What follows are quick takes, with many incomplete sentences, from the recent Directors Forum 2019 held in San Diego. These are highlights from the notes of one participant, from my perspective as a shareholder advocate. If you attended, I am sure you have different takeaways. Please share them as comments. Like all Directors Forums, this one operated under the Chatham House Rule, so you will find no direct quotes. I am not even including names, although you can find them in the Agenda. Additionally, because of that restriction I do not report below on any of the featured speakers. Believe me, they were all fascinating and informative.
To learn more about Directors Forum 2019, click on the following: #directorsforum2019 @cordirforum on Twitter, website, and Linkedin. The tweets from Directors Forum 2019 could be the most comprehensive point-by-point reporting I have seen from any conference.
While Directors Forum 2019 had great speakers and panels, the primary benefit for me and many others, cames from the informal side conversations as we rekindle old friendships and begin new ones. For example, I got tips on how to increase turnout in campaigns to overturn supermajority requirements where management endorses. I also learned what funds might be most receptive to announcing their votes in advance of public meetings. That will be important in getting retail shareholders to vote going forward.
Directors Forum 2019: The Shareholder Perspective
Yes, stock price has an impact on engagement levels, as does market structure issues like dual-class, rulemakings, managing risk. Power relationships get attention. Dilution through blank check stock was mentioned. (Note to self, why are we not seeing shareholder proposals on that issue?)
Attention has been moving from fraud driven events to data breaches and sexual misconduct. Equifax data breach effected ¼ of Americans. Discussed quotas in California and #Metoo incidents. Mention of Annalisa Barrett’s fantastic Second Annual Board Governance Research Report.
Broadening set of candidates. There is a big push for geographically diverse boards. Human capital management is the next frontier. Funds are increasingly withholding against directors, not just voting in favor of shareholder proposals. Independent directors must have skin in the game to be involved in developing company culture with credibility. Diversity of thought is most critical as companies replace board members. Transnational securities litigation has increased with multibillion dollar exposures.
European corporate governance issues tend to make their way to the United States. For example, accounting/auditor concerns from the UK on rotation and consulting. CalSTRS is highlighting companies with same auditor for over 75 years.
Other concerns highlighted: long-term sustainability/risk management, opioids, firearms (ties of financial firms), executive compensation. (Seen as a window into board room, accountability… distorts conduct if incentives are not properly structured) Information asymmetry – skin in the game focuses engagement. Compensation is way too complicated. Incentivize behavior over the long-term. There should be cyber reports at board meetings. Need to focus on governance when going public, not later, because of issues like sunsetting dual class shares and not having frozen supermajority provisions. “Ratification” is not an acceptable response.
Directors Forum 2019: Global Risk and Preparing for the Unpredictable
This discussion revealed systems fluency at public companies but a gap in focus by directors compared to investors with regard to climate engagement. ERP systems need to include assessment and mitigation of atypical risks.
There was a call to pay attention to investor community and SEC interpretive guidance. Look at the global regulatory environment. European companies are paying more attention and that focus will be moving in our direction. Brexit – There has not been much preparation for “no deal.”
Irrational leaders. Trump is a risk factor on most company heat maps. Increasing focus on stakeholders and culture risk. Boards were typically picked by CEO – trending more toward independence. Still, we do have imperial CEOs. Boards need more attention on acquisitions, which are catnip to CEOs and CFOs.
Diversity of background, and life experiences on boards needed to avoid groupthink. Board members from other industries that have already seen various risks, so important to have their perspective. R&D, finance emphasis needed for early boards. Strategies must take various scenarios into account (needs to be at least a plan B) Onboarding orientation and continuing education emphasized, as well as use of mentors for new directors. Directors should be making the rounds internally and with stakeholders.
Attend annual investors day. (Note to self. Why isn’t annual investors day the annual shareholders meeting?) Social media is part of making the rounds. Do not ignore it. More information is better. Of course, social media includes a lot of disinformation. Consider hire a graduate assistant to give directors routine reports on social media. Develop social media policies.
Risk is sometimes assigned to audit committees but the entire board is responsible for ERM. Investors are pushing for better disclosure on climate risk. Reputational risk. Cultural surveys. Reports from whistleblower hotlines. Boards need to give the CEO a list of things they want to be reported to them. Exit interviews, sexual harassment settlements, glass door reports, etc. can be helpful. Directors need lots of face time with employees. One example was discussed where annual employee engagement surveys are shared with directors – every question and aggregate responses.
Directors Forum 2019: Blockchain
Blockchain facilitates sharing sources of truth with smart contracts posted to digital ledgers. Blockchain scores, verifies and self-executes rules. Great for title search and escrow execution. Buy title insurance and add you house to the blockchain. Except blockchain has not been widely implemented in the United States because scaling up requires buy-in from various stakeholders. Reputation can be tokenized. Blockchain is difficult to hack because the latest block includes a summary of the previous block. Software architecture automates trust. Tokenization allows for fractional ownership and easier capital formation.
Blockchain is like an internet of assets that can remove intermediaries. For example, we could buy mutual funds directly through transfer agents. It could facilitate diamond tracking with each having a serial number. REITS. Supply chains – product recalls at car companies – communicating with suppliers through customers. Flight insurance. With a smart contract I could get paid automatically. Self-aware cars could automatically file insurance report.
Transaction sizes can be smaller. We could buy minutes of insurance with Uber. Shipping companies may involve 20 companies. Each company has to track shipping. A shared blockchain ledger makes transactions easier. Permission-less access in crypto currency. Permission required network more like intranet. Could be hybrid. We are slowly moving to decentralized structures. Blockchain is like the open source movement. Think Uber, without the company.
Supply chain, asset tokenization, peer to peer marketplaces. Merced, British Airways, UPS, FedEx, Wal Mart, DeBeers, Western Union, Spotify, Atlantis Hotel for transactions on their property. Each named company is at least beginning the journey toward blockchain.
Although they were great panelists, I am frustrated with the slow pace of adoption in the United States. I need to visit Estonia to see the future of blockchain. The internet did not happen overnight either. Here is more on blockchain.
As reported by Global Proxy Watch, “the first blockchain proxy voting was completed in a dry run with major Japanese issuers, Broadridgesaid Monday. The concept was tested through Investor Communications Japan, an electronic voting platform Broadridge created in 2004 with the Tokyo Stock Exchange. See the simulation as a taste of changes blockchain may bring.”
Directors Forum 2019: The Evolution of Activism
Activism is aimed at generating returns. The activists on our panel agree, they want to leave companies in better shape when they leave. Strategy, board, governance, financial results – those are some major areas of focus. What happens after activist exits? The evidence shows targets outperform during and after.
“Bad” activists use financial engineering to take out assets. Sometimes their agenda is personal and/or concentrates on short-term thinking. Defining the goal and time horizon is critical. Brands can be ruined quickly. Dissent is a healthy part of financial markets. Activists instill an ownership mentality. They are a force for good that sometimes does not work out well
Activism has become more acceptable among institutional investors. In fact they and others send out RFAs (requests for activists). It is now easier to find good directors for activist slates. No target is too large. Activists have empowered independent directors. There is a growing willingness by management to engage.
A disproportionate number of target companies get sold. Synergies often work with bigger companies. Activists have won the confidence of bigger funds because they can see a failure of governance. Activists educate corporate boards about how investors think about capital allocation. Activist often talk to the top 10 shareholders before approaching company.
If you have 100s of companies in your portfolio it is harder to spend the time engaging or getting granular. Mutual fund managers hold for 9 months. These activists hold for 3 years.
Which directors should engage? You need to be able to call BS on your own advisors. Activists want to talk to directors who understand the business and are grounded in company strategy. Do not send the imperial CEO – send independent director(s). It boils down to people against people, not activists or companies against each other.
Disrupting the balance of power away from imperious CEOs to independent boards. Directors should get their own advisors. Uncertainty – has to be managed. Most directors don’t want to be the disrupter. Keep in mind that employees are often calling and doing exit interviews with activists.
Directors Forum 2019: How Did GE Get it so Wrong?
Graduate student researchers compares GE under Jack Welch vs. Jeffrey Immelt. Immelt returned 99% to shareholders. Buying high, selling low. Return on invested capital plummeted. Under Welch, GE had better defined KPI’s and returned 66% of profits to shareholders. Their finance committee closely watched the pension surplus $14B. [Download pdf file The Board’s Role in Monitoring Strategy – Lessons Learned from GE – Berthelot – Lasensky – Somers (1-14-2019)]
Welsh was a heroic leader who didn’t put systems in place, so they weren’t there for Immelt. Compensation will not fix a bad business strategy.
Imelt. Annual performance plan 7 metrics, long-term 5 and another 3 for something else. 20-25 performance measures short-and long-term. Supposed to give sense of purpose and priorities. GE’s didn’t do it. This year just a very few goals, although one is TSR, which is not so good. Don’t let compensation wag strategy dog.
- Neither Welch nor Immelt publicly announced that their growth strategy for GE was through acquisitions, but both employed this strategy in their financial and business decisions to differing levels of success. Welch generated billions of dollars of shareholder value for GE when he was CEO, while Immelt dealt with massive losses during his tenure.
- Welch’s motto was accountability, so he encouraged managers to ask questions, debate, and challenge others—himself included. Immelt did not want to hear bad news from his team or deliver bad news to others.
Questions the board might have asked:
- Is Our Culture Changing?
- Are We Adequately Conservative?
- Are Objectives and Strategies Clearly Defined and Consistent?
- Do We Have an Integration Plan?
- Are We Properly Husbanding Our Company’s Capital?
- Does Our Balance Sheet Match Our Strategy?
- Do Our Compensation Plans Align with Our Strategic Objectives?
- Does Our Board Have the Right Perspective and Experience?
- Are We Asking the Right Questions?
In a 1/17/2019 interview with Doug Henwood, Steven Maher observes that GE represents a transition from management’s focus on production to a focus on investing. Large corporate conglomerates transitioned from overseeing concrete processes and operations, to directing an abstract pool of investment funds. “Top executives no longer saw individual businesses as concrete operations to be managed, but rather as independent investments in a portfolio.” Internal divisions were treated as external companies, leading to the dramatic empowerment of financial functions within the larger firm. This was an interesting observation to me: GE was one of the first to hire a CFO in 1968. In 1962 not a single American company had a CFO. By the 1990’s, CFOs were ubiquitous.
Directors Forum 2019: Mandating Good
Both panelists agreed with Milton Friedman’s statement, which was something like the following:
There is one and only one social responsibility of business – to use its resources and engage in activities designed to increase its profits so long as it stays within the rules of the game, which is to say, engages in open and free competition without deception or fraud.
That certainly does not go far enough for me, but maybe panelists also agreed on the principle of “first do no harm.” Laws change all the time. The rules of the game can be stretched within legal limits but still fall outside the expectations of customers, employees, shareholders, suppliers, regulators and communities. In 2007 the Campaign for Safe Cosmetics released A Poison Kiss, which found:
- 61 percent of lipsticks contained lead, with levels ranging up to 0.65 parts per million.
- Lead-contaminated brands included L’Oreal, Cover Girl and even a $24 tube of Dior Addict.
Where laws fail at mandating good, social norms must become operative. There is no excuse for including lead in lipstick.
Discussion around “first do no harm.” Manage your impacts. What policies is your firm advancing? What steps is it taking to advance? Do your lobbying efforts contribute to good? Board policies should data driven and evidenced based. See critical review of Market for Virtue by David Vogel. Voluntary efforts are positive from advertising and risk perspective but not as effective as regulation. Consider joining the Ceres BICEP Network. Bicept coalition at Ceres group of companies.
Check out this interview about Just Capital. Charitable giving cannot make up for bad behavior. 30% of electricity still coming from coal. W need to decarbonize electricity and electrify energy use. The war for talent will increasingly revolve around employee assessments about what companies are doing to contribute to a better society. Who are you doing good for? Stakeholders are at least as important as shareholders.
There was also some, what I consider unproductive, discussion concerning the question of man-made climate change. For me, that issue is settled. Those interested in the topic of mandating good might be interested in reading The Battle to Do Good. The author, former McDonald’s executive Bob Langert, tells of the brand’s battle to address numerous societal hot-button issues, such as packaging, waste, recycling, obesity, deforestation, and animal welfare. Here’s an excerpt from the GreenBiz Reads book series.
Directors Forum 2019: The International Director
There were 428 new S&P 500 directors last year. 13% were born outside US and 32% had significant international experience.
European boards are much more international. In Germany directors buy their own D&O insurance, including a tail to insure for 10 years after service. Germany does not allow companies to give stock to directors. There are insiders on the board, not even the CEO.
Management teams and boards need to match the international thrust of their company. Companies may believe in the advantages of an international board but physically it can be challenging. California to Germany or India are long flights. Onboarding can be more difficult given cultural difference. Panelists provided some interesting (and funny) examples of language quirks that have led to misunderstanding.
Initially, the Illumina board consisted of directors where all but one was born outside the US. Illumina has 10-year term limit. However, only 4% of firms in the US have term limits and those limits can be up to 20 years. European directors have more of an expectation of engaging with shareholders without management handlers.
Business judgement and independence are more enduring than specialized skills, which fade quickly over time. European CEOs may want more Americans on boards to raise their pay. Board mentorship is helpful, especially when dealing with a new director from a foreign country. If joining a board, meet all the existing directors first to ensure you will be able to get along.
If you attended Directors Forum 2019, please add a few comments below on your experience. Directors Forum seems to be getting better every year. 2020 will be a presidential election year. That will make an interesting backdrop for the next annual event. I hope to see you there.