Archive | December, 2004

December 2004

Calvert Continues Push for Women’s Principles

According to Barbara J. Krumsiek, CEO of Calvert Group, the nation’s largest family of “socially responsible” mutual funds, 9,000 board seats will be opening up during the next two years. Sarbanes-Oxley’s requirements for increasingly “independent” boars has created “an unprecedented opportunity” for diversity.

In 2004, Calvert filed seven resolutions with companies, asking them to diversify their boards of directors and contacted 154 companies that had no female or minority directors. 31% have since added at least one woman or one minority to their board.

Calvert released its Women’s Principles, a code of conduct for corporations, in June. Last week, Dell Inc. and Starbucks Corp. said they would implement the principles. (Conduct Code Aims to Create Diverse Boards, Washington Post, 12/27/04)

Harrigan Unlikely to Disappear

Sean Harrigan called the presidency of the CalPERS board the “the greatest bully pulpit in the world.” From there, he led a drive among institutional investors for rule changes at the U.S. Securities and Exchange Commission to let shareholders nominate their own company directors.

Harrigan said it’s “50-50” whether public pension funds and other institutional investors will win the “crown jewel of corporate governance reform,” the ability to nominate their own directors. Although he lost the CalPERS pulpit, he’s received invitations to sit on corporate boards, for consulting work with the corporate governance reform movement, for a new role in organized labor, offers to speak “all over the world,” and to write a book. (Ousted CalPERS president convinced governor helped bounce him, Sacramento Bee, 12/29/04)

Major Shareholder Reversal

The Wall Street Journal (SEC Says Disney Can Exclude Shareholder Resolution After All, 12/29/04) reports that SEC staff reversed a decision it made just weeks ago, allowing Walt Disney Co. to withhold from its proxy an annual-meeting resolution to let shareholders propose their own board candidates. Last month, they allowed a nonbinding resolution for Disney’s 2005 annual meeting. Some, including the publisher of CorpGov.Net, believed allowing such resolution may have actually been preferable to the SEC’s proposed “proxy access” rules, which would have resulted in a “one size fits all” approach that would allow change at only a few companies each year.

According to the WSJ, “People familiar with the matter said staff may have been concerned that the proposal didn’t adhere closely enough to a rule proposed last year by the SEC that would allow shareholders to nominate directors when they can show widespread dissatisfaction.” Richard Ferlauto, AFSCME’s director of pension investment policy, said the move yesterday “emphasizes the need for the SEC to move swiftly to rule making to determine whether shareholders have got any right at all to nominate directors on company proxies.” “If any company was deserving of proxy access coming out of the 2004 proxy season,” Mr. Ferlauto said, “it was Disney, and they’re off the hook.”

Perhaps it is time to look to a different approach; the proposal originally put forward by James McRitchie and Les Greenberg to allow shareholder proposals to elect directors: Petition File No. 4-461, which the Council of Institutional Investors said “re-energized” the “debate over shareholder access to management proxy cards to nominate directors,” is a better approach. Under that proposal, petitions can be tailored to the specific needs of each company.

In the meantime, we are delighted that AFSCME, which sponsored the resolution at Disney, will appeal the staff decision to the agency’s five commissioners. AFSCME asked the commission to reconsider the issue or at least to direct staffers to explain clearly the reason for the turnaround. (see SEC Staff Reverses on Disney Proxy, Washington Post, 12/30/04) Also see The Five Dumbest Things on Wall Street This Week by George Mannes, TheStreet.com, 12/31/04.

OECD Developing Guidelines for State-Owned Enterprises

The OECD’s Working Group on Privatisation and Corporate Governance of State-Owned Assets is developing a set of guidelines on the corporate governance of state-owned enterprises as a complement to the OECD Principles of Corporate Governance which have now become a touchstone for excellence in the corporate governance of listed and privately owned companies. Although these Guidelines, like the OECD Principles of Corporate Governance, will be non-binding, they will provide a basis for policy makers to address specific governance issues in the state sector. They will deal with such topics as how ownership should be organised, how boards should be appointed, what responsibilities they should be given, and how to ensure transparency and accountability vis-à-vis both the state, as shareholder, and society as the ultimate owner.

The Working Group welcomes specific suggestions by 1/28/04 for wording and for additional areas that might be covered. The Guidelines are expected to be made public in their final form during the course of the Spring of 2005. (see Public Consultation on the draft text of the Guidelines on Corporate Governance of State-Owned Enterprises)

Old Boys Promote Change

Tim Rowley, an assistant professor at the University of Toronto recently set out to illustrate the undue influence of Canada’s “old boys’ network” on corporate boards of directors. After study, he concluded the network of elite interconnected directors facilitated corporate governance reform.
His study, in partnership with Matt Fullbrook, concluded that 16 influential directors who sit on 5 or more boards each form a “corporate elite” in Canada, representing 1% of the 1,689 directors who sit on the 68 boards of companies in the S&P/TSX composite index.

Their boards have done significantly better promoting, rather than blocking, governance changes and their companies score better on measures of governance best practices. Many in the group are full-time professional directors, and feel their credibility and reputation are tied to good governance.
For example, Alcan Inc. chairman Yves Fortier, who sits on five S&P/TSX index boards, said he has seen much “cross-pollination” of governance ideas among boards. When directors see a practice that works well at one company, they promote it at others Indeed, “old boys” adopt new governance ideas “more easily than some of the new boys” because their business experience has demonstrated their value. Additionally, they are more likely to be able to compel an idea to catch hold because they have served for a long time, chair a key board committees, or have more extensive personal contacts. (Study finds corporate ‘old boys’ have positive impact on governance reform, Toronto Globe and Mail, 12/17/04)

Pay Without Performance

In Pay Without Performance Lucian Bebchuk and Jesse Fried argue that incentive structures provided by crony directors encourage CEOs to focus on short-term earnings at the expense of long-term success.

Fewer than 1% of 1,000 executives studied from 1993 to 1999 resigned or left under pressure because of poor performance. Obviously, boards have not been doing their job. “We present evidence that compensation arrangements have often been designed with an eye to camouflaging rent and minimizing outrage,” the authors state. “Firms have systematically taken steps that make less transparent both the total amount of compensation and the extent to which it is decoupled from managers’ own performance.”

They call the existing system’s bluff. The myth is that shareholders already have the power to remove directors but everyone knows the deck is stacked against them. Bebchuk and Fried look to truly empower shareholders, especially through access to the proxy, as a major part of the solution. Access to the corporate ballot will allow shareholders to replace directors and demand greater transparency. Directors who are directly accountable to shareholders will be more aligned with their interests in setting compensation schemes and in all of their other duties.

They point the finger firmly at board directors, arguing that “we should focus not only on insulating directors from the influence of executives (the direction of most regulation in the field so far), but also on reducing their current insulation from shareholders.”

Corporate Disclosures Posted

Information about practices of publicly traded corporations is now only a computer mouse click away, Secretary of State Kevin Shelley announced as he unveiled the new “Publicly Traded Disclosure Search” on the office’s web site.

Public access to this online searchable database gives effect to AB 55 – a bill authored by Shelley when he was Majority Leader of the Assembly – which requires corporations to disclose more information about their practices. In response to highly publicized scandals within some corporations in recent years, Shelley authored AB 55 to demand publicly traded corporations to annually disclose additional information about themselves, including corporate bankruptcy, the corporation’s independent auditors, compensation of certain employees, shares and options paid to directors and top officers, and whether any directors or officers have been convicted of fraud or have filed for bankruptcy.

“By accessing the secretary of state web site, the public will be able to search for information about publicly traded corporations who have filed a corporate disclosure statement with my office,” said Shelley. Every domestic stock and foreign publicly traded corporation doing business in California must file a corporate disclosure statement annually, no later than 150 days after the end of its fiscal year. “This service will provide immediate access to corporation disclosures and the ability to perform detailed searches based on the information contained in the corporate disclosure statement,” stated Secretary Shelley. Disclosures of directors and top officers are also searchable by individual name and/or the disclosure itself.

This appears to be a handy tool…if the company has reported; in a brief search we found many companies doing business in California with no information posted.

Borders (BGP) Golden Parachute Vote Policy Adopted

Borders Group adopted, on Dec. 10, 2004, a policy for golden parachutes to be subject to shareholder vote. This policy was apparently in response to the shareholder proposal on the same topic submitted for the Borders 2005 annual meeting by John Chevedden. Mr. Chevedden reports that Borders has not filed this information with the SEC. Interested readers may want to contact Thomas Carney, Senior Vice President, General Counsel and Secretary, to ask him if or when they intend to do so.

Convergence

Socially Responsible Investing (SRI) has carved out a niche in the financial world, and each year a large number of shareholder proposals are filed at public companies in the US related to issues of corporate social responsibility (CSR). While the primary interests of CSR activists remain distinct from those of traditional corporate governance (CG) activists, the two groups do share an interest in minimizing the risk of negative environmental or social impacts from the operations of the corporation. They also share the objective of achieving transparency and accountability in corporate decision-making. In relation to this latter objective, they both face similar challenges concerning conflicts of interest among key institutional shareholders.

This article (Shareholder activism on environmental issues: A study of proposals at large US corporations (20002003), by Robert Monks, Anthony Miller, and Jacqueline Cook, Natural Resources Forum, Volume 28 Issue 4 Page 317  – November 2004 examines the record of shareholder proposal filing and voting from 2000-2003 for 81 large US public corporations to determine the relative prominence of CSR shareholder activism and the prospects for effective CSR shareholder activism on key environmental issues. The analysis of these data finds that nearly half (45%) of all shareholder resolutions are related to CSR, and that those resolutions which combine issues of CSR with traditional CG activism appeal to slightly more shareholders than issues of CSR alone.

The article also examines shareholder activism at the micro level with a case study of the voting record at ExxonMobil. The article finds that CSR-related shareholder activism represents the majority of shareholder activism within that firm and that resolutions targeted at climate change are particularly well supported. These resolutions draw a connection between environmental risk and risk to shareholder value. While numerous challenges remain for both CG and CSR activists, the article concludes that reforms that strengthen shareholder rights and corporate governance more generally will also benefit CSR activists and the environmental policies they promote in particular. The article ends with some proposed solutions for addressing the perceived conflicts of interest in corporate governance and the shareholder voting process.

SRI in Asia

Eurosif, the European Social Investment Forum, has completed its “Pension Programme SRI Toolkit” designed to help pension fund trustees understand how to integrate SRI into their fund’s investment policy. (Eurosif Launches First European SRI Toolkit for Pension Funds)

Sumitomo Trust & Banking Co. expanded its socially responsible investment (SRI) fund to handle “defined contribution” pension plans in February 2004, to meet the growing demand for corporate social responsibility (CSR) and SRI in Japan. (Japan’s First Environmentally and Socially Responsible Pension Fund for Employees)

The Local Authority Pension Fund Forum (LAPFF) brings together a diverse range of local authority pension funds with combined assets of over £40 billion. The LAPFF report, ‘DELEGATING SHAREHOLDER ENGAGEMENT Local Authority Pension Funds and Fund Managers: Best Practice Guidelines.’ (LAPFF Best Practice Guide to Delegating Shareholder Engagment in Pension Funds)

For more news, see Association for Sustainable & Responsible Investment in Asia.

Museum of the Corporation

First the book, then the movie. Coming in a couple more years…the museum. “Corporate power is undeniably at its greates so far in the history of the world, yet accountability for social and environmental impacts is still at the discretion of the companies themselves, pressured – or not – by their shareholders. The huge phenomenom is both overwhelmingly visible – advertising, retail, brand, incluence on daily life and choices – and yet also stangely invisible in terms of mainstream cultural debate.”

The stated goals for the Museum of the Corporation include:

  • An open space where people can debate one of today’s most powerful influences on social and ecological justice in daily life and global politics, the transnational corporation;
  • A space where people from different sectors and interest-groups, including business, can access new ideas and rigorous information/analysis;
  • A reflective, critical and cultural space;
  • A dynamic space where people can meet each other in a spirit of mutual education and urgent ethical debate; and
  • A space for the unexpected, using creative and art techniques to enable new thinking and new conversations.

The year 2007 will mark the 200th anniversary of the Abolition of Slave Trade Act in the UK, and the 250th anniversary of the Battle of Palashi, India, where the East India Company army defeated the Nawab of Bengal’s army, thus “gaining” Bengal for Britain. An auspicious year for the foundation of a permanent Museum of the Corporation?

Funds Flowing

Net inflows to US equity funds last month were the largest since February, and total industry flows were the strongest in two years, according to a report from Lipper Inc. Overall the total net inflows to mutual funds – some $54 billion – was the largest inflow since November 2002, and the second-largest since November 2001. Half of that went to money market funds, and another 20% flowed to world equity offerings. (PlanSponsor.com, 12/20/04)

Alternative Route to Open Ballot

The Economist (A chink in the boardroom door, 12/16/04) says the SEC’s decision to allow a nonbinding resolution to let a significant group of shareholders nominate their own candidates for the board at the next annual meeting of Walt Disney as “a way around the blockage” faced by its own proposed rule. The magazine then asks how easy will it be for shareholder’s to find nominees.

“According to Korn/Ferry, a headhunting firm, almost twice as many directors of Fortune 1,000 firms refused a board position in 2004 as did in 2002, before Sarbanes-Oxley took full effect.” However, “a survey of over 170 big American firms by Hewitt, a human-resources consultancy, found that the median retainer for board members increased from $35,000 in 2003 to $40,000 this year, while the median per-meeting fee rose from $1,250 to $1,500.” Additionally, although Sarbanes-Oxley imposes additional duties on directors, ” it doesn’t create new ways for shareholders to sue and directors rarely have to pay liabilities of their own pockets. In an article in the latest McKinsey Quarterly, three law professors, Bernard Black, Brian Cheffins and Michael Klausner, the authors could find only one case in America since 1968 in which that happened. 99% of large American companies have insurance D&O insurance.

If the SEC’s decision to allow nonbinding resolutions on elections stands, we will have accomplished much of what we advocated in the petition Les Greenberg and I filed (Petition File No. 4-461) over two years ago, which the Council of Institutional Investors said “re-energized” the “debate over shareholder access (Equal Access – What Is It?). It would actually be better to allow shareholders to propose firm specific requirements for open access than it would be to have the SEC set a general rule that opens access in only a few firms each year because of unrealitically high triggers. One size doesn’t fit all.

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Suck Up to Become a Director

In “The Other Pathway to the Boardroom,” the result of a survey of 1,012 senior managers at 138 major companies, James D. Westphal and Ithai Stern of the University of Texas, found that “people feel a natural obligation to help those who have ingratiated them.” In a twelve month period, challenging the CEO’s opinion on a strategic issue one fewer time, complimenting the CEO on his insight two more times, and doing one personal favor increased by 64% the likelihood of an appointment to a board where the CEO was already a director. (Suck Up and Move Up,Fast Company, 1/2005) The other pathway to the boardroom ought to be sucking up to shareholders through a record of proven performance.

Options Are a Cost…Finally

We have been advocating reform in this area since 1995. Finally, the Financial Accounting Standards Board (FASB) published FASB Statement No. 123R (revised 2004), Share-Based Payment, a revised standard that requires most companies to recognize the cost of stock options on their books by the middle of next year. Public entities, other than small business issuers, will be required to apply Statement 123R as of the first interim or annual reporting period that begins after June 15, 2005, while those that file as small business issuers will have six more months. The FASB announcement said that approximately 750 US public companies are voluntarily applying Statement 123’s fair-value-based method of accounting for share-based payments or have announced plans to do so. Had all companies in the S&P 500 expensed the cost of options, reported earnings would have been 20% lower in 2001, 19% lower in 2002 and 8% lower last year. (Starting in mid-’05, stock options must be expensed, USA Today, 12/16/04)

Bush “Appreciates” Donaldson

A spokesman for President Bush praised SEC Chairman William Donaldson a day after a report that some U.S. business groups are unhappy with him and may seek his ouster. “The president appreciates the job Chairman Donaldson is doing,” White House spokesman Scott McClellan said yesterday.

The U.S. Chamber of Commerce, Business Roundtable and the National Association of Wholesaler-Distributors are lobbying the administration to get the SEC to ease enforcement of corporate-governance rules, the Wall Street Journal reported.

The U.S. Chamber of Commerce, while critical of Donaldson and the agency on some issues such as proxy access, hasn’t urged Bush to dismiss the SEC chairman, said David Hirschmann, senior vice president of the Washington-based group. “We’re trying to send a message that says, rather than aggressive rule-making, reform the SEC,” Hirschmann said. Chamber President Tom Donohue said yesterday that he is “absolutely not” part of any effort to oust Donaldson.

The Business Roundtable isn’t seeking Donaldson’s ouster, said Johanna Schneider, spokeswoman for the association of corporate chief executive officers. (Bloomberg News, 12/16/04)

CalPERS Takes Steps to Crack Down on Disability Fraud

Lying to get a state disability pension would become a crime under legislation to be sponsored by CalPERS in 2005. Workers claiming disability would be forced to undergo follow-up medical exams.

Current State law allows workers whose injuries prevent them from working to collect special disability pensions. Public safety workers injured on the job get even more – half of their income, tax-free, for life. The Bee published several stories of high-ranking safety employees claiming injury claims, a phenomenon that has come to be known as “Chief’s Disease.” Some of the former chiefs took on rigorous new jobs.

The proposed penalties for engaging in fraud would include up to a year in jail, up to a $50,000 fine, and restitution. Additionally, if enacted, the legislation would allow CalPERS to order workers older than retirement age to submit to medical exams to determine if they are still disabled. Lastly, the changes would give Cal-PERS authority to check if members collecting medical pensions are working.

The move is long overdue and may help CalPERS stem the call to switch to a defined contribution plan and give up its efforts to reform corporate governance.

Investment Opportunities

We’ve just come across two investment opportunities that we expect will earn better than average returns and will also advance the causes CorpGov.Net has espoused since 1995. (No, we don’t have any investments in these funds, but we are considering it.) The FTSE ISS Corporate Governance Index Series involves a series of indexes offered by the FTSE Group (FTSE) and Institutional Shareholder Services (ISS). The new series contains a group of equity indexes, with a corporate governance overlay that incorporates ISS corporate governance ratings in the following:

  • Compensation systems for executive and non executive directors
  • Executive and non-executive stock ownership
  • Equity structure
  • Structure and independence of the board
  • Independence and integrity of the audit process

The series includes companies from a universe of 2,300 constituent companies from 24 developed markets. The indexes are as follows:

  • FTSE ISS Developed CGI (covering large and mid cap stocks);
  • FTSE ISS Europe CGI (covering large and mid cap stocks);
  • FTSE ISS Euro CGI (covering large and mid cap stocks);
  • FTSE ISS Japan CGI (covering large and mid cap stocks);
  • FTSE ISS U.S. CGI (covering large and mid cap stocks).

The second investment opportunity comes from Bassi Investments, Inc., a money management firm that invests in companies that invest in their people. Their portfolios:

  • Are based in large part on training investment, strongly related to future stock performance but unknown to most investors, since the information is not included in companies’ public reports.
  • Utilize their research-derived “Bassi Model,” which “combines training data with relevant financial variables to identify appropriate portfolio recommendations and assign portfolio weights designed to maximize expected return.”
  • Capitalize on the knowledge economy. To prosper in the long run, firms must make significant investments in human capital.

Their hypothetical portfolios with the largest investments in employee development between 1997 and 2001 outperformed the S&P 500 by an annualized return of 16.3%, compared with 10.7%. Based on their research, they launched a fund in December 2001. To date, (through 11/3//04) that fund has returned 36.2%, outperforming the S&P 500 by 8%. A second portfolio, launched in January 2003 has earned 41.3%, compared to the S&P 500’s earnings of 34.5%.

Past performance is no guarantee of future results. There are no guarantees for any of the above indexes or funds but, without a doubt, they will advance knowledge in the field of corporate governance and in the area of investment in human capital. If they earn superior returns, that would also be great.

Thanks to Business Ethics for bringing Bassi Investments to our attention. (Are Employee Skills a Cost or an Asset?, Fall 2004) The article called for reporting standards to be strengthened to require all publicly traded firms to report annually on how much they spend on employee education and training. Analysts could then treat these costs as an investment, rather than a cost — thus reducing market pressure to reduce training costs. Further, we need to transform our generally accepted accounting standards to recognize that knowledge has surpassed machines and the stored value of money itself, as the driving force behind the world economy.

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CalPERS Continues to Press Issues

Despite Harrigan’s coming departure at the end of the year and the reappointment of Mike Quevedo Jr., the aggressive campaigns of CalPERS continue. The Investment Committee endorsed two major initiatives promoted by State Controller Steve Westly.

  1. Equity managers will be told to steer future investments away from private sector firms that take jobs away from public sector employees. They don’t want their own money putting members out of work
  2. CalPERS will ask auto officials to meet with the CalPERS and CalSTRS boards to explain why they are suing to block rules designed to start reducing greenhouse gas emissions. (Quevedo Stays on Board of CalPERS, 12/14/04)

Stop Micky Mousing Around

Shareholder activist Les Greenberg suggests shareholders should take a close look before they break out the champaign.  “In a victory for shareholder activists, the Securities and Exchange Commission said Walt Disney Co. should include on its shareholder ballot a proposal that could give investors a say in nominating company directors… It would give Disney shareholders the right to nominate up to two directors in a board election and have them included on the ballot at no cost to the investors…The proposal would ask shareholders at the company’s 2005 annual meeting next spring to set up a process to allow shareholders to nominate up to two directors on the Disney board and for the company to include those nominees in its proxy mailings… If that measure is approved by a majority of shares voted, the stockholders could vote on the outside-nominated directors at the 2006 annual meeting.” (LATimes, 12/11/04, “Disney Investor Proposal Gets a Boost From SEC — An agency opinion backs a vote on giving investors a voice in nominating directors.”)

Greenberg asks why CalPERS), the New York State Common Retirement Fund, AFSCME, and the Illinois State Board of Investment have chosen to submit a proposal that, if it wins and Disney accepts it, would allow a shareholder or group that has held over 5% of Disney’s outstanding common shares for over two years to nominate two directors on Disney’s 11-member board and have them included on the company’s proxy in 2006. Instead of submitting a nonbinding resolution, the “collation of funds,” which owns 0.88% of Disney stock, should identify a slate of qualified candidates and spring for the less than $10,000 Greenberg estimates it would cost to write and file a bare bones proxy statement with the SEC. They could then telephonically solicit votes from institutional shareholders, which own 67.85% of the stock of Disney.

Lear Terminates Poison Pill

Lear (LEA) announced it will terminate its poison pill on December 15, 2004 after a shareholder proposal on this topic won an 85% vote at the Lear 2004 annual meeting. The proponent of this proposal, John Chevedden, had submitted the same topic again to Lear for a vote at the Lear 2005 annual meeting. Chevedden said, “Lear probably terminated its poison pill rather than try to explain to shareholders why it would reject their 85% vote.”

Proxy Advisor Proposal is Key to Corporate Governance Reform

The Corporate Monitoring Project recently submitted its “Proxy Advisor” proposal to Metro One Telecommunications, for inclusion in the company’s 2005 proxy voting form. If implemented, it would let shareowners vote to choose a proxy advisory firm paid with company funds. The same proposal was supported by over 20% of shareowners voting on Oregon Steel’s proxy in April 2004.

According to the proposal’s author, Mark Latham, “The main goal is to reduce the shareowners’ free-rider problem, which greatly restricts willingness to pay for better voting advice. The economic incentives for paying as a group are much stronger than for paying one investor at a time, since even large institutions rarely own more than 5% of a company’s stock.”

CorpGov.Net has endorsed this type of proposal for several years. We believe Latham’s proxy advisor proposal, along with more widely known proxy access proposals, should become the cornerstone of efforts by shareowners to have more influence in corporate governance.

On the proxy access front, CalPERS, the New York State Common Retirement Fund, the Illinois State Board of Investment, and AFSCME have filed a joint proposal calling on Disney to allow shareholders to nominate up to two directors through the proxy process. (see Quiet as a Mouse at Disney?, ISS Friday Report, 12/10/04) If the SEC allows the proposal, it is likely to set off a wave of similar proposals. These will be much more effective if used in conjunction with a proxy advisor proposal, especially one which allows the advisor to provide recommendations in board elections.

Bad Governance = Bad Credit

A new quantitative study by Moody’s Investors Service fround that companies with stronger takeover defenses have riskier credit profiles. Moody’s research finds that more defenses are associated with higher downgrade rates, lower upgrade rates, and higher default rates.

“The association of takeover defenses with downgrade rates appears fairly strong, with the probability of a downgrade increasing as the number of takeover defenses increases for all rating categories,” said Christopher Mann, a Moody’s vice president and author of the study. “The majority of the effects were isolated among companies with the fewest takeover defenses.”

He said the relationship of the takeover index with upgrades follows the opposite pattern. However, with fewer upgrade observations, the results are not as statistically significant.

Moody’s also looked at defaults, but the sample produced only 69 events, and it is difficult to extract meaningful results. Nevertheless, findings were consistent with the research on downgrades, with the relationship strongest for B-rated firms, with whom the majority of defaults originate.

Perhaps surprisingly, the study also suggests ambiguous effects of takeover defenses on equity prices. While Moody’s found a negative relationship between strength of takeover defenses and firm stock returns between 1990 and 1999, this relationship reversed for the 2000-2003 period.

Moody’s found that firms with the fewest defenses earned 8.9% more per year in stock returns than those with the most defenses in 1990 to 1999, which tends to confirm a similar result that was widely publicized in a 2003 study by Paul Gompers, Joy Ishii and Andrew Metrick. But the opposite was the case for 2000-2003 as firms with the fewest defenses earned 14.7% lower annual returns.

The takeaway? Greater defenses could increase credit risk if they lead to management entrenchment, inefficient operations, and uneconomic investments. However, strong defenses could decrease credit risk if they enable managers to pursue conservative business strategies more consistent with the interests of bondholders than of stockholders. (For more information, call 1.212.553.1653)

Discuss Lack of Mutual Fund Action of Global Warming on 12/7/04

A new CERES study prepared by the Investor Responsibility Research Center and released by the nonprofit Results for America will show that the United States? 100 largest mutual funds are NOT using the shareholder resolution process to put the heat on major corporations, such as utilities and auto companies, to reduce global warming risks to shareholder wealth.

This is at odds with the increasing number of other institutional investors, such as pension funds, that have voluntarily disclosed their deliberate decision to support climate-change proxy resolutions, due to the financial risks posed by unmitigated climate change risks.

The study examines the 2004 shareholder proxy voting track record of America’s top 100 mutual fund companies — including Fidelity, Vanguard and American Funds — in the context of global warming resolutions. Only a handful of the top 100 mutual funds were found to have voted in favor of global warming resolutions, with most of the funds reflexively following the “hear-no-evil, see-no-evil” lead of company management under the so-called “Wall Street Rule.”

Findings of the study could prompt mutual fund shareholders concerned about financial risks to companies from climate change to push for change and comes as an increasing number of pension funds support resolutions to get companies to act on the climate risk issue. The funds in question were among the leading voices against enhanced proxy voting disclosure rules, which the SEC put into place in summer 2004. The rules require mutual funds to publicly declare their proxy votes for the first time.

Media briefing speakers will include CERES Executive Director Mindy Lubber; Civil Society Institute President Pam Solo; and IRRC Deputy Director of Social Issues Service Doug Cogan.

To join the live, telephone-based news conference (with Q&A), dial 1-(800) 860-2442 by 1:30 p.m. EST TODAY – Tuesday, December 7, 2004. Ask for the “global warming/mutual fund proxy vote” news event.  A streaming audio recording of the news event will be available on the Web as of 5 p.m. EST today at http://www.ResultsForAmerica.org andhttp://www.ceres.org.

Burton To Head CalPERS?

With Hannigan pushed out as a result of a vote by the State Personnel Board, speculation abounds as to who will replace him as head of the powerful California pension fund. The latest rumor has former Senate President Pro Tem John Burton appointed to the expired term of Mike Quevedo Jr. and assuming the leadership position. Our bet is still on Rob Feckner unless Harrigan can pull off a comeback via the Quevedo seat. Prior to Hannigan’s presidency, the position had traditionally been held by a board member who had been elected to the board by members of the CalPERS system. Feckner as elected by school employees. (Political angling at CalPERS, Sacramento Bee, 12/7/04 and Is Harrigan coming back to CalPERS?, San Jose Mercury News, 12/7/04)

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Perk Defense

Why do some firms tend to offer executives a variety of perks while others offer none at all? A widespread view in the corporate finance literature is that executive perks are a form of agency or private benefit and a way for managers to misappropriate some of the surplus the firm generates. According to this view, firms with plenty of free cash flow that operate in industries with limited investment prospects should typically offer perks. The theory also suggests that firms that are subject to more external monitoring should have fewer perks.

Overall, the evidence for the private benefits explanation is, at best, mixed. A recent study by Raghuram Rajan and Julie Wulf does, however, find evidence that perks are offered most in situations where they are likely to enhance managerial productivity.

First, firms in the sample with more hierarchical organisations lavished more perks on their executives than firms with flatter structures. Why? Perks are a cheap way to demonstrate status. Just as the armed forces ration medals, firms ration the distribution of conspicuous symbols of corporate status.

Second, perks are a cheap way to boost executive productivity. Firms based in places where it takes a long time to commute are more likely to give the boss a chauffeured limousine. Firms located far from large airports are likelier to lay on a corporate jet.

Perks aren’t necessarily purely managerial excess.

Proxy Access Issue On Hold (For Now)

With the reelection of George W. Bush and Harvey Goldschmid’s announcement that he will resign as a member of the Securities and Exchange Commission next year, the proxy access issue is likely to remain on hold for several years. It may still be possible to under the Bush Administration to require majority elections for directors or some other weak variant of the access rule but it is clear that the Business Roundtable and Chamber of Commerce have won this round. The Holy Grail of governance reform will have to wait for the next president.

Absent real accountability to long-term investors, directors will never be independent of management. No matter what bright line rules are adopted, boardroom politics and information flows will lead directors to inevitable psychological dependence on management…unless there is real accountability to shareholders. The SEC’s modest access rule would at least push in that direction. However, perhaps the Bush administration’s failure to adopt even this minor change will allow corporate governance reformers to actually enact a proxy access rule that could be used at most companies, instead of an insignificant minority. (The SEC release estimates that under the proposed access rule shareholders would make a nomination at only 45 (0.3%) of companies each year.)

As Stephen Davis, of Davis Global Advisors, indicated, it is time for shareowners to form “an investor-class version of MoveOn.org, the powerful, web-based mobiliser of grassroots political activism. Without it, director election reform is jammed at the SEC.” (Politics and money: a volatile mix, Financial Times 8/9/04) Let’s make proxy access an issue in the next presidential election.

TIAA-CREF Trustees Resign

Two trustees of one the world’s largest retirement systems, TIAA-CREF, have resigned because of conflicts of interest resulting from a business venture they formed with TIAA-CREF’s independent auditor Ernst & Young, according to a Securities and Exchange Commission filing and as reported by CBSMarketWatch.com.

TIAA-CREF resportedly said the trustees were “not aware that this business relationship raised an issue under the SEC’s auditor independence standards,” and that the two trustees “resigned to ensure there would be no question regarding the independence of the auditor.”

The two trustees, Professor Steven A. Ross of the College Retirement Equities Fund (CREF) and William H. Waltrip of the Teachers Insurance and Annuity Association of America (TIAA), resigned effective 11/30/04.

In August of 2003 Ernst entered into an agreement with a company owned by the two trustees, created to develop intellectual property and other services to value corporate stock options. A year later in August of 2004 Ernest notified TIAA-CREF that the business relationship violated SEC auditor independence standards. TIAA-CREF said neither Ross nor Waltrip disclosed their Ernst relationship on their officer-and-trustee questionnaires for 2003 or 2004, which contained questions about whether either had an affiliation with Ernst.

Value of Independence At Mutual Funds Called Into Question

Researchers at the University of Missouri-Columbia College of Business have found that regulations passed by the Securities and Exchange Commission in hopes of improving mutual fund governance in response to recent scandals may not be as effective as originally anticipated by regulators.

The SEC regulations passed in June required mutual fund boards of directors to consist of at least three-fourths outside directors and that chairmen of the boards must be outside directors. Outside, or independent, directors are individuals who are not employees of the mutual fund and do not have a professional relationship with any recent legal counsel of the fund. However, finance professors Steve Ferris and Sterling Yan found that mutual funds with higher percentages of outside directors or independent chairs don’t charge lower fees and aren’t less likely to be involved in scandals.

“There is no evidence to show that funds with independent chairs charge lower fees or have a greater level of compliance with existing regulations,” Ferris said. “These were among the primary arguments in favor of this requirement, so it is not clear what benefits this requirement provides.”

Ferris and Yan note that the mutual fund industry’s opposition to independent chairs emphasizes that such chairs may be less familiar with the company, can hurt the fund’s earnings performance, need a larger staff, and require more education about the fund. Another argument against requiring outside chairs is that it limits the position to a specific type of individual rather than allowing for selection of the best person.

The study suggests the SEC should focus on board size, outside director compensation and the number of funds each director oversees since these aspects were found to be significantly related to fund fees and the likelihood of fund scandal. The researchers studied a sample of 448 mutual fund families for 2002.

The SEC passed these rules following the mutual fund scandal that broke in 2003 as a result of the investigative efforts of Eliot Spitzer, New York state attorney general. The regulations were an attempt to improve the quality in governance of mutual funds and to make the funds more responsive to shareholders.

We note that perhaps it is the definition of independence that is problematic. To be truly independent, directors need to be nominated and elected by fund holders.

Related Party Transactions Still Pervasive

So-called “related-party” transactions, which figured prominently in high profile corporate meltdowns, continue to be pervasive among companies in the S&P 500, according to a study by RateFinancials, an independent risk research firm.

Based on a comprehensive analysis of proxy statements, RateFinancialsestimates that nearly 40% of companies in the S&P 500 have business arrangements with parties that have material ties to the corporations or their managements. The related-party arrangements involve a wide gamut of relationships, ranging from directors whose law firms receive millions of dollars in fees to office or other leasing arrangements with entities controlled by CEOs or their immediate families. Not surprisingly, related-party transactions are typically buried deep within a company’s proxy statement and are often overlooked by investors.

Although most related-party transactions are legal, they have figured prominently in several high-profile corporate scandals in recent years, including Enron, Adelphia, WorldCom and HealthSouth. More recently, insider deals have been flagged at Marsh & McLennan and Krispy Kreme.

“A significant number of S&P companies continue to ignore the growing outcry for improved corporate governance and actively engage in related-party transactions,” said Victor Germack, founder and president of RateFinancials. “Although related-party transactions do not necessarily involve any legal wrongdoing, they insert conflicts of interest into a company’s corporate governance where none needs to exist. Most of the arrangements were almost always avoidable and therefore appear to raise legitimate questions about whether company insiders are putting their own interests ahead of shareholders.”

One of the most common related-party arrangements involves the hiring of an advisory firm with ties to executives or directors. For instance, Teco Energy retains Ausley & McMullen, the law firm of director DuBuse Ausley. Teco has paid the firm $3.4 million over the last three fiscal years.

RateFinancials also found several deals that were beneficial to company insiders’ family members. This included an arrangement at the clothier The Gap. One of the firm’s general contractors for store construction, Fisher Development, is owned by the Chairman’s brother. Until fiscal year 2002, this construction firm was the primary non-exclusive contractor for The Gap. This relationship has been worth several million dollars to Fisher.

Other arrangements appeared to directly enrich a company’s top level executives. Best Buy leases two stores from its chairman. Combined rent on these two stores was approximately $950,000 for the fiscal year ended February 28, 2004.

Some other prominent companies identified by RateFinancials as being involved with related-party transactions include: Albertsons, AMR, Archer Daniels Midland, Bear Stearns, Clear Channel Communications, CVS, Dell, General Dynamics, Leggett & Platt, MBNA, Safeway, Toll Brothers and Winn Dixie.

For its study, RateFinancials closely examined the filings of companies representing nearly half the market capitalization of the S&P 500, representing nearly every major industry.

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November 2004

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Pay Without Performance

PayWithoutPerformancePay without Performance: The Unfulfilled Promise of Executive Compensation was the best book published in 2004 in the field of corporate governance. Lucian Bebchuk and Jesse Fried focus on one aspect of corporate governance, executive pay, and clearly demonstrate that many features of executive pay are better explained as a result of shear managerial power, rather than arm’s-length bargaining by boards of directors. After thoughtful analysis, they find “systematic use of compensation practices that obscure the amount and performance insensitivity of pay, and the showering of gratuitous benefits on departing executives.” The cost of current corporate governance systems is weak incentives to reduce managerial slack or increase shareholder value and “perverse incentives” for managers to “misreport results, suppress bad news, and choose projects and strategies that are less transparent.” Continue Reading →

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