August 2002

Board Services Grow

Houlihan Lokey Howard & Zukin introduced a new Board of Directors Advisory Service to support outside directors with their increasingly demanding fiduciary duties. Houlihan Lokey will assign a team of investment bankers to provide information, analysis and advice to board members. The Service will review information supplied by clients, analyze the companyís financial situation and stock performance, track institutional investor and market analyst views on the company, review accounting issues, coordinate other board advisors and facilitate communication between the board and management. “By providing an independent source of information, analysis and advice, this service will allow directors to effectively spend their time on important corporate issues and, at the same time, facilitate communication between the board and management,” a spoksman said.

Tip of the Iceberg

How Companies Lie: Why Enron Is Just the Tip of the Iceberg, by A. Larry Elliott and Richard J. Schroth, contend that “gamesmanship has replaced business management competence as executives and their boards have focused on managing the stock first, the business second and strategic value last.” The authors argue for greater SEC authority to review corporate books and accounting practices. At bottom, however, the burden is on investors to display a healthy skepticism toward all financial reports. (Ed., such skepticism might lead investors to take a stronger role, for example, in choosing the company’s auditor) They focus on five areas for reform:

  • Accurate and verified communications
  • Full disclosure of conflicts of interest
  • Real-time accounting and real-time reporting
  • Straightforward accounting rules
  • Real accountability by executives.

SEC Petitioned to Strengthen Environmental Disclosure

Led by the Rose Foundation for Communities and the Environment, foundations with more than $3 billion in aggregate invested assets petitioned the SEC on 8/21/02 to improve requirements for accurate and consistent disclosure of environmental risks.

To clarify the intent of the SEC’s material disclosure requirements and help ensure compliance with existing material financial disclosure requirements, the foundations urge the Commission to adopt the standards for estimation and disclosure of environmental liabilities developed by the American Society for Testing and Materials International (ASTM).

“These standards, which were developed by a consensus process conducted by one of our nation’s leading engineering organizations, provide guidance to companies for the accurate estimation of environmental liabilities and explicitly require reporting companies to aggregate environmental liabilities to determine whether they exceed the SEC’s materiality threshold. The ASTM’s development of these standards has been backed by the insurance industry, in response to the current paucity of information about the financial significance of environmental liabilities.

Disclosure consistent with the ASTM standards would provide investors with standardized information critical to their evaluation of the financial risk associated with a company’s environmental liabilities. Complete and accurate disclosure of financially material environmental risk furthers the Commission’s mission of protecting investors and the public and protecting and restoring public confidence in our markets and in publicly traded companies.”

The petition was signed by the following:

  • Alaska Conservation Foundation
  • As You Sow Foundation
  • Beldon Fund
  • Bullitt Foundation
  • Columbia Foundation
  • Compton Foundation
  • Conservation Land Trust
  • Deep Ecology Foundation
  • Educational Foundation of America
  • French American Charitable Trust
  • Gaia Fund
  • Richard & Rhoda Goldman Fund
  • Gordon Lovejoy Foundation
  • First Nations Foundation
  • Needmor Fund
  • Andrew Norman Foundation
  • Jessie Smith Noyes Foundation
  • Rockefeller Family Fund
  • Rose Foundation for Communities & the Environment
  • San Francisco Foundation
  • The Seventh Generation Fund for Indian Development, Inc
  • Surdna Foundation
  • The Tides Foundation
  • Wallace Global Fund
  • Weedon Foundation
  • William B. Wiener, Jr. Foundation
  • Wilburforce Foundation

This is an important step forward for activism among foundations and, if enacted, will do a great deal to ensure environmental liabilities are reflected in share price. When that happens, we expect corporations will be much better environmental stewards and there will be a stronger correlation between environmentally responsible business practices and corporate profits. According to a 1998 study by the Environmental Protection agency, nearly three-quarters of companies who were fined more than $100,000 for environmental violations failed to tell the SEC in their annual filings.

We urge readers to support this petition by writing to Mr. Jonathan G. Katz, Secretary, U.S. Securities and Exchange Commission, 450 Fifth Street, N.W., Washington, DC 20549 or e-mail Mr. Katz at, indicating that you support the petition to improve requirements for accurate and consistent disclosure of environmental risks submitted by the Rose Foundation for Communities and the Environment and others.

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Profits Down, CEO Pay Up

Even as corporate profits fell 13% in 2001, CEO pay rose by 7%, according to a survey by consulting firm Mercer.

The survey, which looked at 350 of America’s largest corporations, found hat the rise in pay was mainly due to stocks and stock options. In 2001, stocks made up 59% of top executives’ pay, up from 57% in 2000 and 44% in 1997, according to the Mercer report.

CEOs at 23 corporations under investigation for improper accounting pocketed $1.4 billion, or an average of $62 million each, in the last three years. Meanwhile, their companies’ stock values plunged $530 billion, or about 73% of their total value, and their companies laid off a total of 162,000 workers.

Those are key findings in the ninth annual CEO compensation survey of large public companies by United for a Fair Economy and the Institute for Policy Studies.

Additionally, corporate profits reported to the Internal Revenue Service fell from $660 billion in 1996 to $658 billion in 1998, while profits reported to shareholders rose from $753 billion to $817 billion over the same period. (see Statistics on CEO compensation show opposite of pay for performance, 8/26/02, The Kansas City Star)

16 Companies Missed SEC Deadline

The results are in, and 16 of the 691 companies required to certify their financial statements with the SEC by August 14 failed to comply. (The rest must certify by December).

Delinquent companies include: ACT Manufacturing, Adams Resources & Energy, Adelphia Communications, Alaska Air Group, CMS Energy, Consolidated Freightways, Dynegy, Enron, Gemstar-TV Guide, IT Group, McLeodUSA, Mirant, Qwest Communications International, LTV and TruServ. Only IT Group didn’t at least file an excuse.

The SEC has not yet decided what it will do to punish the companies that failed to comply with the certification order.

Jump in Board Turnover Expected

The boardrooms of Fortune 1000 companies could see a director turnover of as much as 50% over the next year, according to executive recruiter Christian & Timbers. “We are getting flooded with calls for board searches as more and more executives ask to be rotated off,” said Christian & Timbers Chairman and CEO Jeffrey Christian. “Many do not want to return to the board.” Christian said that in the post-Enron corporate culture, many directors regard the risk of serving on a board as not worth the rewards.

Recent governance reforms, such as the Sarbanes-Oxley bill, have also increased the overall responsibility of directors, with new requirements for paperwork, conference calls, and committee meetings. Roger Raber, president of the National Association of Corporate Directors, said the average yearly commitment for each board seat is 175 to 200 hours, up from 100 to 125 hours in 1999, often compelling director who once sat on three boards to choose only one.

Stephen Mader, president and chief operating officer of Christian & Timbers, believes the turnover is ultimately positive. “To us this is really a constructive process,” said Mader, “We think that it will open the door for many better motivated directors. Boards are going to have a much better profile of members.” (, 8/14)

Momentum For Expensing Options Grows

No, the major high-tech firms haven’t endorsed expensing options, but they have started to bend. TechNet, a Palo Alto based trade association, whose 250 members include Intel, Microsoft, Oracle, Cisco Systems, and Hewlett-Packard, is considering a new proposal put forth by Intel: “quarterly impact sheets” detailing the number of option grants, the timetable for exercising them, and the potential effect on the corporate bottom line. The group is also considering requirements that executives hold options for five years before exercising them and restrictions on executives’ ability to sell shares. says “the group’s new tactic represents a tacit acknowledgment by the technology industry that support for expensing options among accounting industry groups like FASB, lawmakers on Capitol Hill, and institutional investors has reached a critical mass.” reports that at least 76 public companies, including General Motors, General Electric, Merrill Lynch, American Express and Home Depot have announced that they will expense options in their next fiscal year. (Will Tech Companies Join the Options Parade? 8/26)

Corporate Reincorporation/Inversion/Expatriation

However termed, when done for tax avoidance, companies should be called on it. The August 19th issue of Pensions&Investments carried an editorial objecting to Phi Angelides’ recent efforts to have CalSTRS and CalPERS divest stocks of companies that move corporate registration offshore to avoid US corporate income tax. Pension&Investments argues these firms are simply using legal means to avoid double taxation, once in the country in which profits were earned and again in the US.

The editorial argues that moving to Bermuda simply puts US firms on an equal footing with foreign competitors and increases their ability to continue employing thousands of US workers. “Mr. Angelides either too thick to understand this…” should be using his clout to lobby to eliminate the double taxation of foreign earnings.

While it is true that corporate income tax laws could use a makeover, the picture painted by the editorial falls far short of realism. Companies not only avoid double taxation but can shift their debt disproportionately to their U.S. subsidiary and then deduct interest payments from taxes. As reported in the Washington Post, Stanley Works predicted its move to Bermuda would cuts its taxes by $30 million a year. Only $7 million was due to taxes on foreign income.

It is entirely appropriate that public pension funds avoid investments in companies that avoid paying the taxes that support pension fund members and the state budget. Public pension funs should no more tolerate such blatant tax avoidance by firms in their portfolio than unions should support companies that lock their members out of work.

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Broker Voting Issue Continues

The New York Times carried an article recently that called to the importance of proxy voting. The author, Gretchen Morgenson, praised the New York Stock Exchange for submitting new rules to the SEC requiring all listed companies to put proposed stock option plans to shareholder votes. However, brokerage firms are still free to vote for shareholders on many important issues:

  • election of auditors and directors,
  • proposals to increase the number of shares authorized for issuance,
  • social issues, and
  • compensation schemes that are not related to stock options.

How significant are broker votes? ADP Corporation, which practically has a monopoly on tabulating proxy votes, says that 23% of the votes in the most recent proxy season were cast by brokerage firms that lacked instructions from the true owners of the shares.

As expected, small shareholders with a 1,000 shares or less voted least frequently, 41.5% of the time. But institutional holders (which estimated were those with more than 50,000 shares) who have a fiduciary duty to vote, only voted 72% of the time.

“As long as brokerage firms vote the shares with management, the opposition of shareholders to an issue raised in the proxy will be overridden. The current broker-vote rules, combined with investor apathy, mean that shareholder votes are unlikely to represent what most of the owners want in contested situations.” Those of advocating more democratic corporate governance need to continue to press to eliminate broker voting, except for the purposes of obtaining a quorum. (See “Pick Up the Proxy, Fill It Out and Exert Some Control,” 8/25)

Mutual Fund Industry Calls for Expensing Stock Options

Reality is setting in. The Investment Company Institute, the national association of mutual funds, urged the Financial Accounting Standards Board (FASB) to adopt accounting standards requiring companies to treat stock options as an expense and ensuring uniformity in how those options are valued.

“The mutual fund industry, on behalf of millions of individual investors, invests nearly $4 trillion in equity and fixed-income securities issued by U.S. corporations. Expensing stock options will benefit investors and enhance our nation’s reputation for having the most rigorous accounting and disclosure standards in the world,” said Institute President Matthew P. Fink. (seepress release and letter of 8/21/02)

CalPERS Adopts Conflict of Interest Reforms

The California Public Employees’ Retirement System (CalPERS) adopted reforms at the urging of state Treasurer Philip Angelides that will require banks to root out potential conflicts of interest if they want to do business with the largest US public pension fund. CalPERS will give “significant consideration” to the reforms in hiring money managers to pick stocks and bonds, though it won’t necessarily make the reforms a condition of hiring.

The principles call for brokerages to separate analyst pay from investment banking revenue, create a committee to review and approve all stock recommendations and ask brokerages to disclose whether they have been paid by companies they research. Ted White, director of corporate governance at CalPERS, said staff will send a copy of the guidelines to money managers asking them how they will comply.

The rules were drafted jointly by officials from California, New York and North Carolina in response to recent disclosures of conflicts of interests among investment houses. For example, Pacific Corporate Group, which advised CalPERS to invest more than $750 million in Enron, also earned fees from Enron for locating investors. (see CalPERS rules to prevent conflict of interest , SFGate, 8/20 and CalPERS Adopts Reforms on Conflicts, LA Times, 8/20)

Open Ballot Movement Grows: Holy Grail of Corporate Governance in Reach?

The 8/19 issue of Pensions&Investments includes an article entitled “Wisconsin fund could lead charge for open balloting” by Barry B. Burr. “The State of Wisconsin Investment Board may make open access to corporate proxy ballots – allowing shareholders to place candidates for directors on the ballots – one of its key corporate governance focus issues for the next proxy season.”

The article goes on to mention a call by the Social Investment Forum to the SEC to consider a two candidate minimum and to develop a way for corporations to include shareholder nominees (see nyseletter.html). It also mentions the rulemaking petition to the SEC to require shareholder-nominated director-candidates to appear on the corporate proxy ballots, which I submitted, along with Les Greenberg and the Committee of Concerned Shareholders.

Although Patrick McGurn of Institutional Shareholders Services is quoted in Pension&Investments saying ballot access is “the Holy Grail of corporate governance,” he also points out that “you don’t want 1,000 names on the ballot” and the “feasibility of the idea depends on the details.”

Charles Elson of the University of Delaware’s Center for Corporate Governance says “the solution is an independent nominating committee and independent directors.” TIAA-CREF’s Kenneth Bertsch says they’re interested in hearing ideas but it’s not clear “democratic style election(s) would be worth the conflict and confusion.” Richard C. Ferlauto, of the American Federation of State, County and Municipal Employees says the 2003 season presents an opportunity to rise the issue of “access to the corporate proxy ballot.”

I wish SWIB and AFSCME luck with any plans to raise the issue at individual firms during the next proxy season. I’ll certainly be voting with them but I fear the SEC will simply write a lot of no action letters because of the very rule we have petitioned to change – Rule 14a-(8)(i)8, which prohibits resolutions relating to elections.

Pat McGurn is right, details need to be worked out concerning just how shareholders should get access to the ballot. Our petition could have suggested rules requiring that nominees show the support of shareholders holding at least 1% of the firm. Of course, McGurn could then come back and say you don’t want 100 names on the ballot either. We’re hoping SIF’s letter and our formal petition will result in a flood of letters, cards and e-mails to the SEC, not only supporting shareholder access to the corporate ballot, but also providing detailed suggested amendments. Our petition is one of the opening salvos but it’s a formal request, which I believe requires formal consideration and response by the SEC.

When starting negotiations I don’t think its a good idea to raise the bar too high. That’s why we left the threshold just where it is for resolutions. We generally don’t see 1,000 resolutions on each corporate ballot, although we might get a dozen on some next year.

I think this could be a great debate and I hope some of the ideas spill over into civic elections. If we’re afraid of too many candidates, one way to make the elections more workable would be to institute Instant Runoff Voting. Using IRV there are no wasted votes because you rank the candidates and your votes for losers are instantly reallocated until a consensus winner is chosen. With IRV you could have voted Nader, for example, without throwing the election to Bush.

As C. Russel Hansen, Jr. points out is his August newsletter from “None of the current regulatory proposals changes “who effectively nominates or can veto a director candidate (the CEO), who controls the preparation of the proxy statement (the CEO/CLO), who manages the election meetings and voting process (the CEO/CLO), who effectively determines or can veto director compensation (the CEO), who cuts the director compensation checks (CEO/CFO), who cuts the expense reimbursement checks (CEO/CFO), who cuts the checks to the auditors (CEO/CFO), who cuts the checks to the audit committee advisors (CEO/CFO), who develops the budget, including the piece dealing with board expenses (CEO/CFO) or who procures and pays for the D&O insurance (CEO/CFO).”

Hansen ends his article on “CEO-Centric Boards After the Sarbanes-Oxley Act of 2002” with the following: “…as long as (1) a director’s election, compensation and protection remain in the hands of (or at least preventable by) the CEO, (2) the CEO performs his or her side of the unwritten covenant to nominate, elect and protect, (3) the board likes it like that, (4) the board looks to management to staff the board and committee workload and (5) the underperforming board dragon looks dead, then Sarbanes-Oxley-NYSE-Nasdaq leave the CEO-centric board very much alive and quite well — indeed healthier than ever.”

Shareholder access to the company proxy is as close as we can get at this point to the Holy Grail. Write Mr. Jonathan G. Katz, Secretary, U.S. Securities and Exchange Commission, 450 Fifth Street, N.W., Washington, DC 20549 or e-mail Mr. Katz at, indicating that you support the petition for democracy in corporate elections submitted by the Committee of Concerned Shareholders and James McRitchie, Rulemaking Petition File No. 4-461. Let him know of any amendments you favor. Or, write supporting the SIF letter of 7/24/02. Don’t let the momentum die.

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What You Must Know About Corporate Governance

This book is timely, coming on the heels of the 2002 King Report (King II) and of an increased interest in corporate governance as a result of Enron, Global Crossing and other failures due to corruption and incompetence. From the forward, “If South African companies are to compete for international capital and if much needed jobs are to be created through increased direct foreign investment, behaviour in our boardrooms must be beyond reproach.” The 2000 McKinsey & Company study is cited to reinforce the message that more than 80% of global institutional investors are willing to pay a premium for shares in well-governed companies.

In about 150 pages, corporate managers, secretaries, board members, advisors and investors get a tidy summary of the most essential principles and practices of corporate governance, with a focus on South Africa but with a great deal of applicability in any country using an Anglo-American model (here termed the Anglo Saxon model). The book weaves its tale around King II, which was made public in March of 2002.

After a brief introduction, focusing on the historical development of the corporation, corporate governance (mostly citing the eminent R. I. Tricker), as well as Cadbury and King reports, the book addresses “Strategy and Its Implementation.” Here, the authors point out the duties of executive management vs. those of the board, ensuring the strategy is well formulated and executed. Wixley and Everingham stress the importance of have an independent board with a variety of perspectives “so that a disinterested voice will be heard on any subject of importance.”

The book moves from there to:

  • selecting board members,
  • expected behavior of individual directors,
  • duties of directors and how they function as a group,
  • board committee structures,
  • financial reporting and communication,
  • assessment of risk and internal controls,
  • accountability re financial information,
  • reliability via external audits and internal audits,
  • non-financial information and
  • applicability to the public sector.

Each chapter includes relevant examples from real life. Although the authors closely follow the King report, they do not hesitate to provide advice on controversial subjects not addressed by those reports, such as advocating that options not be repriced and that by should be expensed. “Our view is that the interests of good corporate governance would be well served by accounting for the cost of share options granted as an expense in the company’s income statement.”

Perhaps unique to the King Report, among corporate governance standards, is its treatment of the HIV/AIDS pandemic, recommending that each company describe their strategy, plans and policies. What You Must Know About Corporate Governance is written by Tom Wixley and Geoff Everingham, published by Siber Ink, Cape Town, South Africa, 2002.

Corporate Attorneys Owe Duty to Shareholders, Not Management

In a speech to the American Bar Association’s Business Law Section, SEC Chair Harvey Pitt said, “Outside auditors owe a duty to shareholders and the investing public to assure that a company’s financial reports are reliable and truthfully prepared. Similarly, lawyers who represent corporations serve shareholders, not corporate management.” “This should be self-evident,” he noted. “But recent events indicate some corporate lawyers have lost sight of this axiom, a form of professional blindness that isn’t new….” (see Corporate Attorneys Have Role Similar to Auditors, Says Pitt,, 8/13/02)

Profit From Vice launched the Vice Fund, a no-load mutual fund described as the “first and only open-end mutual fund to invest primarily in “socially irresponsible” industries,” such as alcohol, gambling, tobacco and the weapons industry. In SEC filings the Fund contends that companies in these industries, if managed correctly, will continue to experience significant capital appreciation during good and bad markets. According to the Vice Fund, over the five-year period June 30, 1997, to June 30, 2002, an individual simply investing 25% into each of the alcohol, tobacco, gaming & casino, and aerospace/defense sectorswould have outperformed the S&P 500 index (earning 52.96% versus 11.83%, according to the firm).

Cross My Heart and Hope to Die

That’s what Nell Minow calls the new SEC requirement. Corporations have long been liable for penalties for knowingly filing false or misleading material information. This time, of course, corporate executives really mean it.Just the same, criminal charges will still require proof the officer “knowingly” submitted false reports, which is no different from current law. A recent article Motley Fool article walks readers to the new requirement. See “CEOs Signed. So What?” The SEC says that nearly all of the 697 companies that were ordered to file certified statements about the accuracy of their financials met their 8/14 deadline. More than two-dozen companies failed to certify fully or asked for postponements.

By the end of the year, all 14,000 companies overseen by the SEC must certify their financials, including foreign issuers of debt and equity, under provisions of the recently signed Sarbanes-Oxley Act, which will become effective by 8/29. The typical D&O policy has a dishonesty exclusion, which means that insurers do not have to pay on behalf of a director if he/she is proven to have committed fraud. However, insurers may still have to pay defense costs up until the point that any fraud is actually proven. It is only at that point that insurers can try to claim the money back from a director found guilty of fraud. Expect insurance costs to rise.

Kill the Corporate Dividend Tax

I don’t often favor lowering taxes on corporations, but this idea looks good. It comes from Jeremy Siegel, author ofStocks for the Long Run: The Definitive Definitive Guide to Financial Market Returns and Long-Term Investment Strategies, Andrew Metrick and Paul Gompers. Since interest costs, but not dividend payments, are deductible, management is inclined to raise debt and retain earnings. This tax treatment and CEO dependence on option-based compensation schemes contributed to capital gains, not dividends becoming the preferred source of shareholder return.

If dividends were deductible and retained earnings expensed, corporations would be motivated to pay profits out as dividends. The incentive to take on massive debt, risking bankruptcy, to gain a tax deduction and build management’s power base would be reduced. The emphasis on dividends, rather than capital gains, would reduce use of stock options. Here, I’ll add my two cents, if stock options were also required to be expensed, awards to management and employees would soon be made in shares, rather than options…thus, to some extent, aligning the interests of shareholders, management and employees.

Siegel, Metrick and Gompers also note eliminating the corporate tax on dividends would reduce the number of firms who seek to re-incorporate outside the US in order to shield foreign-earned income US taxes, since they could avoid taxes on foreign-earned income simply by paying out their profits as dividends. Their proposal would also reduce the propensity to over-allocate company stock in employee 401(k) plans since all dividends, not just those in such plans, would be deductible.

Caveats: The authors envision greater use of dividend reinvestment plans (DRIPs), subject to the personal income tax. Secondary offerings would become more common source of raising capital. Firms with good investment prospects would find easy access to additional capital if they released adequate information about expansion strategies.

Although corporate tax revenue be reduced, some losses would be recouped through increased personal taxes on dividends. Additionally, if their corporate dividend exemption idea is adopted, they favor eliminating all other corporate tax credits. “Elimination of these loopholes would not only simplify the corporate tax but should sharply reduce corporate influence-peddling and lessen some of the all-too-cozy ties between politicians and big business.” (A Simple Solution to Stock Market Woes: Kill the Corporate Dividend Tax, Knowledge@Wharton Newsletter, 8/14-27/03)

Banks Sold the Ponzi Schemes

Wall Street banks sold public investors – especially pension funds, a bill of goods – $20 billion worth of “investment grade” WorldCom bonds that protected the banks from their own credit exposure are now worthless. Read more at the Corporate Governance Fund Report, where Institutional Investors are “Pushing Back.” 

Verification Specialists

Fred S. Golden has joined the Corporate Governance Network. His firm, Verificaiton Specialists, can can lead you through the maze of requirements and regulations that now govern the Audit Committee, especially as a result of the new Sarbanes-Oxley Act.

DB Plans Drop 6%, DC Plans 8%

Pensions&Investments reports that defined benefit plans kissed goodby to $208 billion and defined contribution plans $98 billion since September 30th due to the falling market. Defined contribution plans were harder hit because they had a higher percentage of their funds in equities (61.7% v 56.9%). Corporations will no longer be able to carry pension plan funding on the back of investment returns.

Shifting Currents

Forget about global warming and sweatshop labor. This year’s crop of shareholder resolutions is all about excessive chief executive pay and squeaky-clean accounting. The new battleground is corporate governance…making sure company executives don’t cook the books and enrich themselves at the expense of shareholders. We can expect much more of the same next year.

Several comentators on the NYSE amendments pointed out that “the election of directors is currently not a democratic process. This is problematic, as directors represent shareholders, not management. In only the rare circumstances of proxy fights do shareholders get to vote in competitive Board elections. In the current system, the directors nominate and elect one another, with shareholders playing a passive role of rubberstamping nominees.” (Adam Kanzer, General Counsel & Director of Shareholder Activism, Domini Social Investments LLC) We’re starting to get a few signatures for our petition in support of Democracy in Corporate Elections. Activism pays.

Cood Governance Pays in Italy

Does good corporate-governance pay? A new stock maket, he STAR exchange, launched in April 2001 by Italy’s Borsa Italiana for companies that follow a strict set of governance requirements provides more evidence that it does. Listed companies must have a minimum number of independent, nonexecutive directors; ensure that the compensation of managers and directors reflects their performance; and adhere to rigorous disclosure requirements. Companies on the STAR exchange outperformed those on the main board by 16.5% and had a weighted average market-to-book ratio of 3.8, compared with 2.1 on the main exchange. (The McKinsey Quarterly, 2002 Number 3)

Shift to Quality and Away from Risk Means Shift to SRI

The Social Investment Forum and fundtracker Lipper indicate that US investors are pulling money out of most mutual funds but are increasing allocations into socially responsible investment (SRI) funds. Between January and June 2002, SRI fund assets grew 3% while US diversified funds averaged a 9.5% loss. When the S&P 500 lost over 13% in June and diversified funds suffered net redemptions of $13 billion, SRI funds saw net inflows of $47 million.

“The market faces a real crisis of credibility caused, in part, by a seemingly endless procession of corporate scandals,” according to Social Investment Forum President Tim Smith. “Socially and environmentally responsible mutual funds use their influence to promote more corporate responsibility through resolutions, dialogue and encouraging reforms in corporate governance. When you combine that far sighted leadership with good relative performance, screened funds are an increasingly attractive alternative for many of the nation’s investors.” The public is searching for quality and lower risk; 13 of 18 socially or environmentally responsible funds with at least $100 million in assets achieved top performance rankings from Morningstar and/or Lipper for the one and three year period ending June 30, 2002. (Investors Continue to Put Money into SRI Mutual Funds 8/1/02)

Yet even SRI funds are getting nailed. It is one thing for a fund to determine whether a company is, say, a weapons maker. It is quite another to detect whether a company is quietly playing games with its numbers. Better screens are needed. Not everyone can agree that making weapons isn’t socially responsible. However, most would agree that accounting fraud and excess CEO pay shouldn’t fit into the SRI mold.

Computer Associates Sued for Paying Greenmail

Chevra Machzikai Torah, a Brooklyn, New York-based non-profit organization, filed a lawsuit against Computer Associates International and its directors, seeking a refund of the $10 million paid to dissident investor Sam Wyly to call off his proxy fight. The suid claims CA’s 12 directors breached their fiduciary duty in the pay-off agreement, which stipulates that Wyly must not launch another bid for a CA board seat for 5 years. The suit alleges that the payment was made so the existing directors and managers can keep their jobs. It damaged CA’s share price as well as its reputation. (News Briefs,The Corporate Library, 8/6/02)

India Places Last

A McKinsey & Co. survey of 188 companies from a cross-section of emerging markets placed India last in terms or transparency. The survey looked at the emerging economies of India, Malaysia, Mexico, South Korea, Taiwan, and Turkey. South Korea earned the highest score as the emerging market that had adopted the highest quality corporate governance rules or guidelines. Malaysia topped the list with a score of 81 in disclosure and audit quality. (News Briefs, The Corporate Library, 8/6/02)

Questioning the Call for More Shareholder Power

In a recent posting with the above title, Russell Mokhiber and Robert Weissman take a page from Marjorie Kelly’s excellent book, The Divine Right of Capital. “A common diagnosis of the current scandals is that they can be traced to company executives’ ability to function with little accountability to shareholders. An alternative view is that the problem was that executives were thinking too much about what shareholders want.” No, shareholders didn’t want CEOs to rob them blind, but they did want share prices pumped up, “especially in the short term.” That assessment is on target, especially for many mutual funds with high churn rates.

“People are saying we need to align executives closer to shareholders,” Kelly says. “I believe their alignment was too close. We need a corporation that is accountable to someone besides shareholders.” To me, that would be society, enforced by governments. That’s what laws are for…they need to be enforced.

Kelly’s book contains many interesting ideas; Mokhiber and Weissman focus on “time-limited shareholding.” Shareholder control would be progressively transferred to employees, a public entity or a non-profit enterprise. Although they admit, such an idea is “far from immediate enactment,” they see possibilities in coming bankruptcies. (see Questioning the Call for More Shareholder Power, Russell Mokhiber and Robert Weissman)

I’ve long been a huge fan of expanding employee ownership and greater participation by employees in decision-making. At almost every opportunity, I remind readers that firms with these characteristics grow about 10% faster every year than the norm. We’ve built in employee ownership when restructuring through bankruptcy before, as in the Chrysler bailout; we could do it again. There may be cases where progressively transferring control of a corporation to a public entity makes sense, such as with private toll roads and sport arenas. However, keeping the bulk of a corporation’s shares available to the market also has advantages, such as liquidity and the ability to raise capital. In addition, if functioning properly, there are great advantages in having independent outsiders on the board of directors and the profit incentive is a great motivator.

The recent corporate implosion was not due to over-alignment between shareholders and management. Instead it was built on accounting gimmickry embodied in stock options. Because of business pressure on the FASB in the mid-nineties, the cost of stock options resulted in a 9% overstatement of earnings by the S&P 500. Among information technology firms in the S&P 500 the average overstatement due to the cost of options was 33%. Options are not an alignment between shareholders and managers. They are a usurpation of power in the form of heads I win, tails you lose. Options are a one way street, with plenty of upside potential but no downside risk. They motivate CEOs and other executives to undertake risky ventures and aggressive accounting practices. Long term value is out the window when all they need is a timely spike in the value of stock.

A study of 10 different industries by Jack Dolmat-Connell, a principal at Clark/Bardes Consulting, found that companies in which executives had large shareholdings performed significantly better that those in which ownership was small. “Southwest Airlines had high stock-ownership levels and good performance, while Delta Airlines had low ownership and poor performance. Likewise, Dell Computer had high ownership and good performance, while Apple Computer (Steve Jobs owns all of two shares in the company) had low ownership and much poorer performance.” (see Pay for Nonperformance?,, 8/1/02)

Contrary to Kelly’s assertion, shareholders don’t have too much power; they have too little. It was the Business Roundtable, an association of CEOs, not shareholders, that lobbied Congress to keep options “free.” It was CEOs, not shareholders, who have controlled corporate boards…even those with “independent” boards. Allow shareholders to use the company proxy to nominate and elect directors and we’ll see the beginning of truly independent boards. Require options to be expensed and we’ll see those independent boards move away from compensating CEOs with options and towards granting restricted stock. (see below, Options: Expensing and Restricting) (Sign Petition in support of Democracy in Corporate Elections. See our press release: Petition for Democracy in Corporate Elections)

Options: Expensing and Restricting

Citigroup has become the latest company to jump aboard the expensing bandwagon. Reports are they will begin expensing all stock options to management, employees and corporate directors in January, reducing next year’s earnings by 3 cents a share. When fully phased in over the next five years, it should cost about six cents a share.

Citigroup also announced that the bank’s CEO, Sanford Weill, and CFO, Todd Thomson, have personally certified the bank’s financial statements, thus meeting an SEC requirement that 900 of the nation’s biggest companies officially sign-off on a company’s books by August 14.

One of our readers, Thomas Ernst Huenefeld of Cincinnati, writes that sales of stock from exercised options by top executives need to be restricted until after they leave the company. He suggests they only be allowed to sell sufficient shares to pay their income taxes, until ninety days after they leave the company. (They wouldn’t be restricted from selling shares which they acquired in the open market.)

Mr. Huenfeld’s idea is excellent, although I’d favor even a longer restriction on sales…say two years after they leave. This would align the long-term interests of CEOs and shareholders, CEOs would place a greater emphasis on succession planning and we would expect a reduction in accounting trickery, since final compensation would be, at least in part, dependent on the next administration.

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AFL-CIO Supports Worker Access to Corporate Ballots

During a July 30 rally outside he New York Stock Exchange, AFL-CIO President John J. Sweeney announced the organization’s agenda, which calls for putting workers first, holding CEOs accountable, putting integrity back into the markets and ending corporate corruption of politics. “CEOs should no longer have access to company funds to run candidates for their board while worker funds have to spend their own money to elect independent directors.”

We hope the AFL-CIO will urge its members to support the Petition for Democracy in Corporate Elections.

“Cliff Notes” on Corporate Responsibility by Newsbatch

Can’t keep up with all the news? A summary on Corporate Responsibility has been added to The summary provides an in depth account of the major recent scandals, discusses proposals for reform and the extent to which the recent legislation passed by Congress has enacted these proposals.

Mckinsey & Company’s Latest Global Investor Survey, July 2002

Corporate governance remains of great concern for institutional investors, according to the 2002 Global Investor Opinion Survey released by McKinsey & Company, with strengthening the quality of accounting disclosure as the top priority.

Corporate governance is at the heart of investment decisions

  • Investors state that they still put corporate governance on a par with financial indicators when evaluating investment decisions.
  • An overwhelming majority of investors are prepared to pay a premium for companies exhibiting high governance standards. Premiums averaged 12-14% in North America and Western Europe; 20-25% in Asia and Latin America; and over 30% in Eastern Europe and Africa.
  • While the relative significance of governance appears to have decreased slightly since 2000, this highlights that (i) many countries have implemented governance-related reforms that have been welcomed by investors, and
    (ii) more than 60% of investors state that governance considerations might lead them to avoid individual companies with poor governance with a third avoiding countries.

Financial disclosure is a pivotal concern

  • In pursuit of better accounting disclosure, investors resoundingly express support for the introduction of a single unified global accounting standard, with 90 percent favoring such a move. However, investors are split down the middle on the preferred standard.
  • Investors are unified on expensing stock options in P&L statements, with over 80 percent supporting such a change.

Reform priorities focus on rebuilding the integrity of the system

  • Investment behavior is affected by a broad spectrum of factors, not just those at the corporate level. The quality of market regulation and infrastructure is highly significant, along with enforceable property rights and downward pressure on corruption.
  • After strengthening corporate transparency, investors believe companies should create more independent boards and achieve greater boardroom effectiveness through such steps as better director selection, more disciplined board evaluation processes and greater time commitment from directors.
  • Specific policy priorities include strengthening shareholder rights, improving accounting standards, promoting board independence and tighter enforcement of existing regulations.

See Global Corporate Governance Forum.

How International Are European Boards?

Based on the 101 responses received so far, the preliminary findings of the study are:

  • About 20% of executive and non-executive board members are not nationals of the country of incorporation;
  • Swiss and Dutch respondents have the most international boards, while German and Italian respondents are the least international;
  • About 15% of companies that responded have a non-domestic CEO; 10% a non-domestic Chairman;
  • Non-domestic CEOs and Chairmen are found most often among Swedish respondents;
  • In contrast all the CEOs and Chairmen of the German and Italian respondents are domestic.

See presentation by André Sapir, Member, European Commission Group of Policy Advisors, at the ECGI launch, Tuesday 15 January 2002 at La Maison de l’Europe at the Bibliothèque Solvay, Brussels.

Petition for Democracy in Corporate Elections

The Committee of Concerned Shareholders, and James McRitchie, Editor of CorpGov.Net, have jointly filed aPetition for Rulemaking with the Securities and Exchange Commission.

The Petition seeks to create corporate democracy and true accountability. Petitioners ask the SEC to amend its Rule 14a-8(i) so that ALL Shareholders, using the Shareholder Proposal process, will be able to nominate Director-candidates and the names of those Director-candidates must be placed on the corporation’s ballot.

The myth is that the Management reports to the Board. The reality is that the Board reports to the CEO. Strengthening the definition of “independent” Directors will have little impact, as long as they owe their positions to the CEO.

A corporation’s ballot is paid for with assets belonging to ALL Shareholders. Yet, under current Rule 14a-8(i), ONLY the names of Director-candidates nominated by the corporation appear on the corporation’s ballot. Shareholders are denied equal access to the ballot. Instead, Director-candidates nominated by Shareholders must go through an extremely expensive proxy solicitation process.

The present system is rife with conflicts of interest. Since Directors are beholden to Management and/or fellow Directors for their position, they will most likely not ask the “tough questions” of Management, even though they owe a fiduciary duty to Shareholders to ask those questions.

An investor from Germany recently summarized the current system. “When I have started to invest in the USA about 3 years ago I was sure that elections of directors are fair. … So when I have discovered that elections of directors of USA public companies are not democratic I was very surprised and disappointed. … This is EXACTLY how voting in communist countries worked. Everyone could vote, but there was just NO CHOICE of candidates. The point was not how to be elected, but how to get on the election list. With this system no changes were possible, so there was no motivation to improve the governance.” (Emphasis in original.)

The major barrier to democratic corporate elections is the fact that, under present SEC Rules, only the names of those persons nominated by the corporation are required to appear on the corporation’s ballot. The Committee of Concerned Shareholders and James McRitchie have petioned the SEC to amend Rule 14a-(8)(i)(8) to require that ALL nominees for Director positions, who meet the other legal requirements, be included in Corporate proxy materials.

Entrenched Managers and Directors will only improve corporate governance when they can be held accountable, e.g., voted out of office and replaced with Directors chosen by shareholders. Please join with us in this request to Jonathan G. Katz, Secretary, U.S. Securities and Exchange Commission. Please e-mail Mr. Katz at, indicating that you support the petition for democracy in corporate electionssubmitted by the Committee of Concerned Shareholders and James McRitchie.

SRI Funds Take Hold

Investor interest in socially responsible investment funds (SRIs) is running high. According to fund research company Lipper, overall, stock funds experienced outflows of $12.7 billion in June (net after new money is invested and redemptions are made). Yet, SRIs had inflow of $47 million during the same month.

Calvert will soon be screening model for corporate-governance problems, using data compiled by Institutional Shareholder Services. ISS ranks major companies on 51 separate measures from compensation to anti-takeover pills and independence of boards. Those with the lowest scores will be avoided.

Along with labor unions and pension funds, SRIs are quickly becoming the most active in the use of shareholder resolutions. Walden Asset Management’s resolution at data storage company EMC to make its board more independent, won support from 56% of votes cast in 2002, vs. an average 22.5% support for this type of proposal last year. (Not So Bad at Do-Gooder Funds, BusinessWeek, 8/1/02)

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