On February 27, 2015 Vanguard sent out an important letter to many boards of directors of publicly traded companies. The letter, signed by Vanguard’s Chairman and CEO, exhorts directors to follow best practices to ensure that corporate resources are stewarded effectively. But what happens to those boards of directors who are stubbornly entrenched?
Shareholders are busy living their lives and don’t have the capacity or interest in playing babysitter to corporate executives, which is why a Board of Directors is elected. A board of directors is supposed to be accountable to the shareholders but sometimes they need a reminder. Too many continue to act like country club chums with executive management. The Vanguard letter outlines a list of best practices to ensure shareholders are being treated fairly.
The letter begins by highlighting the importance of independent oversight:
[The] Board should be substantially independent of management and have independent leadership (i.e., chair or lead director).
Just a decade ago, three quarters of all CEOs also acted as leaders of their board of directors. As shareholders became increasingly aware of this accountability problem, a passionate minority began calling for CEOs to step down from the chairman position. There is no point in paying a board a hefty salary and travel reimbursement if their role is relegated to blind agreement with the decisions of management.
Times have changed and yet some companies appear stuck in the past. At the close of 2014, only 21.2% of all boards in the Russell 3000 have one person serving as both CEO and board leader. The Vanguard letter acknowledges that while the board composition is now better and more objective than ever, approximately 1 out of every 5 companies still need to separate these roles.
One company that stands out for all the wrong reasons is Nabors Industries (Ticker: NBR). Their CEO, Anthony Petrello, has also held the position of Board Chairman since 1991. In addition to playing this dual role, Mr. Petrello also has the distinction of ranking #1 in a recent study titled, Top 100 Overpaid CEOs.
While Mr. Petrello’s compensation packages have made him a very wealthy man, shareholders have suffered. During the last ten years, shares of NBR have a -6.33% annualized return. During the same period, NBR underperformed its peers in the Oil and Gas drilling sector by an average of 6.22% per year.
Nabors Stock Performance
What makes Vanguard unique is that they are very unlikely to sell a company that is underperforming because a majority of their funds are invested in index funds in what the Vanguard letter called “permanent investments.” If Vanguard is not planning to sell companies that underperform and resist change, how will they respond?
Perhaps the Vanguard letter is a warning shot across the bow of these defiant companies. If Nabors Industries fails to elect a new Chairman, Vanguard could decide to offer shareholder resolutions that would allow independent directors to get elected to the Board. Vanguard could and perhaps even should elect one or more of their own representatives to the board.
Matt Illian
Activist hedge funds are regularly criticized for taking over corporate boards and for dicing up corporations to extract a short term windfall. Perhaps Vanguard should borrow the playbook from these hedge funds but execute their changes with the permanent investors in mind. If Vanguard’s corporate governance strategy is about to become more active, I expect Nabors Industries will be an early target.
Guest Post: Matthew Illian is on the Investment Committee at Marotta Wealth Management, Inc., specializing in small business consulting and retirement plans. He loves spending time outdoors, the less pavement the better, with his wife and three energetic boys. Favorite biking trails: Forest Hill Park
This article first appeared on March 26, 2015 as Vanguard Sends A Letter To Directors, Will A Stick Follow? at Marotta on Money. CorpGov.net changed a couple of graphics and added those wonderful Google ads.
In your blog, you indicate that “The Vanguard letter acknowledges that while the board composition is now better and more objective than ever, approximately 1 out of every 5 companies still need to separate these roles.”
Where is that in the Vanguard letter? I believe they support independent leadership in the form of either an independent chair or lead director.
Please clarify/advise.
Thanks.
I think Randi Morrison makes a good point. Although I wish the case were otherwise, Vanguard appears quite satisfied with an independent chair OR lead director.
As Jordan Wathen points out in a recent post at Motley Fool (A Billionaire’s Warning on Index Funds):
“Scrolling through Vanguard’s votes, you’ll find very few occasions in which it voted against management. Fortune noted that Vanguard voted against separating the CEO and board chairman positions, except when management was in favor of the proposal. Certainly, there have to be at least a handful of companies that would be better run if the CEO weren’t also the chairman of the board. After all, a board’s No. 1 job is to hire and fire a company’s CEO. That’s a tough call for a board to make when the current CEO attends every meeting.
This is largely an industrywide phenomenon. The largest funds don’t take an aggressive stance with their proxy votes, which some would say is a direct result of a conflict of interest. Fund managers have a fiduciary responsibility to their investors, but they also want to win the lucrative business of managing corporate retirement plans, which can generate billions of dollars in assets under management from the largest employers. Alas, C-suite executives aren’t interested in putting employee savings in funds that will vote against them at the next annual shareholder meeting.”
My point was only to say that the last decade has observed a tidal shift towards independent board leadership – not to say that Vanguard has in any way led this shift. I see this Vanguard letter to corporate boards as what could be a new emphasis on becoming more active in corporate governance. If Vanguard becomes a voice for shareholder concerns in the boardroom, I believe this could be the most significant victory for the average investor. Becoming more active will take more than a letter – it will take a significant investment in their corporate governance team. As the largest shareholder of most US corporations, I believe this is Vanguard’s fiduciary duty but I also believe we need to expect that this more active strategy will be resisted by those who believe the only responsibility of Vanguard’s management is to keep their administrative expenses low. Those Vanguard leaders who would like to see Vanguard become more active in this area will need public support and a bit of outcry to overcome the more traditional and passive approach to fund management.