Corporate Governance Books

Book Bites: Bite sized excerpts and reviews from recent books. We welcome additional
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Just as global climate change has increasingly brought us more frequent “once in a century” weather events, increased competition and economic globalization have resulted in lower margins, increased commodification, and increased risk - leading to a similar pattern of economic volatility centered around our financial institutions.

Leo M. Tilman's Financial Darwinism: Create Value or Self-Destruct in a World of Risk paints a rather bleak picture. He sees systemic financial crises as a “permanent feature of the dynamic new world.” This isn't a book for those looking for ideas aimed at governments attempting to reregulate the financial industry, although they would certainly benefit from the reading. Instead, the book offers very practical advice to bankers, institutional investors, and other businesses on how to build risk analysis into strategic decision-making.

In the old paradigm, the risk manager was brought in after major strategic decisions had already been made. In the new paradigm, “risk management becomes the very language of enterprise-wide strategic decisions going forward and that the chief risk officer becomes an executive who gets an equal seat at the table where corporate strategy is decided.”

Tilman identifies at least ten forces contributing to this shift, including:

In the simplest formulaic terms we have gone from: Economic performance = return on assets - cost of liabilities + fees - expenses - cost of capital

To: Economic performance = balance sheet arbitrage + principal investments + systematic risks + fees - expenses - cost of capital

Of course, that's just the beginning of the complexity. Tilman does an excellent job of explaining this paradigm shift, how we got here, what factors need to be examined going forward, and how they can be understood in relatively simple formulaic terms.

Financial Darwinism recognizes that our growing toolbox includes leverage, product design debt management, capital structure, M&A, insurance, securitization, hedging, asset strategies, etc. Each tool must be considered in developing and implementing strategy.

As the world places increasing emphasis on fair valuation, risk-based financial disclosure and risk-focused regulation, Tilman's guide becomes more important for CEOs, directors and fiduciaries who must build risk evaluation into all fundamental decisions. For another perspective, download Putting risk in the comfort zone: Nine principles for building the Risk Intelligent Enterprise™ from Deloitte.

Kent Greenfield's The Failure of Corporate Law: Fundamental Flaws & Progressive Possibilities posits that corporation law shouldn't be thought of as “private” law, which governs the relationships of individuals, but as a branch of “public” law, such as constitutional, tax, or environmental law. Corporations are sanctioned by the state and our goals for them should include more than just maximizing profits for shareowners.

Corporate laws determine the rules for some of the largest most powerful entities in the world and America is exporting our model abroad. I've warned audiences around the world not to adopt our regulatory scheme wholesale. While my advice has been vindicated by the latest financial meltdown, it is good to see an extraordinary legal scholar pushing for thoughtful change.

“Our nation could choose, and should choose,” writes Greenfield, “to require that democratic values govern corporations, rather than having corporate values govern democracy.”

Some functions are just too important to be left to for-profit companies. Airline security is one. Another would be ensuring an economy that meets our collective goals, not just the goals of shareowners, as modeled by a law-and-economic view.

Greenfield's discussions are well argued. His critique of “enablingism” and the role of corporate law limited to establishing default rules parties would choose if they actually negotiated them, to be enlightening. As he points out, it simply reinforces status quo market power, rather than ameliorates it. In this trickle-down theory of law, we get only the rights we can pay for. It's a theory based on the premise that “what is good for shareholders is good for corporations, and what is good for corporations is good for society.”

Yet, income inequality in America is worse than in any other developed nation and is the worst since WWII. What is good for the workers may be a better placeholder for society as a whole than what is good for shareholders. Workers have every incentive to keep their firms alive, whereas shareowners are generally willing to take greater risks because they are more diversified.

Greenfield reminds readers, “The so-called free market was a creation of law, not of nature.” “Private entitlements should spring not from some theory of extralegal natural rights but from a theory of the social good, formed by political judgments about how best to achieve that good.” Treating corporate law as private law exaggerates private rights at the expense of public interest.

Our present legal conception is not inherent in capitalism but was inherited from the laissez-fare politics of the Gilded Age. Corporate law, like labor law, tax law, and environmental law should be predicated on collective political decisions about social goals and ideals. Non-utilitarian values such as equality and human dignity should inform corporate law, just as they inform other areas of law.

A central tenet of the book is that internal governance procedures can lower external enforcement costs. Plus, they follow the corporation outside the boundaries of states and countries. Greenfield critiques the law-and-economics paradigm, arguing that shareowners aren't the only ones entitled to ownership claims. Even though a stakeholder approach should be more efficient overall, he argues it is reasonable for society to forgo the possibility of very high corporate profits to avoid disproportionate harm to workers and communities. This is especially so, given that only a small portion of affluent shareowners stand to the reap the gains from high profits, since 1% own 34% of all shares and 10% own 77%.

Greenfield formulates five principles for those developing public policies in the area of corporate governance:

I like Greenfield's values. He backs up his arguments with research on real behavior, not just with economic theory. For example, research finds that “an individual's decision about whether or not to comply with rules is 'more strongly influenced by legitimacy than it is by estimates of the gain or loss associated with that behavior.'” Monitoring costs are “deadweight losses.” The more we can reduce them by involving workers, the more productive our corporations will be.

Modern democratic states have “cast aside meaningful deliberation about the end or purpose of human life.” The minimalist state attempts only to guarantee peace and facilitate the accumulation of wealth by its citizens. Likewise, the modern corporation.

Corporate Social Responsibility (CSR) widens the dialogue and scope of obligations from economic and legal to social and ethical. Both CSR and Alejo José G. Sison's Corporate Governance and Ethics: An Aristotelian Perspective would move us from a minimalist approach of freedom from oppression or maximum return to one that focuses on the common good, fostering ties and promoting virtue.

Corporate citizenship should move beyond protecting the rights required for the pursuit of economic interests, to engaging in sociopolitical actions based on a broader mission. Instead of a “nexus of contracts,” Sison, though his study of classic political theory grounded in Aristotle, sees a “corporate polity,” reciprocally dependent on the flourishing of stakeholder-constituents.

Under a liberal-minimalist approach to corporate citizenship, each constituent is invited to actively participate in the deliberation and execution of the common corporate good. But not only is that not practical, it doesn't fit Sison's Aristotelian notion of a more civic-republican notion of communitarian corporate citizenship where shareholding managers “represent the stakeholder group best equipped to govern the corporation," since they are fully invested in, and impacted by, their collective actions in the corporation.

Sison provides a strong critique of Coase's “the nature of the firm,” Jensen and Meckling's “agency theory,” and the “shareholder or financial theory” of the firm formulated by Friedman. “Under the guise of asceptic, value-neutral, amoral and 'scientific' theory, immoral business and management practices have in fact been promoted.” Prophecies tend to be self-fulfilling in the social sciences because the knower cannot be separated from the actor.

Behind these oversimplified theories is “an unenlightened subservience to mathematical models as the only vehicles worthy of the name of science.” While math may be neat, “real life is messy.” I like Sison's call for a new theory of the firm grounded in realistic and ethical views of human nature that acknowledge the symbiotic relationship between working toward a common goal and perfecting the self.

Sison also moves readers nicely through a number of case studies that approach Weberian like “ideal types,” from “corporate despots and constitutional rulers” to “aristocratic and oligarchical corporate governance regimes.” Finally in that framework, he reviews an example of a “corporate democracy” and a “corporate polity.”

In democracies, “the majority that governs pursues their own particular interests,” whereas in a polity “the many that participate in governance seek the good of all, the common good.” Democracies, which strive after particular interests within a legal framework characterized by “an emphasis on justice as equality and freedom in the best, and doing whatever one likes in the worst, of cases,” are seen as less noble and inspiring than polities, with their greater focus on the common good.

Sison provides good critiques of United Airlines (the democratic model) and IDOM (the polity model), pointing to where they failed to live up to ideal types. However, I was disappointed that he did not conclude by positing a new theory of the firm that would draw on the lessons of Aristotle.

Instead, he ends with what I suspect he views as more practical advice. For example, those on nominations committees should look for loyalty, administrative capacity and justice as the most relevant characteristics in potential candidates.

Those on compensation committees should focus on moderation of temperance. CEO's should be more interested in virtues rather than excessive pay. Aristotle, he notes, “advocated the education of desire,” such that “people would not crave more than what they actually need.”

The compliance committee should strive for the spirit of obedience to the law, especially in small matters for “small errors or faults are always easier to remedy or rectify than bigger ones.”

At bottom, Sison emphasizes the need for corporate governance to analyze and evaluate not only how changes impact the firm but how they cultivate virtues in those who govern the firm. Only virtue can ensure delivery of the good, since we must depend on virtue to ensure the rules are properly interpreted and implemented. Sison would place less emphasis on developing foolproof instruction manuals and more on developing virtuous habit and customs, since “it is only from habit and custom that the law could draw force and strength.”

“The key to good governance ultimately lies in the education of the governors or rulers,” writes Sison. It is a powerful notion, sure to be embraced by university professors and associations focused on training, such as the NACD. While in no way wishing to diminish the important role of education, I wish Sison had continued with a further exposition of how democratic and polity based business models could be improved. What fertile conditions foster both the common good and the proper education of virtue in employees and leaders? How can we restructure organizations to encourage active engagement in decision-making and the development of virtues in individual participants? Please, give us a second volume.

Ralph Ward, publisher of Boardroom INSIDER, editor or The Corporate Board magazine and author of several books offers an important new volume on the boardroom leadership. Whatever differences people have concerning the direction of corporate governance, it is clear that much comes down to the deliberations of a very small group of people -- corporate directors.

For many decades boardroom leadership came from the CEO who also chaired the board. Now, even where those two positions remain with the CEO, we are seeing a new locus of leadership among newly defined “independent” directors. While there are many good books that lay out the legal obligations of directors, none so clearly examines the concept of “leadership” in the boardroom. As this volume hits the bookstores, let's take a brief look at the corporate governance environment.

A recent Booz Allen Hamilton study of the world's largest 2,500 publicly traded corporations found that forced turnover among CEOs rose by 318% since 1995. Over the last several years, there has been a gradual change in board leadership structures. According to The Corporate Library's 2008 Governance Practices Report, “focus on board independence has led many companies to separate the positions of CEO and Chair of the Board or to name an independent board member to serve as a lead or presiding director.” Their study found the chair position is completely independent of the company at 21% of the almost 3,000 companies studied. Large cap companies are less likely to split the positions than are small cap companies -- 26% of small cap companies, 19% of mid cap, and only 13% of large caps split the positions.

Examining the principles of four very prominent associations we find all recognize this shift to board empowerment. CII says boards should be chaired by independent directors. If they are not, the board should provide a written statement in the proxy materials discussing why combining those roles is in the best interest of shareowners and they should name a “lead” independent director with approval over information flow to the board, meeting agendas, etc. to ensure an appropriate balance of power between CEO and directors.

ICGN principles say the chair of the board should neither be the CEO nor a former CEO and should be independent. The NACD says boards should consider formally designating a nonexecutive chairman. If they don't, they should designate independent members of the board to lead its most critical functions. Even the BRT's principles say that it is “critical that the board has independent leadership.”

Ward's book is certainly timely. It is also fairly comprehensive, without getting bogged down in unreadable details. Although he acknowledges an independent chair may be the dominant model many years down the road, Ward also addresses what many shareowner activists view as interim models involving “lead” and “presiding” directors. He even has a chapter for combined CEO/Chairs on how to cope with the new realities. No matter where your company falls on the spectrum from board "independence" to board “capture,” you'll find your board's leadership needs addressed.

Ward begins with a very short history of boards that takes us from when they were composed primarily of the largest shareowners, to an era of employee directors, and on through Sarbanes-Oxley, which “used the audit committee to bash its way into the boardroom.” Sure, you already know this history but don't skip it. Ward keeps it brief and provides the reader with a good grounding to take the measure of our current trajectory.

The next several chapters cover the new legalities of directors, like meeting in “executive session.” There are better books for systematically laying out these requirements. One of the best is The Role of Independent Directors after Sarbanes-Oxley by Bruce F. Dravis. However, Ward's focus is not so much the requirements themselves but on how they are being met and what best practices leaders are struggling to develop in board evaluations, board logistics, acting as a liaison with the CEO, educating the board, etc.

The book is chocked full of interesting statistics, legal requirements, but most importantly, opinions from experts who have faced the same problems your board is facing now. For example, how important is it to name a new independent chair from existing board members? Whatever you decide, you're very likely to benefit from the advice of others who have already done it. Plus, he provides a large number of valuable references and links to additional resources, like job descriptions for presiding directors, lead directors, and independent chairs. His discussion of how these roles differ and what skills are needed for each is the best I've seen.

At one point, Ward points to the irony that “by forcing independent boards to wrestle more with the regulatory nuts and bolts of the business, we may have actually weakened their powers in relation to management,” presumably because they must depend on management for this information. Luckily, boards have risen to the challenge by developing specialized skills and processes.

How are governance, audit and compensation committees coping? Ward gives us an excellent picture of what is going on inside such committees, what problems they are grappling with, and how they are adapting to new demands. He sees the chairs of each of these committees and the board itself as moving in the direction of approaching these positions “as full-time, consulting-like jobs.” Ward is probably right that better pay and professionalization are next steps.

Further along the trajectory, I couldn't put it any better than his final words. Directors “will support management, but not to a fault; they don't owe their position on the board to the CEO. Rather, the other outside board members and major shareholders elected them to their leadership position, and the latter will lay claim to their loyalty… These next generation board leaders may not have all the answers when it comes to independent board leadership. But they definitely won't be afraid to ask questions.” The New Boardroom Leaders: How Today's Corporate Boards are Taking Charge provides an excellent guide to those wanting to take charge of corporations, the most pivotal institutions in our society.

Barron's Editorial Page Editor Thomas G. Donlan has just come out with a new book, A World of Wealth: How Capitalism Turns Profit into Progress, touting the benefits of free-markets. His timing is not so good, since many attribute the current economic free-fall to a failure to properly regulate markets. While it is important that we not swing too far toward over regulation, Donlan's book isn't all that convincing.

His basic philosophy appears in a brief sentence. "The practical solution to the conflict between private interest and public interest is more private interest." Yes, enclosure of the commons can often improve overall yields, but not all that is held in common should be divided, it takes government to legitimate any such division, and who should reap the benefits is key.

Regarding global warming: "There is no certainty of a payoff from reducing carbon-dioxide emissions - the planet was warming for 10,000 years before there were any industrial emissions." Better to spend money preventing development of areas likely to flood. He seems to say we should write off Florida and Bangladesh. (See map) Obviously, we need to reduce our carbon footprint and encourage people not to build on the beach.

Donlan advocates the "tax magic" of trickle-down, "if you really want to raise taxes on the rich, you should cut their tax rates the way Congress and President Bush did in 2001, 2002 and 2003... America needs a flat-rate tax, on income or on consumption, with the lowest possible rate and broadest possible base." Of course, the lowest possible rate would be zero. How long can we borrow from China?

"The antitrust laws are wrong. They are wrong in practice for hardly any monopoles have ever been effective for long except those fostered and protected by a government. They are wrong in intent, for they work against the consumer's best interests while pretending to provide consumer protection. They are wrong in effect, for they prop up weak competitors and perpetuate their mistakes. And they are wrong in principle, for they deprive owners of the use of their property and interfere with free commerce between free people." Donlan's words fail to ring true when taxpayers are bailing out firm after firm because they are "too big to fail."

On Social Security: "To give low-wage workers a pension that exceeds the economic value of the taxes paid by them and their employers, Social Security dramatically shortchanges higher-income workers." As if the gap between rich and poor is not wide enough already. Blame it on Bismark.

"Economic booms and busts always have their causes in wrongheaded policies imposed by central bankers and governments trying to control economic forces that are actually too strong for them." Our Keynesian solution works out to: "Savings bad. Spending good." While that's bad long-term advice, I always have a problem with people using the term always. I can't agree that "government's job is to stay out of the way of natural economic cycles and let markets work. When governments fight economic cycles, they usually make them worse." From the tulip crisis to the real estate bubble, sometimes government intervention is necessary to prevent "irrational exuberance."

I do agree with Donlan that "real capitalists all too often attempt to use the power of government to their advantage, lobbying and bribing to obtain favorable treatment for their business endeavors." Donlan's solution is more limited government "foreclosed from absolute power." That's seems so 19th century. Herbert Hoover would feel at home.

A better read, which also looks to free-market solutions, is Jonathan R. Macey's Corporate Governance: Promises Kept, Promises Broken (Princeton University Press). Macey examines various market and regulatory mechanisms to improve corporate governance and concludes that our emphasis on regulations and those that have developed are the result of the fact that shareowners are not well organized into effective political coalitions, while managers are. "Managers will staunchly resist corporate governance reforms that put their jobs in jeopardy or threaten their ability to remain independent..."

Regulators and politicians follow the path of least resistance and satisfy the public's outcry that they "do something" "by passing laws like Sarbanes-Oxley that increase the power of 'independent' directors and like the williams Act that weaken the market for corporate control without upsetting the top managers of public companies or any other well-organized special interest group."

As a result, the most effective corporate governance mechanism, the market for corporate control, is hampered by excessive regulation, whereas "ineffective institutions, such as administrative agencies, cerdit-rating agencies, and even boards of directors, enjoy regulatory 'subsidies,'" according to Macey.

Macey is on the right track. Look at what works and what doesn't in keeping the promises that corporations make. For example, he examines the effectiveness of "independent directors" and notes the problem of "board capture," which renders "independence" relatively meaningless since directors become reputationally linked to management. He later notes that dissident directors put forward by activist investors are far less likely to be captured by managers, since their allegiance lies with shareowners. Strengthening of board independence hasn't reduced the incidence of boar capture, he says. Instead, "What the intense focus on boards has done is to increase managerial autonomy and draw attention away from other potentially more effective solutions to the challenge of providing reliable, objective monitoring of corporate management."

Since the really independent directors come from hedge and private equity funds, that's where Macey says we must turn for solutions. While he is mostly right, his focus on reviewing existing institutions and what works doesn't drive him to apply the tool of imagination as much as he could to explore what might work. Are there other ways to have directors be reputationally linked to shareowners? One mechanism would be proxy access. Although he dismisses Bebchuk's proposal for reimbursing rivals because it exacerbates the "credibility problems" facing challengers, he doesn't explore other options of using proxy access.

In examining shareowner voting, he notes that while it may pay investors to become well-informed about "generic or market-wide" corporate governance issues like poison pills, since the costs of learning is spread across all public companies in their portfolio, it doesn't pay for most diversified investors to dig into "firm specific" corporate governance issues, because the cost is greater than the probable reward. Hedge and private equity funds hold larger blocks in fewer companies, so for them firm specific research pays. However, instead of largely dismissing the power of the vote by most investors, I wish Macey had explored other options.

Macey says the core dilemma of corporate governance is that shareowners have "fidelity to the objects of the corporation" (usually maximizing shareowner value), but not the "knowledge by which these things can be best attained." "While managers and directors, who often (though of course not always) have the knowledge (skill) to run the business, they often lack sufficient commitment to the objectives of the shareholders of the corporation."

The market for corporate control, hedge funds and dissident directors all bridge the problem.

Right now, several broadly diversified funds, such as CalPERS, also take positions in activists hedge funds that primarily use corporate governance strategies to unlock value. Through such efforts, they not only move the bar of averages, they also improve their return.

Another potential unexplored by Marey is the idea of more robust proxy monitoring services selected by all shareowners, paid with corporate funds that would remove "free-rider" issues involved when one fund, even a hedge fund, has to do all the heavy lifting. Mark Latham has written extensively on this possibility, and the idea of "voting by brand," an idea that adds some intelligence with minimal effort. See votermedia.org. Building from the power of shareowners coalescing around brands are two other worthwhile projects.

ProxyDemocracy facilitates the ability of users to see how respected shareholder activists, which should include hedge funds at buildout, are voting. This allows retail shareowners to learn from or copy the voting behavior of more knowledgeable investors. Eventually, the site could facilitate direct voting by brand.

A "proxy exchange" proposed by the Investor Suffrage Movement would also facilitate voting by brand by allowing shareowners to assign their proxies to aggregators and ultimately voters, which would include hedge funds and others with firm specific knowledge. Over time, the proxy process would be taken out of the hands of management and would become the responsibility of a self-regulating agency, the proxy exchange. However, what Macey lacks in imagination, he more than makes up for with by explaining existing legal and political problems.

Macey's Corporate Governance is a seminal work, in terms of actually exploring the various corporate governance devices to determine which ones are working, which don't, and why we keep focusing too much on those that don't. As I write this the world's economies are beginning a meltdown, largely the result of promises broken. Macey's readers will have a better understanding of how this happened and what can be done so future promises are kept. Listen to a podcast of Macey discussing his book.

Entrepreneurs and Democracy: A Political Theory of Corporate Governance by Pierre-Yves Gomez and Harry Korine is a sweeping masterpiece with a modest objective - to propose “a framework that allows economists, historians, and political philosophers to talk to each other.” Various professions should use this framework to help determine the future of corporate governance for decades to come.

“'What gives the right to direct a corporation?' is answered by economics from the point of view of performance, by history from the point of view of the evolution of governance, and by liberal political philosophy from the point of view of the foundations of legitimacy.”

Gomez and Korine weave a multi-disciplinary tale of corporate governance history by juxtaposing two powerful forces that arose with modern liberal society:

“From the unstable equilibrium between entrepreneurial force and social fragmentation emerges corporate governance that is both legitimate and performing,” directing the “productive action of people who want to stay autonomous and free.” The quick takeaway: corporate governance must increasingly become more democratic to be seen as legitimate.

“Whereas political harmony in traditional societies is built on complementarity and cooperation, liberal society strives to create social agreement” grounded in individual liberty and competition. “The emergence of the entrepreneur as the heroic figure of capitalism is paralleled by the emergence of democracy” as the accepted institution for reconciling these two forces. “Democracy has spread from the political sphere, to the civic and economic spheres: the history of corporate governance does not escape this movement.”

Contrary to the worries expressed, mostly by those in power, Gomez and Korine contend, “There are good economic reasons to think that the democratization of corporate governance and the growth of economic performance go hand in hand.” Three primary procedures for the maintenance of individual liberty apply increasingly to both political and economic spheres: equality of rights, separation of powers, and representation with public debate

The book follows a sometimes arcane but always fascinating journey, starting with three types property rights in what could be called the dominant corporate governance theory of Roman times:

The book then proceeds to explain the evolution of three models of reference, or forms of corporate governance adopted by leading companies after the fall of feudalism:

In feudal times, the aristocrat owned rights of fructus and abusus, but not usus. The tenant owned rights to usus and fructus but not abusus. Partition of complementary property rights provided the building blocks for a cooperative society, organized around class and mutual dependence. Private property and ownership of all three rights by one party permitted the blossoming of individual liberty and capitalism.

In the tradition of modern liberal thought, work, not ownership, became the more privileged source of political legitimacy. Work reaffirms individual liberty and equality. Whereas ownership can be inherited and can be used to sustain inequality. Management, therefore, eventually took over the entrepreneur's mantle of legitimacy, transforming shareholders from involved owners to coupon clippers.

Shareholders had the right to claim the profits, but little else. Corporate managers were in charge of economic well-being. The unions were in charge of social well-being. The state acted as an arbiter for the general interest. For a while, most accepted the legitimacy of management, based on their claim to superior expertise. That claim quickly came into question during the Depression.

Berle and Means did not blame the downturn on the greed of those who owned shares but rather on their passivity and their failure to check management. They concluded that control groups have “placed the community in a position to demand that modern corporations serve not alone the owners of the control but all of society.” They proposed that corporations seek to maximize the general interests, rather than shareholder profits.

According to Gomez and Korine, most economists endorsed the economic analysis of Berle and Means but not their conclusion. Instead, they have systematically worked to overcome the inherent inefficiency of separating ownership and control by focusing on market forces… hoping to find a cure from within… purified of the need for government intervention, with “agency” theory.

Ironically, “whereas Berle and Means worry that the dilution of the capital base poses problems, contemporary property rights theorists find that the absence of dilution (resulting in illiquid markets) is problematic.”

Gomez and Korine discuss the pure economic model (PEM) and its flaws, such as, “If markets were truly efficient, as PEM contends, no one would seek additional information.” For predicting stock prices, the authors find more value in the science of crowds and mass movements.

Agency theory underestimates the degree of fragmentation. Real divisions occur not only between shareholders and management, but also among shareholders who differ in size, motivation, time horizon and willingness to exert influence and likewise within management itself.

Like the managers of agency theory, shareholders will also seek personal gain by exploiting imperfect information. Shareholders seek to maximize their own profits by exploiting information imperfections. Like managers, they are tempted to maximize sort-term interests, attracting speculative money to raise share price. Neither managers nor shareholders have much incentive to stay loyal to the company. Both can move on easily.

Management knowledge is no longer restricted to a small, elite group. With mass shareholding, workers have become owners. Contemporary corporate governance is less about the opposition between management and shareholders, than about the interplay between “investors” and “shareholders.” Both lay claim to the mantle of the entrepreneurial force.

According to Gomez and Korine, we are entering a new corporate governance paradigm where “investors” are focused on the value of a portfolio of investments. They trade to optimize their portfolio and care little about the fate of any single company.

“Shareowners” focus on individual corporations. Both are interested in profit maximization but shareowners may also be interested in the firm's specific role in defending jobs, securing credit, consolidating business relationships, preventing ecological risk or increasing share price through shareowner intervention.

Management becomes the executor of choices determined primarily by financial markets, driven by investors and shareowners. Where shares are highly dispersed and markets liquid, investors hold sway. In the opposite case, shareowners play the more a critical role. Public opinion is quickly becoming the real counterweight to the direction of entrepreneurial force provided by investors and shareowners.

Both investors and shareowners need transparent and standardized information that is substantially identical in form and universally understood. The institutions that contribute to “good governance” are those that align the internal creation of value, through shareowner activism, with the external interests of investors, though buying and selling.

Investors and shareowners often have a broader knowledge than management concerning sources of performance. For investors, corporate governance is a black box. Participation is costly and less important than transparency. But Gomez and Korine see that, “Between the 'invisible hand' of the markets and the very visible role of management, active shareowners play the roles of catalysts and mediators.”

The authors offer three primary characteristics of contemporary corporate governance.

Continuation of the corporate form is tied to its ability to generate collective wealth and to do so legitimately. The current model in transition from management to public is not too liberal. Rather, it is not liberal enough.

For example, Gomez and Korine note that shareholders may not be the real “residual claimants,” as is so often assumed. If jobs are off-shored to achieve a predetermined level of remuneration to shareholders, employees become the real residual claimants. If tax havens are sought for the same reason, the government becomes the de facto residual claimant.

Employees and governments are increasingly taking the risk. Catch 22. “Either shareholders are not powerful enough to influence management and corporate profits are not maximized - this was the concern of Berle and Means - or, shareholders are too powerful and impose a pre-determined level of remuneration to equity capital.”

The critics of “good” corporate governance decry the extra expense of independent directors and box-ticking exercises. The cost of collecting and interpreting information goes up with the number of shareholders who must take each other's behavior into account. Investors are more interested in outperforming the market than in having an individual company perform well.

However, Gomez and Korine demonstrate that a corporate governance model based only on the calculations of individual interests does not maximize economic performance for society. Market self-regulation is inadequate. So, how do we regulate markets to ensure the convergence of both public and private interests? The answer appears to require greater use of democratic mechanisms. Many are already employed by cutting edge companies. Others are yet to be invented.

After reading The Role of Independent Directors after Sarbanes-Oxley by Dravis and discovering an excellent brief guide for directors, I was reluctant to even pick up Corporate Governance: A Board of Director's Pocket Guide by Eric Yocam and Annie Choi. What more could it offer? Surprisingly, I decided it can be a useful supplement, as the preface notes, for "a quick review." However, it definitely is NOT, as advertised on the back cover, "brief yet complete." (my emphasis)

If you are looking for guidance on your responsibilities as a director under Sarbanes-Oxley (SOX), you'll find them outlined in the Pocket Guide simply with the titles of 11 sections. You get only a hint of what you need to know. Even if you bother to search out the two articles footnoted, there will still be many gaps in your knowledge. While "Sarbanes-Oxley and Cost Engineering" might be a great guide for how SOX impacts "the world of engineering, architecture, and construction," there are better references for directors.

The one page chapter, "Global Governance Comparison," is no better. We are told that "corporate governance various (varies?) from country to country." "Japan, China and South Korea have dramatically different corporate models than those of the United States, Britain and Australia but readers are not given the faintest clue as to how those models differ. We learn that in Germany "a Vorstand is the management board of a corporation where the Aufsichtsrat or Supervisory Board controls the Vorstand." The reader is left clueless as to the composition and roles of these boards, other than that one "controls" the other.

Regarding board independence, the authors cite studies that found "having separate committees to nominate, compensate, audit, and govern are more effective ways to monitor governance rather than having the board itself regulate these items." Good advice, as far as it goes. However, the three page chapter, "Committees," simply lists 17 types of committees. It provides no clue as to which are required and what their composition should be. For example, under SOX, only independent directors can serve on audit committees and at least one must be a "financial expert." The NYSE requires a compensation committee for its listed companies; the NASDAQ doesn't. However, the NASDAQ requires that only independent directors may participate in the decisions. Such basic governance requirements are missing from the Pocket Guide but are readily accessed in the Dravis book.

At the outset of this review I said the Pocket Guide could be a "useful supplement." The book's "strength" lies in providing a laundry list of buzz words. The buzz words are as likely to be derived from management as from governance discussions. For example, in the chapter on "Best Governance Practice" we are given a few bullet points each on SMART Objectives Technique, KISS Technique, and SWOT technique. (Why is the third heading not fully capitalized?) The chapter on "Commitment to Quality" touches on the following: Business Process Improvement Technique, Six Sigma Technique, Total Quality Management Technique, Five Whys Technique, Cause and Effect Technique, and Taguchi Technique. Other chapters give us a few words on the Learning Organization, Capability Maturity Model Integration, Software Engineering Institute (how Carnegie Mellon institute fits into the typology isn't explained), Total Quality Management (repeating one sentence of the two sentence explanation from the previous chapter, in case you missed it), Pareto Principle, and Total Cost of Ownership Technique.

If you might be embarrassed as a director by never having heard of the Taguchi Technique or one of the others, the Pocket Guide will typically provide very brief explanations that might actually be helpful. You can read this one while waiting to board at the airport. It could be 15 minutes well spent. If you only have three minutes, read the appendix and glossary in the back. Following the Pareto Principle, you'll get 80% of the book's value in 20% of the time.

Clearly written, with a minimum of repetition, The Role of Independent Directors after Sarbanes-Oxley by Bruce F. Dravis is an excellent general guide to board duties. Those who seek greater depth can readily attain it through the accompanying CD.

Chapter headings, as follows, provide a broad overview:

SOX effectively federalized elements of corporate governance for publicly traded corporations and its standards have been incorporated into some state laws governing nonprofits. Additionally, private corporations considering an initial public offering or acquisition need structures in place to make a good “fit” if they should choose to go public. Therefore, the topics covered are critical to any type of board. Dravis makes quick review of major director responsibilities short work and the CD expands 165 brief pages to a ready reference guide with thousands of pages.

For example, we read that a waiver of the company's code of ethics, like those given by the Enron board, now gives rise to a reporting obligation. Failure to make accurate and timely disclosure is a violation of the securities laws. The reader might wonder, “What does such disclosure entail?” Easily locate the footnote that refers to Form 8-K, Item 5.05 on the CD and quickly review exactly what the report requires by locating item 5.05 on the hyperlinked form.

With hundreds of footnotes as a guide, the reader can drill down on virtually any legal responsibility. In addition, the CD also includes the text of statutes, regulations, forms, stock exchange rules, speeches, SEC releases, enforcement actions, important case law and other material, including links to important sources on the internet.

Let's take another example. Say we are reviewing the requirements for “Director Nominations by Shareholders.” We read, “If the nominating committee will consider shareholder recommendations for candidates, the proxy statement must describe:

Link to the footnoted regulations and you learn that a company must also, under specified circumstances, report on the disposition of recommendations from a 5% holder or group “provided, however, that no such identification or disclosure is required without the written consent of both the security holder or security holder group and the candidate to be so identified.”

In this fast-moving field, some information quickly becomes dated. For example, Dravis notes that by mid-2006 more than 25% of Fortune 500 had implemented some form of majority voting or modified plurality voting policy or standard. As of early 20008, that figure had risen to about 66%.

However, the director responsibilities reviewed have not changed and Dravis presents them concisely. The Role of Independent Directors after Sarbanes-Oxley and accompanying CD could serve any board member as a valuable reference library in one thin volume.

Managing for Stakeholders: Survival, Reputation, and Success by R. Edward Freeman, Jeffrey S. Harrison, and Andrew C. Wicks. Generally, I am suspicious of any book touting a stakeholder model over one grounded on shareowners. The problem is one of identification. Without a clear party in control, the CEO and board can rationalize just about any position based on balancing “stakeholder” interests.

I'm also concerned with a book on ethics sponsored by the Business Roundtable, since that organization has a long history of ill-founded opposition to shareowner interests, such as expensing stock options and proxy access. Despite these reservations, I can honestly recommend Freeman's book. The corporate form exists for more than simply maximizing shareowner wealth. A stakeholder approach is appropriate in most day-to-day decisions, and this small volume offers good advice.

Any executive or board can benefit by more thoroughly examining their corporation's community of interest. As the authors posit, companies which “find a way to create value for conflicting stakeholder interests will be the winners.” Engagement often leads to value-creation. Even when it does not, a few simple cooperative steps can often diffuse what might otherwise be a damaging situation. “Unilateral action increases the risk of conflict escalation.”

The book lacks ex ante rules for deriving a hierarchy of stakeholders but, instead, takes a more organic approach. More discussion of the fundamental tension between the expectation for substantive debate over disagreements with stakeholders and the reality of our common preference for social cohesion and conflict avoidance would have added value. In Hearing the Other Side: Deliberative versus Participatory Democracy, for example, Diana C. Mutz, reports finding that the degree of cross-cutting discussion decreases as levels of income and education increase. This helps explains why so few corporations make an adequate effort to communicate with stakeholders. Rather than limiting active engagement to the like-minded or withdrawing, Mutz argues for “weak ties” that foster loose engagement and build tolerance.

I would have also liked more of a conceptual framework. For example, readers might have benefited from a discussion of the “rights” of stakeholders using Wesley Hohfeld's fundamental legal concepts of a claim against, a liberty or privilege, an authority or power, and an immunity. Such a discussion would be helpful in framing expectations around stakeholder engagement.

While readers are warned the book is “written for executives, not for academics,” and “we are in the process of creating a separate book that will contain all the academic support,” this reader would have benefited from more science and a more rigorous conceptual framework. Instead, the authors appear to argue that management is still more art than science.

Still, I liked the discussions on the principles of ethical leadership and on leadership by choice, which emphasizes that people must have adequate knowledge of alternatives and at least some options before they truly engage in a genuine choice to follow. Pack the book for your next flight and you'll probably find a reasonable amount of grist for meaningful reflection.

Another useful tool for identifying at least some of your company's stakeholders is touchgraph.com. Try it out by entering the name of your company or its URL to visually portray your firm's 6 degrees of separation in cyberspace.

G atekeepers: The Professions and Corporate Governance
by John C. Coffee Jr.

Although the book was written in the wake of Enron and WorldCom, it is equally applicable to the subprime debacle in its analysis of “gatekeeper failure.” In a personal note to me, Professor Coffee laments, “perhaps I should have waited a year longer to write this book.” Better he should have written it a couple of years earlier, with copies to Allen Greenspan and others charged with regulating and rating the mortgage industry.

However, the book's timing could hardly be better, since substantive reform only seems to occur with a crisis. Implosion of the savings and Loan Industry brought us the Federal Institutions Reform, Recovery and Enforcement Act of 1989. Accounting scandals at Enron, WorldCom, etc. brought us the Public Company Accounting Reform and Investor Protection Act of 2002 (Sarbanes Oxley). The subprime debacle is likely to bring significant reform as well.

It would be great if those advising Presidential candidates would consult Gatekeepers in preparing such proposals. Coffee focuses on auditors, attorneys, securities analysts and credit-rating agencies who inform and advise corporate managers, boards and shareholders. After a brief introduction explaining the failure of gatekeepers and a comparative overview of their roles internationally, Coffee devotes a chapter to each of the four groups. He typically provides an informative history, a review of current issues such as conflicts of interests, and an evaluation. He wraps up the book with a thematic discussion of what's gone wrong and how it might be fixed.

In general, gatekeepers act as “reputational intermediaries” by verifying corporate statements to investors. When trusted and successful, this lowers the cost of capital. However, as Coffee notes, “Watchdogs hired by those they are to watch typically turn into pets, not guardians,” especially in the euphoric environment typified by stock or housing bubbles, when the public is typically lulled into complacency.

As management incentives were aligned with shareholders through options, income smoothing gave way to robbing the future for earnings that could be recognized immediately. Coffee explains how Enron's audit committee was blinded by professional advisers who fed it only the information senior management wanted them to have. Auditors were retrained and incentivized to sell consulting services. He explains why fund managers and gatekeepers tend to herd and why, until four days before Enron declared bankruptcy, its debt was rated “investment grade.' Only those with a financial self-interest, the short-sellers, searched beyond the surface and predicted Enron's accounting restatements. At WorldCom, “the limited due diligence that was conducted appears to have been constrained by the need not to offend the client” and the actual fraud was detected by the firm's internal auditors.

Coffee helps the reader see from a different perspective. For example, while some studies have found that audit firms with high consulting revenues were more likely to acquiesce to questionable earnings management, others found no such correlation. Coffee points out that instead of looking what is already in hand, we should look to possibilities. “The real conflict lies not in the actual receipt of high fees, but in their expected receipt.” That explains why audits became a “loss leader” to obtain consulting services.

Similarly, disclosure of conflicts of interests often does not lead to expected results. Social psychologists find those on the receiving end often let down their guard, thinking because conflicts were disclosed they are being dealt with fairly. However, the conflicted party often feels that, having made the disclosure, they are now free to pursue their own interests aggressively. Gatekeepers is filled with such insights.

The major problem is that gatekeepers have come to view corporate managers, not shareowners, as their principals. Their livelihood depends on being viewed as flexible, problem-solving and cooperative, rather than rigorous or principled. “If left to their own devices and subjected to a significant threat of private litigation, professionals will respond by defining GAAP and auditing standards in their own interest, rather than that of investors.” “Absent a litigation threat, professionals acquiesce in dubious and risky practices that their 'client' wants; but once subjected to an adequate litigation threat, professionals insist upon narrow duties, hopelessly specific safe harbors and a rule-base system that often seems devoid of meaningful principles.”

According to Coffee, “The challenge for the regulator is not to take discretion out of the system, but to preserve and expand it. But discretion must be accorded to the gatekeeper, not the client (whereas present-day GAAP does the reverse).” The gatekeeper must assess not simply whether GAAP contains a rule authorizing a given treatment, but whether discretion so exercised is reasonable. Pressure to reform must come from regulators, investors and the young that the profession hopes to recruit who would find that greater discretion enhances the professions' image in their own eyes and those of the public.

Some of Coffee's more interesting recommendations, at least as I read them:

Break-up the major accounting firms to provide more competition.
Establish an intermediary that receives payment from the issuer but then selects the analyst based on objective criteria, such as their record of predictions.
Restore “aiding and abetting” liability for professionals instead of de facto immunity for knowingly or recklessly participating in fraud.
Formalize the role of “disclosure counsel” by requiring audit committees to retain them to investigate and test corporate disclosures on an on-going basis.

Most corporate governance research has been on large mature businesses. Many have claimed, "One size doesn't fit all."

The Life Cycle of Corporate Governance (Corporate Governance in the New Global Economy) makes an important contribution to the idea that a firm's strategic dynamics and appropriate corporate governance practices are interlinked. It examines both life-cycle stages and how these are shaped by different contexts. The book is helpful in understanding transitions such as how governance changes from start-up to maturity as well as the consequences of ownership dispersion to family firms.

This volume compiles some of the best empirical research to date on the subject and is essential reading for understanding the new global economy.

From a review of the same book, Philip L. Levine writes "Robert A.G. Monks has pulled away the covers, revealing who is in bed with whom, and very clearly articulating how we got to the unbalanced and unhealthy state we find ourselves in." Nell Minow also sings the book's praises:

Sir Adrian Cadbury, most noted for the Cadbury Code, a code of best practice which served as a basis for reform of corporate governance around the world, wrote a lengthily review posted at Amazon.com. (Or course, it wasn't nearly as long as my rambling review.) Below are a few bits:

I was lucky enough to get a pre-print, which I read in a couple of sittings within a few days of its arrival. Corpocracy: How CEOs and the Business Roundtable Hijacked the World's Greatest Wealth Machine -- And How to Get It Back both delights and informs in a way only Bob Monks can, because he has been at the center of so many of the important battles to make corporations more accountable. His lifework has been delineating the underlying dynamics of corporate power to devise a system that combines wealth creation with societal interest. No one else can write as well about "How CEOs and the Business Roundtable Hijacked the World's Greatest Wealth Machine" because no one else has been as engaged as Bob Monks from so many angles.

His insights into pivotal points of view and decisions are enlightening. For example, he points to the role of Douglas Ginsburg, a leader in the field of law and economics, in instilling a belief that it is okay for corporations to violate environmental laws, as long as they account for possible sanctions in their budget. Under Ginsburg's view, according to Monks, people aren't motivated by moral or social obligation but by simple desire and cost-benefit analysis. Then there is Bob analysis of Lewis Powell's court decisions. His finding of a constitutionally protected right to “corporate speech” provided the judicial framework for management “to commit untold corporate resources to influence public opinion and public votes - resources so huge and unmatchable that individual contributions are now all but meaningless in state and nationals elections.” And, of course, the Business Roundtable hold a special place in Bob's heart. The “BRT has come to function in significant part as an agent for the CEOs…who have established themselves as a new and separate class in the governance of American corporations, answerable to virtually no one, accountable only to themselves.”

Monks appears to be a believer in the forces of markets but regulated to ensure a level playing field. Without that, the overall effect has been to turn the stock market into “a gigantic, round-the-clock casino that runs the biggest game the world has ever seen.” Market values and goals have become national goals. Corpocracy is another top-notch effort from the individual who continues to have greater lasting impact on the field than anyone else. Still, I would have placed a different emphasis in the "How to Get it Back" portion of the book..

Monks may be A Traitor to His Class, but he is also a gentleman, reluctant to force change. Through many books, Monks repeated what became almost a mantra that "no new laws" are necessary. I don't recall seeing that in Corpocracy, although Cadbury repeats the phrase in his review. I think Bob is weakening on this point. However, he still seems too confident in the power of persuading elite leaders of the need for change. I'm with John Edwards, when he said recently, “It is unrealistic to think that you can sit at a table with drug companies, insurance companies and oil companies and they are going to negotiate their power away."

When Les Greenberg, of the Committee of Concerned Shareholders, and I started preparing our petition on proxy access in July of 2002, I remember e-mailing Bob, asking if he would sign on with us. It was late in the week when Bob e-mailed back that he had a meeting scheduled with then SEC chairman Harvey Pitt on Monday. If we could get him the proposal over the weekend, he might be able to discuss it at his meeting. We did. My impression is that Bob's primary focus was on Pitt's 2/12/02 response to a letter Ram Trust Services had sent 13 years earlier where Pitt clarified the SEC's stance that proxy voting is in fact an investment adviser's fiduciary responsibility, generally governed by state law. I think Monks was asking Pitt for regulations to enforce that duty through required disclosures. Pitt was apparently won over by Monks, Amy Domini, and others.

My little story has two points. First, most of us don't routinely meet with SEC chairmen. Bob's history of involvement in corporate governance has been as one member of the elite meeting with other members of the elite. Like the fictional character, Forrest Gump, Monks met with many historical figures and has influenced important development. Unlike Gump, Monks has done so with candid intelligence and a deep awareness of the significance of his actions. Second, like the earlier Avon letter, the Ram Trust letter and follow-up eventually led to regulations. Monks may espouse "no new laws or regulations are needed" but several of his most important actions have led down that path.

Perhaps Monks is correct, as Cadbury points out in his review, that foundations have a special obligation to reform the market system which sustains their existence. That's where Monks places much of his emphasis in the "How to Get it Back" portion of the book. In his flights of fantasy, Bob dreams of a president who will use his/her powers to end conflicts of interest and compel good governance in contractors. "The framework is in place. The laws exist," he insists.

Yet, two pages later he notes the need for legal changes. He reminds us the First Amendment "was not meant to protect the Church from government intrusion, but rather to protect the government... We need similar protection today from the dominant institution of our own time, the corporation." He defines corpocracy as “government by the corporations; that form of government in which the sovereign power resides in corporations, and is exercised either directly by them or by elected and appointed officials acting on their behalf.” I can't help but believe that the tide won't turn until the rabble of individual investors demands change. Individual investors have a vote in electing government representatives -- the sovereign power; institutional investors don't.

Lucian Bebchuk and Zvika Neeman, in a recent paper entitled Investor Protection and Interest Group Politics, also proceed on the assumption "that individual investors, who invest in publicly traded firms either directly or indirectly through institutional investors, are too dispersed to become part of an effective organized interest group with respect to investor protection." Yet, their own model contains the following hypotheses.

Therefore, educated individual investors are critical if we have any hope of electing public officials who will protect politics from corporate influence and who will revise the legal framework so that it better combines wealth creation with societal interest. Roger Headrick's "win" last year at CVS/Caremark, based on a margin decided by broker votes, lead to additional calls for the SEC to approve NYSE's proposal to bar brokers from casting uninstructed investor votes in board elections.

According to Broadridge Financial, broker votes on average account for about 19% of the votes cast at US corporate meetings. However, the elimination of broker voting, if the SEC ever gets around to approving it, just takes 60-70% of retail shareowners out of the picture. It doesn't address the more fundamental issues. How can we get shareowners to think of themselves as long-term owners rather than as betters at what Bob calls the biggest casino the world has ever seen? If they know they are owners, what tools can we make available so that voting is not only easier but also more intelligent? There are dozens of possible reforms. Here are seven worthy of further attention:

1. Proxy Assignment

Drawing from the other six, this may be the easiest to implement with a relatively large possible impact. That's why I'm working on it. We need system(s) or perhaps just instructions, so that lazy but somewhat conscientious shareowners can assign their votes to others based on reputation, rather than tossing their proxies in the shredder. I surveyed brokers and determined that making such assignments will not be a problem at most. Now I simply need to find an institution or two willing to take the proxies. Of course there are lots of technical and legal details but they don't appear insurmountable.

That's the working name for a project Andy Eggers started. Andy is working on a PhD in political science at Harvard. The project is now housed within a nonprofit, Proxy Democracy, which Andy also founded. Here's part of what he has posted as a brief description:

Before each voting deadline, we find out how respected institutional investors with a variety of voting philosophies have chosen to vote their shares. We'll help you figure out which funds have similar voting philosophies to yours. When a fund you agree with makes a decision on a stock you own, we'll send you a free alert. You'll have a week or two to look at their decisions and cast your own ballot.

The system appears to depend on funds posting how they voted or intend to vote prior to the shareholder's meeting...with Andy's software crawling the internet to gather the information. This may work well in high profile cases. However, we'll need more institutions to routinely post votes in advance.

Glyn Holton outlined how a "proxy exchange" could allow shareowners to transfer voting rights among themselves or to trusted institutions to increase voter effectiveness (see Investor Suffrage Movement). His proposal lays out a fairly complex system involving four classes of participants:

Shareholders in Europe "are gaining the upper hand, nudging up share prices and sometimes forcing out an executive or forcing the sale of the company. Most recently, the Children's Investment Fund turned dissatisfaction into deal-making at ABN Amro, leading to rival bids for the bank, the largest in the Netherlands, reports the New York Times. (Boards Feel the Heat as Investor Activists Speak Up, 5/23/07)

The Times goes on to discuss the costs of such activist campaigns that appeal to shareholders through newspaper ads. Antonio Borges, chairman of the European Corporate Governance Institute and a vice chairman at Goldman Sachs in London, says sacrifices for short-term gain would remain exceptions because short-term investors could only sell their shares at a profit if they find new investors who believe in the long-term potential of the revamped company.

In reading the article, what struck me is the growing assemblage of activist funds and shareholder associations in Europe. Where is the US equivalent of the VEB (Vereniging van Effectenbezitters or Dutch Investors' Association) or the UK Shareholders' Association? In the US, BetterInvesting is the largest nonprofit organization dedicated to investment education.

Although their goals include helping their members to "learn, share, grow and more fully experience the rewards of investing success," I find no mention on their site equivalent to the UK Shareholders' Association's vow to "protect your rights as a shareholder in public companies and promote improved standards of corporate governance." It might make for more interesting investment clubs in the US if members acted as owners, instead of just stock pickers at the casino.

The US hasn't had an effective advocate for retail shareholders since United Shareholders Association. Deon Strickland , Kenneth Wiles and Marc Zenner documented that USA's 53 negotiated agreements are associated with a mean abnormal return of 0.9 percent, a $54 million shareholder wealth gain. Although Peter Kinder, President, KLD Research & Analytics, Inc., tells me USA "was a significant factor in turning 'good governance' into a checklist of factors that made easy or easier 'maximizing shareholder value', i.e., flipping or extorting the corporation" -- something we obviously have to guard against in any new iteration. I've repeatedly contacted the National Association of Investors Corporation (NAIC) but they do not appear interested in governance issues. As I recall, USA was originally funded by a shareholder's lawsuit. Maybe we need another.

5. Shareholder Advocacy Trust

Richard Macary's AVI Shareholder Advocacy Trust presents an innovative mechanism to combine small shareowners to advocate changes in corporate governance. The Trust sets out its goals, makes its case to shareholders, and then is dependent on contributions. The Trust depends on a monitoring/activist agent who is so compelling that shareholders freely pony up contributions to support work that might pay off. Free rider issues abound.

Because of the expense and free rider issues, the only reason most institutions vote are the federal regulations Bob Monks helped to create that require pension and mutual funds to vote stock in their beneficiaries' interests. Of course another of Bob's important contributions was founding Institutional Shareholder Services, increasing the research done on proxy issues and its availability. The biggest obstacle to voting now is not the time it takes to vote but the research needed to make an informed vote. Most people realize that just going along with the board of directors for lack of an easy alternative is not a meaningful vote. But understanding the proxy issues requires too much time and expertise, especially for individuals.

On that front, the Corporate Monitoring Project and VoterMedia.org, both initiated by Mark Latham, have shown the way to empower voters with better information. Latham's system allows shareholders to allocate collective corporate funds to hire a monitoring firm to advise them on the issues and how to vote. Latham's system would eliminated free rider issues and creates an incentive to pay for much more research.

Mark proposes use of shareowner resolutions to choose an advisor from among competitors. Any proxy advisor could offer its services, specify its fee, and have its name and fee appear in the ballot. The winner would give proxy advice to all shareowners in that company for the coming year. The advice would be published on a website and in the next year's proxy. The company would pay the specified fee to that advisor. The voting could even be designed to hire more than one advisor, with a separate yes/no vote on each candidate. Advisor name brand reputation can make these voting decisions feasible without another level of paid voting advice. (see Proxy Voting Brand Competition, Journal of Investment Management, Vol. 5, No. 1, (2007).

This is more of a technical fix, rather than a monumental reform that will bring in more individual investors but I thought I'd just stick it in here at the end of "how to's" Bob might have discussed. Yair Listokin's Management Always Wins the Close Ones highlights the need for open ballot counting.

Obviously, anything we can do to make corporate elections less rigged will also help to bring shareowners out to vote. Why bother if the fix is in? My hope is that once shareowners get used to voting in their best interests in corporate elections, that behavior will also carry over to civic elections. Activists in either social institution will likely carry over to the other.

Lawrence Mitchell chronicles the formative era of what he calls The Speculation Economy between 1897 and 1919 when the American corporate landscape shifted from independent factories controlled by entrepreneurs to one driven by financiers, promoters, and business managers focused on the stock price - “stock market capitalism” - where more is made from legal and financial manipulation than from practical improvements such as technology, management, distribution or marketing.

This turn was “neither the necessary nor inevitable form of the American economy.” As I read it, the resulting speculative economy pushed our collective life to more atomistic forms of competitive individualism that may eventually be our undoing. “It is within our power either to change it, to modify its rough edges or to accept it as it is,” argues Mitchell. It should be easier to move forward purposely if we understand how we got to where we are now. Mitchell does an excellent job chronicling the journey.

“For almost two decades now, many countries have been at a decision point as to whether they will adopt the American way or pursue their own, or even whether they have much choice in the matter. This book teaches them that they do,” he writes. I've had much the same inclination, warning investors in Japan, Korea, China and elsewhere that they can do better as I try my hand at reforming our own system.

Mitchell breaks the history of this important shift into three rough phases:

In Mitchell's interpretation of history, the giant corporation was created primarily to sell stock that would make its promoters and financers rich. The corporate form limited destructive competition and took advantage of the efficiencies of size and centralized management. The stock market took the place of a vanishing frontier for the middle class. Wall Street became our wilderness and corporate stock our grubstake.

Financiers could profit, whether industrial profits were high or nonexistent. Arbitraging the stock, profiting from price discrepancies instead of work, became the path to wealth and a touchstone of America's self-destructive short-term economy.

American's had long viewed private property as an “extension of the individual, the product of the individual's motivations, interests, talents and efforts.” Competition would be between corporations, rather than individuals. The stockmarket became the measure.

At first, the issues were how to prevent the excesses of monopoly. Yet, the competition between states was a race to the bottom for corporate licensing fees and the eventual defeat of James Madison's idea of chartering by the federal government. Readers learn the origin of terms such as “watered stock,” “overcapitalization” and how the matters of “valuation” and “goodwill” were addressed over time.

Also interesting is the development of the financial press. In 1899, for example, the Wall Street Journal's primary concern was the safety of principal, rather than the rate of return. “Stocks should not be regarded as an investment, because it is optional the with management of a company whether it pays a dividend or not… Therefore the outside investor should always take bonds instead of stock.”

In 1902, the United States Industrial Commission observed that democracy and self-governance were only learned by practice, and the man who was accustomed to “absolute submission in industry” carried the consequences of that submissive posture into civic life. Giant combinations robbed Americans of the kind of entrepreneurial spirit and individualistic impulse they had enjoyed as farmers and small proprietors. Over time, participation in corporate governance, as stockowners, came to be seen as a possible reinforcement to political efficacy.

“As early as 1899, the New York Times implied that investing in securities more or less fulfilled the demands of Locke's labor theory of value. 'As soon as a capitalist is willing to be troubled further, as soon as he begins to take a personal interest in his investment, and to give his personal attention to looking after it, he ceases to be a mere capitalist, and his return from his investment becomes, not merely the interest on his money, but also something in the nature of wages for his own services in the way of superintendence.”

That language, implying that active informed investors can enhance wealth production, presaged CorpGov.net's homepage by almost 100 years. What is new since the 1899 New York Times article is that corporations now have so much control over our society that they have become effective intermediaries for shareholder influence, not unlike the citizen's use of representative government to influence society-at-large. Land gave colonial Americans the right to vote and influence politics. Stock gives modern Americans a similar role with our dominant institutions, corporations.

Mitchell explains that during the time period leading to the speculation economy, having a stake and taking an active interest in corporations was also seen as a defense against socialism. “Ownership would keep workers happy, productive and away from strikes.” By the 1920s offering employees stock ownership was widespread. US Labor Commissioner Carroll D. Wright even predicted in 1903 that the wage system would disappear and be replaced by “profit sharing and cooperative plans.” Maybe that's happened on Wall Street, but elsewhere we have a long way to go.

A large portion of the book is devoted to explaining the various pieces of federal legislation and key players. Mitchell documents the growing influence of financial promoters on politics and a preference for investigatory commissions and delay over substantive regulations. We also see the development of the Republican Party as the representative of financial interests, as well as the importance of alliances with Southern Democrats who were suspicious of any action that would erode state's rights. Ultimately, according to Mitchell, it was a group of Southern Democrats, under Woodrow Wilson, “that made America safe for business.”

The Panic of 1907 was a watershed in moving from the antitrust phase of securities regulation to an antispeculation stage, as people tried to address consequences of the beginning dominance of finance over industry. Here, we see “the idea of securities regulation as consumer protection (treating securities as consumer goods) in contrast to securities regulation for consumer protection (to reduce monopoly prices caused by corporate finance) had only limited acceptance and was not yet embraced as a federal responsibility.” (177)

“As corporations needed to retain cash to grow and dividends became a smaller share of corporate profits, price appreciation followed as a substitute for dividends.” The USA moved into the speculation economy based not on “productive assets or past profits but on the possibility of profits to come at some unspecified point in the future. They demonstrated their willingness to invest on faith…” What had changed was the suitability of stocks as repositories for the savings of ordinary people.

When you bought stock for income, you had to pay attention. Mitchell quotes Graham and Dodd: The typical stockholder “gave at least as much attention to the asset value behind the shares as he did to their earnings records.” The pre-WWI buyer knew the corporation, paid attention to the business. “The postwar buyer did not care about the corporation. He cared about price trends, reputations and rumors.”

Mitchell, highlights the important role played by Liberty Bond drives, which encouraged purchase on the installment plan, in bringing the idea of investing in securities to the American public. Those drives established an army of investors and securities salesmen.

Regulation, as it evolved, focused on the disclosure of the terms for selling, rather then the details of corporate governance…due diligence in purchase, not in ongoing operations. The result is less of an emphasis by investors on fundamental values and more of an emphasis on expectations that are built upon the expectations of others. “The natural response is for management to do what it has to do in order to meet the market's expectations, no matter how unrealistic those expectations may be.”

In the epilogue, Mitchell discusses how, until recently, corporate control was lodged with large stockholders, financial institutions and the families of founders who insulated management from market pressures. The takeover decade of the 1980s stripped that insulation away. “Shareholder valuism” came to describe the purpose of corporations.

Impatient short-term stockholders give managers “irresistible incentives to maximize stock prices at almost any cost to the corporation's long-term health.” Annualized turnover on the NYSE jumped from 36% in 1980 to 88% in 2000 and 118% in 2006. “There can be little question that American business is driven by finance. And the demands of finance have become short-term.” Europe, Japan, Canada, New Zealand and Australia still have concentrated block-holders insulating management and taking a more long-term perspective. But for how long?

Mitchell notes, “When corporate economies are ruled by concentrated ownership, the responsibility for success or failure is primarily on those who own the controlling interests. When a corporate economy is ruled by a stock market characterized by the dispersal of ownership throughout society, responsibility shifts. Members of the speculation economy typically treat their participation in American corporate capitalism as a private matter with their decisions made on the basis of their own self-interest and without much regard for the behavior or decisions of others.”

As I have reported elsewhere, the Gates Foundation holds the same philosophy. How they invest is a private matter, with no relevance to their overall mission. Many of us question if the damage done by such a consistently short-term investment philosophy, and the example set for other foundations and endowments, is undoing the good work of Foundation grants.
The strength of our economy, the health of our people and planet, may depend on our ability to take a longer-term multigenerational assessment of our welfare.

Mitchell concludes that incentives to move us toward long-term health “can only be provided by the market for, in the end, the market is the master.” However, he also makes it clear that markets are socially constructed. They can be reshaped to achieve more salubrious results, if we will only provide the incentives.

Making IT Governance Work in a Sarbanes-Oxley World by Jaap Bloem, Menno van Doorn and Piyush Mittal presents a clear view that integrates corporate governance to IT governance. With 50% of all capital investment going into IT, it is critical that legal compliance be built in. This book discusses the issues and common misconceptions. Then it takes a balanced scorecard approach to providuing a value-added metrics.

Global Strategy: Creating and Sustaining Advantage Across Borders by Andrew Inkpen and Kannan Ramaswamy integrates academic research and case studies to inform readers about global avenues to competition. Political instability, corrpution, inadequate infrastructure, and closely knit ownership structures are addressed. For example, readers are advised that leapfrogging offers the best window for an MNE to bypass poor physical infrastructure - as in widespread diffusion of cell phone use. Direct state ownership often means partnerships must pursue agendas not directly relevant to shareholder wealth maximization. Family control may emphasize profitability over growth.

The chapter on Corporate Governance Issues in International Business provides a good overview of the OECD principles, stakeholder versus shareholder debate and differences in the corporate governance systems typically found in various countries, giving the greatest attention to Anglo countries, Japan, Germany, China, India and Brazil. The authors also discuss the growing demand for foreign directors. Although very brief, the discussion does serve to warn readers that knowledge of international corporate governance is an essential element in global strategies. Books, such as Christine A. Mallin's International Corporate Governance: A Case Study Approach, offer a more comprehensive examination. However, Global Strategy provides a good overview for the practitioner.

Governance and Risk: An Analytical Handbook for Investors, Managers, Directors, and Stakeholders by George S. Dallas (Editor)

This handbook presents the most comprehensive framework for corporate governance as a risk factor that I have ever seen. I have several books on my shelves that compare corporate governance systems in the US, UK, Japan, Germany and France but this one also includes Brazil, China, India, Korea, Russia and Turkey.

I also have plenty of handbooks for directors that describe various duties but Governance and Risk takes the most systematic approach. Each factor is accompanied by instruction, questions, as well as examples of strong and weak profiles.

The premise of rating analysis is that we can isolate and diagnose corporate governance factors that complement traditional credit and equity analysis. This book cites the usual studies, such as Corporate Governance and Equity Prices by Paul Gompers and Andrew Metrick, and a several I had missed, such as Disclosure Practices of Foreign Companies Interacting with U.S. Markets by Tarun Khanna, Krishna Palepu and Suraj Srinivasan.

The most unusual feature of the book is the large number of chapters that lay out the analytical framework used by Standard & Poor's Governance Services in its governance scoring and evaluation process for individual companies, starting with a thorough discussion of limitations. I was a little surprised to read this, assuming they would keep such information under lock and key.

The scoring methodology evaluates roughly 80 analytical factors. In contrast to a checkbox approach, weightings are not necessarily fixed. For example, share registration with an independent body may be relatively meaningless where common practice, such as in the U.S., but takes on greater weight in Russia, where companies serving as their own share registrars have been known to erase contentious shareholders from their books.

Go to Governance and Risk and use the “search inside” features. You'll see the Contents drills in to the micro level in chapters such as

Investors and other stakeholders will find the book a ready reference for factors to consider when investing, voting proxies, or looking up common practices by country. While I am sad to see S&P cease its governance services in the U.S., I am delighted they have left such an important legacy in Governance and Risk. I know that I will be referencing the book for many years to come.

America loves risk-taking CEOs, but when such behavior crosses over to boardrooms it could have massive consequences because of the growing scale of businesses and society's greater dependence on equity markets. Icarus in the Boardroom: The Fundamental Flaws in Corporate America and Where They Came From, by David Skeel draws on Greek mythology to present a candid warning aimed at corporate directors and anyone concerned with our economic future.

Trapped in a labyrinth of his on construction, Dedalus made wings for himself and his son Icarus. He warned Icarus not to fly to close to the sun but Icarus got carried away, failed to heed the warning, and plunged to his death after the sun melted the wax that held his wings together. Similarly, the corporation is a powerful human innovation, but is dangerous if not used properly.

But this book isn't about businesses being “socially responsible,” in the normal sense of health, peace, or global warming. Instead, Skeel is concerned with the impact that corporate failures can have on the economy as a whole. From that standpoint, Icarus in the Boardroom offers excellent advice on creating a sustainable business climate, getting to the source of problems instead of the symptoms.

He attributes several recessions and the Great Depressions to an ”Icarus Effect,” brought on by three factors:

The bulk of the book is devoted to a short history of the corporation followed by an excellent treatment of these three thematic factors and corporate failures though US history. He explains how government has responded to Icarus effects and how corporations have worked to first adapt, then often to circumvent or unravel government's attempt to save us from corporate excesses.

In general, “the lobbying might of corporate managers, and the power of their political contributions, is too great for even relatively minor reform to succeed,” he notes. However, the wake of financial scandals provides an opportunity to “change the political calculus.” We witnessed such changes after the 1929 crash when reforms like creating the Securities and Exchange Commission stopped short of federalizing corporate law.

More recently we enacted Sarbanes-Oxley to address the scandals of Enron, WorldCom and Tyco. Where did we stop short this time? Skeel advises that we partially addressed fraudulent risk but left the other Icarun factors largely untouched. Among Skeel's many recommendations:

“Ordinary Americans no longer see corporations as 'other,'” because more than half now own stock (directly or indirectly). As defined benefit plans dwindle and 401(k) participation increases, Americans have come to see their own stakes, however small, as tied to those of corporations. Skeel cites an important study by Dallas Federal Reserve Economists John Duca and Jason Saving that found “a direct correlation between stock ownership and the Republican vote in recent Congressional elections. As stock ownership goes up, so does the Republicans' share of the Congressional vote.” It's no wonder President Bush keeps pushing privatization of Social Security.

“The increasing identification between ordinary Americans and corporate America is perfectly understandable, but beneath it lurks a terrible irony: at the same time as our passion for real reform has declined, the risks have radically increased,” writes Skeel. In the past, investing in stocks was an activity largely limited to the rich who could afford to speculate. Now stocks have become the investment of choice for “life” savings and retirement.

With so many of us now dependent on corporate performance, let's hope it doesn't take another Great Depression before American's wake up to the need for reforms of the type outlined by David Skeel.

However, most of Skeel's recommendations will require national reforms. With the US Chamber of Commerce spending more than $53 million a year lobbying against such changes, what is an enlightened board member to do (other than terminating membership in the Chamber)? Try the following:

Bebchuk and Fried clearly demonstrated that many features of executive pay are better explained as a result of shear managerial power, rather than arm's-length bargaining by boards of directors. Their recommendations on improving executive compensation are aimed at eliminating or reducing some of the most egregious problems and are written to shareholders, since such reforms are not likely to be raised by "independent” directors, as independence is currently defined. One of their major points is that board members should not only be independent of CEOs, they should also be dependent on shareholders.

McConvill does not dispute that managerial power has led to the decoupling of pay from performance but he takes issue with Bebchuk and Fried's failure to clearly reject agency theory, which “derives from a narrow - and ultimately false - understanding of human motivation and behavior.” McConvill contends “the managerial power thesis assumes that only economic factors (based on agency theory) influence executives in their attitude towards remuneration…” He further writes that Bebchuk and Fried “suggest that managerial power provides a complete explanation” for the decoupling of pay and performance. (my emphasis)

Governance and Ownership, Robert Watson, editor (Edward Elgar, 2005). This is an excellent collection of 20 papers, most published in the late 1990s, enhances our understanding of the relationships between ownership corporate ownership governance. Issues investigated include:

Many of the findings are interesting and run counter to common assumptions in the field. For example, the La Porta et al. (1999) study found that contrary to Berle and Means, companies in most countries (the US included) have “controlling” (10%) shareholders (generally the State or families). Families control about 35% of the largest firms in the richest economies, compared to 24% held by the State. Monitoring and protection of minority shareholder rights take on new meaning.

Wahal (1996) examines pension fund activism in the US and finds, contrary to other studies, no evidence of long term performance improvements. Wahal concludes pension fund activism is no substitute for an active market for corporate control.

Holland (1998) examined fund managers in the UK and finds that institutional voice is typically highly constrained by relative powerlessness and a general unwillingness to interfere, especially during times of good corporate performance. Quasi insider knowledge was typically held “in reserve” until performance took a downturn. Are the costs of monitoring justified if they are only going to be used to accelerate sacking the CEO in times of financial crisis?

David et al. (1998) views the struggle between CEOs and owners over pay. They find that institutional owners that have only an investment relationship with the firm are able to influence CEO compensation, whereas those that also depend on the firm for business are not. (No surprise there, but considers factors not always taken into account by other studies.)

In general, this book has much to recommend it, especially to complacent investors and over-confident executives. Governance and Ownership provides a ready reference to studies that will continue to influence scholarship and practice over the next decade.

Pay Without Performance: The Unfulfilled Promise of Executive Compensation was the best book published in 2004 in the field of corporate governance. Lucian Bebchuk and Jesse Fried focus on one aspect of corporate governance, executive pay, and clearly demonstrate that many features of executive pay are better explained as a result of shear managerial power, rather than arm's-length bargaining by boards of directors.

After thoughtful analysis, they find “systematic use of compensation practices that obscure the amount and performance insensitivity of pay, and the showering of gratuitous benefits on departing executives.” The cost of current corporate governance systems is weak incentives to reduce managerial slack or increase shareholder value and “perverse incentives” for managers to “misreport results, suppress bad news, and choose projects and strategies that are less transparent.”

Their recommendations on improving executive compensation are clearly aimed at eliminating or reducing some of the most egregious of the practices of those they document. Interestingly, the recommendations are written to shareholders, apparently because there is little likelihood such reforms will be raised by even “independent” directors without further corporate governance reforms. A few examples are as follows:

Although many directors now own shares, their related financial incentives are still too weak to induce them to take on the unpleasant task of firmly negotiating with their CEOs. Recent reforms requiring a majority of independent directors, and their exclusive use on compensation and nominating committees, may be beneficial but “cannot be relied on” to produce the kind of arm's length relationship between directors and executives needed. CEOs retain influence over director compensation and rewards, as well as social and psychological rewards. “The key to reelection is remaining on the company's slate.” Remaining on good terms with the CEO and their director allies continues to be the best strategy for renominatation.

Executive compensation “requires case-specific knowledge and thus is best designed by informed decision makers.” They conclude, “While we should lessen directors' dependence on executives, we should also seek to increase directors' dependence on shareholders.” After discussing the now failed “open access” SEC proposal to grant shareholders the right to place a token number of candidates on the ballot after specified “triggering events,” the authors propose the following significant corporate governance reforms:

In their conclusion, the authors recognize the “political obstacles to the necessary legal reforms are substantial” and that “corporate management has long been a powerful interest group.” The demand for reforms must be greater than management's power to block them. “This can happen only if investors and policy makers recognize the substantial costs that current arrangement impose.” Pay without Performance will certainly contribute to such recognition. It should be required reading for every fund fiduciary, SEC board and staff, as well as all members of Congress. Shareholders should read while sitting down.

International Corporate Governance Review 2005. The 3rd edition of Corporate Governance Review brings together the thoughts of industry experts and regulators, making the review the essential reference tool. The Review focuses on major cross-border topics and developing global trends.

Contributors include practitioners from the OECD, EBRD, and the IFC. The review also features regional and country-by-country reviews and a detailed statistical appendix listing companies and countries and their standards of corporate governance. Also included is a fully updated directory listing essential business contacts.

Corporate Governance: Law, Theory, And Policy, Thomas W. Joo, editor (Carolina Academic Press 2004) This excellent reader on corporate governance presents a cross section of mostly academic perspectives on important current issues, including: the role of the corporation, balancing interests, state and federal law, shareholder litigation, criminal and regulatory law, shareholder voice, board composition, director duties in corporate takeovers, executive compensation, and corporate lawyers as gatekeepers.

Many of the articles are modern classics by authors well know to readers of CorpGov.Net, such as Margaret Blair and Lynn Stout, Marleen O'Connor, Stephen Bainbridge, Edward Rock, Roberta Romano, John Coffee, Mark Roe, Barnard Black, Charles Elson, Lucian Bebchuk, Martin Lipton, and Lawrence Mitchell, as well as significant contributions by the editor, Thomas Joo. Each chapter includes questions for classroom discussion or self-directed study.

Joo himself voices some rather revolutionary opinions. For example, in his 2001 essay, “The Modern Corporation and Campaign Finance,” he rejects the current legal model, which legitimizes wealth maximization but refuses to recognize other motives. ”The law should communicate society's disapproval of the mercenary view by rejecting the presumption that shareholders always value wealth above their political preferences.”

Although his conclusion doesn't appear, at that time, to support greater participation by shareholders, he did advocate limiting corporate participation in politics. “Law and markets have created organizations that favors the efficient over the expressive and, thus, have created organizations that deserve less First Amendment protection than individuals do.”

However, by the year 2003, Joo appears to be ready for greater shareholder democracy, criticizing the SEC proposed access rule as “too limited to have much impact. If the SEC is serious about empowering shareholders, the Division should reverse its interpretation that boards may exclude shareholder proposals with respect to voting procedures that 'may result in contested elections of directors.'”

The Recurrent Crisis in Corporate Governance pushes the edge of mainstream thought in this growing discipline. Authors Paul W. MacAvoy and Ira M. Millstein, giants in the field, have well deserved reputations as practitioners and scholars. This thin volume will quickly guide the course for progressive board members concerned with building solid companies, rather than future Enrons.

Although MacAvoy and Millstein stop short of urging direct nomination of directors by shareholders, the author’s do recognize the real benefit of boards being truly independent from the CEO. “The independent and professional board is the ‘grain in the balance’ of survival in the long run.”

Directors who are unwilling to grow should look elsewhere. “Directors on the verge of quitting because of increasing responsibility and liability are not the ‘productive’ directors and, by leaving, imply an average increase in the quality of boards.” This book is for those who choose to stay and focus on what the author’s consider the real target, maximizing the generation of wealth and the return of profit to investors.

The recurrent crisis referenced in the title is primarily the “incapacity to deliver in practice on heightened expectations for governance. There is a void of capability (on corporate boards) which, if not filled will culminate again in misleading and inadequate reported financial results and large managerial extractions of wealth from failing companies.”

In a few brief chapters, the authors review recurrent themes during the last thirty years, from failure of the Penn Central Railroad to the decision by the General Motors board to publish governance guidelines after discharging its CEO, an act once widely acclaimed as a virtual Magna Carta for directors. They also discuss significant initiatives by public pension funds and court decisions that have affirmed the responsibility of directors to review and approve long-term goals and strategies. Yet, even with significant reforms, systemic flaws remain that will result in a continuing cycle of crisis and reform. However, the frequency and severity of such cycles can be significantly reduced through recommendation actions.

Their central theme is the need for independent directors, not just as defined by recent exchange reforms, but real independence, citing for example, studies like that of Shivdasani and Yermack who found that CEO involvement in the selection of directors negatively affected the quality and independence of nominees. P.33 Of course, one of the most significant studies in this area is one which MacAvoy and Millstein published in 1997. Examining data from 154 US companies, they found a positive correlation between active/independent boards and Economic Value Added.

Consistent with those findings, we cannot expect a CEO who is also chairman of the board to prepare the board to adequately evaluate their own lapses or those of senior staff. Therefore, the first and most important reform recommended by the authors is to end that dual role. “Ideally, the board’s chairman should be an independent director.”

The least painful time to make this transition is upon succession, which now often occurs every few years. Because a “lead” director is “still just another director subject to the influence if not dominance of the singular CEO/chairman, we have no confidence in that role as more than a temporary step on the road to separation.”

Other recommendations for boards from the book include the need to:

“The board cannot function without leadership separate from the management it is supposed to monitor.” It has the legal responsibility to do so. “Now it must be empowered with the opportunity to fulfill this responsibility.”

MacAvoy and Millstein end with the following: “Perhaps with these reforms, the recurring crises in governance will take place with less frequency and intensity.” Without these actions, shareholders, and maybe even the great unwashed masses, will be storming the corporate gates demanding much more in the way of a shift in power. The SEC’s latest proposal to allow up to three shareholder nominees could be just the beginning.

Directors should be shaking in their boots. From the January 19, 2004 BusinessWeek – “Lucent Technologies is asking shareholders to scrap its staggered board elections, a takeover defense despised by governance gurus. Allstate ditched its poison-pill takeover defense, citing ‘shareholder sentiment.’ And Alcoa is putting ‘golden parachute’ payments to a shareholder vote. In each case, the action followed a majority shareholder vote at the last annual meeting. Says Patrick McGurn, special counsel at proxy adviser Institutional Shareholder Services: ‘The only way you can explain the difference in behavior is the threat that proxy access may be available.’”

The board that MacAvoy and Millstein envision may be independent from the CEO, but it still is not directly accountable to shareholders. Although not my ideal, it would be a significant step in the right direction for most corporations and might just head off further reforms radical democrats like me have been calling for.