July 2004

Broadcom Settlement Pushes Democratic Corporate Governance

Under the settlement agreement, the cable modem chip maker will be one of only a few US companies that guarantee a board member will be nominated directly by its shareholders.

The agreement gives shareholders the ability to nominate candidates for one seat on the board, requires the board to obtain shareholder approval prior to granting executive stock options, mandates shareholder approval for the repricing of certain options held by directors and senior executives, and requires a majority of the members of Broadcom’s board of directors be independent. The pact also calls for the election of a lead independent director with broad authority and power.

Also included are enhanced internal controls, including mandatory quarterly financial reviews and the implementation of an internal audit function, as well as restrictions on the adoption of defensive measures and anti-takeover devices absent shareholder approval, including measures such as shareholder rights plans and the implementation of staggered board elections.

Four of the 63 settlements reached in class-action shareholder suits so far in 2004 have produced governance reforms, according to Bruce Carton, executive director of securities class-action services for Institutional Shareholder Services.

Secure Retirement a Thing of the Past?

The Center for Retirement Research at Boston College reports that 2002 pension participation was lower than it was in 1979. Some 46% of non-agricultural wage and salary workers, aged 25 to 64, in the private sector participated in a pension plan in 2002, down from 51% in 1979.

Men experienced a sharp decline at all earnings levels, correlated with a drop in union membership and employment by large manufacturers, while participation among women actually increased during the period driven primarily by more a shift to full time employment. In the top quintile of earnings, 65% to 70% of workers of both genders participated in pensions while that number plummeted to about 15% for men and 10% for women in the bottom earnings quintile.

The Empire Stikes Back

Nell Minow, cofounder of The Coporate Library and the most quoted and quotable of corporate governance experts recently noted, “We’re in the part of the movie where the empire is striking back.” “Certainly the corporate community is coming back very strongly to roll back or prevent reform.” Will corporations continue to be ruled by the “dark side” or will more democratic values finally be embraced?

The fact that the House voted to override a rule to require companies to expense stock options is not a good sign. The House vote was 312-111, with 198 Republicans and 114 Democrats voting for H.R. 3574 that would block a proposal by the Financial Accounting Standards Board, which would dramatically reduce the reported earnings of many big companies, especially those in the high-tech industry. Failure to expense stock options has often allowed such companies to report overinflated profits instead of losses.

Even Federal Reserve Chairman Alan Greenspan, far from a wild-eyed radical, told senators “I would be most concerned if Congress intervened.” Joining him are William Donaldson, Warren Buffett, and all of the Big Four accounting firms. The House-passed measure would limit required expensing of options to those owned by a corporation’s top five executives. It also would allow newly public companies to delay expensing for top executives in the first three years.

FASB Chairman Robert Herz said last month they may delay a final rule because corporate America already is facing deadlines to implement other new regulations enacted in 2002 in response to recent scandals.

New proxy access rules, Security Holder Director Nominations, S7-19-03,are also stalled. The rule, which would have allowed shareholders to place their own board candidates on company ballots in extremely limited circumstances, has been held back by SEC Chairman William Donaldson who appears to be caving due to pressure from the Business Roundtable, Chamber of Commerce and other CEO dominated organizations.

Lynn Turner, head of research at proxy adviser Glass Lewis and a former chief accountant of the SEC is quoted in TheSteet as saying “We’ve probably seen as much of a gain as is going to occur. Now the question becomes how much of that gain sticks.” “What’s indisputable is that business is pushing back hard,” said Rich Ferlauto, the director of pension and benefit policy for the American Federation of State, County and Municipal Employees union. “We haven’t stepped back from our agenda at all. There’s no going back.” (Backtracking on the Road to Corporate Reform, TheStreet.com, 7/20/2004)  Perhaps a new Administration would help.

Independent Directors Lower Fraud

A study published in the May/June edition of the Financial Analysts Journal found that having a high proportion of autonomous directors correlates with a drop in fraud. Board Composition and Corporate Fraudalso found the presence of “gray” directors, such as family members, increased the likelihood of wrongdoing.

ICGN Seeks Executive Director

“While the Board will expect the Executive Director to have plenty of ideas and initiative, it is important that the successful candidate does not see this as a political platform.” See the job specifications under What’s new…

Proxy Access Rule

On July 8th Phyllis Plitch, reporting for Dow Jones, said that “despite intense corporate lobbying, a Securities and Exchange Commission proposal to give shareholder director nominees a place on the corporate ballot is still alive.” The basis for the statement is remarks made by Martin Dunn, deputy director of the SEC’s division of corporation finance, at the American Society of Corporate Secretaries’ annual conference. “I don’t think it’s dead, I think it’s a work in progress.” We, and others have speculated the rule is dead until at least after the presidential election.

While CorpGov.Net has never taken a position on a government election, choosing instead to focus on corporate governance, we are seriously considering an endorsement of the Kerry/Edwards ticket. The Republicans on the SEC, other than Donaldson, have indicated their clear opposition to even the watered down Security Holder Director Nominations, S7-19-03 proposal. Jonathan Peterson reports in the LA Times, “opposition from the Republican-oriented business community is passionate. In contrast, both Sen. John F. Kerry, the expected Democratic nominee for president, and his chosen running mate, Sen. John Edwards, have endorsed the idea.”

Is Donaldson going to stand up to the U.S. Chamber of Commerce, which blasted the proposed rule as an attempt by unions and public employee pension funds to gain new leverage over corporate America? The Business Roundtable placed ads in major newspapers signed by chief executives of 40 large corporations, warning that the proposal would erode the independence of directors. (Shareholder Plan a Flash Point for SEC, 7/13/04) Of course, CEOs fear directors that will be independent from them and also accountable to shareholders. Or, as Charles Elson, head of the Center for Corporate Governance at the University of Delaware, stressed recently at the ICGN, directors need to be “independent of management, not independent of shareholders.” We still doubt the rule will move forward until after the elections and we are beginning to believe they will move forward only if Kerry and Edwards are elected.

CalSTRS Ups Profile

The Sacramento Bee reports that California Controller Steve Westly is pushing California State Teachers’ Retirement System to pressure the nation’s largest corporations to tie executive compensation to their companies’ long-term financial performance.

“When you have huge executive compensation at poor performing companies, something is wrong. This is no time to be giving people raises,” said Westly, a trustee of CalSTRS as well as the state’s other major public pension fund, CalPERS. Westly’s proposal for CalSTRS calls for:

  • Linking a large share of executive compensation to major performance goals.
  • Requiring shareholder approval of pay policies.
  • Calling for three-to five-year reviews of compensation programs.
  • Detailing executive contracts in easy-to-understand language.

In addition, Westly is asking CalSTRS to create a “watch list” to expose companies with excessive CEO pay packages. He also wants to promote companies with the best compensation programs.

“Good performance should be rewarded,” Westly said, though “you want to make sure you’re not rewarding poor performance at shareholder expense.”

Trustees of the $114 billion fund voted unanimously to start mapping out a game plan to corral huge compensation packages for high-level executives at the nation’s largest corporations. The trustees’ goal is to get companies to enact standards that keep executive pay in check.

“We want to send a proactive message that any company that is even close to being involved in products or services involved in torture is something we should not be profiting from,” Westly said. “We will not invest in companies that did not adhere to the Geneva protocols on torture.”

Executives from defense contractor CACI International Inc. plan to huddle with CalSTRS and CalPERS next month to explain the company’s role providing interrogators to Iraq prisons. The torture allegations could cause financial risk for the funds, which own a combined 286,982 shares in the company based in Arlington, Va. (Controller targets exec pay, 7/7/04,CalSTRS weighs anti-torture policy, 7/8/04)

Donaldson, We’re Still Waiting

The Washington Post editorialized that the SEC did the right thing when it voted to make the boards of mutual funds more independent. “Mr. Donaldson’s Next Move” should be to move forward on the proposal to provide shareholders with the right to place director nominees on the corporate proxy in very limited circumstances.

“The chief result of this new rule would be that large institutional shareholders — especially the nation’s corporate-governance-minded public retirement funds — would gain a new tool to pressure managers. Companies that pay top executives lavishly despite mediocre performance would be the prime targets.” And the Business Roundtable, which represents those managers quite understandably wants them to continue to have a monopoly, along with the boards they tend to dominate, on nominating candidates for directorships. .

The Post doesn’t mention that institutional ownership of the S&P 500 has grown from 56% in the mid-nineties to 65% as of May 2004. However, the Post does observe, “It seems hard to imagine that an objective observer could oppose this proposal. Shareholders are the owners of public companies, after all.” Only slightly more than half (56%) of CEOs themselves recently reported that their directors were well prepared for board meetings. Even fewer – just 40% – said directors made an effort to learn about the company outside of board meetings. (Shareholder Activism Intensifies Spotlight on SEC Director Nomination Proposal, On Board, June 2004)

Can anyone really believe that directors nominated by shareholder would be less conscientious?

The Corporation: The Pathological Pursuit of Profit and Power

Joel Bakan has authored a book as well as a documentary movie. No, the movie isn’t as entertaining as recent documentaries by Michael Moore but Bakan isn’t overtly trying to influence current elections. Bakan briefly describes the historical evolution of the corporation from its small beginnings in the 1600s to its banishment by the English Parliament in 1720 through to its current domination of government and society.

Major points:

  • Corporations pursue their own economic interest regardless of harmful consequences to people and the environment, externalizing its true costs.
  • Governments have abdicated control by freeing corporations from legal constraints and granting authority over society through privatization.
  • Corporate social responsibility. Although it accomplishes much, it is often a token gesture, and temporary, masking the corporation’s true character.
  • Corporate governance, no matter how reformed, appears to leave us with an undemocratic one share, one vote, not one person, one vote.

“Dodge v. Ford still stands for the legal principle that managers and directors have a legal duty to put shareholders’ interests above all others and no legal authority to serve any others.”

Shareholders can’t be held liable for the corporation’s actions because of limited liability. Directors are protected because they have no direct involvement in the decisions leading to crimes. Executives also escape liability unless they are proven to have been “directing minds.” That leaves the corporation itself and Bakan argues in favor of revoking charters.

“The notion that business and government are and should be partners is ubiquitous, unremarkable, and repeated like a mantra by leaders in both domains.” “Partners should be equals. One partner should not wield power over the other.” “Democracy, on the other hand, is necessarily hierarchical. It requires that the people, through the governments they elect, have sovereignty over corporations, not equality with them.”

Robert Monks sees pension funds as a “proxy for the public good” but Bakan argues that it is still one share equals one vote. Asked if Monks had reduced harms caused by corporate externalities at many companies he has helped reform, “his simple answer was ‘No.’”

“Deregulation is really a form of dedemocratization, as it denies ‘the people,’acting through their democratic representatives in government, the only official political vehicle they currently have to control corporate behavior.” The rising dependency on nongovernmental institutions as a substitute for governmental regulations is socialism for the rich and capitalism for the poor. “The corporations get all the coercive power and resources of the state, while citizens are left with nongovernmental organizations and the market’s invisible hand.”

“The corporation is not an independent ‘person’ with its own rights, needs, and desires that regulators must respect. It is a state-created tool for advancing social and economic policy. As such it has only one institutional purpose: to serve the public interest.”

In the final analysis, Bakan says he would rely on improving the regulatory system.

  • Staffing enforcement agencies at realistic levels, setting fines at a deterrent level, bar repeat offenders from government contracts, and suspend the charters of flagrant violators.
  • Regulations based on the precautionary principle.
  • Allow local governments to play a greater role in regulations, since they are “more willing and able to forge alliances with citizens groups around particular issues.”
  • Protect and enhance trade unions, as well as environmental, consumer, human rights and other organizations.
  • Phase out political donations by corporations and place tighter restrictions the on revolving door of personnel.
  • Proportional representation to encourage disillusioned citizens to participate.
  • Create a robust public sphere to protect that which is too precious to leave to corporate exploitation.

Although most of Bakan’s major points are valid, I’m not ready to give up trying to make corporations more democratic from within or more socially responsible through public and investor pressure.

Pension funds are something of a proxy for the public good and many are not run on one share one vote. At CalPERS, for example, members elect about half the board and the other half are elected by the public or are appointed by elected officials. Although it isn’t ideal, it comes closer to one person one vote than most other institutional investors and CalPERS has a record of fighting for many of the type of reforms Bakan advocates.

SRI funds may not operate as democratically as CalPERS or have as long an investment horizon (which considers externalities) but they do raise public awareness of needed reforms.

Bakan seems to want it both ways with nongovernmental organizations. On the one hand he says they are powerless, on the other he wants them protected and enhanced. Pushing regulations to the local level seems likely to result in deregulation and local governments compete for corporate crumbs.

What is clear is that corporations must be accountable to the larger society or else we’re all in trouble. Government is our only hope when it comes to protecting the commons, like reducing the magnitude of global warming. However, we’ll need all the tools in our bag to get the job done. Saying we need to give government the power to regulate doesn’t make it so. Yet, Bakan’s analysis does well to point to the fact that corporations are social constructs that must be channeled to serve the public interest. Perhaps the book and the movie will inspire action. Buy from Amazon.com


Mutual Fund Voting Policies Studied

Burton Rothberg and Steven Lilien, both of Baruch College in New York, examined voting policies at the 10 largest mutual fund families to get clues as to how funds will vote when they have to start disclosing next month. Included in the study were Fidelity, Vanguard, American Funds, Putnam, Janus, Franklin Templeton, AIM/Invesco, T. Rowe Price, Morgan Stanley Dean Witter and Oppenheimer.

Most oppose poison pills, want auditors free from conflicts of interest and oppose repricing of stock options. However, “Morgan Stanley funds generally vote with company management on major issues. The funds, for example, support management in the selection of directors, with no requirements on board independence.”

Most troubling to the International Herald Tribune writer was the fact that only four of the fund families in the study – Vanguard, AIM/Invesco, American Funds and Putnam – describe in their policies how they deal with personal conflicts of interest, such as when they hold shares of companies that are also their customers in other businesses – for example, a division that administers a 401(k) or other investment plan. (Study sheds new light on fund voting policies, 7/6/04)

Act Now to Reject “The Stock Options Accounting Reform Act”

Citizen Works is advising its readers to tell Congress to stand up for honest. In July the so-called “Stock Options Accounting Reform Act”  (HR 3574) is expected to come up a full House vote. It would block the Financial Accounting Standards Board (FASB) from implementing a common-sense rule to require that stock options be counted as expenses. Currently, stock options are the only major form of compensation that does not have to be counted as an expense, that due to the intervention by Congress in the mid-nineties.

The terrible bill panders to big-donor technology companies that want to be able to continue to mislead investors and the public by failing to account for stock options. Congress needs to hear from citizens and small investors. Tell your Representative to stand up against more Enron-style accounting. Tell them that you are counting on them to support FASB’s plan to require stock options to be expensed.

Sample letter to your Representative on HR 3574:

Full details on the proposal to expense stock options:

Complete resource on Stock Options:

Last week, 23 international institutional investors representing $3.5 trillion worth of funds (including the leading pension funds and investment management funds in Canada, Norway, and Sweden), sent a letter urging FASB to stand firm in expensing options. “International investors have collectively lost billions from recent US corporate scandals, including ones resulting from fraudulent and misleading financial statements,” said the letter. The investors said that financial reporting should be shaped by a goal of comprehensive information, “not by what results in the most attractive reported numbers.” (Citizen Works’ Corporate Reform Weekly, July 5, 2004)

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The Corporation

Fortune magazine (7/12/04) ran a “face off” on the Canadian documentary, The Corporation, which is now showing in the US. One of the movie’s central themes is that if the corporation were a person, he/she would qualify as a psychopath (incapacity to maintain enduring relationships, amoral, callous, deceitful, ignores any social and legal standards to get its way, and does not suffer from guilt, while mimicking the human qualities of empathy, caring and altruism). Fortune says the film is “more balanced than your typical lefty screed.” They asked four leading businessman for their opinion of the film and their average rating was 3.5 out of 4 stars.

Although it will.be seen by far fewer than Michael Moore’s “Fahrenheit 9/11” film, it certainly is worth viewing for anyone trying to improve corporate governance and behavior. More important, we need to encourage the average American to attend.

Concerned Shareholders of Leisure World

The battle for democratic governance extends to Senior citizens at Leisure World in Seal Beach who are battling for their right to see financial records, including expense reports and how much management is paid.

Leisure World, where the average age is 77, is divided into 16 geographical areas run “mutual corporations,” each headed by elected residents. Representatives from each mutual board elect the Golden Rain Foundation Board, an umbrella group that governs the entire community.

In 2002 administrators banned dog walking, forcing residents to carry their dogs from their homes to their cars and drive their pets outside Leisure World’s boundaries for exercise. Resident soon learned that Leisure World wouldn’t give them information which they are entitled to under state law:

  • Why monthly fees increased $30 this year and why the fees still cover a mortgage they say has been paid.
  • How much Leisure World pays contractors to landscape most of the 533-acre property, including the golf course.
  • How much management is paid.

And, of course, there are the typical conflicts of interest. For example, the landscaping contractor is one of the development’s joint owners.

They’re fighting back through lawsuits. Armed with copies of the California Civil Code, the California Corporations Code and Leisure World’s bylaws, the band of residents sought financial penalties from Golden Rain Foundation for each violation. So far, the board has been fined $1,400 — $200 for each plaintiff. The judge then advised the to keep requesting the information. If they don’t get it, he’d see them back in court. (See Rebelling Now a Senior Activity at Leisure World, LATimes, 7/4/04. See alsoAmerican Homeowners Resource Center to learn more about rights in an HOA.)

BRT Appears to Call the Shots

As the ISS Friday R

eport (7/2/04) noted, “Delays appeared likely this week on two key reforms: the SEC’s proposed rule on shareholder access to director nominations, and the Financial Accounting Standards Board’s (FASB’s)proposal to require expensing of options.” The press often reports on the “shareholder revolution.” In reality, the Business Roundtable still seems to be calling the shots. Clearly, we need to turn up the volume and demand our rights. Concerned shareholders must unite! Perhaps a recent commentary in BusinessWeek will help (see “Earth to Silicon Valley: You’ve Lost this Battle,” 7/12/04)

Donaldson Waivers: Time to Dump Bush?

As reported by the New York Times, William H. Donaldson, chairman of the SEC appears in a near paralysis regarding a proposal to permit large shareholders to nominate a limited number of independent directors to corporate boards. “The deadlock all but dooms prospects for the rule to be adopted in time for the new proxy season that begins early next year.”

Last summer and last fall, Donaldson embraced the broad outlines of the plan, but he has since become lukewarm in the face of opposition from the Chamber of Commerce and the Business Roundtable. The measure is clearly supported by the two Democratic commissioners, Roel C. Campos and Harvey J. Goldschmid and opposed by two other Republican commissioners, Paul S. Atkins and Cynthia A. Glassman. Donaldson’s vote is key to enactment.

According to the report, “the fate of the proposal could be determined by the outcome of the election.” Donaldson still supports the concept of giving institutional investors more of a voice at troubled companies, but wants to find a “middle route that addresses the worries on both sides.”

Unfortunately, the key dispute is about power. Will shareholders continue to be at the mercy of entrenched CEOs and boards or will they finally have some voice in nominating one or two directors? The proposal is to take a baby step in the direction of democratic corporate governance. However, for the powers that be, even that step is too much. They are afraid that even token changes can eventually lead to revolution.

If changing presidents is what is needed then investors might be better off throwing their considerable weight behind John Kerry. If a little democracy is good for Iraq, it is certainly good for corporations. (S.E.C. at Odds on Plan to Let Big Investors Pick Directors, NYT, 7/1/04) However, first we need to know where Kerry stands on democracy in corporate governance. So far, all I’ve found is his statement that “the SEC should allow long-term significant investors to have a voice in the selection of a portion of a company’s board of directors.” (see Corporate Accountability…middle of second paragraph)

Additional fodder, care of Citizens Works:

“The Securities and Exchange Commission last week announced an investigation into possible accounting fraud at EasyLink Services Corp., a company where SEC chairman William Donaldson formerly served on the board of directors. Donaldson served on the audit and compensation committees. He has recused himself of dealing with the case.

At issue is how the technology company booked $3 million worth of barter deals related to advertising in 2000. EasyLink said that the $3 million under scrutiny was not “material” to its financial statements.

EasyLink, formerly known as mail.com, converts paper documents into e-mails. During the dot-com boom, its shares were worth as much as $271. Today they are worth $1.63. As head of EasyLink’s compensation, While on the compensation committee, Donaldson voted to forgive a $200,000 loan to the company’s chief executive when the company was struggling financially.

For more, see: “EasyLink Ad Deals Probed; SEC Chief Recuses Himself,” by Carrie Johnson of the Washington Post.” (Citizen Works’ Corporate Reform Weekly, July 5, 2004)

Maybe at this point Donaldson will be more concerned with saving his own skin, rather than leaving a legacy that would have at least been a foot in the door to shifting power.

Goodyear Shareholder Proposal Wins 48% Support

A shareholder proposal subjecting any future Goodyear (GT) poison pill toshareholder vote wins 48% shareholder support. This poison pill vote proposal won 48% of the yes and no votes at Tuesday’s 9:00 a.m. shareholder meeting in Akron. This is a particular strong vote because Goodyear responded to this proposal by terminating its poison pill early – June 1, 2004.

  • Yes votes: 43,277,892 (48.5%)
  • No votes: 45,863,791

A poison pill enables management to flood the market with stock to thwart a potentially profitable bid for company stock. Contact: John Chevedden, 310-371-7872.

Robert J. Keegan, who is also president and chief executive officer of the nation’s largest tiremaker, won a three-year term with 84.5% of the vote. He has been on the board since 2000 and chairman since last July and was paid a $1 million salary plus more than $500,000 in bonuses and other compensation. Newly elected Goodyear directors Rodney O’Neal and Shirley D. Peterson board are reported to own no stock.

Goodyear has cut 6,000 jobs, acknowledged accounting errors that cost it $280 million, lost a combined $2 billion in 2002 and 2003, recently reported its loss in the first quarter narrowed to $76.9 million on record quarterly sales of $4.3 billion, and spent more than $3 billion on restructuring.

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Open Letter to WSJ

James Miller’s “What Would Adam Smith Say?” (Wall Street Journal, 6/29/04) claims that Smith wouldn’t favor the new SEC rules requiring mutual funds to have an independent board chair. According to Miller, rational self-interest requires funds run by inside managers.

However, One need look no further than one of Smith’s most famous quotes to surmise that not only would he favor an independent chair, he would also lift the SEC’s prohibition against share/fund holders from using the corporate/fund proxy to nominate directors.

In criticizing corporations directed by managers, Adam Smith said, “The directors of such companies, however, being the managers rather of other people’s money than of their own, it cannot well be expected, that they should watch over it with the same anxious vigilance with which the partners in a private copartnery frequently watch over their own …. Negligence and profusion, therefore, must always prevail, more or less in the management of the affairs of such a company.”

Under Smith’s logic, there could be no better directors, including the chair, than those chosen by shareholders from their own ranks.

Dems Push Access to Proxy

Six key Democratic members of Congress called for the Securities and Exchange Commission to issue new rules that would provide large investors more access to the process of nominating a board of directors.

The representatives see such a measure as a deterrent to scandal. “Adoption of this rule would prove to be a powerful tool in preventing corporate fraud, as well as restoring beleaguered investor confidence,” said the letter to SEC Chairman William Donaldson, which was released by Michigan’s John Dingell, according to Reuters. Besides Dingell, the letter was co-signed by Massachusetts’ Barney Frank and Edward Markey, New York’s Carolyn Maloney, Colorado’s Diana DeGette and Maine’s Tom Allen. (Democratic Reps. Weigh In on Proxy Rules, CFO.com, 6/30/2004)

William H. Donaldson’s Remarks to Directors College

Consider the situation faced by a sizeable group of shareholders who are committed to the long-term prospects for a certain company, but who confront a company management that refuses to respond to, or even communicate about, the shareholder group’s concerns. The dilemma is that the shareholders have only two practical choices. First, they can choose to cease being committed to the long-term health of the company; in other words, they can sell their stock. Under this choice, they would be forced to give up their belief that with some modest changes in company direction, the company could be more successful in its markets and could therefore be an extremely productive investment over the longer term.

Their second – and only other – choice is to wage an extremely expensive proxy fight. This contest could be for the entire board of directors or for only some seats on the board – a so-called “short slate.” In either case, the proxy fight takes on the trappings of a contest for control. Under this choice too, therefore, the shareholders would be forced to give up their belief that modest changes in company direction could produce the long-term benefits they seek. Instead, they are forced to divert the company’s resources away from the business they’re building, to the proxy fight they’re waging – the last thing the shareholders really want for the company’s future.

The proxy access proposal under consideration by the SEC is an attempt to find a middle ground between the extreme choices of forcing shareholders to give up their long-term interest in the company and sell their stock, on the one hand, and forcing them to wage a wasteful proxy fight on the other. It is an attempt to find a middle ground that would, under certain restrictions and limitations, provide shareholders having a true interest in the long-term health of the company, with a more effective proxy process that gives them a better voice in this nomination and election of the board of directors. In essence, it is an attempt to encourage management and long-term shareholders to communicate more effectively with each other about the company’s future.

The current proposal is important, but complex and controversial. Unfortunately, the controversial aspect threatens to overshadow the importance of what the Commission is trying to accomplish. There are strongly held views on all sides of this issue. While we welcome the expression of all views – that is the essence of our notice and comment rule-making process – the escalating, shrill, and fearful rhetoric on all sides of this issue has drowned out thoughtful discourse and comment. Those who believe that our proposal is a serious and unwarranted threat to the operation of boards and those who believe that our proposal does not go far enough in giving shareholders a more effective proxy process have gone well beyond the bounds of thoughtful and sensible comment.

For example, some proposed offering the company a chance to “cure” the shareholder communication problem on its own – that is, if a majority of shareholders withheld their vote for an incumbent director, the board nominating committee would be empowered to replace the “withheld” director with a new director more acceptable to the shareholders. In response, a prominent publication quoted someone summarizing the proposal like this: “If Bozo A gets voted down, the nominating committee can substitute him for Bozo B.” Similarly, a corporate governance activist has derided this idea as doing no more than replacing “Tweedledum with Tweedledee.”

On the other side, the Business Roundtable has said this one modest change in the proxy rule would, and I quote, “put companies, shareholders, and the economic recovery at risk.” The U.S. Chamber of Commerce has said that the proposal “could seriously impair the competitiveness of America’s best companies [and] put proprietary business information at risk.”

That this is an election year doesn’t help. Reports that this is a partisan political issue miss the point entirely. Republicans and Democrats alike are on all sides of this issue. Politics must not be allowed to drive the public debate or the Commission’s deliberations on this matter, or any other. The imperative here is to approach this issue – like all others – in a thoughtful, measured way and to try to do the right thing for the corporations and shareholders who own them.

I remain committed to responsible and constructive change in this area, and will proceed thoughtfully and carefully. Our goal is the right course, rather than a hasty, less thoughtful course. We will not be forced to act in the face of an artificial deadline. However, after 60 years of repeated Commission consideration of this topic, the time has come for sensible, balanced, and constructive debate leading to action designed to improve our proxy process for the nomination of directors.

So I would encourage you – and the companies you serve – to avoid unproductive rhetoric and focus rather on the central problem the proposed rule addresses – how to find a middle ground between the extreme choices of forcing shareholders to give up their long-term interest in the company and sell their stock, on the one hand, and forcing them to wage a wasteful proxy fight on the other. Let’s not mock those who struggle to find this middle ground. And let’s not proclaim the end of American economic competitiveness if any such middle ground were found. Instead, I would ask you and your companies to provide thoughtful, meaningful input that will help the Commission arrive at an effective, workable solution that will benefit investors, our companies, and our markets. Frankly, they deserve nothing less. (Speech by SEC Chairman: Remarks from Directors College at Stanford University Law School, William H. Donaldson, Chairman, U.S. Securities and Exchange Commission, Stanford, CA, June 20, 2004, Full Text)

Morrison’s Coefficient

According to Don Morrison, “there is a negative correlation between executive pay and common sense. The higher the conpensation, the bigger the blunder” and the “greater the temptation to think you’re the smartest guy in the room.” The results can be catastrophic.

In “Don’t Always Rely on the Smartest Guy in the Room” (Corporate Board Member, July/August 2004), Morrison also discuses “commitment and consistency.” “You do something that looks reasonable, and the result of that act leads you to take another reasonable-seeming step, and so on until you arrive at a disaster you didn’t anticipate because you got there one reasonable step at a time.”

Another explanation for Enronic behavior is “fiduciary co-dependency.” “Your accountant lets you get away with actuarial whoppers because she knows that if she doesn’t, you’ll get a new accountant, who will let you tell even bigger porkies because she doesn’t want to be replaced by a more pliable bean-counter either.”

Give Managers Ownership But Not Votes: or Do the Opposite

“Voting ownership is bad, economic ownership is good,” summarizes the results of a study that compared hundreds of dual-class companies with the larger universe of single-class companies from 1994 through 2001. “What you’d really like to do is give managers a lot of economic ownership in a company, but no votes, which is the opposite of what you see in most dual-class companies.” Metrick conducted the study with Paul A. Gompers, professor of business administration at Harvard Business School, and Harvard economist Joy Ishii. Their paper is entitled, Incentives vs. Control: An Ana lysis of U.S. Dual-Class Companies.

Executives and other insiders who own large blocks of their companies’ shares work harder to boost share prices, benefiting all shareholders. At the same time, insiders with large blocks of votes can become entrenched – using voting clout to stave off outside shareholders’ efforts to replace them if they perform poorly.

The study found that large ownership stakes in insiders’ hands do tend to improve corporate performance, while heavy control by insiders weakens it. Company values improved as insider ownership rose, with the effect reaching a peak when insider ownership reached 33%, based on their share of “cash flow” such as dividends. As insider ownership grew from zero to 33%, Tobin’s Q grew by about 15%. The effect levels off as ownership exceeds 33%, probably because of the wealth effect. Insiders become so rich they have dwindling interest in accumulating more and prefer corporate strategies that emphasize safety over performance.

Growth in insiders’ voting power had the opposite effect as growth in economic stakes. Tobin’s Q declined as insider’s voting power grew, with the loss bottoming out as their voting control reached 45% of the votes available to be cast. As voting power grew from zero to 45%, Tobin’s Q fell by 25%. “This is consistent with the entrenchment effect of voting ownership, i.e., the more control that the insiders have, the more they can pursue strategies that are at the expense of outside shareholders,” the authors write. (The Effects of Dual-class Ownership on Ordinary ShareholdersKnowledge@Wharton)

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