Walden Asset Management filed a letter and resolution (WaldenHPLetterSepChairCEO8-10-10) with HP seeking separation of CEO and chair positions. Given the recent resignation of Mark Hurd (Mark Hurd’s Termination from HP: Case Study), timing seems ripe and important as HP searches for a new CEO. Walden cites Chairing the Board: The Case for Independent Leadership in Corporate North America by the Millstein Center for Corporate Governance and Performance at Yale’s School of Management. HP should take this opportunity to transition to this growing successful model of corporate governance and leadership.
Tag Archives | ceo
Median total annual compensation for North American CEOs declined for the second straight year, according to a preliminary CEO pay survey from The Corporate Library.
The study analyzed CEO compensation data for fiscal 2009 drawn from 823 proxy statements filed in the United States between July 1, 2009, and March 25, 2010.
The report titled The Corporate Library’s Preliminary 2010 CEO Pay Survey, is available for $45 from The Corporate Library’s online store. According to Paul Hodgson,
The decrease marks the first time since The Corporate Library began publishing its annual CEO pay survey in 2002 that the median change in compensation has declined for two consecutive years.
Median total annual compensation for all CEOs in the study declined by 2.78 percent from 2008 to 2009.
The Corporate Library Blog today carries a great post, Inflated CEO pay at Goodyear Tire. Good puns and even better information on CEO Robert J. Keegan’s “maximum payout for a net loss.”
Mr. Keegan received four separate stock option grants. The largest of the four market-priced grants, almost 500,000 of them, was at $4.81. Less than six months later he’d made $6.23 million worth of notional profit on that. This is just irresponsible, and it’s taking advantage of a super-low stock price to grant any stock options at all in such circumstances. It’s virtually impossible NOT to make money in such a situation.
This is Paul Hodgson writing in excellent form, including his conclusion that “it might even be time to vote against Denise Morrison, Rodney O’Neal, Craig Sullivan and Thomas Weidemeyer,” members of Goodyear’s compensation committee.
I’ve only got one complaint. The meeting is tomorrow; for many, voting has already ended. Hopefully, those who subscribe to “Board Analyst,” or other services at The Corporate Library, got this analysis earlier. However, I see, as reported by ProxyDemocracy.org, CalSTRS voted in favor of compensation committee members, so I’m left wondering if timeliness is a frequent issue during the busy proxy season.
PIRC Alerts reports that the UK Church Investors Group (CIG) issued a report on executive pay saying that a ratio between the pay of the top executive and that of the average pay of the lowest 10% of employees in excess of 75 times would be hard to justify. They’ve adopted a common framework. PIRC will provide research and voting advice on group members’ holdings in the FTSE100. In practice this will mean that members participating in the initiative will be able to adopt the same voting stance, making the CIG an important new shareholder voting bloc in the UK’s capital markets.
PIRC also reports, the average vote against a remuneration report at a UK-listed company last year was 17.28%. That compares to a figure for 2008 of 3.2%. If you would like a copy of the 2010 UK Shareholder Voting Guidelines, please contact Janice Hayward on [email protected] or phone 020 7392 7894.
A free report from The Corporate Library concludes that expenses related to CEOs’ personal use of corporate aircraft increased by over 9% at the median between 2007/2008 and 2008/2009. The increase occurred as the incidence of personal corporate jet use held steady.
The report, titled “Proxy Season Foresights #8: CEOs’ Personal Use of Corporate Jets Still Flying High,” analyzed such expenses at more than 2,500 Russell 3000 companies for which data was available for the last two years (as of January 29, 2010). For companies that had not yet filed proxy statements for the 2009 fiscal year, the sample included data from 2007 and 2008; 2008 and 2009 data was used for those that had already filed 2009 proxy statements. Key takeaways include:
- Fifteen percent of Russell 3000 and 40 percent of S&P 500 report aircraft expense for CEOs’ personal use
- Increase in the averages of reported expenses in the last year: 3.3 percent
- Aircraft expense is up an average of over 70 percent (median 9 percent) for Russell 3000 companies with expenses in both years
- Average payout in 2008/9: $131,340
- Median payout in 2008/9: $80,368
- Incidence rate holding steady (around 400 Russell 3000 companies in each of last two years)
- McGraw-Hill is an example of best practices in recouping personal expense
- Tax gross-ups and family use are still prevalent
The report concluded, “in the cases where tax gross-ups and family use were approved, it calls the corporate culture into question: if the board cannot set appropriate limits for the CEO in this regard, will it be able to do so in matters of greater strategic consequence?”
On a related note, Finger Interests Ltd., the Houston investment firm that tried to oust Ken Lewis from Bank of America last year, has a new target this year: The firm filed a motion Monday urging shareholders to vote against director Chad Gifford. According to the Fingers:
Mr. Gifford knew that Bank of America did not undertake sufficient due diligence when they acquired Merrill Lynch. He also knew it was a bad deal for Bank of America shareholders. But he did not have the courage or moral conviction to fulfill his duty to shareholders. Rather, he was more concerned with maintaining his position as a director of Bank of America and making sure that his employment agreement, which entitled him to 120 free hours on the corporate jet (each year), was renewed for another year.
According to a report in the Charlotte Observer, “Gifford had enjoyed a perk from the bank that let him use company-provided aircraft for up to 120 hours a year, in addition to his regular pay as a director. In 2009, Bank of America spent $956,007 on Gifford’s airplane use, plus $293,004 to help him pay the accompanying taxes. It did not renew the agreement for this year.” (Shareholder wants Bank of America director out, 3/30/10) Hat tip to Tweet from Bob Monks.
The current edition features a cover article, The Great Divide: Separating the Chairman and CEO Roles. Thought leaders tackle the issues involved in splitting the two top leadership positions of the corporation. On one side of the debate: “The development is inexorable,” says Ira Millstein. “Beware the simplicity of saying two heads are better than one,” says James Robinson. Sure, the consensus of this group is that such a split should not required by law. Maybe they’re right, but the arguments in favor of splitting the roles in most cases were far more compelling than those opposed. What do you think?
New disclosure requirements are going to make many boards rethink the issue, especially when they have someone in the combined role stepping down. In another article, Henry D. Wolfe offers more timely advice in What you want in a nonexecutive chair, while Diane Lerner and Ira T. Kay offer up Revisiting the pay of the nonexecutive chair.
Several other excellent articles round out the issue, including an interview of Dennis Kozlowski by John Gillespie and David Zweig, authors of Money for Nothing. Their interview is entitled If he had it to do all over. Sure, in hindsight, Kozlowski wishes he had done some things differently; maybe he should have been a little less ambitious.
However, what is presented is mostly the self-portrait of a victim… a victim of a system well documented by Gillespie and Zweig which cedes too much authority to CEOs. If Tyco had a stronger board, he wouldn’t be working in a prison laundry. Staying out of jail, another good reason to strengthen boards by splitting board and chair positions.
In July 2009, the SEC proposed new proxy disclosure rules that will require public companies with a combined CEO/Chairman to disclose why the company believes such a leadership structure is appropriate and what specific role the Lead Director plays in the leadership of the company. via How to Be a Good Lead Director – Boardmember.com.
Unreported in the article is the fact that the new rules have an effective date of February 28, 2010. A January 6th Georgeson Report provided much better and more specific advice: “If the same person holds both positions, companies should disclose whether they have a lead independent director and what role that person plays. In this regard, companies would be well advised to review the details that RMG considers when evaluating whether or not to support a shareholder proposal calling for an independent chairman.” They also discuss what is required in the way of disclosing consideration of diversity in the nomination process.
I think the concept of “lead director” is on the way out. Are the new SEC rules an indication of the U.S. heading toward “comply or explain”?
This new reader, edited by Thomas Clarke and Jean-Francois Chanlat offers up one of the first critiques of the subprime financial crisis within a framework that compares Anglo-American governance features with those of Europe.
At the heart of the collapse was the growth of the derivatives market that was supposed to hedge against losses. Settlements grew from $106 trillion in 2002 to $531 trillion by 2008. In the introduction, Clarke and Chanlat provide an excellent overview of how the crisis unfolded, both in the US and in Europe. They then turn to the contributions of the governance framework: re-regulation, ratings agencies, risk management, incentivization and to more specifics within the framework of financial institutions.
Convergence is in progress but there is tension between the parallel universes. The Anglo-American is characterized by liquid markets, high transparency and where the market for corporate control provides the major discipline… until markets fail. Europe and Asia are characterized by controlling shareowners, weak markets, less transparency and more monitoring by banks.
Many are now questioning convergence and what appears to be a basic philosophy behind the American model… growing inequality. “In the last few years alone, $400 billion of pretax income flowed from the bottom 95% of earners to the top 5%, a loss of $3,660 per household on average in the bottom 95%.”
With the highest level of inequality and poverty among its peers and the lowest job satisfaction rate in two decades, why follow the US? What about the rights of workers and citizens to a more sustainable system? Can the EU transform its economies so that they can sustainably continue to provide a high standard of living? Those are just a few of the topics addressed in the reader through an examination of various dimensions and examples.
Most of the essays are excellent. I especially enjoyed Robert Boyer’s, “From Shareholder Value to CEO Power: The Paradox of the 1990s.” Boyer looks at why CEO remuneration continues to skyrocket in an era of shareholder value. Labor long ago lost power in the US and managers have used the pressure of institutional investors to their own benefit.
Boyer reviews the rise of concern over CEO pay, various options that have been used and their limitations. A series of long-run transformations has occurred in the bargaining positions of workers, consumers, financial markets, the international economy and nation states. The 1960 were characterized by an alliance between workers and managers.
By the 1980s internationalization eroded worker power and by the 1990s we entered a period of hidden alliances between managers and financiers. Managers used the demands institutional investors to redesign their own compensation. Part of that alliance involved a shift away from defined benefit plans to 401(k) type plans and a huge inflow of savings into the stock market with workers at risk.
As support for a political hypothesis of increased managerial power, Boyer analyzes the micro-structure evidence concerning insider trading, diffusion of stock options, lower CEO pay sensitivity of large firms, surge in M&A activity, windfall profits, asymmetrical power on compensation committees, distortion of profit statements, innovation in hiding compensation and the financialization of CEO compensation in a corporate culture that has shifted from engineering to financial management.
He then looks at the larger political arena where economic power is converted into political power. Here he discusses the context of rising inequality and growth of the super-rich with evidence that concentration of wealth is enhanced by stock market bubbles and a tax system that tilts in favor of the rich.
How do we extricate ourselves from this situation? Boyer’s analysis provides some hints. A shift towards a stakeholder conception “would reduce the probability of managerial greed and erroneous strategic decisions.” More public control of accounting practices is needed “to prevent an alliance between CEOs and auditors, at the expense of rank-and-file shareholders.” Last, we need to recognize that monetary policy has been “at the heart of erroneous business strategies and unjustified wealth from CEOs.”
The volume should give readers pause concerning the desirability of convergence on an Anglo-American model and provides well-informed analysis of European models that may lead to a more sustainable path.
“Firms that pay their CEOs in the top ten percent of pay earn negative abnormal returns over the next five years of approximately -13%. The effect is stronger for CEOs who receive higher incentive pay relative to their peers. Our results are consistent with high-pay induced CEO overconfidence and investor overreaction towards firms with high paid CEOs.” That was the conclusion of Performance for pay? The relationship between CEO incentive compensation and future stock price performance by Cooper, Gulen, and Rau… one of two studies highlighted in Does Golden Pay for the CEOs Sink Stocks? (Jason Zweig, WSJ, 12/26/09).
According to Rau, CEOs in his study averaged $23 million—but leave their shareholders poorer (relative to other companies in the same industry) by an average of $2.4 billion per year. Each dollar that goes into the CEO’s pocket appears to take $100 out of shareholders’ pockets. If that is true, there is obviously something very very wrong with the typical incentive structure.
The CEO Pay Slice by Bebchuk, Cremers, and Peyer investigated the fraction of the aggregate compensation of the top-five executive team captured by the CEO – and the value, performance, and behavior of public firms. They found “CPS is negatively associated with firm value as measured by industry- adjusted Tobin’s Q.” CPS is found to be correlated with
- lower (industry-adjusted) accounting profitability,
- lower stock returns accompanying acquisitions announced by the firm and higher likelihood of a negative stock return accompanying such announcements,
- higher odds of the CEO’s receiving a “lucky” option grant at the lowest price of the month,
- greater tendency to reward the CEO for luck due to positive industry-wide shocks,
- lower performance sensitivity of CEO turnover,
- lower firm-specific variability of stock returns over time, and
- lower stock market returns accompanying the filing of proxy statements for periods where CPS increases.
Zweig’s article goes on to cite Benjamin Graham’s 1951 recommendation that directors “must have an arm’s-length relationship with management; they also should combine “good character and general business ability” with “substantial stock ownership.” (They should have purchased most of their shares outright rather than getting them through option grants.)” He also notes that Graham called to independent directors to publish a separate annual report analyzing whether the business is “showing the results for the outside stockholder which could be expected of it under proper management.”
Each month I take readers on a time trip in CorpGov.net’s “WayBack Machine,” to see what we were discussing 5 and 10 years ago. It is interesting to see how often we are grappling with the same issues. If we had only listened to Graham 58 years ago, how different would corporate governance be today? While we can’t change the past, we can at least work to ensure CEO pay is better aligned long-term shareowner value in the future.
Service Employees International Union (SEIU) Master Trust launched a campaign recently, mostly aimed at banks, proposing the following reforms:
- Requiring that at least 80 percent of an executive’s annual compensation be subject to multi-year vesting and/or holding periods;
- Requiring executives and directors to hold a significant equity stake in the company and basing that stake on the value of the executive’s annual compensation package;
- Making the timing of the equity awards predictable so shareowners know by the annual meeting date the total compensation level awarded to the executive team in the previous year;
- Enacting effective clawback provisions that call for the automatic return of any bonus or incentive compensation awarded on the basis of financial results that subsequently required restatement;
- Requiring a substantial portion of annual cash and/or equity bonuses to be held until performance criteria are achieved;
- Making retention grants conditional upon executives remaining with the company;
- Prohibiting executives and directors from engaging in any hedging, derivative or other transactions with respect to equity-based awards granted as incentive compensation;
- Placing restrictions on severance payments, death/disability payments, compensation related to changes in control and perquisites;
- Forming a shareowner advisory committee to advise the board and the compensation committee on executive and director compensation;
- Allowing shareowners to cast an annual advisory vote on executive compensation;
- Including in proxy statements information about the steps being taken to align compensation with long- term incentives, to avoid incentives that promote undue risk taking and to prevent windfalls where there is no long-term shareowner gain;
- Requiring that at least three independent directors serve on the compensation committee;
- Prohibiting compensation committee directors from serving on the audit committee; and
- Adopting bylaws that allow shareowners to place director candidates on corporate ballots subject to certain conditions.
These seem like a good start. However, the devil is in the details. For example, requiring 80% of an exec’s annual compensation be subject to multi-year vesting and/or holding periods… getting 80% two years later meets that vague definition but certainly doesn’t meet criteria that would dissuade CEOs from gaming the system. Certainly, much more needs to be done in this area. RiskMetrics made an important change to their policy for 2010 by assessing the alignment of CEO’s total direct compensation and total shareholder return over a period of at least five years.
More discussion at How to Tie Equity Pay to Long-Term Performance, HBR, 6/24/09; Executive Compensation, Ethicsworld.org; Are senior executives worth what they are paid? Steven N. Kaplan vs Nell Minow, The Economist, 10/28/09.
Whole Foods Market Inc. said co-founder and Chief Executive John Mackey has given up the title of chairman in order to conform with current standards for good corporate governance. As of last spring, about 37% of companies in the Standard & Poor’s 500 stock index had separate chairmen and CEOs, up from 22% in 2002, according to the Corporate Library, a research firm in Portland, Maine. (Whole Foods CEO Gives Up Chairman’s Post, WSJ, 12/24/09)
Both the Conference Board’s Commission on Public Trust and Private Enterprise and the Council of Institutional Investors have long recommended roles of the CEO and Chairman be split to ensure an appropriate balance of power.
CEOs who retain the dual role make it extremely difficult to challenge a powerful chief executive if necessary to protect shareowner interests. When I approached WFMI on this issue several years ago, independent directors didn’t even routinely hold meetings without the CEO present. and be “more likely to have certain troubling governance characteristics than companies where the roles are separated.”
Spearheading the reform effort is the Chairmen’s Forum, an organization of independent chairs convened by The Millstein Center for Corporate Governance and Performance at the Yale School of Management. Last spring, Mary Schapiro told the Council of Institutional Investors that the SEC is “considering whether boards should disclose to shareholders their reasons for choosing their particular leadership structure – whether that structure includes an independent chair, a non-independent chair, or a combined CEO/chair.” If such a requirement goes through, expect withhold votes for directors at companies that provide poor explanations of why they haven’t split the roles.
As an activist shareowner of WFMI, I’ve been after them for years to make this change, along with others such as John Chevedden. I’m under no delusion that Mackey is now under the thumb of the board chair. I’m sure he remains the driving force behind WFMI. However, given his track record of blunders like faking his identity on blogs and denying shareowners the right to present resolutions during the business portion of the annual meeting, at least he now has a better chance of not making a mockery of WFMI’s shareowners. The content of Mr. Mackey’s online postings were directly at odds with the Company’s core values of transparency and stewardship. His refusal to allow shareowner resolution proponents an opportunity to speak during the normal business portion of an annual meeting, even though SEC Rule 14a-8(h)(3) requires that a proponent or representative of a resolution contained in the company proxy must present their proposal, also conflicted with our Company’s "Declaration of Interdependence," which "requires listening compassionately, thinking carefully and acting with integrity."
According to Richard Bernstein, chief U.S. strategist at Merrill Lynch, companies in the top 100 of the S&P 500 with split chairman and CEO outperformed those that combine the roles during the last decade. Corporations with split roles posted a 22% annual return since 1994, outpacing the 18% return earned by firms that did not. WFMI is a great company that could be even better if it took the role of shareowners as seriously it does that of customers and employees. Splitting the roles of CEO and chair is a good sign attitudes may be changing. Instead of viewing participation by shareowners as creating a circus atmosphere, as Mackey has characterized it in the past, maybe now we will see real dialogue that will increase long-term value.
Prior to the Forum, I attended a reception honoring the Rising Stars of Corporate Governance for 2009. Those included in the photo are (left to right, top to bottom):
- Evelynne Change, Coordinator for Corporate Governance, African Peer Review Mechanism (APRM) Secretariat, New Partnership for Africa’s Development (NEPAD)
- George Anderson, Partner, Tapestry Networks
- Elizabeth Ising, Associate Attorney, Gibson, Dunn & Crutcher LLP
- Stephen Brown, Director & Associate General Counsel, Corporate Governance, TIAA-CREF
- Deborah Gilshan, Corporate Governance Counsel, Railpen Investments (a subsidiary of rpmi)
- Rachel Lee, Senior Corporate Counsel, EMC Corporation
- Nada Abusamra, Attorney at Law, Partner, Raphaël & Associés Law Firm
- Julieta Rodríguez Molina, Associate Attorney, Galindo, Arias & López
David Hess, Assistant Professor of Business Law & Business Ethics, Stephen M. Ross School of Business, University of Michigan and Alexis B. Krajeski, Associate Director, Governance and Sustainable Investment, F&C Investment were also named rising stars but were unable to attend the reception.
I also caught this quick shot of several members of the Millstein Center for Corporate Governance and Performance staff who were involved in making the Forum a huge success. Included here from left to right are:
- Michele Grammatico,
- Ira Millstein,
- Meagan Thompson-Mann,
- Milica Boskovic,
- Stephen M. Davis,
- Crysta Collins.
Note regarding the limitations of this report: Often at the Forum several sessions met concurrently; I could only be in one place at once. Additionally, in order to encourage the free exchange of information and opinion, I agreed, generally, not to report for attribution. Therefore, the following notes provide only a brief sketch of what I focused on and how my limited observation mixed with my own opinions. Of course, sessions were designed to elicit debate among experts with often well known conflicting opinions, so consensus was relatively rare but insights were not. I’ve provided some links that may give readers a better understanding of the positions of individual participants.
Plenary 1: What is the proper balance between regulation and private sector initiatives to restore trust in the market system?
Moderator: Ira Millstein, Senior Associate Dean for Corporate Governance, Yale SOM; Senior Partner, Weil, Gotshal & Manges LLP. Discussants: William Donaldson, Chairman, Donaldson Enterprises; Fmr. Chairman, SEC; Founding Dean, Yale SOM; William Goetzmann, Edwin J. Beinecke Professor of Finance and Management Studies and Director, International Center for Finance, Yale SOM; Mats Isaksson, Head, Corporate Affairs Division, Organisation for Economic Co-Operation and Development (photo: right to left)
I think there was general recognition by panelists that we have been through a recent period of very little regulation, when far too many ignored risk. There was frustration that mutual funds and other intermediaries frequently don’t acknowledge or behave as if they work for us. Instead, too many are more concerned with lining their own pockets.
Reference was made to the glorious revolution of 1688. I’m not sure I got the context but I imagine it was a call for shareowner democracy, in much the same way as the Bill of Rights in 1689 ended absolute dominance by the king. While we seem to be near ushering in an era of democratic rights for shareowners, there were also concerns with the likelihood of over regulation, especially enactment of regulations that aren’t enforced, either because of practicalities, lack of will, or follow through.
One danger of over regulation is that it often leads to an assumption that someone is taking care of “it.” Regulations work best when they empower markets and those dependent on the regulated to make the markets work or to enforce the rules.
The focus on “say on pay” for CEOs is overblown, according to at least one panelist. There’s very little evidence that it will bring down pay. In fact, the movement risks taking attention away from the real problem of incentive structures for dealers and traders who were walking away with huge bonuses for short-term deals. Hedge fund and private equity groups were seen as possible problems. Yet one panelist cited an OECD Steering Group conclusion that “activist” hedge funds and private equity firms could help strengthen corporate governance practices by increasing the number of investors that have the incentive to make active and informed use of their shareholder rights.
Regulators frequently respond like generals that just lost a war. They plan how to win the last war, not the next. We need to understand tomorrow’s markets, yet we are the product of our experience. Throwing out Glass Steagall created something of a free for all, although there doesn’t appear to be much political will for turning back.
It all starts with the education. Principles start at home but have been diminished in our educational system, especially in business programs. We lost our bearing with the appointment of SEC commissioners who didn’t believe in rules or regulations.
We need regulations, like we need traffic lights. Too few have asked what makes for a great company. Get at key factors like employee morale and quality, not just making money. Others argued the DNA of selfishness brought us prosperity. Don’t blame everything on markets and don’t expect everything from them. The market won’t fix things that must be fixed by politics, like the disparity of wealth.
Students come into university with a competitive history of community service. Yet, once here, most spend their summers working for hedge funds or commercial banks. Their next level of winning is a salary beyond imagination. We need to change educational structures to broaden the entrepreneurial to include giving back to society.
A fundamental question involves our approach. Do we try to solve with our problems with prescriptive regulations or by empowering shareowner engagement? Clearly, most believe the later. Owners need structures to support their ability to hold management accountable. Proxy access, say on pay (primarily as a vehicle for communication), supercharging dialogue with boards…. those are the directions.
What about rights that follow a share of stock? Should you be rewarded for holding for the longer term? It gets complicated. Most seemed to recognize the importance of large activist shareowners. Some felt that since pension funds feed the private equity funds, they need to take a larger part in keeping these funds in line and their costs down. Others focused on conflicts of interests among intermediaries, such as credit rating agencies that are paid by issuers and given monopoly status by the government. One answer might be rating the raters, either by SEC or others. A member of the audience from Egan Jones pointed to his firm as not being paid by the entities being rated, so there is a clear alignment of interest between investors and the firm.
There were lots of good ideas but little unanimity on solutions. Like mutual funds that make more money by starting more funds than by earning money for their clients, intermediaries seem likely to continue to lead most investors astray.
Plenary 2: Has the public corporation model been under challenge from the current crisis? Are there lessons from private equity?
Moderator: Andrew Metrick (left), Theodore Nierenberg Professor of Corporate Governance, Yale School of Management.
Discussants: Rich Ferlauto (right), Director, Corporate Governance and Pension Investment,
Suzanne Hopgood (left), Director, Board Advisory Services, NACD;
Ronald W. Masulis (right), Frank K. Houston Professor of Finance, Owen Graduate School of Management, Vanderbilt University;
Thomas Werlen (left), Group General Counsel, Novartis International AG
Andrew Metrick started the group off with a reference to Michael Jensen’s Eclipse of the Public
Corporation. Jensen thought the public model was broken.
The KKRs of the world were going to take over, loading corporations up with debt. They would take a direct role in corporate governance. Private equity does seem to be taking a larger role. The public model is costly, based on information intermediaries analyzing markets. Private equity structures better align investor
interests, at least those of the managing partners, with those of the company but investors are not getting a lot of detail with that model either. So, we have two different models to solve asymmetric information issues. Two competing models. Have public markets failed?
Panelists also raised other issues. Are they engaged with beneficial owners and other stakeholders? Do they demonstrate independence of thought or are they trapped in group think? We want diverse directors who are reflective and engaged in self evaluation. Do shareowners have the resources to intervene? They have a collective voice problem, often a lack of expertise but have a fiduciary responsibilities to beneficial owners. What we’ve experienced is regulatory arbitrage, a race to the bottom, seeking the weakest regulator.
At least one panelist felt strongly suspect of the private equity model. Within the top quartile, these funds that can take advantage of cheap money. It wasn’t the model that worked but circumstances. In fact, they were over leveraged, depending on loopholes in tax system. Often they skimmed low hanging fruit and took short-term exit strategies.
Other approaches might include investor representation on boards where, through collective action, they can effectively engage on behalf of beneficial owners. Stakeholder engagement councils could be convened as method of risk management. Certainly, we need more in the way of director disclosure and evaluation concerning their expertise and philosophy. The current information disclosures for director nominees is nearly worthless. Use of new technologies can help get us over collective action problems. Regarding risk management, we need to move to independent chairs but also need inside directors on risk committees with deep knowledge of companies. In a theme often repeated, investment companies must resolve conflicts between their fiduciary obligation to the company and their duty to investors. Resolution must find solely in the interest of investors.
Board composition is critical. Transparency in public companies instills discipline, even if you must issue a statement that investors can no longer rely on financial statements. Turnaround boards must be focused and committed. They should develop their strategic plan, determine skill sets needed, match those with the skill sets of board and ask what value each director brings to board. Disclose it in proxy. Shareholders will love it.
Public corporations in the US are generally characterized by strong management and atomistic shareholders. We suffer from information asymmetry to the degree that it is almost impossible for shareowners to monitor. Unfortunately, independent board members also lack knowledge of the business and management. Frequently, they don’t devote as much time to job as they should. Private corporations generally have fewer board members, more diversity, hands on involvement, and are incentivized to spend more time and effort. Public companies should take a lesson from such private boards. Strengthening boards is more important than shareowner involvement, since most shareowners will never have access to needed information or enough incentive to monitor.
Academic research shows that improving corporate governance is a primary driver of wealth creation. Concentrated ownership gives major owners control. Expertise, financial incentives, guarding against empire building, more efficient reporting systems, high leveraging, managers with invested liquid assets, bonuses in stock rather than cash… Why don’t public boards model such characteristics?
Financial reporting doesn’t track risk taking activity. Quarterly reports lag on risk. Our current system rewards high risk taking for short-term earnings. Inside directors have been dismissed but they are critical with regard to knowing what questions to ask (even better if they are also serve on more than one board).
Leveraged buyouts more frequently have the financial incentives, diversity, and critical skills. Regarding directors in general, foreign directors in the US are not helpful, since they tend to miss meetings. The recent IRRC report, What Is the Impact of Private Equity Buyout Fund Ownership on IPO Companies’ Corporate Governance?, was raised. “Whatever benefits there may be to the private equity model, they seem to disappear once a private equity backed company goes public. The findings are contrary to conventional wisdom and significant for investors,” said Jon Lukomnik, program director of the IRRC Institute. When they go public, such firms were more likely than others to have classified boards, poison pills, and restrictions on director removal by shareholders. Additionally, the report indicates that lucrative consulting agreements for former executives, generous employment agreements, and special bonuses are significantly more common at private equity buyout backed companies. Finally, the analysis indicates that once taken public, executive compensation at private equity backed companies tended to be higher, less performance-related, and less at-risk than at comparable companies that did not have private equity sponsorship.
One panelist asserted the value of discipline around directors with audit experience. Companies perform better with outside discipline and an organized agenda. Outside directors are key. Committee chairs must bring the discipline. Another said good governance isn’t just a matter of process. The key is balancing strategic vision and monitoring functions. Constructive challenge comes most frequently from the chair or lead director. Executive session useful in getting “snits” managed. It forces and focuses discussion. Telephone meetings are useful specific issue. CEOs who speak last will ensure generation of genuine discussion. Private companies are better for rapid change, while public companies are better for high growth mode/cycle. Public companies generally have a lower cost of capital, whereas private companies are easier to restructure. Both have their place.
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Focus Panel 2 (photo right): What effect did the financial crisis have on this year’s proxy season, if any? What is the long-term impact of the crisis on shareholder governance responsibilities?
Moderator: Meredith Miller, Assistant Treasurer for Policy, State of CT.
Discussants: Kenneth Bertsch (right), Executive Director, Corporate Governance, Morgan Stanley Invest.
Abe Friedman (left), Managing Director, Global Head of Corporate Governance & Proxy Voting, Barclays
Miller led off with general statements about the proxy season. There was an increase in no action requests but a reduction in the number granted. There also appears to be an increase in withholds, more requests to split the chair/CEO, more contests. Demands for bonus pools and majority vote were also being pressed.
Other panelists noted the level of engagement is going up. Funds are more frequently being contacted by CEOs CFOs, general counsel, and even board members. Abe Friedman described how he must prioritize, screen and log calls. With the largest fund, I can imagine that gets tough during proxy season. He and others said they pay attention to these calls and often learned something, especially if there is a proxy contest or vote no campaign.
One panelist pointed out there are many issues on the table that still haven’t been resolved. It is time to get serious about majority voting, which may be a done deal at many of the largest companies but has still not been adopted by most small companies. Declassifying boards, poison pills (voting on it), and proxy access… If there ever was a time to focus on the few important things, now is the time.
Again, there was dispute among some panelists and participants on the say on pay issue. All agree that pay is really important because of how it incentivizes. But some think say on pay is not the right answer. It can even be harmful. Say on pay is seen by them as the executive’s safety net. We’re not going to know all the details related to pay, since disclosing strategy would harm competitiveness. And, of course, the execution of strategy should be a prime component in pay for performance. When shareowners vote overwhelmingly for pay that is structured badly, this simply provides legitimacy for poor practices. Say on pay will prove to be a shield, not a sword. Investors should focus on voting out those who approve unjustified pay. Focus on majority vote, so that directors who are not doing their job can be voted out. The ultimate say on pay is voting out directors.
Others who were initially skeptical have come around because the pay issue is the single most significant marker with the public. The cost of poorly structured pay is significant. Owners are already voting on bonuses, stock options. It provides another “pulse check.” Capability needs to be developed. It is an evolutionary process.
Another panelist was pushing hard for 10% thresholds to call a special meeting. This is something Bob Monks also emphasized when I spoke to him about the next point of shareowner leverage. Most shareowners seem to be willing to withdraw resolutions if companies make substantial movement towards a lower threshold. That makes me think shareowners may be settling for 25%, which will be harder to lower in the future. Compromise may not be such a good thing if it draws a line that is more difficult to move in the future.
At least one panelist and several in the audience seemed to be pushing for advance disclosure of proxy votes. Anne Sheehan spoke up from the audience about their experience at CalSTRS of announcing their votes through platforms at Broadridge and ProxyDemocracy. She was glad they started at end of season because it gives them some time to “test drive” the system before going through a full proxy season. Yes, it has been something of an adjustment to plan a little further in advance. Several discussed possible downsides, primarily logistics, increased contact from benefical owners, and being afraid of announcing a vote and then and having to change. I know that ProxyDemocracy is out beating the bushes. I’d love to see more involvement and disclosure by international and mutual funds, as well as endowments and other mission-based funds.
Laura Berry (left), of the Interfaith Center on Corporate Responsibility, spoke from the audience, noting ICCR’s many years of attempting to raise issues regarding subprime loans and asked if panelists would be looking at social proposals more seriously because of their ability to predict problems. Yes. Everyone seems in agreement on that one. As a side note, IRRC celebrates its 40th anniversary through a year-long series of monthly audio podcasts entitled The Arc of Change. You can join ICCR’s Facebook group to keep up on their activities.
Focus Panel 5: The role of institutional investors in restoring trust
Moderator: Anne Simpson (right), Senior Portfolio Manager for Corporate Governance, CalPERS
Discussants: Peter Butler (left), CEO, Governance for Owners LLP
Catherine Jackson (right), Manager, Corporate Governance & Proxy Voting
Ontario Teacher’s Pension Plan
Keith Johnson (left), Head of Institutional Investor Legal Services, Reinhart Boerner Van Deuren
Anne Sheehan (far right), Director of Corporate Governance, California State Teachers’ Retirement System (CalSTRS)
There was discussion about the need to be as transparent as we are asking our companies to be. We need to be working closely with regulatory agewncies and to be prepared for changes. Otherwise, we are going to be like the dog that chased the car and caught it. We need to be active participants in the market, engaging with the SEC and Congress and speaking with one voice.
Keith Johnson said the UK’s University Superannuation Scheme developed a questionnaire for candidates and nominating committees. It asks candidates about their skills, how they relate to those of the board and its needs, as well as why they they will make effective directors. The Canadian Institute of Corporate Directors has posted a list of Key Competencies for Director Effectiveness that ties in well with board evaluations.
Cathrine Jackson said OTPP has been disclosing proxy votes in advance on their website in advance for years. In her opinion, too many funds outsource voting and engagement. Transparency and accountability; OTPP seems to be leading the pack.
One panelist said shareowners need to combine forces. Over diversification has become a problem. We need to “think globally and act locally.” (As an aside, the original phrase “Think Global, Act Local” first appeared in the book Cities in Evolution (1915) by town planner and social activist Patrick Geddes.)
Questions were raised about the skill set fund managers have, how we solve the free-rider issue, who should pay for necessary research, who should actually engage with companies. If companies paid, every shareowner would pay for research. It was suggested that half the money required come from companies, the other half from a levy on every investment scheme that gets tax relief. The issue of shareowner representatives for corporate nomination committees was also raised. Apparently, this is something like the approach used in some Scandinavian countries. (see Swedish director-election rules could cross Atlantic, MarketWatch.com, 4/17/09)
Another issue raised was stock lending with warnings that some have sold their franchise. Most appeared in agreement that funds should always recall their stock for voting. The difficulty arises primarily when special meetings are called. OTPP doesn’t lend their stock anymore. One suggested that long-term shareowners should be given loyalty payments. (Sleight Corporation (link to PowerPoint) in France considered paying extra dividend payments after two years but, as I recall, they rejected the idea.)
What would get shareowners to act responsibly? Suffering huge losses should be motivation enough. Ideas were thrown out such as asking DOL to establish by regulation that pensions must be engaged, enforcing current rules, sharing resources between funds, pooling resources. OTPP is opening up to accept other funds from other entities. California funds have made some attempt to share resources. Engagement must be based on bottom line results. It was a good dialogue with many creative ideas.
Plenary 3: Government as shareholder of or lender to public corporations: What is the government’s role?
Moderator: Jonathan Koppell (right), Faculty Director, Millstein Center for Corporate Governance and Performance, Yale SOM
Discussant: Steve Odland (left), Chairman & CEO Office Depot (As far as I know, Odland was the only CEO to attend or at least to present at the Forum. That’s certainly to his credit but where were the others? More are needed at forums like this to ensure adequate dialogue.)
There was an interesting discussion here by Odland who recounted his experience with investors and a proxy contest. There were multiple shareholders with different timeframes and strategies. The gist of it was that investors aren’t of one voice and even if they are, the voice can change dramatically and sometimes is not accompanied by memory. Whatever strategy management uses, some shareowners aren’t going to like it. He had many good points. Not every activist is a good activist. Odland would like long-term interests to be aligned. Three years seems like forever to many hedge funds and other shareowners. We’ve got to find common ground.
They talked about who is the best owner across boundaries. Is government similar to other investors? How do you deal with generic issues of self-dealing with the government as owner, since the sovereign is both above the law and the regulator. Power corrupts and absolute power corrupts absolutely. Put the finest most capable people on boards to exercise their best independent judgment. CEOs would love to have large shareholders long-term. There was discussion of how to avoid unintended consequences and some commitments from people in the audience to try to work and find common ground with the Business Roundtable.
Plenary 4: Will the crisis help or hinder the integration of the global financial markets?
Moderator: Jeff Sonnenfeld, Lester Crown Professor in the Practice of Management & Senior Associate Dean, Executive Programs, Yale SOM (right)
Discussants: (left to right) Leonardo Peklar, Chairman, Socius Consulting, Inc.; Marcos Pinto, Commissioner, Securities and Exchange Commission of
Brazil; John Sullivan, Executive Director, Center for International Private
Enterprise (CIPE) James Shinn, Lecturer, Princeton University.
Sonnenfeld showed a Saturday Night Live parody of the stress tests. I hadn’t seen it… funny.
The main basis for optimism appears to be the hope that institutional investor will pay a premium for good corporate governance and that corporations will lobby governments to get standards raised. However, there were assertions that there may actually be a slight negative correlation between price and the quality of corporate governance by most indicators. Additionally, there is little evidence of corporations lobbying to improve governance. Witness continued opposition to proxy access from the US Chamber of Commerce and the Business Roundtable.
Don’t give up though. There is a strong correlation between the amount of money managed by pension funds and the quality of governance, especially when they have the political support of the citizens. (Hmm… what about when defined benefit plans are under all out attack?)
Brazil’s Novo Mercado, with its higher governance standards, seems to be working in a “race to the top.” However, apparently a similar attempt in Romania didn’t.
Brazil has had rebirth. Stocks have appreciated 40% since the beginning of year. Flows are positive since January, with about 37% coming from outside Brazil. Most derivatives are also regulated and there is disclosure of related third-party transactions.
In most markets, shareowners have been trading liquidity for control. The financial crisis revealed severe shortcomings in corporate governance. When most needed, standards often failed to provide the checks and balances that companies need in order to cultivate sound business practices. The OECD’s Corporate Governance Lessons from the Financial Crisis provides an overview of these shortcomings and resulting challenges.
There were discussions around block holding, both by families and governments, and how the role of director differs in a country like China where they may represent both shareowners and the government. The wisdom of Millstein’s advice to the OECD was acknowledged to be outcome oriented. How we get there may differ.
Comments from others:
On Thursday, Ira Millstein announced that leaders from the Millstein Center had joined three former SEC Commissioners, a former World Bank President and a former US Treasury Deputy Secretary in calling for enactment of long-championed financial market accountability and transparency reforms that include access to the proxy, say on pay, independent board chairs and creation of a permanent commission to develop and oversee updating of a US code of corporate best practice principles. That was a bold, but important, step for an academic center. To me, it demonstrated why the Forum consistently attracts so many insightful corporate governance leaders from around the globe. – Keith L. Johnson, Chair, Reinhart Institutional Investor Services
More photos from the Forum:
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 moving 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.
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Cynthia Richson moderated the first panel of the Forum’s program on the topic "Shareholder 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 duPont 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.
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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.
The 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.
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Former SEC Chairman Christopher Cox (right) made a plea for an "exit strategy" from government ownership and involvement. 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 attendance, 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 need 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 conference. 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:
|Larry G. Stambaugh||Cynthia L. Richson||James Hale|
|Linda Sweeney||Annalisa Barrett||David Bergheim|
|Bruce Doyle, III, Ph.D.||Karin Eastham||C. Hugh Friedman|
|Deborah Jondall||Garry Ridge||David Salisbury|
|John C. Stiska||Bill Trumpfheller|
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.
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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.
- The strength of a director’s identification with being a CEO will have a positive relationship with resource provision, but a negative relationship with monitoring. The strength of a director’s identification with shareholders will have a positive relationship with resource provision and monitoring. (Directors’ Multiple Identities, Identification, and Board Monitoring and Resource Provision by Amy J. Hillman, Gavin Nicholson, Christine Shropshire)
- After a large spike in likelihood of taking a board seat in year 1, it drops significantly (deterioration). Former officials better take one of those offers quick, before their currency expires. (Former Government Officials as Outside Directors by Lester, Hillman, Zardkoohi, and Cannella)
- Firms linked to fraudulent firms lost an average 1% of market value within 2 days of fraud allegation announcement, $49B overall. Penalties diminished when the linked firm exhibited certain "effective" corporate governance structures (e.g., heavily independent board, inside director ownership) (Director Interlocks and Spillover Effects of Reputational Penalties from Financial Reporting Fraud by Eugene Kang)
- Fewer women sit on boards in countries with long traditions of female elected political officials. (Female Presence on Corporate Boards)
- While the mere presence of women on boards does not increase firm value, greater gender diversity does (Gender Diversity in the Boardroom and Firm Financial Performance).
- CEOs’ ingratiation and persuasion tactics toward institutional fund managers reduce the effect of institutional ownership on specific changes in board structure and composition, CEO compensation, and corporate strategy that are believed to compromise management’s interests. (The Pacification of Institutional Investors)
- Executives ward off stock downgrades by currying favor with analysts that cover their companies. The greater the earnings shortfall, the more favors. Analysts who downgrade a stock receive significantly fewer favors thereafter. Even analysts who see a fellow analyst receive reduced favors from a firm are less likely to downgrade that firm. (Sociopolitical Dynamics in Relations Between Top Managers and Security Analysts)
- Advice seeking by CEOs increases with CEOs’ stock ownership and performance-contingent compensation, and with board monitoring. (Getting Them to Think Outside the Circle)
- CEOs are more likely to manipulate firm earnings when they have more out-of-the-money options or lower stock ownership, and when firm performance is low. (CEOs on the Edge: Earnings Manipulation and Stock-Based Incentive Misalignment)
- Firm-specific downside risk is strongly correlated with CEOs’ stock divestitures and their magnitude. (Too Risky to Hold? The Effect of Downside Risk, Accumulated Equity Wealth, and Firm Performance on CEO Equity Reduction)
- Only a firm’s largest institutional holder is perceived as having an information advantage, based on an increased buy/ask spread. The greater the percentage of shares held by the largest institutional investor, the greater the perceived information advantage. (Information Advantages of Large Institutional Owners)
- Increases in the size of portfolio holdings, number of portfolio blockholdings, portfolio turnover, and the importance of a particular holding reduce monitoring effectiveness. (Institutional Ownership and Monitoring Effectiveness: It’s Not Just How Much but What Else You Own)
- Firms with outsider-dominated (80%+) boards are more likely to enact shareowner resolutions that pass, as are smaller outsider-dominated boards and larger non-outsider-dominated boards. High levels of CEO ownership reduce the likelihood of enactment. (The Ethical Implications of Ignoring Shareholder Directives to Remove Antitakeover Provisions)
- Commercial ratings are not linked to firm performance. Commercial ratings are not linked to shareholder voting (or ISS voting recommendations), according to a forthcoming study by Professor Ryan.
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.
America 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 →
Many, including this reviewer, called Bebchuk and Fried’s Pay without Performance: The Unfulfilled Promise of Executive Compensation the best corporate governance book of 2004. James McConvill’s The False Promise of Pay for Performance: Embracing a Postive Model of the Company Executive, largely a critique of Pay Without Performance, deserves similar attention.
Bebchuk and Fried clearly demonstrated that many features of executive pay are better explained as a result of shear managerial power, rather than arm’s-length bargaining by boards of directors. Their recommendations on improving executive compensation are aimed at eliminating or reducing some of the most egregious problems and are written to shareholders, since such reforms are not likely to be raised by “independent” directors, as independence is currently defined. One of their major points is that board members should not only be independent of CEOs, they should also be dependent on shareholders. Continue Reading →
Pay Without Performance
Pay Without Performance: The Unfulfilled Promise of Executive Compensation was the best book published in 2004 in the field of corporate governance. Lucian Bebchuk and Jesse Fried focus on one aspect of corporate governance, executive pay, and clearly demonstrate that many features of executive pay are better explained as a result of shear managerial power, rather than arm’s-length bargaining by boards of directors.
After thoughtful analysis, they find systematic use of compensation practices that obscure the amount and performance insensitivity of pay, and the showering of gratuitous benefits on departing executives. The cost of current corporate governance systems is weak incentives to reduce managerial slack or increase shareholder value and perverse incentives for managers to misreport results, suppress bad news, and choose projects and strategies that are less transparent.
Their recommendations on improving executive compensation are clearly aimed at eliminating or reducing some of the most egregious of the practices of those they document. Interestingly, the recommendations are written to shareholders, apparently because there is little likelihood such reforms will be raised by even independent directors without further corporate governance reforms. A few examples are as follows:
- To reduce windfalls in equity-based plans, shareholder should encourage that at least some of the gains in stock price due to general market or industry movements be filtered out. At a minimum, option exercise prices should be adjusted so that managers are rewarded for stock price gains only to the extent that they exceed those gains (if any) enjoyed by the most poorly performing firms.
- Executives should be prohibited from hedging or derivative transactions to reduce their exposure to fluctuations in the company’s stock and should be required to disclose proposed sale of shares in advance to reduce perverse incentives to benefit from short-term gains that don’t reflect long-term prospects.
- Do not provide large payments to executives who depart because of poor performance.
- The compensation table should include and should place a dollar value on all forms of stealth compensation, such as pensions, deferred compensation, postretirement perks and consulting requirements.
- Allow shareholders to propose and vote on binding rules for executive compensation arrangements.
Although many directors now own shares, their related financial incentives are still too weak to induce them to take on the unpleasant task of firmly negotiating with their CEOs. Recent reforms requiring a majority of independent directors, and their exclusive use on compensation and nominating committees, may be beneficial but cannot be relied on to produce the kind of arm’s length relationship between directors and executives needed. CEOs retain influence over director compensation and rewards, as well as social and psychological rewards. The key to reelection is remaining on the company’s slate. Remaining on good terms with the CEO and their director allies continues to be the best strategy for renominatation.
Executive compensation requires case-specific knowledge and thus is best designed by informed decision makers. They conclude, While we should lessen directors’ dependence on executives, we should also seek to increase directors’ dependence on shareholders. After discussing the now failed open access SEC proposal to grant shareholders the right to place a token number of candidates on the ballot after specified triggering events, the authors propose the following significant corporate governance reforms:
- Access to the ballot should be granted to any group of shareholders that satisfies certain ownership thresholds. Their example is 5%, held for at least a year.
- Such slates should be able to replace all or most incumbent directors in any given year.
- Companies should be required to distribute the proxy statements of shareholder nominated candidates and should be required to reimburse reasonable costs if they garner sufficient support.
- Legal reforms should require or encourage firms to have all directors stand for election together.
- Shareholders should be given the power to initiate and approved proposals to reincorporate and/or adopt charter amendments.
In their conclusion, the authors recognize the political obstacles to the necessary legal reforms are substantial and that corporate management has long been a powerful interest group. The demand for reforms must be greater than management’s power to block them. This can happen only if investors and policy makers recognize the substantial costs that current arrangement impose. Pay without Performance will certainly contribute to such recognition. It should be required reading for every fund fiduciary, SEC board and staff, as well as all members of Congress. Shareholders should read while sitting down.