Review: A Real Look at Real World Corporate Governance

Larcker-Tayan-real-world-corpgovThis book follows the theme of Corporate Governance Matters: A Closer Look at Organizational Choices and Their Consequences also by David Larcker and Brian Tayan. Larcker is the James Irvin Miller Professor of Accounting, Stanford Graduate School of Business. Brian Tayan is a member of the Corporate Governance Research Program at the Stanford Graduate School of Business. While Corporate Governance Matters (see my review)  focuses on debunking “best practices” in corporate governance, A Real Look at Real World Corporate Governance takes more of an abbreviated case study approach, delving into how several decisions were made by boards at specific companies.

As the authors state: They “have explored issues relating to the board of directors, accounting and internal controls, CEO succession planning, and executive compensation, all from the perspective of understanding what does and does not work in organizational settings.” Their key message is that one-size does not fit all. “Best practices” have limited value.

Individuals elected to the board of directors must be qualified and engaged. To evaluate board quality, a case-by-case analysis is required. The accuracy of financial statements relies on more than just the integrity of the accounting system. It relies on the integrity of the entire organizational system. CEO succession planning is critical to the long-term success of any organization. To be effective, succession planning should be a continuous and ongoing activity within the firm. It is not a one-off decision that periodically arises whenever a CEO resigns, dies, or is fired. Compensation is a vitally important tool that corporate managers and directors use to motivate employees to perform. When designed correctly, compensation packages will attract, retain, and motivate employees to pursue activities that are aligned with the company’s strategy and consistent with its tolerance for risk.

Those are the main messages as Larcker and Tayan explore Lehman Brothers, Enron, Royal Dutch Shell, Baker Hughes, Hewlett-Packard, Apple, Citigroup, Netflix, and others with interesting and colorful examples. The authors conclude “one-size-fits-all” governance solutions do not work. The honest evaluation of a corporate governance system requires an in-depth analysis of the company and its specific situation. This is true not only for the board of directors, but also for policies relating to internal controls, succession planning, and executive compensation.

I agree with Larcker and Tayan that “best practices” and “one-size-fits-all” governance approaches aren’t very effective but given the current corporate governance industrial complex, they are certainly understandable approaches, at least for shareowners… much less so for boards. Directors should be steeped in case studies, evaluating their own board performance in-depth and in context. Shareowners, with the exception of hedge funds and retail investors, have little incentive to do so and most retail investors don’t have the means.

As I have explained elsewhere (Agency Capitalism: Corrective Measures), even the largest funds, such as Vanguard, Northern Trust, BlackRock and Fidelity have little incentive to monitor their portfolios and take an active role in challenging management and boards. Since they hold diverse portfolios, any benefit they could obtain through such actions would equally benefit competitors, while they would bear all the costs (the free rider problem).

Their “real world” incentive is to spend very little, which by necessity leads to a “best practices” “one-size-fits-all” approach. They develop their own proxy voting policies based on this approach and they generally subscribe to one or more proxy advisory services, such as Institutional Shareholder Services or Glass Lewis to help them determine which directors and which proxy proposals conform to their list of best practices.

Commissioner Daniel M. Gallagher of the SEC has been a major critic of the deference shown to proxy advisors, expressing his view that the SEC should withdraw two 2004 no-action letters, issued to Egan-Jones Proxy Services and Institutional Shareholder Services, Inc.which he credits with permitting advisers to rely on the recommendations of proxy advisory firms to vote shares on behalf of their managed accounts.

With their subscription models, Institutional Shareholder Services and Glass Lewis, have very little in the way of resources to take an in-depth approach to the issues, as recommended by Larcker and Tayan. Mark Latham estimates ISS spends about $2,000 to research each proxy. See Proxy Voting Brand Competition on the publications page of

However, Latham has proposed an alternative, which I recently submitted to Cisco Systems. Run a contest where proxy advisors are paid up to $20,000 (ten times as much as ISS) for voting advice. See Proxy Monitoring Contests. While it won’t necessarily lead to the kind of analysis Larker and Tayan advocate, at least the better incentives provided would make that outcome much more likely.

See also the review at Compliance Week.

At less than $10, A Real Look is well worth the price of admission. Directors, CEOs and advisors will find many useful takeaways. However, until changes are made in how proxy advice is dispensed, shareowners will have a more difficult time putting the insights of Larcker and Tayan into practice. Nonetheless, this slim electronic volume should be a rewarding read for all.

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