Archive | June, 2002

June 2002

CalPERS Fails to Act on Expensing Options

“Stock options should not be treated as a business expense,” California’s Governor Gray Davis told the Silicon Valley Manufacturing Group at their board meeting in San Jose. (Davis backs tech firms on options, SFGate.com, 6/13) No Davis doesn’t hold much influence with the SEC or the Financial Accounting Standards Board (FASB) but he does appoint two members to the 13 member CalPERS Board and two officers of his administration also sit on the Board. A week later members of the CalPERS Board took up the issue and delayed any action to endorse or reject expensing stock options until August.

The Council of Institutional Investors, an association of some 120 public, corporate and Taft-Hartley pension funds with assets of $1 trillion, which CalPERS helped to found, threw its support behind expensing options back in March. Federal Reserve Chairman Alan Greenspan cautioned that failure to expense stock options has “introduced a significant distortion in reported earnings, one that has grown with the increasing prevalence of this form of compensation.”

A growing number of editorials in the business press, such as Fortune magazine, have called for expensing options. Standard and Poors announced recently that when it computes core earnings, it will deduct stock options as compensation expense. The International Accounting Standards Board (IASB) is likely to weigh in on the expensing side as our Financial Accounting Standards Board did before Congress interfered at the request of CEOs and Silicon Valley years ago. CalPERS should be taking the lead on this issue. Instead they are hiding.

Options are a form of compensation that clearly have value. A representation of that value should not remain hidden in the footnotes of financial statements. On average options overstated earnings among the S&P 500 by 1% in 1995 when CorpGov.Net went online. In 2000 options resulted in a 9% overstatement of earnings by the same group and among information technology firms in the S&P 500 the average overstatement due to the cost of options was 33%. The total cost to shareholders was $284 billion in dilution.

“How many legs does a dog have if you call the tail a leg? Four. Calling a tail a leg doesn’t make it a leg,” said a wise Abraham Lincoln. After the accounting disclosures of Enron, Global Crossing, Tyco and now WorldCom, the investing public deserves the truth. Ignoring the cost of options doesn’t mean they are not an expense. Let’s hope CalPERS comes to its senses, even if we have to wait until after the elections.

Wealth Transfer

Writing for Directors & BoardsMartin T. Sosnoff, Chairman of Atalanta/Sosnoff Capital, says “Enron ain’t the problem.” (Spring 2002) “Over the past decade there was a landslide transfer of wealth from public shareholders to corporate managers.” Enron is the tip of the iceberg.

The great surge in productivity gains of the back half of the nineties was probably a scam. “After you make adjustments for too liberal assumptions on pension fund rates of return, factor in take-a-bath plant closings, the capitalization of R&D and huge inventory of write-offs, and low salaries to balance the options substitution, it looks as if earnings for the S&P 500 Index grew at their long-term pace of 5%, not the 10% that was reported.”

Sosnoff says the country “needs a swelling populist rage against managements’ venality comparable with the vilification of the trusts, typified by John D. Rockefeller Sr.” “Where’s the Teddy Roosevelt in the wings holding a big stick and ready to pounce.”

Can CalPERS Afford to Throw Stones?

Christopher Palmeri’s article with the above title inBusinessWeek (6/24) raises the issue that CalPERS knew about Fastow’s self-dealing partnerships but didn’t blow the whistle on him or Enron. There has been a spate of resignations at CalPERS, which has underperformed in comparison with other funds. However, his primary focus is on conflicts of interests by board members and those who appoint them, as well as the move to socially responsible investing (SRI).

Should CalPERS have reported Fastow? Undoubtedly. Maybe if those favoring SRI had been more fully in control, they would have. Too often fiduciaries take the attitude that yes this guy is a crook, but he’s our crook and he’s making money for us. Those favoring SRI are more likely to take the long term view. We’re all better off in the long run if crooks are in jail.

Yes, political contributions are troublesome and the potential payoff of a $100 million investment in return for a relatively small political donation continues to be problematic at CalPERS and in the other halls of government. Every time a department awards a contract, every time the legislature passes a bill, we can speculate about the influence of political contributions. And we should. It is obvious to all the money plays too big of a role in politics. At least CalPERS is run by a board that operates, to a large extent, in the open, rather than by a single elected official, as is the case with many pension funds in other states.

If Palmeri’s wanted to raise questions about CalPERS’ governance, why didn’t he discuss board members who leave the board and after a year lobby in order to obtain huge placement fees? One such former board member was recently reelected. Maybe he’s trying to renew his influence so that he can once again try for those fat placement fees when his term is up.

Why didn’t Palmeri discuss board members that simultaneously serve on other private investment boards? Does due diligence on one board serve the other equally? Which board comes first with regard to fiduciary duty? If he wanted to get into good governance practices, what about questioning value of having members serve on a board for more than 30 years? Can such directors still be considered independent? CalPERS has had more than one in this situation.

Is it good governance to have a board member in charge of a $150 billion fund who has declared bankruptcy not once, but twice? One CalPERS board member served as head of the investment committee while declaring bankruptcy twice. California’s Probate Code, which generally governs trustees, says that the office of a trustee that has declared bankruptcy is declared vacant. Is CalPERS above the law? Is it good governance to have voting rules which don’t provide for runoff elections and allow candidates to be elected with as little as 5.5% of the vote, as has happened at CalPERS. I don’t understand why Mr. Palmer failed to mention these issues that seem so much easier to fix than the question of political contributions.

With regard to SRI, CalPERS has been too timid. Had they gotten out of tobacco stocks years ago, as the lawsuits were taking hold, Angelides’ strategy would have been brilliant, financially as well as socially. True, blacklisting several emerging market countries has been widely criticized but not because people think CalPERS would make as much money in the short run wherever it can.

The criticism I heard over and over again while attending a meeting of Asian Development Bank was that CalPERS shouldn’t write off whole countries when there are good companies within those countries with excellent corporate governance practices that can set an example. Why write off India, for example, when Infosys has governance practices that are at least as good as many companies in the US. CalPERS needs to refine its policies to include company rankings as well as country rankings. That way, they will not miss excellent investment opportunities. At the same time, they will encourage individual firms operating in developing countries to adopt good corporate governance standards to attract foreign direct investment. (In the interest of full disclosure, the editor is an Infosys shareholder.)

System Failure

That’s the title of Fortune’s June 24th article on how to bring back investor confidence through 7 suggested reforms:

  1. Earnings- trust but verify. Git rid of so-called proforma earnings; report real results. Expense options, stop the abuse of restructuring charges. Include pension costs but not pension income. The quality of earnings should be graded by auditors.
  2. Rebuild the Chinese wall. Enact regulations that forbid analysts from being involved in banking deals; let them evaluate companies only after they have gone publie.
  3. Let the SEC eat what it kills. The SEC has 100 lawyers to study the disclosure documents of 17,000 public companies. SEC examiners are paid 25 – 40%less than those of other federal agencies. Employee turnover is 30%/year. Yet, the SEC took in $2 billion, 5 times their entire annual budget. Congress should stop diverting their money to other uses.
  4. Pay CEOs, yeah – but not so much. Stock options should be expensed.
  5. Fire the chairman of the bored. Fortune’s writers praise the NYSE’s proposed reforms. The requirement that outsiders on the board meet regularly without management “will have a huge impact.”
  6. Put the “public” back in IPO. “For every dollar startups raised in 1999 and 2000, they paid 58 cents in a combination of fees and forgone proceeds.” The solution has been out there since 1998 when W. R. Hambrechtbegan auctioning IPOs on the Internet. Shares go to the highest bidder and the “IPO slush fund, that big pool of money that feeds all the corruption, evaporates.”
  7. Shareholders should act like owners. 75 mutual funds, penisons and other institutions control $6.3 trillion…44% of the market. “Real reform is only a proxy vote away.” They then reference the next article, “Investors of the world unite!” That article, by Marc Gunther, weaves the story of activism by institutional investors around the central figure of Robert A.G. Monks and does a great job of presenting the struggle through his efforts. “The so-called elections of corporate boards are mostly a sham, and will remain so until dissidents can get access to the company proxy statement to challenge the management slates.” Hopefully, Monks, John Bogle and others will help create a culture of ownership responsibility.

Would Institional Investors Create Better Corporate Governance?

Be careful what your wish for, says BusinessWeek’s John A. Byrne in “Investor Power Has Its Downside, Too” (7/1/02). “Why? For starters, the focus on quarterly numbers would become even more intense.” Shareholder turnover jumped from 12% in 1960 to 98% most recently. Institutional investors made “maximizing shareholder value” the prevailing principle of American business. Byrne argues that shareholders hardly made a peep about the runup in CEO pay and stock dilution as long as prices were going up.

Byrne has a point, but positive directions from such efforts are most likely to come from public pension funds, index funds and SRI funds who tend to be long term holders.

Capital Stewardship Certificate Program

The Center for Working Capital and the National Labor College are offering a certificate program in capital stewardship. The program has four classes. Introduction to Capital Stewardship provides an overview of key concepts, laws and policies. Fiduciary Duties outlines the legal duties of trustees regarding pension fund management. Investment Strategies grounds trustees in the fundamentals of investment decision-making while emphasizing investment techniques for highroad economic strategies. In the final class, Active Ownership and Corporate Governance, trustees will gain a thorough understanding of the benefits of active ownership through proxy voting and monitoring corporate governance. Trustees and plan professionals will explore avenues for maximizing long-term value through corporate governance. This is a great program for union activists who are either pension fund trustees or are hoping to be a trustee. Learn more.

4th World Congress on Environment Management

We understand the 4th World Congress on Environment Management held in Palampur from 7-9 June 2002 on “Sustainability through Good Governance” was a success despite adverse publicity in the international media about the impending nuclear conflict between India and Pakistan. The conference had several outstanding speakers from overseas and was attended by over 400 business leaders, government ministers, policy makers, CEOs, directors and senior managers of public private sector and multinational companies, NGOs and environmentalists. His Holiness the Dalai Lama inaugurated the Congress and presented the Golden Peacock Environment Management Awards.

The conference adopted a “blueprint for action” referenced as the “Palampur Declaration on Sustainable Development.” According to UN Report on Human Development (1998), the income ratio between 20% of the world’s poorest and 20% richest was 1:30 in 1960. It increased to 1:61 in 1990. In 1999 it was 1:74  and today it stands at 1:87. According to the Congress, “poverty is the single largest barrier to sustainability.” Partners in Action for Sustainability (PIAS) is one initiative adopted in the Declaration. The PIAS task will be to disseminate good work done by companies and thus provide role models that we badly need and at the same time encourage companies to seek 3rd party certification to ISO 14001.

Women on Board

The current [email protected] Newsletter contains a discussion by a panel of women executives (scroll down). Sally W. Stetson, president of the Forum of Executive Women, cited statistics showing that the percentage of Fortune 500 corporate boards with at least one woman grew from 63% in 1993 to 84% in 1999. However, women held just 11.2% of total board seats. Why? According to Deborah M. Fretz, CEO of Sunoco Logistics Partners, its because “CEOs go after other CEOs of publicly traded companies.” Maybe stacking the board with CEOs should be considered another conflict of interest, since each member of such a board has a vested interest in raising CEO compensation.

Trade Unions Call for Sustainable Development

Trade unions issued a challenge that could result in one of the biggest ‘grass-roots’ initiatives on sustainable development to date. It may involve millions of workers around the world in joint actions to implement needed changes in their workplace and communities. The proposal to initiate an international program of “Workplace Assessments’ could bring unions and employers together in action plans for change on water and energy uses, transportation, toxic substance and wastes, public and occupational health, as well as participation and basic security.

“We look forward to the day when workers can engage their employers in joint action to set common targets, monitor progress and implement change on broad range of issues,” said Ms. Ching Chabo from the International Confederation of Free Trade Unions’ Asia Pacific office. (Unions issue challenge to UN “Sustainable Development” Meeting, 28/5/2002)

Short Term Efficiencies = Long Term Inefficiencies

The stock market is becoming more efficient over the short term and less efficient over the long term, according to some experts, as reported in Pensions&InvestmentsAlbert S. “Pete” Kyle of Fuqua School of Business, Duke University, says “the market is getting more and more efficient over very short periods of time, over a day or week or month” because more people are trying to make money off price discrepancies through hedge funds. Barr Rosenberg, chairman of AXA agrees because managers face increasing pressure for short term results. Hedge fund assets have grown 1,500% in the last 10 years to $563 billion.

Peter L. Bernstein, a consultant, thinks investors are still driving while looking through the rearview mirror and Robert D. Arnott, managing partner of first Quadrant Corp. is quoted, “I would bet very, very long odd that the risk premium in the next 20 years will not be even as half as large as what we saw in the last 20 years.” (Time is of the Essence, 6/10/02)

Short Term Thinking and CEO Pay

Many CEO’s and board’s are not creating value on a medium term basis and investors would be better off investing in T-bills, according to Mark Van Clieaf of MVC Associates International. His analysis finds that 35% of S&P 500 firms failed to return an after tax profit agreater than the cost of capital over 5 years. In an analysis of the proxy statements of the complete S&P 500 he found that the duration of time over which CEO performance was measured was only 1-year for 55% of the firms. Are they really trying to create long term value?

Fidelity To Fight Excessive CEO Pay

Fidelity Investments, which oversees $800 billion in assets is reviewing how to use itsballots in shareholder votes to protest outsized corporate pay packages, according to Mr. Roiter, Fidelity’s general counsel. Fidelity is considering token gestures such as withholding its votes for corporate directors that have approved excessive executive compensation plans. However, in accordance with a longstanding policy, it probably won’t disclose how it votes, so the effort, while a step in the right direction, will not have as much impact as it could.

In the past Fidelity’s votes against management’s recommendations often involved stock-options plans. The company usually objects to plans that dilute the shares outstanding by more than 10% at large companies or more than 15% at smaller companies. CEO pay increased 535% since 1990, far surpassing the 297% gain in the S&P 500 stock index, the 116% jump in corporate profits and the 32% bump up in workers’ pay, according to Legg Mason Value Trust manager Bill Miller who has joined with CalPERS in withholding support from directors to protest specific corporate practices, such as hiring auditing firms that also do consulting work for a company. (see Fidelity Uses Voting Threats To Fight Excessive CEO Pay, WSJ, 6/12/02)

Gregg Li Joins NETwork

Gregg Li, the Chief Architect of G. Li & Company Ltd., has joined the Corporate Governance NETWork. Mr. Li has over 20 years of experience in the Pacific Rim. He has served as a troubleshooter for the US Federal Government, as a regional internal consultant for American Express in East Asia, as a development consultant for the Vocational Training Council (VTC) in Hong Kong, as an external consultant to the former Coopers & Lybrand MCS Asian operation, and has headed a management think-tank at the University of Hong Kong during the period of Hong Kong’s handover to China. Other principals with the firm include

  • Robert Tricker, an honorary professor at the University of Warwick, Exeter, and Hong Kong.
  • Anthony Siu, engineer, venture capitalist, management consultant, and business angel.
  • Alfred Ho, 30 years in management and organizational development.

Governance and Junk Bonds

Poor corporate governance practices are strongly correlated to U.S. firms getting downgraded to junk bond status, according to Pax World High-Yield Fund manager Diane Keefe. Participate in a briefing at 1:30 p.m. EDT on Wednesday, June 19, 2002 by calling 1-800-966-6338 at 1:25 EDT and asking for the “Pax” or “junk bond” call. The live, two-way phone-based telenews event (with Q&A) will focus on the raft of “fallen angels” — investment grade companies on the cusp of being downgraded to high-yield status but already trading at “junk” levels. Ms. Keefe will discuss the bonds of Tyco, Qwest, E-Trade, Adelphia, WorldCom and a number of other firms.

Pax World High-Yield Fund bills itself as the only socially responsible junk bond mutual fund in the United States. Can’t make it? A streaming audio replay of the call will be available on the Web as of 6 p.m. EDT on June 19, 2002.

Governance Tip-Sheets

CFO.com posted an interesting article on 6/6 entitled “Whose Company Is It, Anyway?,” which dicusses some of the changed proposed by NYSE and Nasdaq. However, the bulk of the article centers on the suddenly increasing number of organizations that have recently come out with governance metrics. Standard and Poor’s Corporate Governance Score (CGS) and Institutional Shareholder Services’ (ISS) Corporate Governance Quotients (CGQ). The Corporate Library and GovernanceMetrics International will release a governance metrics later this year.

No, the rating systems won’t be perfect, Enron might have scored high, but credit rating systems also evolved. “If investors are to take such governance ratings at face value, they must be convinced that the providers of the scores are on the side of shareholders — and not corporate clients,” says CFO’s Jennifer Caplan. The ever quotable Nell Minnow doesn’t see this as a big problem. “I am confident that the market will determine which information is really useful,” she predicts. “It’s like buying a tip-sheet at the race-track. After a while, you learn which ones really work.” It could make the difference between gamboling and investing.

Owners Must Step Up to the Plate

In “The Value of Trust” (6/6/02), The Economist raises three main investors concerns:

  • the role of the research that is published by investment banks;
  • the way in which shares in IPOs are allocated; and
  • the use of accounting rules to mislead investors.

Although the article explores several reforms, at bottom “governance is unlikely to improve much until the institutions that own large chunks of corporate America start acting as real owners, by keeping a sharper eye on their boards and their management.”

Again in “Under the Board Talk” (6/13/02) “shareholders should play a bigger role in the selection of directors.” The Economist also calls for “separating the job of chief executive from that of chairman.” Shareholders should steer board recruitment away from the tiny pool of CEOs of other firms. “Why not trawl more widely, among academics and public servants?”

Finally, in “Designed by Committee,” The Economist notes that “the most powerful catalyst for change ought to be the big institutional investors that have their own fiduciary duty to protect their investors. Right now, these institutions are busily blaming boards for recent wrongs. But this seems rather convenient. One of the more interesting features of the assorted revelations now scandalising the market is that many of them are hardly news….As part of its reforms, the NYSE proposes to give shareholders more opportunity to monitor and participate in governance. This includes allowing them to vote on stock and stock-option plans for bosses, and making companies disclose codes of business conduct and ethics on their websites. In Delaware, judges seem more willing to put their faith in the judgment of sophisticated institutions, and may increasingly throw open contentious issues to a vote. When it comes—as it inevitably will—the next wave of corporate scandals might put institutions, not boards of directors, in its crosshairs.”

Chinese Court Sends Mixed Message

Shenzhen court’s verdict on 6/4 sends a mixed message re investor rights. In Fountain Corp. vs. Caijing magazine, Pu Shaoping and the Stock Exchange Executive Council a Chinese listed company took a media organization to court to defend its reputation. The court ruled that Caijing was guilty of defaming Fountain Corp. because of what the court deemed to be an inaccurate paragraph in a Caijing exposé. At the same time, however, the judgment broke ground in upholding what it said was the media’s “right to expose, comment, criticize, and monitor negative phenomena in society”–as long as the reporting is accurate. (see Wielding a Double-Edged Sword, Far Eastern Economic Review, issue dated 6/20)

Technology Trends

The following technology trends were noted by Broc Romanek, Director of Marketing for RR Donnelley Financial and Editor-in-Chief of RealCorporateLawyer.com. I summarized from the Spring issue of the Corporate Secretary (a publication of the American Society of Corporate Secretaries). Sign up for Romanek’s E-Zine and stay informed.

  • Online Proxy Fights used internet-based solicitation strategies last year at Travis Street partners LLC, Pioneer Group, ICN Pharmaceuticals, Luby’s and Goldfield Corporation, as well as during the Hewlett-Packard Compaq merger. Dissidents used web sites and message boards extensively to access “street name” holders.
  • Electronic Stockholders’ Meetings. Inforte, a small company located in Chicago but incorporated in Delaware, held the first annual meeting exclusively in virtual reality on the internet. 5500 registered and beneficial holders attended. It was cheap; Inforte spent only $2,000 for the webcast through PR Newswire and for an election inspector. I doubt if many will follow suit but simulcasting is likely to grow rapidly.
  • Electronic Offerings. A variable annuity offered by The American Life Insurance Company was probably the first to not also be available on paper. The SEC declared the registration statement effective on October 25th. We can expect more.
  • Electronic Delivery and Voting. Online voting caught up with telephone voting and can be expected to pass it during the 2002 proxy season.
  • Not so FreeEDGAR. Many EDGAR-based services started changing subscription. (see EDGAR,FreeEdgar.com10kwizard.comSection16.net,TheCorporateCounsel.netRealCorporateLawyer.comand TheCorporateLibrary.com).
  • Regulatory Changes. SEC proposal that companies post disclosures on corporate web sites at same time they are filed and increased use by the SEC of their own site.
  • Director Communications. More companies are utilizingextranets for their boards and committees to communicate with management and each other. See RecordCenter andBoardVantage for off the shelf systems.
  • Online Education. Some state bar associations claim over 10% of their members have earned CLE credit online or through a CD-ROM. Additionally,

NYSE Rule Changes in Works

New York Stock Exchange announced new rules for improving corporate governance for NYSE-listed companies. The draft rules, which must be approved by the Securities and Exchange Commission, require listed companies to:

  • maintain a majority of independent directors on their boards and refine independence to require “no material relationship with the listed company either directly or as a partner, shareholder or officer of an organization that has a relationship with the company” (current rules say that a listed company must have an audit committee that includes at least three independent directors.);
  • conduct regular meetings among non-management directors,
  • shareholders owning 20% or more of the company’s shares may not vote on audit committee matters, and
  • get investor approval for all equity-based compensation plans (current rules require shareholder approval of only those stock plans where officers and directors may participate). The is probably the portion of the proposed rules most likely to change do to pressure (see below). The draft rules also state that brokers can vote their clients’ shares only on such proposals after checking with them first (I say, why not just eliminate broker voting altogether?).

NYSE Governance Rules Have Activists Salivating, says Diane Hess of TheStreet.com. “These rules accomplish, in one fell swoop, what shareholders have been striving for,” Nell Minow is quoted as saying. Peter Clapman, senior vice president of TIAA-CREF, the largest pension system in the world, says the guidelines would “remove barriers to effective communications” and “harmonize relationships.” The Business Roundtable has already come out against the NYSE’s proposal for shareholder approval for all plans, saying it could end up reducing the number of options and stock granted to rank-and-file employees because of the additional costs of shareholder approval. Significant changes…definitely, but certainly not everything desired by shareholder activists. Investor approval for all equity based compensation plans is the most radical of the ideas but it probably wouldn’t be as hard for management to take as expensing options.

Ditto Nasdaq, but Less

Nasdaq Stock Market, Inc. announced key rule changes approved by its board on May 22, 2002. These proposed rules will soon be published in the Federal Register, be subject to comment periods, and could be implemented later this summer. Further corporate governance reforms will be examined at the next meeting of the Nasdaq Listing and Hearing Review Council in San Francisco June 26-28. They include:

  • a majority of independent directors on corporate boards;
  • compensation committees composed solely of independent directors;
  • a cooling-off period during which former auditors would be precluded from serving on corporate audit committees;
  • expanding the scope of audit committee authority;
  • strengthening continuing education for directors;
  • increasing the use of corporate codes of conduct and compliance methods to support them; and
  • mandate non-U.S. companies to disclose if they have received waivers of corporate governance standards through a new SEC disclosure requirement.

The rule filings, to be submitted to the SEC now, concern the following subjects:

  • Stock Option Plans. Require shareholder approval for all plans in which officers and directors participate. Although existing exemptions for inducement grants to new executive officers and tax qualified, nondiscriminatory plans such as Employee Stock Ownership Plans (ESOP) were retained, the new rule does not include the so-called “treasury share” exception that would permit a company to use certain repurchased shares to fund options to executive officers without prior shareholder approval.
  • Independent Directors. The definition will be extended to prohibit any payments, other than for board service, including political contributions, in excess of $60,000 and will extend to receipt of such payments by a family member of the director. Furthermore, a director will not be considered independent if the company makes payments to a charity where the director is an executive officer and such payments exceed the greater of $200,000 or 5% of either the company’s or the charity’s gross revenues.
  • Disclosure of material information will be harmonized with the SEC’s full-disclosure rule to facilitate disclosure by issuers using Reg FD methods such as conference calls, press conferences and Web casts, so long as the public is provided adequate notice and granted access.
  • Related Party Transactions. A company’s audit committee or a comparable body of the board of directors must review and approve all related-party transactions.
  • Explicit Prohibition on Misrepresenting Information to Nasdaq. A material misrepresentation or omission by an issuer to Nasdaq may result in the company being delisted.

CEO/Chair Split Favored

The demise of Enron has triggered a spate of criminal investigations and lawsuits against companies and directors, spreading “angst and paranoia through boardrooms.” A McKinsey survey of more than 180 US directors representing 500 companies reveals that just under 40% were not confident they had processes in place to control potential conflicts of interest and even more thought they were not prepared to deal with risk management issues such as assessing the impact of pay on performance. The survey suggested that more than two-thirds believe the board should split the role of chief executive and chairman. (Financial Times, Enron’s Demisse has Taken the Shine Off Boardroom Tables)

15 Minutes

Our 15 minutes of fame came on June 4, 2002 when Paul Krugman’s editorial “Greed is Bad” brought CorpGov.Net to the attention of thousands of New York Times readers.

Krugman points out that “distrust of corporations threatens our still-tentative economic recovery; it turns out greed is bad, after all. But what will reform our system? Washington seems determined to validate the judgment of the quite apolitical Web site of Corporate Governance (corpgov.net), which matter-of-factly remarks, ‘Given the power of corporate lobbyists, government control often equates to de facto corporate control anyway.'” No, we’re not all that apolitical. This is not a situation which we embrace, only the current reality.

As Krugman’s editorial indicates, corporations show no signs changing their ways. “Who will save that malfunctioning corporation called the U.S.A.?” Only the owners of corporations have that power. The most fundamental reform needed is to eliminate the SEC prohibition against using the shareholder resolution process to nominate directors but owners so far aren’t demanding that kind of power. Currently, shareholders can only nominate candidates by paying for an expensive solicitation, while the current management uses company funds, our money, to elect their own candidates. A democratic election process would bring about a real shareholder revolution and fundamental improvements in corporate governance. Other reforms simply treat the symptoms of a failure in democracy.

Global 100 Names ISS to Gadfly List

CFO Magazine’s The Global 100 lists a fairly arbitrary but not unreasonable 100 “major influencers” on global business by category: Raters & Regulators, World Players, Politicians, Taxmen, Exchange Masters, Bankers, CEOs, Investors, Lawyers, Risk Managers, Gadflies, Thought Leaders, and the Rest. There are some of the usual suspects and some surprises. What I don’t understand is the Gadfly label applied to ISS.

“Gadflies” are various types of insects that bite or annoy livestock. But here it is the second definition that obviously applies; “a person who stimulates or annoys, especially by persistent criticism.” Neither definition is particularly flattering but in the corporate world it is generally applied to the Gilbert brothers, Evelyn Davis and others whose shareholder proposals are strictly precatory.

As Robert Monks has eluded, although individually they are often ignored, together gadflies irritate the individual animals and sometimes the herd enough to get them moving. Included in the Global 100 are Toshiaki Murakami M&A Consulting in Japan and David Webb, Editor, of Webb-site.com in Hong Kong. Both have shaken up their respective markets. Murakami’s campaign to open up the value of cash-rich apparel maker Tokyo Style Co. has the look of an American style corporate raider. Webb’s attempt to advance minority shareholders’ interests in Hong Kong-listed companies through his HAMS proposal was recently rejected by the government. Maybe the gadfly label is appropriate to them and even to Mark Mobius, who is termed the “dean of emerging markets investing.” Each has obvious respect but their victories have been limited to date.

However, I’d draw the line at including Institutional Investors Services in this category. “When ISS talks, people listen,” CFO indicates. No kidding; if CEOs and other corporate officers don’t listen, they’ll soon find themselves out on the street. ISS was already responsible for 20% swings in proxy voting. Now they have launched a new service that will initially rate all companies in the Russell 3000 Index and will eventually extend coverage globally. The ratings are scored from 1 to 100, with 100 being a perfect score, and are based on seven aspects of corporate governance:

  1. board structure and composition,
  2. charter and bylaw provisions,
  3. laws of the state of incorporation,
  4. executive and director compensation,
  5. qualitative factors, including financial performance,
  6. D&O stock ownership, and
  7. director education, from an accredited program, including those offered by the National Association of Corporate Directors, the University of Wisconsin/State of Wisconsin Investment Board, the Wharton/Spencer Stuart Directors’ Institute, Dartmouth’s Center for Corporate Governance, and the Stanford Directors’ College.

Companies will be scored individually and will be ranked relative to their peer groups. If ISS is a gadfly, who is the 800 pound gorilla?

Errosion of Investor Confidence

Growing mistrust due to a steady stream of accounting scandals, poor corporate governance and conflicts of interest are is taking a toll. The S&P 500 has lost 7% this year while the Nasdaq composite lost 17.2 percent of its value and is trading 68% below its 2000 peak. The number of investors who say it’s a good time to invest has dropped to levels not recorded since September 2001, according to a monthly Gallup poll. Dubious accounting practices topped the list of concerns.

David M. Blitzer, chief investment strategist at Standard & Poor’s, said investors appeared deeply frustrated today. The New York Times quotes him as saying, that investors “want a sense that it is a fair game and that everybody has an equal chance to win or lose. People seem to feel that for the matter to be settled, somebody is going to have to go to jail.”

Average daily trades at Charles Schwab in April came in at 192,900, down from 235,000 a year earlier and a high of 420,100 trades daily in March 2000. Moody’s, tracking the first five months of 2002, Only 21% of respondents expect higher incomes in six months, according to Moody’s. That is below the 25.7% average from 1996 to 2000 and below the 23.9% of a year ago. (What If Investors Won’t Join the Party? NYTimes, 6/2)

Annual Reports Continue Spin

Despite the call for improved disclosure, annual reports look like business as usual, according to a report by Reuters. “Most corporate reports have become an exercise in spin, offering cheery photos of balding executives with big smiles and reams of only thinly interpreted, financial boilerplate.” Maybe we’ll see better reports next year if the SEC adopts new rules requiring more and timelier reporting on accounting policies and trades.

“Companies will wait for more guidance from the SEC and the exchanges before they do anything more than they absolutely, positively have to,” says Nell Minow, editor of The Corporate Library. “They still just haven’t learned that the one who provides the best, clearest, most accessible information wins.” (U.S. corporate reports yet to heed Enron’s lessons, 5/31)

4th World Congress on Environment Management

7-9 June 2002 in Palampur, Himachal Pradesh (India). The Congress will be inaugurated by Noble Laureate His Holiness the Dalai Lama. Help create a blueprint for good corporate governance which creates long term value for all stakeholders by mobilizing not only the physical capital but also the human capital, social capital and natural capital.

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