directors and in order to induct people of eminence and ability into Boards to discharge the functions as watch dog of other stakeholders interests on Audit Committee, on Remuneration Committee etc., these people should be insulated from the failings of the day–to–day management. Non Executive Directors should be freed from accountability for failures such as a cheque bouncing or a pollution device failing. Amendments in the laws and Rules & Regulations in this regard should be made.
- The issues involving risk management and reputational capital need to be discussed more in-depth.
- Expeditious and cost-effective resolution of commercial disputes is an integral part of Good Corporate Governance. There is a need for WCFCG to establish an Arbitration and Reconciliation Centre which offers cost-effective and time-bound resolution of disputes.
- Standardized, universally applicable, unambiguous and transparent accounting procedures need to be evolved and internationally adopted.
- There is a need for stricter internal audit controls to ensure that debacles such as that of ENRON do not recur.
- WCFCG should set up a Centre for benchmarking best practices in Corporate Governance.
- International Conferences need to be held at frequent intervals to provide opportunity for exchange of ideas on implementation of best practices in corporate governance.
New Delhi 12th Feb., 2002
Pledge for a New TIAA-CREF
In a New York Times article (January 6, 2002), TIAA-CREF’s CEO John H. Biggs said he would support the creation of a new retirement fund that would employ not only negative screens (avoiding certain companies), but also positive screens (investing in companies strong on social responsibility).
Mr. Biggs made his offer in the context of a challenge. He would support creating such a fund only “if you could guarantee the investors would be there to invest.” He explained that TIAA-CREF would need $50 million in seed money, and that the minimum commitment needed from investors to justify the development of such a fund would be $25 million. TIAA-CREF would provide the other $25 million, with the expectation that it could be withdrawn as the fund grew.
Social Choice for Social Change: Campaign for a New TIAA-CREF asks that TIAA-CREF members step up and make a commitment to ensure the launch of this new fund. Click here.
Reaction to CalPERS Withdrawal From SE Asia
“CalPERS’ decision to withdraw investment from the emerging markets of South East Asia viz Malaysia, Indonesia, Thailand and Philippines is counter productive and not in the interest of its own shareholders,” says Dr Madhav Mehra, President of the World Council for Corporate Governance.
A review, conducted by pension consultant Wilshire Associates, led CalPERS to withdrew from the Philippines on financial grounds. Social issues were the key factors in withdrawing from Malaysia and Indonesia. At the same time CalPERS announced it will begin investing in Poland and Hungary. All four of the newly excluded markets have outperformed broader world markets this year, with Indonesia, Malaysia and the Philippines posting increases ranging from 25 – 29%. That compares with a decline of 5.6% for the MSCI World Index.
In an interview with BBC World Dr Mehra said, “Emerging markets in South and South East Asia represent some of the most innovative companies engaged in people- oriented businesses applying best practices in corporate governance and developing new business designs and products that offer the best prospects of value creation for investors.” CalPERS – US’s largest pension fund with assets of over $151 billion – has already banned investments in India and Pakistan. CalPERS’ explanation of their decision as the result of their continuing effort to withdraw from unethical investments “sounds hollow on the face of Enron’s record.” Dr Mehra assets that Enron is not an isolated case of fraud. “Its auditors have claimed that the accounting practices used to cover up were within the law and are followed by thousands of US firms,” he asserts.
Dr Mehra added, “It is also difficult to justify withdrawal on the grounds that these countries are low on performance, transparency and political stability. Some of the knowledge based pharmaceutical and telecom companies have outperformed despite recession. Whilst one can admit some political turmoil in Indonesia and Philippines, there is no serious political instability in the four other countries. Certainly, despite its other problems, India’s record of democratisation is unmatched. In regard to standards of transparency when there is so much evidence of cooking the books in developed economies, it is wrong to single out a few South East Asian economies and punish them for such lapses. The withdrawal appears more likely due to the risk factors in these countries. CalPERS’ concern for the investor, therefore, is quite understandable. Nonetheless, one must realise that stability is the thing of the past and that rapid obsolescence, demographic changes and shift in public values have profoundly changed the competitive environment. Markets of 21st century are driven by aspirations of innovation and sustainability. Short term focus on profits is the surest way for shareholder value destruction.”
Dr Mehra went on to opine that CalPERS’ decision “will dampen the efforts of Alan Greenspan to resuscitate the US economy.” “In any event, investment decisions have to be based on the policies of companies and not countries. You cannot outlaw a whole nation because of the failings of a few. You have to judge each company on its own merits. It is not significant that the countries that have been banned by CalPERS represent some 25% of the world population. What is significant is that it is the 25% that are the potential powerhouse of pent up demand needed to lift the US economy out of its current recession.”
London’s Financial Times (2/22) reported that CalPERS’ “modest presence in Asia will limit the short-term impact on fund flows to the blacklisted countries.” However, the more lasting impact will be to influence others concerned with “socially responsible investment” (SRI). “CalPERS has a massive leadership role in the US,” says Allan Conway, head of global emerging markets at WestLB Asset Management. “This will have a snowball effect which can only gain momentum.” Other critics question the rationale of pulling out of SE Asian states while continuing to invest in US companies with significant manufacturing presence in these countries. “While on one level I’m encouraged that CalPERS has come to the decision to use the power of its investment capital to promote certain social objectives,” Matthew Kiernan, of Innovest, said, “I’m somewhat puzzled by their apparent lack of interest in doing so for the other 99 per cent plus of their portfolio which are in countries and regions which themselves are not devoid of social and environmental challenges, notably the United States itself.” Similarly, while CalPERS avoids direct investment in China, because of questionable labor practices and the integrity of its political system, it continues to invest in Hong Kong-listed Chinese companies.
From my own perspective, I believe the action by CalPERS Board is based on good intentions but bad policy. I agreed with the tobacco pull out and advocated such a move years prior to the Board’s action. Tobacco, when used as directed, is harmful. It has no redeeming qualities (other than the ability to earn short term profit at the long term expense of others). I also reluctantly supported the investment boycott of South Africa. I would have rather seen pressure on companies in South Africa to resist unjust laws and bring down apartheid through direct engagement. However, the since the boycott movement was a worldwide effort, it was effective.
In the current case, I do not see CalPERS leading or joining a worldwide effort to reform or bring down the governments of its blacklisted countries. Their action may allow Board members to “wash their hands” but the impact is likely to be minimal in bringing about change. This is especially true since the Board’s action comes at a time when these markets are on the rise.
Rating countries based on transparency, political stability and labor practices/standards is reasonable but the approach should be used in tandem with corporate governance ratings. Combining the “scores” of the two scales would still result in CalPERS investing substantially more in countries with transparency, political stability and good labor practices. However, exceptional corporations in difficult environments should not be completely off bounds. CalPERS practices engagement in the US market. It hardly ever does the “Wall Street Walk.” Something closer to that policy should also hold true for its international investments.
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End to Political Contributions
BP, the world’s third-largest oil company, announced it will halt all of its political contributions worldwide, possibly motivated to avoid accusations of influence peddling in the era of Enron. BP CEO Sir John Browne said the company would continue to engage in policy debate, but would not fund any political activity or party. According to the Center for Responsive Politics, BP, which makes about half of its money in the United States, spent $1.1 million on the 2000 U.S. elections, with two-thirds going to Republican candidates. BP was the first major oil company to acknowledge the threat of global warming. Royal Dutch/Shell says it had a long-standing policy of not contributing to political parties, political organizations or their representatives. more at: New York Times, 2/28 andBayArea.com, Reuters, 2/28
CalPERS Adopts New Emerging Market Policy
CalPERS has completed its comprehensive review of emerging market countries, which takes into account broad financial factors as well as transparency, political stability and labor practices/standards.
“We now have in place a blueprint to examine which emerging markets can support institutional investment,” said Michael Flaherman, Chair of CalPERS Investment Committee. “It is a screen and an important entry point for investments into our portfolio that will help to protect our pensioners assets in the emerging markets.”
Based on its new review process, CalPERS will begin taking a public equity position in Poland and Hungary, while eliminating its public equity investment position in Indonesia, Malaysia, the Philippines and Thailand.
Identify Accounting Fraud, Tricks and Best Practices
The Financial Numbers Game, by Charles Mulford and Eugene Comiskey, could not have been released to a more eager audience. Months ago Enron was the country’s seventh largest company, in terms of revenue. Now the company has all but vanished, amid revelations of questionable accounting practices that allowed Enron to overstate profits, while dodging taxes. They did it, in part, by keeping billions in debt off the books through partnerships. The authors help you understand and identify:
- premature or fictitious revenue
- aggressive capitalization and extended amortization policies
- misreported assets and liabilities
- creative income statements
- problems with cash flow reporting
Earnings management can fall within or beyond the boundaries of generally accepted accounting principles. Key targets of a recent SEC campaign were big-bath charges, creative acquisition accounting, cookie jar reserves, materiality judgments and revenue recognition practices. Statistical research shows that such practices are not uncommon, given the rarity off small losses and small declines in profits, as well as the large numbers of consensus forecasts that either just meet of barely exceed consensus forecasts. Professional reaction to these practices is discussed.
The book also highlights many of the creative ways of presenting income statements, “the premier playground for those who engage in the financial numbers game” and cash flow reporting. A great reference book for board members (especially audit comittee members), fund fiduciaries, regulators and others. Includes helpful glossaries and references for each discrete chapter.
Lax Environmental Liability Reporting
Three out of four US corporations surveyed openly violated SEC environmental financial debt accounting regulations, according to the EPA. Congressional committees investigating the hundreds of millions of debt hidden in the Enron scandal don’t appear to be aware of the environmental liability problem, according to the Environmental News Service (ENS). “This departure from SEC mandated disclosure puts good companies at a disadvantage in the absence of reporting EPA legal proceedings,” says EPA attorney Shirin Venus.
The SEC is required to enforce federal securities laws, protecting investors and maintaining fair and efficient markets. However, in the past 20 years the SEC has only once enforced its S-K financial environmental accounting regulation. Under current federal securities law, “material” information is anything that an “average investor” ought reasonably to be informed of before buying a security but many auditors and their clients define environmental materiality as any event or news which will affect a company’s revenues by a 10% threshold level. The SEC’s efforts are lagging behind investor needs. The average investor should demand a lower material standard. (Public Companies Tweak Accounting to Hide Environmental Debt, ENS, 2/18/02) For more information, see the Corporate Sunshine Working Group.
Bogle Calls for Federation of Long-term Investors
John Bogle, founder and former chief executive of The Vanguard Group, told the New York Society of Security Analysts that abuses that led to the downfall of Enron are widespread and must be addressed through pressure from mutual funds and other big institutional investors. A “Federation of Long-term Investors,” could be the nucleus of a new shareholder group that could grow in size, bringing in “active” fund managers who pick and choose stocks based on investment potential. The heart of the problem has been the willingness of the corporate governance system to focus on stock prices as opposed to long-term corporate value.
Fat Exec Pay Tied to High Turnover
Matt Bloom and John G. Michel of the University of Notre Dame find that large corporate pay disparities are associated with lower job tenure and higher turnover among company managers. The lesson: Resentment in company ranks over fat paychecks for top executives causes more problems than just grumbling. “Dispersed pay structures promote the survival and retention of star managers, but at the cost of increasing workforce instability and turnover among remaining managers.” In contrast, “minimizing pay differentials creates a more egalitarian environment, which tends to reduce both the competition among managers and the impetus for them to leave…creating greater workforce stability.'”
The findings, “are robust across different samples, at different periods of time, at different managerial levels and after accounting for external labor market effects.” “We believe these findings support the assertion that pay dispersion per se has important implications for employee outcomes and is of strategic importance for organizational decision-makers.” (February/March issue of the Academy of Management Journal)
Another study in the same issue finds evidence of the harmful effect high turnover of personnel has on teamwork in pro basketball. Even on losing teams, the researchers find, keeping teammates together resulted in a significant gain in the following year compared to teams with more turnover.
Enron Gives Black Eye to Corporate Governance
The deception, hubris and possible criminal fraud that led to the decline and fall of Enron was bad enough, say several Wharton faculty members and a former CEO. But just as appalling was the performance of Enron’s board of directors. Read a frank exchange of ideas from Michael Useem and others at Wharton’s Center for Leadership and Change Management.
Airborne Finally Yields on Confidential Voting
After Rick Ziebarth and the Teamsters received 68% or higher of the voting shares for each of the last 3 years, Airborne’s management and Board of Directors finally saw the writing on the wall and adopted a policy that keeps proxy votes confidential but the Board has failed to yield on annual elections of the Board of Directors and the redemption of the company’s poison pill. see Teamster Scores Victory for Airborne Shareholders, PRNewswire, 2/12. Update: On 2/15 the Board authorized redemption of the poison pill.
Plaintiffs’ Lawyers Shudder
The SEC is arguing in a closely watched securities fraud case that high attorney fees could get law firms kicked off federal class actions. (see SEC Weighs In on Securities Fraud Case, Jason Hoppin, The Recorder, 2/13.
Dim View of Bidding for Class Actions
A study commissioned by a federal appeals court has taken a dim view of a controversial practice adopted by some federal judges in big securities class actions-asking law firms vying to represent plaintiffs to bid for the assignment. A study commissioned by the Philadelphia-based U.S.
Circuit Court of Appeals for the 3rd Circuit concluded last month that competitive bidding for class action counsel positions is generally a bad idea. Plaintiffs lawyers often jockey for the position of lead counsel, hoping for the biggest fee. Without a bidding process, the choice is made at the sole discretion of the judge presiding over a case. “The risks and complications associated with a judicially-controlled auction counsel against its use except under certain limited circumstances,” the 3rd Circuit task force concluded in its final report on Jan. 17.
How limited? Of the 14 cases in which competitive bidding was used, only one fit the panel’s criteria. While the 3rd Circuit’s chief judge, Edward Becker, has said the task force doesn’t speak for the court, the report gives class action lawyers with cases in New Jersey, Pennsylvania, Delaware, and the Virgin Islands weighty ammunition for arguments against bidding for work. Time will test how other circuits react, but U.S. Judges Vaughn Walker of the Northern District of California and Milton Shadur of the Northern District of Illinois are already on record as saying the panel’s work was flawed and failed to give credit to the good points of bidding. (Legal Times, 2/4, Study Frowns On Class Action Auctions 3rd Circuit Task Force Says Judges Should Significantly Limit Their Use Of Competitive Bidding For Class Action Counsel)
High Tech SRI Index
KLD and Nasdaq have createe the KLD-Nasdaq Social Index, “the first index to screen Nasdaq companies for social and environmental criteria.” The following social and environmental criteria were applied to Nasdaq Composite domestic companies: over $1 billion in market capitalization; rejection of alcohol, tobacco, gambling, military contracting, nuclear power, and firearm stock; qualitative screens rate companies on community citizenship, diversity, employee relations, environmental protection, product safety, and non-U.S. operations.
Top ten holdings of the KLD-NSI index include Oracle Corp. (ORCL), a computer software and systems producer, which has notably strong diversity policies; Amgen, Inc. (AMGN), a biotech research and production company with exceptional community involvement programs; and Qualcomm Inc. (QCOM), a communications technology firm that KLD has rated highly in terms of involving employees in company ownership and management. Currently only 283 companies qualify for inclusion in the KLD-NSI. (First Nasdaq-based Social Index Unveiled, SocialFunds.com, 2/12)
Even His Mom Isn’t Buying Skilling’s Story
Former Enron CEO Jeffrey Skilling is not only being grilled by Congressional committees, Skilling’s mom, Betty Skilling, says she finds it hard to believe the former Enron executive was not aware of wrongdoing on his watch. She told Newsweek, “When you are the CEO and you are on the board of directors, you are supposed to know what’s going on with the rest of the company. You can’t get off the hook with me there. … He’s going to have to beat this the best way he can.” Ouch!
Sen. Ernest Hollings told Reuters he is unhappy with the way Pitt is handling the entire Enron fiasco. He thinks Pitt has been quiet on Enron because he did work for Enron’s former auditor (Andersen) prior to joining the SEC. “I’m not satisfied,” Hollings told the wire service. “Whatever he (Pitt) would recommend, I’d look at with a jaundiced eye.” (Hollings Disses Pitt, CFO, 2/12)
NACD to the Rescue
In the wake of Enron’s collapse and last year’s September 11 tragedy, corporate directors are reminded more than ever of their critical oversight responsibility to ensure the safety and proper management of fiscal integrity, human resources and information resources. And yet, according to a <a href="Join other directors who will share their seasoned experience in corporate crisis situations Ð bankruptcy, physical threats to employees and information security breaches that threaten operations and credibility. Learn step-by-step processes for avoiding undue risk and minimizing damage from unexpected events. Register today!
View the entire program and register”>recent survey of national directors conducted by the National Association of Corporate Directors and the Institute of Internal Auditors, only 37% of directors responded that a formal risk management process was in place in their organization. Even more surprisingly, 17% of directors stated they did not even know whether their corporation had a formal method for identifying risks. Join other directors who will share their seasoned experience in corporate crisis situations – bankruptcy, physical threats to employees and information security breaches that threaten operations and credibility. Learn step-by-step processes for avoiding undue risk and minimizing damage from unexpected events. Register.
OECD Launches Newsletter
The Organization for Economic Cooperation and Development launched the Corporate Affairs Newsletter to promote free markets in order to achieve sustainable growth. The first issue (see what’s new) carries a discussion of accounting and audit issues… timely, given the Enron situation. The next edition of the Newsletter will be available in May 2002. To get on the mailing list, register by selecting “corporate governance as your theme.
4th Asian Corporate Governance Roundtable meeting; Mumbai, India, 10-12 June 2002 (Shareholders Rights and Equitable Treatment of Shareholders). Participating countries include Australia, Brunei Darussalam, Canada, China, Hong Kong China, India, Indonesia, Japan, Korea, Malaysia, Mexico, Mongolia (as an observer), New Zealand, Singapore, Chinese Taipei, Thailand, the UK, and the US.
Non-Audit Services by Auditor Associated with Lower Quality Earnings
In their study, The Relation Between Auditors’ Fees for Non-Audit Services and Earnings Quality, Richard M. Frankel, Marilyn F. Johnson, and Karen K. Nelson found the purchase of non-audit services from the auditor is associated with lower quality earnings. They also found evidence that investors associate non-audit fees with lower quality audits and, by implication, lower quality earnings. Their evidence indicates that firms paying high non-audit fees are more likely to engage in earnings management. They predict firms “may reduce the purchase of non-audit services to avoid the appearance of non-independence.
Enron Fallout in UK
Enron’s auditor, Arthur Andersen faces a backlash in the UK. A number of major investment funds have threatened to vote against the firm’s reappointment at shareholder meetings. Manifest, the UK proxy voting advisor believes that all companies’ audit committees should include a qualified auditor and thinks this aspect of governance is overlooked. “Whereas fat-cat pay grabs headlines, audit can seem trivial,” says Sarah Wilson, managing director at Manifest. “But experience shows that it is a key risk management area for shareholders. Legislation should be changed in the UK to enforce full disclosure of audit and non-audit related fees paid to the same organization.”
Clarification Sought on What Constitutes Controlling Company in UK
In the face of relatively low voting levels in comparison to institutional ownership levels, The Myners Report recommended the introduction of ERISA-style regulations regarding corporate governance, shareholder activism and intervention in failing companies. These regulations will primarily apply to Pension Funds, Local Government Pension Schemes and their fund mangers.
Manifest received a number of calls concerning the Takeover Panel Rules. Institutions are concerned about possible inconsistencies as to how active governance could be perceived in the context of ‘controlling’ a company. The Myners Report seeks earlier and closer involvement in under-performing companies but Manifest and its clients are concerned with the possible penalties that could be imposed if an institution got involved in the ‘wrong sort’ of activism and was considered a controlling company.
Manifest believes that it would be helpful for the Takeover Panel to undertake an independent review and clarify the position of Concert Parties in the context of governance and activism followed by a guidance note to interested parties. (seeManifest calls on The Takeover Panel for rule clarification) This will have a number of beneficial effects:
- Elimination of regulatory uncertainty towards legitimate, non-predatory patterns of shareholder intervention;
- Encourage market-based governance programs without the need for institutional case by case review of individual activities;
- Demonstrate commitment to continued market best practice policy development
CalPERS: The Watchdog That Failed to Bark
According to a widely published article originating with the New York Times, the CalPERS Board was warned by outside advisors that Enron’s chief financial officer, Andrew Fastow would face conflicts of interest between his duties to the LJM 3 limited partnership, which he pitched to CalPERS, and Enron. Disclosure of such an investment could lead to embarrassment for CalPERS, especially to its reputation as a corporate governance activist.
Roland Machold, a co-founder of the Council of Institutional Investors, said he wondered why the pension fund managers “did not go right to the board, as it used to do in the old days, and say they were concerned that the board had approved something so conflicted.”
Prompt action by the CalPERS Board, such as talking with the Enron board or putting Enron on their focus list, might have made a huge difference to California taxpayers. Stock losses totaled more than $248 million at California pension funds alone, to say nothing of the $325 million loss suffered by the Florida state pension fund and additional losses at other public pension funds.
Why didn’t the world’s most famous corporate watchdog bark? The Board’s own conflicts of interest may have played a part. Bob Carlson (Board member since 1971) serves on the board of 12 Franklin funds. Bill Crist (Board member since 1987) also served on the board of the Pacific Rim Prosperity fund for many years. Which fiduciary duty gets a higher priority when opportunity knocks or conflicts arise, CalPERS or the private investment funds?
Between stints on the CalPERS Board, Kurato Shimada, (served 1987-1999, reelected in 2001) along with former Board member Albert Villalobos and retired state senator William Campbell lobbied the Board to invest $250 million in the CIM California Urban Real Estate Fund. It was the first vote ever attempted without a staff recommendation in the pension fund’s 68-year history. Is Shimada more concerned with members or building placement fee opportunities (typically 1% of the investment)?
Many Board members continue to accept expensive entertainment, diners and other gifts from those contracting with the System. In direct violation of the Government Code, they raised their own salaries and were subsequently sued by State Controller Kathleen Connell. With such conflicts of interest on their own Board, it is not surprising that CalPERS took no action to further investigate Enron.
If they had read Enron’s SEC filings, the following should have lead to questions (see 10-K’s: A Good Read for the Curious Investor, New York Times, 1/20/02):
- Enron director, John Urquhart was paid $493,914 for providing consulting services to Enron.
- Enron director, Lord John Wakeham, received $72,000 for advice on Enron’s European operations.
- Enron director Herbert Winokur was affiliated with the privately owned National Tank Co. that made sales to Enron worth $370,294.
- Sharon Lay, sister of Enron chairman and chief executive Ken Lay, was paid $517,200 for travel services provided to the firm.
Additionally, they would have noticed Enron not only avoided paying income taxes in four of the last five years, it also collected $381 million in tax “refunds.” Maybe that wouldn’t have mattered to the CalPERS Board. After all, 18 year Board member Charles Valdes largely avoided paying taxes for seven years and declared bankruptcy twice while serving as the Chairman of the Board’s Investment Committee.
How can we end conflicts of interest in corporations when our own pension funds, even those with excellent reputations such as CalPERS, are riddled with such conflicts themselves? CalPERS and other public pension funds should use the Enron scandal as an opportunity for self-examination. Public employee pension funds that invest in tax evading corporations are like police who sell criminals their guns. They’re not following a good long-term strategy. (CalPERS knew of problem but kept silent: State pension fund didn’t share data on executives’ conflicts, San Francisco Chronicle, 2/5/)
BP and Royal Dutch/Shell Leading: ExxonMobil and ChevronTexaco Lag
BP and Royal Dutch/Shell are leading the field in terms of socially responsible and envrionmentally friencly behaviour, while ExxonMobil and ChevronTexaco have been slow to embrace good practics, according to a survey released by Co-operative Insurance Society, the UK insurer. See UK oil companies are better behaved, says survey, FT.com, 1/23.
Arthur Anderson Can be Held Liable
According to attorney Brian J. Donovan, Enron’s outside legal counsel, outside auditors/consultants, and investment bankers/stock analysts can be held liable for the losses sustained by the corporation’s investors when the corporate client has committed fraud, despite protections afforded by the Private Securities Litigation Act of 1995.
Section 1962(c) of the Racketeer Influenced and Corrupt Organizations Act provides that “It shall be unlawful for any person employed by or associated with any enterprise…..to conduct or participate, directly or indirectly, in the conduct of such enterprise’s affairs through a pattern of racketeering activity or collection of unlawful debt.” Mail fraud and wire fraud are the two most common forms of racketeering activity relied upon by civil RICO plaintiffs.
A 1993 Supreme Court case, Reves v. Ernst Young, 507 U.S. 170 (1993), which is frequently cited by the accounting profession, held that a RICO defendant must participate in the operation or management of the enterprise itself in order to be subject to Section 1962(c) liability. In that case, the Court held that the outside accounting firm was liable for damages under both the Arkansas Security Act and the Securities Exchange Act of 1934 for material misstatements associated with demand notes. However, the accounting firm, which was sued as an entity enterprise, was not liable under the RICO statute because the firm had maintained its role as an outsider and did not participate in management decisions.
In order to successfully plead a civil RICO Section 1962(c) claim, a plaintiff, in an Enron-like case, should allege that the corporation’s directors and officers, management, outside legal counsel, outside auditors/consultants, and investment bankers/stock analysts had conducted or participated in the conduct of the affairs of the corporation through a pattern of racketeering activity by forming an “association-in-fact” enterprise. The plaintiff would file suit against the insider association-in-fact enterprise rather than against
just a single outsider entity enterprise. As an insider association-in-fact enterprise, the individual defendant entities, e.g., the outside auditor/consultant, could no longer claim, as was done in Reves, that they were outsiders and therefore not liable under RICO.
A civil RICO plaintiff who properly pleads each of the four principal requirements for a Rico civil claim may be entitled to recover threefold the damages he sustains and the cost of the suit, including a reasonable attorney’s fee. Maybe this will help stem the flood of earnings restatements and accounting irregularities.
Back to the topConference Board Questions Impact of 911
The Jan/Feb edition of Across The Board carries a cover article, Below the Bottom Line, that asks “do today’s multinationals have a role in ending word hunger, seeking social justice and redistributing wealth.” While weeding out terrorists cells is a necessary short-term step, in the longer term we must improve the conditions that may have contributed to the breeding of terrorists.
Global Conflict on Horizon
Writing in December’s ISSue Alert, Stephen Deane sees a storm brewing between US led globalization and European national or regional sovereignty. Europeans question US accounting and tax structures which disadvantage shareholders. Specifically, not expensing option grants to income statements (if they had, earnings per share would have dropped 9% in 2000) and allowing a tax deduction when employees exercise their options (companies get to write off the difference between strike price and market value).
The Council of Institutional Investors has long advocated recognizing stock option grants as an expense. Even accounting firms Deloitte & Touche and Arthur Anderson agree. TheInternational Accounting Standards Board (IASB) drew fire in September when it announced that one of its top priorities is to develop a global standard for the accounting treatment of stock options.
Let’s hope Congress has learned from the Enron scandal and keeps out of accounting standards setting this time. Unfortunately, Deane reports that is not the case. Michael Oxley(R-Ohio), who chairs the House Financial Services Committee, has fired off letters to the IASB, the US Financial Accounting Standards Board (FASB) and the US Securities and Exchange Commission warning that requiring companies to expense options “would sharply diminish their use, harming American workers in a profound way.”
In our opinion there is just about no action that could help American workers more than proper accounting. Yes, a few greedy CEOs could be hurt but let’s hope the Europeans win.
Options Use Up
According to an article in the New York Times, the issuance of options is up and many question the supposed link to pay for performance. CEOs who received more last year, even as their companies suffered, include Daniel A. Carp of Eastman Kodak, John T. Chambers of Cisco Systems, Scott G. McNealy of Sun Microsystems and Harvey R. Blau of Aeroflex. Pearl Meyer & Partners reported the number of options granted by 50 major companies was up in 2001 an average of 12% from 2000 and expects the trend to continue.
Watson Wyatt Worldwide reports that average options overhang for Standard & Poor’s 500 firms was 14.6% of outstanding shares in 2000, up from 13% in 1999, with another percentage point or two expected to be added in 2001. In 1999, the LongView Collective Investment Fund, which manages some AFL-CIO pension money, submitted a shareholder proposal to the Chubb Corporation seeking to better align option grants with performance. The proposal failed but Chubb got the message; half the options later issued to senior management have an exercise price 25% higher than when they were granted. The NYT article indicates that consultants estimate that only 2-4% of large companies use such premium priced options. (Even Last Year, Option Spigot Was Wide Open, 2/3/2)
CEO Survey on CSR
PricewaterhouseCoopers’ fifth annual Global CEO Survey, “Uncertain Times, Abundant Opportunities,” reported highest confidence among CEOs in Corporate Social Responsibility (CSR) reputation amongst North American CEOs, with 64% feeling strongly that the public perceives their company as a positive social performer and 30% with more guarded confidence. Asia-Pacific CEOs had the lowest confidence in public perception of their companies as positive social performers, with only 28% feeling strongly confident and 54% feeling more cautiously confident. Most CEOs agree that CSR does not amount to public relations “spin” (51 percent), that CSR is vital to profitability (68%), and that CSR must remain a priority, even amidst the current economic downturn (60%). (see CEOs Worldwide Prioritize Corporate Social Responsibility, SocialFunds, 2/1/2)
MassMutual Owners to Take Charge
For the first time in U.S. history, policy owners of a major mutual insurance company, MassMutual, have united to nominate their own slate of candidates for election to a board of directors, announced John H. Jameison, Executive Director, of the MassMutual Owners Association (MMOA), a nonprofit corporation of concerned policy owners of Massachusetts Mutual and the former Connecticut Mutual Life Insurance companies.
Analyst Guidance Anticipated
The National Association of Securities Dealers, the New York Stock Exchange and the Securities and Exchange Commission are planning a joint regulatory measure that would codify industry best practices for research analysts to avoid analyst conflicts. (see Rules Or Guidance Expected, Compliance Reporter, 1/27/02)
Global Markets, Domestic Institutions:
Corporate Law and Governance in a New Era of Cross-Border Deals
April 5-6, 2002, Columbia Law School, New York, New York
The Center for International Political Economy and Columbia Law School are jointly sponsoring a conference on the dynamic tension between the inherently domestic nature of corporate law and governance institutions, and the increasingly global markets for capital, assets, and managerial talent. Topics of discussion are wide ranging. Registration is free, but space is limited, so it is important to register early. The conference will be held in the Kellogg Conference Center, 15th Floor, International Affairs Building, Columbia University, corner 117th Street and Amsterdam Avenue. To register, send an e-mail with the word “Conference” in the subject matter line to[email protected]
Include the following information in your message: (1) name, (2) institutional affiliation, and (3) whether you
plan to attend the lunches on Friday and Saturday, and the reception on Saturday evening.
Speakers and panelists include: Ronald Gilson (Columbia Law School), Edward Rock (University of Pennsylvania School of Law), Henry Hansmann (Yale Law School), Brian Cheffins (University of Cambridge) & Randall Thomas (Vanderbilt Law School), John Core (Wharton), John Coffee (Columbia Law School), Merritt Fox (Univ. of Michigan Law School), Michel Goyer (MIT, Max Planck Institute), Jeffrey Gordon (Columbia Law School), Peter Muelbert (Mainz), Luca Enriques (University of Bologna), Jonathan Macey (Cornell Law School), Lynn Stout (UCLA Law School), Katharina Pistor (Columbia Law School), Reinier Kraakman (Harvard Law School), Bernard Black & Michael Klausner (Stanford Law School), Roberta Romano (Yale Law School), Zohar Goshen (Hebrew University), William Allen (NYU Law School, formerly Chancellor, Del. Court of Chancery), Mark Roe (Harvard Law School), Corporate Law’s Limits, Andrei Shleifer (Harvard Economics Department), Curtis Milhaupt (Columbia Law School) & Mark West (University of Michigan Law School), Hugh Patrick (Columbia Business School), Mark Ramseyer (Harvard Law School) & Yoshiro Miwa, (University of Tokyo, Faculty of Economics), David Weinstein (Columbia Economics Department), Kon-Sik Kim (Seoul National University) & Joongi Kim (Yonsei University), Lawrence Liu (Lee & Li; Soochow University School of Law), Tarun Khanna (Harvard Business School)
Does it get any better than this? If I could get there, I definitely would.
NACD Provides Analysis of Lessons from Enron
The National Association of Corporate Directors has risen to the occasion in response to the recent failure of Enron . TheirDirector’s Monthly Extra includes commentary and analysis on major events in corporate governance… as they are unfolding. DM Extra will be a members-only publication delivered electronically, as critical issues arise. DM Extra is an added benefit of NACD membership. Recommendations include the following:
- Understand financial reporting practices
- Recognize, and if appropriate, reduce corporate and board complexity
- Protect retirement plans
- Set and follow policies and rules pertaining to conflict of interest
- Refrain from improper insider training
- Ensure auditor independence
- Issue, improve and enforce internal document retention policies
- Educate and empower the board to detect and ensure correction of inappropriate financial reporting
- Embrace corporate ethics by creating a climate of integrity and responsibility, expressed in both written codes and living example
The Globalization of Corporate and Securities Law in the Twenty-First Century
Corporations have become dominant players in the global economy. This fact makes it imperative that legal scholars examine how major corporations are managed and financed and how such corporations interact with the nation states in which the corporations conduct operations. The 2002 Annual McGeorge International Law Symposium will explore this topic on 2/23 with distinguished legal experts. The Editor of CorpGov.Net will also be in attendance. The conference is open to the public with a $150 charge for MCLE credit for non-alumni attorneys. For more information on the program, call: (916) 739-7141. Panels include:
- Comparative Corporate Governance: Converging on an American Model?
- Global Securities Markets and Regulation
- Corporate Responsibility and Regulating the Global Enterprise
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2002 Proxy Season Preview and Briefing
IRRC will provide an overview and detailed information on corporate governance and social responsibility issues facing corporations and their shareholders in the United States and abroad during the 2002 proxy season. A number of new shareholder initiatives are in the works for 2002, promising a particularly interesting year, and making this session a must see event. San Francisco 2/26, New York 3/1. Registration is free, but space is limited.
E-mail from Phil Goldstein on Preventing Future Enrons
Everyone and his brother has proposed changes to prevent future Enrons. My suggestion is more modest but should be more easily implemented. It is designed only to prevent the outrageous scenario we have witnessed of an auditor destroying documents or claiming a Fifth Amendment privilege or lawyer-client privilege during an investigation of fraud. I propose that every accounting firm unilaterally require its employees as a condition of employment to agree to cooperate in and not to frustrate any legitimate fraud investigation of a client and, in that connection, to waive his Fifth Amendment right and any lawyer-client privilege. I would expect the Big Five will reflexively oppose it but I wonder on what pretext? That they can’t get enough qualified accountants to agree in advance to cooperate in fraud investigations? The simple fact is that any accountant who will not cooperate in a fraud investigation is, by definition, not qualified.
In any event, even if the Big Five try to bury this proposal, it can go forward in other ways. Here’s how.
Corporations themselves can require a cooperation provision to be included in any auditor engagement agreement. So, even if no Big Five firm will break ranks, some lower tier firms looking for work will agree. Eventually (probably pretty soon) economic reality will set in as multi-million dollar engagements start going to firms that will agree to a cooperation provision. Of course, I don’t expect many large corporations will be willing to take the lead on this either. So what then? A populist approach could get the ball rolling. Binding or non-binding stockholder proposals can be submitted by the good governance types like Calpers or small stockholders to require that the auditor agree not to frustrate any investigation into fraud at the company. (I would love to see an opposition statement explaining why that is a bad idea, e.g, “This is a matter that should be left to the discretion of the co-conspirators in the fraud, uh the board.”) Hell, if these proposals don’t pass, then forget the whole thing. Stockholders are just too dumb to look out for themselves.
Also, while I am concerned with excessive regulation, I suggest that the SEC’s Division of Investment Management propose a rule that a cooperation clause be part of any auditor engagement agreement with a registered investment company. Since the ICA already contains lots of requirements that are supposed to protect small investors, this would seem to be a very small but sound additional protection against fraud. I don’t see PWC, for example, willing to give up its dominant market position in the mutual fund industry by balking at this. Once the mutual fund industry demonstrated that qualified auditors can be found who will agree to waive their constitutional rights in return for getting or keeping work (surprise, surprise), all resistance will quickly disappear.
No matter what is said in opposition to this proposal, it will come out as the self-serving nonsense that it surely will be, i.e., management, directors and auditors looking to save their own skins by frustrating legitimate efforts to investigate fraud. And, by the way, after this proposal is implemented, it would be a good idea to extend it to every employee of every public corporation in the United States.
S&P Rates Hong Kong Below China on Corporate Governance Practices
Based in large part on poor ownership structures due to the high number of family dominated firms, Hong Kong trails the mainland China, according to a new Standard & Poor’s survey. Hong Kong firms averaged 6 out of 10, whereas China averaged 7. Singapore and Australia had the highest scores in the region, with Korea, Thailand, and Malaysia trailing behind Hong Kong and the Philippines, Indonesia, and Taiwan further down. (The Corporate Library,Newsbriefs)
Unions Boycott Enron Directors
The AFL-CIO is urging companies to not renominate Enron directors for election to their respective corporate boards. “Directors who permitted the accounting deception that led to the collapse of a company worth over seventy billion dollars are not suited to serve on other boards,” said Richard Trumka, secretary-treasurer of the AFL-CIO. “Enron’s directors need to be held accountable for their record.”
- They waived conflict-of-interest rules to let Enron executives participate in related-party transactions that led to a $1.2 billion reduction in shareholder equity.
- They failed to question Enron’s use of off-balance-sheet entities to remove debt and losses from Enron’s financial statements.
- They approved Enron’s annual report to shareholders without ensuring Enron’s financial statement disclosure was straightforward and comprehensible. (see Look for the Union Label at CFO.com)
Corruption – a Stumbling Block in Good Governance
In a stirring address to 400 industry leaders and policy makers from 20 countries attending the recently concluded 2nd International Conference on Corporate Governance in Mumbai’s Taj Hotel, Dr P C Alexander, Governor of Maharashtra stated that “corruption in India was the biggest stumbling block to good governance.” Quoting Mehbubul Haque, the distinguished economist, Dr Alexander stated “corruption in India is not down stream but upstream; it travels on wings to bank accounts in Switzerland; it promotes instead of imprisons the corrupts and perpetuates poverty. It is the greatest sin against humanity and calls for a crusade by everyone.”
The theme of the conference was “Corporate Governance – Turning Rhetoric into Reality.” The conference was addressed by Mr N Vittal, Central Vigilance Commissioner, Justice M N Venkatchaliah, Chairman, Constitution Review Committee, Mr P Chidambaram, Former Finance Minister and eminent legal luminaries such as Mr Kapil Sibal, Mr K K Venugopal and Dr A M Singhvi.
Dr Madhav Mehra, President of the World Council for Corporate Governance, in his theme address stated that “the role of Corporate Governance has never been more vital. Transparency, accountability, integrity, equity and responsibility in the governance of corporation can have a transformational effect on our entire economic and social performance. Yet high profile corporate failures are not only taking place in India but also in the west such as Enron, Marconi and Swissair. It is time, therefore, that we reflect why 7 years after the Cadbury Report there continues an enormous cleavage between the rhetoric of corporate governance and reality.”
Dr Mehra continued, “Corporate Governance goes way beyond disclosures and compliance. It is concerned with empowering people, spurring and pursuing innovation and improving efficiency. It addresses conflicts of interest, which can impose burdens on the enterprise and ensures transparency and probity in corporate affairs to improve business standards and public accountability.” He asserted that “the impact of corruption and corporate and public mis-governance is alienating the civil society and is a ticking time bomb. It has widened the gap between rich and poor and created a crisis of confidence which has severely jeopardized our ability to attract investment, both domestic and foreign.”
“The most effective bulwark against fanatic terrorism is the building of a strong middle class o f entrepreneurs, investors and shareholders. This cannot come about without linking corporate governance with good public governance.” Dr Mehra called upon the US to prioritise the expenditure of billions of dollars earmarked for the war on terrorism and allocate resources to proactively facilitate good public and corporate governance systems, that bring about transparency, legitimacy, accountability, equity, integrity and responsibility.
One of the most notable sessions was “Legal, legislative and regulatory framework on corporate governance” addressed by world’s foremost jurists including the two former Chief Justices of India, Justice Venkatachaliah and Justice Ahmadi, Dr A M Singhvi, former Finance Minister Mr P. Chidambaram, Mr Kapil Sibal and Mr K. K. Venugopal. All speakers agreed that what was required was not new codes but a resolve to punish those who are found guilty of violating the existing codes and thereby set example for others.
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Enron, CalPERS and Tax Dodgers
As someone who’s known for monitoring and trying to influence CalPERS activities for many years, I’ve been getting a lot of e-mail and telephone calls lately. Public employees in California are worried that Enron’s bankruptcy will mean a drop in our retirement. It has certainly impacted our mutual fund investments, which according the Sacramento Bee suffered losses approaching $800 per person.
The bulk of our funds at CalPERS are invested as a modified index. CalPERS buys a piece of just about every major company and rebalances its portfolio frequently to ensure stocks are held in the same relative proportions. The Los Angeles Times (11/30) indicates that CalPERS owned 3 million shares. At Enron’s peak, its shares traded for nearly $85, so CalPERS’ holdings in Enron were once valued as high $255 million but, presumably because they bought relatively early and held, CalPERS lost less than $50 million.
CalPERS also invested with Enron in two limited partnerships, known as JEDI I and JEDI II, a reference to “Star Wars” that stood for Joint Energy Development Investments. According to a recent article in the Sacramento Bee (CalPERS inadvertently linked to fall of Enron, 1/24) CalPERS reported a gain of $133 million on JEDI, earned $171.7 million on JEDI II, and still has its original investment of $175 million in the second partnership.
The Bee indicates that a decision by CalPERS to cash out of JEDI I in 1997 may have hastened Enron’s demise. “Rather than simply pay CalPERS off, Enron set in motion a convoluted debt plan to raise the money and used questionable accounting methods to keep the whole matter secret from shareholders. That enabled Enron to hide more than a half-billion dollars in debts. Last November, Enron acknowledged that these questionable practices had enabled it to overstate corporate profits by $396 million the previous four years – a disclosure that destroyed what was left of Enron’s weakened credibility, and probably sealed its doom.”
So California public employees can go back to worrying about growing old, gaining weight, the kids, the job, or whatever…our retirement funds at CalPERS are safe from the Enron debacle. That doesn’t mean there aren’t important lessons to be learned. At least eleven Congressional Committees are crawling all over Enron and their auditor, Arthur Andersen. Out of every crisis comes opportunity.
Few saw Enron’s bankruptcy coming but apparently the company did disclose deals with members of its board of directors in their proxy statement published earlier in 2001. The following were among the items that should have lead to questions:
- Enron director, John Urquhart was paid $493,914 for providing consulting services to Enron.
- Enron director, Lord John Wakeham, received $72,000 for advice on Enron’s European operations.
- Enron director Herbert Winokur was affiliated with the privately owned National Tank Co. that made sales to Enron worth $370,294.
- Enron paid $517,200 for travel services provided by a firm 50% of which was owned by Sharon Lay, sister of Enron chairman and chief executive Ken Lay. (see 10-K’s: A Good Read for the Curious Investor, New York Times, 1/20/02)
- More than two years ago in an interview with CFO.com, Andrew Fastow, Enron’s CFO boasted that he had helped keep almost $1 billion in debt off Enron’s balance sheet through the use of a complex and innovative arrangement. (see What Andy Knew)
Shareholders who just read the large print in Enron’s financial reports might have thought Enron paid hundreds of millions of dollars in corporate income taxes over the last five years. However, the footnotes revealed that no taxes were due. According to a report in the New York Times, Enron not only avoided paying income taxes in four of the last five years (they paid $17 million in 1997), using almost 900 subsidiaries in tax-haven countries and other techniques, it also collected $381 million in tax “refunds.” (Enron Avoided Income Taxes in 4 of 5 Years, 1/17/02)
And, of course, there’s the matter of Arthur Anderson. Enron paid Andersen millions in consulting fees and then employed them as auditors. When he was chairman of the SEC, that’s the type of conflict of interest which Arthur Levitt tried to ban. The current SEC chair, Harvey Pitt, seems less likely to move forward in this area, since he has a history of representing Arthur Anderson, each of the Big Five and fraud king Ivan Boesky. So far he has proposed that the largely self-policed accounting profession be overseen by a group dominated by outside experts. But the proposal would not ensure that auditors remained independent from their clients. Mr. Pitt could choose to get tough and break with his past but it would be like Nixon going to China.
Last year the SEC fined Arthur Anderson $7 million for approving the accounts of Waste Management, even though its accounting methods seemed designed to mislead investors, according to a recent article in The Economist. Arthur Anderson also had to pay $110 million to settle a lawsuit over auditing work at Sunbeam. The article indicates Anderson is not the only problematic accounting firm. (The twister hits, 1/17/2002)
One thing is clear; CalPERS should be taking a closer look at proxy statements and SEC filings for evidence of poor corporate governance practices. They’ve got plenty of company in other public employee funds, including Ohio Public Employees Retirement System ($68.8 million loss), New York State Common Retirement Fund ($58 million loss), State Retirement System of Illinois ($15 million loss), to name just a few.
The United Brotherhood of Carpenters union has filed 12 proposals calling on companies not to hire the same accounting firm to do both audit and consulting work. Among the companies targeted are Apple Computer, Bristol-Myers Squibb, Avon Products, Dominion Resources, Liz Claiborne and Manpower, according to the Investor Responsibility Research Center.
William Greider, author of “One World, Ready or Not,” is calling for the creation of public auditors, “hired by government, paid by insurance fees levied on industry and completely insulated from private interests or politics.” (Crime in the Suites, Sacramento Bee, 1/27/02). This would certainly reduce conflicts of interest, but I’m not sure the pendulum of public opinion has swung that far yet.
One of the more innovative approaches to ensure auditor independence was introduced last year at SONICblue by Mark Latham of the Corporate Monitoring Project. Latham’s proposal would let shareowners vote to select the auditor, not just ratify a firm selected by the board of directors. Competing to please shareowners rather than directors who often serve at the pleasure of management, would create “new pressure for higher standards and tougher audits,” according to Latham. (see also SocialFunds.com)
CalPERS should be supporting such proposals. However, I’ve got a more fundamental concern. Should CalPERS, whose members depend on taxpayers, be investing at all in companies flagrantly avoid paying taxes? Should CalPERS aim for the highest returns or should it also be considering the possibility that the very companies we’re investing in could be undermining our jobs, our communities and our way of life. William Crist, who heads CalPERS, was compared to Darth Vader by the Paris daily, Liberation, for allegedly squeezing corporate management for ever higher profits, regardless of the social hardship imposed on French citizens.
At the heart of President Bush’s agenda is mistrust of government. Shift a portion of Social Security to the stock market. Give tax breaks to corporations and the rich because their investments will end the recession. Maybe public attention on politically connected tax dodging document shredding executives will move Americans to finally push hard for campaign financing reform and competent government employees to keep us safe, not only from foreign terrorists, but also from our own home grown greed.
Enron is not an isolated case of impropriety. Before Global Crossing went from $60 to pennies a share, CEO Gary Winnick cashed out. After running Lucent into the ground, executives sold $12 million in shares back to the company and CEO Richard McGinn left with an $11.3 million severance package.
CalPERS’ Statement of Investment Policy for Global Proxy Voting Principles (March 21, 2001) says the System “has a duty to maximize the value of its investments, in order to avoid the increases in state and local government taxes that might otherwise be needed to pay the employer’s share of costs.” However, according to the Constitution, the Board’s “duty to its participants and their beneficiaries shall take precedence over any other duty.”
The courts have ruled that “any reasonable investment that provides direct benefits for the participants – even if it does not necessarily yield an adequate economic return – would be permissible.” (Social Responsibility in Investment Policy and the Prudent Man Rule, California Law Review: Vol. 68, 1980, p. 518) I doubt taking shareholders actions to encourage corporations to pay their taxes or even prohibiting investments in habitual tax evaders would reduce the System’s return. If it does, we’ll have even greater incentive to plug tax loopholes until companies that pay earn more than those that don’t.
In addition, favoring companies that pay their taxes could certainly be considered a “collateral benefit,” which wouldn’t violate the “exclusive purpose” requirements of pension fund trust laws. After all, if taxes don’t get paid, neither do public employees. I’ve been invited by the Asian Development Bank to speak at the Forum on Corporate Governance in Asiaduring their annual meeting in early May. I’d like to be able to tell them California public employees are willing to place limits on the short term “duty to maximize the value of its investments.” Should CalPERS be contributing to an atmosphere of tax evasion and other negative unintended consequences or should it be encouraging portfolio companies to take a long term sustainable approach? Perhaps the Board will address this issue at their offsite later this month.
High Corporate Governance Standards in Nairobi
Corporate Governance rules issued by Kenya’s Capital Markets Authority for the 51 firms that trade on the Nairobi Stock Exchange included the following standards:
- No person shall be a director of more than three publicly listed companies.
- Audit committees must include at least three non-executive board members who must be familiar with basic accounting principles and be “informed, vigilant and effective overseers of the financial reporting process and the company’s internal controls.”
- Directors will be proposed by a nominating committee, with a majority of non-executive directors.
- Independent non-executive directors should constitute at least one third of the board.
- Separation of CEO and chairman’s roles.
- Annual general meetings.
- Annual reports must disclose the level of compliance with corporate governance rules, and where they have not obeyed them, explain the steps being taken to ensure full compliance.
NACD Governance Survey Available
The 2001-2002 Public Company Governance Survey has been released by the National Association of Corporate Directors. It covers broad structure and practices of more than 5,000 US publicly traded companies and includes the views of hundreds of CEOs and outside directors. Want to know what the current benchmark practices and emerging trends are in corporate governance? Find out by getting the 5th survey. Also available from NACD is Board Leadership in Troubled Times. It may be too late for Enron but you can provide your directors and CEO with the tools they need to manage risk in an uncertain economic and social environment or in times of major crisis.
Also upcoming is NACD’s Annual Corporate Governance Conference, 4/28-4/30, in Washington, DC. “Adding Vision to Oversight” is the theme. Board performance is very often measured on how well directors deal with a crisis and how well they manage the situation after the siege is underway. This year, we hear a new public criticism: Why didn’t the board anticipate a problem in the first place? Where was the board? Where was the planning? This year’s annual conference will provide forums to discuss board strategies – not just when a company is in trouble, but also preemptive practices for when trouble is on the way.
UK to Require Pay Disclosure
UK’s Labor government to require publicly traded companies to report what they pay board members. Shareholders won’t be setting the salaries for individual members but they will be able to cast a nonbinding vote on general remuneration policy and that’s a step forward. Currently, most companies disclose director pay but don’t offer shareholders the right to vote.
Labor to Rebuild Chinese Wall
The AFL-CIO shareowners resolution calls for Goldman Sachs Group to bar its analysts from participating in the sales efforts of underwriters, and to stop linking analysts’ pay to the performance of the investment-banking group. It also recommends that the securities firm prevent its analysts from owning stock in the companies it covers. (see Rank-and-File: AFL-CIO Goes After Goldman: Union Busts Wall Street)
Watson Wyatt Worldwide has found evidence that improvements in human-capital practices (which includes both compensation and traditional human-resources concerns such as employee recruiting and retention) can boost a company’s financial performance. The consultants claim the practices are a leading, rather than a lagging, indicator of financial performance. Former studies found that significant jumps in an index of human-capital improvements tend to lift shareholder value 20%.
The average corporate pension plan shrank more than 11% in 2001, requiring many plan sponsors to contribute to their funds for the first time since before the boom of the 1990s, says William M. Mercer.
USA Networks Opens Books
USA Networks disclosed its internal operating budget through 2003, division by division. “We think this is a better way of providing information,” says CFO Mike Sileck. “We let analysts see our budget, which by definition is our best indicator of future activity, and we stop wasting time and energy on the game.” That certainly puts them near the head of the disclosure pack, small as it is.
Roundtable on Shareholder Proposals
the Corporate Governance Advisor (Jan/Feb) published a “Roundtable on Shareholder Proposals.” Participants included the SEC’s Martin Dunn, Pat McGurn of ISS, Nell Minow of The Corporate Library, John Wilcox of Georgeson Shareholder Communications and Beth Young, a consultant for the AFL-CIO.
Minow expressed her opinion that it is “unfathomable” that companies go to the SEC without first contacting the proponent to understand their concerns. Two trends she sees is more interest in identifying companies doing business in countries that either support terrorism or have other national security issues and increasing use of message boards. She notes that while she was with Lens she got some of her best information from an employee in a company’s bookeeping office “who gave us all kinds of wonderful data.
Minow also mentioned her own work at The Corporate Library, which includes a list of all directors who own less that 100 shares, who have missed meetings and other information, such as all the CEO employment contracts of the top 2000 companies. She’d like to see more shareholders using their right to inspect records under section 220 of the Delaware Code. Looking at the minutes of the board meetings “we found that what they leave out, as well as what’s in there, can be very useful.”
Wilcox focused his advice on how corporations can prepare for the proxy season. “Get rid of all the red flags that are going to attract shareholder proposals.” Don’t wait until TIAA-CREF is knocking at your door to get rid of that dead hand poision pill. “There’s already enough case law showing that it’s probable not a good idea.” Secondly, analyze who your owners are. This will help your know if you’re likely to risk getting a majority vote and whether you’ll need to negotiate. Third, resolve up front where your firm stands on policy issues. Will you fight standard issues like poision pills, governance issues, and environmental reporting? Then, when you do get a proposal, do a vote projection and meet with the shareholder proponent. Get advice from legal counsel, assess your chances of getting a no-action letter from the SEC and get advice on a communication strategy.
Young agreed with the need to meet with proponents to find out what’s really behind their concerns. She also stressed how important it is to “have a person with the authority to commit the company to a particular course of action present at the meeting and able to commit the company.” Companies often “oppose any request by shareholders to either meet with independent directors or have independent directors involved in the shareholder proposal process and the settlement process. I think this is a huge mistake.” Independent directors can be crucial in facilitating a settlement.
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Asian Institute of Corporate Governance (AICG) to Host 2nd Asian Corporate Governance Conference May 16-17, 2002
Proposals for papers to be presented are solicited. The first page should contain the title; name of the author(s), complete address, telephone, fax numbers and E-mail addresses. If there are multiple authors, indicate which author will attend and which will present the paper. Also, indicate whether you would be willing to serve as a session chair and/or discussant. All submitted papers must be accompanied by an abstract of at least 250 words. Send all submissions via e-mail with a Word or PDF attachment to the local organizer: Sooyun Joo, Assistant Director, Asian Institute of Corporate Governance, College of Business Administration, Korea University.
Russian Regulator to Discuss Corporate Governance in New York on February 4th
The chairman of the Russian Federal Commission for the Securities Market, the Russian analog of the U.S. Securities and Exchange Commission, will offer a presentation on the state of the Russian stock market, which was the fastest-growing in the world in 2001, on Monday, February 4 in New York.
FCSM Chairman Igor Kostikov will release for the first time the completed national Code on Corporate Governance, detail the regulatory agency’s accomplishments to date, and outline the government’s capital market development plan for 2002. Detailed printed information on the Russian capital market and the new Code not previously released will be provided in press kits. A reception and opportunity to meet Mr. Kostikov will follow the presentation.
Mr. Kostikov will address journalists, financial analysts, and others at the Reuters 30th-floor auditorium at 3 Times Square (between 42nd and 43rd Streets) at 4:00 p.m. Contact Jonathan Murno of the Emerging Markets Traders Association at 212 908-5000 or [email protected] to register. Preregistration is necessary for admission.
Press and analyst interviews with Mr. Kostikov can be organized by contacting Emerging Markets Communications, LLC at 202 331-7751. Mr. Kostikov speaks fluent English and his biography can be found at the FCSM website. Mr. Kostikov will be in New York Feb. 1-4 to participate in the annual meeting of the World Economic Forum.
3.4 Degrees of Separation
“The Small World of the Corporate Elite” by Mina Yoo,Gerald F. Davis and Wayne E. Baker is a great paper for anyone interested in the interconnectedness of corporate boards. Look for a summary in the 11/2001 issue ofDirectorship or the 11/2001 issue of ISSueAlert. The full text will probably appear in an upcoming edition of the Administrative Science Quarterly.
The research paper demonstrates that the corporate elite in the US is a “small world,” in which the average distance between any two Fortune 1000 companies is 3.4 intermediaries and between any two Fortune 1000 board directors is 4.3. The “small-worldness” of the corporate elite is not the result of conspiratorial design but of the intrinsic properties of the networks themselves. These properties transcend individual directors and companies, sustaining a similar interlocking structure of networks over time despite major changes in corporate governance and organizational structure. For example The mean path length for boards was 3.4 in 1982, 3.5 in 1990 and 3.4 in 1999. For directors it was 4.2, 4.3 and 4.3 respectively.
Today’s “inner circle” of the corporate elite is disproportionately African-American and/or female, serving on several boards at the same time. Interestingly, “the size of the average distance increases roughly logarithmically with the size of the network, not linearly. Thus doubling the number of companies in the network increases the average path length only modestly.” Expanding from the Fortune 1000 to all 5,610 firms on the NASDAQ or NYSE lengthens the path only to 4.7. As more foreign corporations begin trading in US markets, a similarly tight global elite is likely to emerge.
After discussing the possibility that the American model of corporate governance might be adopted around the world,Lawrence E. Mitchell ends his book, Corporate Irresponsibility: America’s Newest Export, with the words, “backlash is likely to arise in cultures that prize community over the pursuit of individual wealth.” The events of September 11, 2001 have proven Professor Mitchell prophetic. Those looking to examine the roots of resentment against American-style capitalism would be hard pressed to find a more relevant critique.
“Corporate Irresponsibility” should be mandatory reading for pension and mutual fund fiduciaries, especially those considering investment abroad, as well as for anyone on the speaker’s tour at international corporate governance conferences. Before advocating universal standards based on an Anglo-American model of corporate governance, we need to consider what the unintended consequences might be.
The United Nations Development Program reported in 1999 that American economic and cultural dominance has accelerated the widening divide between rich and poor nations. Mitchell also cites a study by Richard Freeman and Joel Rogers, “almost two-thirds of the increase in American gross domestic product from 1979 to 1996 went to the top 5% of families,” making our level of income inequality “the most unequal in the developed world.”
At the center of Corporate Irresponsibility is Mitchell’s examination of the impact of putting a short-term rise in stock prices above all other corporate goals. The need to maximize short-term stock prices leads corporations to shift their costs to the general public and the environment. Plant closings, poorly trained alienated workers, unsafe products, underinvestment in research and development, an undermining of democratic institutions, and increased stock market volatility are just of few of the many sins identified.
The “simple lesson about deferring gratification, about foregoing short-term pleasures for long-term benefits,” which many of us try to drum into our teenage children has obviously been lost on money market managers as well. Profits are crucial but trying to maximize profits for shareholders on a quarterly basis is almost certainly a self-defeating strategy for the long term. In addition, although globalization is here to stay, the world will be a poorer place if corporations continue to undermine sovereignty and culture for the sake of extracting increased profits on behalf of those who hold capital.
According to Mitchell, American’s have become increasingly focused on liberties, our right to get what we can and keep it, instead of equality, which often imposes obligations. Our dominate corporate governance model gives artificial creatures (corporations) the rights of natural persons. Unfortunately, no corporation has the moral framework of a human being, which allows us to forego short-term pleasures (profits) for long term goals such as sustainability and a healthy environment.
Corporate law has consistently moved to “replace any sense of common purpose with a very individualized concept of competing legal rights and duties.” Its as if we developed our system thinking, “let the corporations maximize stockholder wealth,” we’ll use “other institutions to keep them in check.” Unfortunately, corporations have come to dominate those other institutions. Schools provide a monopoly to Pepsi or Coke for cafeteria sales. The political system appears to be for sale to the highest bidder, with campaign finance reform still a distant dream. One family was in the news recently for offering to sell their child’s naming rights for corporate advertising purposes. Our own creation has come to dominate our lives. Like Stanely Kubrick’s computer Hal, who does some terrible deeds, like killing off the spaceship’s crew in the movie 2001 a Space Odyssey, corporations are dedicated to their mission and have an instinct for self-preservation.
Mitchell doesn’t hold back his criticism of those traditionally concerned with socially responsible investing either:
- The Domini Social Equity Fund “held substantial portions of its portfolio in the convicted monopolist Microsoft (7.72 percent), Cisco (7.38 percent), and market-dominator Intel (6.15 percent), among others.”
- “Between 1995 and 2000 TIAA-CREF made only one shareholder proposal relating to social issues.” Although its Statement on Corporate Governance “professes a concern for nonstockholder constituencies, the Statement notes that these constituencies, unlike stockholders, who have only their vote, have the ability to protect their interests through contracting with the corporation.” Entities with vastly different resources often cannot protect themselves against giant corporations. That point negates TIAA-CREF’s expressed concern for social responsibility.
- CalPERS voting guidelines may give a nod to human rights abroad by setting forth an expectation that portfolio companies operating in countries where human rights abuses occur adhere to “maximum progressive practices” to eliminate such abuses but their guidelines also acknowledge CalPERS’ fiduciary obligation to maximize returns. “Like the TIAA-CREF Statement, the Guidelines spend most of their time setting out voting principles designed to keep portfolio corporations free and available for hostile takeovers and thus short-term price maximization.”
- Aided by the AFL-CIO’s Center for Working capital, labor pension funds have taken on the same focus on the short term as TIAA-CREF and CalPERS.
Mitchell offers several solutions:
- Eliminate stockholder voting and make boards self-perpetuating. One way to move investor focus to the long-term is to eliminate the central premise of mistrust…the system of watchers watching watchers watching watchers. Mistrust leads to untrustworthiness. Mitchell, for example, argues that “the major way compensation is kept in check is not by law — it’s by public disclosure and embarrassment.”
- Boards should stand for election every five years rather than every year, with a moratorium on hostile takeovers in the interim.
- Lengthen the time between financial reports. Instead of being required to file financial reports with the SEC every quarter, require them every 2 or 3 years or every 5 years. Companies could report more frequently if they wanted to. This would give managers more “freedom to let their long-term plans mature.”
- Place a tax on frequent trades so that more stockholders become shareowners. Mitchell quotes consultant Frederick Reicheld, “Many managers find it nearly impossible to pursue long-term, value-creating strategies without the support of loyal, knowledgeable investors.”
- “Change the accounting rules to treat employees as assets instead of liabilities.”
- “Disallow depreciation in corporations in which the ratio of highest-to-lowest paid employee exceeds a certain amount.”
- “Stock issued pursuant to executive option plans would be punitively taxed if the executive sold the stock in too short a period.”
Many of Mitchell’s recommendations hinge on restoring trust. He points out that 33% of the nonagricultural workforce were supervisory in 2000. “Excessive supervision creates a management style of discipline and culture of distrust that is destructive of the social fabric.” However, employees will typically work harder, share ideas and cooperate only if they trust management to share the gains.
Given the Enron/Aurther Anderson debacle, any serious move to eliminate shareholder voting or lengthen the period between board elections or financial reports appears unlikely. In fact, SEC chairman Harvey Pitt wants to move away from quarterly reports to real-time release of corporate results. This will increase the short-term focus. Trust for those at the top has crumbled and won’t be restored by giving them even greater flexibility. Mitchell points out that, if our economic system limits meaningful participation to those with capital, “then a significant proportion of the population is robbed of its ability to participate in economic life other than as consumers, which hardly seems like a role designed to foster human freedom and dignity.”However, many of us do have capital… tied up in out pension funds, our 401(k), and our IRAs. Typically, someone else is managing it for us.
I believe we will only begin to restore our freedom and dignity when we participate in directing that money, how it is used and how our shares are voted. Mitchell’s suggestions for a small tax on frequent trades and changing accounting rules to treat employees as assets, instead of liabilities, are a step in the right direction…much more so than requiring that less information to go to stockowners.
Kelly on NPR
Marjorie Kelly, author of The Divine Right of Capital: Dethroning the Corporate Aristocracy, will be interviewed by David Molpus, workplace correspondent for National Public Radio, for the All Things Considered show. The show will air Wednesday afternoon, 1/16/2002. They’ll be talking about why Enron represented a failure of corporate governance. Kelly’s experience as the editor of Business Ethics magazine and author of the Divine Right of Capital is sure to provide insights into Enron.
One of the primary concerns of her book is that secondary market stock transactions do little to enhance the value of the corporation. The current rights stockholders over corporations is not unlike that of former aristocracies over land and peasants. In reality, employees are the ones who increase the value of businesses and they should get the bulk of the profits.
Shareholder Action as a Social Change Tool
Responsible Wealth will hold a mini-conference combining education and action on February 18th. Conference participants will be introduced to using the shareholder resolution process as a tool for social change The conference will be held across the street from the Hartford Civic Center, the site of the Disney Annual Meeting.
The agenda will include:
- Information on the history of shareholder activism as a tool for social change and Responsible Wealth’s history of using shareholder resolutions to initiate discussion of executive pay issues.
- An opportunity to meet and share ideas with others interested in economic justice and corporate social responsibility.
- A time to hear stories from Responsible Wealth members who have been actively involved in shareholder activism.
- Small group discussions with options including: Reforming Corporate Governance Practices; How Much is Enough?; and Telling a Different Story about Wealth Creation.
- A discussion of how pay at the top relates to pay at the bottom. Sister Ruth Rosenbaum, economist and founder of the Center for Reflection, Education and Action (CREA) will talk about her work on sustainable living wages.
- Discussion of our plans for the Disney annual meeting on February 19.
The conference fee is $125 and includes lunch and dinner on February 18. For more information, contact Scott Klinger <[email protected]> or call 617-423-2148 ext. 20.
Canadians Want SRI
A poll conducted by Vector Research found that most Canadian shareholders believe corporations operating both nationally and internationally must take into account their responsibilities for human rights, the environment, their employees and local communities.
Business executives should expand their responsibilities to embrace a broader social ethic, according to 74% of those polled. Wealthy shareholders (59%) say they prefer pension funds with investments in socially responsible companies, instead of those that seek only the highest returns. The vast majority (75%) want the government to establish standards for social responsibility and oblige firms to report on how well they are meeting the standards. Canadian shareholders (81%) believe Canada should pursue an international agreement for enforceable corporate accountability standards.
A majority (54%) believe corporations and trade unions should be prohibited from donating to political parties and candidates. Copies of the complete poll results and are available at the Canadian Democracy and Corporate Accountability Commission, under the heading public opinion poll.
CalPERS Board Sued Again for Legal Violation
The California Association of Professional Scientists (CAPS) filed a lawsuit in Sacramento Superior Court challenging the December 19 decision by CallPERS to loan the Davis Administration $1.3 billion as part of its deficit reduction plan. CAPS alleges that CalPERS failed to give required legal notice of the action. CAPS seeks to have the CalPERS approval reversed and have the action properly noticed for a future CalPERS meeting. State law requires at least 10 days advance notice of proposed actions but CalPERS’ spokeswoman Pat Macht said the proposal was announced within the 48-hour time period required for “emergency” situations. “The state only came to us at the last minute, and made an offer that needed to be confirmed in time to prepare for their budget,” she said.
Under the plan, the Davis Administration would be allowed to delay retirement payments and then repay the amount with 8.25% interest, an amount that is higher than the state would have to pay if it borrowed on the open market. The money would be paid back when the governor’s election is over and presumably state revenues have recovered. In return, the state would provide additional inflation protection to state retirees. Historically, CAPS has placed greater emphasis on the need to improving the Miscellaneous retirement benefits by raising the pay formula for future retirees.
Lawsuits filed by CAPS and other groups against previous administrations have established the legal principle that uncompensated borrowing from CalPERS constitutes an illegal raid. In order to make a budget-balancing program involving CalPERS money legal, the Board must make a determination that it provides members a compensating benefit. Although the Board has previously claimed on several occasions that it is exempt from state law, they have not made that argument yet in this situation. The legal battle appears to hinge on what constitutes a legal emergency. Sacramento Superior Court Judge Gail D. Ohanesian will hear the case in the coming weeks. The suit is the second one filed against CalPERS recently for ignoring state statutes. In a successful suit last year, California state controller Kathleen Connell sued CalPERS for not following state guidelines regarding pay increases. That determination has been stayed pending the outcome of an appeal.
Governance Leader on Tour
Madhav Mehra, President – World Council for Corproate Governancea has been involved in a series of one day seminars organized at 4 metropolitan areas in India – Delhi, Kolkata, Bangalore and Mumbai, organized by the Centre for Corporate Governance in association with Institute of Directors, New Delhi, India. Mehra’s tour is a lead up to the 2nd International Conference on Corporate Governance. Western models of corporate governance, are mostly based on maximization of shareholder value. However, Mehra argues that employees, whose knowledge accounts for 70% of corporate assets, must be made part of any governance system. Governance must not focus merely on shareholders but must also consider customers and employees who commit their lives for the corporation.
“Traditionally speaking, the constitution of a company’s board of directors is confined to its shareholders. The aim here is to maximise their value,” said Dr. Mehra. In the current knowledge economy, however, such a policy could lead to a conflict of interest between stakeholders and employees. A modern corporation, therefore, must measure and monitor total wealth creation, including that of employees, suppliers and clients. Good governance should pre-suppose a long-term and sustained benefit to the society at large through collaborative efforts, rather than focusing on short-term gains of enhanced value to the shareholders and efficient management of entities. Indian Institute of Management Director, Rammohan Rao, said companies would have to take a long-term view and not be obsessed with quarterly results.
Proportion of Income from Ownership Rises
Back in the 1950’s, Louis Kelso predicted that the percentage of total income earned from labor would shrink in comparison with that derived from capital. The Economic Policy Institute reports that from 1973-1999 labor’s share dropped from 74.4% to 70.5% while income from capital grew from 14.5% to 20.3%. Apparently, these rates do not include increases from realized capital gains or potential capital gains from securities that have appreciated. If factored in, these gains would have further added to the shift to asset-based income. (Employee Ownership Report, 1-2/2002) Attend an NCEO workshop “Introduction to ESOPs.”
Back to the top
Auditor Proposals on Rise
In the wake of Enron’s collapse, pension funds and others have been flooding the firms they own with proposals for change. Enron paid Andersen $52 million in 2000 for both audit and non-audit services, then declared bankruptcy this year on December 2nd. “What’s new this year is these auditor independence proposals. That’s something that we really haven’t seen before,” says Pat McGurn, vice president atInstitutional Shareholder Services.
The United Brotherhood of Carpenters union have filed 12 proposals calling on companies not to hire the same accounting firm to do both audit and non-audit work. Among the companies targeted are Apple Computer, Bristol-Myers Squibb, Avon Products, Dominion Resources, Liz Claiborne and Manpower, according to the Investor Responsibility Research Center.
In 2001, the SEC handled 438 requests from companies for permission to exclude shareholder proposals from their proxies, down from 477 requests in 2000. Shareholder proposal activity is expected to “increase slightly” this season, according to John Wilcox, vice chairman of Georgeson Shareholder, which manages shareholder communications programs for many big companies.
One of the most innovative approaches to ensure auditor independence was introduced last year at SONICblue by Mark Latham of the Corporate Monitoring Project. Latham’s proposal would let shareowners vote to select the auditor, not just ratify a firm selected by the board of directors. Competing to please shareowners rather than directors, would create “new pressure for higher standards and tougher audits, according to Latham.
“The average investor may seem ill-equipped to assess auditor quality on her own. But she need not do this on her own — she would benefit from consensus-building discussion by the entire investment community. Shareowners are asked to vote each year on the choice of directors, yet it is much easier to assess reputations of auditors than of board members, because there are only a handful of auditing firms, versus hundreds of board candidates for a diversified portfolio of stocks over the years.” (Latham)
Although the SEC allowed SONICblue management to omit the resolution from the proxy, my hope is that with some slight modification it can be reworded to win SEC approval. To read Latham’s SONICblue proposal, management’s response, Latham’s response, the SEC’s no action letter, and Latham’s comment on the SEC decision, see Corporate Monitoring website (corpmon.com).
Cash is King
According to pay consultant William M. Mercer, only 18% of the compensation of American chief executives (and 40% of that of UK chief executives) came from fixed salaries last year. The rest came from variable sources, such as stock options and other performance-related bonuses. Watson Wyatt, another pay consultants says 90% of listed American companies have options “under water” (i.e., the share price is below that at which the options were issued). Cash may be coming back into favor. One way to minimize overhang are “stub options,” short-term options which vest within 12 months but expire after 13, compared to most options which vest within four years and expire after ten. (The Economist, Under water, 11/8)
Increase Board Opportunities
In “Tips for Corporate Board Election,” (Wall Street Journal, 12/26) Charles H. King of Korn/Ferry International, suggests involvement in cultural, religious and political groups, as well as corporate governance conferences. Consultant and board director Jenne K. Britell recommends nonprofit board service. Also helpful is Boardseat.com. Whether you’re looking to get on a board or are building a board of directors or advisors, Boardseat.com can help you make the connection. They’ve also got a growing list of articles and FAQs on everything from “Advisory Boards – The Basics” to “What to Do With Not-For-Profit Board Members Who Don’t Do Anything.”
Help for Fiduciaries in Meeting Triple Bottom Line
Since 1995 our Corporate Governance site at CorpGov.Net has served as an interactive resource for those who believe active participation by shareholders in governing corporations can increase triple bottom line returns (adding economic, environmental and social value). SRI World Group, Inc. has now created the most definitive guide in print on the subject that we have seen. Sustainable and Responsible Investment Strategies: A Guide for Fiduciaries and Institutional Investorsis a must read for every director who has been challenged by colleagues, when attempting to consider sustainability in stock picking and when exercising care and judgment as a shareowner.
Sustainable and Responsible Investment Strategies is written by SRI World Group, which has provided consulting services to fiduciaries, walking them through key decision steps and helping them identify what factors may be the most appropriate for their institutions in achieving sustainable and responsible investment strategies. Now you can get many of the benefits of their workshops in a handy, easily referenced volume.
The book is divided into four chapters covering the terms and strategies of sustainable investing, fiduciary responsibilities, performance, how to implement the strategies right for your organization. Appendices include decision trees, profiles of institutions, financial performance graphs of several mutual funds, guidance documents from the US Department of Labor, sample shareholder resolutions, an extensive list of institutions and their strategies, policy guidelines and timetable of important historical events.
Another source for those concerned with the triple bottom line is the National Association of Corporate Directors. The November issue of their newsletter, Director’s Monthly, has articles providing boardroom a guide to the triple bottom line, diversity initiatives, and an update of the Caux Round Table’s principles for business. “The ‘Triple Bottom Line’: A Boardroom Guide” is written by Michael Sauvante, Chairman and CEO of Rolltronics Corporation. Rolltronics has an innovative corporate structure. A limited liability company, controlling 25% of the stock, makes ownership available to employees and contractors. The Rolltronics Foundation, which fosters sustainability through philanthropic and educational enterprises, owns another 25%. Sauvante discusses natural capital and cradle-to-grave closed loop systems, citing: Natural Capitalism and Mid-Course Correction. He goes on to discuss social capital, citing such books as The Emperor’s Nightingale, Profit Building and Wealth Creation and Wealth Sharing.
Other books favorable mentioned in the November issue: Winning the Influence Game, which explains how to maximize effective government relations, and Lessons from the Top, profiles of 50 prominent CEOs.
Raid Agreement May Settle Suit and Help Balance Budget in California
California will save over a billion dollars by “restructuring pension contributions” to CalPERS. The arrangement was made in an emergency closed-door meeting. The state will continue to make its standard contributions for the rest of this fiscal year but will reduce the rates used to determine how much the state contributes to the system. When Governor Pete Wilson deferred payments to the plan to balance the budget in the early 1990s, CalPERS called it a “raid,” sued and won (then reduced the state’s contribution rate in a vain hope that Wilson would use the money to boost salaries of state employees). This time the CalPERS board agreed to the “restructuring.”
According to an article in the Sacramento Bee (CalPERS deal aids budget, 12/20/01) “in return for the lower contribution rates in the short term, retirees will receive stronger inflation protections down the road.” Inflation protection is to kick in when inflation erodes pensions by 20%, instead of 25%. What the Bee leave out is that the “agreement” is dependent on Kathleen Connel dropping a lawsuit, allowing the board to raise its reimbursement rate and that of money managers at CalPERS. Apparently, the only board member to vote against the deal was Charles Valdes, who was recently reelected to the CalPERS board by a landslide election results to be announced later this month) even though he declared personal bankruptcy twice, didn’t pay taxes for about seven years, and was asked to resign by about 1/5 of the legislature.
Connel should stick with her suit despite being widely criticized in the financial press. Connel didn’t sue to stop CalPERS from raising the pay of investment managers, a widely reported; she sued to stop the CalPERS Board from placing itself above the law, the minor impact on the pay of investment managers is incidental.
CalPERS is a great advocate of good corporate governance, including transparency and compliance with the law. Yet, when the CalPERS Board violates California laws and obfuscates their activities, the financial press, including Governance, Pensions & Investments and others, seems all too willing to accept that the primary issue was a pay increase for investment managers.
Here’s the real story. CalPERS Board members wanted a raise but their reimbursement is clearly set in statute. Rather than sponsor legislation, they argued that Proposition 162, which gave the Board independent authority to protect the fund from political raids, allows them to ignore statutory pay limits because such limits interfere with the performance of fiduciary duties.
The Board argued that higher pay was needed to attract competent Board candidates. However, at about the same time they also voted for election rules that would have made it nearly impossible to unseat an incumbent. According to an editorial in the Sacramento Bee their proposed rules risked creation of “a permanent board: unaccountable, untouchable and isolated from the people who elect it.”
Fortunately, CalPERS members were able to head off that action but the salary increases went through. When the Board raised their own pay they provided themselves cover by also raising the salaries of a few investment managers. The strategy worked, since the financial press has not focused on the Board’s own raises at all.
While its true that CalPERS needs to pay its money managers more if it is to continue to attract top talent, the same is true for CalSTRS and the Treasurer’s Office. The same is true for many job classifications in state service. CalPERS isn’t unique.
If the CalPERS Board actually believed their fiduciary responsibilities overrode the law, they could have challenged the Department of Personnel Administration and the Controller in court, instead of simply ignoring the law. However, the courts are no more likely to allow the Board to unilaterally raise their own pay and that of civil servants as it is to forgive traffic tickets to members who claim travel at the posted speed would cause them to violate their fiduciary duty because they’d be late for a meeting.
Dr. Connel should be praised for upholding the law. Retirement boards should be able to plan ahead and go through the normal legal process to raise salaries as needed. Most importantly, they should not place themselves above the law. Kudos to Valdes for the courage to vote against the lastest deal (even though he originally voted for the raises).
Back to the topFood Chain: Watching the Watchers
Governance‘s December editorial, “The food chain,” argues that corporate governance is not just about ensuring managers run companies in the best interests of owners. Since owners and managers exist at “several removes,” trustees, fund managers, and custodians operate in a governance “food chain.” While the past decade focused largely on the relations between managers and directors and directors and shareholders, the focus is now appropriately shifting. He cites, as an example, an article on Unilever in the same issue. It seems the Unilever pension fund, which sued its fund manager for the negligence, was monitored via “nods and winks rather than formal and professional processes.” “Managers and directors have learned to become open, accountable and professional in their dealings with key constituencies. Its time that fund managers and pension fund trustees followed suit.”
ISS Sides With HERE
Hotel Employees Restaurant Employees International Union won support of Institutional Shareholder Services (ISS) in its move to convince shareholders of Loews Corporation to vote against the company’s proposal to create a separate tobacco “tracking stock” for Lorillard. Key points in the ISS report include:
- (B)ecause the company’s tracking stock will be issued via an IPO, current shareholders of the parent company will receive no direct benefit in the transaction.
- According to the empirical studies conducted on tracking stock and the parent stock, there is no compelling evidence to suggest that tracking stock maximizes long-term shareholder value for the parent’s stock.
- One cannot ignore the concerns raised by HERE in that the tracking stock transaction may have been structured to more preserve insider voting interests of Lorillard rather than to maximize shareholder value.”
- The creation of a tracking stock creates a serious conflict for the company’s board.”
Millstein on 911
Corporate governance expert Ira M. Millstein, of Weil, Gotshal and Manges, wrote to the Financial Times in October expressing his concern that “eliminating poverty and misery is crucial to the “just war”; ideologues and fanatics breed on poverty and oppression.” “Diminishing the great economic divide between ‘haves’ and ‘have nots’ will require as much energy, effort and dedication as rooting out those who perpetrated the events of September 11.” (see posting atragm.com)
I would add that of course we need to root out terrorists, but let’s not sweep away our independent judiciary, the right to a public trial, the right to an appeal, the right to counsel, due process, equal protection and habeas corpus in the process. Good governance depends on broadening stakeholders in the system (per Millstein), while ensuring the system is transparent and protective of civil liberties.
End of Limited Liability
Russell Mokhiber and Robert Weissman’s latest corp-focus advances an idea of Lawrence Mitchell’s; limited liability for corporate shareholders should end. “Limited liability encourages stockholders not to care, ” Mitchell says in his latest book, Corporate Irresponsibility: America’s Newest Export (Yale University Press, 2001). Instead of limited liability, he advocates that corporations buy insurance. Risk would then be factored into the cost of doing business based on risk…better than sticking it to a creditor if the corporation fails.”
Mokhiber and Weissman like the idea but recognize it won’t be adopted anytime soon. They suggest an interim step would be to take away constitutional protections and limited liability from the worst-acting corporations. They call for a Corporate Character Commission (CCC), with members chosen from the “human person community.” (As opposed to the human nonperson community?)
Just as the Federal Communications Commission reviews broadcast licensees, the CCC would review corporate charters. They call it a “modest step” to a future where the corporations are subservient to moral human beings. I call it interesting but unlikely.
I would have rather seen Mokhiber and Weissman focus on Mithchell’s idea that earnings reports be required annually rather than quarterly or that the capital gains tax be increased on stocks held for fewer than thirty days. Both measures could contribute to a longer time horizon by shareholders and management, something that might be positive for everyone…and, in my opinion would be more likely. Another more modest step in the right direction would be requiring mutual funds to adopt and publish proxy-voting policies and to record and publicly disclose their proxy votes (read Amy Domini’s letter to the SEC).
Monks on Forefront Again: ExxonMobil Should Separate Chair and CEO to Protect Value
Robert A.G. Monks’ recent shareholder resolution calling for separation of the Chairman and CEO positions at ExxonMobil may result a giant step forward in cooperation between those concerned with corporate governance and the SRI/environmental communities. The move was sparked by his growing concern that the ExxonMobil Board of Directors is failing to protect long-term value in the company from Chairman and CEO Lee Raymond’s increasingly extreme position and public image.
“In the last year there have been dozens of stories highlighting criticism of the company for its environmental and social positions. Bad publicity destroys shareholder value and Exxon is undervalued compared to its peer group when it should be at a premium. We need to reverse this before investors’ holdings feel the effects more,” said Monks.
His resolution cites ExxonMobil’s bad press “…nearly half of the people familiar with [ExxonMobil] continue to give it a poor grade for environmental responsibility,” (Wall Street Journal, 2/7/01.) “ExxonMobil’s stubborn refusal to acknowledge the fact that burning fossil fuels has a role in global warming is creating a PR backlash against the world’s biggest company.” (O’Dwyer’s PR Weekly, 5/23/01) “The Reputation Institute and Harris also identified companies with the worst reputations in America, including Philip Morris Cos., Exxon and Kmart Corp…” (Wall Street Journal 9/23/99) “the company is increasingly isolated on the issue, not only from the international scientific community but also from its European competitors…” (Wall Street Journal, 3/22/01)
Monks lays primary blame on Lee Raymond. His “unflinching attitude to global warming, to ExxonMobil’s businesses in regressive regimes, and his disdain for gay rights sparked a boycott of Exxon’s products in Britain, and even calls for a boycott in the US.” (PR Week 11/26/01)
Taking a lead from the UK’s Myners Report, which promotes responsible activism, Monks’ resolution argues that Raymond’s antagonistic approach to public issues is causing damage to the company’s reputation, and that the board is failing to meet its basic duties. The resolution states:
RESOLVED that the shareholders request the Board to separate the roles of Chairman and CEO and designate a non-executive and independent director as Chairman as soon as possible (without violating current employment contracts).
Campaign ExxonMobil announced its support for the resolution. “We are pleased to see an investor with the track record and influence of Robert Monks taking on this company over its handling of this issue,” said Peter Altman, National Coordinator of Campiagn ExxonMobil. “I look forward to building support for this resolution over the next several months.” “No matter how hard the company closes its eyes and wishes, global warming isn’t going away. The smart course is to admit it is happening and get on with realistic solutions that will prevent the worst from happening.”
Free gift. I’m not sure why Capstone Publishing keeps allowing Robert Monks to give away his books on the internet but he’s done it again. Hopefully, readers of The Emperor’s Nightingale on-line will enjoy the book so much they’ll want the handy bound edition. If you so, click through CorpGov.Net we need the revenue to keep you informed.
Back to the topBroadgate Survey
The bear market has wiped out an estimated $1 trillion in shareholder value. A year-end survey of US institutional investors by Broadgate Consultants, finds that 76% of the 89 survey participants expect pressure from institutional investors on corporate governance matters to increase next year. Top concerns:
- Stock option grants and pension fund accounting. The rising quantity of stock options being issued to employees and their potential dilutive effect. Overly optimistic assumptions concerning pension fund returns.
- Takeover activity in 2002 to contribute to market gains, especially in technology, telecommunications, financial institutions and health care.
- 51% of the respondents said there should be more federal regulation of IPOs.
Reddy on Indian First Principles
Dr. Y.R.K. Reddy, Chairman of Yaga Consulting Pvt. Ltd., has been researching Corporate Governance with special reference to Public Enterprises and Banking in India. We are delighted to be able to present his insights, including 33 recommendations, in our Commentary section. See The First Principles of Corporate Governance for Public Enterprise.
Domini Challenges SEC; We Urge You to Join Her
Domini Social Investments sent a letter to the Securities and Exchange Commission (SEC) urging adoption of a rule requiring all mutual funds to adopt and publish proxy-voting policies and to record and publicly disclose their proxy votes. The letter from Amy Domini to SEC Chairman Harvey L. Pitt states that proxy voting disclosure “should be considered a fundamental fiduciary obligation that mutual funds owe to their shareholders, and should be required as a matter of law.”
Two years ago, Domini Social Investments became the first mutual fund manager in America to disclose the actual proxy votes it casts for each company in its portfolios. All proxy votes are published on Domini’s website, along with the firm’s annual proxy voting guidelines covering more than ninety corporate governance, social and environmental issues. “We think our shareholders have a right to know how we intend to vote their shares on important issues of corporate governance and social and environmental responsibility,” says Ms. Domini, the firm’s founder and a managing principal.
In her letter to the SEC Chairman, Ms. Domini commends the SEC on its recent efforts to encourage greater disclosure and transparency by mutual funds, including the plain English prospectus and detailed disclosure requirements regarding investment strategies, risks and fees. “Disclosure [of proxy voting] would promote accountability and transparency,” writes Domini, “which are not only guiding principles of our financial regulatory system but have been special concerns of the Commission in recent years.”
“I can think of no other instance where the Commission countenances opacity rather than transparency in the discharge of fiduciary obligations,” continues Domini. “Indeed, when it comes to proxy voting there is not even a record-keeping requirement, let alone a disclosure requirement. I believe it is time to address this anomaly.” Yet, “proxy voting is the most direct means by which individual investors – either directly or through financial intermediaries like mutual funds – can play an active role in influencing corporate behavior.”
Ms. Domini’s letter also points out that “there is mounting evidence that progress on social, environmental and corporate governance issues is linked to long-term corporate performance.” “The Commission need not embrace the notion that proxy voting on social, environmental or corporate governance issues positively impacts fund value or corporate financial performance in order to acknowledge that many investors surely believe that it does,” writes Domini. “And if this is true, then they should be entitled to this information – just as they are entitled to information on mutual fund strategies, risks and fees.”
“Proxy voting disclosure will provide the information that mutual fund investors need to ensure that their mutual funds are accurately representing their interests when they vote on corporate governance, social and environmental issues,” concludes Ms. Domini. “I would urge the Commission to propose for adoption a rule requiring all mutual funds to adopt and publish proxy-voting policies and to record and publicly disclose their proxy votes.”
Read MS. Domini’s full letter. Please join Ms. Domini and others by dropping an e-mail to SEC Chairman Harvey L. Pitt. Let him know that you agree; mutual funds should be required to adopt and publish proxy-voting policies and to record and publicly disclose their proxy votes.
Asian Institute of Corporate Governance (AICG)
The first “Asian Corporate Governance Conference” on December 14, 2001 appears to a sellout event. The AICG invited internationally renowned scholars, economic policy makers, and practitioners from Asian countries and the US to discuss the current developments in corporate governance. Congratulations!
Longer term goals of the AICG are
1. Maintain and conduct research on corporate governance related databases
2. Support top-rated academic research on corporate governance
3. Organize international conferences on corporate governance
4. Provide education programs for top-level directors
5. Publish monographs and working papers on corporate governance
6. Interact with other leading research institutes on corporate governance throughout the world
Crompton to Head IRRC
The Investor Responsibility Research Center, (IRRC) announced the appointment of Linda Crompton, MA, MBA, as President and CEO, effective January 1, 2002. Crompton is the founder and former President and CEO of Citizens Bank of Canada, Canada’s first truly electronic bank and the country’s first bank with a publicly stated social mandate. Crompton is recognized in Canada as an innovative business leader and a compelling speaker on the global significance of corporate social responsibility.
“At a time when business is feeling both economic and shareholder pressure, IRRC will benefit greatly from Linda Crompton’s expertise,” said Luther Jones, IRRC’s chair. “Ms. Crompton understands first hand, the dynamic and often difficult balance between meeting business objectives and being accountable to stakeholders.”
In addition to her academic credentials, Crompton brings 25 years of experience in business, finance and organization development as well as a deep understanding of social and environmental issues. “It is an honor to take over the leadership of such an important organization as IRRC,” said Crompton, “Never before has the world felt so small and so interconnected. It is in times like these that we become acutely aware of the need to understand the greater impact of our business decisions.”
Crompton succeeds Scott Fenn, who announced plans to retire earlier this year after a 23-year career at IRRC, including six years as President.
For over 25 years, IRRC has been the pre-eminent source of high quality, impartial information on corporate governance and social responsibility issues affecting investors and corporations worldwide. Today, IRRC provides research, software products and consulting services to nearly 500 subscribers and clients representing institutional investors, corporations, law firms and other organizations.
Back to the topHistorical Review
Fro its 25th anniversary issue, Directors & Boards does is again with “An Oral History of Corporate Governance, 1976-2001.” The editors interviewed luminaries from business, finance, law and academia who trace the evolution of corporate boards from the largely ceremonial bodies of the 1970s to the more activist boards of today. Among participants are longtime corporate directors Raymond Troubh and Barbara Hackman Franklin, fund manager John Neff, arbitrageur Guy Wyser-Pratte, shareholder activist Nell Minow, former CalPERS General Counsel Richard Koppes, Vanguard Co. founder John Bogle, Spencer Stuart recruiter Thomas Neff, National Association of Corporate Directors founder John Nash, Harvard business professor Jay Lorsch, and former Delaware Court Chancellor William Allen.
Other sections include “The Way It Was,” which features exerts from past issues and “The Shape of Things to Come,” which examines emerging issues such as the increasing involvement of small and mid-size companies in corporate governance issues and the continuing effect of globalization. Close to 300 executives, past and present, appear in the issue as commentators on how boards have transformed themselves over the past quarter of a century.
Few saw it coming but apparently the company did disclose deals with members of its board of directors in their proxy statement published earlier this year that should have lead to suspicions about other practices.
- Enron director, John Urquhart was paid $493,914 last year for providing consulting services to Enron.
- Enron director, Lord John Wakeham, received $72,000 last year for advice on Enron’s European operations.
- Enron director Herbert Winokur was affiliated with the privately owned National Tank Co. that made sales to Enron worth $370,294 last year, the proxy statement said.
- Enron paid $517,200 last year for travel services provided to Enron employees. The travel agency business that provided the services is 50 percent-owned by Sharon Lay, sister of Enron chairman and chief executive Ken Lay.
Perhaps the Ohio Public Employees Retirement System ($68.8 million loss), New York State Common Retirement Fund ($58 million loss), CalPERS ($45 million loss), State Retirement System of Illinois ($15 million) and others will now spend more time carefully reviewing proxy statements for clear evidence of poor corporate governance practices.
Good Governance Pays
Firms that preserved shareowner rights had stock outperformed those that bolstered management’s power during the 1990’s, according to “Corporate Governance and Equity Prices,” a paper co-authored by Harvard economists Paul A. Gompers and Joy L. Ishii and Wharton School professor Andrew Metrick.
“Firms with weaker shareholder rights earned significantly lower returns, were valued lower, had poorer operating performance, and engaged in greater capital expenditure and takeover activity,” according to the paper at the Yale School of Management Finance and Accounting Seminar series.
The study tracked data on corporate governance provisions collected by the Investor Responsibility Research Center (IRRC) on about 1,500 firms from September 1990 through December 1999. The authors then constructed a straightforward “Governance Index,” assigning one point for every provision that reduced shareowner rights. The higher the score, the weaker the shareowner rights and the stronger the management power. An investment strategy that bought the firms in the lowest decile of the index (strongest shareholder rights) and sold the firms in the highest decile of the index (weakest shareholder rights) would have earned abnormal returns of 8.5 percent per year during the sample period.
Weaker shareholder rights are associated with lower profits, lower sales growth, higher capital expenditures, and a higher amount of corporate acquisitions.
In a related item, in emerging markets good corporate governance tends to be a good indicator of superior stock performance. A recent study of 495 companies by CLSA Emerging Markets showed that while the stocks of the largest 100 companies covered fell an average of 8.7% last year, the stocks of the companies rated best for corporate governance rose an average of 3.3%.
Catalyst Reports on Women’s Progress
Women continue to make small gains by taking board seats at large companies in the world. In the 2001 Census of Women Board Directors of the Fortune 1000, Catalyst found that women now hold 12.4% of the board seats, up from 11.2% in 1999. “We have seen a 25.8% increase in the number of Fortune 500 companies with women on their boards since we started counting. Between 1993 and 1996 the number jumped from 345 companies with at least one woman on their board to 417. The pace the slowed over the last five years and there are now 434 companies,” said Catalyst President Sheila Wellington. “If the rate of change remains constant in the F500, women will occupy 25% of the board seats by 2027,” said Wellington.
Catalyst also tracks “Blue Ribbon Boards” with more than 2 women. In 1999 their were 296 companies. This year the number has risen to 317 companies. In the first year of the Catalyst census, 155 of the F500 companies had no women board directors. In Catalyst’s ninth year of counting, only 67 of the F500 still have no women. Women of color comprise about 2% of the F1000 boards seats and 18.1 % of the board seats held by all women. They hold 178 of the 8,941 seats among the 839 companies for which Catalyst could confirm race and ethnicity.
Of the 178 seats:
- 131 seats are held by African American Women
- 30 seats are held by Hispanic Women
- 15 seats are held by Asian American women
- 2 seats are classified as “other
For additional information or to obtain a copy of this report, please call 212-514-7600.
HERE Opposes Lorillard Tracking Stock
The Hotel Employees Restaurant Employees International Union (HERE) announced opposition to a proposal by Loews to create a “tracking stock.” representing its minority interest in the economic performance of Lorillard, Loews’ tobacco subsidiary. “Rather than spinning-off Lorillard to shareholders and allowing shareholders to realize the full value of the tobacco asset, our company has proposed a financial gimmick that doesn’t maximize value for shareholders,” said Matthew Walker, HERE General Vice President.
HERE concerns include:
- The limited voting rights of tracking stock, with no recourse to assets, no board representation, and options by Loews to redeem the shares – would likely dampen market appetite for a public offering. Studies show that tracking stocks have a poor performance record.
- There are no assurances that the proceeds of the proposed tracking stock sale will flow directly to Loews’ shareholders since Loews will use the proceeds of the tracking stock offering for “general corporate purposes.”
- The tracking stock will create significant potential conflicts of interest among stockholders, the board of directors and management.
- The tracking stock was approved by a board dominated by insiders. The tracking stock will allow the Tisch family, which owns over 30% of Loews, to retain control of Lorillard.
- “As part of Loews, Lorillard is currently valued by the market at less than $20 per share. If an independent Lorillard were to trade at P/E ratios similar to other tobacco companies, it would trade in the $40-50 range,” Walker said. HERE has filed a shareholder proposal for the Loews’ 2002 annual meeting seeking a spin-off of Lorillard to shareholders.
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Capstone Publishing has made available online the full text of The New Global Investors by Robert A. G. Monks. You can download it a chunk at a time in Adobe or the entire book via a zip file. That’s the second book Monks has made available online. The first was Power and Accountability. That book, with Nell Minow, brought many into the field of corporate governance. With The New Global Investors, Bob is introducing his important work to another generation. Read it online and then buy them both through Amazon (Global and Power).
Corporate Governance – Turning Rhetoric into Reality
2nd International Conference on Corporate Governancescheduled to be held in Hotel Taj Mahal, Mumbai on 18th and 19th January, 2001 will proceed despite the monumental tragedy of 11 September 2001. Most countries have developed their corporate governance codes. Therefore, the most challenging task is to assess how these codes are being implemented. The Conference will provide a unique platform for exchanging information on the practices of corporate governance worldwide. It is expected to be attended by 500 delegates from 30 countries and offers an unrivaled opportunity for interaction and networking with global leaders in business and government.
CREF Keeps Tobacco
At its annual meeting, College Retirement Equities Fund (CREF) encountered a large number of activists seeking to have the fund withdraw its investment tobacco companies led by the national corporate accountability organization, Infact. TIAA-CREF is one of Philip Morris’ largest institutional investors. The resolution was defeated by 70.1% to 24.6% (with 5.2% abstaining).
“Philip Morris’ Marlboro Man is arguably the world’s leading source of youth tobacco addiction. It was designed nearly 50 years ago to capture the youth market and it has succeeded,” said Camille Chow, a sophomore at Brown University who participated in the protest. “How can an investment fund that is dedicated to serving the education and research communities justify funding the Marlboro Man’s global rampage?”
The activists also challenged Elizabeth Bailey, a professor of business ethics at the
University if Pennsylvania’s Wharton School of Business, a CREF trustee and holds a seat on Philip Morris’ board.
401(k) Fatally Flawed
Watson Wyatt Worldwide examined 252 large companies with both defined-benefit and 401(k) plans for the 1990-1995 period and found the defined-benefit plans bested the 401(k) plans by 2.4% per year. 401(k) plans at Morningstar, Prudential, and Hewitt Associates between 1995-1998 earned annualized returns of 13.5%, 10.5%, and 11.8%, respectively, versus a 21.2% return for a global 70/30 mix of stocks and bonds. According to an article in Barron’s, “Given low equity returns, high expenses, and poor planning, it is likely that most 401(k) investors will obtain near-zero real returns in the coming decades.” “The inevitable government bailout will make the savings and loan resolution of the last decade look like lunch at Taco Bell.”
“The self-managed defined-contribution concept is fatally flawed,” according to William Bernstein. (Barron’s, Riding for a Fall: The 401(k) is likely to turn out to be a defined-chaos retirement plan, 11/26)
State Pensions Squander Surpluses
According to an article in November’s Institutional Investor, before he became the Bush administration’s antiterrorism czar as head of the new Office of Homeland Security, Tom Ridge bought off Pennsylvania opponents of a piece of legislation by giving legislators a 50% hike in their retirement packages, while the state’s 234,000 teachers, and 109,000 other public workers, won a 25% increase. Critics blasted the compromise as a $10 billion giveaway.
Ridge did it by making use of the surplus in the Pennsylvania Public School Employees’ Retirement System. “Arcane rules of pension accounting” allow states to average their assets over several years. “Smoothing” allows them to bank on “surpluses” by using financial data that is two to five years old. Institutional Investor reports that at least 4 of the 11 states that tapped their pension funds in the past year have moved from surplus to deficit. Assuming current market valuations, Pennsylvania, has smoothed a 123.8% level of funding on June 30, 2000, to about 97%. However, Stephen Nesbitt, senior managing director at Wilshire Associates, estimates “the actuarial value of assets is roughly 10 percent less than the market value of assets.”
The average pension fund has fallen from a 116% to a 106% surplus, according to Wilshire Associates, and 44 states have seen revenues decline this year. In 1996 the average public pension was funded at 92% but with the four year bull market, that increased to 116% by January 2000. Assets rose 20% annually, from $825 billion to $1.72 trillion.
Over the last two years, not only have assets been falling but liabilities have been rising due to both benefit hikes and the decline in interest rates, which should lead states to use lower discount rates and expected earnings. “According to the pension liability index produced by New York-based money manager Ryan Labs, between September 2000 and September 2001 pension liabilities grew at a 14.64 percent clip.” While some retirement systems have chosen to lower their discount rate assumptions, Governmental Accounting Standards Board rules do not require them to do so.
Smoothing works both ways. asset growth lags as market values climb bu smoothing works to prop up values when the market declines. However, a fund can also choose to ignore its normal smoothing process to embrace market values. Institutional Investor provides examples, most dramatically West Virginia and Louisiana, where lower contributions and generous pay hikes produced large unfunded pension liabilities and dramatic debt loads. (Institutional Investor, Squandering the surplus, 11/2001)
CEOs on the Line
The 2001 survey, “CEO Turnover in a Global Economy,” administered for Russell Reynolds by Wirthlin Worldwide which conducted interviews with 300 institutional investors in Australia, Canada, France, Japan, the UK and the US, found 15% of institutional investors called for a CEO’s termination in the past year. In Australia and the UK the numbers were even higher, 37% and 27% respectively said they had “contributed” to a CEO’s departure. Succession planning has become a major concern of 81% institutional investors.
US investors express dissatisfaction with a CEO either through written communication (37%) or selling their stock (35%), while investors in Australia, France, Japan and the UK convey opinions of a CEO’s performance through meetings with a company’s board and senior management. Most investors believe that companies in their country adhere to sound corporate governance practices; notable exceptions include Japan (3%) and Australia (37%). Establishing global corporate governance standards are favored by Canadian (68%), Japanese (53%) and French (51%) investors more than those in the UK (43%), US (38%) and Australia (37%). Two-thirds of investors surveyed have voted for a shareholder resolution within the past year; 15% have sponsored a resolution. (CEO Turnover in a Global Economy)
UK Firms Improving but Still Fall Short
Four out of five companies fail to meet corporate governance expectations, according to the UK’s National Association of Pension Funds (NAPF). In a report on compliance with the FSA’s Combined Code, NAPF found that 49% of UK’s top 400 companies failed to meet the recommendation that only independent non-executive directors should set directors’ pay levels. However, the percentage complying with NAPF policy expectations in all respects has nearly doubled in just two years.
Labor funds showed increased sophistication in choosing where to file proposals, and the more focused approach was rewarded with high shareholder votes, especially for executive compensation proposals, according to the IRRC. The average vote on executive compensation proposals rose from 8.5% in 2000 to 13.45%. The International Brotherhood of Electrical Workers (IBEW) Pension Benefit Fund proposal with the New York State Common Retirement Fund (NYCERS) asking Sprint’s directors to adopt a no-repricing policy won the support of approximately 46% of the votes cast. For a wrap-up of the last season, see Labor’s Money.
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IRRC Study Results
IRRC’s “Board Practices/Board Pay 2001: the Structure and Compensation of Boards of Directors at S&P 1,500 Companies,” found advancement in rising director independence and in the overall composition of audit committees. However, after years of gradual director diversification, it appears that the spread of women and minority directors to more boards has come to a halt. Cash amounts paid to directors continue to increase and 81% of the S&P 1,500 companies analyzed grant their directors supplemental stock options or share awards, or both, and most companies make grants every year.
Study highlights include the following:
- The trend toward increased independence on boards goes on, rising another 2% this year. Compensation committees continue to post high levels of independence, but the biggest jump occurred on audit committees, which rocketed to 90% average independence overall this year. Also, 70% of the companies surveyed had completely independent audit committees, increasing from just 51% three years ago.
- Most boards have stabilized in size, but Technology boards actually got smaller in 2001.
- Women and minorities are more likely than directors overall to be independent from the company where they sit on the board. 86% of directorships held by women and 82% held by minority directors are classified as independent, compared with 66% generally.
- Annual retainers grew by 7% this year, to $28,292 while the median level rose more than 10%. Interestingly, the biggest jumped in retainer levels occurred in the beleaguered Communications Services sector, where the average retainer rose 14% to $41,818, and the median level soared almost 17% to $35,000.
- Slightly more than 10% of companies have disclosed stock ownership guidelines for directors.
- The average value of one-time stock option grants is typically about three times that of annual option awards.
- About a fifth of companies give directors an opportunity to take stock in lieu of cash annual pay—and 30% of those companies provide directors with an incentive to do so.
Canadians Call for Greater Board Independence
In Canada, the Joint Committee on Corporate Governance released its final report, Beyond Compliance: Building a Governance Culture. Key recommendations include:
- All boards should have an independent board leader who is chosen by the full board and who is an outside and unrelated director. This requirement should be a condition of listing on a Canadian stock exchange.
- The independent board leader should be accountable to the board for ensuring that the assessment of the CEO and the succession planning functions are carried out and the results discussed by the full board.
- All boards should develop and disclose a formal mandate setting out their responsibilities. Performance should be assessed against this mandate and the results of the assessment discussed by the full board.
- Outside board members should meet at every regularly scheduled meeting without management and under the chairmanship of the independent board leader.
- Independent directors of a public corporation remain responsible for significant shareholder. All parties must ensure the proper functions of governance are carried out.
Joint Committee was established by the Canadian Institute of Chartered Accountants (CICA), the Canadian Venture Exchange (CDNX) and the Toronto Stock Exchange (TSE) to review the state of corporate governance in Canada and recommend changes to ensure Canadian governance practices are among the best in the world. A copy of the final report can be downloaded from the at the Joint Committee on Corporate Governance’s internet site.
CalPERS Turns Up Heat
The CalPERS Board of Administration approved a strategic plan that adds $1.7 billion to the pension fund’s active corporate governance investments and targets additional corporate governance strategies in Japanese and European markets. The action brings CalPERS investments in active corporate governance strategies to $3 billion. The plan includes a $1.2 billion investment to external active corporate governance managers in the U.S., Japan, and Continental Europe; and a $500 million allocation to establish “CalPERS Internal Relational Program.” Listed below are some developments in the Japanese and European markets cited by CalPERS staff as recent developments that “make governance strategies attractive to institutional investors.”
- Cross shareholdings have declined from 45.8% to under 35% and will likely continue to decline
- Foreign equity ownership has increased steadily since the mid 1980’s and is now approximately 20%
- Merger and acquisition deals in Japan reached a record 1,635 in 2000 up 40% from 1999
- Shareholder lawsuits have risen from less than 30 in 1992 to nearly 300 in 1999
- Implementation of mark to market accounting effective March of 2002
- Foreign acquisitions are becoming more common, for example, Ford taking over Mazda, Renault acquiring Nissan, and GE Capital taking over Japan Leasing
- Financial deregulation laws passed in 1999
- June 2000 Publication of Berlin Group’s German Code of Corporate Governance
- January 2002 marks the start of new tax reforms in the EU which will limit the capital gains burden for unwinding cross shareholdings
- Germany and France now allow any shareholder with a 5% holding in a company to call an Extraordinary General Meeting
- Privatization of retirement obligations from the state into private sector pension funds in the EU will significantly increase the funds flowing into European equity markets. Globalization of capital markets have forced companies on the Continent to focus on governance issues or be shunned by foreign institutional investors
- Corporate collapses of Metallgesellschaft and Schneider property group in Germany and the financial scandal of Olivetti in Italy are breaking the traditional stakeholders power over these companies
CalPERS’ primary source of potential investments for the internal program will be “through value and governance screens developed in the Corporate Governance Unit. Potential investments may include current, previous, or potential Focus List companies. However, we expect the number of Focus List companies that will be held in the Internal Relational Portfolio to be limited.” (for more information see Item 6E from theNovember 2001 Investment Committee agenda)
Great to see this move. It would be more encouraging, however, if CalPERS were actually commit to increase investments in its Focus List companies before announcing them. Would Warren Buffett or Robert A. G. Monks target firms without adding additional investments? Neither should CalPERS.
Two major issues in corporate governance are the extent to which governance impacts financial performance, and the growing impact of social issues on corporate activity.
Corporate Governance and Economic and Economic Performance, edited by Claus Bugler, tackles the first issue with an analysis of Austria, Belgium, Germany, France, Italy, Japan, the Netherlands, Spain, Turkey, and the UK. He concludes that more direct shareholder monitoring is beneficial to a firm’s success and that minority shareholders are consistently worse off in countries with weaker shareholder protection and illiquid securities markets. The key to more efficient corporate governance is vigilance by institutional investors and prudent regulation by government.
John Elkington, whose Cannibals With Forks: The Triple Bottom Line gave us the concept of “triple bottom line” reporting (company disclosure of social, environmental and economic performance), now provides advice on how companies can build sustainability into their operations. The Chrysalis Economy: How Citizen CEOs and Corporations Can Fuse Values and Value Creation claims to be “an early guide to new forms of capitalism that will eventually come to dominate the global economy.”
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CalPERS Board Overruled
Last year the CalPERS Board raised their own salaries in defiance of Government Code limits and also raised their portfolio managers’ pay by 11%, claiming a provision in the state constitution that gives them protection from political interference also gives them broad authority to ignore state laws which make it difficult to fulfill their fiduciary duty. The California Department of Personnel Administration (DPA) refused to recognize such extralegal authority. The CalPERS Board then issued letters to State Controller Kathleen Connell to implement the pay hikes over DPA’s objections. When Connell refused, the Board set up its own payroll system. Connell took the Board to court, arguing the Board is subject to state law. I filed a similar action with the Office of Administrative Law.
Judge Charles C. Kobayashi, of the Sacramento Superior Court ruled that CalPERS can’t ignore state law. “The authority to administer the retirement fund does not mean CalPERS has become a separate system that is no longer subject to existing state laws that apply to all governmental agencies.” If CalPERS believed they were right, they should have challenged DPA and the Controller in court, instead of simply ignoring the law. CalPERS was permanently enjoined from increasing the per diem of Board members or employees, increasing the reimbursement to public agency employers of Board members, maintaining a separate payroll system for employees, increasing employee salaries and, most importantly, “declaring a statute unenforceable…unless an appellate court has made a determination that such a statute is unconstitutional.” CalPERS appealed the ruling. I’d guess their chances of success are slim to none. The only press coverage I saw on the ruling itself was in the October 29th edition ofPensions&Investments.
CalPERS Chief Investment Officer Daniel Szente also seems to have little faith the Board will prevail, announcing he will step down on November 30, 2001 to take a new job at McMorgan & Co. rather than await the outcome of the legal battle to roll back his compensation. Szente lasted only 15-16 months. SeeCalPERS press release.
Szente said that if Connell is successful it will hamper CalPERS’ ability to achieve excellent investment returns and effectively manage risk. Yet, for many years the CalPERS system operated just fine without offering enormous salaries to attract investment managers from outside the civil service. It would be interesting to see a comparison of portfolio performance (based on value added above the market) before and after the higher salaries. Since CalPERS has offered no such evidence of pay for performance, I doubt a positive correlation exists.
In addition, many, if not most, professionals who choose to work for the State of California are underpaid in relation to private sector counterparts. Why should investment managers at CalPERS be singled out for higher pay than their counterparts at CalSTRS or the Treasurer’s Office? The Board is in danger of creating a revolving door where CIO’s pick up a year or two investing huge amounts for CalPERS and then negotiate a fat deal for themselves elsewhere. If the Board really believes the high salaries are justified, they should sponsor legislation to raise their own pay and should document the need for higher pay for their investment officers with DPA.
Appealing through the courts on this case is a waste of money better spent on member retirements and services. In addition, whereas before the Board could argue they were complying with the law, even though their constitutional authority grants them certain exemptions, it will soon be clear to everyone that the constitution protects the fund against political raids; it doesn’t place the Board above the law. The court is no more likely to allow the Board to unilaterally raise their own pay and that of civil servants as it is to forgive speeding tickets to members who claim travel at the posted speed would cause them to violate their fiduciary duty because they’d be late for a meeting. Board members should learn to follow the law and plan ahead.
Which Shareholders Should Decide at TIAA-CREF?
Business Week’s Robert Barker has weighed in on the running battle between TIAA-CREF and SRI activists. Let Shareholders Decide This One, he says in the 11/19 edition. Barker points out that SRI advocates have failed to seek to get their issue on the TIAA-CREF “proxy” for fear of losing, even though a 1995 survey found that 81% of what he says are “contributors” (I’m sure most would see themselves as investors) to/in the Social Choice Account favored seeking out “companies who have an outstanding record of good performance on social issues rather than relying on negative screens.”
Barker says “the people whose money is at stake” should be able to “make broad decisions about how it is invested.” However, its not clear if his solution is to let all members of TIAA-CREF decide the issue by vote or just those invested in the Social Choice Account. How many of TIAA-CREF’s 2.3 million clients are invested in the Social Choice Account which makes up about 1.5% of its $260 billion portfolio? If investments are proportionate to members, should 98.5% of members who have nothing invested overrule the 1.5% that are willing to put their money at risk.
On the surface a vote appears very reasonable. I wish other funds, such as CalPERS had provisions for such voting on issues the board refuses to address. Even if the vote is limited to those with investments in the Social Choice Account, we all know that TIAA-CREF can easily influence the voting by inflating cost projections or claiming that positive investments are likely to earn less or that they are somehow illegal. TIAA-CREF should either honor the 1995 survey, which was to evaluate “whether any changes should be made,” or they should agree to be neutral on a vote by Social Choice investors.
SRI Gains Ground
Australian pension funds must now report on how they handle social issue proposals at corporations they’ve invested in, according to Fairvest’s Corporate Governance Review (CGR). Similar legislation was enacted not long ago in the UK and has been introduced in Canada as bill S-11. According to Stephen Davis, editor of Global Proxy Watch, pension fund disclosure will emerge as the “darling corporate governance bill of political parties around the world.” The same issue reports that average voter turnout (including proxies) ranged from a low of 35% in Australia to 83% in the US, with Britain, Germany, France and Japan following between from low to high.
Blueprint for Success
The October edition of Director’s Monthly contains an informative article on Compensation Committee Structure by James Reda of Buck Consultants in Atlanta. He include much of the usual good advice concerning the need for independence, the scope of activities, communication and minutes. However, one factoid stood out in my mind; committee chairmen are nominated by the CEO 40% of the time. Not exactly independence, eh?
E-Delivery Offers Savings Aplenty
The 2001 survey by the American Society of Corporate Secretaries estimates that E-delivery of annual reports and proxy materials could save $38 million industry-wide in postage savings alone. One method used is to collect e-mail addresses and send an e-mail notice when proxy season rolls around. No paper is involved so the potential savings is great. However, sending a paper proxy in the mail and instructions for finding the annual report online results in greater savings because twice as many shareholders opt in.
Also in the Fall edition of The Corporate Secretary is Gwendolyn King’s expectationss of a corporate secretary. They should have the administrative skills of a chief administrative officer, interpersonal skills of the chief human resources officer, legal skills of the general counsel, financial skills of the CFO and vision and decisiveness of the CEO.
Creative Accounting and Shareholder Lawsuit
The SEC’s Financial Fraud Task Force expects to review one out of every four annual reports. Prosecutors last year obtained convisions in 62 of 64 cases.
Ten Overnite Transportation worker/shareholders filed a shareholder suit against executives at parent company Union Pacific charging breach of ficuciary duty for wasting corporate assets on a “concerted, unlawful anti-union campaign.” According to the NLRB, Overnight has had more complaints filed per employee than any othher company in the US. “The severity of the misconduct is compounded by the involvement of high-ranking officers,” according to the NLRB. (For these and other interesting items, see Business Ethics, 9-10/2001 edition.
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Insurers Support Disclosure of Social, Environmental and Ethical Risks
The Association of British Insurers (ABI) announced that its members expect companies to disclose how social, environmental and ethical risks are being handled. Examples include board-level identification and assessment of risk, descriptions of company policies for managing risk, and descriptions of procedures for verifying company disclosures.
“SRI disclosure will provide investors with confidence that a company understands the risks it faces and is positioning itself to deal with them,” said Chris Mellor, chief executive of AWG, one of the UK’s largest water utilities. “The ABI’s guidelines are a crucial and valuable step in helping companies prove to themselves and others that they are up to the mark.” (Social Funds, 10/30)
ISO Tackles Corporate Social Responsibility
The International Organization for Standardization has launched an online forum to study the feasibility of standardizing the measurement of corporate social responsibility. The forum, hosted by the Canadian Office of Consumer Affairs, has been set up to facilitate worldwide discussion of the possible role of standards in defining the elements of corporate social responsibility. It is designed to provide a mechanism for increasing awareness and promoting constructive discussion of new and existing corporate social responsibility initiatives, and their relevance to existing or potential standards projects.
The forum operates as a list-serve. E-mail postings are sent to every member of the forum, and there is no cost to participate. To join the online forum, contact the forum facilitator, Dr. Kernaghan Webb, senior legal policy advisor and chief of research at the Canadian Office of Consumer Affairs, at[email protected]. At the initiation of the Trinidad and Tobago Bureau of Standards, a workshop on corporate social responsibility will take place on 10 June 2002, in Port-of-Spain.
IOD Establishes Indian Corporate Governance Center
Institute of Directors forms Corporate Governance Center to improve the functioning of corporations and the credibility and liquidity of stock markets by promoting research and practice of Corporate Governance Principles. For more information, contact [email protected]. The center will undertake the following functions.
- Formulate Codes for good Corporate Governance in government, trade and industry.
- Advise government and industry on best practices in good Corporate Governance.
- Conduct research relating to best practices in Corporate Governance internationally.
- Organize seminars, conferences, and workshops to create awareness in the Indian corporate sector of the need for good Corporate Governance.
NACD Report on Board Evaluation
The National Association of Corporate Directors has released its Report of the Blue Ribbon Commission on Board Evaluation: Improving Director Effectiveness. This groundbreaking study on effective self-evaluation is designed to help boards and individual directors improve performance. The report was led b a commission of 30 corporate directors and leading governance experts.
Regular board and directors evaluations are favored by 91% of directors, according to a recent NACD survey. The report provides tips on directors, issues, information, evaluation process and performance goals. It also provides sample evaluation forms, a case study and diagnostic tools. Copies available by calling Doreen Kelly Ruyak at 202-779-0509 or e-mailing you request to [email protected].
Director’s Pay Up in 2001
A Towers Perrin survey of annual proxy statements filed this year by 250 companies representing a cross section of the S&P 500 found that nonemployee corporate director compensation has risen to $118,337 in cash and stock in 2001, up from $100,807 in 2000. Most of the increase is in the form of stock options. Directors received three-quarters of their compensation in stock and one-quarter in cash, a shift from last year’s mix of two-thirds stock and one-third cash.
Ninety-four percent of all companies provided some form of annual or recurring stock compensation to directors. Median annual stock compensation, based on each company’s 2000 fiscal year-end stock price, jumped 23% to $73,205 in 2001 from $59,430 in 2000. Median cash compensation of $49,000 was up modestly from $46,000 in 2000.
Seventy-four percent awarded stock options; 26% made outright grants, and 25% awarded deferred, or phantom stock, which settle upon termination or at some future date. Restricted stock, granted subject to limits on sale or transfer until certain future conditions are met, was awarded by 18% of the companies.
One-time grants were awarded by 29% of the companies, typically paid when a director is first elected to a board. The median one-time stock-based grant was $151,587. Only 4% of companies reported a retirement plan, down from 22% four years ago.
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Code Compliance Listed on Italian Stock Exchange Site
The Italian Stock Exchange site now includes information concerning the level of compliance with the Exchange’s voluntary corporate governance code. Unicredito SpA and Banca di Roma SpA are currently among the country’s most transparent firms with detailed annual or financial reports. Bulgari SpA was at the other end, ignoring most to the code’s recommendations and operating without a compensation committee, an internal audit committee, or any clear rules to determine how directors are chosen or how shareholder meetings are governed. The voluntary rules were adopted in 1998 to attract both foreign and domestic investors.
UK Pension Plan Reporting Incomplete
A survey by Friends of the Earth, London, indicates that more followup is needed to ensure recently enacted disclosures have an impact. Since 7/2000 UK pension plans have been obligated to publish a “Statement of Investment Principles” concerning the extent to which social, environmental and ethical considerations are taken into account when making investment decisions.
FOE surveyed the UK’s largest 100 plans but 35 either refused to participate or didn’t provide enough detail to properly evaluate. FOE found the majority of statements to be “vague or ambiguous,” with responsibility for implementation often passed to money managers without guidance or monitoring plans. (The same is true of studies of US funds who are charged with ensuring that proxies are voted in the best interest of beneficiaries.)
It appears that many funds are simply complying with the new legislation with the least amount of effort and commitment possible. Those plans that did include social, environmental, ethical and corporate governance issues often failed to include accountability mechanisms allowing trustees to monitor fund managers. Less than 1/3 of funds surveyed were able to show how they reported back their actions.
“It is clear that pension funds will have to significantly increase resources in the area of monitoring…to ensure the effective implementation of socially responsible investment objectives…,” the report said. (Large U.K. plans get failing grade on social responsibility concerns,Pensions&Investments, 10/1/01)
Proxy Solicitation at CREF
The College Retirement Equities Fund will hold its annual meeting at 10 a.m. on November 13, 2001. The event will take place at the company’s headquarters at 730 Third Avenue in New York City.
The annual meeting gives CREF participants the opportunity to elect or reelect trustees and vote on participant proposals presented in the proxy statement. TIAA trustees are selected by the TIAA Board of Overseers, but the annual balloting process allows participants to express their preferences for current nominees and recommend future candidates. Mailing of CREF and TIAA election materials to participants began on October 12. Eligible participants have until noon on November 13 to cast their votes.
The TIAA-CREF coalition for responsible investment plans an interesting twist by seeking to rally support by those in attendance and by proxy solicitation.
FIRST: Those who can attend the meeting are encouraged to attend a pre-meeting on Monday evening, November 12 in New York City. RSVP to Neil Wollman, no later than Monday, October 29, 2001.
SECOND: The group has appealed to those who are unable to attend to lend their proxy to another CREF activist so that they may legitimately attend the Annual Meeting. Kelle Louaillierat Infact is coordinating the paperwork and that effort.
Sheryl Pressler and Hypocrisy
Not long ago I got a call from Barry Burr ofPensions&Investments asking what I thought of Sheryl Pressler’s almost $8 million severance package from Lend Lease Corp. Pressler had been Chief Investment Officer at CalPERS prior to her stint at Lend Lease’s US unit, Lend Lease Real Estate Investments. I’m often critical of both high corporate severance pay packages and CalPERS, so Mr. Burr might well have expected something more than “no comment.”
Of course $8 million is a lot to pay when giving someone the sack, but apparently Ms. Pressler had a good law firm representing her in negotiating her entrance and exit packages. Jones Day Reavis & Pogue is the same firm that now employees her former general counsel at CalPERS, Richard Koppes, one of the major brains behind CalPERS’ successful corporate governance strategy. I thought to myself that Pressler’s package was outrageous but what else is new?
Now comes an editorial by Mr. Burr in the October 15th edition of P&I, right next to one on the 911 attack on the World Trade Center. Burr chides institutional shareholder activists from hypocrisy because of their lack of response to the large Pressler pay-out after only a year due in part to her refusal to take another assignment.
Having done no research on the matter, I may be completely off base, but I’d speculate that although TIAA-CREF, Lens and the various state pensions that Mr. Burr chides may use Lend Lease’s services, few have substantive investments in the firm itself. The Council of Institutional Investors and its members are generally critical of executive compensation at companies in their portfolio because excesses tend to drive down the value of their holdings.
It didn’t surprise me that Pressler didn’t work out at Lend Lease. CalPERS is a much different animal. Its portfolio generally tracks the market because such a large percent of its equities are essentially indexed. Doing well at CalPERS may mean moving the market through corporate governance activism, rather than picking good investments or timing the market.
For additional insight on those who manage investment managers take a look at the latest McKinsey Quarterly (2001/4). Based on a survey of 3,320 people working in the asset management industry, they found that only 38% of respondents feel their companies recruit better staff than do their competitors. “Most of the respondents think that their managers have effective processes for evaluating their performance but don’t use that information to develop and reward potential high performers or to move out low performers.” “Asset managers could manage their talent more effectively for less than they spend now on managing it poorly—in the eyes of their employees, at least.”
If Mr. Burr wants to look at pension funds and cry hypocrisy I’d advise him to look no further than the CalPERS Board. His editorial points to their alleged violation of state law when they raised the salary of 10 internal portfolio managers. Even clearer was the fact that raising their own salaries violated the law. I have requested a determination by the Office of Administrative Law and State Controller Kathleen Connell included that action in her recent lawsuit. Both may takeseveral additional months for a decision.
Even better, take a look at the current election at CalPERS. If Burr did, he would be the only member of the press doing so, even though 1.2 million members are eligible to vote and CalPERS Board members wield enormous power. The press has taken absolutely no interest. Want to write about hypocrisy? Incumbent Charles Valdes, currently seeking reelection, brags of his financial acumen and that “your fund will be safe” if he is reelected. What he doesn’t mention, and neither does the press, is that during the time he chaired the CalPERS Investment Committee he also declared personal bankruptcy twice, 24 members of the Legislature called for his resignation, and he represented public employees but failed to pay state and local taxes for approximately seven years.
CalPERS is widely known as a proponent of good corporate governance and more open corporate elections, yet Mr. Valdes voted with a majority of the Board for rules which, according to the Sacramento Bee “risk creation of a permanent board: unaccountable, untouchable and isolated from the people who elect it” (Calpers Muzzles Critics). They want corporate board members to avoid conflicts of interest, yet, this Board member and others routinely accepted gifts from CalPERS contractors.
(Note: In the interest of disclosing potential conflicts of interest, the Editor of Corporate Governance, James McRitchie, is running for the CalPERS Board against the incumbent.)
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Sidney Abrams Appointed to CalPERS Board
California Governor Gray Davis named Abrams to serve as the insurance industry representative on the California Public Employees Retirement Board. His term expires in January 2005. Abrams is an actuary with more than 30 years of experience providing services to Taft-Hartley pension (joint union/management) and other employee benefit plans. (press release)
SRI Funds Edge Out Competition
According to Morningstar, 35% of the socially responsible mutual funds (19 out of 54) they track earned either four or five stars, compared with 32.5% of all mutual funds. (Social Investment Forum News)
Reuel Khoza to Focus on Corporate Governance
South Africa’s new president of the Institute of Directors says “Good corporate governance creates an attractive climate for foreign direct investment. If investors do not know what to expect, their interest is dampened. My objective is to make corporate governance the thing for local companies to subscribe to not just for the major organizations but also for medium-sized and small businesses.” Mr. Khoza is also chairman of Eskom and Co-ordinated Network Investments, and a director of Standard Bank.
“I have been involved with Judge Mervyn King in hosting events to exchange points of view with other members of the commonwealth. Now, with the review of the King commission (final report due mid-February), there will be new challenges. Lately the thrust has been for the triple bottom line, involving the social, environmental and economic or financial aspects of business. I aim to push to the fore with this.”
Khoza, a long-time member of the institute and its deputy president for the past three years, says he will promote corporate governance in the Southern African Development Community and Europe. “I aim to be more than just the figurehead for the institute,” he says.
Khoza is the Institute’s first black president and Carol Scott, executive chairwoman of Imperial’s car rental and touring division and of Tourvest, is the first woman to be appointed a vice president of the body.
The latest membership figures show a female membership of 12%, while black membership is at 15%. (10/22, Africa News Service)
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Symposium on Corporate Governance in the Banking and Financial Services Industries
Few public policy issues have moved to center stage as quickly as corporate governance. Shareholders, creditors, regulators, and academics are all examining decision making in corporate and other organizational forms and, in some cases, are proposing changes to governance structures to enhance efficiency and accountability. In the banking and financial services industries, governance and board oversight received close attention during the turbulent late 1980s. A recurring theme among the interested parties is that poor governance played an important role in many serious problems. With this issue in mind, the Federal Reserve Bank of New York, the Journal of Financial Intermediation, and the Salomon Center and Department of Finance at New York University’s Stern School of Business have organized a symposium to foster a better understanding of managerial decision making and sound corporate governance practices in financial institutions.
The sponsors cordially invite you to attend the symposium, to be held at the Kaufman Management Education Center of New York University’s Stern School of Business on November 8-9, 2001. There is no registration fee for attending the symposium. Seating, however, is limited and therefore, you must register in order to attend the symposium.
Liabilities Up, Assets Down
Pension liabilities went up 26% in 2000 and assets dropped 2.5%, resulting in a drain of about 28.5%. This year, liabilities are up 2.8%, while assets are down 12.5%, resulting in a drain of 15.3%. As a result, pension funds with funding less than 140% two years ago may now be facing a deficit. Rob Arnott, of Quadrant LP, believes pension funds can no longer assume 8-10% returns. “I’d be leary of return assumptions of more than 6% to 7%,” he said. (Pension plans face tougher times as funding levels dip, Pensions&Investments, 10/1/01)
FSBA Wins Under PSLA
The Florida State Board of Administration (“FSBA”), the employee pension fund for Florida State and County employees, announced a $61 million settlement against Vesta Insurance Group.
This action, under the Private Securities Litigation Act of 1995, was brought as a class action on behalf of Vesta investors. Vesta has also agreed that a majority of its Board will be independent directors, that it will appoint audit, nominating and compensation committees comprised entirely of independent directors and that its audit committee would comply with the recommendations of the Securities and Exchange Commission’s blue ribbon panel on the effectiveness of audit committees.
The Boardroom Analysis Online Resources Database (BAORD) is a relatively new site intended as a resource for academics, analysts, activists – anyone with a general interest in issues of corporate governance and corporate social responsibility. It indexes hundreds of resource “providers” that make a contribution of one kind or another to this broad field.
Resource “providers” qualify for inclusion into BAORD if their sites make available documents, publications, databases, directories, events notifications, projects, online discussions, commentary, reference lists – anything that facilitates the research or information-finding process.
BAORD categorizes resources to facilitate focused searches. Search criteria can be set by the user via a simple web-based search form. The user can further narrow their search by using keywords or simply by selecting from a directory of “providers.”
If a potential “provider” would like to be included in BAORD or if an existing provider would like to make changes their listing this can also be done at the BAORD site. All submissions are moderated for appropriateness and authenticity.
This is a free resource and in order to keep it current and useful resource providers are encouraged to review listings.
Simon Deakin Named Robert Monks Professor of Corporate Governance at Cambridge University
Simon Deakin as the inaugural holder of the Robert Monks Professor of Corporate Governance. Professor Deakin joins the Judge Institute of Management from the University’s law faculty where he has been a lecturer for the last ten years. He is a leading expert in corporate governance and has published widely on the subject through a variety of research projects on inter-firm contracting, hostile takeover bids, the duties of company directors and the role of ‘stakeholders’ in corporate restructuring and insolvency.
The professorship has been established in perpetuity thanks to a donation of $4M from Mr Dennis Kozlowski of Tyco International. Press release. Robert Monks has already funded a research center at the Judge Institute. We look forward to great work coming out of the Judge Institute at Cambridge.
Accountability of Institutional Investors
CalPERS and TIAA-CREF are widely known as advocates of good corporate governance, but what about their own governance?
I have often called the CalPERS Board into question on this site and am currently engaged in running for the Board of Administration. (For more on the election, see the CalPERSand PERSWatch sites) The incumbent, Charles P. Valdes, wants to continue to represent CalPERS’ 1.2 million members, even though he didn’t pay “$6,000 in federal income tax; $54,856 in state income taxes, interest and penalties; $23,808 in county property taxes, interest and penalties; and $18,254 in delinquent mortgage payments, according to court documents. Valdes has not paid property taxes on his house in Carmichael since 1989 and is nearly six years delinquent in paying for garbage collection, sewer and storm drainage, according to county records.” (Member of PERS Board Faces Financial Difficulty; Debts Include More Than $84,000 in Taxes, 8/9/97, Sacramento Bee)
If having a tax evader represent public employees is not ironic enough, Mr. Valdes also chaired the CalPERS Investment Committee while declaring bankruptcy twice. Valdes voted for rules which “risk creation of a permanent board: unaccountable, untouchable and isolated from the people who elect it.” (Calpers Muzzles Critics, 5/25/99, Sacramento Bee Editorial) He and others on the Board accept gifts from CalPERS contractors and have voted to ignore various California laws, claiming their constitutional authority exempts them from public notice and other rulemaking requirements, as well as from statutory limits on their own salaries, even though the overextension of their authority has been discredited in Sacramento County Superior Court. (Kathleen Connell for Controller et al. v. CalPERS Board of Administration, case no. 98CS01749) (CalPERS board votes itself big pay increase, 9/21/00, Sacramento Bee) Further, as a result of his ethnic slurs, 24 members of the California Legislature have called for his resignation. (Resignation of CalPERS Official Urged, 10/27/99, Sacramento Bee)
The list goes on and on. Yet, since he has been endorsed by the California State Employees Association, has all the advantages of incumbency and because the elections traditionally receive no press coverage, he is likely to be reelected. In California we need to not only reform the CalPERS election process (some reforms that I worked on will take effect next year) but some of our unions as well. At least the CalPERS structure provides for direct nomination and election of almost half its board by members of the System. I’ve frequently reported here on the efforts of Abby Fuller, Neil Wollman and others involved in the Social Choice for Social Change: Campaign for a New TIAA-CREF. Recently, I received the following article from David E. Ortman, Executive Director of the Northwest Corporate Accountability Project, which calls into question TIAA-CREF’s Corporate Governance policy and attributes some of its failings to TIAA-CREFs own governance structure.
TIAA-CREF’s Policy Statement On Corporate Governance Disappoints Shareholders
In March 2000, TIAA-CREF posted its latest Policy Statement on Corporate Governance. What is surprising is how weak it is. If TIAA-CREF is complying with its own policy there is little to praise because the bar is set so low.
For example, TIAA-CREF does not oppose “independent” directors working on contract for the corporation. TIAA-CREF does not support shareholder resolutions concerning separation of the positions of CEO and chairman. Otherwise, TIAA-CREF’s own CEO, Chairman of the Board, and President John Biggs couldn’t wear so many hats. TIAA-CREF does not support the formation of shareholder advisory committees, the requirement that candidates for the board be nominated by shareholders, or a requirement that directors must attend a specific percentage of board meetings, unless the board supports such measures. TIAA-CREF’s policy says that staggered election of directors can provide legitimate benefits to the board.
As much a concern is what TIAA-CREF’s policy does not say. Under “Fiduciary Oversight” nothing is said about the current controversy of auditors also working as consultants for the corporation. Under “Global Standards of Corporate Governance” nothing is said about avoiding bribery in international dealings. Under “Social Responsibility Issues” there is no specific reference to an environmental audit. Also, in the Appendix on “Executive Contracts” TIAA-CREF opposes any outright ban on “golden parachute” severance agreements.
Don’t TIAA-CREF participants deserve better?
The “Get Out of the Bad, and Into the Good” campaign continues in New York City. As the nation’s largest pension fund, TIAA-CREF, a retirement fund mainly for educators, prides itself on being responsive to shareholders and a “concerned investor” on social responsibility matters. The fund, however, continues to hold large investments which put public health, factory workers, and citizens at risk. Why should life-giving pension money be invested in deadly tobacco, sweatshop labor, or an oil company tied to one of the most brutal dictatorships in the world? There are more positive ways to invest and still earn good returns. A broad-based coalition is calling for funds to be invested in affordable housing and in companies which are, for example, pioneering socially or environmentally responsible products or services. Contacts for further information: Main contact in NYC is Dave Wilson, 212–674-9499, [email protected]; or national campaign organizer, Neil Wollman, 219-982-5346,[email protected].
The coalition urges supporters to call John Biggs, CEO, 1-800-TIA-CREF (842-2733), ext. 4280.; or 212-490-9000. You’ll likely have to leave a message with his secretary, but do ask for a response. You can also email Mr. Biggs, as well at “Contact Us” or at [email protected].
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Join eRaider’s Battle to Redefine Contested Elections
The NYSE has given eRaider a unique chance to make its case against broker votes in contested elections and they are asking for your help. Please visit their website and help them write their proposal. While many have been trying for years to do away with all broker votes, they have met with stiff opposition and have been unsuccessful thus far. eRaider is proposing a narrower but more winnable argument. They have asked the NYSE to re-consider how it designates elections. Currently there is a strict rule that for an election to be declared contested, dissidents must solicit each shareholder by mail. For any beneficial owner who is unsolicited and does not vote, the broker will be allowed to vote the shares and of course will vote them for management. Broker votes are the reason why proxy contests are expensive and weighted towards management. A recent stuy found that allowing broker votes added an average of 14.2% to management’s total.
eRaider had requested that the NYSE change the way it defines active solicitation to include the Internet and to drop the exclusive focus on each separate shareholder. In return, the staff at the NYSE has requested that we present a position paper on the subject. eRaider proposes changing the definition of “active solicitation” from mailing a letter to actively soliciting on the Internet. Those methods would include emailing owners, posting on all active message boards and maintaining a website with proxy material.
Come to their Shareholder Rights message board and post your thoughts about defining contested elections. They will submit their proposal on October 10, and are open to any ideas, suggestions or arguments. They want to convince the NYSE that they speak not just for an Internet activist fund, but also for a representative sample of serious stockholders that use the Internet.
You can be part of our proposal in three ways. If you agree with eRaider, just post your name and they’ll list it in the final document. If you don’t agree, argue and maybe they’ll change their proposal. Anyone is free to add a comment that they will include as an appendix to the proposal to show the NYSE the range of individual investor opinions. Comments must be signed with a real name and address; and emailed to eRaider at[email protected].
Corporate Governance Series by Council on Foreign Relations
Is capital market integration inducing global convergence on the so-called “Anglo-American” model of minority investor protections? What explains the variation in response to convergence among countries and between institutional practices? Who are the winners and losers from governance reforms, what types of resistance does this provoke, and what is the role of foreign governments in molding governance changes? Above all, what are the policy implications of corporate governance change for the United States government and its regulatory agencies? Is there a role for official intervention, or should this be left to market forces?
The Roundtable series will seek to answer these questions on two parallel tracks. One track will examine the role in global governance changes by actors such as institutional investors, financial professionals such as accountants and investment bankers, international financial organizations such as the IMF, World Bank, OECD, and BIS, and governments, including the European Union. The other track will analyze the pattern of governance change in specific countries and regions.
James Shinn and Peter Gourevitch are managing the Roundtable series. Jim Shinn is a Fellow at the CFR in New York. He spent 15 years in Silicon Valley, where he founded Dialogic, later acquired by Intel, and several other software firms. He has a BA from Princeton, an MBA from Harvard, and a PhD from Princeton. Peter Gourevitch is a Professor at the University of California San Diego, former dean of UCSD’s Graduate School of International Relations, and editor of International Organization. He has a BA from Oberlin and a PhD from Harvard, where he is spending 2001/02 as a Research Fellow at Harvard’s Center for European Studies.
Founded in 1921, the Council on Foreign Relations is a nonpartisan membership organization, research center, and publisher. It is dedicated to strengthening America’s role in and understanding of the world by better comprehending global trends and contributing ideas to U.S. Foreign Policy. For further information about the Council or the Roundtable Series, please contact Lisa Shields, the Director of Communications, or James Shinn.
South Africa’s First Corporate Governance Unit Trust
The Fraters Earth Equity Fund aims to influence corporate behavior by constructive engagement in the companies in which it invests. The fund will also has a socially responsible investment fund agenda but no restrictions imposed on the portfolio manager. According to James Frater, managing director of Frater Asset Management, “The release of the draft King II report on corporate governance, set to be implemented in January next year, has highlighted the need for broader reporting, not just purely financial disclosure.” “We fully support the call for reporting on social, environmental, health and ethical issues, or the so-called ‘triple bottom-line reporting’ as we acknowledge the relationship between good corporate citizenship and financial performance.”
The collapse of Leisurenet, Regal, Macmed, Paradigm, and other have demonstrated the need for better corporate governance monitoring by shareholders in South Africa. Corporate Footprint will provide Frater with an analysis of corporate citizenship practices to be used to guide investment decisions and engagement strategies. Practices to be monitored include transparency, accounting, community involvement, workforce engagement, AIDS awareness, empowerment, customer and supplier relations, and environmental concerns. Like more progressive funds in the US and EU, the Fraters Fund will publish their voting records on our web site.
“A typical resolution could call on the company to appoint additional independent directors, adopt an environmental management plan or declare its HIV/AIDS policies and strategies,” said cofounder Michael Leeman. Fraters, established in 1998, has managed the Futuregrowth Pure Fund unit trust, which has excluded tobacco, alcohol, gambling and financial services since July 2000 and earned a 38.5% return over the 12 months ending June 2001. (Africa News Service, 10/05/01)
Corporations Becoming More Dependent on Open Market Equity
Corporations have become increasingly dependent on open market equity to finance their expansions, according to The Conference Board. Governance activism is “shifting the economic clout to investors with equity stakes,” says Carolyn Kay Brancato, Director of The Conference Board’s Global Corporate Governance Research Center and co-author of the report.
International equity holdings by the largest US pension funds continue to show that a small group of activist investors among them can exert considerable leverage over corporations in these countries. The largest 25 US pension fund holders of international equity held $288.4 billion in international stocks as of September 30, 2000, accounting for roughly 16% of the $1.85 trillion foreign equity held by all US investors.
US and UK financial institutions held 57.2% and 57.7%, respectively in the largest 25 corporations. There is significant pressure to bring disclosure of information up to US standards. Regulators and/or stock exchanges are pushing companies to increase disclosure and transparency. Global equity markets are competing for capital, opening up traditionally close relationships between companies and institutional investors, especially banks, in countries such as the United Kingdom and Germany. As major blocks of shares are unwound in favor of broader equity participation, minority shareholders insist on improvements with regard to fair voting rights, access to proxies, and ability to provide input to management.
The attitude of management of a company toward corporate governance is a crucial factor. Does management view the board of directors as an asset, or as a barrier to overcome so that they can get on with the business of running the company? Is the board kept properly informed by management and, in turn, does the board keep investors informed so that they can act as responsible owners?
Also high on the list of investor wants are adequate auditing systems. Boards must establish procedures to ensure the reliability and independence of the auditing process, and to quickly come to terms with and correct any failures. “A striking development is the extent of communications among institutions around the world,” concludes Brancato. “Institutional investors abroad are able to give support to local investors and learn from them about the key issues in their particular markets. When possible, they also try to forge alliances with local investors to share knowledge and expertise, creating a world of global investors.”
Research Report 1297-01-RR, The Conference Board: What Do Institutional Investors Want? Calling The Conference Board’s Customer Service Department at (212) 339-0345 or visit The Conference Board’s website. Media can request a free copy by calling (212) 339-0231.
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