Archive | December, 2009

Two Overlooked Lessons From the Financial Crisis

In the year-end reflections two contributing factors deserve more attention. First, "prophetic warnings" from religious groups on the dangers of subprime loans via shareowner resolutions. Second, a call from Sanford Lewis for boards to revoke implicit policies of "don’t ask, don’t tell" with regard to liability issues.

The current financial meltdown should remind us of the importance and interconnections between ESG issues. Fully a dozen years before Wall Street experts and regulators reluctantly recognized the contribution of subprime mortgages to the current financial crisis, faith-based organizations urged major corrective action. The summer 2008 issue of The Corporate Examiner, a publication of the Interfaith Center on Corporate Responsibility (ICCR), carried an extensive review entitled The Buck Stops Here: How Securitization Changed the Rules for Ordinary Americans.

Subprime mortgages came about as a way to extend credit to lower-income people after passage of the federal Community Reinvestment Act in 1977, which encouraged banks to lend money in their local communities. Many ICCR members had pushed for the Act because subprime mortgages can give low income applicants access to home ownership when the cost and terms of conventional mortgages would be prohibitive. However, IRRC members were also on the forefront calling for subprime loans to be used responsibly, with reasonable terms.

As early as 1993, ICCR members filed six resolutions to more closely regulate subprime mortgages. “When our institutional investor members view their holdings through the lens of justice and sustainability, the priorities for action that emerge frequently anticipate market moves. Time and time again, the prophetic voice of faith has allowed our members to anticipate emerging areas of corporate responsibility, in investment policy as well as in social, economic and environmental policy. For more than a decade before anyone else, our visionary members have been expressing concerns related to predatory lending practices, inappropriate underwriting standards and the potential consequences of securitization of debt instruments," says ICCR Executive Director Laura Berry.

If financial markets had paid more attention to ICCR, perhaps we wouldn’t have gotten into the financial meltdown… certainly, it wouldn’t have been as big. Boards and shareowners would do well to pay more attention to this "early warning" system.

Earlier this year, I had the pleasure of providing editorial and substantive advice to Sanford J. Lewis, Counsel to the Investor Environmental Health Network, on his paper Don’t Ask, Don’t Tell: A Poor Framework for Risk Analysis by Both Investors and Directors (HLSCG&FR, 11/15/09) Lewis describes a growing clash between the needs and duties of directors and investors to manage risks, and attorneys who advise “don’t ask; don’t tell,” in order to minimize corporate liability in any possible future litigation. He warns that a strategy based on culpable deniability serves no one well.

Accounting principles for reporting environmental liabilities, for example, include subjective language such as “to the extent material,” “when necessary for the financial statements not to be misleading,” and “encouraged but not required.” At the same time, section 302 of Sarbanes-Oxley requires the CEO or CFO to certify the financial statement “fairly presents” the company’s financial condition, regardless of whether the financial statement is technically in compliance with generally accepted accounting principles.

Directors are caught between a rock and a hard place. If they report only “known minimum” liabilities, they risk violating SOX. However, a "fair presentation," could be used as evidence in court and raise possible settlement costs.

Lewis recommends a principled approach to “prejudicial” information, where a balancing test is used to weigh how prejudicial and how useful information will be. Under federal and state rules, evidence which might be considered prejudicial will nevertheless be found to be admissible in evidence if it is “more probative than prejudicial.” "A similar balancing test should be applied by accounting and securities rulemakers in considering the types of required disclosures to support the needs of investors."

Boards who listened too closely to the advice of their attorney’s may have been ignorant of potential risks but they can hardly be though blameless. We need to move from "don’t ask, don’t tell" to a careful weighing of the evidence and accounting standards that provide for more in the way of disclosure.

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Whole Foods: Progress But Still a Lapdog Board

As I previously posted, Whole Foods Splits Positions, WFMI’s shareowners are making progress. Now, I see from their SEC filing they did more than split CEO and Chair positions.

Additionally, our board of directors amended Article IX of our bylaws to provide that, in order for shareholders to approve an amendment to, or a Bylaw inconsistent with, certain bylaw provisions, the amendment or inconsistent Bylaw must be approved by the affirmative vote of a majority of the outstanding shares. This requirement applies to the advance notice bylaws, written consent procedures bylaws, vacancies bylaws, Article III, Section 1 of the Bylaws which pertains to the composition of the Board of Directors, Article VII of the Bylaws which pertains to indemnification, and Article IX of the Bylaws which pertains to bylaw amendments. Previously, the affirmative vote of 75% of the outstanding shares was required to amend, or adopt a Bylaw inconsistent with, those provisions.

That’s great news. Leroy McDowell provided coverage of the change for Westlaw (Corporate Governance Watch: Activist Pushes Whole Foods Toward Simple Majority Voting, 12/29/09). McDowell attributes the change to be the result of “a longer standing shareholder proposal, submitted by the infamous John Chevedden.” McDowell fails to note that Chevedden’s last resolution on the topic won 57% support. Yet, the Board took no action until a few days ago.

Frustrated by the Board’s inaction, I submitted a resolution for the 2010 annual meeting that calls on the Board to establish an independent board committee to meet with me and to obtain any additional information needed before presenting a recommendation to the full Board. Perhaps this pushed the Board to act. While I’m pleased with the move to split positions and do away with supermajority requirements, I’m not so pleased with the explanation offered in the SEC filing.

Whole Foods Market always has strived to maintain high corporate governance standards. In keeping with this goal, the Board added the Lead Director designation in 2000, and since that time, has shifted all of the responsibilities of the Chairman of the Board to the Lead Director. Despite this shift in responsibilities which has rendered the Chairman role to a mere title, the Company repeatedly has received proposals from corporate activists to separate the Chairman and CEO roles. To avoid unnecessary distraction and protect the Company’s corporate governance profile, Mr. Mackey believes giving up the Chairman title to be in the best interests of the Company and its stakeholders. (my emphasis)

From the language, it would appear that Whole Foods is making the changes, not because they believe in good governance but because they want to avoid unnecessary distraction. Additionally, although the changes were made by the Board, it is obvious Mr. Mackey was “the decider,” as our former President would say. On his blog (12/29/09), Mr. Mackey writes, “Was I forced to give up the Chairman’s title? Absolutely not! Both the idea and the decision to give up the title were completely my own… At no time has anyone on the Board or in management ever asked me to give up the title.”

As I indicate in my resolution to Form a Majority Vote Committee, WFMI’s Lead Director, John Elstrott now Chairman, has been on the board for 14-years. That should be a red flag to shareowners. Back in 1996 the relatively conservative National Association of Corporate Directors, in its Report on Director Professionalism, called for term limits. The NACD suggested a term limit of between 10 and 15 years.

After about 10 years, most directors have been completely captured by the CEOs who brought them to the board and who decide their pay and perks. Long-term directors also get too comfortable. They are not generally innovating against themselves.

If Elstrott ever was independent, he should no longer be considered so. Additionally, according to a report from The Corporate Library, three other directors are  outside-related and three owned no stock (Jonathan Sokoloff, Jonathan Seiffer and Stephanie Kugelman). Shareowners should continue to push on directors to invest a substantial portion of their own wealth in the company (not through grants for board service but from their own savings) and should also push on them to act independently.

Mackey was ahead of most with his vision of a shift toward natural food and his adoption of decentralized decision-making, something of an experiment in workplace democracy. Team members meet regularly to decide everything from local suppliers to who should get hired. Democracy seems to have worked well for Whole Foods at the shop floor level. It is time the company also adopted more of a democratic approach with regard to the Board and its shareowners.

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Directors From Failing Boards: A More Nuanced Approach

Gretchen Morgenson’s What Iceberg? Just Glide to the Next Boardroom (12/26/09) tells of directors who were supposedly minding the store as disaster struck at companies like Countrywide Financial, Washington Mutual or Fannie Mae and how many have moved on to other boardrooms. Morgenson’s article implied that shareowners should vote them out at their new companies. In I Read Morgenson; Now What?, I tried to tell readers how to do just that. Paul Hodgson – Senior Research Associate with The Corporate Library offers up another approach. (Directors and Blame. Where does the fault lie?, 12/30/09)

Paul’s is much more nuanced, pointing out that being a member of a failed board shouldn’t necessarily brand one for life. “Fair enough, the two PACCAR directors who served on the Washington Mutual board (for 38 years) and the Countrywide board (for four years) are two among a total of 12 directors, but they must still be having some kind of effect. Is it a good one and was the 38 years at WaMu just a bad dream? Or is their service on a failed company board irrelevant. Or is it an advantage?”

His blog post seems to lead on that such experience could be an advantage if they learned from it, or a disadvantage if they were incriminated in the failure. He notes Peter Cohan’s recommendation from Why American Corporate Governance is a Bust as adding a requirement or best practice that directors be required to “buy significant stakeholdings.” If their wealth is tied to the company, they will be vigilant in protecting shareowners. Paul then asks, “Might they not be driven by the kind of impetus that drives executives with millions of stock options to book revenue that hasn’t been earned yet, to manipulate earnings, to artificially boost stock prices?”

He recognizes there is no single solution that will always apply but then concludes that at least an apology may be due. “It goes a long way when you are asking for forgiveness, and re-election is a form of forgiveness.” In general, I agree with Peter Cohan and would like to see more directors with their wealth ties into the firm. Yes, that can lead to accounting gimmicks, but that why we should require that substantial holdings be long-term, extending even for some time after they have left the board.

I like Paul’s call for apologies but even that is not so straightforward. What if these directors did everything they could to avoid trouble at Washington Mutual and Countrywide? Would they need to apologize for not convincing the rest of the board or for remaining on the board, instead of making a noisy exit?

One of the fundamental problems that shareowners have in monitoring boards is that boards are such a black box. We don’t know who is responsible for what, other than by what committees they sit on.

Instead of an apology, or perhaps accompanied by one, directors should offer up an explanation of what went wrong, their role in it, and what lessons they learned.

The SEC’s new disclosure requirements will mandate proxies include an evaluation of each nominee’s “competence and character,” including the particular experience, qualifications, attributes or skills that led the board to conclude that the person should serve as a director of the company. Such notice is also required to include a list of other directorships held by each director or nominee at any public company during the previous five years, rather than only current directorships. I would love to read, among these disclosures, explanations from candidates about their roles as directors and why we should elect them despite the taint that may come from such service. Will apologies and explanations be forthcoming?

While Weil, Gotshall & Manges put out an excellent briefing today, SEC Disclosure and Corporate Governance (December 30, 2009), that goes over the disclosures and many other new requirements, I don’t see any recommendations for apologies. “As a starting point, the nominating committee chair and company counsel should consider requesting updated CVs from each of the directors (some companies may choose to include additional questions in the D&O questionnaire). Companies should begin drafting this section of the proxy statement early since each director will likely take a keen interest and may have comments.”

Keen interest indeed, as Paul Hodgson notes, “PACCAR coyly omits the WaMu and Countrywide service in its directors’ bios.” Next year they can’t. Will they include apologies or explanations? Maybe Michelle Leder will be the first to let us know at

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Top Ten for 2010

Ira M. Millstein, Holly J. Gregory and Rebecca C. Grapsas of Weil, Gotshal & Manges LLP offer up Ten Thoughts for Ordering Governance Relationships in 2010, including recommendations for boards, shareowners and regulators.

This Week in the Boardroom: 12/24/09 TK Kerstetter and Scott Cutler also addresses their Top 10 Board Issues for 2010. Response to one item from Kerstetter — no, we haven’t gone too far in requiring independent directors. Independent directors can certainly have expertise and can contribute the same value with less potential conflicts of interest.

Neither the top ten lists offer up anything earth shattering; both are well worth attention. See also, How Socially Responsible Investors View Companies in 2010 from the GreenBiz Staff.

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Fix the Boards – Fix the System

Money for Nothing: How the Failure of Corporate Boards Is Ruining American Business and Costing Us Trillions by John Gillespie and David Zweig begins with a story familiar to just about everyone on the globe — corporate and economic collapse brought on by greedy CEOs. The authors look behind the headlines to reveal and document the systematic failure of corporate boards who are supposed to look out for shareowner interests but are still too often picked by the very ones they are supposed to advise and monitor… the CEOs.

They discuss how companies spend enormous sums of shareholder money to fight off reforms, either directly or through organizations like the US Chamber of Commerce or the Business Roundtable. According to the authors, “corporate boards remain the weakest link in our free enterprise system.”

A brief overview is provided on how we got here and what it means for shareowners and society. Much of the book is given over to example after example of conflicts of interest, overlapping boards, and a world driven by the greed and status needs of CEOs. Studies have shown that 80% of acquisitions fail to deliver and many fail outright. Too often they are driven by incentives that reward empire building over the generation of profits.

Jennifer Lerner, the only psychologist on the faculty of Harvard’s Kennedy School of Government, finds that “Americans tend to exhibit anger more readily than those in many other cultures, and the effects of being in power closely resemble those of being angry.” CEOs and other executives, it turns out, have substantially larger appetites for risk and are more optimistic about outcomes. Changing the context can improve outcomes, especially where the environment demands “predecisional accountability to an audience with unknown views.” In the case of corporations, that would be a diverse independent board, not predictable lapdogs of management.

Later chapters review “The Myth of Shareholders’ Rights” and other issues, including proxy mechanics that allow moving shares to be voted multiple times based on the “day of record,” when large blocks of stocks may be most likely to have several different owners. They document that not only do shareowners have little power, the gatekeepers and guardians paid to protect shareowner interests are almost always conflicted, leading to de facto control by management. At the same time, laws like the “business judgment rule” make it nearly impossible to hold fiduciaries accountable. Pension assets that are turned over to plan managers who provide kickbacks back to corporations earned 29% lower returns, according to a cited 2009 GAO report. The failures documented by Gillespie and Zweig cost investors and the public trillions, bringing the world economy to its knees.

It is time boards stopped being the CEOs friend and instead took on the role of the CEO’s boss. After a thorough examination of the issues, documented with an abundance of real-life examples, Gillespie and Zweig close with a list of recommendations that could go far in changing the culture of the boardroom, strengthening accountability, reducing conflicts of interest, and getting shareowners involved. In a very abbreviated form:

  • Create a new class of public directors and a training consortium
  • Insist of gender, ethnic, and perceptual diversity
  • Limit directors to three or fewer boards and require substantial “skin in the game”
  • Initiate more communication between directors and shareowners
  • Split chair/CEO roles & learn lessons from nonprofits
  • Allow 10% of shareowners to call an extraordinary general meeting
  • Add clout to say-on-pay, reform executive compensation, and shareholder approval of golden parachutes
  • Ban staggered boards and require majority votes elections
  • Proxy access for shareowners, daylight nominating & election processes, & require real board evaluations
  • Require board risk committees & empower boards to gather independent information
  • End conflict of interest in mutual fund voting by allowing third party voters per Investor Suffrage Movement
  • Reform voting mechanics to end manipulation by management
  • Reform auditor business model & Fix “up the ladder” provision of SOX
  • Reform rating agency model, fully disclose lobbyist expenses, provide real funding for SEC enforcement
  • Federalize corporate law
  • Better coverage of governance issues by the financial media
  • Better financial education, including how corporate governance works

Gillespie and Zweig hit all the bases for a solid home run. They tell us how the game is fixed and how the rules can be changed to play fair. After all, shareowners own the “ball” and all the other equipment. Will we listen? Even more importantly, will we act?

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Corporate Governance Idol

We’re all critics now with TV shows like American Idol, So You Think You Can Dance?, Project Runway, Top Chef, etc. Stephen Marche calls out an important trend in Is "American Idol" Holding America Together? (Esquire, 01/10) Here are a few snippets:

The sense of entitlement to judge everyone and everything, all day and every day, feeds and fuels our pop-culture appetite, and it finds its broadest, most democratic expression in the "Idol" format… a mass of contestants, a group of gatekeepers, and a victor chosen by popular vote.

We watch for the judges, not the judged, and to listen to their instruction for the next generation of talent… Who would have thought that Simon Cowell rather than some Nobel prize winner would be the one bringing Americans together?

Last March I heard Nell Minow on Intelligence Squared… a good show that could be even better with more focus. Here’s an idea for Gary Lutin’s Shareholder Forum, the Investor Suffrage Movement, MoxyVote or Broadridge Communications — prior to the annual meeting hold a debate between resolution proponents and corporate representatives. Or, pit the Chamber of Commerce against The Corporate Library, the Business Roundtable against the Council of Institutional Investors . Have a panel of academics, knowledgeable on the subject critic presentations, provide their votes and their reasons — then give verified shareowners and the general public an opportunity to vote on the resolutions.

At first, such a show is unlikely to take top billing on YouTube or some other media but over time it has the potential to become popular. After all, Exxon Mobil’s policies impact us all a lot more than the next great vocal performer. Shouldn’t viewers be more excited about the opportunity to influence an outcome that can actually impact them? Change corporations, save the habitable Earth.

Corporate Governance Idol or whatever it is called could provide investors with an education they are unlikely to find at American Association of Individual Investors or other sites that focus on stock picking, rather than share owning. While the SEC’s educational efforts aim at consumer protection, CorpGov Idol would aim at empowering investors to take ownership of their corporations, educating them on issues that are likely to apply to other companies as well… issues like splitting the chair/CEO positions, annual elections, majority vote, threshold for a special meeting, more disclosure of potential environmental liabilities and how they will be addressed.

It will be interesting to see if shareowners vote differently than the general public. It would also be interesting to identify trends over time as issues are more fully explored and participants are educated. Could Andrew Shapiro, Richard Breeden, or John Chevedden be the next American Idol. Tune in next week to find out and don’t forget to vote.

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I Read Morgenson; Now What?

Gretchen Morgenson’s What Iceberg? Just Glide to the Next Boardroom (NYTimes, 12/26/09) tells of directors who were supposedly minding the store as disaster struck at companies like Countrywide Financial, Washington Mutual or Fannie Mae and how many have moved on to other boardrooms. For example, Thomas P. Gerrity was a board member of Fannie Mae from 1991 to 2006 and is now on the board of Sunoco.

After going through a litany of such directors, Morgenson notes that “because of the way director elections are structured, board members can win their seats if they receive just one vote of support.” While that is still true at most companies, at 2/3 the S&P 500 and many others directors must offer their resignation if they don’t get a majority of share votes. Of course, boards can reject such resignations. Even if they are accepted, the board can simply replace Tweedledum with Tweedledee.

“Shareholders interested in ousting a director or two must mount an expensive proxy fight,” writes Morgenson. The SEC will probably adopt a mild form of proxy access in 2010, which will allow a few directors to be nominated by very large shareowners or groups beginning in about 2011. Other solutions offered up include: instituting term limits for directors, separating the roles of board chairman and chief executive, and allowing shareowner groups holding 10% a company’s to call special meetings where we can throw tainted directors out.

So, what should the average retail investor do with this information? If you have a pension plan or own mutual funds, see how they are voting. You can either do this by:

  • going to the fund’s individual site and searching for their proxy voting record and policies or
  • going to FundVotes or ProxyDemocracy. Here you can quickly see if your fund actively votes against directors, votes in favor of corporate governance measures (term limits, split CEO/chair, 10% threshold) or see if your fund is basically a lapdog… always voting with management.

Once you get a look at how your funds are voting, you may want to either switch to other funds that take their fiduciary duties to vote seriously or you may want to write them a letter or e-mail suggesting they support measures such as those mentioned by Morgenson.

If you own stocks you should be exercising your right to vote. Think your votes don’t count? Think again. Read On2 Adjourns Meeting on Google, Solicits More Votes, where the ProxyDemocracy Blog discusses the impact of Moxy Vote, the proxy-voting platform for individual investors. Management has extended the voting deadline twice, in part because ballots representing 18.9 million On2 shares, or 11% of those outstanding, were cast through the Moxy Vote Web site. Under e-proxy rules, up to 95% of retail shareowners are simply clicking delete. In such circumstances, your one vote can basically have the power of twenty! Apathy may make you stronger as an individual voter, but since we also need to overcome the apathy of all those lapdog funds, we need to mobilize retail shareowners.

If you have some time and want to put in some effort, search for “proxy voting” or “research.” If you just want to “do the right thing” and are willing to trust funds and advisors, check out the following three resources and copy from your trusted brand:

  1. not only offers advice from various sources on proxy voting but also voting in civic elections. They are just getting started, so one of the problems is that you are likely to find yourself looking up a company but finding no advice.
  2. has been around the longest and reports on advanced voting by some huge funds like CalSTRS, CalPERS, and Florida SBA, as well as SRI/CSR funds like AFSCME Employees Pension Plan, Calvert, CBIS, Domini, Green Century, MMA Praxis and Trillium Asset Management. Go to this site a week before the deadline and you’ll probably be able to see how several funds are voting. In fact, you can tell them what stocks you own and they will notify you by e-mail when they know how funds are voting.
  3. is the newest site. Again, you’ll probably find they won’t have advocates offering advice on many of the stocks you own at this point. However, a handy feature is that you can actually vote your stock through their platform and they keep track of votes cast. You can either manually enter the control number sent by your broker or you can link your brokerage account directly.

Now that you know how to be a responsible owner of stocks by voting your proxies, you should also consider signing up at to network with like-minded shareowners. You’ll get some news, intelligent discussion and they’ll help you prod elected officials. It is critically important to work to reform corporations as well as they government, since corporate managers have so much influence over both.

Also sign up at the Investor Suffrage Movement. Volunteer to be a “field agent. You could save an activist shareowner hundreds of dollars in travel expenses by simply standing up at an annual meeting near you and reading a prepared statement in support of a shareowner resolution, like one calling for shareowners representing 10% of a company’s stock being able to hold a special meeting. If you want to get further involved, this is the place… from t-shirts to building a proxy exchange database.

Last, keep up with the news at We’re moving much of the news to a blog format by the beginning of 2010, so you’ll be able to subscribe through RSS or via e-mail and each news item will finally have its own URL… so important to many of you who would like to link to our coverage and comments. Sign up for Kachingle, the coming crowdfunding source. For $5 a month, you’ll be supporting not only but many other important web-based resources.

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Moving Toward Democracy

Andrea Bonime-Blanc and Mark Brzezinski, writing for the NYTimes (Business and the Way of Democracy, 12/26/09) argue “Much like transitions to democracy over the past four decades transformed governments from mostly authoritarian to mostly democratic, we are currently witnessing a transformation of global corporations from a more or less opaque shareholder-centric model to a more transparent multi-stakeholder model.”

According to Bonime-Blanc and Brzezinski, companies are embracing five trends:

  1. Adopting better governance with stronger shareholder rights, board rules, director accountability and pay for performance.
  2. Integrating corporate integrity programs into business strategy and leadership development.
  3. Pursuing dialogue with multiple and increasingly vocal stakeholders.
  4. Engaging proactively with regulators intent on trans-border cooperation and enforcement (especially regarding anti-corruption, anti-money laundering, antitrust and anti-fraud).
  5. Catering to two critical constituents — employees and customers — who have shown greater willingness, and ability, to “vote with their feet.
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CEO Greed Doesn't Work for Shareowners

“Firms that pay their CEOs in the top ten percent of pay earn negative abnormal returns over the next five years of approximately -13%. The effect is stronger for CEOs who receive higher incentive pay relative to their peers. Our results are consistent with high-pay induced CEO overconfidence and investor overreaction towards firms with high paid CEOs.” That was the conclusion of Performance for pay? The relationship between CEO incentive compensation and future stock price performance by Cooper, Gulen, and Rau… one of two studies highlighted in Does Golden Pay for the CEOs Sink Stocks? (Jason Zweig, WSJ, 12/26/09).

According to Rau, CEOs in his study averaged $23 million—but leave their shareholders poorer (relative to other companies in the same industry) by an average of $2.4 billion per year. Each dollar that goes into the CEO’s pocket appears to take $100 out of shareholders’ pockets. If that is true, there is obviously something very very wrong with the typical incentive structure.

The CEO Pay Slice by Bebchuk, Cremers, and Peyer investigated the fraction of the aggregate compensation of the top-five executive team captured by the CEO – and the value, performance, and behavior of public firms. They found “CPS is negatively associated with firm value as measured by industry- adjusted Tobin’s Q.” CPS is found to be correlated with

  1. lower (industry-adjusted) accounting profitability,
  2. lower stock returns accompanying acquisitions announced by the firm and higher likelihood of a negative stock return accompanying such announcements,
  3. higher odds of the CEO’s receiving a “lucky” option grant at the lowest price of the month,
  4. greater tendency to reward the CEO for luck due to positive industry-wide shocks,
  5. lower performance sensitivity of CEO turnover,
  6. lower firm-specific variability of stock returns over time, and
  7. lower stock market returns accompanying the filing of proxy statements for periods where CPS increases.

Zweig’s article goes on to cite Benjamin Graham’s 1951 recommendation that directors “must have an arm’s-length relationship with management; they also should combine “good character and general business ability” with “substantial stock ownership.” (They should have purchased most of their shares outright rather than getting them through option grants.)” He also notes that Graham called to independent directors to publish a separate annual report analyzing whether the business is “showing the results for the outside stockholder which could be expected of it under proper management.”

Each month I take readers on a time trip in’s “WayBack Machine,” to see what we were discussing 5 and 10 years ago. It is interesting to see how often we are grappling with the same issues. If we had only listened to Graham 58 years ago, how different would corporate governance be today? While we can’t change the past, we can at least work to ensure CEO pay is better aligned long-term shareowner value in the future.

Service Employees International Union (SEIU) Master Trust launched a campaign recently, mostly aimed at banks, proposing the following reforms:

  • Requiring that at least 80 percent of an executive’s annual compensation be subject to multi-year vesting and/or holding periods;
  • Requiring executives and directors to hold a significant equity stake in the company and basing that stake on the value of the executive’s annual compensation package;
  • Making the timing of the equity awards predictable so shareowners know by the annual meeting date the total compensation level awarded to the executive team in the previous year;
  • Enacting effective clawback provisions that call for the automatic return of any bonus or incentive compensation awarded on the basis of financial results that subsequently required restatement;
  • Requiring a substantial portion of annual cash and/or equity bonuses to be held until performance criteria are achieved;
  • Making retention grants conditional upon executives remaining with the company;
  • Prohibiting executives and directors from engaging in any hedging, derivative or other transactions with respect to equity-based awards granted as incentive compensation;
  • Placing restrictions on severance payments, death/disability payments, compensation related to changes in control and perquisites;
  • Forming a shareowner advisory committee to advise the board and the compensation committee on executive and director compensation;
  • Allowing shareowners to cast an annual advisory vote on executive compensation;
  • Including in proxy statements information about the steps being taken to align compensation with long- term incentives, to avoid incentives that promote undue risk taking and to prevent windfalls where there is no long-term shareowner gain;
  • Requiring that at least three independent directors serve on the compensation committee;
  • Prohibiting compensation committee directors from serving on the audit committee; and
  • Adopting bylaws that allow shareowners to place director candidates on corporate ballots subject to certain conditions.

These seem like a good start. However, the devil is in the details. For example, requiring 80% of an exec’s annual compensation be subject to multi-year vesting and/or holding periods… getting 80% two years later meets that vague definition but certainly doesn’t meet criteria that would dissuade CEOs from gaming the system. Certainly, much more needs to be done in this area. RiskMetrics made an important change to their policy for 2010 by assessing the alignment of CEO’s total direct compensation and total shareholder return over a period of at least five years.

More discussion at How to Tie Equity Pay to Long-Term Performance, HBR, 6/24/09; Executive Compensation,; Are senior executives worth what they are paid? Steven N. Kaplan vs Nell Minow, The Economist, 10/28/09.

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CII Supports SEC Effort to Increase Potential Liability at Credit Rating Agencies

The SEC is considering a proposal to rescind an exemption that would cause Nationally Recognized Statistical Rating Organizations to be included in the liability scheme for experts set forth in Section 11, as is currently the case for credit rating agencies that are not NRSROs.

NRSROs “have generally escaped accountability for their shoddy performance and poorly managed conflicts of interest, at least in part because of their statutory exemption from liability. Rule 436(g) shields only those few rating agencies designated as NRSROs from liability as experts for making untrue or misleading statements when their ratings are included in registration statements,” according to the Council of Institutional Investors.

CII believes effective reform of the credit ratings industry hinges on the following steps:

  • Enhanced SEC oversight
  • Reduced reliance on ratings by all market participants
  • Strengthened internal controls of NRSROs
  • Expanded transparency of credit ratings
  • Heightened standards of accountability for NRSROs

See CII’s letter to the SEC in support of Concept Release on Possible Rescission of Rule 436(g) Under the Securities Act (File Number: S7-25-09) (see also Concept Release No. 33-9071A). SEC Fact Sheet. Speech by Commissioner Luis A. Aguilar.

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Overcoming Short-termism: The Key Issue

Gary Larkin, who blogs for the Conference Board, did a great interview Q&A With Martin Lipton and Richard Ferlauto: Short-termism. (12/09/09) Here’s a snippet on the question, Do you think short-termism played a role in the destruction of long-term shareholder value:

Lipton: Absolutely. Short-termism resulted in financial services companies taking undue risk, more so than in the past. They created more and more leverage. Businesses were generally borrowing on a short-term basis and subjected themselves to a liquidity crisis. Monetary policy created historically low interest rates and too many companies did not resist the “bargain.”

Ferlauto: The time horizons and its parallel investment orientation may be the most fundamental question that investors — especially fiduciaries for retirement funds — face today. Too many investors till think that they are better off with “Make the money and get out [of the market]’ or ‘Make the money now and not care about its longer term repercussions.’ You’re eating your seed corn for short term gains. Many firms are not competitive now because they didn’t make the investments in technology, human resources or internal development that in the long run contributes to wealth creation for shareowners and other stakeholders.

I found it interesting that it is the conservative, Lipton, who sees the solution in direct action by the federal government, while Ferlauto appeals to issuers to work more closely with their shareowners… although in the end Ferlauto also sees intervention by the federal government as necessary, since individual companies aren’t willing to break out of the model on their own.

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Whole Foods Splits Positions

Whole Foods Market Inc. said co-founder and Chief Executive John Mackey has given up the title of chairman in order to conform with current standards for good corporate governance. As of last spring, about 37% of companies in the Standard & Poor’s 500 stock index had separate chairmen and CEOs, up from 22% in 2002, according to the Corporate Library, a research firm in Portland, Maine. (Whole Foods CEO Gives Up Chairman’s Post, WSJ, 12/24/09)

Both the Conference Board’s Commission on Public Trust and Private Enterprise and the Council of Institutional Investors have long recommended roles of the CEO and Chairman be split to ensure an appropriate balance of power.

CEOs who retain the dual role make it extremely difficult to challenge a powerful chief executive if necessary to protect shareowner interests. When I approached WFMI on this issue several years ago, independent directors didn’t even routinely hold meetings without the CEO present. and be “more likely to have certain troubling governance characteristics than companies where the roles are separated.”

Spearheading the reform effort is the Chairmen’s Forum, an organization of independent chairs convened by The Millstein Center for Corporate Governance and Performance at the Yale School of Management. Last spring, Mary Schapiro told the Council of Institutional Investors that the SEC is “considering whether boards should disclose to shareholders their reasons for choosing their particular leadership structure – whether that structure includes an independent chair, a non-independent chair, or a combined CEO/chair.” If such a requirement goes through, expect withhold votes for directors at companies that provide poor explanations of why they haven’t split the roles.

As an activist shareowner of WFMI, I’ve been after them for years to make this change, along with others such as John Chevedden. I’m under no delusion that Mackey is now under the thumb of the board chair. I’m sure he remains the driving force behind WFMI. However, given his track record of blunders like faking his identity on blogs and denying shareowners the right to present resolutions during the business portion of the annual meeting, at least he now has a better chance of not making a mockery of WFMI’s shareowners. The content of Mr. Mackey’s online postings were directly at odds with the Company’s core values of transparency and stewardship. His refusal to allow shareowner resolution proponents an opportunity to speak during the normal business portion of an annual meeting, even though SEC Rule 14a-8(h)(3) requires that a proponent or representative of a resolution contained in the company proxy must present their proposal, also conflicted with our Company’s "Declaration of Interdependence," which "requires listening compassionately, thinking carefully and acting with integrity."

According to Richard Bernstein, chief U.S. strategist at Merrill Lynch, companies in the top 100 of the S&P 500 with split chairman and CEO outperformed those that combine the roles during the last decade. Corporations with split roles posted a 22% annual return since 1994, outpacing the 18% return earned by firms that did not. WFMI is a great company that could be even better if it took the role of shareowners as seriously it does that of customers and employees. Splitting the roles of CEO and chair is a good sign attitudes may be changing. Instead of viewing participation by shareowners as creating a circus atmosphere, as Mackey has characterized it in the past, maybe now we will see real dialogue that will increase long-term value.

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How Politics Shaped the Political Economy of Global Finance

The Political Economy of Global Finance Capital by Richard Deeg and Mary O’Sullivan review 6 influential books on the topic in light of the recent financial crisis.

The most important developments highlighted:

  • the move from a predominant focus on state-centered patterns of regulation to a more comprehensive understanding of the role of states and private actors in building a transnational governance regime that mixes public and private regulation;
  • the intensified effort to understand the causal forces that shape the political economy of global finance based on more complex models that allow for an interaction among interests, institutions and ideas; and
  • increased attention to new sources of systemic risk in the global financial system, as well as a greater consideration of the consequences for domestic politics of interactions with the global financial system.

They argue that we must do more to understand the behavior of actors who enact the rules of global finance, not just those who generate the rules. More must be done to assess the costs and benefits of financialization at the global and national levels.

Some interesting points highlighted:

  • The financial crisis emanated not from the periphery but from the very core of the system.
  • Facilitated flows from poor countries to rich countries, rather than the historically opposite direction.
  • Coordinated market economies that rely on welfare production regimes for promoting and protecting the investment by firms in skill sets and specific assets may have a competitive advantage with financial globalization, the opposite of conventional thinking.
  • These protections inhibit convergence in corporate governance.
  • Financialization, where maximization of short-term shareowner value through dashboard metrics, has compromised the interests of other stakeholders and corrodes the coordinated system of capitalism.
  • Extraordinary incentives contributed to willingness to pursue aggressive strategies without due attention to risks.

How is it that false illusions were conferred sufficient legitimacy to deafen alternative views and stymie reform? In our thinking, a lot may come down to the power held by CEOs and their organizations like the Business Roundtable and the Chamber of Commerce. They can spend shareowner money like there is no tomorrow in defending a system that still gives CEOs virtually dictatorial power. On the other side, institutional investors are held to fiduciary duties that limit such lobbying efforts, even by the few that don’t have direct conflicts of interests, such as in trying to attract those 401(k) accounts from CEOs.

Happy Holidays: More, More, More: Gifts For the CEO Who Has Everything (clip from Nightly Business Report via The Corporate Library Blog, 12/24/09)

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CorpGov Bites

Check out the CorpGov Blog, a work in progress. After years of demands that we have indexed articles, an RSS feed and other advantages of blogs, we’re finally beginning to adapt. With our 15th anniversary coming up in 2010, maybe it is time to join the 21st century. Your feedback is appreciated, either via e-mail or through your comments on the blog. I’m still not sure about the look, how it should be organized, how to maintain the number one search status we’ve had on the term “corporate governance” since before google, how to change the URL’s, how to add an e-mail subscribe function, etc., etc. Your suggestions, especially when accompanied with instructions, are more than welcome.

WorldBlu discusses How to Democratize Corporate Ownership, using Equal Exchange as an example of a for-profit Fair Trade company in the US that owned and governed by employees on a one-person/one-share/one-vote basis.

Faith and finance: Of greed and creed (FT, 12/23/09) explores the morals of the financial sector. Was it a “greedy focus on the short term?” Others cite a diminished a sense of responsibility, allowing personal and institutional self-interest to overshadow customer service and risk management. “The root problem, Lord Turner, free-thinking chairman of the Financial Services Authority, the UK industry regulator, famously said this summer, is that too much business over the past decade has been ‘socially useless.'” The article reports mixed responses as to lessons learned.

I would ask, just how useful is the entire financial sector? As Simon Johnson discussed in The Quiet Coup (theAtlantic, May 2009) “From 1973 to 1985, the financial sector never earned more than 16 percent of domestic corporate profits. In 1986, that figure reached 19 percent. In the 1990s, it oscillated between 21 percent and 30 percent, higher than it had ever been in the postwar period. This decade, it reached 41 percent. Pay rose just as dramatically. From 1948 to 1982, average compensation in the financial sector ranged between 99 percent and 108 percent of the average for all domestic private industries. From 1983, it shot upward, reaching 181 percent in 2007.”

A new report from Ceres and Mercer, Energy efficiency and real estate: Opportunities for investors, identifies efficiency as a significant front in mitigating climate change, and recommends that investors focus on efficiency measures in their real estate holdings. The report recommends that as a first step, investors launch energy efficiency initiatives by developing benchmarks and then create achievable targets in the implementation of projects. (Investing in Energy-Efficient Buildings Can Reduce Emissions While Strengthening Portfolios, Sustainability Investment News, 12/24/09)

A study by Pascual Berrone and Russell Reynolds Associates of Spainish companies found 60% of board chairs said institutional investors exercised little or no involvement in corporate governance. (The Need for Investors to Wield More Board Influence, IESE Insight) How different is it elsewhere?

“Everybody who works with retirement plans should presume that they will owe a fiduciary duty or they will owe a duty for loyalty to those who they service,” says Matthew Hutcheson, an independent pension fiduciary quoted in Coming soon: Broader definition of fiduciary under ERISA (InvestmentNews, 12/23/09). “Brokers who haven’t viewed themselves as fiduciaries need to ask what they might need to do differently.”

The common statement that the world was becoming flat was questioned at the Global Ethics Forum held at the UNOG-United Nations Office at Geneva. In our many problems of poverty, environment, Ponzi schemes, growing income gaps – speakers emphasized how civil society had lost confidence in business and in its leaders.

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Global Perspectives on Corporate Governance and CSR

Edited by Güler Aras and David Crowther, Global Perspectives on Corporate Governance and CSR is a vital exploration of issues around the possibility of developing theories and practice aimed at good corporate governance and good corporate behavior.

In the opening essays, the editors slice and dice the topics several different ways. They look at governance from the perspective of top down, consensusual, networks and markets. Eight principles are reviewed: transparency, rule of law, participation, responsiveness, equity, efficiency and effectiveness, sustainability, and accountability. Systems analyzed include Anglo-Saxon, Latin, and Ottoman models. Then they discuss the overlap with corporate social responsibility of concepts such as transparency, accountability, responsibility and fairness. The rules versus principles debate, the divorce between owners and managers, risk and rewards are weighed.

Moving on to CSR, they discuss roots in Robert Owen, stakeholder theory, the ever changing semiotic nature of assumed understanding, especially with regard to terms like sustainability. A typology is proposed, moving from window dressing to cost containment, stakeholder engagement, measurement/reporting, sustainability, transparency and finally to accountability, reflecting increased maturity not unlike Maslow’s hierarchy of needs.

These variables, concerns and framework are then again parsed by country and culture, as understood in an increasingly global environment. Sustainability is discussed as a moving target. No longer merely concerned with the financial resources of the firm but all the physical resources of the planet. Good financial and environmental performance in the present is an investment in the future of the company. There is no dichotomy, since the concepts conflate into one concern. A global framework is in the making and diverse cultures each have something to offer.

The bulk of the book is then broken down into three parts, representing regional, local and then theoretical perspectives. We more from Europe to Japan, Latin America to Africa — then on to evolution in developing countries, state enterprises, family firms and the use of technology in advancing corporate governance. One finding is similar reform efforts being undertaken in many countries aimed at increased investor protection, transparency, accountability and professional board work. Convergence is also seen in Japan, where the traditional stakeholder model may be evolving to more North American models. Similarly in Africa, a hybrid approach is developing that integrates western style models with pragmatic developmental needs, contributing to an economic democracy that may some day direct and control corporations for the common good.

The book concludes with chapters which attempt to integrate current knowledge into theory. Kurt Strasser looks at problems associated with layers of legally separate corporations, subsidiaries, and calls for a more holistic "enterprise" analysis to get around current legal formalities. Thomas Clarke and Alice Klettner support Robert Hinkley’s 28 Words to Redefine Corporate Duties. Directors are to act in the best interests of the company.. "but not at the expense of the environment, human rights, the public health or safety, the communities in which the corporation operates or the dignity of its employees." Clarke and Klettner remind us:

The problem of material production has essentially been solved. The primary remaining global dilemmas are that overproduction and massive surpluses still coexist with desperate poverty and need, and that the resource base for industry is rapidly depleting and damaging, potentially irreparably, the eco-system. It is possible that confronting these dilemmas will force the rethinking of corporate objectives, structures, and activities that is necessary.

The editors wrap up the text nicely, expressing concern with the trajectory of accounting, where profit is brought forward before it is earned and liabilities can be ignored if they reduce current profitability. They reject Locke’s notion that the whole purpose of society is to safeguard the rights of individuals. Instead, they embrace Tocqueville’s argument that government should regulate individual transactions to safeguard against circumstances where the welfare of some is advanced at the expense of others. We are left to confront the central problem with Liberalism; "the mediation of rights between different individuals only works satisfactorily when the power of individuals is roughly equal."

As to corporate reporting, Aras and Crowther see it no longer focused on past accomplishments but on benefits to be accrued, not as a communication medium "but rather a mechanism for self promotion." GRI and AA1000 are discussed as important integrative reporting initiatives but critics would say "it is only under the Anglo-Saxon model of governance that there could ever be a need for CSR." The Cartesian dichotomy doesn’t arise in Latin or Islamic models. Of course, the Anglo-Saxon model appears to be dominant, so integrative efforts are needed. The editors conclude that any such developing standard must be sufficiently flexible to "allow for the full extent of cultural variation throughout the world."

Given the state of inequality between not only individuals but countries, it is hard to see how such standards will be mediated. although this volume sets a high standard in the necessary task of exploring the issues needing resolution before corporate governance and CSR can be fully integrated.

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Guest Commentary From Glyn Holton: Emergency at Intel

Intel Corp. recently announced they will no longer hold annual shareholder meetings. Instead, they plan to host shareholder forums, or “virtual shareholder meetings.” In 2000, Delaware enacted legislation allowing corporations to do exactly this. Arrogantly, that state’s legislators granted shareholders no say in the matter, leaving the decision solely to the discretion of corporation’s entrenched boards.

There is every reason to believe that, with strong safeguards, virtual shareholder meetings could enhance shareholder participation in meetings while protecting—even restoring—shareholder rights that have atrophied over the decades. However, no such safeguards are in place. Intel and other smaller corporations are taking a go-it-alone approach, forcing virtual shareholder meetings on unhappy shareholders. After Delaware changed its laws, the Council of Institutional Investors wrote the CEOs of all Delaware corporations asking them not to conduct virtual meetings. Unions have expressed concerns. Walden Asset Management has encouraged shareholders to write letters to Intel.

Here are just a few scenarios illustrating how virtual meetings will deprive shareholders:

  1. A well known shareholder activist plans to ask some pointed questions at the shareholder meeting, but his connection to the meeting somehow fails. He is left wondering if he was targeted or if there truly was an honest technical problem.
  2. A shareholder wants to challenge the chair’s conduct of the meeting with a point of order. She is within her rights to do so and may interrupt the chair for this purpose, but she finds that the electronic forum software won’t allow her to do so ….. one more shareholder right lost.
  3. A shareholder wants to make a floor amendment, but the software doesn’t allow that either.
  4. The meeting software provides no means of group communication, such as applause of booing, so shareholders come away from meetings with no sense of how other shareholders felt.
  5. Corporate executives decide to pre-record their comments for a virtual shareholder meeting, including answers to pre-selected “shareholder questions.” The executives then don’t bother logging in during the actual “meeting.”

Most annual meetings are heavily scripted. The chance for real interaction often comes in informal encounters before and after the formal meeting. Those opportunities will also be gone with virtual meetings.

Shareholders have been discussing what might be an appropriate response to Intel’s move, but there are few attractive options. The SEC will not intervene to preempt a Delaware law. We could launch a withhold vote campaign against the directors of Intel and other corporations that host electronic-only meetings. That would entail participating in—and thereby accepting as legitimate—the virtual meetings.

We reject Delaware’s law in the same way abolitionists rejected the Supreme Court’s Dred Scott decision in 1857. A corporation that doesn’t hold shareholder meetings is dead in the same way that a human being that doesn’t breathe is dead. Putting up a website and calling it a “meeting” doesn’t change that.

This is a crisis because the problem is going to spread. Working with Jim McRitchie of CorpGov.netand other interested parties, the United States Proxy Exchange (USPX) is exploring whether to launch a withhold proxy campaign against Intel and other corporations that adopt electronic-only meetings. Under such a campaign, shareholders would refuse to participate in those “meetings” on the grounds that they are illegitimate. Shareholders would withhold their proxies. If enough did so, offending corporations would fail to achieve quorum. Because retail brokers will vote “routine” matters, such as management sponsored resolutions, it won’t be enough for investors to not return their proxy materials. They will have to explicitly ask their broker to withhold a proxy on their behalf.

If we decide to proceed with a withhold proxy campaign, we will implement a web portal through which institutional and retail shareholders may join the campaign and coordinate their activities. At this early stage, please e-mail Glyn Holton to express support or ask questions. We will then keep you informed of developments.

Note from publisher: See also virtual meetings Virtual Shareholder Meetings by Elizabeth Boros. The USPX aims to be a chamber of commerce, representing the legitimate interests of shareholders and is in the process of getting 501(c)(6) status with the Internal Revenue Code. The board set dues at $9 a month. Membership benefits include advocacy, web-based resources, and a magazine to be launched this Spring. Step up to the plate and e-mail Glyn Holton to become a member.

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