2002 Proxy Season Preview and Briefing
IRRC will provide an overview and detailed information on corporate governance and social responsibility issues facing corporations and their shareholders in the United States and abroad during the 2002 proxy season. A number of new shareholder initiatives are in the works for 2002, promising a particularly interesting year, and making this session a must see event. San Francisco 2/26, New York 3/1. Registration is free, but space is limited.
E-mail from Phil Goldstein on Preventing Future Enrons
Everyone and his brother has proposed changes to prevent future Enrons. My suggestion is more modest but should be more easily implemented. It is designed only to prevent the outrageous scenario we have witnessed of an auditor destroying documents or claiming a Fifth Amendment privilege or lawyer-client privilege during an investigation of fraud. I propose that every accounting firm unilaterally require its employees as a condition of employment to agree to cooperate in and not to frustrate any legitimate fraud investigation of a client and, in that connection, to waive his Fifth Amendment right and any lawyer-client privilege. I would expect the Big Five will reflexively oppose it but I wonder on what pretext? That they can’t get enough qualified accountants to agree in advance to cooperate in fraud investigations? The simple fact is that any accountant who will not cooperate in a fraud investigation is, by definition, not qualified.
In any event, even if the Big Five try to bury this proposal, it can go forward in other ways. Here’s how.
Corporations themselves can require a cooperation provision to be included in any auditor engagement agreement. So, even if no Big Five firm will break ranks, some lower tier firms looking for work will agree. Eventually (probably pretty soon) economic reality will set in as multi-million dollar engagements start going to firms that will agree to a cooperation provision. Of course, I don’t expect many large corporations will be willing to take the lead on this either. So what then? A populist approach could get the ball rolling. Binding or non-binding stockholder proposals can be submitted by the good governance types like Calpers or small stockholders to require that the auditor agree not to frustrate any investigation into fraud at the company. (I would love to see an opposition statement explaining why that is a bad idea, e.g, “This is a matter that should be left to the discretion of the co-conspirators in the fraud, uh the board.”) Hell, if these proposals don’t pass, then forget the whole thing. Stockholders are just too dumb to look out for themselves.
Also, while I am concerned with excessive regulation, I suggest that the SEC’s Division of Investment Management propose a rule that a cooperation clause be part of any auditor engagement agreement with a registered investment company. Since the ICA already contains lots of requirements that are supposed to protect small investors, this would seem to be a very small but sound additional protection against fraud. I don’t see PWC, for example, willing to give up its dominant market position in the mutual fund industry by balking at this. Once the mutual fund industry demonstrated that qualified auditors can be found who will agree to waive their constitutional rights in return for getting or keeping work (surprise, surprise), all resistance will quickly disappear.
No matter what is said in opposition to this proposal, it will come out as the self-serving nonsense that it surely will be, i.e., management, directors and auditors looking to save their own skins by frustrating legitimate efforts to investigate fraud. And, by the way, after this proposal is implemented, it would be a good idea to extend it to every employee of every public corporation in the United States.
S&P Rates Hong Kong Below China on Corporate Governance Practices
Based in large part on poor ownership structures due to the high number of family dominated firms, Hong Kong trails the mainland China, according to a new Standard & Poor’s survey. Hong Kong firms averaged 6 out of 10, whereas China averaged 7. Singapore and Australia had the highest scores in the region, with Korea, Thailand, and Malaysia trailing behind Hong Kong and the Philippines, Indonesia, and Taiwan further down. (The Corporate Library,Newsbriefs)
Unions Boycott Enron Directors
The AFL-CIO is urging companies to not renominate Enron directors for election to their respective corporate boards. “Directors who permitted the accounting deception that led to the collapse of a company worth over seventy billion dollars are not suited to serve on other boards,” said Richard Trumka, secretary-treasurer of the AFL-CIO. “Enron’s directors need to be held accountable for their record.”
- They waived conflict-of-interest rules to let Enron executives participate in related-party transactions that led to a $1.2 billion reduction in shareholder equity.
- They failed to question Enron’s use of off-balance-sheet entities to remove debt and losses from Enron’s financial statements.
- They approved Enron’s annual report to shareholders without ensuring Enron’s financial statement disclosure was straightforward and comprehensible. (see Look for the Union Label at CFO.com)
Corruption – a Stumbling Block in Good Governance
In a stirring address to 400 industry leaders and policy makers from 20 countries attending the recently concluded 2nd International Conference on Corporate Governance in Mumbai’s Taj Hotel, Dr P C Alexander, Governor of Maharashtra stated that “corruption in India was the biggest stumbling block to good governance.” Quoting Mehbubul Haque, the distinguished economist, Dr Alexander stated “corruption in India is not down stream but upstream; it travels on wings to bank accounts in Switzerland; it promotes instead of imprisons the corrupts and perpetuates poverty. It is the greatest sin against humanity and calls for a crusade by everyone.”
The theme of the conference was “Corporate Governance – Turning Rhetoric into Reality.” The conference was addressed by Mr N Vittal, Central Vigilance Commissioner, Justice M N Venkatchaliah, Chairman, Constitution Review Committee, Mr P Chidambaram, Former Finance Minister and eminent legal luminaries such as Mr Kapil Sibal, Mr K K Venugopal and Dr A M Singhvi.
Dr Madhav Mehra, President of the World Council for Corporate Governance, in his theme address stated that “the role of Corporate Governance has never been more vital. Transparency, accountability, integrity, equity and responsibility in the governance of corporation can have a transformational effect on our entire economic and social performance. Yet high profile corporate failures are not only taking place in India but also in the west such as Enron, Marconi and Swissair. It is time, therefore, that we reflect why 7 years after the Cadbury Report there continues an enormous cleavage between the rhetoric of corporate governance and reality.”
Dr Mehra continued, “Corporate Governance goes way beyond disclosures and compliance. It is concerned with empowering people, spurring and pursuing innovation and improving efficiency. It addresses conflicts of interest, which can impose burdens on the enterprise and ensures transparency and probity in corporate affairs to improve business standards and public accountability.” He asserted that “the impact of corruption and corporate and public mis-governance is alienating the civil society and is a ticking time bomb. It has widened the gap between rich and poor and created a crisis of confidence which has severely jeopardized our ability to attract investment, both domestic and foreign.”
“The most effective bulwark against fanatic terrorism is the building of a strong middle class o f entrepreneurs, investors and shareholders. This cannot come about without linking corporate governance with good public governance.” Dr Mehra called upon the US to prioritise the expenditure of billions of dollars earmarked for the war on terrorism and allocate resources to proactively facilitate good public and corporate governance systems, that bring about transparency, legitimacy, accountability, equity, integrity and responsibility.
One of the most notable sessions was “Legal, legislative and regulatory framework on corporate governance” addressed by world’s foremost jurists including the two former Chief Justices of India, Justice Venkatachaliah and Justice Ahmadi, Dr A M Singhvi, former Finance Minister Mr P. Chidambaram, Mr Kapil Sibal and Mr K. K. Venugopal. All speakers agreed that what was required was not new codes but a resolve to punish those who are found guilty of violating the existing codes and thereby set example for others.
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Enron, CalPERS and Tax Dodgers
As someone who’s known for monitoring and trying to influence CalPERS activities for many years, I’ve been getting a lot of e-mail and telephone calls lately. Public employees in California are worried that Enron’s bankruptcy will mean a drop in our retirement. It has certainly impacted our mutual fund investments, which according the Sacramento Bee suffered losses approaching $800 per person.
The bulk of our funds at CalPERS are invested as a modified index. CalPERS buys a piece of just about every major company and rebalances its portfolio frequently to ensure stocks are held in the same relative proportions. The Los Angeles Times (11/30) indicates that CalPERS owned 3 million shares. At Enron’s peak, its shares traded for nearly $85, so CalPERS’ holdings in Enron were once valued as high $255 million but, presumably because they bought relatively early and held, CalPERS lost less than $50 million.
CalPERS also invested with Enron in two limited partnerships, known as JEDI I and JEDI II, a reference to “Star Wars” that stood for Joint Energy Development Investments. According to a recent article in the Sacramento Bee (CalPERS inadvertently linked to fall of Enron, 1/24) CalPERS reported a gain of $133 million on JEDI, earned $171.7 million on JEDI II, and still has its original investment of $175 million in the second partnership.
The Bee indicates that a decision by CalPERS to cash out of JEDI I in 1997 may have hastened Enron’s demise. “Rather than simply pay CalPERS off, Enron set in motion a convoluted debt plan to raise the money and used questionable accounting methods to keep the whole matter secret from shareholders. That enabled Enron to hide more than a half-billion dollars in debts. Last November, Enron acknowledged that these questionable practices had enabled it to overstate corporate profits by $396 million the previous four years – a disclosure that destroyed what was left of Enron’s weakened credibility, and probably sealed its doom.”
So California public employees can go back to worrying about growing old, gaining weight, the kids, the job, or whatever…our retirement funds at CalPERS are safe from the Enron debacle. That doesn’t mean there aren’t important lessons to be learned. At least eleven Congressional Committees are crawling all over Enron and their auditor, Arthur Andersen. Out of every crisis comes opportunity.
Few saw Enron’s bankruptcy coming but apparently the company did disclose deals with members of its board of directors in their proxy statement published earlier in 2001. The following were among the items that should have lead to questions:
- Enron director, John Urquhart was paid $493,914 for providing consulting services to Enron.
- Enron director, Lord John Wakeham, received $72,000 for advice on Enron’s European operations.
- Enron director Herbert Winokur was affiliated with the privately owned National Tank Co. that made sales to Enron worth $370,294.
- Enron paid $517,200 for travel services provided by a firm 50% of which was owned by Sharon Lay, sister of Enron chairman and chief executive Ken Lay. (see 10-K’s: A Good Read for the Curious Investor, New York Times, 1/20/02)
- More than two years ago in an interview with CFO.com, Andrew Fastow, Enron’s CFO boasted that he had helped keep almost $1 billion in debt off Enron’s balance sheet through the use of a complex and innovative arrangement. (see What Andy Knew)
Shareholders who just read the large print in Enron’s financial reports might have thought Enron paid hundreds of millions of dollars in corporate income taxes over the last five years. However, the footnotes revealed that no taxes were due. According to a report in the New York Times, Enron not only avoided paying income taxes in four of the last five years (they paid $17 million in 1997), using almost 900 subsidiaries in tax-haven countries and other techniques, it also collected $381 million in tax “refunds.” (Enron Avoided Income Taxes in 4 of 5 Years, 1/17/02)
And, of course, there’s the matter of Arthur Anderson. Enron paid Andersen millions in consulting fees and then employed them as auditors. When he was chairman of the SEC, that’s the type of conflict of interest which Arthur Levitt tried to ban. The current SEC chair, Harvey Pitt, seems less likely to move forward in this area, since he has a history of representing Arthur Anderson, each of the Big Five and fraud king Ivan Boesky. So far he has proposed that the largely self-policed accounting profession be overseen by a group dominated by outside experts. But the proposal would not ensure that auditors remained independent from their clients. Mr. Pitt could choose to get tough and break with his past but it would be like Nixon going to China.
Last year the SEC fined Arthur Anderson $7 million for approving the accounts of Waste Management, even though its accounting methods seemed designed to mislead investors, according to a recent article in The Economist. Arthur Anderson also had to pay $110 million to settle a lawsuit over auditing work at Sunbeam. The article indicates Anderson is not the only problematic accounting firm. (The twister hits, 1/17/2002)
One thing is clear; CalPERS should be taking a closer look at proxy statements and SEC filings for evidence of poor corporate governance practices. They’ve got plenty of company in other public employee funds, including Ohio Public Employees Retirement System ($68.8 million loss), New York State Common Retirement Fund ($58 million loss), State Retirement System of Illinois ($15 million loss), to name just a few.
The United Brotherhood of Carpenters union has filed 12 proposals calling on companies not to hire the same accounting firm to do both audit and consulting work. Among the companies targeted are Apple Computer, Bristol-Myers Squibb, Avon Products, Dominion Resources, Liz Claiborne and Manpower, according to the Investor Responsibility Research Center.
William Greider, author of “One World, Ready or Not,” is calling for the creation of public auditors, “hired by government, paid by insurance fees levied on industry and completely insulated from private interests or politics.” (Crime in the Suites, Sacramento Bee, 1/27/02). This would certainly reduce conflicts of interest, but I’m not sure the pendulum of public opinion has swung that far yet.
One of the more innovative approaches to ensure auditor independence was introduced last year at SONICblue by Mark Latham of the Corporate Monitoring Project. Latham’s proposal would let shareowners vote to select the auditor, not just ratify a firm selected by the board of directors. Competing to please shareowners rather than directors who often serve at the pleasure of management, would create “new pressure for higher standards and tougher audits,” according to Latham. (see also SocialFunds.com)
CalPERS should be supporting such proposals. However, I’ve got a more fundamental concern. Should CalPERS, whose members depend on taxpayers, be investing at all in companies flagrantly avoid paying taxes? Should CalPERS aim for the highest returns or should it also be considering the possibility that the very companies we’re investing in could be undermining our jobs, our communities and our way of life. William Crist, who heads CalPERS, was compared to Darth Vader by the Paris daily, Liberation, for allegedly squeezing corporate management for ever higher profits, regardless of the social hardship imposed on French citizens.
At the heart of President Bush’s agenda is mistrust of government. Shift a portion of Social Security to the stock market. Give tax breaks to corporations and the rich because their investments will end the recession. Maybe public attention on politically connected tax dodging document shredding executives will move Americans to finally push hard for campaign financing reform and competent government employees to keep us safe, not only from foreign terrorists, but also from our own home grown greed.
Enron is not an isolated case of impropriety. Before Global Crossing went from $60 to pennies a share, CEO Gary Winnick cashed out. After running Lucent into the ground, executives sold $12 million in shares back to the company and CEO Richard McGinn left with an $11.3 million severance package.
CalPERS’ Statement of Investment Policy for Global Proxy Voting Principles (March 21, 2001) says the System “has a duty to maximize the value of its investments, in order to avoid the increases in state and local government taxes that might otherwise be needed to pay the employer’s share of costs.” However, according to the Constitution, the Board’s “duty to its participants and their beneficiaries shall take precedence over any other duty.”
The courts have ruled that “any reasonable investment that provides direct benefits for the participants – even if it does not necessarily yield an adequate economic return – would be permissible.” (Social Responsibility in Investment Policy and the Prudent Man Rule, California Law Review: Vol. 68, 1980, p. 518) I doubt taking shareholders actions to encourage corporations to pay their taxes or even prohibiting investments in habitual tax evaders would reduce the System’s return. If it does, we’ll have even greater incentive to plug tax loopholes until companies that pay earn more than those that don’t.
In addition, favoring companies that pay their taxes could certainly be considered a “collateral benefit,” which wouldn’t violate the “exclusive purpose” requirements of pension fund trust laws. After all, if taxes don’t get paid, neither do public employees. I’ve been invited by the Asian Development Bank to speak at the Forum on Corporate Governance in Asiaduring their annual meeting in early May. I’d like to be able to tell them California public employees are willing to place limits on the short term “duty to maximize the value of its investments.” Should CalPERS be contributing to an atmosphere of tax evasion and other negative unintended consequences or should it be encouraging portfolio companies to take a long term sustainable approach? Perhaps the Board will address this issue at their offsite later this month.
High Corporate Governance Standards in Nairobi
Corporate Governance rules issued by Kenya’s Capital Markets Authority for the 51 firms that trade on the Nairobi Stock Exchange included the following standards:
- No person shall be a director of more than three publicly listed companies.
- Audit committees must include at least three non-executive board members who must be familiar with basic accounting principles and be “informed, vigilant and effective overseers of the financial reporting process and the company’s internal controls.”
- Directors will be proposed by a nominating committee, with a majority of non-executive directors.
- Independent non-executive directors should constitute at least one third of the board.
- Separation of CEO and chairman’s roles.
- Annual general meetings.
- Annual reports must disclose the level of compliance with corporate governance rules, and where they have not obeyed them, explain the steps being taken to ensure full compliance.
NACD Governance Survey Available
The 2001-2002 Public Company Governance Survey has been released by the National Association of Corporate Directors. It covers broad structure and practices of more than 5,000 US publicly traded companies and includes the views of hundreds of CEOs and outside directors. Want to know what the current benchmark practices and emerging trends are in corporate governance? Find out by getting the 5th survey. Also available from NACD is Board Leadership in Troubled Times. It may be too late for Enron but you can provide your directors and CEO with the tools they need to manage risk in an uncertain economic and social environment or in times of major crisis.
Also upcoming is NACD’s Annual Corporate Governance Conference, 4/28-4/30, in Washington, DC. “Adding Vision to Oversight” is the theme. Board performance is very often measured on how well directors deal with a crisis and how well they manage the situation after the siege is underway. This year, we hear a new public criticism: Why didn’t the board anticipate a problem in the first place? Where was the board? Where was the planning? This year’s annual conference will provide forums to discuss board strategies – not just when a company is in trouble, but also preemptive practices for when trouble is on the way.
UK to Require Pay Disclosure
UK’s Labor government to require publicly traded companies to report what they pay board members. Shareholders won’t be setting the salaries for individual members but they will be able to cast a nonbinding vote on general remuneration policy and that’s a step forward. Currently, most companies disclose director pay but don’t offer shareholders the right to vote.
Labor to Rebuild Chinese Wall
The AFL-CIO shareowners resolution calls for Goldman Sachs Group to bar its analysts from participating in the sales efforts of underwriters, and to stop linking analysts’ pay to the performance of the investment-banking group. It also recommends that the securities firm prevent its analysts from owning stock in the companies it covers. (see Rank-and-File: AFL-CIO Goes After Goldman: Union Busts Wall Street)
Watson Wyatt Worldwide has found evidence that improvements in human-capital practices (which includes both compensation and traditional human-resources concerns such as employee recruiting and retention) can boost a company’s financial performance. The consultants claim the practices are a leading, rather than a lagging, indicator of financial performance. Former studies found that significant jumps in an index of human-capital improvements tend to lift shareholder value 20%.
The average corporate pension plan shrank more than 11% in 2001, requiring many plan sponsors to contribute to their funds for the first time since before the boom of the 1990s, says William M. Mercer.
USA Networks Opens Books
USA Networks disclosed its internal operating budget through 2003, division by division. “We think this is a better way of providing information,” says CFO Mike Sileck. “We let analysts see our budget, which by definition is our best indicator of future activity, and we stop wasting time and energy on the game.” That certainly puts them near the head of the disclosure pack, small as it is.
Roundtable on Shareholder Proposals
the Corporate Governance Advisor (Jan/Feb) published a “Roundtable on Shareholder Proposals.” Participants included the SEC’s Martin Dunn, Pat McGurn of ISS, Nell Minow of The Corporate Library, John Wilcox of Georgeson Shareholder Communications and Beth Young, a consultant for the AFL-CIO.
Minow expressed her opinion that it is “unfathomable” that companies go to the SEC without first contacting the proponent to understand their concerns. Two trends she sees is more interest in identifying companies doing business in countries that either support terrorism or have other national security issues and increasing use of message boards. She notes that while she was with Lens she got some of her best information from an employee in a company’s bookeeping office “who gave us all kinds of wonderful data.
Minow also mentioned her own work at The Corporate Library, which includes a list of all directors who own less that 100 shares, who have missed meetings and other information, such as all the CEO employment contracts of the top 2000 companies. She’d like to see more shareholders using their right to inspect records under section 220 of the Delaware Code. Looking at the minutes of the board meetings “we found that what they leave out, as well as what’s in there, can be very useful.”
Wilcox focused his advice on how corporations can prepare for the proxy season. “Get rid of all the red flags that are going to attract shareholder proposals.” Don’t wait until TIAA-CREF is knocking at your door to get rid of that dead hand poision pill. “There’s already enough case law showing that it’s probable not a good idea.” Secondly, analyze who your owners are. This will help your know if you’re likely to risk getting a majority vote and whether you’ll need to negotiate. Third, resolve up front where your firm stands on policy issues. Will you fight standard issues like poision pills, governance issues, and environmental reporting? Then, when you do get a proposal, do a vote projection and meet with the shareholder proponent. Get advice from legal counsel, assess your chances of getting a no-action letter from the SEC and get advice on a communication strategy.
Young agreed with the need to meet with proponents to find out what’s really behind their concerns. She also stressed how important it is to “have a person with the authority to commit the company to a particular course of action present at the meeting and able to commit the company.” Companies often “oppose any request by shareholders to either meet with independent directors or have independent directors involved in the shareholder proposal process and the settlement process. I think this is a huge mistake.” Independent directors can be crucial in facilitating a settlement.
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Asian Institute of Corporate Governance (AICG) to Host 2nd Asian Corporate Governance Conference May 16-17, 2002
Proposals for papers to be presented are solicited. The first page should contain the title; name of the author(s), complete address, telephone, fax numbers and E-mail addresses. If there are multiple authors, indicate which author will attend and which will present the paper. Also, indicate whether you would be willing to serve as a session chair and/or discussant. All submitted papers must be accompanied by an abstract of at least 250 words. Send all submissions via e-mail with a Word or PDF attachment to the local organizer: Sooyun Joo, Assistant Director, Asian Institute of Corporate Governance, College of Business Administration, Korea University.
Russian Regulator to Discuss Corporate Governance in New York on February 4th
The chairman of the Russian Federal Commission for the Securities Market, the Russian analog of the U.S. Securities and Exchange Commission, will offer a presentation on the state of the Russian stock market, which was the fastest-growing in the world in 2001, on Monday, February 4 in New York.
FCSM Chairman Igor Kostikov will release for the first time the completed national Code on Corporate Governance, detail the regulatory agency’s accomplishments to date, and outline the government’s capital market development plan for 2002. Detailed printed information on the Russian capital market and the new Code not previously released will be provided in press kits. A reception and opportunity to meet Mr. Kostikov will follow the presentation.
Mr. Kostikov will address journalists, financial analysts, and others at the Reuters 30th-floor auditorium at 3 Times Square (between 42nd and 43rd Streets) at 4:00 p.m. Contact Jonathan Murno of the Emerging Markets Traders Association at 212 908-5000 or [email protected] to register. Preregistration is necessary for admission.
Press and analyst interviews with Mr. Kostikov can be organized by contacting Emerging Markets Communications, LLC at 202 331-7751. Mr. Kostikov speaks fluent English and his biography can be found at the FCSM website. Mr. Kostikov will be in New York Feb. 1-4 to participate in the annual meeting of the World Economic Forum.
3.4 Degrees of Separation
“The Small World of the Corporate Elite” by Mina Yoo,Gerald F. Davis and Wayne E. Baker is a great paper for anyone interested in the interconnectedness of corporate boards. Look for a summary in the 11/2001 issue ofDirectorship or the 11/2001 issue of ISSueAlert. The full text will probably appear in an upcoming edition of the Administrative Science Quarterly.
The research paper demonstrates that the corporate elite in the US is a “small world,” in which the average distance between any two Fortune 1000 companies is 3.4 intermediaries and between any two Fortune 1000 board directors is 4.3. The “small-worldness” of the corporate elite is not the result of conspiratorial design but of the intrinsic properties of the networks themselves. These properties transcend individual directors and companies, sustaining a similar interlocking structure of networks over time despite major changes in corporate governance and organizational structure. For example The mean path length for boards was 3.4 in 1982, 3.5 in 1990 and 3.4 in 1999. For directors it was 4.2, 4.3 and 4.3 respectively.
Today’s “inner circle” of the corporate elite is disproportionately African-American and/or female, serving on several boards at the same time. Interestingly, “the size of the average distance increases roughly logarithmically with the size of the network, not linearly. Thus doubling the number of companies in the network increases the average path length only modestly.” Expanding from the Fortune 1000 to all 5,610 firms on the NASDAQ or NYSE lengthens the path only to 4.7. As more foreign corporations begin trading in US markets, a similarly tight global elite is likely to emerge.
After discussing the possibility that the American model of corporate governance might be adopted around the world,Lawrence E. Mitchell ends his book, Corporate Irresponsibility: America’s Newest Export, with the words, “backlash is likely to arise in cultures that prize community over the pursuit of individual wealth.” The events of September 11, 2001 have proven Professor Mitchell prophetic. Those looking to examine the roots of resentment against American-style capitalism would be hard pressed to find a more relevant critique.
“Corporate Irresponsibility” should be mandatory reading for pension and mutual fund fiduciaries, especially those considering investment abroad, as well as for anyone on the speaker’s tour at international corporate governance conferences. Before advocating universal standards based on an Anglo-American model of corporate governance, we need to consider what the unintended consequences might be.
The United Nations Development Program reported in 1999 that American economic and cultural dominance has accelerated the widening divide between rich and poor nations. Mitchell also cites a study by Richard Freeman and Joel Rogers, “almost two-thirds of the increase in American gross domestic product from 1979 to 1996 went to the top 5% of families,” making our level of income inequality “the most unequal in the developed world.”
At the center of Corporate Irresponsibility is Mitchell’s examination of the impact of putting a short-term rise in stock prices above all other corporate goals. The need to maximize short-term stock prices leads corporations to shift their costs to the general public and the environment. Plant closings, poorly trained alienated workers, unsafe products, underinvestment in research and development, an undermining of democratic institutions, and increased stock market volatility are just of few of the many sins identified.
The “simple lesson about deferring gratification, about foregoing short-term pleasures for long-term benefits,” which many of us try to drum into our teenage children has obviously been lost on money market managers as well. Profits are crucial but trying to maximize profits for shareholders on a quarterly basis is almost certainly a self-defeating strategy for the long term. In addition, although globalization is here to stay, the world will be a poorer place if corporations continue to undermine sovereignty and culture for the sake of extracting increased profits on behalf of those who hold capital.
According to Mitchell, American’s have become increasingly focused on liberties, our right to get what we can and keep it, instead of equality, which often imposes obligations. Our dominate corporate governance model gives artificial creatures (corporations) the rights of natural persons. Unfortunately, no corporation has the moral framework of a human being, which allows us to forego short-term pleasures (profits) for long term goals such as sustainability and a healthy environment.
Corporate law has consistently moved to “replace any sense of common purpose with a very individualized concept of competing legal rights and duties.” Its as if we developed our system thinking, “let the corporations maximize stockholder wealth,” we’ll use “other institutions to keep them in check.” Unfortunately, corporations have come to dominate those other institutions. Schools provide a monopoly to Pepsi or Coke for cafeteria sales. The political system appears to be for sale to the highest bidder, with campaign finance reform still a distant dream. One family was in the news recently for offering to sell their child’s naming rights for corporate advertising purposes. Our own creation has come to dominate our lives. Like Stanely Kubrick’s computer Hal, who does some terrible deeds, like killing off the spaceship’s crew in the movie 2001 a Space Odyssey, corporations are dedicated to their mission and have an instinct for self-preservation.
Mitchell doesn’t hold back his criticism of those traditionally concerned with socially responsible investing either:
- The Domini Social Equity Fund “held substantial portions of its portfolio in the convicted monopolist Microsoft (7.72 percent), Cisco (7.38 percent), and market-dominator Intel (6.15 percent), among others.”
- “Between 1995 and 2000 TIAA-CREF made only one shareholder proposal relating to social issues.” Although its Statement on Corporate Governance “professes a concern for nonstockholder constituencies, the Statement notes that these constituencies, unlike stockholders, who have only their vote, have the ability to protect their interests through contracting with the corporation.” Entities with vastly different resources often cannot protect themselves against giant corporations. That point negates TIAA-CREF’s expressed concern for social responsibility.
- CalPERS voting guidelines may give a nod to human rights abroad by setting forth an expectation that portfolio companies operating in countries where human rights abuses occur adhere to “maximum progressive practices” to eliminate such abuses but their guidelines also acknowledge CalPERS’ fiduciary obligation to maximize returns. “Like the TIAA-CREF Statement, the Guidelines spend most of their time setting out voting principles designed to keep portfolio corporations free and available for hostile takeovers and thus short-term price maximization.”
- Aided by the AFL-CIO’s Center for Working capital, labor pension funds have taken on the same focus on the short term as TIAA-CREF and CalPERS.
Mitchell offers several solutions:
- Eliminate stockholder voting and make boards self-perpetuating. One way to move investor focus to the long-term is to eliminate the central premise of mistrust…the system of watchers watching watchers watching watchers. Mistrust leads to untrustworthiness. Mitchell, for example, argues that “the major way compensation is kept in check is not by law — it’s by public disclosure and embarrassment.”
- Boards should stand for election every five years rather than every year, with a moratorium on hostile takeovers in the interim.
- Lengthen the time between financial reports. Instead of being required to file financial reports with the SEC every quarter, require them every 2 or 3 years or every 5 years. Companies could report more frequently if they wanted to. This would give managers more “freedom to let their long-term plans mature.”
- Place a tax on frequent trades so that more stockholders become shareowners. Mitchell quotes consultant Frederick Reicheld, “Many managers find it nearly impossible to pursue long-term, value-creating strategies without the support of loyal, knowledgeable investors.”
- “Change the accounting rules to treat employees as assets instead of liabilities.”
- “Disallow depreciation in corporations in which the ratio of highest-to-lowest paid employee exceeds a certain amount.”
- “Stock issued pursuant to executive option plans would be punitively taxed if the executive sold the stock in too short a period.”
Many of Mitchell’s recommendations hinge on restoring trust. He points out that 33% of the nonagricultural workforce were supervisory in 2000. “Excessive supervision creates a management style of discipline and culture of distrust that is destructive of the social fabric.” However, employees will typically work harder, share ideas and cooperate only if they trust management to share the gains.
Given the Enron/Aurther Anderson debacle, any serious move to eliminate shareholder voting or lengthen the period between board elections or financial reports appears unlikely. In fact, SEC chairman Harvey Pitt wants to move away from quarterly reports to real-time release of corporate results. This will increase the short-term focus. Trust for those at the top has crumbled and won’t be restored by giving them even greater flexibility. Mitchell points out that, if our economic system limits meaningful participation to those with capital, “then a significant proportion of the population is robbed of its ability to participate in economic life other than as consumers, which hardly seems like a role designed to foster human freedom and dignity.”However, many of us do have capital… tied up in out pension funds, our 401(k), and our IRAs. Typically, someone else is managing it for us.
I believe we will only begin to restore our freedom and dignity when we participate in directing that money, how it is used and how our shares are voted. Mitchell’s suggestions for a small tax on frequent trades and changing accounting rules to treat employees as assets, instead of liabilities, are a step in the right direction…much more so than requiring that less information to go to stockowners.
Kelly on NPR
Marjorie Kelly, author of The Divine Right of Capital: Dethroning the Corporate Aristocracy, will be interviewed by David Molpus, workplace correspondent for National Public Radio, for the All Things Considered show. The show will air Wednesday afternoon, 1/16/2002. They’ll be talking about why Enron represented a failure of corporate governance. Kelly’s experience as the editor of Business Ethics magazine and author of the Divine Right of Capital is sure to provide insights into Enron.
One of the primary concerns of her book is that secondary market stock transactions do little to enhance the value of the corporation. The current rights stockholders over corporations is not unlike that of former aristocracies over land and peasants. In reality, employees are the ones who increase the value of businesses and they should get the bulk of the profits.
Shareholder Action as a Social Change Tool
Responsible Wealth will hold a mini-conference combining education and action on February 18th. Conference participants will be introduced to using the shareholder resolution process as a tool for social change The conference will be held across the street from the Hartford Civic Center, the site of the Disney Annual Meeting.
The agenda will include:
- Information on the history of shareholder activism as a tool for social change and Responsible Wealth’s history of using shareholder resolutions to initiate discussion of executive pay issues.
- An opportunity to meet and share ideas with others interested in economic justice and corporate social responsibility.
- A time to hear stories from Responsible Wealth members who have been actively involved in shareholder activism.
- Small group discussions with options including: Reforming Corporate Governance Practices; How Much is Enough?; and Telling a Different Story about Wealth Creation.
- A discussion of how pay at the top relates to pay at the bottom. Sister Ruth Rosenbaum, economist and founder of the Center for Reflection, Education and Action (CREA) will talk about her work on sustainable living wages.
- Discussion of our plans for the Disney annual meeting on February 19.
The conference fee is $125 and includes lunch and dinner on February 18. For more information, contact Scott Klinger <[email protected]> or call 617-423-2148 ext. 20.
Canadians Want SRI
A poll conducted by Vector Research found that most Canadian shareholders believe corporations operating both nationally and internationally must take into account their responsibilities for human rights, the environment, their employees and local communities.
Business executives should expand their responsibilities to embrace a broader social ethic, according to 74% of those polled. Wealthy shareholders (59%) say they prefer pension funds with investments in socially responsible companies, instead of those that seek only the highest returns. The vast majority (75%) want the government to establish standards for social responsibility and oblige firms to report on how well they are meeting the standards. Canadian shareholders (81%) believe Canada should pursue an international agreement for enforceable corporate accountability standards.
A majority (54%) believe corporations and trade unions should be prohibited from donating to political parties and candidates. Copies of the complete poll results and are available at the Canadian Democracy and Corporate Accountability Commission, under the heading public opinion poll.
CalPERS Board Sued Again for Legal Violation
The California Association of Professional Scientists (CAPS) filed a lawsuit in Sacramento Superior Court challenging the December 19 decision by CallPERS to loan the Davis Administration $1.3 billion as part of its deficit reduction plan. CAPS alleges that CalPERS failed to give required legal notice of the action. CAPS seeks to have the CalPERS approval reversed and have the action properly noticed for a future CalPERS meeting. State law requires at least 10 days advance notice of proposed actions but CalPERS’ spokeswoman Pat Macht said the proposal was announced within the 48-hour time period required for “emergency” situations. “The state only came to us at the last minute, and made an offer that needed to be confirmed in time to prepare for their budget,” she said.
Under the plan, the Davis Administration would be allowed to delay retirement payments and then repay the amount with 8.25% interest, an amount that is higher than the state would have to pay if it borrowed on the open market. The money would be paid back when the governor’s election is over and presumably state revenues have recovered. In return, the state would provide additional inflation protection to state retirees. Historically, CAPS has placed greater emphasis on the need to improving the Miscellaneous retirement benefits by raising the pay formula for future retirees.
Lawsuits filed by CAPS and other groups against previous administrations have established the legal principle that uncompensated borrowing from CalPERS constitutes an illegal raid. In order to make a budget-balancing program involving CalPERS money legal, the Board must make a determination that it provides members a compensating benefit. Although the Board has previously claimed on several occasions that it is exempt from state law, they have not made that argument yet in this situation. The legal battle appears to hinge on what constitutes a legal emergency. Sacramento Superior Court Judge Gail D. Ohanesian will hear the case in the coming weeks. The suit is the second one filed against CalPERS recently for ignoring state statutes. In a successful suit last year, California state controller Kathleen Connell sued CalPERS for not following state guidelines regarding pay increases. That determination has been stayed pending the outcome of an appeal.
Governance Leader on Tour
Madhav Mehra, President – World Council for Corproate Governancea has been involved in a series of one day seminars organized at 4 metropolitan areas in India – Delhi, Kolkata, Bangalore and Mumbai, organized by the Centre for Corporate Governance in association with Institute of Directors, New Delhi, India. Mehra’s tour is a lead up to the 2nd International Conference on Corporate Governance. Western models of corporate governance, are mostly based on maximization of shareholder value. However, Mehra argues that employees, whose knowledge accounts for 70% of corporate assets, must be made part of any governance system. Governance must not focus merely on shareholders but must also consider customers and employees who commit their lives for the corporation.
“Traditionally speaking, the constitution of a company’s board of directors is confined to its shareholders. The aim here is to maximise their value,” said Dr. Mehra. In the current knowledge economy, however, such a policy could lead to a conflict of interest between stakeholders and employees. A modern corporation, therefore, must measure and monitor total wealth creation, including that of employees, suppliers and clients. Good governance should pre-suppose a long-term and sustained benefit to the society at large through collaborative efforts, rather than focusing on short-term gains of enhanced value to the shareholders and efficient management of entities. Indian Institute of Management Director, Rammohan Rao, said companies would have to take a long-term view and not be obsessed with quarterly results.
Proportion of Income from Ownership Rises
Back in the 1950’s, Louis Kelso predicted that the percentage of total income earned from labor would shrink in comparison with that derived from capital. The Economic Policy Institute reports that from 1973-1999 labor’s share dropped from 74.4% to 70.5% while income from capital grew from 14.5% to 20.3%. Apparently, these rates do not include increases from realized capital gains or potential capital gains from securities that have appreciated. If factored in, these gains would have further added to the shift to asset-based income. (Employee Ownership Report, 1-2/2002) Attend an NCEO workshop “Introduction to ESOPs.”
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