The conference opened with a great dinner and a fascinating keynote speech by Jim Chanos, founder and managing partner of Kynikos Associates, the world’s biggest short-seller. In introducing him, conference co-host Larry Stambaugh proudly held up a copy of the Financial Times from two days earlier that had Chanos’ picture not only above the fold but above the headlines. (View from the Top, 1/26/09) In the FT interview Chanos said of the banks, "there is still a lot of damage on these balance sheets that has not come out." Asked if America’s financial shift is moving from New York to Washington, he said, "power is beginning to shift… anyone who doesn’t see that is kidding themselves." He thinks the next target for regulation is likely to be private equity funds.
Short positions represent only a small portion of hedge fund activity, according to Chanos. Take out 3-6% being arbitraged and that leaves only about 0.5-1% of pure shorts. Although short-sellers are often viewed as "skunks at the garden party," "we’re not your enemy." In fact, short sellers are needed for efficient markets. He told of the case of three Irish banks that lost 40% of their value and had to be nationalized when short-sellers were required to disclosure their positions.
Short sellers are "real-time financial accountants," whereas the SEC reviews are more like "archeology." He advised that when short-sellers attack, directors should ask their CEO or CFO why. If they don’t know, they’d better find out, because they are usually doing so based on real evidence of problems. He questioned why the SEC has so few staff with real world experience, suggesting that at least one commissioner should be someone with trading desk experience. He thought it was a good time to short the rating agencies and questioned how senior executives of Wall Street banks could be so clueless. Perhaps they weren’t, because many were shorting their peers.
Chanos sees that any company still distributing analog products is likely to be in trouble, given the marginal costs of distribution over the Internet. Expect a shakeout of firms as the giants go digital. On a more global scale, he seems to be shorting Mexico, seeing a crisis coming. He covered an enormous amount of ground and took lots of questions. No, he’s never been called by a director to find out why he is shorting a company. Ask your CEO or CFO. He’s usually found some accounting issues that show bad judgment.
Everyone I talked to learned a lot from Chanos. He wasn’t a "skunk at the party" at all, at least not at Directors Forum 2009. Those of you who were unable to attend might glean the much of essential message from Short Sellers Keep the Market Honest. (WSJ, 9/22/09) Of course, you’ll have missed a great deal of wit and charm. See also, IIROC releases two studies on marketplace trends related to short sales.
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Cynthia Richson moderated the first panel of the Forum’s program on the topic "Shareholder Hot Topics." Richson co-founded the Directors Forum and has been a dynamic figure in corporate governance well before creating the Directors’s Summit for the State of Wisconsin Investment Board, which the Forum used as something of a model. Panelists were among the most distinguished in the field: Richard Ferlauto, Peggy Foran, Mike McCauley and Pat McGurn. The auditorium was modern and comfortable. (right) Here, I’m not going to report individual comments either here or as I discuss other panels, since that could stifle frank debate at future Forums.
Needless to say, there was a lot of speculation concerning the role the Federal government will take at financial companies coming under the TARP. Shareowners will be taking a laser light to executive compensation, especially repricing. There are expectations that holding periods will extend beyond tenure. Investors expect stronger succession planning. Compensation should be built around developing and meeting strategic plans and leadership expectations.
Shareowners will be more proactive. Corporations should talk to their major investors before taking controversial actions. Companies expect investors to talk with them before submitting resolutions. Panelists expressed concern over both short-term shareowners and CEOs. They briefly discussed recommendations of the Group of Thirty, the Aspen Institute’s Principles, the shift to independent chairs, and many other issues. One colorful bit of advice that I think all would agree with came from Pat McGurn. "Engagement is critical. Don’t get in a defensive fetal position."
John Wilcox, Chairman of Sodali, previously with TIAA-CREF and Georgenson, moderated the panel, "Do You Know Who Your Shareholders Are? The Changing Face of Activism." Distinguished panelists included William Ackman, Brian Breheny, John Olson and Frank Partnoy. Short-selling was again discussed, including the issues of disclosure, share lending, voting by short-sellers, etc. Readers might want to review ICGN’s best practices from 2007.
Another topic discussed was the fact that so many investors are short-term holders, rather than long-term owners. Panelists appeared to agree that companies shouldn’t take action to placate shareowners by generating short-term gains that would impair long-term value. However, they couldn’t agree on requiring something like a one year holding period before being eligible to vote.
Again, it was another far-ranging discussion about disclosures, the need to create forward looking risk models, the problem of real property prohibitions against foreign ownership above 5%, the desire of shareowners to be able to talk with their elected representatives (directors), the use of Reg FD as an improper excuse not to engage (see interpretive release), and much more.
The final Monday morning session was on "The Future of Corporate Governance: the Next Five Years?" Henry duPont Ridgely, Steven A. Rosenblum, Richard Ferlauto, and Sara Teslik were moderated by James Hale. (picture on right) Again, lots of disagreement among this group. However, they all appeared to agree that technology is leveling the playing field. Just as it helped Obama win office, it is changing the way corporate governance is pursued.
Another development that could have lasting impact is the Delaware Supreme Court’s agreement to accept questions certified to it by the SEC. The first questions involved AFSCME’s proposal to CA, Inc. The Court knocked that decision out in twenty days. There was general agreement that dialogue is needed but disagreement as to how big of a stick shareowners need to get into the conversation. Majority vote provisions for director elections have been tremendously effective. Future actions may focus more on directors, rather than symptomatic issues that are often addressed in shareowner resolutions. When shareowners can speak with one voice, that facilitates agreements.
Directors need to focus on process with regard to risk. Bad outcomes don’t equal bad faith but bad documentation can certainly lead to trouble. There was a good discussion around split chair/CEO movement, including mention of Millstein’s recent attention to the topic. Yet, when the chair wants to actually be the CEO, the split might not work as well.
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Almost on cue, the keynote speaker for lunch, Rex D. Adams, discussed their transition to separating out the role of chairman. At that time Invesco was a UK company and the idea was pushed by investor groups, such as the Association of British Insurers. Invesco kept the structure when the moved to a New York Stock Exchange listing but is now reexamining their position. He acknowledged good arguments that a single position strengthens the focus of accountability on one person and ensures against distraction. However, he thinks the split provides greater transparency with respect to roles and puts the board in a better position to evaluate the CEO and management team. As chairman, he sets the board agenda and governs allocation of the board’s time but does so in close collaboration with the CEO. There were several questions from the audience and Adams did a good job of detailing his experience with split roles.
The afternoon broke into concurrent sessions. I missed "IFRS: Sound Principles — Or More Room for Manipulation?" Here’s a recent update from Business Finance – Regulatory Strategy 2009: What to Watch Right Now. Instead, I opted for the more popular, "Compensation: Pay Practices Under Fire, with panelists Karin Eastham, Charles Elson (left), JoAnn Lublin, Robert McCormick, and Anne Sheehan, moderated by David Swinford. Much of the discussion centered around repricing options, most of which are currently underwater. Movement now is to rethink the base vs bonus with more emphasis on restricted shares.
Directors were warned to tread carefully. Investors have a sense of betrayal and compensation packages may be the best place to regain trust… or lose it altogether. A good explanation goes a long way. I heard it in the panel and elsewhere that more investors are focusing on pay equity within the enterprise. Does the comp committee even look at it? Too often, CEO pay is driven totally by comparisons with other companies with no look within the organization. Employees won’t be motivated if CEO pay gets too far out of alignment. Few boards appear to be cutting back on board pay… maybe because directors are putting in so much more time and effort.
Of course, CEO pay remains the hot button issue and Forum panelists are in the news commenting. "This is different. The arguments against curbs don’t make sense any longer. My friends will bring up the issue even before I do. Opinion has been galvanized," said Robert McCormick. (CEO pay cuts: Not just for banks, CNNMoney.com, 2/4/09)
I then missed "Risk Assessment: Questions Directors SHOULD be Asking." Here are materials on that subject from Deloitte. Instead, I attended a session on "Corporate Governance "Lite" for Smaller Companies." The panel consisted of Janet Dolan, Gregory P. Hanson, William McGinis and Deborah Rieman, moderated by Scott Stanton. Panelist discussed some issues common to small companies, like too often trying to rely on board members as adjunct staff experts. Again, there was discussion of split chair/CEO positions and at what stage that transition might take place. They discussed SOX, the fact that small companies have thin or no coverage from analysts and their stock price is more vulnerable to attack on shareholder bulletin boards. The most fascinating discussion for me was of founders who don’t want to let go of the reins. What made it even more so, was discussion from audience members in that position.
That evening at dinner, we heard from New York Times columnist Joe Nocera. His speech was short and highly entertaining. He took a lot of questions from the audience on wide-ranging topics from the "great unwinding" that would have happened if Bush had been successful in privatizing Social Security, to the likelihood of credit card debt forming the next crater. One thing he was definitely sure of, each generation discovers its own cycle of "fear and greed." The cycles seem to be accelerating.
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Former SEC Chairman Christopher Cox (right) made a plea for an "exit strategy" from government ownership and involvement. The speech was very similar to one he delivered to a joint meeting of the Exchequer Club and Women in Housing and Finance last December. He spent some time on how we got into the mess, explained the economy goes through cycles and although he did not discount the need for intervention, his main message was that we shouldn’t conflate the role of market regulator with market actor. He said Congress does two things well, "nothing and overreacting."
Interestingly, he made no mention of reinstating the leverage limits the SEC removed on 2004 under William Donaldson. For years, financial institutions could lend 12 for every 1 dollar they held in reserve. "Using computerized models, the SEC, under its new Consolidated Supervised Entities program, allowed the broker dealers to increase their debt-to-net-capital ratios, sometimes, as in the case of Merrill Lynch, to as high as 40-to-1." (Ex-SEC Official Blames Agency for Blow-Up of Broker-Dealers, New York Sun, 9/18/08)
The 2004 decision gave the SEC authority to review the banks’ increasingly risky investments in mortgage-related securities but the program was a low priority for Cox. Seven staff, without a director, were assigned to examine the companies, with assets more than $4 trillion. As of September 2008, "the office had not completed a single inspection since it was reshuffled by Cox more than a year and a half ago." "The commission’s decision to effectively outsource its oversight to the companies themselves fit squarely in the broader Washington culture of the past eight years under President George W. Bush" according to U.S. regulator’s 2004 rule let banks pile up new debt, International Herald Tribune, 10/3/08.
Bill George was next up. He’s the type of inspirational leader conferences often put at the beginning to fire up those in attendance, but it works just as well to end on a high note. The themes of his advice to directors have broad appeal:
- Board independence is critical. Executive sessions were the most important thing to come out of SOX.
- Board composition should reflect their customer base — a diversity of life experiences and thought. Strongly favors self-evaluations and a mechanism to ensure directors rotate off.
- The form of board leadership isn’t so important — it doesn’t guarantee results.
- Time and commitment are important. He also favors totaling the location of board meetings for context/access.
- Board chemistry is important and is often improved by offsites or other informal occasions that result in honest conversations and straight talk about values and strategy.
- Increase interactions with management, not just the CEO. The company’s future may depend on it.
- On executive compensation, look internally as well for equity issues. How is pay for performance viewed from the inside?
- Ensure the corporation’s reputation through transparency. Employees should hear it from the company first, not the newspaper.
- Maximizing short-term shareholder value will destroy the company — focus on the next 10 years. Don’t forecast earnings — let the analysts do that.
- Remember that government charters companies to do something of value. Ensure you a fulfilling society’s mission and instill values in those coming up. People are not just motivated by money. Search for meaning and significance, being part of something special.
Continuing the theme of ending with a bang, the last panel of the Forum was "Selecting & Training Directors — the Role of the Governance/Nominating Committee." The moderator was Richard Koppes. Panelists were Bonnie Hill, James Melican and Kristina Veaco. Whereas some might argue that Christopher Cox spoke too long and left too little time for questions, that certainly wasn’t the case here. The audience had every opportunity to ask for advice on issues that concerned them. Hill spoke on lawsuits, risk issues and culture… much around how Home Depot had learned its lessons the hard way with shareowners. Melican talked about working with clients, such as CalPERS, about the needs of a particular board. With proxy access coming, proxy advisors may be placed in such a role on a more routine basis. Veaco got right into the grit of reference binders, policies, contracts, charters, etc., emphasizing the need for new director orientation and the benefits of being assigned a mentor. Plan ahead and get items on an annual calendar… two to three years ahead. Now that’s planning!
They talked about the importance of resources, like The Corporate Library, the Society of Corporate Secretaries and Governance Professionals, and Stanford Directors College. Hill (pictured at right) spoke of the importance of getting to know the directors before you join a board and the need for boards to think ahead, keeping a reserve of potential directors in the pipeline. She stressed the importance of peer evaluations… and the need to shred the written component. Melican suggested evaluations should be conducted by a third party rather than in-house staff. Veaco preferred evaluations have a written component as well as an oral interview and that the most sensitive questions/answers would occur orally, but that in any event the questionnaires would not be kept and only summaries of the results would be provided.
Hill advised shareowners they don’t have to submit a proposal before getting a hearing. Have the conversation prior to submitting proposals. Veaco seconded that, saying discussions should go on all year, not just during proxy season. Corporate secretaries should be reaching out to top shareowners.
Hill spoke of the increased time commitment directors are making and the use of conference calls and tools like BoardVantage. Again, split chair and CEO came up as a topic as it did so often at this year’s Forum. Hill described their use of a lead director at Home Depot. Pay was also touched on again. Home Depot has moved away from a per meeting charge, using a flat retainer. Veaco said in her experience directors are paid meeting fees, even when they are called on to attend a large number of meetings, and the amount is the same for telephonic as for in-person meetings, but companies can handle this differently. Melican stressed the need to look beyond compensation to what shareowners might view as perks. This is not the time for junkets in Paris or to line up the limousines. Look at your charitable contribution match. Think of eliminating meeting fees and address the issues before they hit the press. (see also Nominating/Governance Committee Roundtable)
Of course, much of the essence of the Forum were the encounters that happened outside the formal conference. The beautiful setting, wonderful food, small number of participants to speakers, the high quality of both, and the importance and timeliness of the topics all contributed to a very successful program. I’m sure Linda Sweeney has already begun planning Directors Forum 2010.
This year’s steering committee did a great job. Three cheers to each of the following:
|Larry G. Stambaugh||Cynthia L. Richson||James Hale|
|Linda Sweeney||Annalisa Barrett||David Bergheim|
|Bruce Doyle, III, Ph.D.||Karin Eastham||C. Hugh Friedman|
|Deborah Jondall||Garry Ridge||David Salisbury|
|John C. Stiska||Bill Trumpfheller|
Comments From Attendees
Putting Jim Chanos on the agenda on the first evening was absolutely brilliant. The theme of the meeting was the focus on shareholders. Many of us, including me, had never heard a talk by a short seller! Bill George was very inspirational and a wonderful way to top off the meeting. — Julia Brown, Targacept, Inc.
It’s always useful to understand what the latest issues are from a shareholder’s (or shareholder activists’) point of view. That helps us as management to be mindful of those as we make decisions and communicate with the shareholders. And, the exchange of ideas with other attendees was invaluable in helping improve our own companies’ performance on an ongoing basis. — Bruce Crair, Local.com
The planning and organization of the event left nothing to chance making it an outstanding experience. The Forum brought together people with diverse thinking and backgrounds but all dedicated to improving corporate governance throughout the United States. I was proud to attend and be part of the conference. — Richard A. Collato, YMCA of San Diego County; Director Sempra Energy, WD40, Pepperball Technologies and Project Design Consultants
The highlight for me was Bill George’s presentation – concise, insightful and practical. — John F Coyne, Western Digital Corporation
It was the best one yet – I really enjoyed listening to all the speakers — Lynn Turner, former SEC chief accountant
The conversational format, close to the audience, was much better than the usual sitting up high on a stage all lined up on a panel — Kristina Veaco, Veaco Group
My second Director’s Forum – again this year, very worthwhile. — Lou Peoples, Northwestern Corp.
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Pre-Conference Bonus Session
Even before Directors Forum 2009 began, there was a very worthwhile "Pre-Conference Bonus Session," entitled The Latest Research in Corporate Governance, presented by the Corporate Governance Institute at San Diego State University. There were two concurrent sessions. I attended Management and Law reviews. Therefore, I missed Finance and Accounting. All bibliographies and presentations are available on the CGI’s Post Conference Materials page.
Lori Ryan did a great job of touching on some of the highlights of studies published in 2008 on "management" topics. Following are a few of the many findings that struck me.
- The strength of a director’s identification with being a CEO will have a positive relationship with resource provision, but a negative relationship with monitoring. The strength of a director’s identification with shareholders will have a positive relationship with resource provision and monitoring. (Directors’ Multiple Identities, Identification, and Board Monitoring and Resource Provision by Amy J. Hillman, Gavin Nicholson, Christine Shropshire)
- After a large spike in likelihood of taking a board seat in year 1, it drops significantly (deterioration). Former officials better take one of those offers quick, before their currency expires. (Former Government Officials as Outside Directors by Lester, Hillman, Zardkoohi, and Cannella)
- Firms linked to fraudulent firms lost an average 1% of market value within 2 days of fraud allegation announcement, $49B overall. Penalties diminished when the linked firm exhibited certain "effective" corporate governance structures (e.g., heavily independent board, inside director ownership) (Director Interlocks and Spillover Effects of Reputational Penalties from Financial Reporting Fraud by Eugene Kang)
- Fewer women sit on boards in countries with long traditions of female elected political officials. (Female Presence on Corporate Boards)
- While the mere presence of women on boards does not increase firm value, greater gender diversity does (Gender Diversity in the Boardroom and Firm Financial Performance).
- CEOs’ ingratiation and persuasion tactics toward institutional fund managers reduce the effect of institutional ownership on specific changes in board structure and composition, CEO compensation, and corporate strategy that are believed to compromise management’s interests. (The Pacification of Institutional Investors)
- Executives ward off stock downgrades by currying favor with analysts that cover their companies. The greater the earnings shortfall, the more favors. Analysts who downgrade a stock receive significantly fewer favors thereafter. Even analysts who see a fellow analyst receive reduced favors from a firm are less likely to downgrade that firm. (Sociopolitical Dynamics in Relations Between Top Managers and Security Analysts)
- Advice seeking by CEOs increases with CEOs’ stock ownership and performance-contingent compensation, and with board monitoring. (Getting Them to Think Outside the Circle)
- CEOs are more likely to manipulate firm earnings when they have more out-of-the-money options or lower stock ownership, and when firm performance is low. (CEOs on the Edge: Earnings Manipulation and Stock-Based Incentive Misalignment)
- Firm-specific downside risk is strongly correlated with CEOs’ stock divestitures and their magnitude. (Too Risky to Hold? The Effect of Downside Risk, Accumulated Equity Wealth, and Firm Performance on CEO Equity Reduction)
- Only a firm’s largest institutional holder is perceived as having an information advantage, based on an increased buy/ask spread. The greater the percentage of shares held by the largest institutional investor, the greater the perceived information advantage. (Information Advantages of Large Institutional Owners)
- Increases in the size of portfolio holdings, number of portfolio blockholdings, portfolio turnover, and the importance of a particular holding reduce monitoring effectiveness. (Institutional Ownership and Monitoring Effectiveness: It’s Not Just How Much but What Else You Own)
- Firms with outsider-dominated (80%+) boards are more likely to enact shareowner resolutions that pass, as are smaller outsider-dominated boards and larger non-outsider-dominated boards. High levels of CEO ownership reduce the likelihood of enactment. (The Ethical Implications of Ignoring Shareholder Directives to Remove Antitakeover Provisions)
- Commercial ratings are not linked to firm performance. Commercial ratings are not linked to shareholder voting (or ISS voting recommendations), according to a forthcoming study by Professor Ryan.
Professor Paul Graf‘s bibliography highlighted some important recent court decisions and articles but his presentation honed in more on common threads and direction, which I find difficult to summarize. Much of his talk centered around the concept of "good faith," which can’t be indemnified. The duty to act in good faith is "intertwined" with the duty of care, but it is different. It is "shrouded in the fog of hazy jurisprudence, grounded in the duty of loyalty, but it does not involve self dealing." "It is more culpable than a breach of the duty of care—gross negligence."
Sounds a bit like a Zen koan. In Disney, failure to act in good faith is 1) where the fiduciary intentionally acts with a purpose other than that of advancing the best interests of the corporation, 2) where the fiduciary acts with the intent to violate applicable positive law, or 3) where the fiduciary intentionally fails to act in the face of a known duty to act, demonstrating a conscious disregard for his duties. The last was emphasized by Graf, who went on to quote several other attempts to surround the concept of good faith, including Nowicki’s notion that courts are focusing on bad faith, instead of defining good faith. I liked his distillation of Hill and McDonnell. "On the continuum of liability from duty of care to duty of loyalty, good faith occupies the vast middle ground." Apparently, ill defined ground.
From what I gathered, the duty of care is morphing into the duty of good faith in recent cases such as Stone v. Ritter and Ryan v. Lyondell. Plaintiff alleged the directors knew that they had a known duty to act to ensure an offer was the highest available but they chose not to act. Therefore, good faith was implicated for purposes of the motion to dismiss. What was crystal clear was the need to document "actions" taken, even if they would otherwise be viewed as non actions, since if the board "acts," its actions are reviewed under the more favorable business judgment rule.
In sessions I did not attend, David DeBoskey provided a review of 2008 in Accountancy and Nikhil Varaiya reviewed Finance. You can find their bibliographies and presentations on CGI’s Post Conference Materials page.