Few who have seen it can forget the iconic scene from the movie Wall Street when Michael Douglas’s character Gordon Gekko stands up, microphone in hand, at Teldar Paper’s shareholder meeting and says: “The point is, ladies and gentleman, that greed, for lack of a better word, is good. Greed is right, greed works.” Cinematic legend. What if it’s also the key to better small-cap corporate governance?
Those exclusively ensconced in the mid- and large-cap governance ecosystems often proudly proclaim that the days of boards predominantly being comprised of “friends of the CEO” are in the rear-view mirror. Conversely, those who spend time in the vast majority of public company boardrooms – those of micro- and small-cap companies – know differently. That is, myriad boards are still handpicked by CEOs, governance standards propagated by Nasdaq and NYSE notwithstanding.
When CEOs intuitively feel like they benefit little from supervision, they install board members who will default to “oversight-lite.”
Has governance at smaller public companies improved since the Enron-era scandals, and in the wake of Sarbanes-Oxley and Dodd-Frank? The short answer is: a bit.
Institutional investors know that more often than not the boardroom efficacy of any given small-cap company is a reflection of the CEO’s personal opinion regarding corporate governance. Look behind the curtain of a well-governed small-cap company and you will likely find a CEO who values it. The opposite is also true.
Institutional investors regularly lament that many micro- and small-cap CEOs seem to view corporate governance as an expensive, form-over-substance, time-consuming, necessary evil that adds little value.
Contrast that widespread perception with the fact that the largest institutional investors spend fortunes on analyzing corporate governance in their portfolio companies. Put differently, those who manage trillions of dollars believe that better governed companies will put more money in their clients’ pockets, yet scores of micro- and small-cap CEOs appear to believe that corporate governance is a waste of time.
If this seems confounding – it is.
Before discussing what can be done to bridge this value-destroying chasm, first a few thoughts about how this could be the status quo in the first place.
Founder’s syndrome. Many small public companies are inextricably linked to their founders. Those founders rarely lack confidence, and often feel like they, themselves, are uniquely suited to guide the company forwards (perhaps quite rightly sometimes, by the way). In other words, visionaries require unimpeded views of the future, so all “non-visionaries” should best stay out of the line of sight.
Self-fulfilling prophecy. When CEOs intuitively feel like they benefit little from supervision, they install board members who will default to “oversight-lite.” Corporate governance is reduced to a tautology.
Regulations and activism. Entrepreneurs are often entrepreneurs because they are independently minded, and revel in upsetting the apple cart. It’s not surprising that they aren’t keen on Congress, stock exchanges, or hedge funds trying to tell them how to do that. The more rigorous oversight is foisted upon small-cap CEOs, the more it is reviled.
Perhaps the path to more committed, fulsome small-cap corporate governance lies in the carrot, not the stick? What if small-cap CEOs were to, first, acknowledge, then embrace, what large asset managers all know; public companies overseen by artfully composed, courageous, engaged, truly objective boards of directors tend to make more money?
What if the elephant in the boardroom… is the board?
I tested out this “carrot” at an investor conference, where I shared the stage for a panel discussion with NACD’s Steve Walker, and CamberView’s Peter Michelsen in front of predominantly micro-cap CEOs. It went over with a resounding thud. Or so I thought.
Over the weeks subsequent to the conference, I received numerous phone calls from CEOs in attendance. One of them said he was chagrined to admit that he’d never once thought that more effective governance would put more money in his pocket. Another had a similar comment, and poignantly conceded that it’s impossible to square his view with BlackRock’s extensive analysis of portfolio company governance.
Maybe a little greed is what’s required to change the paradigm once and for all; i.e., “if better governance is going to financially benefit me (the CEO) and my shareholders, then sign me up!” Probably not Gordon Gekko and Bud Fox “greed.” Maybe more like Warren Buffett and Charlie Munger “greed.”
A version of this article was published in Directorship magazine.
Adam J. Epstein advises the boards of pre-IPO and small-cap companies through his firm, Third Creek Advisors, LLC (TCA). Prior to founding TCA, he co-managed special situation hedge funds operated by Enable Capital Management that invested in more than 500 small-cap financings. Mr. Epstein speaks monthly at corporate governance and investor conferences, and is the author of The Perfect Corporate Board: A Handbook for Mastering the Unique Challenges of Small-Cap Companies (New York: McGraw Hill, 2012). In April 2015, The Perfect Corporate Board was the #2 ranked corporate governance book on Amazon.
Publisher’s Note: I gave Epstein’s book five stars. His guest post is timely for me as I once again try to convince Reed’s Inc. (REED) Founder, CEO and Board Chair, Chris Reed, that his/our company would be better served with a more independent and activist board. Greed works. As I argued last year, board members should also be shareholders. Two of Reed’s directors own no shares and the small amount they are paid for their service provides little incentive to provide real input.
Reed’s has great potential, as analyzed by Lester Goh at 70% Upside – For Starters – Driven By Margin Expansion At Reeds. However, as Goh points out,
the CEO has historically tried to do everything himself without outside help. Suffice to say, this did not always work out and led to predictably poor results. In my view, the fact that the CEO has brought on outside help recently (the new hires) is a huge plus with respect to his credibility, and certainly strengthens my confidence in current management.
I hope Goh’s assessment is correct. However, Reed’s has had a succession of CFOs. I’m not swayed the new CFO and COO will really make a difference. I have yet to see evidence in Mr. Reed such as Epstein saw in his example above of a CEO who recognized that “more effective governance would put more money in his pocket.” Greed works, but only if given a chance.
The Reeds, Inc. 2014 proxy (page 7 ) stated: “The affirmative vote of the majority of the votes cast at the Annual Meeting is required to elect the directors, ratify the selection of the auditors and approve Proxy Access for Shareholders.” However, even though one director (Daniel S.J. Muffoletto) failed to win a majority vote, our Company’s SEC filing declared “the Company’s shareholders elected the existing board of directors for a one year term.” When shareholders withhold a majority of their vote from a board nominee, that director should not be seated. Zombie directors can suck the life out of a company.
Once again, Reed’s current proxy says (page 9), “In accordance with applicable law and our Bylaws, the election of directors shall be by the affirmative vote of the majority of the votes present and entitled to vote.” Yet, if a majority of shares are once again voted against Daniel S.J. Muffoletto our company will say we elected him.
This year, Reed’s shareholders will not only get to vote on each director (and I will once again recommend against those holding no shares in our company) but we will also get to vote on my proposal to require a majority vote to elect directors. Let’s hope shareholder recognize that greed works. Directors who own a substantial amount of shares, especially purchased with their own funds, care more and work more effectively.
If Mr. Reed were a bit greedier, he would endorse the majority vote proposal and embrace the fact that “public companies overseen by artfully composed, courageous, engaged, truly objective boards of directors tend to make more money.” Even if Reed doesn’t recognize that, I’m hoping other shareholders will. Greed works; vote for PROPOSAL 5: SHAREHOLDER PROPOSAL ENTITLED “DIRECTORS TO BE ELECTED BY MAJORITY VOTE.” (Page 11)
The those who are curious, NPR’s Shankar Vedantam provides a scientific explanation of what might be driving Mr. Reed’s refusal to seek a more independent and engaged board… the earned dogmatism effect.
Thanks once again to Adam Epstein for his timely post and his good advice. Greed works, at least, as Epstein notes, the Warren Buffett and Charlie Munger form of greed.