August 2008

PSLRA Under False Attack

J. Brown begins another interesting series of comments… this time on the Chamber’s attack on the PSLRA entitled, Securities Class Action Litigation: The Problem, Its Impact, and The Path to Reform. The reason for the Chamber’s urgency, according to Brown, is that Democrats are likely to take more seats in Congress with the next election, so the time for Republicans to act is now. The Report emphasizes the increase in the number of class action suits that have been filed in the first half of 2008 but fails to consider that 51% of the filings made in 2008 since June 30 have been related to the subprime collapse.  (The Chamber of Commerce and Excessive Litigation: Be Careful What You Wish For)

Retail Shareowning Down

Individual ownership of US stocks has fallen to a record low, according to a report by the Conference Board. Retail investors owned 34% of all shares and 24% of stock in the top 1,000 companies at the end of 2006, the last year for which figures are available. Individual investors owned 94% of all stocks in 1950 and 63% of all shares in 1980. (Retail investors in US equities hits low, FT, 9/1/08)

Investor Suffrage Update

Glyn Holton’s latest newsletter for the Investor Suffrage Movement lays out an ambitious plan, beginning with a “field agent” program involving volunteers who will perform such tasks as filing shareholder proposals and attending annual meetings as legal proxies. I’m helping with this task and hope many readers will consider joining the program. Here’s how he describes the next three months:

  • September: Incorporate the movement and start drafting the *Field Guide* that field agents will turn to for guidance as they submit proposals or attend shareholder meetings. Mostly during September, we want individuals who plan on becoming field agents to approach friends and colleagues about also becoming field agents.
  • October: In early October, Glyn will take an organizing trip to the West Coast to meet with Jim McRitchie and many of the people he has invited to become field agents. Following that we will formally sign up everyone who has volunteered to be a field agent. That should be complete by the middle of the month, and people can get to work on assigning proxy rights and filing shareholder proposals. November is some corporations’ deadline for filing shareholder proposals, so timing may be a little tight. Obviously, we will need to complete the *Field Guide* and implement some sort of on-line exchange for matching field agents with shareholder activists and proxy rights — probably spreadsheet based.
  • November – December: Filing shareholder proposals. We may have a holiday social for people in Boston … or in cities with multiple field agents.

His timeline goes into next year and the newsletter includes Glyn’s travel schedule. Of course, the “movement” also has T-Shirts available. I’d say we’re off to a great start.

With a growing network all around the country, and internationally, of people willing to help write resolutions, file them and represent shareowers at annual meeting, I fully expect the dynamics begin to change for institutional investors and retail shareowners. Soon we will all be filing many more resolutions and coordinating our efforts. Within a few years, democracy will be taking a giant leap within corporate governance.

Alert: Comment on NYSE Proposal for Weaker Independence Standards

The NYSE has proposed and the Commisson has approved amendments to the rules of the NYSE that weaken its already weak definition of independence.  The amendments raise the amount of “direct compensation” that can be earned from $100,000 to $120,000. A second amendment weakens conflict of interest relationships with the outside auditor. (The SEC and the Erosion of Director Independence,, 8/28/08) I encourage readers to write a comment letter to Include File Number SR-NYSE-2008-75 on the subject line.

Norway Investors to Set KPIs

Norway’s largest institutional investors have confirmed plans, backed by the country’s Ministry of Finance, to push the country’s top companies to report to a public set of standards on issues such as the environment, labour and human rights, after Responsible Investor revealed their intentions last month.

The Norwegian investors are planning to publicly release the information requirements to encourage other European investors to receive the same data from companies in their home markets. (Norway’s biggest investors outline plans to go direct to companies for ESG data, Responsible Investor, 8/28/08) Those who take the initiative will be setting Key Performance Indicators (KPIs) for environmental, social and governance issues and long-term viability that may be adopted around the world.

Icahn Speaks for Many

Carl Icahn says proxy contests are more expensive and time consuming than they should be. He blogs that 3 Senseless Steps in A Proxy Contest are the costs and delays in obtaining the shareholder list, the amount spent by target companies to prevent a shareholder from being elected to a board, and the risk faced by professionals who risk losing a company’s future business if they conduct business with the insurgent investor.

ICGN Opposes EC Auditor Liability Cap

ICGN called on the European Commission (EC) to rethink guidelines for limiting auditors’ liabilities, saying a on cap auditor liabilities would “reduce audit firm accountability, provide a market incentive to take audit shortcuts, and reduce overall audit quality. As has been emphasized by the European insurance profession, such a cap will not prevent large/catastrophic losses and will not improve the availability of corresponding insurance coverage.” (Letter, 8/19/08)

ICGN Mid-Year in Delaware

The ICGN mid-year meeting of 2008, hosted by the State of Delaware, will take place in Wilmington, Delaware on Wednesday December 10, at the Hotel DuPont, with a reception and dinner beforehand on December 9. This conference will look at the new reform agenda in corporate governance in the US market following the impact of the US presidential elections and consider how these affect and are affected by global developments. Find out more.

$274 Million Profit on Bear Sterns

On March 11, when Bear stock was trading at around $63, someone purchased $1.7 million worth of Bear Stearns “put” options for 5.7 million shares at a price of $30 and another 165,000 shares at $25. These put options were scheduled to expire only 9 days later. On March 14, the CBOE listed a series of new Bear put options that would expire in less than five days. One was for 630,000 shares at a price of $5, a price 90% below the current trading price. As one expert observer was quoted as saying,  “nobody in [his] right mind would buy that put unless [he] knew what was going down.” Another expert said that “when you buy $5 strikes when the stock is trading over $50, you either have to be manipulating, or you have to have insider information.”

“If the SEC can connect the dots, showing that the investors who made those bets were also responsible for the market rumors that brought Bear Stearns down, it could be one of the most brazen financial crimes ever.” (From the Pages of The Pomerantz Monitor: Suspicions Grow Over the Demise of Bear Stearns, 8/26/08)

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DB vs DC

West Virginia lawmakers were informed Monday that the movement of nearly 15,000 teachers and educational workers from a defined contribution plan to a traditional pension plan will shave about $22 million off – that’s right, shave OFF – the state’s retirement benefit expenses. The estimate given to lawmakers by state actuary Harry Mandel was radically different from early statements that the DC to DB migration would actually cost the state as much as $78 million to subsidize pensions for teachers and service personnel who transferred to the Teachers Retirement System but had limited assets in their Teachers Defined Contribution (TDC) plans. (WVA DC to DB Migration Could Mean Big Savings, PlanSponsor, 8/26/08)

CEO Pay, Still Burning Issue

77% of Americans polled last year felt that corporate executives “earn too much.” Yet, CEOs at S&P 500 companies got an average 2.6% pay hike to $10,544,470 — 344 times the pay of typical American workers.

Ordinary US taxpayers are subsidizing the earnings of executives by at least $20 billion says Sarah Anderson, an analyst at the Institute for Policy Studies (IPS), due primarily to tax loopholes.

  • A large chunk of private investment and hedge fund manager earning come from the 20% of profits realized when they sell fund assets. Preferential treatment to this “carried interest” costs $2.66 billion because the tax rate is 15%, instead of 35% for ordinary income.
  • Unlimited deferred compensation. Annual cost: $80,600,000. 83.4% of S&P 500 companies offered such accounts for their top brass in 2007. Many corporations guarantee executives an above-market rate of return on the dollars in their deferred pay accounts.
  • Offshore deferred compensation. Annual cost: $2,086,000,000. Hedge Fund Research, a Chicago-based analyst firm, estimates that of the total $1.86 trillion invested in hedge funds, $1.25 trillion is kept in funds registered offshore. The practice of stashing funds in offshore banks, one Senate investigation has found, costs U.S. taxpayers an estimated $100 billion dollars each year.
  • Unlimited tax deductibility of executive pay. Annual cost: $5,249,475,000. Tax law allows corporations to deduct the cost of executive compensation from their income taxes, as a business expense, so long as this compensation remains “reasonable.”
  • Stock option accounting double standard. Annual cost: $10,000,000,000. Current accountingrules value stock options on their grant date. The current tax code values stock options on the day that executives decide to cash them in. The two numbers rarely match, and in recent years, the actual “in-the-pocket” value has been significantly higher than the grant date estimate. As a result, companies can lower their tax bill by claiming deductions for options-related costs that are much higher than what they report in their financial statements. By reporting a low expense for stock options on financial statements, corporations can show higher quarterly net earnings.

study by Harvard University professors Lucian Bebchuk and Yaniv Grinstein found that the pay and benefits given to the top five executives in a large group of big corporations in the years 2001 to 2003 amounted to 10% of the total earnings of these firms. (How long will politicians look the other way on CEO pay?, Christian Science Monitor, 8/25/08) That’s up from 5% in 1993-1995, so it is difficult to argue that CEO pay represents an insignificant amount of firm profit. CEO still tops the agenda when I talk with regular workers about corporate governance. Both McCain and Obama favor “say on pay” but both have been relatively silent on the issue lately.

According to Executive Excess 2008: How Average Taxpayers Subsidize Runaway Pay (from which most of the findings above were drawn), “Congress has never taken an explicit, up-or-down floor vote on any of the major tax code loopholes that enrich our current captains of industry and finance. These loopholes, instead, owe their provenance to obscure bureaucratic rulings that lavishly paid corporate lawyers and lobbyists have stretched and distorted far beyond their original rationale.” Unions have traditionally been the strongest advocates of economic fairness but unions have been in decline. “Without legislative action to allow more workers the right to organize, the divide between compensation for top executives and the rest of us will only continue to grow.” Thanks to the Institute for Policy Studies and United for a Fair Economy for bringing us this important report.

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Restatements Lower… Maybe Too Low

Is the steep decline in restatements and material weaknesses this year due to improvements that resulted from Sarbanes-Oxley or to a lenient SEC? That the question posed by Nicholas Rummell inTumble in restatements sparks criticism of SEC, Financial Week, 8/25/08)

“It appears the SEC is giving companies a pass when it comes to making restatements for errors,” said former SEC chief accountant Lynn Turner. “I have been told the SEC has even told people contemplating restatements they don’t need to.”

An SEC advisory committee, led MFS Investment Management chairman Robert Pozen, would limit restatements related to prior periods to cases in which the numbers affect current periods. Rummell cites a statement by John White, director of the SEC’s division of corporation finance, that indicates he would favor such a move because it will result in “more timely financial reports and avoid the costs to investors of delaying prompt disclosure of current financial information in order for a company to correct multiple prior filings.”

A Compliance Week study of S&P 500 companies found that 11 reported material weaknesses in their latest filings compared to nearly 400 in 2006.

Broken Proxy Voting System

When the vote-counting error happened at Yahoo I said forget about Yahoo… look at Broadridge Financial Solutions. Is the system broken?

Nicholas Rummell has done a good investigative first cut, asking several who use their service and others. “We believe the system needs to be carefully inspected to determine what other errors could occur and increase transparency,” said the Florida State Board of Administrators. “What we have now doesn’t work,” observed Meagan Thompson-Mann, a visiting research fellow at Yale University’s Millstein Center for Corporate Governance. Broadridge is “an accident waiting to happen,” according to Marcel Kahan and Edward Rock. That’s just a sample. (Questions surround proxy firm that botched Yahoo vote count, 8/22/08)

I’m not sure that Broadridge is to blame but the system of accurately tracking proxies is broken… not that it ever really worked like it should. It was designed for a time of few contests and few passing resolutions. The markets have changed and the whole proxy voting system should be revisited and reconstructed.

Lowe’s Governance Standards Not So High

“Today’s action by the board of directors further illustrates Lowe’s long tradition of strong corporate governance policies and practices,” explained Robert A. Niblock, chairman and CEO. (Lowe’s Announces Four Corporate Governance Initiatives, MarketWatch, 8/22/08)

What were the changes? The board voted to remove all remaining supermajority vote requirements. Good. But the other changes didn’t set a high threshold.

  • Establish the position of lead director when companies with high standards are splitting the roles of chair and CEO.
  • They amended their bylaws to allow shareholders holding greater than 50% percent of the company’s outstanding voting shares to call a special meeting. Yes, they’ve met the typical US standard but in the UK and elsewhere it has long been 10%.
  • They now will allow limit directors to serving on a maximum of six public company boards, including the Lowe’s board. Again, they achieve the norm but other companies, such as Pfizer, limit directors to four boards.

CorpGov Bits

Broadridge Financial Solutions plans to launch an electronic shareholder forum. Unlike others, this one will validate that participants are actually shareholders. Since Broadridge has a virtual monopoly over the retail shareholder communications market in the US, as a result of its extensive links with brokerage firms, the forum they develop might be expected to be used by others. (CEO sees project as ‘unique’ rival to investor chat rooms, IR Magazine, 8/21/08)

Ulrike Malmendier and Geoffrey A. Tate studied CEOs who achieve “superstar” status via prestigious nationwide awards from the business press and found they subsequently underperform. Award-winning CEOs extract significantly more compensation following the award and spend significantly more time and effort on public and private activities outside their company, such as assuming board seats or writing books. The effects are strongest in firms with weak corporate governance. (Superstar CEOs, SSRN, 3/15/07) Your CEO’s Won One More Top Award? Too Bad, Corporate Board Member, 9-10/08 brought the study to our attention.

The NYSE and Nasdaq have both amended their listing standards to conform their director independence requirements to the related party transaction requirements of Item 404 of Regulation S-K. Specifically, the SROs have raised the compensation bar from $100,000 to $120,000 for purposes of deeming a director independent. Separately, the NYSE also amended the independence requirement on relationship with the company’s auditor to allow an immediate family member of a director to be employed by the auditor so long as the relation is not a partner of the audit firm or working on the company’s audit. (NYSE and Nasdaq Conform Director Independence Standards to SEC Regulation S-K, Jim Hamilton’s World of Securities Regulation, 8/20/08)

Of 57 resolutions filed by a range of socially concerned investors, almost half were withdrawn after companies ranging from Continental Airlines to El Paso made commitments on setting targets for reducing greenhouse gas emissions and other issues. (Climate resolutions ‘having big impact,’, 8/20/08)

Dr William (Bill) Crist, former president of the board of CalPERS, has been appointed to the board of Governance for Owners Group LLP (GO) and will take over as Chairman in October.  Robert Monks, who chaired GO since its inception in 2005, will step down from the board, remain a partner and be closely involved as a senior advisor. (press release, 8/20/08)

New resource from the Center for International Private Enterprise: Corporate Governance for Emerging Markets is a concise introduction to the topic, which describes strategies and examples for reforming corporate governance practices in line with local needs.  Includes five examples of reform efforts.

The Shareholder Association for Research and Education (SHARE) provides active ownership services, including proxy voting and engagement services as well as education, policy advocacy and practical research on emerging responsible investment issues in Canada. They recently expanded their database of shareholder proposals filed at Canadian companies to includes proposals filed from 2000 to 2008. OK, who’s got a similar tool for the U.S.?

Competing with the NYSE looks at the rivalry between the New York Stock Exchange (NYSE) and the Consolidated Stock Exchange (Consolidated) from 1885 to 1926 and concludes competition is good.

The Corporate Library’s latest report, “Pay Now Sue Later,” explores the compensation practices of 54 companies that were the object of an SCA suit during 2005. The findings suggest that boards do not change their behavior in regards to compensation as a result of litigation.

According to Global Warming: The Director’s Perspective, “The key is to define the oversight responsibilities of the board in relation to the responsibilities of the executive team, using traditional notions of oversight and governance to drive a disciplined corporate strategy on a complex issue.”

Michael Kane is doing a great job of compiling a CSR directory, as Bill Baue points out in Investor Advocates Upping Effectiveness by Creating Issue-Specific Networks. Working together helps make those small steps in the longest march to democracy more enjoyable. Find a network, or several, and lend a hand.

“If you were a turkey in a democracy, would you vote for Christmas? That’s what the Hong Kong Government is hoping members of Hong Kong Internet Registration Corporation Ltd (HKIRC) will do at an Extraordinary General Meeting at 9 a.m. this coming Saturday, 23-Aug-08, by voting to reduce their representation on the HKIRC board of directors, and hand control of it to the Government.” Read Stop the .HK Takeover, by David Webb.

The 2007 edition of Weil, Gotshal & Manges’ The 10b-5 Guide: A Survey of 2007 Securities Fraud Litigation is now available on The Survey contains summaries of recent decisions concerning the federal securities laws and highlights particular topic areas, such as the heightened pleading requirements under the Private Securities Litigation Reform Act of 1995, secondary liability and loss causation. Securities fraud class action filings increased 43% in 2007, fueled in part by the subprime mortgage crisis, so this edition is a welcome summary.

Floyd Norris reports on a court case on compensation for mutual fund managers involving a difference of opinion between two conservative judges. Frank H. Easterbrook’s decision said fund directors should have the final say on pay, relying in part on a recent academic study financed the Investment Company Institute, a mutual fund trade group. Richard A. Posner’s dissent pointed to a May 2008 study by Camelia M. Kuhnen, which found evidence that connections between fund directors and managers “foster favoritism, to the detriment of investors.” (Judges in Dispute Over Mutual Funds, NYT, 8/16/08) One can just imagine the changes that will come if we get a President who appoints more liberal judges.

Pensions & Investments reports that corporate governance rules such as “say on pay,” higher taxes on hedge funds and private equity shops, and wider pension coverage are items likely to work their way onto the Democratic Party’s platform. (Un-conventional thinking, 8/18/08) Regardless of the outcome, we are happy to see corporate governance as a topic of important discussions.

Public pension funds in the U.S. are increasing bets on high-risk hedge funds and real estate in an attempt to fill deficits in retirement plans and make up for their worst performance in six years. South Carolina’s retirement system adopted a plan in February to invest as much as 45 percent of its $29 billion in hedge funds, private equity, real estate and other alternatives, from nothing 18 months ago. (States Double Down on Hedge Funds as Returns Slide, Bloomberg, 8/14/08) While flexibility is welcome, public pension funds aren’t the rights place for a gambling mentality. Imagine the backlash against public employees if a fund has to be significantly bailed out because of risky investments.

BusinessWeek’s will launch Business Exchange at the end of September with hundreds, and soon thousands, of vertical wiki-type guided topic pages. Each Business Exchange topic page links to articles and blog posts from myriad other sources. They’re hoping to double online visits. (Topic Pages to Be Hub of New BusinessWeek Site, NYT, 8/17/08) I’m curious as to how corporate governance as a topic will break out.

After a GAO report found that almost two-thirds of companies in the United States usually pay no corporate income taxes, NYT opines: “Here is a crazy idea to address the United States’ gaping fiscal deficit: persuade corporate America to start paying taxes.” “Even as corporate profits have soared — reaching a record of 14.1 percent of the nation’s total income in 2006 — the percentage of these profits paid out in taxes is near its lowest level since the 1930s.” While our corporate tax rates are among the highest in the industrial world, the taxes corporations actually pay are among the lowest. (The Corporate Free Ride, 8/18/08) Pierre-Yves Gomez and Harry Korine are right, taxpayers, not shareowners, may not be the real “residual claimants” as tax havens are sought to achieve a predetermined level of remuneration to shareowners and managers.

Gary Lutin continues his important work at The Shareholder Forum. We’re delighted to see The Corporate Library giving his efforts their assistance by allowing him to post a copy of their Analyst Alert: ‘Say on Pay’ 2008. Congratulations to The Corporate Library, now celebrating their 10th year, and to Lutin for conducting an extensive “say on pay” forum.

Brendan Sheehan, reviewing the 2008 proxy season for The Corporate Secretary magazine, concludes: “There is one thing we can certainly count on for next year. As the credit crisis continues to play out and we develop a better understanding of the causes, it is possible that shareholders will make a strategic shift in voting practices toward risk management and performance metrics, and away from some of the ‘pure’ governance elements common to the past.” (A season of surprises, 8/2008)

Corporate Voting vs. Market Price Setting concludes that, “Price-setting shareholder places lower value upon management control of companies than the median voter. If price-setting shareholders provide a reasonably accurate gauge of value (a proposition that underlies every event study) and value maximization is the goal of corporate law (as most assume)—then the results suggest a need for corporate voting reforms.”

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Entrepreneurs and Democracy

Entrepreneurs and Democracy: A Political Theory of Corporate Governance by Pierre-Yves Gomez and Harry Korine is a sweeping masterpiece with a modest objective – to propose “a framework that allows economists, historians, and political philosophers to talk to each other.” Various professions should use this framework to help determine the future of corporate governance for decades to come.

“’What gives the right to direct a corporation?’ is answered by economics from the point of view of performance, by history from the point of view of the evolution of governance, and by liberal political philosophy from the point of view of the foundations of legitimacy.”

Gomez and Korine weave a multi-disciplinary tale of corporate governance history by juxtaposing two powerful forces that arose with modern liberal society:

  • Entrepreneurial force, which sees opportunities and provides direction to collective activity
  • Social fragmentation, which ensures individual liberty

“From the unstable equilibrium between entrepreneurial force and social fragmentation emerges corporate governance that is both legitimate and performing,” directing the “productive action of people who want to stay autonomous and free.” The quick takeaway: corporate governance must increasingly become more democratic to be seen as legitimate.

“Whereas political harmony in traditional societies is built on complementarity and cooperation, liberal society strives to create social agreement” grounded in individual liberty and competition. “The emergence of the entrepreneur as the heroic figure of capitalism is paralleled by the emergence of democracy” as the accepted institution for reconciling these two forces. “Democracy has spread from the political sphere, to the civic and economic spheres: the history of corporate governance does not escape this movement.”

Contrary to the worries expressed, mostly by those in power, Gomez and Korine contend, “There are good economic reasons to think that the democratization of corporate governance and the growth of economic performance go hand in hand.” Three primary procedures for the maintenance of individual liberty apply increasingly to both political and economic spheres: equality of rights, separation of powers, and representation with public debate

The book follows a sometimes arcane but always fascinating journey, starting with three types property rights in what could be called the dominant corporate governance theory of Roman times:

  • Usus – the right to make use of property
  • Fructus – the right to benefit from the fruits property
  • Abusus – the right to destroy or sell property

The book then proceeds to explain the evolution of three models of reference, or forms of corporate governance adopted by leading companies after the fall of feudalism:

  • Familial, characterized by enfranchisement of the entrepreneur
  • Managerial, with the emerging separation of powers
  • Public, characterized by representation and public debate

In feudal times, the aristocrat owned rights of fructus and abusus, but not usus. The tenant owned rights to usus and fructus but not abusus. Partition of complementary property rights provided the building blocks for a cooperative society, organized around class and mutual dependence. Private property and ownership of all three rights by one party permitted the blossoming of individual liberty and capitalism.

In the tradition of modern liberal thought, work, not ownership, became the more privileged source of political legitimacy. Work reaffirms individual liberty and equality, whereas ownership can be inherited and can be used to sustain inequality. Management, therefore, eventually took over the entrepreneur’s mantle of legitimacy, transforming shareholders from involved owners to coupon clippers.

Shareholders had the right to claim the profits, but little else. Corporate managers were in charge of economic well-being. The unions were in charge of social well-being. The state acted as an arbiter for the general interest. For a while, most accepted the legitimacy of management, based on their claim to superior expertise. That claim quickly came into question during the Depression.

Berle and Means did not blame the downturn on the greed of those who owned shares but rather on their passivity and their failure to check management. They concluded that control groups have “placed the community in a position to demand that modern corporations serve not alone the owners of the control but all of society.” They proposed that corporations seek to maximize the general interests, rather than shareholder profits.

According to Gomez and Korine, most economists endorsed the economic analysis of Berle and Means but not their conclusion. Instead, they have systematically worked to overcome the inherent inefficiency of separating ownership and control by focusing on market forces… hoping to find a cure from within… purified of the need for government intervention, with “agency” theory.

Ironically, “whereas Berle and Means worry that the dilution of the capital base poses problems, contemporary property rights theorists find that the absence of dilution (resulting in illiquid markets) is problematic.”

Gomez and Korine discuss the pure economic model (PEM) and its flaws, such as, “If markets were truly efficient, as PEM contends, no one would seek additional information.” For predicting stock prices, the authors find more value in the science of crowds and mass movements.

Agency theory underestimates the degree of fragmentation. Real divisions occur not only between shareholders and management, but also among shareholders who differ in size, motivation, time horizon and willingness to exert influence and likewise within management itself.

Like the managers of agency theory, shareholders will also seek personal gain by exploiting imperfect information. Shareholders seek to maximize their own profits by exploiting information imperfections. Like managers, they are tempted to maximize sort-term interests, attracting speculative money to raise share price. Neither managers nor shareholders have much incentive to stay loyal to the company. Both can move on easily.

Management knowledge is no longer restricted to a small, elite group. With mass shareholding, workers have become owners. Contemporary corporate governance is less about the opposition between management and shareholders, than about the interplay between “investors” and “shareholders.” Both lay claim to the mantle of the entrepreneurial force.

According to Gomez and Korine, we are entering a new corporate governance paradigm where “investors” are focused on the value of a portfolio of investments. They trade to optimize their portfolio and care little about the fate of any single company.

“Shareowners” focus on individual corporations. Both are interested in profit maximization but shareowners may also be interested in the firm’s specific role in defending jobs, securing credit, consolidating business relationships, preventing ecological risk or increasing share price through shareowner intervention.

Management becomes the executor of choices determined primarily by financial markets, driven by investors and shareowners. Where shares are highly dispersed and markets liquid, investors hold sway. In the opposite case, shareowners play the more a critical role. Public opinion is quickly becoming the real counterweight to the direction of entrepreneurial force provided by investors and shareowners.

Both investors and shareowners need transparent and standardized information that is substantially identical in form and universally understood. The institutions that contribute to “good governance” are those that align the internal creation of value, through shareowner activism, with the external interests of investors, though buying and selling.

Investors and shareowners often have a broader knowledge than management concerning sources of performance. For investors, corporate governance is a black box. Participation is costly and less important than transparency. But Gomez and Korine see that, “Between the ‘invisible hand’ of the markets and the very visible role of management, active shareowners play the roles of catalysts and mediators.”

The authors offer three primary characteristics of contemporary corporate governance.

  • Omnipresent information. Familial governance operated on the principle of secrecy, managerial governance on expertise and the ability to interpret information. Today markets require a permanent flow of increasingly standardized information. Companies must look “normal” and comply with “best” practices or explain why they don’t.
  • De-privatization of corporation. Shareowners and investors, to some extent, work for the corporation, even though formally outside of it, by contributing significantly to strategy.
  • Debate and representation of interests play an increasing role. Legitimacy depends on discussion between interests and making the contents of that discussion public. Public opinion has become the main counterweight to the entrepreneur. Actors have melded – consumers, owners, workers, citizens are often the same, enlarging the circle of discussion. Large multinational corporations now occupy a collective space that fewer private individuals can hope to control alone, as more and more people are collectively implicated.

Continuation of the corporate form is tied to its ability to generate collective wealth and to do so legitimately. The current model in transition from management to public is not too liberal. Rather, it is not liberal enough.

For example, Gomez and Korine note that shareholders may not be the real “residual claimants,” as is so often assumed. If jobs are off-shored to achieve a predetermined level of remuneration to shareholders, employees become the real residual claimants. If tax havens are sought for the same reason, the government becomes the de facto residual claimant.

Employees and governments are increasingly taking the risk. Catch 22. “Either shareholders are not powerful enough to influence management and corporate profits are not maximized – this was the concern of Berle and Means – or, shareholders are too powerful and impose a pre-determined level of remuneration to equity capital.”

The critics of “good” corporate governance decry the extra expense of independent directors and box-ticking exercises. The cost of collecting and interpreting information goes up with the number of shareholders who must take each other’s behavior into account. Investors are more interested in outperforming the market than in having an individual company perform well.

However, Gomez and Korine demonstrate that a corporate governance model based only on the calculations of individual interests does not maximize economic performance for society. Market self-regulation is inadequate. So, how do we regulate markets to ensure the convergence of both public and private interests? The answer appears to require greater use of democratic mechanisms. Many are already employed by cutting edge companies. Others are yet to be invented.


Korean President Lee, who served as CEO of Hyundai Engineering & Construction and took office in February as the nation’s first leader from a corporate background, granted amnesty to Hyundai Motor Chairman Chung Mong-koo, SK Energy Chairman Chey Tae-won and Hanwha Group chairman Kim Seung-youn, who were convicted of crimes such as fraud, embezzlement and assault. Most of the pardoned businessmen were already out on bail after receiving suspended jail terms.

The Korean Chamber of Commerce and Industry said the special pardon will help boost transparent corporate governance and ethical management. (President Pardons Convicted Tycoons, Korea Times, 8/12/08) Just exactly how pardoning corporate criminals will boost good corporate governance wasn’t explained.


First Chapter 10-35 of the North Dakota Century Code gave companies a choice, after July 1, 2007 to be subject to new provisions for their articles of incorporation that include:

  • Majority voting in election of directors.
  • One year terms for directors.
  • Say on pay.
  • Proxy access.
  • Reimbursement for successful proxy contests.
  • Separation of Chair and CEO.
  • 10% holders can call “special meeting.”

Now South Dakota has an initiative on the general election ballot that could outlaw naked short selling across the country. Los Angeles-based American Entrepreneurs for Securities Re-form, which sponsored the South Dakota initiative, last week promised to organize similar campaigns in 18 other states if the SEC does not move to restrict naked short selling permanently for all companies. (Hedge funds alone in fight against short-selling curb, Investment News, 8/11/08) Continuing the race to the top.

Advisor or Cop?

An interview with Lon Allan, CEO, NACD Silicon Valley Chapter. Hosted by Priya Cherian Huskins, Senior Vice President, Woodruff Sawyer. View this informative podcast on the role of the board. Sign up for the Director Professionalism Course, San Francisco, CA, August 19-20, 2008.

Clawback Resolutions

Steven M. Davidoff, blogging for the New York Times as “The Deal Professor,” discusses the clawback provisions of Sarbanes-Oxley Act under Section 304, which protect against “misconduct,” and the case of E. Stanley O’Neal at Merrill Lynch in The Stan O’Neal Resolution (8/7/08). Davidoff has come up with the resolved portion of a shareowner’s resolution to address the issue that a company’s highly compensated employees can accrue sizable short-term profits under typical incentives while ignoring larger risks. His draft text reads as follows:

The shareholders of [insert company name] hereby request the board of directors amend the by-laws of the company or otherwise adopt a formal policy to require that all incentive compensation paid in any year to any employee of the company who earns greater than $1 million in that year be required to be repaid to the company if the board or any committee thereof later reasonably determines at a later date that the company data on which the incentive compensation is based have not been achieved or resulted from error(s).

Davidoff then discusses how management is likely to seek to try to exclude such resolutions on the basis that they “substantially implement” an existing management policy that tracks SOX. But SOX is applicable only if “misconduct” is involved. Davidoff’s resolution only requires a finding of “error.” The SEC has permitted companies to exclude clawback proposals only where the form and substance of a company’s existing clawback provisions correspond closely to those sought in the proposal. Davidoff’s proposes what is essentially a “no-fault” clawback, so a finding of “misconduct” wouldn’t be necessary. That is substantially different than most companies policies, which track the more difficult to make findings required by SOX.

I applaud Davidoff for encouraging his readers to file clawback resolutions. However, his resolution seems a little harsh. It seeks to require recoupment of all incentive pay over $1 million, even if an unintentional error is made that only partially impacts the amount of incentive pay. Better language was contained in a resolution last year by Chris Rossi at ExxonMobil and presented by Robert Monks. It just happens to be the subject of the exact SEC decision Davidoff refers to in offering a possible defense:

Shareholders request our board to adopt a bylaw to enable our company to recoup all unearned incentive bonuses or other incentive payments to all senior executives to the extent that their corresponding performance targets were later reasonably determined to have not been achieved or resulted from errors.

The Rossi proposal would have senior executives return only that portion of bonuses that aren’t actually earned. That seems fair. I’m all for taking back income that isn’t earned, but companies still need to provide incentives to attract top talent. Executives shouldn’t be punished so severely for what may be unintentional errors. Let them keep what they actually earn and not a penny more. For additional information, see an advisory from Gibson Dunn & Crutcher LLP, “Clawbacks” of Executive Compensation, posted July 17, 2008 at

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Inventing the Future

On the back of the July/August edition of The Corporate Board magazine is a famous, but too little lived by, quote from computer scientist Alan Kay. “The best way to predict the future is to invent it.” Ralph Ward continues to do a fine job editing this unique publication for board members attempting do just that.

John Pepper, the independent chairman of Walt Disney, leads the issue with “Best Practice” Boards and CEOs. Nothing revolutionary here… stick to your values, back up the CEO when he/she is right, do your homework and push to make the company better… but Pepper’s remarks and the accompanying interview provide insights into the evolution of board dynamics.

Readers following the advice of H. Stephen Grace and John E. Haupert in “Shaping the Nominating/Governance Committee” will find this committee transformed from a sleepy refuge that meets once a year to one of the hottest spots in the boardroom. They advise NGCs to expand involvement in succession planning from CEO to C-suite positions, from updating governance documents to ensuring diffusion of power, from codes of ethics to “codes of conduct,” and even creating and monitoring corporate-wide risk analysis. Clearly, such expansion must be coordinated with the Audit Committee but lots of food for thought.

More practical advice is offered by Overton Thompson III and Ryan D. Thomas in “The New world of Leveraged Buyout ‘Deal Protection” and by Lori Lynn Phillips and Nicole M. Ryan in “Managing an Internal Investigation.”

However, from my perspective as a shareowner activist, I gravitated most heavily to Brian Sullivanand Michael Kelly‘s Activist in the Boardroom. The number of activists getting seats without proxy fights continues to accelerate. The authors advise:

  • Keep an open mind. Many have made a big investment. “They have every reason to try to ensure that their recommendations will have a positive effect on the share price.”
  • Make shreholder meetings a priority. A lesson leaned the hard way by Home Depot in 2006.
  • Admit there may be problems. Shareowners don’t usually get involved when value is headed up.
  • Conduct due diligence on activists. Examine their track record and their objectives.
  • Avoid a PR war. “Let the activists shoot from the hip, and save your comments for the boardroom.”
  • Rally around the company’s best interests. Keep the focus on “making the best decisions for the shareholders.”

The magazine’s “In Review” section highlights recent trends and provides a couple of retrospective quotes form five and ten years ago, including one from publisher, James McRitchie on the growing role of institutional investors as mediators between the individual and the modern corporation. “Spoken & Written,” provides more current quotes. Here are a couple, much abbreviated:

  • Today, the attitude is very clear that the board is the CEO’s boss, and CEOs understand that they are accountable and answerable. – Edward M. Liddy, The Allstate Corporation
  • This black-box perception of boards is a serious problem in and of itself, because all of us have a stake in the effective functioning of organizations that affect our lives and our society in so many ways. – William G. Bowen, author of The Board Book

“Directors’ Register” keeps readers posted on who was recently elected to various boards. Rounding out the publication is one of my favorite features, “Conversations.” This issue’s conversation was with Susan Stautberg, the founder and president of the WomenCorporateDirectors group. She recognizes the growing importance of capital flows. “Directors need to know not only their company’s business, but how to deal with issues like derivatives, global stock issues, and globalization… Boards want directos with experience in supply chains, or manufacturing in China, or strategic HR, or marketing.”

Eyes are opening and The Corporate Board is one of the prime resources for those actively creating the future.

New Audit Publications

The Institute of Internal Auditors (IIA) published two new editions in its series of Global Technology Audit Guides® (GTAGs). GTAG 10: Business Continuity Management and GTAG 11: Developing the Information Technology (IT) Audit Plan recognize the criticality of proactive planning when managing and sustaining effective IT systems.

Business Continuity Management (BCM) is designed to help prepare organizations for natural or man-made events that could disrupt operations. This guide includes disaster recovery planning for continuity of critical IT infrastructure and business application systems.

“Despite high-profile events such as 9/11 and hurricane Katrina, some companies are still not as prepared for a disaster as they think they are,” said IIA Director of Technology Practices Lily Bi. “In a time of crisis, if you’re not sure how you’re going to deal with your critical business functions and IT systems that support those functions – you’re taking a huge risk. This guidance can help internal auditors evaluate the effectiveness of their plan before it’s too late.”

Yahoo Vote

Yes, five Yahoo directors, including CEO Jerry Yang were re-elected to the board with much higher protest votes than previously reported. (Revised Tally Increases ‘No’ Votes for Yahoo Directors, NYT, 8/5/08) But the real question nonYahoo shareowners should be asking is how could Broadridge Financial Solutions have made such an error and how common are such errors? Broadridge says it was a “truncation error.”

Perhaps this is symptomatic of larger problems at Broadridge. See What is Broadridge Thinking? I’m beginning to question the competence of this near monopoly. Note: The day after I posted this item, J. Robert Brown did a much more extensive look at the situation, Miscounting Shareholder Votes, at

Lead Director Network (LDN)

On July 8, 2008, members of the LDN met in New York City for the network’s inaugural meeting to key issues confronting lead directors. Sponsored by King & Spalding and convened by Tapestry Networks, the LDN is a group of lead independent directors, presiding directors, and non-executive chairmen drawn from America’s leading corporations who are committed to improving the performance of their companies and to earning the trust of their shareholders through more effective board leadership. There first newsletter, Lead Director Network Viewpoints, was issued on July 30, 2008. This is a valuable venture. (The Role and Value of the Lead Director — A Report from the Lead Director Network, The Harvard Law School Corporate Governance Blog, 8/6/08)

However, far more value will come out of the Millstein Center’s peer organization of independent chairmen of North American corporate boards. That is clearly the direction corporations are headed. Their first meeting is scheduled for October 7th.

Qserp Saves Intel $65 million in Year One Taxes

“Qualified” supplemental executive retirement plans are a way to give top officers bigger benefits from the regular pension plan “without [necessarily] increasing staff benefits at all,” says an article in the WSJ. (Companies Tap Pension Plans To Fund Executive Benefits, 8/4/08) The little known, but increasingly used mechanism, allows companies to capture tax breaks intended for pensions of regular workers and use them to pay for executives’ supplemental benefits and compensation.

Ellen Schutz and Theo Francis appear to have looked most closely at Intel, as one example, and found that “a majority of the tax-advantaged assets in Intel’s pension plan are dedicated not to providing pensions for the rank and file but to paying deferred compensation of the company’s most highly paid employees, roughly 4% of the work force.” As companies phase out their pension plans, more assets become available to cover Qserps… another troublesome tax loophole.

Voting Slide Final Blog posts the latest e-proxy statistics from Broadridge. As of June 30th 653 companies have used voluntary e-proxy. Only 1.1% requested paper after receiving a notice. 57% of companies using e-proxy had routine matters on their meeting agenda; 31% had non-routine matters proposed by management; and 12% had non-routine matters proposed by shareholders. None were contested elections. Based on 586 meeting results, the retail vote dropped from 20.6% to 5.5% and the number of retail shares voting dropped from 34.8% to 16.7%. (Broadridge’s “Final” E-Proxy Stats for the Proxy Season, 8/5/08)

Developing a system that will allow shareowners to vote all their shares more easily is critical, if the average American is to view corporate election outcomes as legitimate. ProxyDemocracy andiSuffrage seem to be the only ones working on intelligent solutions.

Shareowner Activism

Lynn Stout is one of the most astute academic observers of corporate governance. Yet, when she writes commentaries for newspapers she often comes off sounding like a shill for entrenched managers. Why Carl Icahn Is Bad for Investors, in the WSJ (8/1/08) was no exception. Perhaps newspapers are more prone to publish controversial opinion pieces that generates reader interest and siding with entrenched managers won’t alienate corporate sponsors.

According to Professor Stout, “Shareholder activism can raise the stock price of a particular company, to benefit particular shareholders, in the short run. But it lowers the value of the stock market as a whole, for average investors, in the long run.” Advocating for passive shareownership makes about as much sense as advocating that if landlords would just let renters trash their units rents would be cheaper and that would be good for society.

Stout notes, “numerous studies show that while the shareholders of an acquired company typically receive a premium in a sale, the shareholders of the generally much-larger acquirer often lose when the acquirer’s stock declines.” Then she protests that “Icahn demands sales when he owns the target — but protests mightily” when he owns stock in the would-be acquirer. Of course, this is a argument formore activism, not less because while management pay tends to go up as companies acquire others, shareowner value goes down.

Stout argues that hedge funds are out to make a quick buck at the expense of long-term shareowners and that “shareholder activism hurts average investors by making entrepreneurs and managers more reluctant to operate as public companies.” First, Carl Icahn my be bad for shareowners but Richard Breeden and Ralph V. Whitworth are not. Stout makes the all too common mistake of lumping all shareowner activists together. Shareowners are just as prone to opportunistic behavior as managers.

Second, Stout’s threat that public companies will go private when faced with too much shareowner activism is false. What happens when public companies go private? They become totally dominated by “activist shareholders” because they or their direct representatives now comprise a majority of the board.

Stout unintentionally make the case that what we actually need is more activism. A good step in that direction, without having the private firm disadvantage of less liquidity, would be to embrace proxy access for shareowner nominees. Facilitating the ability of shareowners to elect their own directors will better align the interests of managers and shareowners.

If Stout has a bone to pick with shareowners, I wish her opinion piece would have discussed “Fiduciary Duties for Activist Shareowners,” where she and coauthor Iman Anabtawi argue that the rules of fiduciary duty, which traditionally have applied to only to officers, directors, and controlling shareowners, should now be applied to activist minority investors as well because with the rise of shareowner democracy they often exercise “ad hoc” control.

I certainly agree with her that “there is no reason to believe that newly-empowered activist shareholders are immune to the forces of greed and self-interest widely understood to tempt corporate officers and directors.” I’m sure that some shareowners “promote corporate actions that gives them a personal, material economic benefit to the detriment or exclusion of other shareholders.”

I also agree with critics that Stout’s proposal “l would create “an incremental risk to shareholders that will raise the cost of all equity capital via reduced price multiples that will be priced into an investor’s buying decision for either the direct liability risk or the cost of purchasing insurance to deal with such a risk” and that her proposal would create “a definitional morass that is as murky if not more so than the business judgement rule.” (Andrew Shapiro, 3/3/08) For example, Stout’s proposal “recognizes that minority shareholders can exercise control even when they are not voting.” The burden of demonstrating that a shareowner both exercised influence and had a material economic interest in the outcome that differed from that of other shareowners would seem to be high.

While I’m interested in the idea that activist shareowners owe some degree of loyalty to other shareowners of a company, extending fiduciary duties to all shareowners that can influence a corporation and who may benefit from such influence in ways that other shareowners may not seems totally impractical as initially proposed by Anabtawi and Stout. However, the idea that shareowners should more fully disclose material facts of their transactions and conflicts of interests is worthy of further discussion. Indeed, it was the topic of hot debate when Chairman Cox put forth an SEC proposal that would have required far more burdensome disclosures for simply proposing a shareowner resolution on proxy access than for actually running a proxy contest.

Anabtawi and Stout are onto something important… with power comes responsibility. If shareowners actually do get proxy access and corporations become more democratic, we must develop mechanisms to not only hold the Fordist bureaucrats of entrenched management accountable, we must also hold controlling and high influencing shareowners accountable by narrowing the field of imperfect information they can exploit.

In the most interesting book of 2008, Gomez and Korine (Entrepreneurs and Democracy: A Political Theory of Corporate Governance) argue the role of entrepreneur has been supplanted by shareowners. “The opinion of the entrepreneur is no longer carried by a single individual, or even a group of managers, but rather by public opinion as expressed through the financial markets and the media.” Additional thought and regulations are certainly needed because, as Gomez and Korine note, “financial markets are often as capricious as the movement of crowds.”

Neither management nor shareowners have adequate incentives to stay loyal to the corporation. Managers have access to a worldwide market for senior executive talent. Shareowners can move their investments at close to the speed of light. As both seek to maximize personal gains, the public could be left in a state of havoc. Market self-regulation is inadequate to ensure performance of the economy. As Gomez and Korine point out, “What we still do not understand exactly is in what way the efficiency of the corporation and the quality of corporate governance are related.” Hopefully, competition between models will lead to building the logic of economic performance into a system that also assures the legitimacy of “good” corporate governance.

What CEO Skills Really Matter?

Using a dataset of assessments of CEO candidates for companies involved in private equity transactions (PE) – buyout (BO) and venture capital (VC) – Steven N. Kaplan, Mark M. Klebanov, and Morten Sorensen studied how CEO characteristics and abilities relate to hiring decisions, PE investment decisions, and subsequent performance. CEOs were assessed in seven general areas – leadership, personal, intellectual, motivational, interpersonal, technical and functional.

They then divide abilities into two important dimensions: (1) general talent and (2) team player and interpersonal talents versus fast, aggressive, and persistent behavior. They find success more strongly related to execution skills, particularly for LBOs, and not related or negatively related to the interpersonal, team-related skills. And success is not related to incumbency.

From a post by Kaplan to the Harvard Law School Corporate Governance Blog, “The results suggest that CEO talent can be measured and those talents are important for hiring, investment and success. General talent matters for success. However, on the margin, execution-related attributes, not team-related attributes seem to drive success. This suggests that team-related attributes may be overweighted in CEO hiring decisions.” Interestingly, their findings did not support Jim Collins’ assertion that successful CEOs exhibit compelling modesty, build strong teams, and give credit to others / take blame on themselves. (Which CEO Characteristics and Abilities Matter?, 7/08)

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