February 2004

Volume 12, Number 1

Corporate Governance: An International Review remains the world’s premiere academic journal on the subject under Christine Mallin’s capable editorial hands. The January 2004 edition includes a review of corporate governance rating services by Howard Sherman of GovernanceMetrics International and Nick Bradley of Standard & Poor’s Governance Services group, as well as reviews of tools and rating ideas in Germany and Greece.

An empirical study, “The Stock Market Reaction to the Introduction of Best Practices Codes by Spanish Firms,” finds the market reacts positively to announcements of compliance with the code of best practice that imply a major restructuring of the board of directors, whereas no wealth effects are observed for announcements that relate to isolated reforms recommended by the code. Another empirical study, “The Link Between Earnings Timeliness, Earnings Conservatism and Board Composition: evidence from the UK,” finds firs with a higher proportion of outside board members are more likely to recognize bad news in earnings on a timely basis, yet they don’t display greater reporting conservatism with respect to good news.

Along with several other feature articles, the Review also includes book reviews, including one by Marc Goergen on Mark J. Roe’s excellent Political Determinants of Corporate Governance, as well as a section entitled “Corporate Governance Update,” which attempts to highlight news around the world. No quarterly publication can keep readers up-to-date on world news. However, I always see items that I have failed to notice and it is always interesting to see what the editor includes.

Buy from Amazon.com Political Determinants of Corporate Governance

California May Trump SEC’s Move Toward Democracy

California’s Secretary of State Kevin Shelley sponsored legislation in California, introduced by Assemblymember Judy Chu that appears to go a step further than the SEC’s rulemaking, Security Holder Director Nominations, S7-19-03AB 2752 would require publicly traded corporations doing business in California to have election procedures meeting specified requirements, such as:

  • Shareholder eligibility: Corporate election procedures would allow shareholders or groups with more than 2% of the company’s stock held for 2 years to nominate directors. This compares with the SEC’s proposed requirement of a 5% threshold and without the “triggering” event to stall action.
  • Soliciting support: Companies would be required to make information available to shareholders no less than once per year regarding all individuals or groups interested in soliciting support to nominate candidates for the board. The notifications required by the corporation will better enable shareholder coalitions to form.
  • Deadlines and candidate information: Proxy statements shall include 250 word statements provided by director candidates. The proposed SEC rules require far fewer words and contemplates use of shareholder internet sites to convey information.
  • Candidate limits: Not less than 40% of the total number of directors on the board must be eligible for nomination by shareholders. The SEC proposal limits most companies to 1 or 2 shareholder nominated directors.
  • Nomination process: In order to have a nominee included in a company’s proxy statement and proxy card, the nominating shareholder or group must provide specified notice to the company, no later than 80 days before the company mails its proxy material.
  • Allowable restrictions: The procedures may include restrictions to restrict nominees who are not independent or are convicted criminals. “Independent” may need to be further defined but the law would not appear to preclude shareholder from nominating professional “relational investors” or turnaround specialists, unlike the SEC proposal.
  • A company’s proxy card shall identify shareholder nominees, and shall present the nominees in an impartial manner. Each candidate must be voted on separately. This provision helps to level the playing field.
  • If a company includes statements in its proxy statement supporting company nominees or opposing shareholder nominee(s), the nominating shareholder or nominating group shall be given the opportunity to include a statement not to exceed 500 words per nominee.
  • Companies would be required to make information regarding the process and deadlines to nominate and elect an individual to the board available on their website and in their annual report.
  • The Secretary of State shall, not later than December 31, 2005, provide access to the corporate election procedures by means of an online database. This provision would seem to require a substantial amount of work the Secretary of State. How would the possible need for an appropriation during California’s budget crisis impact the bill’s chances of passage?

Further, the bill would require that corporations doing business in California shall implement any shareholder proposal that passes by a majority vote, unless the proposal clearly states it is advisory. If a corporation establishes a means to place an advisory shareholder proposal on the ballot, it shall also establish a means to place shareholder proposals on the ballot that are required be implemented. The bill provides for fines of up to $100,000 dollars a day for every day a proposal is not implemented. Contact Information: Julio Martinez is staffing the bill for Assemblymember Chu. His office number is (916) 319-2049. Willie Guerrero, Assistant Secretary of State, is the contact within Kevin Shelley’s office. Please cc James McRitchie, Publisher of CorpGov.Net.

Letters should be directed to: Assemblywoman Judy Chu, State Capitol Room 2114, Sacramento, CA 95814 and Secretary of State Kevin Shelley, 1500 – 11th Street, Executive Office, Sacramento, CA 95814. The SEC got over 12,000 comments on their rulemaking. I hope Shelley and Chu can handle the mail this bill will generate.

Fiduciary College – Save the Date

Fiduciary College at Stanford Law School explores “best practices” for fiduciaries interested in discharging their responsibilities prudently and effectively. Learn from and work with experts from academia, government, and investment management, as well as seasoned pension, endowment, and foundation function practitioners.

Comcast and Disney

Communications Workers of America President Morton Bahr issued thefollowing statement recemtly:

We’re pleased that the Securities and Exchange Commission will allow Comcast shareholders to address the issue of disproportionate voting power and to call for reforms, as outlined in the shareholder proposal submitted by the CWA Members’ Relief Fund.

Comcast’s capital structure defies the most fundamental aspect of shareholder democracy – the principal of one vote per share. It gives CEO Brian Roberts and his family a 33-1/3 percent undilutable voting control even though they own less than one percent of the market value of the company.

This archaic structure, in which the family’s Class B stock holdings are given undue weight over Class A holdings, is more commonly seen at small companies – not Fortune 100 giants like Comcast. It gives CEO Roberts an effective veto power over shareholder initiatives and stifles accountability.

This issue is especially important in light of Comcast’s ongoing effort to take over the Walt Disney Co. Under terms of Comcast’s proposal to Disney, Roberts would continue to control one-third of the voting power of what would be one of the world’s most powerful media conglomerates.

Until this issue is settled, I can see no reason to vote in favor of the proposal to take over Disney. I also urge readers to withhold votes from Michael Eisner. From the ISS recomendation, “If there were ever a case for separating the roles of chairman and CEO, this company is the poster child. Were there a shareholder proposal on the ballot to separate those roles, we would support it.”

Kitchen-Table Vigilance

John Wasik, Author of The Kitchen-Table Investor and Retire Early and Live the Life You Want Now, argues that vigilant investors might have detected the troubles that besieged Parmalat, Enron and other companies whose accounting practices turned them into corporate pariahs if there had been greater transparency. “The momentum for enhanced corporate democracy is stronger than ever.”

Parmalat, for example, scored 2.5 out of 10 (6.5 was the median score) on a measure of board accountability. Only three of 13 Parmalat directors were classified as independent by GMI. A traditional response to the “unchecked power” of shuttered boardrooms has been increased government regulation.

Wasik notes that “unfortunately, that approach has limits and has never been totally effective against fraudulent activities. Corporate malfeasance, though, can be more effectively policed by more than 100 million global investors than by a handful of government agencies. Such vigilance often starts with a simple question: Is management operating in the best interests of shareholders?” (Could Investors Have Detected Parmalat, Enron Woes?: John WasikBloomberg, 2/16/04)

Editor: We couldn’t agree more. In the U.S. what’s needed is not more regulations requiring that companies tick off boxes. Instead, shareholders should be empowered to actively monitor. What better way for that to happen than to allow shareholders to play a much more significant role in nominating and electing directors?

Women Add Value

A study of 353 of the 500 largest US companies from 1996 to 2000, by BMO Financial Group and Catalyst, shows that companies in the top quartile in terms of having the most women executives showed a return on equity of 17.7% and a total return to shareholders of 127.7% compared to 13.1% and 95.3% for the bottom quartile, those with the lowest percentage of women among their top officers. (BusinessWeek 1/26,  Corporate Governance Alliance Digest, 02/17/04)

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Avoiding Shareholder Battles

Rob Norton’s “The SEC Opens the Boardroom to Unhappy Investors,” in the March/April edition of Corporate Board Member magazine, offers sound advice on what directors should do now to prepare for possible changes in nominating procedures that will give shareholders a little more power.

  • Move quickly to restructure the nominating process along the lines of the SEC requirements. Many boards have already instituted some of the required reorganization and disclosures, but many have done too little. In a survey of 150 members of the Business Roundtable conducted last June, for instance, a third of the companies said their nominating or governance committees had no process for communicating or responding to shareholder nominations of board candidates.
  • If your company has not already done so, take steps to demonstrate a readiness and willingness to add truly independent, tough-minded outside directors—the kind whose nominations assure shareholders that the company is genuinely interested in having a board that represents their interests as well as management’s. And make sure to communicate the company’s seriousness to the public and to institutional investors. Says Kerry Moynihan, a managing partner at the executive search firm Christian & Timbers: “Companies can inoculate themselves against unwanted nominations if they are seen as having a rigorous process in place to nominate directors who aren’t just the CEO’s golf buddies.”
  • Consider taking steps to avoid the triggering events that would enable shareholders to make the board open the proxy to outside nominees.
  • Reach out to shareholders. A less combative and ultimately more effective way to avoid having institutional shareholders propose their own candidates would be to make sure that lines of communication are open and effective. “Board members should make an effort to know who their shareholders are—which can be difficult,” says John Wilcox, vice chairman of Georgeson Shareholder Communications in New York. “Directors should then analyze what kinds of issues might be of concern to them, either through surveys or other kinds of research.” Says Charles Elson, director of the John L. Weinberg Center for Corporate Governance at the University of Delaware, “My advice to board members is: Communicate with your institutional holders, listen to them, and be sensitive to their needs. It’s as simple as that.”

Norton concludes with the following admonition, “if companies dig in their heels and fight the trend—and especially if corporate scandals continue—what the SEC has done so far with proxy access may turn out to be merely the beginning of a longer march toward making the nomination and election of directors less like the discreet boardroom protocols of the past and more like the rough-and-tumble battles of political contests.”

Real Reform of Nominations

Phillip Goldstein, President of Kimball & Winthrop, Inc., wrote one of the more interesting supplementary comment letters to the SEC regardingSecurity Holder Director Nominations, S7-19-03(comments. Through his usual wit, Goldstein asks the Commission to scrap its “proxy access” proposal and restart with a new objective. “All shareholders have a fair opportunity to vote for the nominees of their choice. The only way they can do that is if they are provided with a proxy card that includes all bona fide nominees.”

Goldstein recommends that new rules be modeled after Section 481 of theLabor-Management Reporting and Disclosure Act of 1959. Granting shareholders of publicly traded corporations the same level of voting rights as union members would “ensure the free exercise of the voting rights of stockholders and almost certainly would be upheld by a court as a valid exercise of the Commission’s rulemaking authority.”

Victory for Shareholder Democracy

Judge Richard J. Holwell denied a preliminary injunction sought by the MONY Group claiming that Highfields Capital Management’s inclusion of a duplicate proxy card in a campaign to defeat a corporate merger violated rules passed pursuant to section 14(a) of the Securities Exchange Act of 1934.

Holwell said that a bar could be seen as “frustrating the animating spirit that lies at the core” of the rule in question, which is intended to make it easier for shareholders to communicate without having to mount expensive battles. (Dissident’s Use of Proxy Card Exempt From Rules, Law.com, 2/14/04. Judge Rules in Favor of Opponents of MONY Takeover, NYTimes, 2/12/04)

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Lawsuit Threatens Speech at Shareholder Meetings

Cintas Corporation brought a defamation lawsuit against Timothy Smith and Walden Asset Management for alleged statements he made at their annual shareholders meeting accusing Cintas of supporting sweatshops.

Not only does such a move threaten to silence critics who will now fear expensive lawsuits, it also could put a serious damper on fun. Shareowners have one opportunity each year to confront managers with tough questions. Will frequent filers, such as Evelyn Y. Davis and John Chevedden, be forced into silence. Walden, which advocates “socially responsible” investing sponsored a resolution at the October 14, 2003 Cintas meeting asking the company to evaluate its vendor code of conduct and the compliance of off-shore factories and suppliers. The lawsuit seeks damages of at least $75,000, plus unspecified punitive damages and an injunction preventing Walden from making statements linking Cintas to Haitian sweatshops.

Shareowners who believe such a lawsuit is counterproductive might want to contact William C. Gale, Senior Vice President-Finance and Chief Financial Officer of Cintas Corporation at 513-573-4211. (Citizens Advisers Urges Cintas Corp. to Withdraw Defamation Lawsuit Against Shareholder Advocate, Shareholder Action Network, 2/12/04. Cintas sues for defamation, The Cincinnati Enquirer, 2/6/04) You might also want to post to the Yahoo! message boardeRaider, or elsewhere.

SEC RoundTable March 10th

The Securities and Exchange Commission will host a roundtable on March 10, 2004, from 9 a.m. – 5:15 p.m., to discuss the rules proposed by the Commission on Oct. 14, 2003, relating to Security Holder Director Nominations, S7-19-03. The proposals would, under very limited certain circumstances, require companies to include shareholder nominees for directors on their proxy ballot.

The roundtable will take place in the William O. Douglas Room of the Commission’s headquarters at 450 Fifth Street, N.W., Washington, D.C. on March 10, 2004. The public is invited to observe the discussion, and seating will be available on a first-come, first-served basis. It appears there will be many small panels with about a 10 minute time allocation to each person on the panel. The roundtable discussion also will be available via webcast on the Commission’s Web site. A final agenda and list of participants will be published in a press release prior to the roundtable discussion.

The Commission will accept comments regarding issues addressed in the roundtable discussion and otherwise regarding the proposed rule amendments from March 10, 2004 until March 31, 2004. Submit your comments to rule-comments@sec.gov. Be sure to refer to File No. S7-19-03 in the subject line. Comment letters will be posted on the Commission’sWeb site. Only include information that you wish to make available publicly.

For additional information, contact Lillian C. Brown or Andrew Brady, Division of Corporation Finance, at (202) 824-5250, or, with regard to investment companies, John M. Faust, Division of Investment Management, at (202) 942-0721, U.S. Securities and Exchange Commission, 450 Fifth Street, N.W., Washington D.C. 20549.

Compliance Webcast

Companies that focus on complying ONLY with the letter of the law may find themselves with bloated controls, burgeoning expenses, and enduring headaches. But corporate leaders who embrace the spirit of the law should see a re-energized company, reassured investors, and maybe even reduced costs. Research conducted by McKinsey Co. found that 57% of institutional investors said that good governance determined whether they increased their holdings in a company. Sign-up now for 2/5/04 2 PM ET broadcast. (Bridge to Excellence: Comply, Sustain and Improve)

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Investing in Firms With Good Corporate Governance Pays

Mutual funds that invest in companies with superior governance practices, such as the Sequoia Fund and Northern Large Cap Value Fund, tend to have better long-term returns, according to a study by Lipper Inc.

The 10 large-company value, core and growth funds with the best records of investing in good-governance companies had better one-, three- and five-year returns than their average competitor, said fund research company Lipper and GovernanceMetrics International, which rate corporate governance practices. However, funds with worse corporate-governance investments actually did better over one year, probably due to the technology stock rally in 2003. (Mutual funds benefit from strict governance, Contra Cost Times, 2/2/04)

CBS.MarketWatch.com’s Gadfly Gets It

After reading comments submitted on the SEC’s Security Holder Director Nominations, S7-19-03 rulemaking, self-described “gadfly” Michael Collins writes that “free elections are more likely in Iraq than at U.S. corporations.” See Fair Elections? Not for U.S. Companies (1/31/04, you’ll have to search for it). Collins sees through the Business Roundtable’s argument that CEOs should continue to play a larger role in choosing directors than “special interest groups,” such as pension funds and shareholders. Let’s hope others read his commentary and become enlightened. The movement seems to be growing. California Secretary of State Kevin Shelley, who oversees elections for public office, recently indicated that he wants a law forcing companies doing business in California to allow shareholders to nominate candidates for corporate boards of directors. (Fundamental change in corporate governance proposed, San Jose Business Journal, 1/19/04) See also Should Corporations Try Democracy?

GE, Striving for Average

General Electric was named the “world’s most respected company” for the six straight year in a survey of 903 CEOs conducted by PriceWaterhouseCoopers for the “Financial Times.” However, shareholder activist John Chevedden is battling for them to just reach average with regard to director independence. He beat back GE’s challenge to the SEC, so his proxy proposal will be in the 2004 GE proxy with minor changes.

RESOLVED: Shareholders request that our Board initially strive for and then at least maintain an average independence level for our Board. This proposal includes that, once adopted, if our company reverts back to the current practice, this will be subject to a shareholder vote.

Chevedden uses the standard from the Council of Institutional Investorsthat “A director is deemed independent if his or her only non-trivial professional, familial or financial connection to the corporation or its CEO is his or her directorship.”

By the Council’s definition, Chevedden believes the average Board at major U.S. companies is 70% to 80% independent. “This proposal requests that our board at first strive to be average and then maintain or exceed average. In 2003 our board was 59% independent” – considerably below average.

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