Yale Governance Forum June 2009: Restoring Trust

Rising StarsPrior to the Forum, I attended a reception honoring the Rising Stars of Corporate Governance for 2009. Those included in the photo are (left to right, top to bottom):

  • Evelynne Change, Coordinator for Corporate Governance, African Peer Review Mechanism (APRM) Secretariat, New Partnership for Africa’s Development (NEPAD)
  • George Anderson, Partner, Tapestry Networks
  • Elizabeth Ising, Associate Attorney, Gibson, Dunn & Crutcher LLP
  • Stephen Brown, Director & Associate General Counsel, Corporate Governance, TIAA-CREF
  • Deborah Gilshan, Corporate Governance Counsel, Railpen Investments (a subsidiary of rpmi)
  • Rachel Lee, Senior Corporate Counsel, EMC Corporation
  • Nada Abusamra, Attorney at Law, Partner, Raphaël & Associés Law Firm
  • Julieta Rodríguez Molina, Associate Attorney, Galindo, Arias & López

David Hess, Assistant Professor of Business Law & Business Ethics, Stephen M. Ross School of Business, University of Michigan and Alexis B. Krajeski, Associate Director, Governance and Sustainable Investment, F&C Investment were also named rising stars but were unable to attend the reception.

I also caught this quick shot of several members of the Millstein Center for Corporate Governance and Performance staff who were involved in making the Forum a huge success. Included here from left to rightMillstein Center staff are:

Note regarding the limitations of this report: Often at the Forum several sessions met concurrently; I could only be in one place at once. Additionally, in order to encourage the free exchange of information and opinion, I agreed, generally, not to report for attribution. Therefore, the following notes provide only a brief sketch of what I focused on and how my limited observation mixed with my own opinions. Of course, sessions were designed to elicit debate among experts with often well known conflicting opinions, so consensus was relatively rare but insights were not. I’ve provided some links that may give readers a better understanding of the positions of individual participants.

Plenary 1: What is the proper balance between regulation and private sector initiatives to restore trust in the market system?

Moderator: Ira Millstein, Senior Associate Dean for Corporate Governance, Yale SOM; Senior Partner, Weil, plenary1Gotshal & Manges LLP. Discussants: William Donaldson, Chairman, Donaldson Enterprises; Fmr. Chairman, SEC; Founding Dean, Yale SOM; William Goetzmann, Edwin J. Beinecke Professor of Finance and Management Studies and Director, International Center for Finance, Yale SOM; Mats Isaksson, Head, Corporate Affairs Division, Organisation for Economic Co-Operation and Development (photo: right to left)

I think there was general recognition by panelists that we have been through a recent period of very little regulation, when far too many ignored risk. There was frustration that mutual funds and other intermediaries frequently don’t acknowledge or behave as if they work for us. Instead, too many are more concerned with lining their own pockets.

Reference was made to the glorious revolution of 1688. I’m not sure I got the context but I imagine it was a call for shareowner democracy, in much the same way as the Bill of Rights in 1689 ended absolute dominance by the king. While we seem to be near ushering in an era of democratic rights for shareowners, there were also concerns with the likelihood of over regulation, especially enactment of regulations that aren’t enforced, either because of practicalities, lack of will, or follow through.

One danger of over regulation is that it often leads to an assumption that someone is taking care of “it.” Regulations work best when they empower markets and those dependent on the regulated to make the markets work or to enforce the rules.

The focus on “say on pay” for CEOs is overblown, according to at least one panelist. There’s very little evidence that it will bring down pay. In fact, the movement risks taking attention away from the real problem of incentive structures for dealers and traders who were walking away with huge bonuses for short-term deals. Hedge fund and private equity groups were seen as possible problems. Yet one panelist cited an OECD Steering Group conclusion that “activist” hedge funds and private equity firms could help strengthen corporate governance practices by increasing the number of investors that have the incentive to make active and informed use of their shareholder rights.

Regulators frequently respond like generals that just lost a war. They plan how to win the last war, not the next. We need to understand tomorrow’s markets, yet we are the product of our experience. Throwing out Glass Steagall created something of a free for all, although there doesn’t appear to be much political will for turning back.

It all starts with the education. Principles start at home but have been diminished in our educational system, especially in business programs. We lost our bearing with the appointment of SEC commissioners who didn’t believe in rules or regulations.

We need regulations, like we need traffic lights. Too few have asked what makes for a great company. Get at key factors like employee morale and quality, not just making money. Others argued the DNA of selfishness brought us prosperity. Don’t blame everything on markets and don’t expect everything from them. The market won’t fix things that must be fixed by politics, like the disparity of wealth.

Students come into university with a competitive history of community service. Yet, once here, most spend their summers working for hedge funds or commercial banks. Their next level of winning is a salary beyond imagination. We need to change educational structures to broaden the entrepreneurial to include giving back to society.

A fundamental question involves our approach. Do we try to solve with our problems with prescriptive regulations or by empowering shareowner engagement? Clearly, most believe the later. Owners need structures to support their ability to hold management accountable. Proxy access, say on pay (primarily as a vehicle for communication), supercharging dialogue with boards…. those are the directions.

What about rights that follow a share of stock? Should you be rewarded for holding for the longer term? It gets complicated. Most seemed to recognize the importance of large activist shareowners. Some felt that since pension funds feed the private equity funds, they need to take a larger part in keeping these funds in line and their costs down. Others focused on conflicts of interests among intermediaries, such as credit rating agencies that are paid by issuers and given monopoly status by the government. One answer might be rating the raters, either by SEC or others. A member of the audience from Egan Jones pointed to his firm as not being paid by the entities being rated, so there is a clear alignment of interest between investors and the firm.

There were lots of good ideas but little unanimity on solutions. Like mutual funds that make more money by starting more funds than by earning money for their clients, intermediaries seem likely to continue to lead most investors astray. AndrewMetrick

Plenary 2: Has the public corporation model been under challenge from the current crisis? Are there lessons from private equity?

Moderator: Andrew Metrick (left), Theodore Nierenberg Professor of CorpRichFerlautoorate Governance, Yale School of Management.

Discussants: Rich Ferlauto (right), Director, Corporate Governance aSuzanne Hopgoodnd Pension Investment,

Suzanne Hopgood (left), Director, Board Advisory Services, NACD; Ronald W. Masulis

Ronald W. Masulis (right), Frank K. Houston Professor of Finance, Owen Graduate School of Management, Vanderbilt University; Thomas Werlen

Thomas Werlen (left), Group General Counsel, Novartis International AG

Andrew Metrick started the group off with a reference to Michael Jensen’s Eclipse of the Public
. Jensen thought the public model was broken.
The KKRs of the world were going to take over, loading corporations up with debt. They would take a direct role in corporate governance. Private equity does seem to be taking a larger role. The public model is costly, based on information intermediaries analyzing markets. Private equity structures better align investor

interests, at least those of the managing partners, with those of the company but investors are not getting a lot of detail with that model either. So, we have two different models to solve asymmetric information issues. Two competing models. Have public markets failed?

Panelists also raised other issues. Are they engaged with beneficial owners and other stakeholders? Do they demonstrate independence of thought or are they trapped in group think? We want diverse directors who are reflective and engaged in self evaluation. Do shareowners have the resources to intervene? They have a collective voice problem, often a lack of expertise but have a fiduciary responsibilities to beneficial owners. What we’ve experienced is regulatory arbitrage, a race to the bottom, seeking the weakest regulator.

At least one panelist felt strongly suspect of the private equity model. Within the top quartile, these funds that can take advantage of cheap money. It wasn’t the model that worked but circumstances. In fact, they were over leveraged, depending on loopholes in tax system. Often they skimmed low hanging fruit and took short-term exit strategies.

Other approaches might include investor representation on boards where, through collective action, they can effectively engage on behalf of beneficial owners. Stakeholder engagement councils could be convened as method of risk management. Certainly, we need more in the way of director disclosure and evaluation concerning their expertise and philosophy. The current information disclosures for director nominees is nearly worthless. Use of new technologies can help get us over collective action problems. Regarding risk management, we need to move to independent chairs but also need inside directors on risk committees with deep knowledge of companies. In a theme often repeated, investment companies must resolve conflicts between their fiduciary obligation to the company and their duty to investors. Resolution must find solely in the interest of investors.

Board composition is critical. Transparency in public companies instills discipline, even if you must issue a statement that investors can no longer rely on financial statements. Turnaround boards must be focused and committed. They should develop their strategic plan, determine skill sets needed, match those with the skill sets of board and ask what value each director brings to board. Disclose it in proxy. Shareholders will love it.

Public corporations in the US are generally characterized by strong management and atomistic shareholders. We suffer from information asymmetry to the degree that it is almost impossible for shareowners to monitor. Unfortunately, independent board members also lack knowledge of the business and management. Frequently, they don’t devote as much time to job as they should. Private corporations generally have fewer board members, more diversity, hands on involvement, and are incentivized to spend more time and effort. Public companies should take a lesson from such private boards. Strengthening boards is more important than shareowner involvement, since most shareowners will never have access to needed information or enough incentive to monitor.

Academic research shows that improving corporate governance is a primary driver of wealth creation. Concentrated ownership gives major owners control. Expertise, financial incentives, guarding against empire building, more efficient reporting systems, high leveraging, managers with invested liquid assets, bonuses in stock rather than cash… Why don’t public boards model such characteristics?

Financial reporting doesn’t track risk taking activity. Quarterly reports lag on risk. Our current system rewards high risk taking for short-term earnings. Inside directors have been dismissed but they are critical with regard to knowing what questions to ask (even better if they are also serve on more than one board).

Leveraged buyouts more frequently have the financial incentives, diversity, and critical skills. Regarding directors in general, foreign directors in the US are not helpful, since they tend to miss meetings. The recent IRRC report, What Is the Impact of Private Equity Buyout Fund Ownership on IPO Companies’ Corporate Governance?, was raised. “Whatever benefits there may be to the private equity model, they seem to disappear once a private equity backed company goes public. The findings are contrary to conventional wisdom and significant for investors,” said Jon Lukomnik, program director of the IRRC Institute. When they go public, such firms were more likely than others to have classified boards, poison pills, and restrictions on director removal by shareholders. Additionally, the report indicates that lucrative consulting agreements for former executives, generous employment agreements, and special bonuses are significantly more common at private equity buyout backed companies. Finally, the analysis indicates that once taken public, executive compensation at private equity backed companies tended to be higher, less performance-related, and less at-risk than at comparable companies that did not have private equity sponsorship.

One panelist asserted the value of discipline around directors with audit experience. Companies perform better with outside discipline and an organized agenda. Outside directors are key. Committee chairs must bring the discipline. Another said good governance isn’t just a matter of process. The key is balancing strategic vision and monitoring functions. Constructive challenge comes most frequently from the chair or lead director. Executive session useful in getting “snits” managed. It forces and focuses discussion. Telephone meetings are useful specific issue. CEOs who speak last will ensure generation of genuine discussion. Private companies are better for rapid change, while public companies are better for high growth mode/cycle. Public companies generally have a lower cost of capital, whereas private companies are easier to restructure. Both have their place.

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panel 2

Focus Panel 2 (photo right): What effect did the financial crisis have on this year’s proxy season, if any? What is the long-term impact of the crisis on shareholder governance responsibilities?

Moderator: Meredith Miller, Assistant Treasurer for Policy, State of CT.

Discussants: Kenneth Bertsch (right), Executive Director, Corporate Governance, Morgan Stanley Invest. KennethBertsch

Abe Friedman (left), Managing Director, Global Head of Corporate Governance & Proxy Voting, Barclays

Abe FriedmanMark Preisinger (Note product placement. That got a laugh.), Director of Corporate Governance, Coca-Cola CompanyPreisingerYerger and Ann Yerger, Executive Director, Council of Institutional Investors.

Miller led off with general statements about the proxy season. There was an increase in no action requests but a reduction in the number granted. There also appears to be an increase in withholds, more requests to split the chair/CEO, more contests. Demands for bonus pools and majority vote were also being pressed.

Other panelists noted the level of engagement is going up. Funds are more frequently being contacted by CEOs CFOs, general counsel, and even board members. Abe Friedman described how he must prioritize, screen and log calls. With the largest fund, I can imagine that gets tough during proxy season. He and others said they pay attention to these calls and often learned something, especially if there is a proxy contest or vote no campaign.

One panelist pointed out there are many issues on the table that still haven’t been resolved. It is time to get serious about majority voting, which may be a done deal at many of the largest companies but has still not been adopted by most small companies. Declassifying boards, poison pills (voting on it), and proxy access… If there ever was a time to focus on the few important things, now is the time.

Again, there was dispute among some panelists and participants on the say on pay issue. All agree that pay is really important because of how it incentivizes. But some think say on pay is not the right answer. It can even be harmful. Say on pay is seen by them as the executive’s safety net. We’re not going to know all the details related to pay, since disclosing strategy would harm competitiveness. And, of course, the execution of strategy should be a prime component in pay for performance. When shareowners vote overwhelmingly for pay that is structured badly, this simply provides legitimacy for poor practices. Say on pay will prove to be a shield, not a sword. Investors should focus on voting out those who approve unjustified pay. Focus on majority vote, so that directors who are not doing their job can be voted out. The ultimate say on pay is voting out directors.

Others who were initially skeptical have come around because the pay issue is the single most significant marker with the public. The cost of poorly structured pay is significant. Owners are already voting on bonuses, stock options. It provides another “pulse check.” Capability needs to be developed. It is an evolutionary process.

Another panelist was pushing hard for 10% thresholds to call a special meeting. This is something Bob Monks also emphasized when I spoke to him about the next point of shareowner leverage. Most shareowners seem to be willing to withdraw resolutions if companies make substantial movement towards a lower threshold. That makes me think shareowners may be settling for 25%, which will be harder to lower in the future. Compromise may not be such a good thing if it draws a line that is more difficult to move in the future.

At least one panelist and several in the audience seemed to be pushing for advance disclosure of proxy votes. Anne Sheehan spoke up from the audience about their experience at CalSTRS of announcing their votes through platforms at Broadridge and ProxyDemocracy. She was glad they started at end of season because it gives them some time to “test drive” the sysLaura Berrytem before going through a full proxy season. Yes, it has been something of an adjustment to plan a little further in advance. Several discussed possible downsides, primarily logistics, increased contact from benefical owners, and being afraid of announcing a vote and then and having to change. I know that ProxyDemocracy is out beating the bushes. I’d love to see more involvement and disclosure by international and mutual funds, as well as endowments and other mission-based funds.

Laura Berry (left), of the Interfaith Center on Corporate Responsibility, spoke from the audience, noting ICCR’s many years of attempting to raise issues regarding subprime loans and asked if panelists would be looking at social proposals more seriously because of their ability to predict problems. Yes. Everyone seems in agreement on that AnneSimpsonone. As a side note, IRRC celebrates its 40th anniversary through a year-long series of monthly audio podcasts entitled The Arc of Change. You can join ICCR’s Facebook group to keep up on their activities.

Focus Panel 5: The role of institutional investors in restoring trust

PeterButlerModerator: Anne Simpson (right), Senior Portfolio Manager for Corporate Governance, CalPERS

Discussants: Peter Butler (left), CEO, Governance for Owners LLP

Anne SheehanCatherine JacksonCatherine Jackson (right), Manager, Corporate Governance & Proxy Voting
Ontario Teacher’s Pension Plan Kieth Johnson

Keith Johnson (left), Head of Institutional Investor Legal Services, Reinhart Boerner Van Deuren

Anne Sheehan (far right), Director of Corporate Governance, California State Teachers’ Retirement System (CalSTRS)

There was discussion about the need to be as transparent as we are asking our companies to be. We need to be working closely with regulatory agewncies and to be prepared for changes. Otherwise, we are going to be like the dog that chased the car and caught it. We need to be active participants in the market, engaging with the SEC and Congress and speaking with one voice.

Keith Johnson said the UK’s University Superannuation Scheme developed a questionnaire for candidates and nominating committees. It asks candidates about their skills, how they relate to those of the board and its needs, as well as why they they will make effective directors. The Canadian Institute of Corporate Directors has posted a list of Key Competencies for Director Effectiveness that ties in well with board evaluations.

Cathrine Jackson said OTPP has been disclosing proxy votes in advance on their website in advance for years. In her opinion, too many funds outsource voting and engagement. Transparency and accountability; OTPP seems to be leading the pack.

One panelist said shareowners need to combine forces. Over diversification has become a problem. We need to “think globally and act locally.” (As an aside, the original phrase “Think Global, Act Local” first appeared in the book Cities in Evolution (1915) by town planner and social activist Patrick Geddes.)

Questions were raised about the skill set fund managers have, how we solve the free-rider issue, who should pay for necessary research, who should actually engage with companies. If companies paid, every shareowner would pay for research. It was suggested that half the money required come from companies, the other half from a levy on every investment scheme that gets tax relief. The issue of shareowner representatives for corporate nomination committees was also raised. Apparently, this is something like the approach used in some Scandinavian countries. (see Swedish director-election rules could cross Atlantic, MarketWatch.com, 4/17/09)

Another issue raised was stock lending with warnings that some have sold their franchise. Most appeared in agreement that funds should always recall their stock for voting. The difficulty arises primarily when special meetings are called. OTPP doesn’t lend their stock anymore. One suggested that long-term shareowners should be given loyalty payments. (Sleight Corporation (link to PowerPoint) in France considered paying extra dividend payments after two years but, as I recall, they rejected the idea.)

What would get shareowners to act responsibly? Suffering huge losses should be motivation enough. Ideas were thrown out such as asking DOL to establish by regulation that pensions must be engaged, enforcing current rules, sharing resources between funds, pooling resources. OTPP is opening up to accept other funds from other entities. California funds have made some attempt to share resources. Engagement must be based on bottom line results. It was a good dialogue with many creative ideas.Jonathan Koppell

Plenary 3: Government as shareholder of or lender to public corporations: What is the government’s role?

Moderator: Jonathan Koppell (right), Faculty Director, Millstein Center for Corporate Steve OdlandGovernance and Performance, Yale SOM

Discussant: Steve Odland (left), Chairman & CEO Office Depot (As far as I know, Odland was the only CEO to attend or at least to present at the Forum. That’s certainly to his credit but where were the others? More are needed at forums like this to ensure adequate dialogue.)

There was an interesting discussion here by Odland who recounted his experience with investors and a proxy contest. There were multiple shareholders with different timeframes and strategies. The gist of it was that investors aren’t of one voice and even if they are, the voice can change dramatically and sometimes is not accompanied by memory. Whatever strategy management uses, some shareowners aren’t going to like it. He had many good points. Not every activist is a good activist. Odland would like long-term interests to be aligned. Three years seems like forever to many hedge funds and other shareowners. We’ve got to find common ground.

They talked about who is the best owner across boundaries. Is government similar to other investors? How do you deal with generic issues of self-dealing with the government as owner, since the sovereign is both above the law and the regulator. Power corrupts and absolute power corrupts absolutely. Put the finest most capable people on boards to exercise their best independent judgment. CEOs would love to have large shareholders long-term. There was discussion of how to avoid unintended consequences and some commitments from people in the audience to try to work and find common ground with the Business Roundtable.

Plenary 4: Will the crisis help or hinder the integration of the global financial markets?Jeff Sonnenfeld

Moderator: Jeff Sonnenfeld, Lester Crown Professor in the Practice of Management & Senior Associate Dean, Executive Programs, Yale SOM (right)

Discussants: (left to right) Leonardo Peklar, Chairman, Socius Consulting, Inc.; Marcos Pinto, Commissioner, Securities and Exchange Commission of
Brazil; John Sullivan, Executive Director, Center for International Private
Enterprise (CIPE) James Shinn, Lecturer, Princeton University.

Leonardo PeklarMarcos PintoJohn SullivanJames Shinn

Sonnenfeld showed a Saturday Night Live parody of the stress tests. I hadn’t seen it… funny.

The main basis for optimism appears to be the hope that institutional investor will pay a premium for good corporate governance and that corporations will lobby governments to get standards raised. However, there were assertions that there may actually be a slight negative correlation between price and the quality of corporate governance by most indicators. Additionally, there is little evidence of corporations lobbying to improve governance. Witness continued opposition to proxy access from the US Chamber of Commerce and the Business Roundtable.

Don’t give up though. There is a strong correlation between the amount of money managed by pension funds and the quality of governance, especially when they have the political support of the citizens. (Hmm… what about when defined benefit plans are under all out attack?)

Brazil’s Novo Mercado, with its higher governance standards, seems to be working in a “race to the top.” However, apparently a similar attempt in Romania didn’t.

Brazil has had rebirth. Stocks have appreciated 40% since the beginning of year. Flows are positive since January, with about 37% coming from outside Brazil. Most derivatives are also regulated and there is disclosure of related third-party transactions.

In most markets, shareowners have been trading liquidity for control. The financial crisis revealed severe shortcomings in corporate governance. When most needed, standards often failed to provide the checks and balances that companies need in order to cultivate sound business practices. The OECD’s Corporate Governance Lessons from the Financial Crisis provides an overview of these shortcomings and resulting challenges.

There were discussions around block holding, both by families and governments, and how the role of director differs in a country like China where they may represent both shareowners and the government. The wisdom of Millstein’s advice to the OECD was acknowledged to be outcome oriented. How we get there may differ.

Comments from others:

On Thursday, Ira Millstein announced that leaders from the Millstein Center had joined three former SEC Commissioners, a former World Bank President and a former US Treasury Deputy Secretary in calling for enactment of long-championed financial market accountability and transparency reforms that include access to the proxy, say on pay, independent board chairs and creation of a permanent commission to develop and oversee updating of a US code of corporate best practice principles. That was a bold, but important, step for an academic center. To me, it demonstrated why the Forum consistently attracts so many insightful corporate governance leaders from around the globe. – Keith L. Johnson, Chair, Reinhart Institutional Investor Services

More photos from the Forum:

Andrew Shapirogroup 1Meredith Millergroup2>Mary Ellen Andersen
Ira MillsteinStephen Davis

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