Corporate Governance: Online Book Reviews

Renton Nick nrenton@bigpond.net.au, Company Directors: Masters or Servants? Wrightbooks Pty Ltd., Victoria, Australia, 1994, Telephone (03) 596 4262. The cover note promises "objectivity." Perhaps it is but I was a little frustrated with the fact that Mr. Renton's good advise is not supported with a single footnote. For example, Renton recommends that a company's cash which is surplus "to the immediate needs of its traditional activities" should be returned to shareholders.

He argues that such issues are ethical rather than economic. If an investor buys shares in a bank she does not expect it to be put at risk drilling for oil. If an environmentalist buys shares in a clean company he does not want it to diversify into something polluting the environment. For Renton, the immorality of such changes in direction without shareholder consent is not affected by the financial outcome. However, much as I may share Renton's high moral standards, many readers would be more convinced by research.

For example, in "Agency Costs of Free Cash Flow, Corporate Finance and Takeovers," (American Economic Review,1986, vol. 76, 323-29) Michael Jensen provides an example from the oil industry where in the mid-1980s integrated oil producers spent $20 per barrel to explore for new oil reserves rather than return profits to shareholders or buy proven reserves selling in the marketplace for $6 per barrel. Jensen finds the worst agency problems in firms with poor investment opportunities and excess cash. There are many other studies showing the adverse effects of diversification on company valuation (see, for example, "Corporate Focus and Economic Returns," Journal of Financial Economics,1995, vol. 37, 67-87, by Robert Comment and Gregg Jarrell).

Regardless of the lack of citations or case examples, Renton provides an excellent checklist, often accompanied by good advise, on a litany of director concerns from the conduct of shareholder meetings and performance measurement to share distribution issues, litigation, and corporate takeovers. The book is geared to Australia, so tax and other legal provisions will be different in other countries. For example, shareholder lists in Australia are not only available to other shareholders but to the general public as well.

Renton's coverage of election systems is typical. He provides a relatively balanced portrait of several options, including typical approaches, as well as proportional representation, and cumulative voting. Whether Mr. Renton's advise is taken or not, his book is sure to help many readers more fully consider the obligations of directors and the various possibilities in meeting them.

Scott Rodrick

Rodrick, Scott and Corey Rosen Employee Stock Ownership Plans: A Practical Guide to ESOPs and Other Borad Ownership Programs Harcourt Professional Publishing, 1999. Buy it through our affiliation with Amazon.com.

Want to own your job, decrease your business taxes or increase employee productivity? Here's the definitive guide. Employee stock ownership plans (ESOPS) have grown to include 9 million participants controlling $400 billion worth of stock in 11,000 US firms.

Employee Stock Ownership Plans, 2000 edition, provides essential information on the tax benefits of ESOPS. For example, once the plan owns 30% or more of the stock, the selling owner can defer capital gains tax on the sale by reinvesting in domestic securities. No tax is due until these securities are sold. If they go into an estate, capital gains taxes need not be paid.

This definitive guide covers voting of shares…such as when voting rights are passed through, how unallocated shares are voted and how ESOPS can be used as an effective defense against takeovers. Eighteen chapters, each written by an expert in the field, cover valuation, employee buyouts, accounting rules, administration, the duty of trustees, rights of participants, benefit distribution rules, and repurchase obligation issues. In addition to ESOPs, the book includes chapters on stock options, 401(k) plans and profit sharing alternatives. A companion CD-ROM features relevant forms, cases, regulations and statutes.

Studies have long demonstrated that companies with participative ownership plans can expect 6-11% higher growth rates. Why shouldn't your firm be among them?

Susan Shultz

Shultz also includes a discussion of director liability and future board trends. Appendices contain additional resources:

Shultz interviewed an impressive list of academics, attorneys, CEOs, consultants, directors, institutional investors, and others for background material. This allows her to pepper her book with real life examples and compelling stories. The Board Book can help boards avoid common pitfalls and investors act like owners instead of speculators.

Bob Tricker

Tricker, R.I. (Bob), Pocket Director, The Economist Books, 1998. As the editor of Corporate Governance, the internet site, I frequently get requests from new directors who are looking for a practical guide to help them meet the most challenging task in the modern corporate world, how to improve their effectiveness and that of their board. What single book will explain their duties, describe needed core competencies, evaluation practices and inform them of fundamental debates in corporate governance? The Pocket Director not only deals with these issues, it also includes an A-Z dictionary of the field's most important ideas and concepts, a list of best practices, proforma charters, sources of information and recommendation for further reading.

The most amazing feature of the Pocket Director is its universal relevance for directors in every situation, from nonprofits and family firms to public corporations in locations as varied as Afghanistan, Zimbabwe and the United States. As the editor of Corporate Governance - An International Review, Bob Tricker is uniquely qualified to provide examples common to most directors but explained in terms specific to the cultural circumstances of individual countries. Frankly, I wouldn't have thought it possible, especially in a slim volume not much larger than a checkbook. The Pocket Director should be the first book in any corporate governance library. Buy it now at a discount!

Michael Useem

Managerial capitalism ascended during the century's middle decades. "The decisions they made often affected the lives of thousands of people, yet they were seemingly accountable to no one." However, the new rules of investor capitalism are now beginning to prevail. The large holdings of institutional investors and the growth of indexing as a major investment strategy have prevented the ready selling of under-performing companies; investors are now more likely to "speak out than to cash out." Whereas managerial capitalism tolerated a host of company objectives, Useem argues that under investor capitalism enhancing shareholder value has become paramount.

According to Useem, the struggle for corporate control is no longer "just another squabble among the rich and powerful," since most Americans now "derive a substantial fraction of their current or future livelihood from the performance of companies whose stock they directly or indirectly own through pension funds and mutual funds." Critical to the book's many informative insights are a series of interviews the author conducted between 1991 and 1995 with a wide array of corporate and investor executives. The result, is a rare behind the scenes look at how "investor capitalism" is reshaping the corporation.

The dismissals of top executives at GM, Digital, IBM, Kodak, Kmart, and others were only the "most visible edge of a more widespread development." "Shareholders can replace directors, directors can replace managers, and managers in turn can replace shareholders." Each party is now on a more equal footing. Institutional investors put out their Focus List but corporations now use investor relations staff to hold "shareholder mix" campaigns. Such campaigns usually seek to increase the holdings of employees, whose livelihood is often tied to incumbent management, and individual investors with modest holdings who are not in a position to pressure the firm. Some industries are better suited for such campaigns; investor clubs, for example, love the stock of prominent consumer companies. Less visible corporations have a more difficult time changing owners.

Yet, for all the changes increasing the voice of institutional investors, only 6% of 375 major firms surveyed in 1992 received a single director nomination from an institutional investor. Another study cited by Useem shows that "directors' careers bear little or no relationship to their performance on behalf of shareholders."

The book contains a wealth of information and behind the scenes examples of how corporations comply with the principle of equality before the law, with regard to communications with analysts, but still manage to treat some analysts more equal than others. Useem's description of an executive's frustration with pension fund managers in comparison with mutual fund managers is particularly interesting. "Mutual fund managers pay more attention to strategic directions, product performance, and prospective risks. Strong pension managers, by contrast, seem more preoccupied with the formalities of governance." For the CEO the "challenging--and useful--questions lay in product strategy rather than broad policy." This guided how he allocated his time. However, with the average mutual fund turning over their stock every 6 months, instead of once every 7.5 years for the average public pension fund, I have to wonder if the vision of this and similar CEOs might be just a little short sighted, especially given the importance that "corporate governance" issues may play as money moves more widely abroad.

Useem points to the recent dramatic increases in the global market. Capitalization of the Hong Hong Kong market, for example, went from $74 billion in 1988 to $385 billion in 1993. Prior to 1990, 20% or less of new equity investments went to foreign stocks; by the beginning of 1994 that was up to 40%. These investments have displaced the investments of the World Bank, national governments and private creditors as the largest source of external financing. Useem notes "the days of divergent governance systems presiding over convergent governance forms are numbered." The Financial Accounting Standards Board is working with international counterparts such as the International Accounting Standards Committee (IASC) and bodies such as the International Organization of Securities Commissions are harmonizing securities standards. The Department of Labor requires pension fund managers to cast informed proxy votes with the same diligence as in the U.S. (see Interpretive Bulletin 94-2...temporarlly unavailable) CalPERS has announced a program to expand international holdings from 13% to 20% of its assets. Convergence is a major theme in Useem's brief picture of future developments.

The convergence theme is also carried over when Useem brings the split between corporate and money managers down to the personal level. Company executives see each other at the Business Roundtable, Committee for Economic Development and Bohemian Grove. "They frequent the same clubs, sometimes the same schools, occasionally the same islands." Those presiding over public pension funds and investment companies, however, remain remote from the "higher reaches of traditional business community." Their networks instead lead to such professional circuits as the New York Society of Securities Analysts and the Association for Investment Management and Research. For Useem the M.B.A., as the "credential of choice for movement into top management at both large firms and large investors," will result in "two years of shared training...each of the two sides will have a lingering appreciation for the concerns and challenges of the other."

I agree with Useem, it is important that "investors come to know a company not simply through the market exchange of its shares and careful reading of its quarterly reports. They also come to know by meeting its management." This would certainly be an advance over takeover threats and proxy battles which have characterized the recent past. The strength of Investor Capitalism lies in its vivid descriptions of personal communications derived from dozens of interviews and Useem's unique ability to draw on a large number of surveys from other reputable sources. While personal relations will be critical to building the next stage of development, it is also important to examine the process constraints within the current system which shape our everyday behavior.

For example, open-ended mutual funds have liquidity problems which discourage "ownership" and long-term holding. Section 16(b) of the Securities Exchange Act of 1934 requires shareholders with 10% or more of a stock to return short-swing profits, even if the trading was done without inside information. Most pension funds exist in a culture of "blame avoidance" built around the legal concept of "prudence." Although portfolio theorists generally agree that 99% of the risk management value of diversification can be achieved with a portfolio of only 100 stocks, pension plans continue to over diversify. Congress and/or the Securities and Exchange Commission could provide mechanisms for hybrid "relational" type mutual funds by allowing funds to require some notification prior to withdrawal and by adjusting 16(b) requirements. Congress and/or the Department of Labor could clarify that prudence, under ERISA, is to be evaluated on a portfolio-wide, rather than individual investment basis. The mutual cooperation between long-term owners and corporate executives which Useem envisions appears unlikely to be fully realized, regardless of the benefits of shared educational experiences, unless such structural reforms are made.

Useem notes that "when U.S. company executives describe the relations they have established with investors, few cite other company experiences and none allude to non-U.S. models." He concludes that "companies have, of necessity, invented their own solutions to the problems of managing a far more concentrated yet still remarkably diverse ownership base." The increasing use of books such as Michael Useem's Investor Capitalism, Monks and Minow's Watching the Watchers, Mark Roe's Strong Managers, Weak Owners, and Margaret Blair's Ownership and Control in MBA programs should go a long way, both in reducing the need of company executives to continually reinvent emerging solutions to problems in the area of corporate governance and in furthering their dialogue with shareholders.

Ralph D. Ward

Ralph Ward grabs the reader from page one with a Barbarians at the Gate style tale of the board revolution at General Motors. For the first six chapters I kept wondering if I could somehow buy into the movie rights. By chapter 7, however, he is shifting gears into a history of boards of directors and their function. The likelihood of a movie faded but the book never looses its lively pace through 60 informative chapters with headings like "How to Launch a Board Revolt," "Q: Why is Board Education like Sex Education," and "Take Me to Your Lead Director."

Ward tells the familiar tale, chronicled by Berle and Means and updated by Mark Roe, of how owners were usurped by managers. The recent era of corporate raiders and rubber stamp boards is fading into history as shareholders and their board representatives gain an equal footing with CEOs. Ward draws on his years of experience as editor of The Corporate Board to inform the reader of current trends and to speculate on the future.

For example, Ward tells us that new boards are looking for skills in telecommunications and technology, marketing, international markets, finance, restructuring, entrepreneurial skills, and service industries, as well as for demographic diversity. Ward devotes several chapters to describing the work of audit, compensation, and nominating committees. He also looks examines emerging committees in corporate governance and compliance as well as more specialized committees. He sees the likelihood that small board secretariats will strengthen the board's hand in working with management by helping them dig through the data.

Looking at the chair/CEO controversy, Ward concludes that in most cases the independent outside chair "would not have enough muscle yet to make a difference." "This does not mean we should give up on the idea of a separate chair, but rather that supporters may have been too early with the idea for it yet to be effective." Ward sees lead directors as a "fallback" position that is likely to take hold sooner but on a less formal basis.

Most readers will find that Ward takes a balanced and reasoned approach to SEC regulations, director liability, stakeholder influence, and the dozens of other issues which he covers in brief but informative discussions. Perhaps most controversial is his contention is that we may soon be seriously considering proposals for federal the chartering of corporations. Ward breezes through past proposals by James Madison, William Jennings Bryan, T. Roosevelt, Wilson, Taft, William O. Douglas, Ralph Nader, and more recent efforts. He points out that "the very Congress that gained power in 1994 by proclaiming a return of power to the states passed the Private Securities Litigation and Reform Act of 1995" which preempts state powers in shareholder suits and adds federal disclosure requirements.

Ward argues that several federal laws have defused the radical call for federal chartering while bringing us closer to a de facto federal system. "While federal chartering waves of the past century were stirred by politicians, jurists, and consumer advocates, a renewed effort would likely be led by shareholders." "If federal corporate certification could supersede state lawsuits, coordinate often contradictory federal regulations, and set clear standards for board behavior, it might well draw new fans from the business sector." I find his arguements compelling. If shareholders and businesses united around such a proposal now, we might avoid populist based demands, with confusing stakeholder provisions for constituent based boards, which are likely to resurface in an economic downturn.

New from Ralph Ward,

Improving Corporate Boards : The Boardroom Insider Guidebook
One of the most frequent requests from readers of CorpGov.Net is for a book on how to improve their board. Finally I can recommend a book that doesn't read like a dry academic text and is built on real life examples. Ward presents a clear guide to solving the most common problems facing boards. Each chapter provides a concise overview of a problem or focus area, several real life examples, internet resources, advice from various experts and a checklist summary. CalPERS should consider sending Mr. Ward's book to each board member of the companies on its focus list.

N. E. Renton

Scott Rodrick

Susan Shultz

Bob Tricker

Michael Useem

Ralph D. Ward