Tag Archives | boards

Fair Pay, Fair Play: Very Good Advice on Pay but Poor Sociology

Robin Ferracone hits the right buttons in her new volume (Fair Pay, Fair Play: Aligning Executive Performance and Pay) when she describes how to develop of an “alignment” report that can be used by boards and shareowners to ensure executive pay will be judged as “fair.” She also interviewed the right people to work in a reasonable degree of wisdom from the perspective of shareowners. However, she falls short in glossing over high executive pay as a potential problem, a “myth.” 

That’s understandable, given that she is a pay consultant. Shouting out that most CEOs are overpaid isn’t likely to win clients, since most compensation committee members still look to CEOs and other incumbent directors, not shareowners, to hold them accountable… although that may be changing. The book is clearly aimed at compensation committees but shareowners will also find the book useful, once they get past some of the contradictions in Ferracone’s analysis as an amateur sociologist and into the tools she has developed to better align pay with performance.

Warren Buffett, who doesn’t use compensation committees or consultants at Berkshire Hathaway thinks the best way to effect irresponsible board members and overpaid CEOs is to embarrass them. Nell Minow advises that stories on overcompensated CEOs loudly name all members of the compensation committee.

In contrast, Ferracone hopes that “solid and consistent analysis, not embarrassment” using her “Alignment Model” will lead corporations to “self-monitor and adjust their executive pay practices, and that voluntary reform will obviate the need for additional government intervention and allow government to go back to helping solve other problems in our society, such as issues in education and the environment.” Yes, and if companies would just take the necessary steps voluntarily, governments won’t have to mandate measures to address global climate change. We can all imagine it; but will it happen?

As a result of the recent financial crisis, many investors have seen their 401(k) plans reduced to 200½(k) plans. Those who haven’t lost their jobs and still hold some equity in their homes count themselves lucky. Ferracone’s says, “The notion that America’s wealthy people have become wealthier by virtue of seizing the wealth from others instead of creating it is just simply misguided logic.”

The rich may not have “seized” our wealth at the point of a gun, but they did largely take control of our government through false advertising… dramatically reducing their own taxes, overturning laws and regulations designed to guard against fraud and externalizing corporate costs, filling regulatory agencies with executives who believe companies will “self-monitor.” Citizens United further entrenches CEO power, since they spend company funds to install candidates friendly to their own entrenched power.

The rich now bring home the largest proportion of income since the 1920s. One out of seven Americans lives below the poverty line, while the top 2% fight to retain Bush tax cuts amounting to $700 billion over 10 years. Upward mobility in the USA is now lower than in almost all other developed economies. The only industrialized democracy with a higher concentration of wealth in the top 10% than the United States is Switzerland. (Poverty Rises as Wall Street Billionaires Whine, Huffington Post, 9/18/10; Wealth, Income, and Power by G. William Domhoff, updated August 2010)

The American Dream was based on a growing middle class and the prospect that by working hard, you could rise from log cabin birth to business tycoon or President. While the dream is still alive, myths often take time to die.

Ferracone wants to dispel myths, but she focuses her pitch at helping boards find that zone of acceptability, where pay is aligned with value delivered. High pay can still be justified, even in a “say on pay” environment.

While Ferracone’s alignment model is a surer route to justifying pay at most companies than putting up the pirate flag of Larry Ellison or hiding behind all-virtual shareowner’s meetings, such as that held by Symantec, I can’t give Ferracone a free pass as myth buster, even though her actual discussions on how to pay for performance are on target.

According to Ferracone, the vast majority of CEOs are not overpaid. Their compensation, adjusted for company size, industry, performance and inflation, has been virtually flat over the last 15 years, only increasing 1.6 times. Productivity gains alone account for all but $400,000 of the increase.

Investors agree. “About 75% of the investors surveyed by the Center On Executive Compensation in 2008 said that they had no real concerns about the levels of executive compensation in the United States.” Who are the members of the Center? They are the chief human resource officers of 300 of the large companies. They work for the CEOs! (See their comments to the SEC requesting a narrow view on Dodd-Frank) Who were the investors surveyed? They were the top twenty-five institutional U.S. equity investors. Many, like Goldman Sachs, JP Morgan, and Morgan Stanley were the same “investors” who took the financial services sector from 20% of the economy to 40% before the crash, through bets on synthetic derivatives and other nonproductive “investments.”

Even after driving the world economy to the abyss and being bailed out, the CEOs of many of these large investment firms still got huge bonuses. Ask the beneficial owners if CEOs are overpaid; you’ll get a different response. They didn’t put “say on pay” or a requirement to report pay ratios into the Dodd-Frank bill because 75% of the biggest institutional investors surveyed had no concerns. They did so because beneficial owners and average Americans are outraged.

Unfortunately, the American Dream and the personal aspirations of too many CEOs are built around the trinity of wealth, power and fame. These superficial values have become too embedded in the American consciousness. As we strive to resolve the financial crisis, we would do well to examine the need for a constructive shift in values. (See, for example, Corruptions of the American Dream: Wealth, Power and Fame by Joseph Yumang, a graduate student at Saint Mary’s College Of California). CEOs should be looking more to their mission, rather than their pay, to measure their success. Having one’s mission of dying with the most toys and money should no longer be socially acceptable.

Ferracone contends people are angry because a small percentage of companies have distributed excessive pay packages, which she rather arbitrarily defines as companies paying at the 95th percentile or higher…  coupled with low performance.  Yes, it is hard to argue that outlier CEOs paid anywhere from 15 to over 250 times median performance-adjusted pay deserved what they got.  Does that mean those who weren’t outliers earned their pay?

No, not even according to Ferracone.  Many companies say that they align pay with performance, but most don’t know whether, in fact, they’ve achieved alignment. Only 8% of variation in Performance-Adjusted CompensationTM (i.e., compensation after performance happens) is explained by variations in performance, defined as Total Shareholder Return (TSR); on the other hand, 30% of variations in Performance-Adjusted CompensationTM (PACTM) is explained by differences in company size, 11% is explained by industry, and 51% is unexplained. With only 8% explained by performance, how can Ferracone argue the vast majority of CEOs are not overpaid?

In a study Ferracone herself conducted, she found the vast majority of board directors and executives feel as though greater government intervention will not only not solve the Alignment issue, but could make matters worse. Is this supposed to be a revelation? Of course they don’t want government intervention.

Ferracone does offer some degree of balance in her Epilogue. She notes, “executive compensation should mostly be a matter that is between shareholders and the executives they employ.” Government “needs to make sure shareholders have the rights they need to appropriately influence the companies in which they are invested.”

Unfortunately, the first right she goes on to mention is the ability to buy and sell shares in a level exchange process. While that’s important, the “Wall Street Walk” encourages poor pay alignment, since if the investors who are unsatisfied walk away the more passive investors who are left are unlikely to take action regarding pay abuses.

She adds that shareowners “need to be in a position to elect board directors and vote on key proposals that affect their equity.” Good, but I would have felt better if she had inserted the word “nominate” with regard to selecting directors. Those interviewed by Ferracone for the book overwhelmingly indicated that retention is an overblown argument for increasing executive pay.  Most CEOs identify strongly with their companies and generally won’t leave companies because of pay. If true, why are so many of them paid so much? Of course, the problem isn’t just incentives for CEOs. After all, traders at AIG Financial Products practically brought the entire economy down, and none were senior executives.

Ferracone’s firm, Farient Advisors LLC, is one of a growing number of pay advisers that sprung up to meet the needs of compensation committees that don’t want to be seen as conflicted by hiring the same firm that simultaneously works for management. That’s certainly a positive step in the right direction, as is Ferracone’s discussion of how to align pay and performance.  Ferracone moves beyond Corporate America’s Pay Pal (NYTimes, 10/15/10) by wanting to be the shareowner’s pay pal too. If both sides converge around her Performance-Adjusted CompensationTM that would be another good move.

Yonca Ertimur, Fabrizio Ferri and Volkan Muslu offer some further hope in their paper, Shareholder Activism and CEO Pay (download pdf). They studied a sample of 134 vote-no campaigns and 1,198 non-binding shareholder proposals related to executive pay between 1997 and 2007 and found that shareholders are sophisticated enough to identify firms with excess CEO pay, both when targeting firms and when casting their votes.

Proposals that try to micromanage level or structure of CEO pay receive little or no voting support. Instead, shareholders favor proposals related to the pay setting process (e.g., subject certain compensation items to shareholder approval). These proposals are also more likely to be implemented. In some cases, compensation-related activism has a moderating effect on CEO pay levels. Firms with excess CEO pay targeted by vote-no campaigns experience a $7.3 million reduction in total CEO pay. The reduction in CEO pay is $2.3 million in firms targeted by proposals sponsored by institutional proponents and calling for greater link between pay and performance. (Hat tip to Stephen Davis for tweeting about the study.)

Perhaps the increasing power and sophistication of shareowners, combined with somewhat more neutral firms, like Farient Advisors LLC, will make the difference. Probably even more important, is the need for a shift in cultural values so that CEOs are driven by more altruistic missions than simple greed.

See also, Executive Compensation and Corporate Governance in Financial Firms: The Case for Convertible Equity-Based Pay (pdf) by Jeffrey N. Gordon, July 2010 and What’s your CEO really worth? INSEAD’s Corporate Governance Initiative creates a model, 9/22/2010.

Continue Reading ·

Video Friday

Through PERSWatch.net, I had the distinct pleasure of sponsoring a second CalPERS Candidate Forum (the first was last year), thanks to co-sponsorship by the Sacramento Central Labor Council, facilitation by the League of Women Voters of Sacramento County, use of the CalSTRS Boardroom, video by CalPERS and cooperation from 2010 State Board Election candidate Inderjit Kallirai and incumbent George Diehr, as well as unopposed School incumbent Rob Feckner and unopposed and Public Agency incumbent Priya Mathur. As I indicate in the opening video, my hope is not only that such forums will become routine at CalPERS but that CalPERS will push similar forums at corporations facing director election contests either through proxy access or the normal route.

Q&A Part 1

Q&A Part 2

Closing Statements and Conclusion

Continue Reading ·

Video Friday

Meredith Whitney, CEO of Meredith Whitney Advisory Group LLC. In 2007, she was the first financial analyst to predict major losses for Citigroup, one of the nation’s largest financial services companies. Program from Sunday, September 5, 2010. Q&A CSpan. Hat-tip to The Big Picture.

The United States of Inequality: Introducing the Great Divergence by Timothy Noah, Slate, Sept. 3, 2010.

This Week in the Boardroom: 9/9/10, Board Preparation for Proxy Access with TK Kerstetter, President, Corporate Board Member and Scott Cutler, Executive Vice President, NYSE Euronext.

Continue Reading ·

No Need for Hysteria Over New Proxy Access Rules

In the wake of the SEC’s approval of management proxy access for three percent shareholders, it’s quite surprising to note the vehemence of the remaining opposition to such action. For example, the Wall Street Journal in its lead editorial on August 30, 2010 entitled Alinsky Wins at the SEC, which in itself makes clear the extent of its opposition, states that the new rule will only “help activists and unions, not shareholders.” Similarly, an unnamed official of the U.S. Chamber of Commerce speaking on Yahoo Finance on August 25, 2010 states that it will fight this action “using every method available” because it is “a giant step backwards for average investors” and David Hirschmann, the Chamber’s President/CEO of its Center for Capital Markets Competitiveness, in the same place, characterized the new rules as ones that allow “the proxy process to be [used] to give labor-union pension funds and others greater leverage to try to ram through their agenda” which “makes no sense.”

Institutional investors and other proponents of improved governance should be prepared to respond in the media and elsewhere to such arguments.

Perhaps the most simple and compelling response is that the new rules permit nothing which was not already permitted – i.e. a change in board composition through shareholder vote. That is, any investor has been and remains able to wage a proxy fight for board representation to seek to “ram through” (or pursue) their agenda. While the new rules are intended to and will obviously lead to more minority representation by reducing the cost of its pursuit, it was already contemplated by all pertinent law. Investors have also had and retain the right under 1934 Act Rule 14a-8 to include on proxy cards many proposals for action not involving director elections.

Indeed, allowing proxy access to investors hardly guarantees them a board seat. They still must convince the holders of the requisite number of shares in the pertinent jurisdiction – none of which is being changed – to vote for their candidates. If simply allowing proxy access to minority holders of itself will greatly expedite their candidacies, what does this say about the level of shareholder satisfaction with management and its slates?

Even if a board seat is obtained by an investor, it is just that; a seat, and not a majority capable of imposing its own agenda. Given that proxy access for large firms with market caps exceeding $33 billion will require ownership of more than $1 billion of stock for more than three years, one wonders why there is so much concern. We are not talking about miniscule, “gadfly” shareholders with no real economic interest, only pursuing a social agenda. What is more a part of capitalism than allowing a meaningful voice to large investors in a company?

Apart from these somewhat mechanically-oriented, but still significant, arguments, lurks the ultimate consideration, namely the need for better governance, which can only be accomplished with real accountability for boards. When Jim McRitchie brought all of this to the fore 8-10 years ago through his writings and suggestions to the SEC, reasonable, knowledgeable people could argue about whether there was a general governance problem. In light of the numerous debacles over the last decade starting with Enron, few would want to take the negative side of this argument today. Many, including the author of this post, would argue about how to improve governance, but the “whether” part of the debate is a different story.

The status quo has not worked. In far too many cases, directors have been asleep at the proverbial switch while managements brought down companies and imposed huge costs on societies. One way or the other, there needs to be additional accountability for boards, and this initiative is quite modest, in that it does not change in any way the substantive standards to which directors are held. That is, the only accountability for even catastrophic decisions is removal from office – not financial liability. Commentators have lamented the modesty of this effort.

When called upon to defend the new rules, all concerned should keep in mind and remind the public, what they do and don’t do relative to the status quo, as well as why this action has been taken now.

Continue Reading ·

7 Qualities of an Innovative Board

  1. Strategic – A board that strives to be strategic makes a constant and conscious effort to ensure strategic focus to every issue it deliberates.
  2. Healthy Skeptics – Questions at board meetings should be clear and direct, not obtuse; open, not closed; positive and building, not negative and tearing down.
  3. Diligently Prepared – Directors cannot expect to move to the level of adding value and innovation to an organization if they are not prepared.
  4. Diversely Competent – Innovative boards have diverse, skilled, experienced, competent people on them.
  5. High Expectations – Not only should board members prepare diligently, there should be an expectation that everyone will have prepared with that same level of diligence.
  6. Delegate – Shaping the right committees, populated with the right people, who have the right skills, allows the board to delegate and trust their work.
  7. Empower and Encourage – Trust, but verify. A Board should never substitute its own judgment for management’s – but it does ensure that management is exercising sound judgment.

Helpful list? That’s just the tip of the iceberg… more at BrownGovernance. If you’re not subscribing to their free newsletter or attending their conferences, you’re missing out.

Continue Reading ·

CorpGov Bites

Opinion: Business to Blame for Anti-Business Mood, Marty Robins, Special to AOL News, 7/8/10. Where management was utterly disengaged from the business at hand, is it any wonder the public, and lawmakers, are demanding more regulation of the economy… resistance to good-faith efforts to improve governance by bolstering management oversight doesn’t endear business to society. Marty Robins also writes an occasional guest post to CorpGov.net.

Could your company outperform its competitors by 85% in sales growth and 25% gross margin? A group of Gallup clients achieved this competitive advantage by applying our behavioral economic principles. (Applied Behavioral Economics: The Next Discipline)

The idea that the human mind is based on an internalised statistical decision making algorithm is one we’ve met before. It’s a research fallacy which each successive generation of academics falls into by firstly using their latest research tools – statistical analysis packages, digital computers, etc – as metaphors for the way the mind works and then assuming that this is the way the mind actually works. There is a huge behavioural bias behind behavioural finance but it’s not the experimental participants who are subject to it, but the experimenters. (Behavioural Finance’s Smoking Gun)

Filing Deadlines and Proxy Solicitors – Checklist from The Activist Investor.

“We have recommended that internal audit should be outsourced rather than in-house because internal audit in-house is always dependent on the management of the company. Internal audit from outside will always be better, and then it should be given to chartered accountants,” ICAI President Amarjit Chopra told India’s the Economic Times (ICAI for compulsory outsourcing of internal audit functions, 7/8/10).

Not much new in the following but certainly glance-worthy:

  • Proxy Access Defense #1, Truth on the Market
  • Investors: be careful what you wish for, FT, 7/5/10. Can any of the players really afford the time or resources required to make engagement a reality?
  • The Future of the Board of Directors, Martin Lipton, Harvard blog, 7/6/10. We should recognize that the purpose of corporate governance must be to encourage management and directors to develop policies and procedures that enable them to best perform their duties (and meet our expectations), while not putting them in a straight jacket that dampens risk-taking and discourages investing for long-term growth and true value creation. (CorpGov.net: Short-term shareowners are handing out the straight jackets.)
  • Proxy Access: A Sheep or Wolf in Sheep’s Clothing? I sometimes feel the same way about some Stanford University research as some of them seem to think about proxy access, a wolf in sheep’s clothing, although this latest bit doesn’t seem to say much.
Continue Reading ·

Banking on Governance

Leverage and Risk in US Commercial Banking in the Light of the Current Financial Crisis (available from SSRN) by Christian C.P. Wolff and Nikolaos I. Papanikolaou examines the relationship between leverage and risk in US commercial banking market. From their abstract:

Our findings indicate reliably that both on- and off-balance-sheet leverage contributes to (systemic) risk, which implies that large banks do not maintain a level of leverage that could allow for equity capital to act fully as a buffer, absorbing losses and enabling the business to continue in case of financial distress. In a similar vein, a direct link between short-term leverage and risk is reported, showing that leverage is one of the main factors responsible for the serious bank liquidity shortages that were revealed in the current crisis. We also find that those banks that concentrate on traditional banking activities typically carry less risk exposure than those that are involved with new financial instruments. The latter finding could play a role in the current discussion about a possible revival of the Glass-Steagall Act. Overall, our results provide a better understanding of the main causes of the present crisis and contribute to the discussion on the reinforcement of the existing regulatory framework.

Reforming Governance of ‘Too Big to Fail Banks’ – The Prudent Investor Rule and Enhanced Governance Disclosures by Bank Boards of Directors (available at SSRN) by Michael Alles and John Friedland looks at the governance challenges posed at boards of large banks, since they have proven inadequate to the task of controlling risk. From the abstract:

We propose a two step procedure to improve bank governance. First, we give bank directors an explicit standard to assess the outcome of their actions: the Prudent Investor rule which is the requirement for trusts, but has been replaced in the last hundred years by the less stringent Business Judgment rule. Adopting the Prudent Investor rule would return to director’s responsibility to control the risks of banking activities. To enforce the higher standard, we propose to use disclosure as a disciplining mechanism. We base the new disclosure regime on Section 404 of the Sarbanes Oxley Act that requires managers to implement controls over the firm’s financial reporting processes and to publicly attest to their effectiveness. This section failed to prevent the credit crisis because it was too narrowly focused. We recommend that the provision be broadened to encompass governance controls in general, and that responsibility for disclosure be placed on the bank board rather than on managers.

Ah, if only academics had a bigger role in ruling the world.

Continue Reading ·

Building High Performance Boards

The Canadian Coalition for Good Governance’s (CCGG) has issued a revised report on Building High Performance Boards. Here’s a quick overview with just a few examples of best practices highlighted — the report contains many more:

Facilitate shareholder democracy

Allow shareholders to vote for individual directors; no slates. All directors should be up for election each year – board terms should not be staggered. Adopt a majority voting policy for director elections, using language that is substantially similar to the CCGG model policy (available at www.ccgg.ca). Get shareholder approval before issuing 25% or more of the shares of the company as part of a transformational transaction. Report voting results on SEDAR within 5 business days, indicating the actual number of votes cast for, against and/or withheld for each resolution.

Ensure at least two thirds of directors are independent of management

Make sure at least two-thirds of directors are “independent.” Have a formal board policy that limits the number of board and committee director interlocks on the board. Report all board and committee interlocks to shareholders.

Separate the roles of Chair and Chief Executive Officer

The independent members of the board should appoint an independent board chair to function in a non-executive capacity, with a defined mandate and role. The board chair should be prepared to invest a considerable amount of time and effort, and should ideally be independent of the controlling shareholder, where there is one.  The independent chair (or independent lead director) should set board agendas with the CEO and other directors and be responsible for the quality of the information sent to directors. The CEO should be required to leave the board when he or she retires. In cases where an incoming CEO has been recruited from outside the company, the board can consider keeping the former CEO as a board member during a transition period. The board should establish an annual review process for the chair and report on it to shareholders.

Ensure that directors are competent and knowledgeable

Each director’s career experience and qualifications should be described in the proxy circular. Some directors should have financial accreditation and/or be financially literate.  All directors should demonstrate well developed listening, communicating and influencing skills so they can actively participate in board discussions and debate.  We believe that directors who hold a full-time executive position should have only one or two outside public company directorships (recognizing that there can be value in a senior executive gaining board experience in another or related industry) and that directors who are not employed full time should generally hold no more than four outside corporate directorships that take up a significant amount of time.

Maintain and disclose to shareholders a ‘matrix’ of director talents and board requirements to identify skill gaps on the board and to create a board built on a diversity of background, skills and experience. Disclose each director’s relevant skills. Build and maintain an “ever-green” list of suitable candidates to fill planned or unplanned vacancies. Have a plan in place for the orderly succession. Establish a continuing education program for directors to update their skills and knowledge of the company, its businesses and key executives, and to address ongoing and emerging issues in the functional areas of the board (like corporate governance, audit, compensation practices and risk management). Disclose to shareholders the education programs directors participate in every year.

Ensure that the goal of every director is to make integrity the hallmark of the company

To deepen their understanding of developing ethical issues, directors should read appropriate literature or attend seminars and then act accordingly. When meeting with company employees (including the CEO and other senior officers), directors should take the opportunity, whenever possible, to emphasize the importance of integrity. Directors should demonstrate a proven understanding of fiduciary duty and their role as fiduciaries.

Emphasize the importance of integrity during in-camera sessions, and consider whether the CEO and other senior officers demonstrate the right “tone at the top” to ensure a culture of integrity throughout the organization. + many more

Establish mandates for board committees and ensure committee independence

Hold in camera sessions with independent directors only, as a regular part of all committee meetings. Review committee charters every year and amend or confirm the mandate and procedures based on information received from the board and committee evaluation processes. Make sure every committee includes directors of diverse backgrounds and at least one director with significant expertise relevant to the committee’s role. Plus, many recommendations for individual committees.

Establish reasonable compensation and share ownership guidelines for directors

Require directors to own the equivalent of five years’ annual retainer in the form of shares or deferred share units within five years of becoming a director. Boards may wish to establish interim targets (e.g. 3 times annual fees after 3 years on the board) to allow the director to work toward the total requirement.

Evaluate board, committee and individual director performance

Make sure the performance review process assesses a director’s skill set against the company’s strategic plan, environment and needs. Determine and document the kinds of events that would normally lead a director to resign from the board (not meeting attendance expectations, age or change in principal occupation or place of residence, for example). Evaluate the performance of individual directors every year using a confidential peer-review survey. Disclose the performance review processes in the proxy circular in enough detail to demonstrate that there is a strong and viable system in place.

Oversee strategic planning, risk management and the hiring and evaluation of management

Financial institutions should establish a separate risk committee, made up of independent directors, that focuses on the governance of risk. Another model has every committee addressing the risks relative to their mandate within each committee then bringing its perspective to the entire board. Disclose to shareholders the board’s analysis of the primary risks of the business and describe how the corporation is monitoring and mitigating the risks.

Assess the Chief Executive Officer and plan for succession

Review succession plans for the CEO and other senior executives once a year (or more frequently) and review with the CEO the performance of his or her direct reports.

Develop and oversee executive compensation plans

The consultant should align its interests solely with the interests of the corporation and not have any other conflicting interests. The independent consultant should earn most (if not all) of its fees from the company for work performed for the compensation committee. Link compensation and risk management.

Report governance policies and initiatives to shareholders

Report in the proxy circular how and to what extent the company complies with each of the guidelines in this document. Our disclosure best practices documents (which are available at www.ccgg.ca) include many examples of effective disclosure. Have the chair of each committee available to answer questions at the Annual General Meeting.

Engage with shareholders within and outside the annual meeting

Provide opportunities for shareholders to have access to board members outside of the annual meeting to discuss issues that concern either party. Add an advisory shareholder “Say on Pay” resolution to each annual meeting agenda.

See also, Restoring Trust in Corporate Governance, Posted by Benjamin W. Heineman, Jr., Harvard Law School Program on Corporate Governance and Program on the Legal Profession, on Wednesday January 27, 2010.

Continue Reading ·

SVNACD: New Proxy Rules on Executive Compensation

Networking Before SVNACD Meeting

What are the new SEC disclosure rules for executive compensation, especially the “risk” to the corporation of their compensation plans? How are companies dealing with these new rules — what do the early returns from this proxy season indicate? Are these new SEC requirements more of an annual risk assessment of compensation than disclosure rules — is any company really going to make a disclosure that its compensation policies create a risk to the entity? Will the RMG/ISS guidelines have as much, or more, impact than the SEC rules? How will these rules relate to pay for performance? Exactly what compensation programs are “unduly risky”? What mitigation practices will companies adopt? What are the “best practices” that should be considered?

Those were some of the issues taken up by panelists bright and early at 7:30 am at a monthly meeting of the Silicon Valley chapter of the NACD:

  • Lon Allan, Chairman of the Silicon Valley chapter of the NACD.
  • Katie Martin, Senior Partner at Wilson Sonsini Goodrich & Rosati’s Palo Alto office, where she practices corporate and securities law. 
  • Tom LaWer, Senior Partner at Compensia, a management consulting firm providing executive compensation advisory services.
  • John Aguirre, Senior Partner at the law firm of Wilson Sonsini Goodrich & Rosati, specializing in executive compensation and employee benefits, including tax, ERISA and federal and state securities laws.

I’m certainly no expert in this area but I’m sure it was paradise for actual practitioners in the trenches. What follows are a few items that struck me as an interested observer. Although I know I got the order of panelists right, who said what is less certain. The links are to sites I think readers might find useful. I didn’t run them by the speakers for endorsement.

Katie Martin

Katie Martin started with some discussion on changes to required disclosures. For example, directors must disclose seats held at any time during last five years.  Legal proceedings: 10 year look back, rather than 5. Disclosure is expanded to include judicial proceedings relating to mail or wire fraud, violations of state securities, disciplinary sanctions.

Disclose experience, qualifications, attribute and skill that led to selection. Most are placing disclosures right below the biography. She discussed the new RiskMetrics Group Risk Indicators GRId (their new gov scoring system). The old CGQ scores will be frozen on March 17, 2010 and retired completely at the end of June 2010. Here’s an SEC FAQ for issuers.

My own impression, reinforced at the meeting, is that the SEC rules are largely non-prescriptive, whereas the substance of disclosures will mean more when graded by RMG. Verify the facts. Look at ways to improve. Use new D&O questionnaires, which ask directors to self-identify their particular experience, qualifications, attributes and sills.

Diversity considerations. Whether, if so, and how. The SEC rules include no mandates and the definition of diversity is being interpreted broadly.

Board leadership structure. Whether and why CEO and Chair are same or separate. If same, description of Lead Independent Director is critical. Review governance policies with respect to the role of lead independent director to consider whether further clarity is needed. Discuss and document the rationale for your current leadership structure.

Risk management oversight. Disclose the board’s responsibility for risk-management oversight. For example, is it the responsibility of entire board or is the function assigned to one or more committees for different categories of risk? This is a good opportunity to discuss these issues with the board and/or appropriate committees. Discussion will normally bring some changes and more formality. There is a trend toward having a separate risk management committee, not so much in the tech sector, but in larger firms.

With the new rules regarding 8-K requirements, we’re talking close to real-time disclosure, within 4 business days after meeting. File preliminary results, if final results not known.

Non-GAAP Financial Measures: Recent SEC Interpretations. Historically, restrictive approach by SEC to non-GAAP financial measures. Recent changes have not led to full blown non-GAAP report but anything that flushes out trends would be positive. SEC filings should be consistent with other public communications. If doing an offering, get comfort from auditors. (Revised SEC Interpretations Regarding Non-GAAP Financial Measures, Cooley Godward Kronish LLP, 2/26/10)

Focus on process aspects, risk and possible litigation. Don’t let your board get blind-sided.

John Aguirre

John Aguirre – New Compensation Disclosure Rules: Policies and Practices Relating to Risk Management — Requires narrative disclosure regarding compensation policies and practices for all employees to the extent that risks arising from such policies and practices are “reasonably likely to have a material adverse effect on the company.” Reasonably likely is the same disclosure threshold used in the Management Discussion & Analysis. Whether disclosure is required is a facts and circumstances test for each company and its compensations programs (e.g., the program features and goals). Dodd bill may require comp committee to have their own attorney. Focus on process.

Risk disclosure, grants, and consultant fee disclosure… Forward-looking statements that don’t create risk.

SEC examples of practices that may have risk requiring disclosure included business unit that:

  • carries a significant portion of company’s risk profile.
  • has compensation structured significantly different from other units within the company.
  • is significantly more profitable than other units.
  • has compensation expenses as a significant percentage of unit’s revenues or compensation that varies significantly from the overall risk and reward structure of the company, such as when bonuses are awarded upon accomplishment of a task, while income and risk to company from task extend over a significantly longer period of time.

If disclosure is required, the SEC noted possible areas for discussion:

  • General design philosophy and manner of implementation of compensation policies and practices for employees whose behavior is most affected by incentives created, as related to risk-taking on behalf of company.
  • Risk assessment or incentive considerations, if any, in structuring compensation policies and practices in awarding and paying compensation.
  • How compensations policies and practices relate to realization of risks resulting from employee actions in both short and long term, such as policies requiring clawbacks or imposing holding periods.
  • Policies regarding adjustments to compensation policies and practices to address changes in risk profile. Material adjustments that have been made to compensation policies and practices as a result of changes in risk profile. Extent of monitoring of compensation policies and practices.

List of SEC’s examples is not exhaustive. SEC expects principles-based approach in the disclosure, similar to CD&A requirements. Avoid generic or boilerplate discussion. SEC does not require an affirmative statement that a company’s risks arising from its compensation policies and practices are not reasonably likely to have a Material Adverse Effect. If a company does not disclose any material adverse risks, the SEC likely will, in the course of its review, issue a comment asking the company to explain the nature of the internal analysis that was conducted in making its determination that no disclosure was required.

What should you do? Update board or comp committee on new rules. Consider whether compensation policies need updated. In addition to the examples John provided, which I expect may be referenced on the SVNACD site, here are some examples from Holme Roberts & Owen LLP.

Must disclose aggregate “grant date fair value” of awards computed in accordance with FASB ASC Topic 718. Whole value of the award, even if they may never get it. This effects who is covered in your table.

Tom LaWer

Tom LaWer – The SEC has set a very high bar for disclosure. If disclosures are made, expect disclosure of past issues along with disclosure of how the issue has been fixed. The rules provide a fresh opportunity to focus in on the risk assessment of compensation policies and practices. The examination will likely influence compensation plan design… Revising compensation programs to improve design based on issues uncovered in the risk review. You might indicate, for example, that policies are reviewed annually.

No generally accepted compensation principles. Best practice guidance is sometimes conflicting. Most guidance is conventional wisdom. Standards may evolve over time based on empirical research. SEC examples tend to focus on the issues for financial companies.

Again, RMG risk guidelines might be a more important driver than the SEC.  He went over several practices that will get further scrutiny and possible mitigating factors. It is a good time to review and assess for correct goals, mix, use, and design flow. For example, did the person who was demoted still got their bonus because there was no discretion built into the compensation plan?  Are you doubling up, because long-term and annual incentive plans are based on the same metrics? Tell shareowners how your actions ensured these problems don’t arise again.

Here are some handouts from a similar panel meeting of the Twin Cities Chapter of the National Association of Stock Plan Professionals and brief overviews from O’Melveny & Myers, Grant Thornton LLP , Seyfarth Shaw LLP., Jenner & Block, Dorsey & Whitney LLP, Ulmer & Berne LLP, Thomson Reuters, and TheCorporateCounsel.net.  I hope readers find these links helpful. The panel did a great job on a rather technical topic and brought home in many examples how requirements might be addresses, especially by the predominately high tech companies of Silicon Valley. Also be sure to see SVNACD’s page with handouts and interviews, as well as a podcast from KPMG/NACD, New SEC Proxy Disclosure Rules for 2010: What Boards Are Doing to Prepare.

Continue Reading ·

ICGN Issues Global Guidelines for Setting Non-executive Director Pay

In new calls for strengthened accountability, transparency and alignment in non-executive director pay, the International Corporate Governance Network (ICGN) is specifically calling for pay to consist solely of a combination of a cash retainer and equity based remuneration. The ICGN also calls for the elimination of perquisites for non-executive directors.

Commenting on the new Guidelines the ICGN Chairman, Christianna Wood says,

As the shareholder’s representatives, non-executive directors are elected by the owners of the company and must have a strong alignment of interest with the owners in the form of meaningful equity ownership while serving on the board. Furthermore, directors have a conflict of interest in that they set their own pay and as a result need to provide the utmost transparency and clearly state the board’s philosophy behind the director remuneration programme.

These principles were crafted over the last several years in a consultation that included many of the largest global shareowners.  Ted White, Chairman of the ICGN Remuneration Committee responsible for developing the new Guidelines also commented,

These principles were hotly debated by our members from around the world.  While practices differ from country to country, continent to continent, we all agreed that this was an important policy and that the principles of accountability, transparency and alignment of interest were agreed upon principles that should exist in the setting of all non-executive director remuneration programmes.

The ICGN acknowledges that remuneration practices differ around the world.  Carl Rosen, ICGN Executive Director added:

Among the agreed upon themes are that non-executive director equity remuneration should be immediately vested and not performance-based.  The ICGN believes that directors should have solely cash retainer and equity ownership remuneration, with a preference against the use of options.

The Guidelines aim to help communicate investors’ perspectives on this critical issue and are primarily addressed to companies and their non-executive board members.  Since remuneration policies are set by the board, it is important that they be transparent, address shareholder expectations, and those setting them be held accountable. Accordingly, three principles underpin these guidelines: transparency, so investors can clearly understand the program and see total remuneration for non-executive directors; accountability, to ensure that boards maintain the proper alignment of interests in representing owners; and alignment of interest between non-executive directors and shareowners.  The cornerstone of non-executive director remuneration programs should be alignment of interest through the attainment of significant equity holdings in the company meaningful to each individual director.  Key aspects of the Guidelines are as follows:

  • Places an emphasis on non-executive director alignment of interest with long-term owners.
  • Draws a distinction to differences to executive remuneration, particularly related to performance-based remuneration.
  • Opposes the use of performance-based remuneration for non-executive directors.
  • Examines the tools of remuneration, and favors solely cash retainer and equity, with a preference against the use of options.
  • Provides flexibility for companies to implement the principles in ways consistent with their unique circumstances.
  • Calls for clear disclosure including the philosophy of the non-executive director programme.
  • Calls for equity to be vested immediately but subject to holding periods.
  • Suggests companies establish ownership guidelines for non-executive directors.
  • States non-executive directors should not be eligible for retirement benefits.

The Guidelines are intended to be of general application around the world, irrespective of legislative background or listing rules. As global guidelines, they need to be read with an understanding that local rules and structures may lead to different approaches to these concepts. The ICGN will also seek change to legislation, regulation or guidance in particular markets where we believe that this will be helpful to generating corporate governance improvements and particularly where such change will facilitate dialogue and accountability.

The ICGN Non-executive Director Remuneration Guidelines has been developed by the ICGN Remuneration Committee in consultation with ICGN members. A consultation paper on the subject was sent to ICGN members for comment and a wide range of responses were received and contributed toward the final draft. The Guidelines will be launched at the ICGN Conference, being held on the 24 – 25 March at London’s Guildhall, entitled ‘Will shareholders rise to the ownership challenge?’ The event is hosted by the City of London and supported by the Department for Business, Innovation and Skills, among other partners.

Continue Reading ·

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.

Continue Reading ·

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.

Continue Reading ·

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 footnoted.org.

Continue Reading ·

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.

Continue Reading ·

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?

Continue Reading ·

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 corpgov.net 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. TransparentDemocracy.org 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. ProxyDemocracy.org 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. MoxyVote.com 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 Shareowners.org 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 CorpGov.net. 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 CorpGov.net but many other important web-based resources.

Continue Reading ·

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.

Continue Reading ·

A Primer for Boards

Cornelis A. de Kluyver, an academic and practitioner with global experience, has written A Primer on Corporate Governance published by Business Expert Press. While not nearly as extensive as recent textbooks by Bob Tricker or Monks and Minow, this is a quick read that provides most of the basics for future directors and those who work with them.

He very briefly reviews the history of corporations, rise of fiduciary capitalism, recent moves to federalize corporate governance, various conflicts of interest, and provides a thumbnail international sketch. However, his short explanations sometimes over simplify. For example, in reviewing director duties he states, "the primacy of shareholder value maximization wa affirmed in a ruling by the Michigan State Supreme Court in Dodge vs. Ford Motor Company.

Unfortunately, he’s not alone in perpetuating this myth. In Why We Should Stop Teaching Dodge v. Ford (pdf, Virginia Law & Business Review, spring 2008), Lynn Stout argues more convincingly that credit for the concept that corporations exist only to make money for shareholders should go to law professors, not the courts. Dodge v. Ford is best viewed as a case that deals not with directors’ duties to maximize shareholder wealth, but with enforcing the fiduciary duty of controlling shareholders to minority shareholders. Because different shareowners have different investment time frames, tax concerns, attitudes toward risk, etc. it is impossible to discern a single, uniform measure of shareholder wealth to be maximized. Additionally:

  • Articles of incorporation typically don’t say they are organized primarily to profit shareholders but, instead, for anything lawful.
  • Similarly, state corporation codes typically provide their purpose is "to conduct or promote any lawful business or purpose" and many authorize corporate boards to consider other stakeholders.
  • Judges routinely refuse to impose any legal obligation on directors to maximize shareowner wealth.

De Kluyver does explore stakeholder theory but concludes shareholder value maximization "will continue to dominate the U.S. approach to corporate law for the foreseeable future," with the courts giving boards increasing latitude.

Elsewhere, he discusses governance reforms and concludes, "There is real danger, however, that the rise in shareholder activism, the new regulatory environment, and related social factors are pushing boards towards micromanagement and meddling." Many of us wish there had been a lot more "meddling" by boards prior to the current financial crisis, but de Kluyver is writing for board members, not shareowners.

Although he appears to reject recent moves to require specific subsets of directors to be independent, he appears to agree they should be more allied with shareowners than with management and that separating the roles of chairman and CEO "gives boards a structural basis for acting independently."

In discussing stock options, de Kluyver notes, "Until recently, many U.S. companies were not very diligent in assessing the cost and value of options and treated options as being cost-free." He says nothing about the Business Roundtable’s campaign to undermine the Financial Accounting Standards Board. An uninformed reader could be left with the impression that CEO’s had no role in this effort to hide costs. Likewise, he says "most of the pressure on boards on the last 25 years has come from shareholders." Hasn’t more pressure come from CEOs who are there providing direction at every board meeting? Even with recent steps empowering shareowners, CEOs still hold more sway over boards, including who is nominated.

In discussing shareowner proposals, de Kluyver says, "One of the most popular shareholder proposals today demands that shareholder be allowed to directly nominate and elected directors rather than work with the slate recommended by the board’s nominating committee." Popular in what sense?

The SEC allowed such proposals for many years until it looked like the proposals would obtain majority votes. Then the SEC, without changing the governing regulations, decided such resolutions violated the rules. That position stood for many years until challenged by AFSCME. When the underground regulations were overturned by the court only about three such proposals were introduced before the SEC, under Cox, banned them through new regulations. Now, under Schapiro, such proposals will again be legal, probably in 2010. To describe "proxy access" proposals in 2009 to be "the most popular shareholder proposals today," without much explanation, seems misleading.

In the book’s epilogue de Kluyver revisits the issue of "proxy access." However, rather than clarifying the issue he informs readers that the SEC considered proposed rules to allow it, but rejected them. Of course this is true, but de Kluyver gives the impression the issue is dead, whereas everyone following this issue has known for years that "proxy access" would be back on the table under a new administration. It would be important to note that majority voting requirements, the end to "broker voting" and proxy access will require boards to cooperate more closely with shareowners.

The book is at its best in borrowing liberally from thought leaders and consensus shaping organizations by providing various lists of best practices: Succession Planning is an Ongoing Process; CEO Selection: Common Board Mistakes; Succession Planning: Best Practices; Red Flags in Management Culture, Strategies, and Practices; 10 Questions About Ethics and Compliance for the Board; Five Questions About Hedging; Enterprise Risk Management: The Board’s New Tool; Executive Compensation: Best Practices, What Defines Best In-Class Boards?,; etc.

Regardless of my nitpicking, de Kluyver gets the big picture right. "The tug of war between individual freedom and institutional power is a continuing theme of history. Early on, the focus was on the church; more recently, it was on the civil state. Today, the debate is about making corporate power compatible with the needs of a democratic society." De Kluyver offers readers information that can help them to become better directors and better corporate citizens.

Continue Reading ·

ShareOwners.org Launched

Finally a social networking site that will actually accomplish something. Yes, you can “friend” people and post to their “wall.” However, you can also send a powerful message to Congress that shareowners are mad about the lack of accountability and poor regulatory framework for corporations. Shareowners.org promises to provide a central core network for involvement by shareowners and beneficial owners in corporate governance activism.

When asked by Barry Burr, of Pensions and Investments, if pension funds would have a role in the new organization, Rich Ferlauto, of AFSCME, answered in the affirmative. They will be working with funds, especially public pension funds, to mobilize their own members.

Right now, ShareOwners.org will help engage typical investors by sending their comments in support of the group’s agenda directly to their members of Congress. Over the long run, ShareOwners.org’s broad four-part agenda focuses on the need for stronger regulation (including a beefed-up SEC), increased accountability of boards/CEOs, improved financial transparency and protection of the legal rights of investors. At some point, shareowners will also be able to vote their shares directly through ShareOwners.org.

The current agenda can be summarized as follows:

  1. Stronger regulation of the markets through a beefing up the Securities and Exchange Commission (SEC), ensuring that it has the resources and authority to increase supervision and enforcement of financial professionals, hedge funds, and mutual funds, and also forfeiture of compensation and bonuses earned by management in a deceptive fashion, strengthening state-level shareowner rights, and protecting whistleblowers and confidential sources who expose financial fraud and other corporate misconduct.
  2. Increased accountability of boards and corporate executives by allowing shareowners to vote on the pay of CEOs and other top executives, empowering shareowners to more easily nominate directors for election on corporate boards, requiring majority election of all members of corporate boards at American companies, splitting the roles of chairman of the board and CEO at major companies, stopping the practice of brokers casting votes for shareowners in board elections, and allowing shareowners to call special meetings.
  3. Improved financial transparency, including a crackdown on corporate disclosure abuses used to manipulate stock prices, strengthening corporate disclosures so that shareowners can better understand long-term risks, and protecting U.S. shareowners by promoting new international accounting standards.
  4. Enhanced protection of the legal rights of defrauded shareowners, which means preserving the right of investors to go to court to get justice, ensuring that those who play a role in committing frauds bear their share of the cost for cleaning up the mess, and allowing state courts to help protect investor rights.

The site also includes the results of an extensive survey that shows American investors want major reforms. Hopefully, they also want to learn how to more effectively influence boards and management at the companies they invest in. I urge readers to sign-up to become members of this important new network. While you are there, send a message to Congress and go ahead, add me as a friend and write something on my “comment wall.” (see Group to use Internet to mobilize shareholders, P&I, 6/25/09; A third of American investors are “angry” (hopefully not enough to torture their advisors), The National Post, 6/25/09; press release)

Visit ShareOwners.org

Continue Reading ·

Proxy Access and Hybrid Boards

The Chamber of Commerce opposes the SEC’s proposals on proxy access, claiming that such decisions reside within individual states. “No compelling reason exists to overturn the long-standing state law role in controlling the substantive rules regarding director election,” wrote the Chamber’s Richard Murray in a letter to Schapiro. “Pursuit of a federal right to access will lead to a one size fits all rule.” (Chamber Challenges SEC Over Proxy Access, Directorship, 5/1/09) “The Chamber believes that greater proxy access would not advance the financial interests of individual investors. Instead, it would allow labor unions and other special interest groups to advance their agendas at the expense of these investors.” (U.S. Chamber Calls Greater Proxy Access Good for Special Interests, Bad for Individual Investors, press release, 7/25/07)

“The potentially harmful consequences of proxy access must be considered. As
CEOs of leading U.S. companies, we are concerned about these renewed attempts to allow special and disparate interests to sidetrack corporate boards, as well as the inevitable effect these attempts will have on the ability of management and boards to focus on the long term value creation for shareholders and employees,” said John J. Castellani, President of Business Roundtable, an association of chief executive officers of leading U.S. companies with more than $5 trillion in annual revenues and nearly 10 million employees. (Business Roundtable Statement on SEC Proxy Access Proposal, press release, 5/20/09)

Rarely, however, do opponents of proxy access cite studies to support their agruments, which are more likely to be grounded in their own selfish interest to remain entrenched than in any true concern for shareowners or the US ecomony. Unions can’t hijack corporate elections if it takes a majority vote to elect directors, as it now does at most of the companies with CEOs in the BRT.

A recent study, Effectiveness of Hybrid Boards by Chris Cernich, Scott Fenn, Michael Anderson and Shirley Westcott, prepared by Proxy Governance under contract with the Investor Responsibility Research Center, looked at the effectiveness of 120 “hybrid” boards formed when shareowner activists were able to get a short slate elected and found total returns at such companies were over 19 percent — 16.6 percentage points better than peers. Total share price performance through the three-year anniversary of the hybrid boards averaged 21.5 percent — almost 18% percentage points more than their peers.

More than half of the excess return occurs within three months after an activist announces their intention to battle for board seats. Investors bid up its shares in hopes that a hybrid board will result in positive changes. Not suprisingly, performance was better where dissidents held a greater proportion of shares. They have both a better chance to get elected and more incentive to monitor. However, boards that seated a sole dissident moderately outperformed, whereas companies with three new directors significantly underperformed. Perphaps more positions being contested led to more resources being drained from the company and a greater distraction of management.

Companies whose hybrid boards were created through contest settlements averaged a sale premium of 29.6%, more than double the 13.5% average premium for companies whose hybrid boards were created by a proxy contest which went to a shareholder vote. Full blown proxy contests, like wars, can be expensive for both sides. Proxy access appears likely to bring positive changes at less cost, like the gradual transitions of democratic elections in government.

Expect to see more activist investors once proxy access becomes a reality. Like classic value investors, these firms rely on fundamental analysis showing that a company’s inherent value is greater than its trading price. Unlike most, however, they don’t wait for the market to recognize the value. They work for changes to close the gap. When they do get elected, they frequently bring much greater resources and experience to boards than most directors. Expect to see more funds like Steel Partners, Ichan Partners, Ramius Capital Group, Barington Capital Group, Breeden Capital Management, Relational Investors, Riley Investment Management, Third Point, Costa Brava Partnership, MMI Investments, Oliver Press Partners, and Lawndale Capital Management. I’ve updated our links page for such groups. If you know of others, please let me know.

Continue Reading ·

Women on Corporate Boards of Directors

Women on Corporate Boards of Directors: International Research and Practice, edited by Susan Vinnicombe, Val Singh, Ronald J. Burke, Diana Bilimoria, and Morten Huse presents an excellent set of worldwide research on progress, strategies, results, and challenges.

Overall, progress seems to be glacial but more pronounced in European countries, such as Norway with legislated quotas.

Women’s representation appears associated with representation in senior management, smaller pay gaps, equity legislation, work-family initiatives, social/cultural support, quality of board deliberations, and increased profit. Of course, if the correlation with increased profit proves strong enough, we may see growing demand for the Pax World Women’s Equity Fund and others that promote gender equity. So far, correlations seem too weak, although several public pension funds, including CalPERS and CalSTRS may help the cause.

One of the more interesting papers in this collection is that of Val Singh, who focuses on Jordan and Tunisia. I haven’t seen much research on corporate governance in Arab countries, especially focused on women, and was surprised to learn 10% of Tunisian directors are women. It is difficult enough trying to get inside the "black box" of boardrooms anywhere. Creating benchmark studies in Arab countries must be even more difficult, given what at least appears to this outsider as a general reluctance to tackle gender issues.

Women do much better at state-run businesses. In the US, we seem to be more willing to experiment at companies that are broken, so the financial crisis may present an opportunity. However, several researchers warn of a "glass cliff." Apparently, women are invited onto more boards where companies are failing and are desperate. They are paid less at companies performing well and more at those doing poorly. Like directors elected by dissident shareowners, women directors are often isolated as outsiders and do better when they are not alone.

At the February 2009 "Women in Investments" conference in Sacramento, CalSTRS board member Carolyn Widener, drew a big laugh when she quoted Nicholas Kristof about speculation at Davos, Switzerland concerning "whether we would be in the same mess today if Lehman Brothers had been Lehman Sisters." Eventually, if resurrected, maybe we’ll have Lehman Sisters and Brothers. This volume contains some of the best research to date from a wide variety of disciplines around the world that may just help to get us there.

Continue Reading ·

January 2009 Special News Supplement: Directors Forum 2009

The conference opened with a great dinner and a fascinating keynote speech by Jim Chanos, founder and managing partner of Kynikos Associates, the world’s biggest short-seller. In introducing him, conference co-host Larry Stambaugh proudly held up a copy of the Financial Times from two days earlier that had Chanos’ picture not only above the fold but above the headlines. (View from the Top, 1/26/09) In the FT interview Chanos said of the banks, "there is still a lot of damage on these balance sheets that has not come out." Asked if America’s financial shift is Chanosmoving from New York to Washington, he said, "power is beginning to shift… anyone who doesn’t see that is kidding themselves." He thinks the next target for regulation is likely to be private equity funds.

Short positions represent only a small portion of hedge fund activity, according to Chanos. Take out 3-6% being arbitraged and that leaves only about 0.5-1% of pure shorts. Although short-sellers are often viewed as "skunks at the garden party," "we’re not your enemy." In fact, short sellers are needed for efficient markets. He told of the case of three Irish banks that lost 40% of their value and had to be nationalized when short-sellers were required to disclosure their positions.

Short sellers are "real-time financial accountants," whereas the SEC reviews are more like "archeology." He advised that when short-sellers attack, directors should ask their CEO or CFO why. If they don’t know, they’d better find out, because they are usually doing so based on real evidence of problems. He questioned why the SEC has so few staff with real world experience, suggesting that at least one commissioner should be someone with trading desk experience. He thought it was a good time to short the rating agencies and questioned how senior executives of Wall Street banks could be so clueless. Perhaps they weren’t, because many were shorting their peers.

Chanos sees that any company still distributing analog products is likely to be in trouble, given the marginal costs of distribution over the Internet. Expect a shakeout of firms as the giants go digital. On a more global scale, he seems to be shorting Mexico, seeing a crisis coming. He covered an enormous amount of ground and took lots of questions. No, he’s never been called by a director to find out why he is shorting a company. Ask your CEO or CFO. He’s usually found some accounting issues that show bad judgment.

Everyone I talked to learned a lot from Chanos. He wasn’t a "skunk at the party" at all, at least not at Directors Forum 2009. Those of you who were unable to attend might glean the much of essential message from Short Sellers Keep the Market Honest. (WSJ, 9/22/09) Of course, you’ll have missed a great deal of wit and charm. See also, IIROC releases two studies on marketplace trends related to short sales.

Back to the top

Cynthia Richson moderated the first panel of the Forum’s program on the topic "Shareholseatingder Hot Topics." Richson co-founded the Directors Forum and has been a dynamic figure in corporate governance well before creating the Directors’s Summit for the State of Wisconsin Investment Board, which the Forum used as something of a model. Panelists were among the most distinguished in the field: Richard Ferlauto, Peggy Foran, Mike McCauley and Pat McGurn. The auditorium was modern and comfortable. (right) Here, I’m not going to report individual comments either here or as I discuss other panels, since that could stifle frank debate at future Forums.

Needless to say, there was a lot of speculation concerning the role the Federal government will take at financial companies coming under the TARP. Shareowners will be taking a laser light to executive compensation, especially repricing. There are expectations that holding periods will extend beyond tenure. Investors expect stronger succession planning. Compensation should be built around developing and meeting strategic plans and leadership expectations.

Shareowners will be more proactive. Corporations should talk to their major investors before taking controversial actions. Companies expect investors to talk with them before submitting resolutions. Panelists expressed concern over both short-term shareowners and CEOs. They briefly discussed recommendations of the Group of Thirty, the Aspen Institute’s Principles, the shift to independent chairs, and many other issues. One colorful bit of advice that I think all would agree with came from Pat McGurn. "Engagement is critical. Don’t get in a defensive fetal position."

John Wilcox, Chairman of Sodali, previously with TIAA-CREF and Georgenson, moderated the panel, "Do You Know Who Your Shareholders Are? The Changing Face of Activism." Distinguished panelists included William Ackman, Brian Breheny, John Olson and Frank Partnoy. Short-selling was again discussed, including the issues of disclosure, share lending, voting by short-sellers, etc. Readers might want to review ICGN’s best practices from 2007.

Another topic discussed was the fact that so many investors are short-term holders, rather than long-term owners. Panelists appeared to agree that companies shouldn’t take action to placate shareowners by generating short-term gains that would impair long-term value. However, they couldn’t agree on requiring something like a one year holding period before being eligible to vote.

Again, it was another far-ranging discussion about disclosures, the need to create forward looking risk models, the problem of real property prohibitions against foreign ownership above 5%, the desire of shareowners to be able to talk with their elected representatives (directors), the use of Reg FD as an improper excuse not to engage (see interpretive release), and much more.

The final Monday morning session was on "The Future of Corporate Governance: the Next Five Years?" Henry James HaleduPont Ridgely, Steven A. Rosenblum, Richard Ferlauto, and Sara Teslik were moderated by James Hale. (picture on right) Again, lots of disagreement among this group. However, they all appeared to agree that technology is leveling the playing field. Just as it helped Obama win office, it is changing the way corporate governance is pursued.

Another development that could have lasting impact is the Delaware Supreme Court’s agreement to accept questions certified to it by the SEC. The first questions involved AFSCME’s proposal to CA, Inc. The Court knocked that decision out in twenty days. There was general agreement that dialogue is needed but disagreement as to how big of a stick shareowners need to get into the conversation. Majority vote provisions for director elections have been tremendously effective. Future actions may focus more on directors, rather than symptomatic issues that are often addressed in shareowner resolutions. When shareowners can speak with one voice, that facilitates agreements.

Directors need to focus on process with regard to risk. Bad outcomes don’t equal bad faith but bad documentation can certainly lead to trouble. There was a good discussion around split chair/CEO movement, including mention of Millstein’s recent attention to the topic. Yet, when the chair wants to actually be the CEO, the split might not work as well.

Back to the top

Almost on cue, the keynote speaker for lunch, Rex D. Adams, discussed their transition to separating out the role of chairman. At that time Invesco was a UK company and the idea was pushed by investor groups, such as the Association of British Insurers. Invesco kept the structure when the moved to a New York Stock Exchange listing but is now reexamining their position. He acknowledged good arguments that a single position strengthens the focus of accountability on one person and ensures against distraction. However, he thinks the split provides greater transparency with respect to roles and puts the board in a better position to evaluate the CEO and management team. As chairman, he sets the board agenda and governs allocation of the board’s time but does so in close collaboration with the CEO. There were several questions from the audience and Adams did a good job of detailing his experience with split roles.

Charles ElsonThe afternoon broke into concurrent sessions. I missed "IFRS: Sound Principles — Or More Room for Manipulation?" Here’s a recent update from Business Finance – Regulatory Strategy 2009: What to Watch Right Now. Instead, I opted for the more popular, "Compensation: Pay Practices Under Fire, with panelists Karin Eastham, Charles Elson (left), JoAnn Lublin, Robert McCormick, and Anne Sheehan, moderated by David Swinford. Much of the discussion centered around repricing options, most of which are currently underwater. Movement now is to rethink the base vs bonus with more emphasis on restricted shares.

Directors were warned to tread carefully. Investors have a sense of betrayal and compensation packages may be the best place to regain trust… or lose it altogether. A good explanation goes a long way. I heard it in the panel and elsewhere that more investors are focusing on pay equity within the enterprise. Does the comp committee even look at it? Too often, CEO pay is driven totally by comparisons with other companies with no look within the organization. Employees won’t be motivated if CEO pay gets too far out of alignment. Few boards appear to be cutting back on board pay… maybe because directors are putting in so much more time and effort.

Of course, CEO pay remains the hot button issue and Forum panelists are in the news commenting. "This is different. The arguments against curbs don’t make sense any longer. My friends will bring up the issue even before I do. Opinion has been galvanized," said Robert McCormick. (CEO pay cuts: Not just for banks, CNNMoney.com, 2/4/09)

I then missed "Risk Assessment: Questions Directors SHOULD be Asking." Here are materials on that subject from Deloitte. Instead, I attended a session on "Corporate Governance "Lite" for Smaller Companies." The panel consisted of Janet Dolan, Gregory P. Hanson, William McGinis and Deborah Rieman, moderated by Scott Stanton. Panelist discussed some issues common to small companies, like too often trying to rely on board members as adjunct staff experts. Again, there was discussion of split chair/CEO positions and at what stage that transition might take place. They discussed SOX, the fact that small companies have thin or no coverage from analysts and their stock price is more vulnerable to attack on shareholder bulletin boards. The most fascinating discussion for me was of founders who don’t want to let go of the reins. What made it even more so, was discussion from audience members in that position.

That evening at dinner, we heard from New York Times columnist Joe Nocera. His speech was short and highly entertaining. He took a lot of questions from the audience on wide-ranging topics from the "great unwinding" that would have happened if Bush had been successful in privatizing Social Security, to the likelihood of credit card debt forming the next crater. One thing he was definitely sure of, each generation discovers its own cycle of "fear and greed." The cycles seem to be accelerating.

Back to the top

Former SEC Chairman Christopher Cox (right) made a plea for an "exit strategy" from government ownership and Christopher Coxinvolvement. The speech was very similar to one he delivered to a joint meeting of the Exchequer Club and Women in Housing and Finance last December. He spent some time on how we got into the mess, explained the economy goes through cycles and although he did not discount the need for intervention, his main message was that we shouldn’t conflate the role of market regulator with market actor. He said Congress does two things well, "nothing and overreacting."

Interestingly, he made no mention of reinstating the leverage limits the SEC removed on 2004 under William Donaldson. For years, financial institutions could lend 12 for every 1 dollar they held in reserve. "Using computerized models, the SEC, under its new Consolidated Supervised Entities program, allowed the broker dealers to increase their debt-to-net-capital ratios, sometimes, as in the case of Merrill Lynch, to as high as 40-to-1." (Ex-SEC Official Blames Agency for Blow-Up of Broker-Dealers, New York Sun, 9/18/08)

The 2004 decision gave the SEC authority to review the banks’ increasingly risky investments in mortgage-related securities but the program was a low priority for Cox. Seven staff, without a director, were assigned to examine the companies, with assets more than $4 trillion. As of September 2008, "the office had not completed a single inspection since it was reshuffled by Cox more than a year and a half ago." "The commission’s decision to effectively outsource its oversight to the companies themselves fit squarely in the broader Washington culture of the past eight years under President George W. Bush" according to U.S. regulator’s 2004 rule let banks pile up new debt, International Herald Tribune, 10/3/08.

Bill George was next up. He’s the type of inspirational leader conferences often put at the beginning to fire up those in atBill Georgetendance, but it works just as well to end on a high note. The themes of his advice to directors have broad appeal:

  • Board independence is critical. Executive sessions were the most important thing to come out of SOX.
  • Board composition should reflect their customer base — a diversity of life experiences and thought. Strongly favors self-evaluations and a mechanism to ensure directors rotate off.
  • The form of board leadership isn’t so important — it doesn’t guarantee results.
  • Time and commitment are important. He also favors totaling the location of board meetings for context/access.
  • Board chemistry is important and is often improved by offsites or other informal occasions that result in honest conversations and straight talk about values and strategy.
  • Increase interactions with management, not just the CEO. The company’s future may depend on it.
  • On executive compensation, look internally as well for equity issues. How is pay for performance viewed from the inside?
  • Ensure the corporation’s reputation through transparency. Employees should hear it from the company first, not the newspaper.
  • Maximizing short-term shareholder value will destroy the company — focus on the next 10 years. Don’t forecast earnings — let the analysts do that.
  • Remember that government charters companies to do something of value. Ensure you a fulfilling society’s mission and instill values in those coming up. People are not just motivated by money. Search for meaning and significance, being part of something special.

Continuing the theme of ending with a bang, the last panel of the Forum was "Selecting & Training Directors — the Role of the Governance/Nominating Committee." The moderator was Richard Koppes. Panelists were Bonnie Hill, James Melican and Kristina Veaco. Whereas some might argue that Christopher Cox spoke too long and left too little time for questions, that certainly wasn’t the case here. The audience had every opportunity to ask for advice on issues that concerned them. Hill spoke on lawsuits, risk issues and culture… much around how Home Depot had learned its lessons the hard way with shareowners. Melican talked about working with clients, such as CalPERS, about the needs of a particular board. With proxy access coming, proxy advisors may be placed in such a role on a more routine basis. Veaco got right into the grit of reference binders, policies, contracts, charters, etc., emphasizing the Bonnie Hillneed for new director orientation and the benefits of being assigned a mentor. Plan ahead and get items on an annual calendar… two to three years ahead. Now that’s planning!

They talked about the importance of resources, like The Corporate Library, the Society of Corporate Secretaries and Governance Professionals, and Stanford Directors College. Hill (pictured at right) spoke of the importance of getting to know the directors before you join a board and the need for boards to think ahead, keeping a reserve of potential directors in the pipeline. She stressed the importance of peer evaluations… and the need to shred the written component. Melican suggested evaluations should be conducted by a third party rather than in-house staff. Veaco preferred evaluations have a written component as well as an oral interview and that the most sensitive questions/answers would occur orally, but that in any event the questionnaires would not be kept and only summaries of the results would be provided.

Hill advised shareowners they don’t have to submit a proposal before getting a hearing. Have the conversation prior to submitting proposals. Veaco seconded that, saying discussions should go on all year, not just during proxy season. Corporate secretaries should be reaching out to top shareowners.

Hill spoke of the increased time commitment directors are making and the use of conference calls and tools like BoardVantage. Again, split chair and CEO came up as a topic as it did so often at this year’s Forum. Hill described their use of a lead director at Home Depot. Pay was also touched on again. Home Depot has moved away from a per meeting charge, using a flat retainer. Veaco said in her experience directors are paid meeting fees, even when they are called on to attend a large number of meetings, and the amount is the same for telephonic as for in-person meetings, but companies can handle this differently. Melican stressed the need to look beyond compensation to what shareowners might view as perks. This is not the time for junkets in Paris or to line up the limousines. Look at your charitable contribution match. Think of eliminating meeting fees and address the issues before they hit the press. (see also Nominating/Governance Committee Roundtable)

Of course, much of the essence of the Forum were the encounters that happened outside the formal confesettingrence. The beautiful setting, wonderful food, small number of participants to speakers, the high quality of both, and the importance and timeliness of the topics all contributed to a very successful program. I’m sure Linda Sweeney has already begun planning Directors Forum 2010.

This year’s steering committee did a great job. Three cheers to each of the following:

Comments From Attendees

Putting Jim Chanos on the agenda on the first evening was absolutely brilliant. The theme of the meeting was the focus on shareholders. Many of us, including me, had never heard a talk by a short seller! Bill George was very inspirational and a wonderful way to top off the meeting. — Julia Brown, Targacept, Inc.

It’s always useful to understand what the latest issues are from a shareholder’s (or shareholder activists’) point of view. That helps us as management to be mindful of those as we make decisions and communicate with the shareholders. And, the exchange of ideas with other attendees was invaluable in helping improve our own companies’ performance on an ongoing basis. — Bruce Crair, Local.com

The planning and organization of the event left nothing to chance making it an outstanding experience. The Forum brought together people with diverse thinking and backgrounds but all dedicated to improving corporate governance throughout the United States. I was proud to attend and be part of the conference. — Richard A. Collato, YMCA of San Diego County; Director Sempra Energy, WD40, Pepperball Technologies and Project Design Consultants

The highlight for me was Bill George’s presentation – concise, insightful and practical. — John F Coyne, Western Digital Corporation

It was the best one yet – I really enjoyed listening to all the speakers — Lynn Turner, former SEC chief accountant

The conversational format, close to the audience, was much better than the usual sitting up high on a stage all lined up on a panel — Kristina Veaco, Veaco Group

My second Director’s Forum – again this year, very worthwhile. — Lou Peoples, Northwestern Corp.

Back to the top

Pre-Conference Bonus Session

Even before Directors Forum 2009 began, there was a very worthwhile "Pre-Conference Bonus Session," entitled The Latest Research in Corporate Governance, presented by the Corporate Governance Institute at San Diego State University. There were two concurrent sessions. I attended Management and Law reviews. Therefore, I missed Finance and Accounting. All bibliographies and presentations are available on the CGI’s Post Conference Materials page.

Lori Ryan did a great job of touching on some of the highlights of studies published in 2008 on "management" topics. Following are a few of the many findings that struck me.

Professor Paul Graf‘s bibliography highlighted some important recent court decisions and articles but his presentation honed in more on common threads and direction, which I find difficult to summarize. Much of his talk centered around the concept of "good faith," which can’t be indemnified. The duty to act in good faith is "intertwined" with the duty of care, but it is different. It is "shrouded in the fog of hazy jurisprudence, grounded in the duty of loyalty, but it does not involve self dealing." "It is more culpable than a breach of the duty of care—gross negligence."

Sounds a bit like a Zen koan. In Disney, failure to act in good faith is 1) where the fiduciary intentionally acts with a purpose other than that of advancing the best interests of the corporation, 2) where the fiduciary acts with the intent to violate applicable positive law, or 3) where the fiduciary intentionally fails to act in the face of a known duty to act, demonstrating a conscious disregard for his duties. The last was emphasized by Graf, who went on to quote several other attempts to surround the concept of good faith, including Nowicki’s notion that courts are focusing on bad faith, instead of defining good faith. I liked his distillation of Hill and McDonnell. "On the continuum of liability from duty of care to duty of loyalty, good faith occupies the vast middle ground." Apparently, ill defined ground.

From what I gathered, the duty of care is morphing into the duty of good faith in recent cases such as Stone v. Ritter and Ryan v. Lyondell. Plaintiff alleged the directors knew that they had a known duty to act to ensure an offer was the highest available but they chose not to act. Therefore, good faith was implicated for purposes of the motion to dismiss. What was crystal clear was the need to document "actions" taken, even if they would otherwise be viewed as non actions, since if the board "acts," its actions are reviewed under the more favorable business judgment rule.

In sessions I did not attend, David DeBoskey provided a review of 2008 in Accountancy and Nikhil Varaiya reviewed Finance. You can find their bibliographies and presentations on CGI’s Post Conference Materials page.

Continue Reading ·

Icarus in the Boardroom

Icarus in the BoardroomAmerica loves risk-taking CEOs, but when such behavior crosses over to boardrooms it could have massive consequences because of the growing scale of businesses and society’s greater dependence on equity markets. Icarus in the Boardroom: The Fundamental Flaws in Corporate America and Where They Came From (Law and Current Events Masters), by David Skeel draws on Greek mythology to present a candid warning aimed at corporate directors and anyone concerned with our economic future.

Trapped in a labyrinth of his on construction, Dedalus made wings for himself and his son Icarus. He warned Icarus not to fly to close to the sun but Icarus got carried away, failed to heed the warning, and plunged to his death after the sun melted the wax that held his wings together. Similarly, the corporation is a powerful human innovation, but is dangerous if not used properly. Continue Reading →

Continue Reading ·

Corporate Governance: Law, Theory, And Policy

Joo-CGCorporate Governance: Law, Theory and Policy, edited by Thomas W. Joo (Carolina Academic Press 2004), this excellent reader on corporate governance presents a cross section of mostly academic perspectives on important current issues, including: the role of the corporation, balancing interests, state and federal law, shareholder litigation, criminal and regulatory law, shareholder voice, board composition, director duties in corporate takeovers, executive compensation, and corporate lawyers as gatekeepers.

Many of the articles are modern classics by authors well know to readers of CorpGov.Net, such as Margaret Blair and Lynn Stout, Marleen O’Connor, Stephen Bainbridge, Edward Rock, Roberta Romano, John Coffee, Mark Roe, Continue Reading →

Continue Reading ·

The Recurrent Crisis in Corporate Governance

The Recurrent Crisis in Corporate Governance The Recurrent Crisis in Corporate Governance pushes the edge of mainstream thought in this growing discipline. Authors Paul W. MacAvoy and Ira M. Millstein, giants in the field, have well deserved reputations as practitioners and scholars. This thin volume will quickly guide the course for progressive board members concerned with building solid companies, rather than future Enrons.

Although MacAvoy and Millstein stop short of urging direct nomination of directors by shareholders, the author’s do recognize the real benefit of boards being truly independent from the CEO. “The independent and professional board is the ‘grain in the balance’ of survival in the long run.” Continue Reading →

Continue Reading ·