March 2002

Kennesaw Weighs in on Corporate Goverance Reforms

Enron, Global Crossing and other recent debacles have stirred a great deal of thinking in recent months. Kennesaw State University’s Corporate Governance Center released a set of17 principles “to advance the current dialogue and to promote investor, stakeholder, and financial statement user interests.” Dana R. Hermanson, Director of Research, notes “we believe that these principles should be at the heart of current efforts to reform corporate governance and financial reporting in the wake of the Enron disaster.” Paul D. Lapides, Director of the Corporate Governance Center indicates the principles are offered “to promote investor, stakeholder, and financial statement user interests.” Most of the recommendations are fairly standard fare for post-Enron reviews (directors should be independent, audit firms should perform no consulting for audit clients, etc.) but several are either long overdue reforms or are building cutting edge consensus:

  • The current GAAP financial reporting model is becoming increasingly less appropriate for US public companies. The industrial-age model currently used should be replaced or enhanced so that tangible and intangible resources, risks, and performance of information-age companies can be effectively and efficiently communicated to financial statement users. 
  • The roles of Board Chair and CEO should be separate.
  • Analysts should not be compensated based on their firms’ investment banking activities.
  • Corporate management should face strict criminal penalties in fraudulent financial reporting cases.  The Securities and Exchange Commission should be given the resources it needs to effectively combat financial statement fraud. 

The Center draws on a distinguished list of staff, fellows and advisors. Their major strengths in the area of accounting are getting a lot of attention as a result of Enron.

Corporate Boards Should Focus on Performance, Not Conformance

After the corporate governance revolution of the 1990s that led to a new era of accountability to shareholders, the Enron debacle has brought new attention to the role of corporate boards and governance. Board members increasingly realize the need to act more vigorously to hold managements accountable. They are more likely to actively probe areas such as conflicts of interest and compensation of top executives. At the same time, however, would-be reformers must guard against going too far and imposing rules that tie managements’ hands.

These were some key issues that Wharton professors and a former CEO of Campbell Soup discussed at a session on corporate governance in Philadelphia as part of the Wharton Fellows program.

Proxy Voting Is a Fiduciary Duty, Pitt Says

The head of the Securities and Exchange Commission, Harvey Pitt, has asserted that money managers should view their corporate proxy votes as a fiduciary duty in a private letter to a former affiliate of LENS. The letter was in response to a 1988 request for guidance. In the letter Pitt explained that “an investment adviser must exercise its responsibility to vote the shares of its clients in a manner that is consistent with the general antifraud provisions of the Advisers Act, as well as its fiduciary duties under federal and state law to act in the best interests of its clients.”

“We have asked every SEC chairman since 1988 about this” and delivered each a copy of the 1988 letter, recalled Nell Minow, a former Lens principal who now runs the Corporate Library. Investment managers “are going to have to justify every [proxy] vote they make,” Ms. Minow said. “The fact that management recommends it won’t be enough.” The move will certainly be used by activists to persuade mutual funds and others to vote in the best interests of fund holders. Let’s hope it has an impact similar to DOL’s Avon Letter of February 23, 1988. (WSJ, 3/21)

Reforms Needed Post-Enron

Joan Bavaria, President and CEO of Trillium Asset Management, founding Chair of CERESand co-founder the Social Investment Forum recently offered Ten Responses to the Enron Crisis for Socially Responsible Investors, summarized and annotated here as points 1-10. Appearing before the House Financial Services Committee Subcommittee on Capital Markets, Insurance, and Government Sponsored Enterprises, Peter Clapman, senior vice president and chief counsel for corporate governance of pension and financial services provider TIAA-CREF commented on five major areas in need of reform, summarized here as points 11-15. Since many more reforms are needed, I took the liberty of adding four of my own recommendations.

  1. Transparency. We need to continue to work for more transparency around all aspects of corporate operations. “Transparency” of the future will include more disclosure of such items as off-balance sheet debt and secret off-shore tax havens. A coalition known as the Corporate Sunshine Working Group is pushing the Securities and Exchange Commission to require greater disclosure from companies on their environmental liabilities. CERES and the GRI have made gigantic strides around the environment and other sustainability issues.
  2. The Audit. The integrity, independence and reputation of the audit must be restored. We must fight against the conflict of interest inherent when the auditor also serves as a business consultant.
    • Ed. note: One of the more innovative approaches to ensure auditor independence was introduced at Fleetwood Industries by Mark Latham of the Corporate Monitoring Project. Latham’s proposal would let shareowners vote to select the auditor, not just ratify a firm selected by the board of directors. Latham believes competing to please shareowners rather than directors who often serve at the pleasure of management, would create “new pressure for higher standards and tougher audits.”
  3. Off Balance Sheet Transactions. Socially responsible investors might consider careful scrutiny of the balance sheet as part of routine social analysis, looking for signs of off-balance sheet or hidden transactions. Responsible companies have nothing to hide.
  4. Campaign Finance Reform. Once campaign finance reform legislation has passed, socially responsible investors should begin to ask companies for information on their contributions, even if they are channeled to obscure non-profits in lieu of political parties or politicians.
  5. Boards of Directors. Boards should be closely monitored for independence, diversity, interlocking positions and conflicts of interest. Board compensation should not be so excessive as to discourage questions and dissonance in Board meetings. The CEO of a company should not also chair the Board of Directors.
  6. Executive Compensation. Top managing executives’ pay should not be so linked to the short-term valuation of shares and options to tempt managers to foreclose on the future of a company for the benefit of their short-term enrichment. Shareholders should continue to advocate more balanced compensation plans. According to United for a Fair Economy, after nearly two decades of real wage declines, workers’ pay rose 28% in the 1990s (before adjusting for inflation). Meanwhile, CEO pay has rose 443%.
    • Ed. note: An increasing abuse is the use of zero-cost collars to hedge their bets on stock options. As Charles M. Elson, director of the University of Delaware’s Center for Corporate Governance: “It’s like a baseball player betting on the other team. If the executive is collaring, shareholders should be aware of it.” Hedging undermines the purpose of performance-based pay, since it cuts the risk of ownership. Unlike an outright sale of stock, investors rarely learn of hedging transactions because they are reported to the SEC on Form 4, and are rarely filed electronically. They’re not included in other company filings, such as the proxy or 10-K reports. Most services that provide insider-trading data to investors fail to pick up such transactions.
  7. Ethics Policies. Internal ethics statements and policies should be scrutinized, disclosed and discussed at shareholder and Board meetings. Mere disclosure does not guarantee compliance. We can ask companies how they monitor internal compliance.
  8. Tax Policies. The SRI community should put its weight behind all efforts to increase the short-term capital gains tax or otherwise change the tax structure to encourage long term ownership of stock. The short-term focus of Wall Street causes honest corporate managers to eye Wall Street minute by minute when they should be looking out for the long-term welfare of their company.
    • Ed. note: I’d like to see the SRI community also taking shareholders actions to encourage corporations to pay their taxes or even screening out investments in habitual tax evaders. Enron not only avoided paying income taxes in four of the last five years (they paid $17 million in 1997), using almost 900 subsidiaries in tax-haven countries and other techniques, it also collected $381 million in tax “refunds.” They wiped out much, if not all, of their tax liability despite reporting nearly $2 billion in profits from 1996 through 2000. That’s not a good SRI record as far as I’m concerned. From 1995 to 2000, corporate earnings jumped by more than a third, but taxes rose by only about 17%. The tax code has become so riddled with loopholes that tax avoidance has become a profit center of its own. Reforms are desperately needed.
  9. Renewable Energy. Socially responsible investors should continue to advocate sustainable sources of energy. Distressingly left out of most of the public debate around Enron, energy issues sit at the heart of both this scandal and the terrorist acts of the fall. This country is dependent on external sources for what remains the essential plasma of our economy and life style. There has been a distressing step backwards away from support of alternative clean fuels.
  10. Sustainable Investments. The SRI community should advocate legislation that requires pension managers to ask companies in which they invest for long-term planning that addresses sustainability issues (environment, human rights, community interaction).
  11. Conflicts of Professionals. Too often accountants and lawyers ostensibly representing the company, in fact, wind up representing only its senior management such as at Enron. Professional organizations must do a better job through education and discipline to minimize these abuses.
  12. Regulation of Accounting Profession. An independent board should oversee the accounting profession with its own funding source and with the legal authority to enforce rules and impose sanctions for wrongdoing. TIAA-CREF also favors periodic rotation of a company’s auditors and not using the same firm for accounting and consulting services.
  13. Executive Compensation. Reforms are needed to require that the cost of stock options be reflected in financial statements and that shareholder approval for dilutive stock option plans be in place.
  14. Role of Stock Exchanges. The New York Stock Exchange and NASDAQ must be an important engine for change. The exchanges must impose stronger standards for director independence and education, shareholder approval for all material equity plans, and policies that seek out conflicts of interest.
  15. Education of Directors. Not all individuals are qualified to be directors in today’s complex market place simply because they are asked to serve. Audit Committee directors only recently had to meet a standard of financial literacy — literally the ability to understand a financial statement. Compensation committee directors often do not take a proactive role on behalf of the company because they lack an understanding of issues and do not hire independent consultants when needed. Stock options overuse and abuse stems from the inadequate performance of many compensation committees and the board as a whole.
  16. Options. Their costs need to be not only reported but expensed. If the estimated cost of options were taken as an expense against earnings in 2000, the net profits of Standard & Poor’s 500-stock index companies would have been 9% lower reported, according to Bear, Stearns & Co. Properly accounting for options is not easy but ignoring their costs is the wrong solution.
  17. Employees should get to elect the trustees for their 401(k)s and pension plans; its a simple matter of democracy and controlling your destiny.
  18. Voting. Broker voting should be eliminated. Currently, if shareholders don’t vote their proxies within 10 days of the annual meeting, their broker will vote for them…always in favor of management’s recommendations. Second, institutional voting must be in the investors interest. Since 1988 Department of Labor has held that voting rights must be voted in the interests of members and beneficiaries, not plan sponsors. That rule should be enforced and extended to mutual funds and other institutional investors. The rule should also require disclosure. How can we hold our pension and mutual fund fiduciaries accountable unless we know how they vote? Third, not really a reform but we need a third-party provider to consolidate the voting advice of CALPERS, Calvert, Citizens, Domini Social Investments, Meritas Mutual Funds, MMA Praxis, Pax World Fund and others who will surely follow.
  19. Board elections. The SEC prohibition against using the resolution process to nominate directors must go. The only way shareholders can run candidates is to pay for a solicitation, while the current management uses our funds to tout their candidates on the company proxy.

Poor Showing for India

Indian blue chips garnered poor ratings in a Standard & Poor’s survey of transparency and disclosure at 350 prominent Asian and Latin American companies. The survey awarded 10 possible points on a basis of 98 information attributes grouped into 3 categories: financial transparency and information disclosure; investor relations and ownership structure; and, board and management structure and processes. Nineteen out of the 43 Indian companies surveyed, including Hindustan Lever, Hindustan Petroleum, ITC, the State Bank of India, and Reliance Industries, received a score of 4. Six Indian firms, including Mahanagar Telephone Nigam Ltd., Reliance Capital, Sterlite Industries, Raymond and Silverline Technologies, each scored 3, while Cipla walked away with a paltry 2. Conversely, Infosys Technologies and SIS scored 7, a score which no other Indian corporations equaled. (The Corporate Library)

Shareowner Action Center updated for 2002 recently updated its online Shareowner Action Center with new information from the Investor Responsibility Research Center. The new IRRC Proxy Voting Checklistprovides summary information on all corporate social policy shareowner resolutions filed in the United States for the 2002 proxy season. Issues raised in these resolutions address energy and the environment, fair employment, global labor standards, executive pay, board diversity, and a host of other issues. The IRRC checklist includes the company name, annual meeting date, resolution subject, and sponsor (including resolutions withdrawn or omitted). To date, the IRRC Proxy Voting Checklist includes 271 resolutions filed with 177 US companies for 2002, by far the largest list available on the Internet without charge.

I only wish they had included resolutions on all issues. I’ve always believed that corporate governance defenses, which aim to further entrench management, should also be of interest to those concerned with social issues. If we spent more effort addressing the root of the problem, undemocratic corporate governance, we wouldn’t have so many symptoms to deal with.

The checklist in the Shareowner Action Center will be updated with voting results in early June. For more immediate information, contact IRRC.

Federal Class Action Suits Surged in 2001

Post-Reform Act settlements average almost $25 million, up from $8 million Pre Reform Act, and rise significantly if an accounting firm or underwriter is also a defendant.

The 327 federal securities class action litigation suits filed in 2001 represent a 60% increase over the number of filings in 2000, and the companies sued lost a total of more than $2 trillion in market capitalization during the class periods, a 157% increase from the market capitalization loss during the class periods for the 204 companies sued in 2000, according to the figures released by the Stanford Law School Securities Class Action Clearinghouse in cooperation with Cornerstone Research. The 327 cases do not include an additional 138 securities class actions filed in 2001 alleging fraud in the IPO underwriting process with no additional allegations. The IPO cases were analyzed separately.

Earnings Overstated by $130 Billion

US firms may have overstated their earnings by $130 billion, according to the London-based Centre for Economics and Business Research (CEBR), which believes that accounting practices are “less rigorous” in the US than they are “elsewhere.” “There is a systematic bias toward making profits look rosier than the underlying economics might suggest,” according to DEBR Director Mark Pragnell. Investor Relations Business (IRB) 3/11, carries an interesting commentary on the report and notes, “if the report’s claims about corporate overstatements are correct, the Dow Jones Industrial Average’s current range of 7,500 to 9,500 is some 2,000 points higher than they should be.” Pragnell attributes the source of the problem, in part, to the link between executive pay and performance.

Worried? You could sell your stock or resign from the board but you might do better by reading Zabihollah Rezaee’s timely book Financial Statement Fraud: Prevention and Detection. This will be especially helpful to boards of directors and audit committees so you’ll know when accounting practices are going over the line.

In 1999 the Committee of Sponsoring Organizations of the Treadway Commission (COSC) identified 300 public companies involved in alleged financial statement fraud. They found CEOs and CFOs linked in 83% of the cases. Most had been audited by one of the Big Five. Enron and a skeptical market call for more conservative reporting. Rezaee takes you through familiar cases such as Waste Management and Sunbeam but also goes to the cutting edge of electronic reporting using XBRL taxonomy, which enables online and real-time disclosure of financial information…thus, providing a tremendous aid in addressing the SEC’s Fair Disclosure regulation. Equal and simultaneous access, I hope that’s where we’re headed.

In the meantime, Mr. Rezaee reminds us to:

  • Employ senior execs who are knowledgeable about financial reporting.
  • Directors need to pay special attention to pressures caused by pay for performance incentives.
  • Develop and attitude of professional skepticism.
  • Pay close attention to integrity and reputation issues.
  • Monitor opportunities and motivations for management to override internal control structures (don’t waive your ethical code like the Enron board did).
  • Appoint knowledgeable, experience, and independent directors

Another good source for insights on the subject is Ralph Ward’s Boardroom Insider. Ralph reminds us that even “America’s gold standard of supermarket tabloid trash,” the National Enquirer, recently featured “Enron: Adultery, Greed, How they ripped off Americans!” Accounting fraud is right up there with two headed space monkeys. Of course, its also grabbing headlines at C-SPAN, CNN and CNBC. The latest issue gives the following advise on outside auditors

  • Is the outside audit firm performing any of the inside audit functions, and if so, how many? Enron has been slammed for farming out many of its internal audit tasks to outside auditor Arthur Andersen, but such contracting is not uncommon. In the future, though, such an arrangement, which pretty well lets auditors audit their own work, will be outside the pale.
  • Does the audit firm perform any other consulting work for the company? Ask your inside auditors about the various formulas used to calculate how much consulting work is too much, but be aware that the rules here are shifting overnight. Barbara Hackman Franklin, one of America’s most respected audit committee pros, reports that one of her boards had a rule that any consulting expenditure with the audit firm over $500,000 required board approval. Just 6 months ago this limit would be considered fairly strict, but at the audit committee’s February meeting the approval threshold was lowered – to zero.  Any expenditure now requires board pre-approval.
  • Major corporations have long had a revolving door between the outside auditor and inside staff positions, with audit partners easing directly into high-paying jobs with the company. While this offers nifty career options, it weakens auditor independence. More companies now head off temptation by banning the hiring of partners or managers of the audit firm who worked with company accounts. Usually this limitation is for a set period of time, typically 3 years.
  • Of course, coziness between the auditor and the company can be more inbred. Carol Zacharias, of CNA in New York, recalls the case of a company that engaged a Big 5 audit firm when it went public in 1971, and used the same auditor for the next 3 decades (also hiring its CFO and accounting chief from the same firm). The familiarity seems to have bred contempt, however – the company was socked with a multimillion dollar SEC fine a few years ago for overstating income. Moral of the story – term limits for auditors (anywhere from 3 to 7 years) may be a wave of the future.
  • Here’s one often overlooked conflict, says Zacharias. Does the outside audit firm’s own retirement plan hold stock in the company? This sounds like a whole barrel of conflicts, yet it is not uncommon, especially with some young venture firms (the ones who most need an independent eye on their accounts).

M&A Consulting Battles for Independence at Tokyo Style Corporation

M&A Consulting, whose mission is to unlock value with effective corporate governance and to promote shareholder value in the Japanese market, submitted a second shareholder proposal to Tokyo Style Corporation (TSE 8112), nominating two candidates as independent directors. This proposal is in response to the company’s failure to respond to their initial proposal dated January 31, 2002, which requested that they produce their own candidates for independent directors.

Predicting Key Shareholder Reaction

Identifying and understanding important investors can help predict the direction of share prices, according to a recent study reported in The McKinsey Quarterly, 2002 Number 2. Just as it is possible to know and predict your customers well, because there are only so many of them, it is also possible to predict stock price movements since the average firm there is a maximum of only 100 current and potential investors that significantly influence share prices. By identifying these critical individual or institutional investors and their motivations, executives can predict how they will react to announcements—and more accurately estimate the direction of stock prices.

Investors who have weight and a propensity to throw it around can reasonably account for at least 1% of a stock’s trading volume for a given quarter. Once a company has identified each of its primary movers, the next step is to profile all of them, describing how they make decisions. “What does the investor want to invest in, using what valuation methodologies? How is it likely to react to events or to data, which after all can be interpreted in many ways? Are its investments subject to any constraints, such as their size and frequency? Second, the profile should describe each investor’s views on issues that the company might face.”

Of course data gathering for such analysis must be done with great care since SEC regulations prohibit companies from disclosing material information to some but not all investors. “Typically, indirect questions work best,” seems like an understatement. Companies adopting such a strategy will stop viewing the market as a monolithic adversary. Instead of asking why the market moved, “they should pinpoint who bought, who sold, and why.” Think of your company as a private company and you’ll immediately see the need to understand your owners.

Will investor relations units head the call of authors Kevin Coyne and Jonathan Witter? If they do, they will take on a newly strategic role, testing major plans for their effect on share price and suggesting modifications to bring the plans into better alignment with the views of key shareholders. (see What makes your stock price go up and down)

Chevedden Puts TRW on the Spot at Annual Meeting

From the TRW annual meeting proxy dated March 4, 2002: The Company received a letter from a shareholder indicating his intention to request a vote at the annual meeting of shareholders for the Company to report, orally and in writing, at the annual meeting and in the next Company news release after the annual meeting the following information:

  • the identity of Directors who have philanthropic links to the Company, quantifying these philanthropic links and reporting whether such Directors are also members of the Audit Committee;
  • the attendance of Directors at the annual meeting of shareholders;
  • whether the Company’s independent auditors perform audit consulting services and the categories of other consulting services the Company’s independent auditors perform, including the percentage of their overall fee for each category representing more than 10 percent of their annual fee; and
  • the topics and outcome of any Rule 14a-8 proposals, including challenges by the Company of such proposals to the Securities and Exchange Commission.

If any of these matters properly comes to a shareholder vote at the meeting, the holders of the proxies solicited by this proxy statement intend to exercise their discretion to vote against any request for reports on these matters and against modifying the Company’s existing policies and practices on the matters to which the proposal relates.

In addition to taking a position of nondisclosure, management scheduled the meeting for 8:30 AM on April 24. According to John Chevedden, “an 8:30 start is a good way to discourage attendance: Force all local shareholders to fight rush-hour traffic and make sure that all out-of-town visitors spend a night in Cleveland.” John, why not stay two nights? Take in the 2nd City Student Improv at Kennedy’s Theatre where audience members are encouraged to yell out suggestions for the scenes and be a part of the show. Let’s see what they can do with topics from the TRW meeting.

Further Disclosure for Options

Starting in April, companies must include tables in their 10-K reports disclosing information about all employee stock option plans. In the past, only plans voted on and approved by shareholders had to be disclosed, and then only in footnotes. Now, companies will have to include tables identifying the number and weighted average exercise price of outstanding options; warrants and rights; and the number of securities available for future issuance under existing equity base compensation plans. The requirement certainly falls far short of a proposal by the International Accounting Standards Board to expense stock options but it is a move in the right direction.

Denton’s Providence Capital Turns Up Volume

Providence Capital’s corporate governance seminar entitled “Good Governance Pays” was well attended by a virtual whose who in the field. Professor Gompers’ study, “Corporate Governance and Equity Prices,” was well received. Providence’s small private investment portfolio returned more than 29% last year. “After Enron, the institutional investor community can no longer count on regulators, boards, lawyers, auditors or credit rating agencies,” Denton said. “They can’t rely on those folks. They have to rely on themselves by sponsoring their own director nominees.”

Companies targeted by Providence face the threat of a shareholder resolution urging the redemption of poison pills adopted without shareholder approval, a Denton-backed board slate, and a “director nomination by-law amendment.” Directors who refuse to heed a majority shareholder vote to dissolve a poison pill would be later disqualified as a director.

The bylaw amendment will likely face a legal challenge before it even came to an annual meeting vote but if it flies “the subject matter it would open up to shareholder action would be voluminous,” according to Pat McGurn, director of corporate programs at Institutional Shareholder Services. Look also for a rise in activity from Ralph Whitworth’s Relational Investors and Andrew Shapiro’s Lawndale Capital.

Corporate Governance Developments and the New Tools of Governance

The 1st International Conference on Corporate Governance: Corporate Governance Developments and the New Tools of Governance, will mark the official launch of the Centre for Corporate Governance Research at the Birmingham Business School, University of Birmingham, Edgbaston, Birmingham, UK. There will be specially invited sessions from keynote speakers, including Ariyoshi Okumura from Japan and Howard Sherman from the US; and presentation of papers by leading academics in the field including Marco Becht. Sir Adrian Cadbury will be attending the event as the External Advisor to the Centre for Corporate Governance Research.

Papers are invited on issues relating to any field of corporate governance. Possible topic areas may include boards of directors, executive remuneration, corporate governance ratings systems, internet and corporate governance, electronic voting, institutional investors, developments in corporate governance codes, etc.

Date: Tuesday 9th July 2002. Conference Fee per Delegate: £140 fee includes lunch and refreshments, and a set of conference papers.

Death Threat for Whistle Blower

Liu Shuwei, a researcher at the prestigious Central University of Finance and Economics in Beijing, reportedly blew the whistle on Hubei Lantian Co — a producer of fish and lotus root. Revenue seemed unusually high and the government had no record of some claimed assets. She wrote a brief article for publication in an “internal” magazine for bankers with a circulation of just 180, recommending they shut off credit to the company. Shortly afterwards China Construction Bank, Bank of China and others followed her advice.

Then she was served her with a writ for defamation and received dozens of death threats. Lantian apologized to investors in a public announcement. Apparently, 10 officials have been questioned in an investigation into whether the company had provided false financial information. The defamation case was postponed indefinitely. Lantian could be a test case for a new judicial decision allowing shareholders to sue companies for releasing false information. CITIC Industrial Bank and Minsheng Bank are suing for nonpayment of $16 million in loans after banks froze the company’s accounts. The case may not have the impact of Enron but it has drawn attention to poor accounting practices in China.


In an appearance before the Senate Banking Committee, Federal Reserve Chairman Alan Greenspan said “even though Enron was a great tragedy for a number of people, especially the employees who worked there, it probably has created a positive set of forces to improve corporate governance.” “I think we are going to find it was a net plus to our economy,” if corporate rules were improved as a result.”

Triple Bottom Line Simulation

Increasing evidence demonstrates that socially responsible investing (SRI) generates returns at least comparable to traditional investing. On 5/21/01, more than 40 institutional treasurers and investors met in New York City to participate in the Triple Bottom Line Simulation Conference. Five of their peers, institutional investors like themselves, presented case studies on actual social investments of more than $100 million. Next, socially responsible investment firms presented the products to be considered for the simulation. Finally, the large investors sat down and created five portfolios of social investments.

Each portfolio focused on a different aspect of socially responsible investing: social screening, shareholder activism, community development, and social venture capital, while one portfolio followed general SRI investing guidelines. Groups then divided the funds in each portfolio, allocating percentages to equity, fixed income, alternative investments, and cash. Once they chose the actual investments comprising their portfolio, they were ready to commence the simulation. All five simulations so far are outperforming the financial benchmarks. seeInstitutional Investors Try Their Hand at Socially Responsible Investing at

Who Is To Blame For Outrageous Executive Pay?

According to Frank Glassner CEO, Compensation Design Group, it’s a combination of institutional investors, Congress, corporate governance activists and the media. Institutional shareholders see the corporation’s main purpose as maximizing shareholder returns and profits, emphasizing short-term profits rather than the long-term health of the company.

Legislation enacted by Congress to deal with excessive executive compensation tied the deductibility of executive compensation to a pay for performance. Again, emphasizing short-term profitability and stock performance. CEO pay soared with stock prices. The “eagle eye of corporate governance activists and the omnipresent role of the media” simply add fuel to the fire.

Glassner believes corporations must correct their ambitious need to push short-term stock prices and institutional shareholders should back off. Management should be “more sensitive to the hardships you are asking your employees to endure… some type of sacrifice in today’s environment is a must.” “One less Barbie Dream House isn’t going to hurt anyone.” If the rank-and-file has to make financial sacrifices, so should the company management. In turn, when the company experiences increased profitability, all levels of the organization should share the wealth in one way or another.

“When Chairman Pitt said that the SEC will act in cases where executives collect from illusory gains but do not ‘suffer the consequences of subsequent restatements, the way the public does,’ he could have been speaking directly to Kenneth Lay himself. With Enron, plenty of innocent people were hurt and lives were ruined.” “Enron and Global Crossing have been a slap in the public’s face,” said Glassner. “Allowing those executives to walk away with the cash would be the equivalent of letting a bank robber keep the stolen proceeds and lecturing him to ‘never, ever, rob a bank again.'”

Good Governance Pays

Providence Capital will host a corporate governance seminar entitled “Good Governance Pays” in New York City on Friday, March 8, 2002 at 10:00 AM at the Peninsula Hotel (700 Fifth Avenue at 55th Street). The session will highlight the growing awareness of corporate governance’s impact on stock price performance. The seminar will also discuss how the institutional investor community is reacting to corporate governance post-Enron and effective tactics for promoting shareholder-friendly corporate governance at publicly traded corporations.

“In the last couple of years there have been many companies that have ignored majority shareholder votes on non-binding proposals concerning poison pills, staggered boards and other corporate governance matters. Examples include Merck, Albertson’s and Electronic Data Systems Corporation,” said Herbert A. Denton, President of Providence Capital. “When companies routinely reject shareholder wishes, institutional investors need to consider alternative tactics, including submitting an alternative slate of director nominees.”

The discussion will be open to the media and members of the institutional investor community. A Q&A session will follow the presentation. Presenting will be Mr. Denton, and Paul A. Gompers, Professor of Business Administration and Director of Research at Harvard Business School. Professor Gompers co-authored a recent study entitled “Corporate Governance and Equity Prices.” The study found that, from 1990 through 1999, investments in well governed companies responsive to shareholder interests outperformed – by over 900 basis points per year – investments in companies structured to resist change.

Participants can register to attend in person by calling (212) 888-3200 and asking for Ester Done. In addition, a live conference call will be available by calling (785) 832-1077. To view PowerPoint presentation and to read the study, go to

Summary of the Recommendations
2nd International Conference on Corporate Governance

Despite the threat of an impending South Asian war, the conference sponsored by the World Council for Corporate Governance was attended by 416 business leaders and policy makers from 20 countries. There was a consensus that corporations must recognise that globalisation offers them both the strength and opportunity to usher in a just and conflict free world for their own security, survival and sustainability. Corporate governance must integrate the issues of environmental and social responsibility for sustainable wealth creation. It was felt that a free market is meaningless without internalisation of true costs. Economic costs must reflect the full ecological costs; Also valuing true worth of the earth was the only hope of bringing the 3 billion poor in the market economy and help them reap the benefits of globalisation and bridge the widening gap between the world’s poor and rich.

The launch of Indian Sustainability Movement planned on 5th June 2002 in New Delhi to synchronise with World Environment Day is to sensitise the government and business on the enormous business opportunity in restructuring the economy on renewable fuels and innovating products and services to make them environmentally sustainable.

The launch will be followed by a 3 day Environment Congress beginning in Palampur (HP) on 7 June 2002 and incorporating International Mountain Convention to coincide with International Year of Mountains 2002. It will focus world attention on the plight of mountain people, creating sustainable livelihoods for them and protecting and promoting their unique heritage and culture. The theme of the Congress is “Sustainability through Good Governance”. The output of these discussions will be presented to the 3rd International Conference on Corporate Governance to be held in New Delhi on 27th and 28th September 2002.

  1. Corporations must recognize that globalisation offers them both the strength and opportunity to usher in a just and conflict free world for their own security, survival and sustainability.
  2. The scope of Corporate Governance should be enlarged to encompass Good Governance in all its aspects taking cognizance of the political, administrative, economic, social and judicial environment in which they function. Board of Directors ought to balance the interests of capital providers with those of other stakeholders and aim for a long term and sustained business success. Good Corporate Governance ought to create value for all stakeholders including society at large.
  3. As the Enron debacle indicates, a good corporate governance code is no guarantee of good corporate governance. There needs to be stricter monitoring and enforcement of laws, as well as punishment for corporate scams to ensure that those who violate the public trust do not go without penalty. Along with a requirement of disclosures and accountability, laws should be amended to mete out swift and deterrent punishment to the offenders.
  4. There needs to be a separation of the role of Chairman and CEO and greater scrutiny of CEO by the Board of Directors.
  5. There should be a clear separation of the audit and consulting functions. These should in no circumstance be done by the same organization.
  6. Corporate Governance ought to cover disclosures on Environmental and Social responsibility.
  7. Sustainability ought to be the end game of business. No business activity that jeopardizes the ability of future generations to meet their own needs should be permitted.
  8. There is a need for economic costs to reflect full ecological costs. Accounting practices need to ensure that environmental costs are properly internalized.
  9. There needs to be greater recognition of the importance of intellectual and reputational capital and the tectonic shift in public values with the onset of knowledge economy.
  10. Rapid obsolescence and irrelevance are the two greatest risks to corporations in the knowledge economy. Governments and businesses need to collaborate to provide incentives for innovations of new business designs and products with least impact on environment.
  11. A primary goal of good corporate governance ought to be to foster a culture of creativity, innovation and entrepreneurship to protect the business from irrelevance and obsolescence. It should aim to leverage the intellectual capital to serve the unarticulated customers and untapped markets.
  12. There needs to be greater awareness of the need for Corporate Social Responsibility. An Award to recognize achievements of Corporate Social Responsibility as distinct from the existing award on Excellence in Corporate Governance will be a good way to encourage corporate role towards society.
  13. It is unpractical to hold non-executive Directorship or Directorship in ten and more companies. The rules for Directorships need to be amended so that the number of directorships a person can hold is less then ten.
  14. It is vital that a minimal training programme be designed and organized for Directors, both Executive and Non-executive, covering key aspects of good corporate governance and director responsibilities – statutory, environmental and social. There should be a compulsory induction programme for institutional nominees.
  15. Corporations should continuously internalize the evolving best practices in corporate governance.
  16. To strengthen Boards of Directors and in order to induct people of eminence and ability into Boards to discharge the functions as watch dog of other stakeholders interests on Audit Committee, on Remuneration Committee etc., these people should be insulated from the failings of the day–to–day management. Non Executive Directors should be freed from accountability for failures such as a cheque bouncing or a pollution device failing. Amendments in the laws and Rules & Regulations in this regard should be made.
  17. The issues involving risk management and reputational capital need to be discussed more in-depth.
  18. Expeditious and cost-effective resolution of commercial disputes is an integral part of Good Corporate Governance. There is a need for WCFCG to establish an Arbitration and Reconciliation Centre which offers cost-effective and time-bound resolution of disputes.
  19. Standardized, universally applicable, unambiguous and transparent accounting procedures need to be evolved and internationally adopted.
  20. There is a need for stricter internal audit controls to ensure that debacles such as that of ENRON do not recur.
  21. WCFCG should set up a Centre for benchmarking best practices in Corporate Governance.
  22. International Conferences need to be held at frequent intervals to provide opportunity for exchange of ideas on implementation of best practices in corporate governance.

New Delhi 12th Feb., 2002

Pledge for a New TIAA-CREF

In a New York Times article (January 6, 2002), TIAA-CREF’s CEO John H. Biggs said he would support the creation of a new retirement fund that would employ not only negative screens (avoiding certain companies), but also positive screens (investing in companies strong on social responsibility).

Mr. Biggs made his offer in the context of a challenge. He would support creating such a fund only “if you could guarantee the investors would be there to invest.” He explained that TIAA-CREF would need $50 million in seed money, and that the minimum commitment needed from investors to justify the development of such a fund would be $25 million. TIAA-CREF would provide the other $25 million, with the expectation that it could be withdrawn as the fund grew.

Social Choice for Social Change: Campaign for a New TIAA-CREF asks that TIAA-CREF members step up and make a commitment to ensure the launch of this new fund. Click here.

Reaction to CalPERS Withdrawal From SE Asia

“CalPERS’ decision to withdraw investment from the emerging markets of South East Asia viz Malaysia, Indonesia, Thailand and Philippines is counter productive and not in the interest of its own shareholders,” says Dr Madhav Mehra, President of the World Council for Corporate Governance.

A review, conducted by pension consultant Wilshire Associates, led CalPERS to withdrew from the Philippines on financial grounds. Social issues were the key factors in withdrawing from Malaysia and Indonesia. At the same time CalPERS announced it will begin investing in Poland and Hungary. All four of the newly excluded markets have outperformed broader world markets this year, with Indonesia, Malaysia and the Philippines posting increases ranging from 25 – 29%. That compares with a decline of 5.6% for the MSCI World Index.

In an interview with BBC World Dr Mehra said, “Emerging markets in South and South East Asia represent some of the most innovative companies engaged in people- oriented businesses applying best practices in corporate governance and developing new business designs and products that offer the best prospects of value creation for investors.” CalPERS – US’s largest pension fund with assets of over $151 billion – has already banned investments in India and Pakistan. CalPERS’ explanation of their decision as the result of their continuing effort to withdraw from unethical investments “sounds hollow on the face of Enron’s record.” Dr Mehra assets that Enron is not an isolated case of fraud. “Its auditors have claimed that the accounting practices used to cover up were within the law and are followed by thousands of US firms,” he asserts.

Dr Mehra added, “It is also difficult to justify withdrawal on the grounds that these countries are low on performance, transparency and political stability. Some of the knowledge based pharmaceutical and telecom companies have outperformed despite recession. Whilst one can admit some political turmoil in Indonesia and Philippines, there is no serious political instability in the four other countries. Certainly, despite its other problems, India’s record of democratisation is unmatched. In regard to standards of transparency when there is so much evidence of cooking the books in developed economies, it is wrong to single out a few South East Asian economies and punish them for such lapses. The withdrawal appears more likely due to the risk factors in these countries. CalPERS’ concern for the investor, therefore, is quite understandable. Nonetheless, one must realise that stability is the thing of the past and that rapid obsolescence, demographic changes and shift in public values have profoundly changed the competitive environment. Markets of 21st century are driven by aspirations of innovation and sustainability. Short term focus on profits is the surest way for shareholder value destruction.”

Dr Mehra went on to opine that CalPERS’ decision “will dampen the efforts of Alan Greenspan to resuscitate the US economy.” “In any event, investment decisions have to be based on the policies of companies and not countries. You cannot outlaw a whole nation because of the failings of a few. You have to judge each company on its own merits. It is not significant that the countries that have been banned by CalPERS represent some 25% of the world population. What is significant is that it is the 25% that are the potential powerhouse of pent up demand needed to lift the US economy out of its current recession.”

London’s Financial Times (2/22) reported that CalPERS’ “modest presence in Asia will limit the short-term impact on fund flows to the blacklisted countries.” However, the more lasting impact will be to influence others concerned with “socially responsible investment” (SRI). “CalPERS has a massive leadership role in the US,” says Allan Conway, head of global emerging markets at WestLB Asset Management. “This will have a snowball effect which can only gain momentum.” Other critics question the rationale of pulling out of SE Asian states while continuing to invest in US companies with significant manufacturing presence in these countries. “While on one level I’m encouraged that CalPERS has come to the decision to use the power of its investment capital to promote certain social objectives,” Matthew Kiernan, of Innovest, said, “I’m somewhat puzzled by their apparent lack of interest in doing so for the other 99 per cent plus of their portfolio which are in countries and regions which themselves are not devoid of social and environmental challenges, notably the United States itself.” Similarly, while CalPERS avoids direct investment in China, because of questionable labor practices and the integrity of its political system, it continues to invest in Hong Kong-listed Chinese companies.

From my own perspective, I believe the action by CalPERS Board is based on good intentions but bad policy. I agreed with the tobacco pull out and advocated such a move years prior to the Board’s action. Tobacco, when used as directed, is harmful. It has no redeeming qualities (other than the ability to earn short term profit at the long term expense of others). I also reluctantly supported the investment boycott of South Africa. I would have rather seen pressure on companies in South Africa to resist unjust laws and bring down apartheid through direct engagement. However, the since the boycott movement was a worldwide effort, it was effective.

In the current case, I do not see CalPERS leading or joining a worldwide effort to reform or bring down the governments of its blacklisted countries. Their action may allow Board members to “wash their hands” but the impact is likely to be minimal in bringing about change. This is especially true since the Board’s action comes at a time when these markets are on the rise.

Rating countries based on transparency, political stability and labor practices/standards is reasonable but the approach should be used in tandem with corporate governance ratings. Combining the “scores” of the two scales would still result in CalPERS investing substantially more in countries with transparency, political stability and good labor practices. However, exceptional corporations in difficult environments should not be completely off bounds. CalPERS practices engagement in the US market. It hardly ever does the “Wall Street Walk.” Something closer to that policy should also hold true for its international investments.

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