Tag Archives | Corporate Governance

CorpGov Trends at Largest US Public Companies

2010 Corporate Governance of the Largest US Public Companies General Governance Practices (Shearman & Sterling LLP, pdf) The survey provides a wealth of data concerning board practices at the top 100 companies. A few highlights with a focus on issues of significance to shareowners:

  • 82 have implemented some form of majority voting in uncontested director elections, up from 75 last year. In light of the fact that the Reform Act does not include a majority voting requirement with respect to uncontested elections, it is likely that majority voting will receive a great deal of attention during the 2011 proxy season.
  • Independent directors constituted 75% or more of the directors on the boards of 88 of the Top 100 Companies surveyed this year. The CEO was the only non-independent director at 59 of the Top 100 Companies.
  • Fifteen of the Top 100 Companies have a Chief Risk Officer. In addition, the boards of directors of eight of the Top 100 Companies have a risk committee, and nine of the other Top 100 Companies have a risk committee generally comprised of members of management.
  • Separate individuals serve as CEO and chair of the board at 30 of the Top 100 Companies, but of these companies only 11 have adopted an explicit policy of splitting the two offices. The chair is independent at 17 of the 30 companies with a separate chair. All 70 of the Top 100 Companies that have combined the offices of CEO and chair of the board have appointed a lead independent director.
  • Of the Top 100 Companies, only six have a Shareholder Rights Plan or “Poison Pill.”
  • Of the Top 100 Companies, 20 have a Classified or Staggered Board of Directors.
  • Of the Top 100 Companies, 69 disclosed transactions in which the company was a participant and in which a related person had a direct or indirect material interest.

Shareholder proposals for Removal of Supermajority Voting Requirement, Director Elections by Majority Vote and Shareholder Action by Written Consent all had an average level of support of over 50%. Most frequently submitted shareowner proposals:

  • Independent Board Chair
  • Two Nominees for Each Director Position
  • Cumulative Voting for Directors
  • Annual Election of Directors
  • Redemption of, or Shareholder Vote on, Poison Pill
  • Director Elections by Majority Vote
  • Removal of Supermajority Voting Requirement
  • One Vote Per Share
  • Certain Shareholders Can Call Special Meetings
  • Reincorporate in North Dakota
  • Shareholder Action by Written Consent
  • Succession Policy
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What the HP Episodes Tell Us About Governance

The events following the dismissal of Mark Hurd at HP illustrate why I have so vehemently advocated introduction of a result orientation into governance law (Require Affirmative Proof in Specified Circumstances of “Too Big to Fail Companies” in Order to Meet the Business Judgment Rule). As we know, Hurd was dismissed in early August in the wake of revelations of his involvement with a female HP contractor which may have included the filing of erroneous expense reports. He was paid about $35 million in cash and stock in accordance with contractual severance provisions.

In rapid succession, HP made two large acquisitions at prices well above prior market prices (HP’s Acquisition Binge Continues With ArcSight Deal). Hurd accepted a position as co-president of Oracle and Sam Palmisano, IBM’s CEO, strongly criticized Hurd’s management of HP by stating that he had drastically deemphasized research and development, IBM’s Chief Thumps H-P, WSJ, 9/15/2010.

All of this indicates that the HP board was more focused on the peripheral matters of Hurd’s relationship and expense reports than on his business strategy, which appeared to have been a short-sighted one leaving technological gaps in its offerings. We have seen too many situations where this was the case. The financial sector is a perfect example of where boards, while they may have utilized proper process, appeared to disregard highly questionable business strategies which led to disaster.

Obviously, HP has not suffered the same fate as Lehman, Bear Stearns, Citigroup, etc. Nevertheless, the spate of acquisitions coupled with Palmisano’s observations suggest that there may have been reason for concern (and perhaps actual concern) with underinvestment in the business. This makes the HP board’s focus on peripheral matters so distressing. The relationship with the contractor was irrelevant to the company’s business prospects, while the expense issue, which would have necessitated dismissal if there were clear evidence of fraud, was quite ambiguous and did not come close to this level. The payment of the large severance suggests that the board agreed that there was no clear evidence of misconduct. Apparently, no action would have been taken but for the personal indiscretions, despite much more fundamental concerns.

For governance to genuinely improve in this proxy access era, we’ll need boards to critique business strategy being pursued by management for coherence and common sense, to voice objections when necessary, and to take strong action when such objections are not heeded. As a general counsel who has experienced the problems resulting from an overly involved public company board, I emphasize that this does not mean board involvement in day to day business decisions, which must remain the province of management as a matter of efficiency and to avoid undermining management authority and credibility.

It does mean the board familiarizing itself with management’s strategy at a high level and determining if it makes sense in the first instance or, even if it did, if changing circumstances warrant fundamental changes. If management is going to be dismissed or sanctioned, it must be on account of matters which have a bona fide impact on shareholder value. Whether or not there are personal indiscretions, management must be held accountable for the direction of the company and the results of its stewardship

The HP board was apparently unwilling to act with respect to Hurd’s business strategy and acted only when peripheral matters, which are arguably minutiae, became public and embarrassed the company. Financial industry boards never acted against management which was plainly on the wrong track, because none of these peripheral matters presented themselves. The societal consequences are clear. Going forward, we need a focus on what really matters.

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Proxy Access: Private Ordering with High Threshold Minimums

Since filing the initial 21st century petition for proxy access in 2002 with Les Greenberg, I have written extensively on the need. With the 3-2 vote by SEC commissioners, as most expected, it will soon be a reality… in time for at least a portion of the 2011 proxy season. What we proposed back in 2002 was essentially what the Chamber, BRT and other rear-guard organizations have been calling “private ordering.” Let each company decide. Of course, ours was based on what shareowners would propose and pass, not simply on what an entrenched board and management might install without a shareowner vote.

As reported elsewhere, Proxy Access Is In (Lucian Bebchuk and Scott Hirst, Harvard Law School, 8/25/10).

Under the rule, a shareholder (or shareholder group) would need to hold more than 3% of the company’s shares for more than 3 years to be eligible to use the rule to place director candidates on the corporate ballot. These eligibility requirements, together with the rule’s procedural requirements, will place substantial limits on its use. (To illustrate, according to data put together by CalPERS, the 10 largest public pension funds together hold less than 2.5 percent at Bank of America, Microsoft, I.B.M. and Exxon Mobil.)

It should also be noted, the “First to File” rule was replaced with a “Size Matters” rule. As Bebchuk and Hirst indicate, “To the extent that these limits prove excessive, we hope that the SEC will reconsider the thresholds set today.” The limits are excessive but the SEC also voted to amend Rule 14a-8 to enable shareowners to include, on corporate proxies, proposals related to election and nomination procedures, like we could for many years until the SEC reinterpreted that rule, without a rulemaking or even notice, to prohibit such proposals. AFSCME v AIG led to a brief window of opportunity for shareowners when the court overturned that illegal action by the SEC. However, under Cox, the SEC they then changed the rule to prohibit private ordering by shareowners, even suggestions for private ordering, which is essentially what nonbinding resolutions do.

It is very important to have a base threshold. The new Rule 14a-11 puts entrenched managers and boards on notice that they are slightly more likely to be held accountable. Shareowners may be able to nominate and elect up to 25% of the board. While that doesn’t give them any real power to move the corporation in a different direction without the consent of the already entrenched, at least they’ll have a front row seat and will be able to make arguments, if they can get a second. Existing board members might just begin to get the feeling they are accountable to shareowners… not just fellow board members and the CEO.

One of the most important clarifications regarding the revised Rule 14a-8 is contained in footnote 674 of the release, concerning what is meant by a proposal under 14a-8 that may “conflict” with 14a-11.

Under the Proposal, Rule 14a-8(i)(8) would allow shareholders to propose additional means, other than Rule 14a-11, for inclusion of shareholder nominees in company proxy materials. Therefore, under the Proposal, a shareholder proposal that sought to provide an additional means for including shareholder nominees in the company’s proxy materials pursuant to the company’s governing documents would not be deemed to conflict with Rule 14a-11 simply because it would establish different eligibility thresholds or require more extensive disclosures about a nominee or nominating shareholder than would be required under Rule 14a-11. A shareholder proposal would conflict with proposed Rule 14a-11, however, to the extent that the proposal would purport to prevent a shareholder or shareholder group that met the requirements of proposed Rule 14a-11 from having their nominee for director included in the company’s proxy materials.

What the SEC has done is establish “private ordering” with a very high floor. Within a few years, we can expect to see 100s of proposals calling for more reasonable thresholds and holding periods, as well as allowing a greater proportion of shareowner nominees. Corporate governance activists have been given a new focus. Just as we have been struggling to obtain majority vote standards, we will now be fighting for more reasonable nomination requirements. To the John Cheveddens and Ken Steiners of the world I say, “Time to gear up; may a thousand access proposals bloom.” Start with small companies where the SEC has delayed implementation of Rule 14a-11 and where, on average, corporate governance reforms are furthest behind. Have an access proposal ready for next year? Please share it.

See also Pesky shareholder activists gain influence: After years of battling futilely to rein in corporate boards, ‘gadflies’ are winning votes, LATimes, 8/23/10; Speech by SEC Chairman: Opening Statement at the SEC Open Meeting; SEC Approves Final Proxy Access Rule, RMG, Ted Allen, 8/25/10; In 3-2 Vote, SEC Finally Adopts Proxy Access Rule, Compliance Week, 8/25/10; Social Investment Forum Welcomes Federal Proxy Access Rule, 8/25/10; press release, Shareowners.org, 8/25/10; ProfessorBainbridge, 8/25/10; The Conference Board blog, 8/25/10; S.E.C. Makes Access to Proxy Ballots Easier, NYTimes, 8/25/10; Jim Hamilton’s World of Securities Regulation, 8/25/10; Activist Shareholders Get a Louder Voice, Sarah Morgan, SmartMoney, 8/25/10; The SEC Adopts Proxy Access, theCorporateCounsel.net/Blog, 8/26/10; The Promise of Access, theRacetotheBottom, 8/5/10. And here’s a paper of mine published by the Corporate Board in July 2003, Toward Democratic Board Elections; Proxy Access & Shareholder Citizenship: The Quest for Inclusion, Marcy Murninghan, 8/26/10.

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CorpGov News Bites

CalPERS. A report from consultant Wilshire Associates found that activist involvement by CalPERS increased returns at many of  the 142 “Focus List” companies. Prior to the pension’s involvement, the companies’ returns averaged 83.3% below their various benchmarks; afterward they yielded returns 12.7% above the benchmarks. Although the cumulative 12.7% is not as high as past results, their corporate governance program still much more than pays for itself. From the report:

Most investment resources in the industry continue to be focused on identifying small misvaluations in publicly traded stocks. This is, perhaps, unfortunate since investors are not earning a satisfactory return on the manager fees and brokerage costs they pay, given the evidence showing that the public stock markets are fairly efficiently priced. However, the evidence is equally clear that many corporate assets are poorly managed and that resources spent on identifying and rectifying those cases can create substantial opportunity and premium returns for active shareholders.

CalPERS announced several actions to address concerns raised by the City of Bell salary controversy, including:

  • Posting audit reviews of public agency membership and payroll data submitted to the retirement system
  • Highlighting significant findings of public agency reviews and regularly report them to the CalPERS Board
  • Establishing procedures and guidelines for CalPERS working-level staff to notify supervisors and senior management of unusually high compensation and salary increases such as those that occurred in Bell

In addition, CalPERS helped establish the Public Employee Compensation and Benefits Task Force, which includes CalPERS staff and representatives public employer organizations, League of California Cities, California State Association of Counties, employee and labor organizations, legislative staff and other, focusing on:

  • Options for providing greater public disclosure of public employee compensation, benefits, and other information related to total employee compensation and benefits
  • Options regarding caps on total compensation that can be considered for retirement purposes
  • Options for mitigating the impact of excessive salaries on the retirement costs of a public employee’s previous public employers and other public agencies in the same liability risk pool

CalPERS had previously announced plans to review the compensation of CalPERS-covered employees who earn $400,000 or more per year in salary.  Phase two of the review will look at CalPERS member salaries of $245,000 per year and above.

On September 7, 2010, from 6:00 p.m. – 7:30 p.m., the Sacramento Central Labor Council and PERSWatch.net will host a “CalPERS Candidates’ Forum,” moderated by the League of Women Voters of Sacramento County. The forum will be held in the CalSTRS Boardroom at 100 Waterfront Place in West Sacramento, next to the pyramid. We’re trying to arrange for free parking but haven’t confirmed that yet. This is your opportunity to meet and question the candidates. A video of the forum will be archived on the CalPERS website.

Citigroup. Nice item by David Reilly in the WSJ (Citigroup’s Paltry Debt Penalty, 8/17/10) He sides with U.S. District Judge Ellen Segal Huvelle who refused the SEC’s proposed $75 million settlement with Citigroup over the bank’s failure in 2007 to disclose sub-prime mortgage risks. Goldman Sachs recently paid $550 million for a lesser offense but the SEC only wants $75 million from Citigroup. Why go after only two Citigroup executives for the paltry sums of $100,000 and $80,000 and why should shareowners pay for the execs alleged missteps?

The problem is Citigroup shareholders, under current rules, couldn’t necessarily oversee their company. That is partly due to the difficulty in challenging board directors… For shareholders to be held accountable, the SEC has to let them act more like owners.

Unfortunately, even under the SEC’s most probable proxy access rules shareowners may just have a better view of wrong doing and their money sliding away, since even under the best of circumstances they will only get to nominate 1/4 of the board.

Climate Change. With extreme weather mounting and Congress dithering, WRI report outlines what we can do now to reduce GHGs. The summary, “Everything You Need to Know About Global Warming in 5 Minutes,” by Boston investment manager Jeremy Grantham of GMO does a great job of ticking off the causes, consequences, and controversies surrounding climate change. (The Go-Getter Approach to Climate Change, 17 August 2010, MurninghanPost.com.

Cooperatives. If sustainable technologies are about the what of the living economy, local and shared ownership designs are about the who: who will own the productive capacity of the nation, who will control it, and who will benefit from the wealth created. Minwind Energy is an example of shared ownership, an emerging, broad category of ownership design in which ownership is shared among individuals (as in cooperatives or employee-owned firms) or between individuals and a community organization (as in a community land trust, where families own their homes while a nonprofit owns the land they stand on). (A Different Kind of Ownership Society, via Yes! Magazine, Marjorie Kelly and Shanna Ratner, 8/3/10)

Corporate Governance. It is no longer realistic to look to government to rectify problems caused in the private sector, or to simply ignore such problems and their broader consequences. We all need to look for innovative ways to avoid such problems, such as using the governance process to do so. (Why Corporate Governance Matters to Everyone, Marty Robins, The Huffington Report, 8/17/10)

With the specter of dramatic regulatory changes hovering over them, U.S. public companies have been acting aggressively to streamline corporate governance practices and establish their executive compensation priorities, according to Shearman & Sterling’s eighth annual Corporate Governance Surveys of the 100 largest U.S. public companiesKey corporate governance findings include:

  • Majority voting in uncontested director elections has been implemented in some form by 82 of the 100 largest companies, up from 75 last year and from just 11 as recently as 2006.
  • Despite amendments to NYSE Rule 452 implemented last year (eliminating broker discretionary voting in director elections), no director standing for reelection at one of the 100 largest companies failed to receive majority support this year.
  • The number of Top 100 Companies at which the CEO is the only member of the board of directors who is not independent increased significantly, rising to 59 this year from 49 last year.
  • The number of Top 100 Companies with classified boards, of which there were 54 in 2004, declined to only 20, and of those 20, more than one-third were either in the process of declassifying their boards or received approval from their shareholders this year to do so.
  • Seventy-one companies disclose they maintain an executive compensation clawback policy (an increase from 56 companies in 2009 and 35 in 2007  — representing a 103% increase in four years). This will become increasingly significant, as the new Dodd-Frank Act mandates clawbacks if a material restatement would have affected the amount received.
  • There was a decrease in the overall number of compensation-related shareholder proposals; however, advisory say-on-pay policies continued to be the most prevalent proposal. In addition, the survey suggests that companies cannot assume that their say-on-pay advisory resolutions will pass. For example, three public companies (including one Top 100 Company) failed to win majority support in the 2010 proxy season.

Economy. Biflation, generally defined as inflation and deflation occurring simultaneously in different parts of the economy—specifically, rising prices for commodities that trade in global markets and falling prices for things bought with credit domestically, like homes and automobiles. (Is ‘Biflation’ Real?, Newsweek, 8/16/10)

Electronic Board Meetings. Despite the obvious advantages of using technology and moving to electronic meeting management, few companies have achieved buy-in and taken board meetings to an electronic platform. Some have, however – and South Jersey Industries (SJI) is one such early adopter. (Best practice: establishing an electronic meeting management process, Corporate Secretary, 8/17/10)

Global Corporate Citizenship. Prof. Surinder Pal Singh outlines how global corporate citizenship rests on four pillars: values; value protection; value creation; and evaluation. These four pillars not only underpin the long-term success and sustainability of individual companies, but are also a major factor in contributing to broader social and economic progress in the countries and communities in which these companies operate. Along with good governance on the part of governments, they offer one of our greatest hopes for a more prosperous, just and sustainable world. (The Concept of Corporate Citizenship in a Global Environment, Political Wag, 8/17/10)

As the US markets continue to debate whether we are still in a recession, on the road to recovery, or headed for a double recession, the Indian government is busy imposing regulations to boost corporate philanthropy and social responsibility. In an economy that continues to post steady growth despite upheavals across Europe and the U.S., India Inc. is increasingly facing scrutiny for its role—or notable absence—in the social and environmental growth of the country. (Forcing CSR in India: Is Regulation the Answer?, The CSR Blog, 8/16/10)

Green Chemistry. Two California departments within Cal/EPA are working to identify “chemicals of concern” in consumer products. Eventually, they will push companies to substitute less toxic chemicals and maybe even ban some of those that are killing us now.

Greenest Campuses. 162 American colleges and universities rated by the Sierra Club. Also includes first steps on Chinese campuses.

Proxy Plumbing. The Shareholder Communications Coalition consisting of the Business Roundtable, National Association of Corporate Directors, National Investor Relations Institute, Society of Corporate Secretaries and Governance Professionals, and the Securities Transfer Association prepared a PowerPoint presentation to explain its recommendations for reforming the proxy voting and shareholder communications rules. “This presentation document is intended to help public companies, investors, and other interested parties understand how the proxy system can be improved to benefit all stakeholders.” This is an important initial assessment of feedback on the SEC’s proxy plumbing concept release. I suspect I will disagree with several parts but I heartily endorse their call to:

  • Do away with the VIF and replace it with a proxy card.
  • Pass voting authority directly to beneficial owners.
  • Enable beneficial owners to transfer their proxy authority back to their brokers or bank (e.g. client directed voting) or to another third-party.

Research in Progress. Stanford’s Rock Center for Corporate Governance and the Corporate Secretary’s organization are conducting a survey “to get some hard data and research on what companies are actually doing and hopefully figure out once and for all what elements of governance reform actually lead to improvements and which do not.”

SECRebecca Files finds that cooperation with the SEC through forthright disclosure of a restatement (e.g., disclosures reported in a timely and visible manner) increases the likelihood of being sanctioned, perhaps because it improves the SEC’s ability to build a successful case against the firm. However, both cooperation and forthright disclosures are rewarded by the SEC through lower monetary penalties. (SEC Enforcement: Does Forthright Disclosure and Cooperation Really Matter?, SSRN, 7/14/10)

The SEC settled its suit with New Jersey over securities fraud by issuing a cease-and-desist order, which the state accepted without admitting or denying the findings. No penalties were imposed. According to the SEC NJ claimed it had been properly funding public workers’ pensions when they had not. The SEC has a special unit looking into more public pension disclosures. (Pension Fraud by New Jersey Is Cited by S.E.C., NYTimes, 8/19/10)

The S.E.C. said the fraud began in 2001, when New Jersey increased retirement benefits for teachers and general state employees. New Jersey did not have the money to put behind the new benefits, but every year after that, the state treasurer certified that the pensions were being funded according to the plan.

The SEC finally confirmed they will consider adopting proxy access rules on 8/25. Still no word on threshold, holding period, small issuer exemption. next Wednesday, August 25th at an open Commission meeting. No word on how the big question marks – the ownership threshold and holding period – will be resolved. Sunshine notice. The U.S. Chamber of Commerce has retained Eugene Scalia, the son of U.S. Supreme Court Justice Antonin Scalia, to review the forthcoming SEC rules for a potential legal challenge. (SEC Plan to Pry Open Corporate Boards May Face Challenge, Bloomberg, 8/11/10) J. W. Verret of the George Mason University School of Law has already proposed more than a dozen way to circumvent the law in his paper Defending Against Shareholder Proxy Access: Delaware’s Future Reviewing Company Defenses in the Era of Dodd-Frank.

Shareowner Engagement. With the passage of the Dodd-Frank Wall Street Reform and Consumer Protection Act, power has shifted to shareholders.  The 2011 proxy season is a game-changer as the rules require boards to seek shareholder support for compensation programs and even directorship candidates. (Directors, Do You have a Shareholder Engagement Program?, Karen Kane Consulting, 8/12/10)

United States Proxy Exchange (USPX).  The USPX is a non-government organization dedicated to facilitating shareowner rights, primarily through the proxy process. They are structured as a chamber of commerce but unlike a typical chamber of commerce—which represents corporate executives—the USPX represents shareowners. Membership includes both institutional investors and sophisticated retail investors—many of whom have finance, corporate or legal expertise from their careers. Together, they work to promote an environment where engaged shareowners create value through the corporations they own. Check out their new website. Please join me; sign up for membership.

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CorpGov WayBack Machine

Stepping into the CorpGov.net WayBack Machine, here’s just a few of the issues we were covering in the past.

Ten years ago:

“The last time someone voluntarily gave up power was in 1800, when George Washington did it,” said Les Greenberg. Greenberg wants shareholders of cafeteria operator Luby’s to vote in favor of removing anti-takeover devices, electing directors annually and canceling bonuses for management if sales, profits or the share price decline. Oh, and he’s also running for the board. San Antonio Express-News writer Bill Day observed that “a decade after democracy finally sprouted in Russia, Eastern Europe and South Africa, it makes sense that a pro-democracy movement would be pushed in corporations.”

Executive compensation expert Graef Crystal continues to hammer on excessive compensation. By 2015 the ratio of the average executive’s pay to that of the average worker will approach that which existed in 1789, when Louis XVI was king of France. “And you know what happened to Louis XVI,” he says. “And by the way, they got his wife, too.”

Since 1971, this socially responsible mutual fund has made their voting results available to shareholders upon request. Now, with the help of Proxy Monitor, Pax World has taken the next step, joining Domini Social Investments in posting their proxy voting decisions.

Five years ago:

Compensation for directors of large US companies was up 18% in 2004, according to Mercer Human Resource Consulting.

TheCorporateCounsel.net Blog reported that two more companies have entered the fold: Circuit City and ADP.

Wilshire Associates told CalPERS the $190 billion fund’s annual target list of underachievers generated an extra 15.3% in stock value over a five-year period, a dramatic drop from 54% in 1995. < One of the most common questions we get from readers is: “How do I get on a corporate board?” Now, Directors & Boards devotes almost an entire issue to that subject.

The Corporate Monitoring Project’s Mark Latham scored a very respectable 11.4% affirmative vote for a recent proxy advisor proposal. Similar to previous resolutions by the Project, it called on Metro One Telecommunications to hire a proxy advisory firm for one year, to be chosen by shareowner vote.

Amnesty International USA (AIUSA) launched Share Power to facilitate the ability of individuals to voice their concerns to institutions that hold investments and are required to vote proxies on their behalf.

In “Tocqueville at 200” a recent Wall Street Journal editorial badly misinterprets Alexis de Tocqueville’s vision. (7/29/05, page W13) Although concerned about possible tyranny by majorities, central to his democracy are three defining elements: equality of rights, separation of powers, and representatives engaging in public debate. For a better take, download Democracy in Corporatia: Tocqueville and the Evolution of Corporate Governance by Pierre-Yves Gomez, Unité Pédagogique et de Recherche Stratégie et Organisation and Harry Korine, London Business School, 10/2003. Magnifique!

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Entrepreneurs and Democracy: A Political Theory of Corporate Governance

“From the unstable equilibrium between entrepreneurial force and social fragmentation emerges corporate governance that is both legitimate and performing,” directing the “productive action of people who want to stay autonomous and free.” The quick takeaway: corporate governance must increasingly become more democratic to be seen as legitimate. Continue Reading →

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Populism Begins in the Boardroom

There is an intriguing place where we might begin the work of a renewed economic populism: in corporations, not the capital. If the goal of populism is the amelioration of life for the many, then President Obama could strike a confounding (in a good way) pose by calling on the private sector to take up an idea put forward this week by Fareed Zakaria: unleash a corporate stimulus. “The Federal Reserve recently reported that America’s 500 largest nonfinancial companies have accumulated an astonishing $1.8 trillion of cash on their balance sheets,” Fareed writes. “By any calculation (for example, as a percentage of assets), this is higher than it has been in almost half a century. And yet, most corporations are not spending this money on new plants, equipment, or workers…[Such] investments would likely have greater effect and staying power than a government stimulus.” A populism that begins in the boardroom—that would really be change we could believe in. (The Right Kind of American Populism and Obama’s CEO Problem, Newsweek, 7/12/10).

I’m not sure Obama has the power to get the private sector to start spending. Congress certainly didn’t do a good job of tying bank bailouts to bank loans. However, I certainly agree with Jon Meacham and Fareed Zakaria, populism could begin in the boardroom.

Imagine a political system in which the incumbents get to select all election candidates, and voters have no choice but to vote for these nominees, or not vote at all. Such “democracy” rules the US proxy process by which investors elect corporate board members. Now, an “open ballot” movement among big shareholders is working to shake up how boards are elected.

The Magna Carta was drafted in response to the excessive use of royal power, while the move for proxy access stems from the abuse of power by management at Enron, WorldCom, Tyco and others.

The first clause of the Magna Carta guarantees “freedom of elections” to clerical offices of the English church to prevent the king from making appointments and siphoning off church revenues. A shareholder’s Magna Carta would prevent managers from having undue influence over corporate boards and will prevent them from using corporate coffers as their personal bank accounts.

Think markets and proxy contest are the answer? Who has enough to buy BP? Even after much of the wealth has been destroyed, the takeover and transition of poorly governed corporations back to profitability is also expensive, generally estimated to range between two to four percent of the value of the firm. There may be very heavy transaction costs for employees through layoffs, lost wages, increased divorce and suicide rates, as well as to communities in the form of lost taxes and charitable contributions. In contrast, the cost of proxy driven changeovers have run considerably below one percent.

In August of 1977, the Business Roundtable recommended “amendments to Rule 14a-8 that would permit shareholders to propose amendments to corporate bylaws, which would provide for shareholder nominations of candidates for election to boards of directors.” Their memo noted such amendments “would do no more than allow the establishment of machinery to enable shareholders to exercise rights acknowledged to exist under state law.” Now the BRT seems to think proxy access will be the end of the world.

In “Toward Democratic Board Elections,” published by The Corporate Board (7-8/2003) I noted, “After years of allowing shareholder proposals concerning elections, the SEC in 1990 issued a series of no-action letters ruling that proposals concerning board nominations could be excluded. Proposals by institutional investors were beginning to win majority votes. Perhaps the SEC realized failing to issue no-action letters could soon have consequences.” The court in AFSCME V. AIG came to the same realization three years later.

Competition for board positions has traditionally stimulated share value. Researchers have found that firms with stronger shareholder rights had higher firm value, higher profits, higher sales growth, lower capital expenditures, and fewer corporate acquisitions. Investors who bought firms with the strongest democratic rights and sold those with the weakest rights would have earned abnormal returns of 8.5 percent per year during a sample period.

It is paradoxical that the standard justification for autocratic practices in industry is its alleged efficiency, since empirical research results do not support that conclusion. Increased rank-and-file responsibility, increased participation in decision-making and increased individual autonomy are all associated with greater personal involvement and productive results.

The keys to creating wealth and maintaining a free society lie primarily in the same direction. Both require that broad-based systems of accountability be built into the governance structures of corporations themselves. By accepting the responsibilities that come with ownership, pension funds and other institutional investors have the potential to act as important mediators between the individual and the modem corporation. Indeed, populism that begins at the boardroom could change populists could believe in.

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Worth Reading

The Deal Magazine’s Guide to Corporate Governance provides a great introduction to the subject, divided into bite-sized segments.

  • What Berle and Means have wrought – “a complete guide to the corporate governance complex of attorneys, dealmakers, academics, judges and politicians.”
  • Attorneys – Here the focus is on Ira Millstein and Marty Lipton at the opposite ends of the spectrum.
  • Academia – Harvard University’s Lucian Bebchuk often spars with Stanford University’s Joseph Grundfest.
  • Hedge Funds – Carl Icahn, T. Boone Pickens, Ralph Whitworth.
  • Pension Funds – CalPERS, CalSTRS, TIAA-Cref
  • The Law – Leo Strine, Mary Schapiro, Barney Frank, RiskMetrics

Know someone who wants to know the basics but won’t read more than a single page? Download a pdf, “Governance on the Head of a Pin” by Dan Boxer, UMeLaw School for use in his classes and with boards.

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CorpGov Provisions in Senate Bill

Annette L. Nazareth of Davis Polk & Wardwell LLP nicely summarizes the provisions of the Restoring American Financial Stability Act of 2010 that passed the Senate in her post on the Harvard Law CorpGov blog, Senate Bill Passes with Broad Corporate Governance and Compensation Provisions, 5/21/10.

  • Listing exchanges would be required to impose a majority vote standard in uncontested director elections for all listed companies, reverting to the plurality standard in contested elections.
  • Authorizes the SEC to prescribe rules permitting shareholders to include their own director nominations in issuer proxy solicitation materials. (proxy access)
  • Within six months after enactment, any proxy statement that requires compensation disclosure must include an annual nonbinding vote to approve executive compensation as disclosed under Item 402 of Regulation S-K.
  • Requires exchanges to adopt standards requiring listed companies to have policies enabling the recovery of incentive-based compensation (including stock options awarded as compensation) from current or former executive officers following a restatement.
  • Listing exchanges would also be directed to impose additional independence requirements on the compensation committee, taking into account consulting, advisory and other compensatory fees and affiliate status.
  • Listing exchanges must prohibit broker discretionary voting in connection with the election of directors, executive compensation or any other significant matter, as determined by the SEC.
  • All publicly traded nonbank financial companies that are supervised by the Board of Governors of the Federal Reserve System must have a risk committee, and all publicly traded bank holding companies with assets over $10 billion would be required to have a risk committee.
  • Requires further disclosure of the link between compensation and performance, employee and director hedging, and excessive compensation at certain financial institutions.

Its the bill everything we’d like? Not by a long-shot. Hopefully, we can come back and fill in some of the gaps later. (see Bonfire of the Loopholes, NewsWeek, 5/21/10;  Frank to chair financial reform committee, Reuters, 5/24/10; and a comparison of the Frank and Dodd bills by Weil, Gotshal & Manges LLP, 5/24/10)

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Strine Rocks Stanford

The last time I covered an event sponsored by the Arthur and Toni Rembe Rock Center for Corporate Governance at Stanford I complained that it was just attended by a few Stanford students. Such a program would have packed the house at Harvard, with students coming from all over the Boston area. (Stanford Rock Center Proxy Access Forum) This time I don’t know where they came from but the auditorium was packed… standing room only. Maybe it was the featured speaker who may just have more influence on corporate governance than anyone else in the whole world. (Disclaimer: These are my recollections of the event. I don’t type quickly and I didn’t record it, so there are bound to be errors. Let me know if you spot any. Oh, and sorry about the poor quality photos; I lost most in a download glitch.

Ron Gilson

Ronald Gilson introduced the Honorable Leo E. Strine, Jr., Vice Chancellor of the Delaware Court of Chancery, noting the Chancery is the closest to a common law court that we have in the US. He praised the court for linking experience and logic. Judges at the Chancery come over time to deeply understand their subject matter and many of the leading cases have been written by Strine over his 12 years at the Court. Not only is he widely known and respected for the opinions he has rendered, he is also one of leading scholars on corporate governance based on published articles.

Gilson also likened Strine to Groucho Marx.  I don’t recall if Gilson elaborated on that comparison but I presume it is based on Strine’s quick wit and rapid fire monologue. Strine welcomed the comparison, saying he had just watched Duck Soup (a political farce) again the other night. He played to his audience with quips, such as Harvard being “Stanford East.” He made cultural references from Leave it to Beaver and Gilligan’s Island to current rock tune lyrics. Weaving humor and popular culture references into his talk gave a light tone to an important subject that impacts us all.

Strine began talking about the long tradition in the Delaware Chancery of being immersed in both the academic and real world. He related a story or two that conveyed to the audience that he believes government has an important role to play. Water, the Internet, etc. allow commercial exploitation of public technology. Government does make a contribution.

Leo E. Strine, Jr

The generation of durable wealth is (or should be) the primary goal of for-profit business.  The law provides investors limited liability to encourage wealth generating innovative behaviors that involve risk. Isn’t technology great. You can look at beautiful people on your laptops or iPad at the same time you listen to me speak, he said.

Strine made it clear that he favors a republican model of corporate governance over a democratic model, that is corporations are  representative democracies, as opposed to direct democracies. In corporate governance, shareowners elect the board and the board represents the shareowner’s interests in their relationship with management. Shareowners may be required to vote on mergers and in other rare circumstances but primary authority is left to directors. The investor’s firm specific risk can then be diversified through many investments, which take only minimal involvement.

Direct democracy would refocus management’s attention from the actual business to meeting shareowner demands. Managers would become politicians.  (Sidebar: See Toward A True Corporate Republic: A Traditionalist Response To Bebchuk’s Solution For Improving Corporate America, Harvard Law Review, 2006, which is written by Strine but “should not be confused” as representing his own opinion. It is offered as the perspective of “an open-minded corporate law ‘traditionalist.’ My description of this perspective attempts to describe fairly a school of thought about the American corporate governance system that not only has many adherents among investors, but also pervades the two major political parties whose members populate Congress and state legislatures,” says Strine. So, although the viewpoint is disclaimed as Stine’s, it appears he believes it is held by just about everyone else of any importance, except Lucian Bebchuk.)

Because corporations are republics, we have an interest in the fairness of elections, especially the election of directors. Indexed funds have no option to exit; they hold bad companies all the way down, until they’re out of the index. Investors are (or should be) looking for boards to ensure a sound corporate strategy, avoiding imprudent risk. There are collective action problems. Affordable challenges to management and entrenched boards (he didn’t use that term) are important in letting the market work. Strine appears to approve of an enhanced Rule 14a-8(i)(8), opt-in option for shareowner director nominees… not surprising, since that’s what Delaware adopted. (see SEC Commissioner Troy A. Paredes’ 5/20/09 speech on the subject) Strine believes the rules regarding shareowner nominees should be “investor driven,” rather than mandated by government. That would make better use of the corporate treasury by avoiding nuiscance campaigns. Investors should decide issues like when challengers would get a subsidy. Majority (of shares) should decide for themselves.

Then Strine took aim at investors with short time horizons. It isn’t just managers and directors who have a role to play if the system is to work. Shareowners must also fulfill their role with their own long-term interests in mind, based on their usual time-frame for investing, saving for the college expenses of their children and for their own retirement. Strine talked about the “separation of ownership from owners,” with more and more stock being held through intermediaries.

What are the most widely held companies in America? They’re not companies that actually make something, they’re funds like Fidelity and Vanguard. Here, as I recall, he made an indictment central to the whole talk; the more rights have been given to “alienated shares” (since they’re owned indirectly through funds), the more we are driven to short-term strategies of investing and governance.

His points then began to come in rapid succession, so I started taking them in bullet form.

  • stockholders who make substantive proposals should have substantial long-term interests… $2,000 threshold far too low
  • disclosure requirements should be updated regularly, 13D requirements are a joke; the English have figured this out
  • Adolf Berle – embraced by right wing-nuts. Strange reinterpretations out of Chicago. Adolph Berle discussed separation of ownership from management and control but now we have separation of ownership from ownership. Too many fund managers are looking out for their own interests, rather than those of beneficial owners. He doesn’t believe in an unregulated market. Concerned about dispersed weak stockholders. Managerial class could become dominant (but now we should be more concerned with fund managers?). We’re obsessed with agency costs… could be “part of a drinking game.” Separation of ownership from ownership is one of the very big problems.
  • Vanguard, Fidelity and other funds have the most stockholders (implication, with very little voice)
  • 70% stock controlled by institutional investors…. subsidized by tax breaks…. limited choice through your typical 401(k) plan
  • mountains of money flowing to these funds.
  • hedge funds – good news you may get to invest in them through your pension fund because they’re “sophisticated investors.” But your pension trustees are not and they’re investing in hedge funds with an average 300% turnover.
  • Mutual funds – 100% turnover a year turnover… pension funds similar
  • 138% turnover in 2008 but then I thought he said 300% in 2008 across all exchanges. Anyway, point is too much turnover.
  • High speed trading strategies are inconsistent with likelihood of beating the market…. Strine’s an indexed investor.
  • Unfortunately, the time horizon of many institutional investors is one year or shorter.
  • Owning Intel 10 times in 8 years isn’t long-term investing.
  • The most rational investors are the least represented.
  • Hedge funds, pressured to deliver 30% returns, are going to focus on short-term.
  • Fund families normally vote together. Indexed funds within family echo the voice of family’s active funds, even though time horizon longer.
  • Easy to press for votes because of internet.
  • Excessive leveraging, accounting, managing risk (Says, won’t find these as corporate governance strategies — but actually I think TCL and GMI have been strong in these areas)
  • Got CEO link to pay only after pressure from institutional investors and pay then soared.
  • Reduction in takeover defenses, pill, majority voting (70% of largest firms now have)
  • Short-term investors pressed for stock buy-backs, CEO turnover.
  • Strong market for corporate control. Boards have never been more responsive. Excessive risk, under investment in firm.
  • Contradictory to fight for shareowner rights and long-term growth since 100% turnover each year.
  • Also fueled by ISS, which has a 2 year time-frame for their policy.
  • Capital gain tax policy based on 1 year equated with long-term holding.
  • If given more clout, it is vital that institutional investors be more accountable to beneficiaries and fund holders.
  • Fund managers must compete on qtrly basis, since we buy into what’s hot and trade out of those that are prudent.

Strine ended by quickly throwing out some reform ideas to consider. (some of these may have been from a keynote at Directors Forum 2010) I didn’t get them all down but here are a few:

  • Pricing and tax to discourage short-termism and fund hopping.
  • Informed voting mandate has been potent. Unfortunately, there has been no informed investing mandate. Fundamental risk should be factored in.  Build fundamental risk analysis into corporate governance measures. We need balance in risk compared to voting.
  • Compensation of investment managers should be based on the horizons of beneficiaries and beneficial owners. Incentives should be based on long-term holding.
  • 401(k) and college plans consistent with those time horizons. Stop mixing altogether. Create funds that focus on those objectives
  • Indexes should act and vote consistent with long-term — stop giving vote to short-term buybacks and other strategies that temporarily bump up stock but actually rob from the company’s future.
  • Limitations on leveraging and disclosure by hedge funds. Decrease ability to push companies into risky business.
  • Proxy advisory services – “shouldn’t have to pay for the recipe.’ Should be able to read the cook book (can’t you? — You can at RiskMetrics, they even invited comment before finalizing for season). Can’t rely on voting advice unless their horizon is at least 5 years.
  • Fixing the definition of “sophisticated investors.” Many trustees aren’t sophisticated investors and shouldn’t be able to take their funds into unregulated pools. If pools dry up, that may lead hedge funds to disclose, since they need that capital. County pension funds are generally not sophisticated investors…. its your money…. publicly subsidized. They are not effective monitors. Chasing returns is digging deeper holes. Yet, they insist they want access. There aren’t as many personal sophisticated investors…. if they don’t qualify as someone who can easily afford to lose their money, they should be banned or trained and certified.
  • We need to know more about hedge funds – positions, voting policies, etc.

Nonbinding annual say on pay (Microsoft proposed a more sensible every three years), election reform, how much further can we go? Further incursions on the republican model create a public forum for pet concerns. Just how much direct democracy do we want?  Constititons promote stability. The Senate is the oldest classified board. More important to promote long-term outcome.

Californians should have a special ability to identify with the problems of direct democracy because some of the mess out here (my words) is proposition driven. Companies (management) should have more leeway not less. 14a-8 voice nonbinding plebicite. $2,000 stock, no filing fee. Issues of corporate governance claiming to link to corporate profit should only be introduced in resolutions by shareowners with millions of dollars in holdings and a $2,000 filing fee. The current process ties up directors and officers with issues de jour without substantial benefit to the company or most investors.

Boards are working harder but not on the right things. We’ve mandated too many independent committees. The boards priorities have shifted to accomplish what is legally mandated first. You get what you mandate. New laws and mandates tell boards what more they are required to do but not what they can now do less of. How do we give them time to focus on what’s important?

Humans are fallible, especially when given too much to do. When given more, say what they should be doing less of. They should be focusing on what preserves value long-term. We can’t have everything. There must be tradeoffs. With choices come costs. Stop blaming those who run companies. We can’t expect managers to deliver long-term when the market is driven by gimmicks. People are seeking profits in too many stupid ways. Investors should look in the mirror for what needs fixed.

I think there was an implication that if proxy access is needed anywhere, it is needed at mutual funds. We won’t have optimal corporate governance until institutional investors can be held accountable. Investors should focus less on leverage and gimmicks, more on real cash flow and perfecting business strategies. Let’s get away from checklist proposals.

(Sidebar: See also Overcoming Short-termism: A Call for a More Responsible Approach to Investment and Business Management, The Aspen Institute. Also of note is Governance at Fortune’s 100 Best Companies to Work For, The Corporate Library Blog, 2/5/10. Most of the companies which excel in the employee satisfaction are privately held. Among those that are public, company founders or families have a disproportionate ownership stake. These firms feel less pressure to meet quarterly expectations and can take more of a long-term perspective.)

Leo Strine Answers Questions

Q/A: Someone, I think a student, asked about rating agencies – choice A & B. Investor is interested in green rating. Strine answered there is too much risk tolerance for equity investors and the cost of externalities is too high for society, so he seemed to be endorsing a green strategy, other things being equal.

I asked a question about TransUnion or Smith v Van Gorkem. The Chancery had ruled against the board for gross negligence but then the Delaware legislature almost immediately took an action that could be considered overruling the Court because they enacted provisions in their General Corporations Code that allow directors insurance to cover gross negligence (Delaware General Corporation Law, section 102(b)(7)).

Even though I was listening intently, I didn’t hear a direct answer. Maybe criticizing any decision made in the Delaware legislature, even one made 25 years ago, is impolitic for a judge in the Delaware courts. I don’t know. He seemed to say that without such coverage, companies would have a hard time attracting director candidates. Additionally, I think he said something to the effect that protecting against corporate externalities was the more important issue.

Gilson raised the issue that AIG, before it imploded, had one of the best corporate governance ratings. He listed several strong features, including hold until retirement provisions. Strine said that there has been too much emphasis on independent directors and independent committees. We should be anticipating what the investor is looking for.  Much of corporate governance standards are noise that only hurt a board’s ability to do its job. The electorate doesn’t want corporations to seek silly risky short-term gains with long term losses but investors aren’t out to protect society… they’re out to get money.

The problem at AIG was a “cult” that owed allegience to one person. Expertise to do exotica is lacking. They didn’t have an extermal monitor. Old style boards may have been fatter, happier, involved more employees, and the community. Board may have included a banker, members from related industries, a lawyer; they worried about the long-term. Now, there is an expertise gap. The need for independent monitors is higher. The derivatives at AIG were so complex they couldn’t be monitored. If you don’t know how your company makes money, you shouldn’t serve on the board.

Gilson followed up with something about the UK’s Walker Commission and how they’d maybe gotten it right, with an emphasis on risk management.  I think Strine replied with something about bubble behavior not being new but some of the vehicles are, like credit default swaps. In many states you can’t bet on football but can bet on a company going down. Complexity is a risk in itself. What Lehman could get, now everyone can get.

There was another question asking if value and stock price are completely disconnected?  Strine answered that prices are informative. Unfortunately, too many people trade on the greater fool theory.  There’s plenty of evidence of not engaging in long-term investment because of the (hot?) market. Head injured investor behavior, is compounded by empowering them. If you tell people you’re going to get them a 30% return, you’re going to have press for short-term gains.

In the old days boards might tell you to get lost (Strine used stronger language). Now days they don’t stand and fight. Independent directors have become too much like politicians out to make a deal to keep ISS/RMG happy. Better to elect hedge funds to the board. At least it keeps them locked up. “It is the drive by shootings that get me.” There is a tendency that the market will over value what’s hot. Stock option backdating isn’t good idea. People do things (maybe especially bad things?) in herds. When markets reward companies for risk and fail to discipline too often, it distorts everyone’s approach.

The last question came like a bit of a bombshell considering the huge applause Strine had been given (more than I have ever heard for anyone else at these events) and the general deference he had been given. The question was something like, Isn’t it disingenuous to go after institutional investors, as if they were responsible for the recession? You say that shareowners have all this power but they’re only on the cusp of reaching what they’ve been going after, namely proxy access. Strine was essentially being accused of Blaming the Victim.

Strine responded that there is plenty of blame to go around but that institutional investors largely hadn’t faced up to their contribution. If you create an incentive structure built on short-term profits, you’ll get more risk taking than healthy returns. There was a failure of prudential regulation the wrong profit incentives. Investors have been trying to blame managers but they didn’t temper their own risk. Takeover defenses are way down, options were their idea (ed: institutional investors, because options linked pay to performance… but only in one direction). There are more independent directors. Plenty of blame.. bond rating agencies. His main point seemed to be that investors weren’t out there temporing risk, but were instead rewarding it.

I would have loved for the conversation to continue around this core issue but the program had already gone on longer than expected, so another good evening ended too soon. My own assessment is that Strine had many excellent points. Shareowner pressures for higher returns do shift costs to society in the form of externalities. The idea of tying pay to performance has largely backfired. The problem of churn is huge. While I agree with Strine that shareowners have gained power through a number of recent reforms like majority voting at very large companies, it is also true that shareowners have little direct control. Even if they win proxy access, the current proposal is to allow no more than 25% of any company’s nominees to come directly from shareowners.

There’s no question that Strine has emerged as the hardest-working, wittiest and most outspoken judge at the Delaware Chancery. He’s also been very innovative, like when he ordered Tyson to complete a merger with IBP or when he negotiated a deal between PropleSoft and its hostile acquirer, Oracle. However, Strine wants Delaware’s opt-in model, rather than a mandate from the SEC on proxy access. I can’t help thinking that is because his ship is tied to Delaware. Not only do a fifth of their revenues come from franchise taxes on corporations, Delaware also has a substantial revenue stream from unclaimed dividends and abandoned accounts held by brokers incorporated there, which Strine helped to negotiate for a former governor.

Corporate governance expert Charles Elson said the Dodd provisions requiring a majority vote for directors and providing greater legal backup to the SEC’s proxy access proposal could spell “the beginning of the end” for the state.  A corporate exodus could leave the state in a “severe fiscal crisis,” searching for new revenue through dramatic increases in income taxes or a new sales tax, he said. “What everybody is worried about is things [getting] chipped away,” said Rich Heffron of the Delaware State Chamber of Commerce. “A company might say, ‘Why do I have to be in Delaware? I could be in Colorado.’ ” (Wall St. reforms could bite Delaware, The News Journal, 5/19/10)

I still tend to think real shareowners have too little, not too much, power. I couldn’t disagree more with his idea that shareowner proposals should be limited to those with millions of dollars in holdings who must pay a fee of $2,000 to get their item on the ballot. What’s next, a poll tax? Some of the most important reforms have been led by so-called gadflies like Lewis Gilbert and John Chevedden.

However, the problem of short-term investment horizons is real. Strine calls on tax policies to discourage short-termism but he certainly didn’t elaborate. Let’s get specific. What about taxing speculative gains (held less than 90 days) at 60%, less than a year at 35%, two years at 25% and thee years or more at the current rate of 15%? Even three years isn’t really long-term, but at least that would head us in the right direction. We could also make use of a Dutch auction system mandatory in IPOs or at least encouraged, so that companies begin public life with more long-term shareowners, rather than speculators.

Strine says risk isn’t factored enough into proxy voting decisions. I agree. One problem is that proxy advisors, like RiskMetrics, don’t have the staff to really dig into most companies. They tend to rely too heavily on governance policies applied broadly to most companies. A proposal recently revised for reintroduction by Mark Latham would allow shareowers to vote funding to advisors, based on the quality of their advice. Since the proposal essentially spreads the cost to all shareowners and avoids free-riders, it should result in far more money being spent, resulting in more in-depth research. (see Ultimate Proxy Advisor Proposal, Voter Media Finance Blog, 5/15/10)

For more from Leo Strine, see Why Excessive Risk-Taking Is Not Unexpected, New York Times DealBook, 10/5/09 and Toward Common Sense and Common Ground? Reflections on the Shared Interests of Managers and Labor in a More Rational System of Corporate, Harvard Law School John M. Olin Center for Law, Economics and Business Discussion Paper Series, 05/2007.

It was great to see a packed house. I hope it set a solid precedent for future events put on by the Arthur and Toni Rembe Rock Center for Corporate Governance at Stanford. See you there next time. In the meantime, check out this and other recorded events as they are posted.

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CEOs Running Scared in Washington

Businesses have intensified their efforts to kill the “proxy access” provision of the Senate’s financial regulation bill. Forty CEOs lobbied in Washington, DC last week alone.  “This is our highest priority,” said John Castellani, president of the Business Roundtable, which represents 170 chief executives. Last week alone, Castellani said, 40 chief executives were in town visiting Capitol Hill about proxy access, since they see it eroding their power.

“This hinges on senators recognizing the fact that boards in too many companies like Citigroup or AIG really failed in their responsibilities here,” said Daniel Pedrotty, director of the AFL-CIO Office of Investment. With proxy access, shareholders would be able to send a strong message to management if they weren’t happy with a company’s strategy, for instance, in managing risk or charting growth.

Currently, shareowners must pay thousands, sometimes millions, of dollars to run candidates that aren’t selected by current CEOs and boards. Proxy access would force companies to add shareowner nominees to the corporate proxy, at minimal cost, allowing them to comprise up to 25% of boards… if a majority of other shareowners agree with their picks. That still leaves current boards in control but the mere idea that some directors could be replaced has CEOs worried.

Senators Thomas R. Carper (D-Del.) and Bob Corker (R-Tenn.) have introduced amendments that would cut proxy access from the bill, but there are more than 250 other proposed amendments as well. It is hard to know which will get heard. Castellani said the BRT has gotten a sympathetic hearing from several Senators.

Jeff Mahoney, general counsel at the Council of Institutional Investors, said fears are overblown. “Just because you put someone on the proxy card doesn’t mean they’ll be elected,” he said. “At the end of the day, no one is going to get on the board unless most of the owners of that company want that.” (CEOs from far and wide band against financial bill provision, The Washington Post, 5/14/10.

Robert Sprague and Aaron J. Lyttle analyze the development of current corporate governance standards and examine whether the current financial crisis can provide an avenue for change. They find that a “significant shortcoming of the shareholder primacy norm, as supported by the business judgment rule, is that corporate directors and officers have a plain incentive to maximize short-term profits, possibly, as in the case with Citigroup, at the expense of the overall viability of the firm.”

There is one critical assumption underlying the discretion provided to corporate directors and officers under the business judgment rule—if shareholders are displeased with directors, and the officers they hire and supervise, the shareholders can elect new directors. This replacement power is especially important when director decisions are insulated from judicial review due to the business judgment rule.

Unfortunately, that ability is largely an illusion. Shareowners have very little input into electing directors, since in most cases all they can do is vote for or withhold their vote from management’s candidates. Sprague and Lyttle conclude, “The most viable possible revision to corporate governance in the United States is to allow shareholders access to proxies to nominate alternative directors.” (Sprague, Robert and Lyttle, Aaron J., Financial Crisis: Impetus for Restoring Corporate Democracy (January 26, 2010). Midwest Academy of Legal Studies in Business Conference Proceedings, 2010. Available at SSRN: http://ssrn.com/abstract=1529733)

Martin B. Robins would take a complimentary but different approach, reversing the present burden of proof placed on plaintiffs in actions alleging breach of a directors’ duty of care under certain circumstances. (Require Affirmative Proof in Specified Circumstances of “Too Big to Fail Companies” in Order to Meet the Business Judgment Rule)

We need a legal regimen which forces directors at systemically important firms to familiarize themselves with what management is doing, and ask the tough questions of management before policies are implemented, to see if the downside risk of those policies is understood (or has been considered at all) and to change course when even an originally well conceived strategy is no longer suitable. Ultimately, we need to force directors to consider on an ongoing basis whether their firms’ managements should be in their positions at all, in order to screen out dishonest, reckless or incompetent persons.

Elsewhere, Robins argues, “pending bills only divert the focus from holding responsible those making the decisions requiring resolution and encourage more bad decisions.” (ROBINS: Financial regulations miss the target, The Washington Times, 5/13/10)

Although far from the recommendation of Robins, thecorporatecounsel.net/Blog reports on two amendments to the Dodd bill that “would significantly expand the disclosure obligations of ’34 Act companies – principally because they contain no meaningful disclosure thresholds (i.e. materiality), and in the case of the Byrd Amendment, would significantly expand the bases upon which directors and officers may be found personally liable for failures to disclose.” (Drilling Down Into the Dodd Bill Amendments: Personal Liability for Directors and Officers!, 5/14/10)

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CorpGov.net WayBack Machine

Ten years ago in CorpGov.net. BusinessWeek calls governance activist investor Andrew Shapiro the Gary Cooper of corporate governance in their 5/29/2000 edition. I didn’t quite get the connection. Maybe its that Shapiro charisma or that frontier mystique with a worldly polish. Regardless of his relation to the film star, the article pointed out Shapiro’s bylaws, which he put in place at Quality Systems, are “fast becoming a template for other investors looking to create change.”

Following the lead of Domini Social Investments, Calvert’s new fund has announced it will post its proxy votes starting in 2001.

Preliminary results reported by IRRC (4/21) indicate that 12.7% of First Union shareholders voted to require the nominating committee to nominate two candidates for each board position. The resolution also called for statements by candidates on why they believe they should be elected were also to be included with future proxies.

Five years ago in CorpGov.net. EBSA, which enforces the Employee Retirement Income Security Act (ERISA), closed 4,399 civil investigations in FY 2004, with nearly 7 in 10 of those producing corrected ERISA violations. Criminal investigations led to the indictment of 121 people in 205 cases and the recovery of $5.6 million. The agency prosecuted wrongdoers under criminal statutes governing theft or embezzlement from employee benefit plans, lying on ERISA-required documents, as well as offering, accepting, or soliciting a bribe in order to influence the operations of an employee benefit plan. EBSA listed six key fiduciary violations:

  • failing to operate a plan prudently and for the exclusive benefit of participants;
  • using plan assets to benefit certain related parties;
  • failing to value plan assets properly at their current fair market value or to hold assets in trust;
  • failing to make benefit payments due under the terms of the plan;
  • taking adverse action against an individual for exercising his or her rights against the plan;
  • failing to offer continuing group health-care coverage for at least 18 months after a worker leaves the company.

Public customers of securities brokerage firms are required to agree to arbitrate disputes using specified forums. Drawing on 30 years of experience serving as an NASD arbitrator and as legal counsel for either claimants or respondents, Les Greenberg recently filed a Petition for Rulemaking (File No. 4-502) that seeks to level the playing field. The Petition requests the creation of rules designed to:

  • specifically permit arbitration panel members, should they elect to do so, to conduct legal research, or, in the alternative, forbid Self-Regulatory Organization (“SRO”) sponsored arbitration forums from restricting arbitrators from conducting legal research;
  • abolish the requirement that a securities industry arbitrator be assigned to each three person panel hearing customer disputes or, in the alternative, require that information presented to a panel of arbitrators by a securities industry arbitrator be revealed to the parties during open hearing;
  • require SROs to conduct continuing evaluations of the ability of every arbitrator on their panels to perform his/her duties, including, but not limited to mandatory peer evaluations;
  • require SROs to train arbitrators in applicable law;
  • require SROs to reveal in pre-dispute arbitration agreements whether their arbitrators are required to follow the law in their decision-making process, the training of their arbitrators in the law, and their process, if any, to evaluate their arbitrators on a continuing basis; and,
  • require the SEC’s Division of Market Regulation to specifically oversee SROs to determine whether they are in compliance with rules adopted pursuant to items (1) through (5), inclusive.

Majority Vote Momentum Grows. Proposals won 57% support at Raytheon, 52% at Freeport McMoRan Copper & Gold Inc., 51% at Federal Realty Investment Trust, 46% at Motorola Inc., 45% at Bristol-Myers Squibb Co., 43% at Verizon Communications and 42% at General Growth Properties.

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Stanford Rock Center Proxy Access Forum

Proxy Access Panel

The Arthur and Toni Rembe Rock Center for Corporate Governance at Stanford University has quickly emerged as a focal point for conferences and seminars, research, and the development of new educational and course materials. The May 6th Proxy Access Forum was the latest iteration of the fine work being done at the Center.

My disclaimer: I don’t take notes quickly enough to get quotes. What follows are a few highlights of what I thought were some of the important messages conveyed by each of the panel participants and the moderator. I left them in note taking fashion, so there can be no confusion these are my impressions (and because it is quicker for me), rather than the fully articulated sentences of the speakers. Although there was a great deal of back and forth dialogue, it was easier for me to just place thoughts under the persons name, rather than trying to capture the interactive dynamics. Within a couple of weeks, you’ll be able to watch the event on the Center’s internet site under May 2010. I highly recommend it.

Both Paredes and Friedman provided their own standard disclaimers. They were expressing their own opinions, not those of the Securities and Exchange Commission or the SEC Investor Advisory Committee.

Troy A. Paredes, SEC Commissioner.  Voted against proposal. Objected to a-11

Troy Paredes

(mandatory) not opt-in a-8 (private ordering). Seeks balance between federal and state roles. Disclosure requirements of SEC are complementary to though control through state. Long-standing enabling approach of states vs prescriptive (mandatory one-size-fits-all) under federal. Different governance regimes optimal. Embraces private ordering provisions implemented by DE… Proxy access and expense reimbursement. His other concerns are for workability.  Opportunity costs for staff. Proxy access will divert scarce SEC resources. Has some doubt proposal will increase shareowner value.  Having input us helpful and gives us a lot to think about. Long history around this issue.

Francis (Frank) S. Currie, Davis Polk & Wardwell LLP – Regrets overly hard

Frank Currie

positions taken by the business community against opt-in proposals introduced previously at the SEC under the previous administration. Objects to one-size-fits all approach. While companies are allowed to innovate under a-8, they can’t make access harder.  We’ll see if the final regulations are softened. Rumor is the Commission will take a hard line. Concerned with SEC as referee.  Explaining how it works at our company will take a lot of time. DE approach much more workable. Use experience of companies to come up with a best process. However, with all the scandals and public anger, the SEC is unlikely to soften.

Advice for companies. Study proposal in great detail. How mechanics effect what company already has in place…. like advance notice provisions.  Do they clash?  Your own rules on what candidates should look like. How many boards serve on?  Rules might only apply to company nominees. Companies will need new timelines, taking into account possible shareowner nominees. Companies should be working on knowing their shareholders. Are they happy, unhappy? Why? Engage in a dialogue. Most are only going to be looking to proxy access as a nuclear weapon. Talk to them about new disclosures in place this year about why candidates selected by nominating are the best qualified. The whole way of running against a short slate makes difference; much more like a contest. Shareowners already have a lot of new weapons… broker votes gone, easier to withhold nomination with majority vote. We’ve already achieved overall balance, since these other corporate governance reforms alredy enable dialogue.  High degree of uncertainty is reason for shareowner value going down when proxy access is considered. (reference to “The Regulation of Corporate Governance.”

Abe M. Friedman, BlackRock, Inc. Has 17 staff responsible for voting. Written guidelines. Vote in best economic interest of shareowners. Re proxy access,

Abe Friedman

supportive. The right is critical… no question in my mind. Best place to nominate is in the nominating committee.  When you buy, you give up the right to hear decisions made in public. Board sessions are in a competitive market, so are private. Checks and balances slow in government… to make sure rights are protected and deliberative. Our companies, we want them to turn on a dime. In a well functioning company, we want directors nominated in the nominating committee because directors have the information and know what goes on in board meetings.

However, we also know that some boards fail. Not that they tried something that didn’t work, but they’re doing things in the interest of CEO, board member, etc. not in the interest of shareowners.  In those cases, shareowners need a new voice. Proxy contests are very expensive and cumbersome. Favors a-11. But think right should be used only when there is some triggering event. That doesn’t seem to be the direction we’re going though. Now we’re pushing for a high enough threshold, 2 years holding to not make proxy access too easy.

RiskMetrics’ power is exaggerated. Most investors take research from multiple firms.  Shareowners can’t make a decent proposal within the 500 words limitations, so opt-in procedures for proxy access can only be written by companies. Frank wanst companies to design; Joe wants shareowners to design… but shareowners can’t.  The idea that the combination of a-11 and a-8 is only going one way is a red herring because what shareowners are going to vote for reducing their rights? We need to ensure a good basic rule.  The cost of private ordering would be enormous… cost of putting it together at each company and litigating.

In response to comment from audience: It isn’t hard to find directors. Lots of people willing to serve.  There is no doubt shareowners have made progress. There are fewer interested party transactions. What we need are a few basic rights: majority voting, end to or right to vote on poison pills, inject voice in boardroom. Few things. He doesn’t think say on pay is one of the critical few.

Anne Sheehan, CalSTRS.  Briefly described CalSTRS… teachers. Holdings aren’t

Anne Sheehan

as large as BlackRock but votes 7,000 issuers a year. Ability to nominate is ultimately what this is all about. Average holding is 14 years. Would use it rarely, after massive failure. Now option is to withhold vote from director.  Many companies going to majority vote standard. But if a company fails to do anything, we need that access right. We talk to companies. They would have heard from us for years before we are nominating directors. 21 resolutions filed, all but 5 resolved. Ultimate tool in tool chest. We entrust directors to run the business.  S&P 500 majority vote, not smaller companies. Last year shareowners voted against directors but boards didn’t accept resignation or allowed them to continue. Companies can already enact proxy access, but few have. CalSTRS is asked by nominating committees for recommendations and, along with CalPERS, they are building a database of potential directors based on a broad diversity of skill sets.

Joe Grundfest, Stanford. In the proxy access debate, I’m a strong agnostic for what type of access should be allowed at each company. Socially optimal result

Joe Grundfest

should allow each group of shareowners to design the best proposal for their company. He almost hopes SEC does adopt a-11 so that he can file a brief questioning rational basis for their decision. If shareowners are smart enough to elect, why not smart enough to set the rules? First thing he will read the final rule for is the basis for the standards a-11.  He looks forward to litigating. Six cases challenged at the SEC for setting arbitrary standards, six cases lost.

In response to Sheehen, there are corporations where companies kept directors after losing majority votes but they made changes, like getting rid of a staggered board. Shareowners may have actually wanted to end staggered boards more than they wanted to remove specific directors, so they accomplished something. Life expectancy of CEO at company much reduced when shareowners are ignored. The closer the SEC gets to proxy access, the more stock goes down, so most shareowners don’t view it as a plus.  The SEC’s own questions in the rulemaking pointed to the error of their ways. Questions were more concerned with the ease of getting a nominee on the proxy, rather than the need for change at companies. The most obvious thing to do to create more defensible benchmarks in regulations is ask shareowners what they want. The SEC could have then weighed responses based on the size of a respondent’s holdings. A scientifically designed sample would have provided a better starting point and a much more defensible rule.

During the Q&A, I briefly raised some objections to the methodology and conclusions of the event study, “The Regulation of Corporate Governance” by Prof. David Larcker.  Although the change in Delaware code to facilitate proxy access, through opt-in, may have been a preemptive strike aimed at weakening the need for the SEC’s rule, I didn’t think it should be seen as an event that would reduce the likelihood of a-11. (Sidebar: I take a very skeptical view of event studies, based on price fluctuations around introducing a bill or initiating a rulemaking because so many of these initiatives fail… maybe I should take a more careful look at the study but even if proxy access is associated with lower stock values in the short-term, that wouldn’t convince me that access wouldn’t be positive in the long run. As a rule is introduced, shareowners are concerned with uncertainty and additional expenses of more contests. Once a rule is in place, it is unlikely to be used with much frequency but the tool yields dividends to shareowners because it has a deterrent effect.)

The real point I tried to raise was the idea that since the business community was so concerned with being forced into expensive proxy contests if proxy access goes through, they should advocate amending the rule limit or eliminate active proxy solicitation. Limits on campaign spending would also be good for shareowners, since expenditures largely come out of corporate treasuries, reducing the money available for dividends or expanding the business. There didn’t seem to be a any takers. Both Currie and Parades seemed to favor reimbursing challengers for their solicitation expenses when they achieve some minimum threshold of the vote.

I also expressed my objection to one of the ideas offered up in the background paper prepared with the Forum. (see Stanford Rock Center Proxy Access Reform Paper)

Corporations, corporate law firms, and publicly traded companies have generally maintained that each nominating shareholder or shareholder group should only have one nominee, as opposed to the SEC’s proposal to permit a qualifying shareholder to have multiple director nominees. Accordingly, the final Rule 14a-11 could have a single nominee per shareholder requirement.

I said that even though I thought I had been following the discussions on proxy access, I hadn’t heard much discussion of this possibility and thought it didn’t make sense, since one investor or group would be more capable to recommending nominees that fit, both with the remaining board and with each other, with regard to skills and experience. Currie clarified that the idea wasn’t necessarily one that would be taken up in Commission amendments but they included it simply because it was contained in a large number of comments.

Another great event, attended mostly by Stanford students who didn’t add much to the dialogue. Maybe Stanford students will take these forums less for granted in the future and will come better prepared with questions based on a more thorough reading of the related materials. I can’t help thinking the event would have packed the house at Harvard, with students coming from all over the Boston area.

When I studied at Boston College, we sometimes had more students at Harvard sponsored events than Harvard did. I suppose our interloping was helped along by something like a precursor to the Boston Consortium. The fact that we could take classes at any member university probably helped.  Students from all over the Bay Area should be taking advantage of future events at the Arthur and Toni Rembe Rock Center for Corporate Governance. And other than the panelists, where were the Bay Area investors, directors and CEOs? At least at last night’s event there were a smattering (from Intel and ICGN; both contributed to the dialogue). Hopefully, more will attend over time.

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Corporate Governance: Principles and Practices

Billed as the first law school casebook in its field, Corporate Governance: Principles & Practices, should also appeal to students of management, corporate directors, shareowners and anyone interested in the major legal concepts, laws and court cases that shape this dynamic field. The many questions raised in each chapter are helpful in clarifying issues likely to arise in common practice.

Formatted like a CCH or Aspen guide, the book is divided into numerically indexed chapters, sub-chapters, and headings, almost down to the paragraph level… great for speedy reference.

The book starts with an excellent overview of history and a comparison of nexus of contracts, director primacy, communitarian, team production and other models. It then moves on to board powers, processes and duties, the role of shareowners, elections, compensation, social responsibility, ethics, comparative corporate governance, an assessment of whether good corporate governance pays and appendices on suggested paper topics, a menu of shareowner proposal topics and a list of recommended resources, including corpgov.net.

Walter Effross does an excellent job of covering the basic issues, summarizing important points and introducing his readers to thought leaders in the field.

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In Search of the Good Corporate Citizen

Winner of a 2010 Telly Award as an outstanding video production and the winner of a 2010 WorldFest-Houston Award, this outstanding video takes viewers beyond the pressures involved in hitting the numbers to show how the best business leaders steer companies through tough ethical challenges.

The show weaves together expert panel discussions, personal accounts from real-life white-collar criminals and whistleblowers, and “person-on-the-street” perspectives from the financial centers of New York and London. 28 public television stations in 20 states have picked up the program and counting.  The DVD is available to colleges and companies for a modest licensing fee.

Here’s a few lines from the DVD regarding the need for involvement by institutional investors:

Tom: How about the institutional investors? Do they have a role?

Win: I think they need to play a role too.  I think at this point we have socially responsible investment funds but really the investment community does not understand much about ethics management of the companies they are investing in.  I think they should for a couple reasons.  One it’s going to protect the investments they are making to understand that risk profile.  Secondly, if they do that I think it will send a very important message to the management of these companies that how they manage ethics matters to the bottom line.  And I think if society in general gets in line behind these companies that are trying to do this well I think we will have much more success in this search for the good corporate citizen.

Denny Swenson, Executive Producer, brought together a panel with years of experience, including: Bill George, former Chairman and Chief Executive Officer of Medtronic; Ben Heineman, former General Counsel of General Electric; Donna Boehme, former Chief Compliance and Ethics Officer for BP and BOC Group; Bill Prachar, former CEO of American Ecology, and Chief Ethics Officer for Waste Management and Teledyne.

The show compares comments from business people to a survey of over five thousand employees from various companies across the country. The survey showed:

  • 27% of sales and marketing personnel have observed colleagues engaging in deceptive sales practices— so one might say that even sales people don’t fully trust sales people!
  • 52 % of respondents believe they will be rewarded for results, not how they achieved them.
  • Less than half the employees surveyed believe that senior management knows what kind of behavior really goes on inside their companies.

Preview the show. Read the press release and the transcripts. Visit the website to tune into local broadcasts, buy the videos and learn how you can become a sponsor of future productions. As a former ethics officer, I highly recommend the series and wish I had such tools available for discussion when I was in the business.

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Learning and the Disappearing Association Between Governance and Returns

Study by Lucian A. Bebchuk, Alma Cohen, and  Charles C.Y. Wang finds the governance provisions (G-Index) used by Gompers, Ishii, and Metrick (2003) that showed abnormal returns during the 1991-1999 period was no longer associated with abnormal returns during the period of 2000-2008.

Consistent with the learning hypothesis, they document that (i) attention to corporate governance from the media, institutional investors, and researchers has exploded in the beginning of the 2000s and remained on a high level since then, and (ii) until the beginning of the 2000s, but not subsequently, market participants were more positively surprised by the earning announcements of good-governance firms than by those of poor-governance firms.

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China's Increased Voting Power

World Bank members voted to place China’s voting power in the organization behind the United States and Japan. The China’s stake in the bank climbed from 2.8% to 4.4 %. Given that China has made many achievements in eradicating poverty, we have reasons to believe the country will contribute more to global efforts on poverty reduction. (A resounding vote, China Daily, 04-27-10)

The World Bank’s private sector arm has signed its first deal to finance Chinese investment in Africa. (China Shifts Its Africa Investment Strategy, Forbes, 4/28/10) Will working more with international bodies, such as the World Bank improve China’s corporate governance, human rights and environmental standards?

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Corporate Governance Paradigm in Crisis

The March 2010 edition of Corporate Governance: An International Review (CGIR), one of our favorite “stakeholders,” contains three articles that struck me as particularly significant.

Corporate-Governance Ratings and Company Performance: A Cross-European Study by Annelies Renders, Ann Gaeremynck, and Piet Sercu finds a significant positive relationship between corporate-governance ratings and performance across 14 developed economies in Europe from 1999-2003. The strength of this relationship seems to depend on the quality of the institutional environment, the correlation being weaker in countries with higher corporate governance ratings and stronger in countries with weaker shareowner protection laws. The authors find that improvements in corporate-governance ratings over time result in decreasing marginal benefits in terms of performance.

Second, the editorial by William Q. Judge, Editor in Chief, is significant in announcing a new type of article, which CGIR intends to publish. Noting the thesis of Thomas S. Kuhn’s The Structure of Scientific Revolutions, that paradigms do not get replaced until a credible alternative arrives that more effectively describes and explains unsolved puzzles, CGIR now invites “Perspectives” to “challenge the existing paradigm in which corporate governance research operates, point to anomalies that are not being solved, and suggest an alternative world-view that may better solve the problems before us.” The first such offering is included in the issue and is prominent governance consultant John Carver.

Like governance ratings by The Corporate Library’s ratings, Carver’s theory appears to be built from the ground up, measuring from the ideal, rather than from common practices.

A Case for Global Governance Theory: Practitioners Avoid It, Academics Narrow It, the World Needs It includes the following opening observation:  “A credible theory of corporate governance will not arise by studying what is.”

Since governance is a social construct, we are not best served by “studying our own creation in order to tie together practices that grew in the absence of theory. Taking that course is to forever constrain tomorrow’s possibilities by today’s practices.”

I assume it is his long-time consulting practice that taught him it is better to start with what we need from corporate boards, rather than what they already do. “Therefore, it is not descriptive theory we need for governance but prescriptive theory.”

Once we have determined the needs of governance, those need can serve as the measure to judge the appropriateness of “accounting standards, structural considerations, reporting methods, techniques of delegation, officers’ roles, the choice of topics for board involvement, even statutes and codes.”

Clarifying what boards are for must not be based on the needs of CEOs (as is all too common today). Because boards’ prime fiduciary obligation is to owners, their organizational authority comes from owners, and their relationship to management is one of greater authority, boards are organs of ownership, not of organs of management.

Carver’s theory, like his practice, builds on the central position of the board. If we examine the board’s central purpose, we are only distracted from our theory building by recounting how boards have been used. We must start from the barest necessity.

The board represents owners in the governance of the enterprise… The board is owner-representative before it is the CEO’s superior and, in fact, before it makes a decision to have a CEO to begin with… It is the board’s necessary function, then, to define and demand what owners want the organization to accomplish and what risks it may take… Construed in line with this raison d’être, the board should be the most vigorous shareholder activist in sight.

Starting from this basic foundation, Carver argues that many other things follow:

  • Board agendas, for example should become the board’s agendas rather than management’s agendas for the board.
  • The board chairman works for the board, not the other way around.
  • Sarbanes Oxley is misdirected, since if assigns responsibility to sub-board units, rather than recognizing the board’s accountability for all its delegated authority.
  • Advising the CEO is an optional obligation. “Responsible governance theory cannot allow the mandatory to be sacrificed to or even potentially weakened by the optional.” “The board’s unique responsibility is not to give good advice, but to ensure that the CEO produces good performance.”

Carver’s theory has been elaborated into what he calls his “Policy Governance” model, which

positions governance as an owner-representative function rather than a management function; provides for resolute board action despite diversity of views among owners and even among directors; balances overcontrol and undercontrol through a policy design that enables boards to control what they need to control and safely leave to the CEO what they do not need to control; avoids both rubber stamping and micromanaging; optimizes the values of CEO empowerment and board control; moves directors from advising on management’s job to defining management’s job; forces the practice of group authority by allowing no way to elude it; ensures that committees are aligned with dominant board accountability; positions the topmost of a two-tier board arrangement as the owner-representative (“governing” board), and illuminates any practice or structure that detracts from total board allegiance to agency responsibility (such as executive/inside directors and chair-CEO duality).

While he doesn’t claim his model to be the only governance theory possible, he does argue forcefully that a globally-applicable theory would facilitate progress by introducing a common language, enhancing public perception of corporate boards as accountable stewards, clarifying the distinction between governance and management, guiding productive research, clarifying roles, and aiding investor confidence.

Kuhn posited that “normal science” is predicated on the assumption that scientists know what the world is like. Anomalies are discounted until extraordinary investigations lead the profession to new paradigms, incompatible with time-honored theories. Scientist reject the old paradigm only when the new has more explanatory power.

Unlike the natural sciences, where paradigms are used to explain and predict, corporate governance is socially constructed. Paradigms in our discipline are normative models, used to to discipline and guide. The major stumbling block to shifting paradigms is recognizing the element of choice. We aren’t stuck with what we have. We can choose to move to a whole new paradigm, if it offers a better foundation for building the kind of world we want.

Personally, I doubt if the current crisis will push us into a new corporate governance paradigm. However,  it may accelerate explorations of what such a paradigm might look like. I’m delighted to learn that  Corporate Governance: An International Review will facilitate such discussion.

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CorpGov Bites

The rewards of virtue Does good corporate governance pay? Studies give contradictory answers (The Economist, 4/26/10). Interesting review of a small body of research. Yet, the article provides no real contradiction to the idea that good corporate governance does pay… we’re just having some problems measuring it.

Riding Herd on Company Management, WSJ, 4/27/10. Roger Ferguson, of TIAA-CREF, points to Amgen, which provided shareholders with the ability to comment directly to the compensation committee. He calls on shareowners to more fully engage and on mutual fund companies to have more independent boards of directors, who can put shareholder interests ahead of those of the investment adviser.

EOG investor calls for capping executive severance, The Houston Chronicle, 4/27/2010. Innovative proposal by Amalgamated Bank’s LongView Funds at the annual meeting of EOG Resources, Inc. (NYSE: EOG). The proposal urges the board to adopt a policy prohibiting any equity awards to top executives from automatically vesting upon a change in control.

Wal-Mart Workers Can Sue as Group in Gender-Bias Case Over Pay, BusinessWeek, 4/27/2010. Does anyone need further evidence that getting ahead of the curve on ESG issues pays? In 2001, the company settled 13 lawsuits by paying out $6 million. How much will it cost to settle claims by 2.5 million current and former employees?

SEC Investor Advisory Committee announces agenda for May 17, 2010 meeting. Written statements to be considered by the SECIAC should be received on or before May 10, 2010 through the Commission’s Internet submission form or by sending an e-mail; include File Number 265-25-04 in the subject line.

Credit Rating Agency Hit With Subpoena for Failing to Comply With Investigation, Social Funds, 4/26/10. The Financial Crisis Inquiry Commission (FCIC) issued its first subpoena, to Moody’s Investors Service, for “failing to comply with a request for documents in a timely manner.”

Shareholders veto HKEx resolution, webb-site.com, 4/22/10. Investors sent a clear message to the Hong Kong Exchanges, voting by 70.2% against a proposal to allow the company to bypass board meetings and pass resolutions with a simple majority of signatures.

Next SEC Governance-Reform Target: Proxy Advisors?, Agenda, 4/26/10. The SEC will issue its long-awaited concept release by the end of June on suggested reforms of the proxy voting system such as NOBO/OBO classification, client-directed voting, voting mechanics, and regulation of proxy advisers.

Stanley Black & Decker launches video annual review, Cross Border, 4/26/10. “We’ve created the site to give you access to information in a way that’s more interactive, cost effective and better for the environment. As you travel around the site, you’ll learn about Stanley’s performance in 2009, and you’ll hear from some of our leaders about our exciting future as Stanley Black & Decker.”

Arthur Levitt: The Real Governance Problem, Directorship, 4/27/10. A failure of regulatory oversight led to the problems we now are dealing with. We need a resolution authority to handle the failure of financial institutions.
Regulatory responsibility should be divided into four major areas: prudential regulation and supervision (which applies to deposit-taking banks); market regulation and supervision; consumer and investor protection regulation; and systemic risk oversight.

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Require Affirmative Proof in Specified Circumstances of "Too Big to Fail Companies" in Order to Meet the Business Judgment Rule

“There is no such thing to my mind as an innocent stockholder. He may be innocent in fact, but socially he cannot be held innocent. He accepts the benefits of the system. It is his business and his obligation to see that those who represent him carry out a policy which is consistent with public welfare.” — US Supreme Court Justice Louis Brandeis

We seem to have moved very far from Brandeis’ ideal for shareowners, even to the point where directors too, are absolved of all responsibility, as long as they follow a very minimal set of process rules. In an effort to prompt discussion of a poor corporate governance as a critical but largely ignored cause of the financial crisis, Martin B. Robins shifts our focuses to outcomes in his draft Dawn Following Darkness: An Outcome-Oriented Model for Corporate Governance.

After reviewing and largely rejecting several currently proposed reforms, as insufficient by themselves, he suggests that directors at highly interconnected firms that are too big to fail assume a greater amount of direct responsibility for seriously adverse outcomes. Such responsibility would take the form of a reversal of the present burden of proof placed on plaintiffs in actions alleging breach of a directors’ duty of care.

Under his proposal, D&O insurance at such firms, if allowed at all in order to order to reach agreement on reforms, could have a high deductible payable by individual directors. One half the premium would also be paid by the directors and procurement of such insurance would need to be approved in advance by shareowners holding at least 60% of the firm’s voting equity.  Directors could escape liability by affirmatively demonstrating they have properly overseen management along the lines of Smith v. Van Gorkom.

Robins writes that he is generally satisfied with current public policies regarding director liability, except where inadequate corporate governance can “impact those outside the corporation,” which seems to me rather broad, since a great many firms externalize costs, but which he restricts to something like what most of us would consider companies that are “too big to fail.” Smith v. Van Gorkom emphasized the need for directors to “inform themselves ‘prior to making a business decision of all material information reasonably available to them.”

However, as Robins points out, to encourage directors to continue to undertake risky but potentially value-maximizing strategies in good faith, the Delaware Legislature promptly enacted title 8, section 102(b)(7) of the Delaware Code to allow corporations to include in their certificates of incorporation language “eliminating or limiting the personal liability of a director to the corporation or its stockholders for monetary damages for breach of fiduciary duty [other than duty of loyalty or intentional misconduct/bad faith] as a director.” Apparently, more members of the Delaware Legislature are dependent on management than on shareowners, since shareowners would have been unlikely to provide such a total escape from liability.

Robins believes, “the time has come to reconsider this policy of simply absolving directors who properly inform themselves of relevant information of any responsibility for the ultimate use of such information.” Blind deference to the judgment of rating agencies, when you know they have drastically reduced their standards should no longer suffice.

SEC protections are largely built around requirements of disclosure and the prohibition of deceit. Boards are generally fully protected by the business judgment rule, except when their firm is “in play.” Then, they are expected to heighten their focus with respect to potential changes in control. Noting that non-M&A matters like credit underwriting and investment standards can also have great impact, Robins calls for the development of “comparable jurisprudence governing oversight of operational matters.”

Perhaps to build up the value of his own proposed reforms, he appears to attack say on pay and proxy access, which “call upon attenuated logic to believe that shareholders will recognize poor performance by directors early enough to prompt them to exercise authority to cause their removal and timely installation of a new board which will insist upon a reversal of the ill-founded management policies before they do serious damage.” While I would not be so quick to dismiss efforts to align the interests of directors and shareowners, as well as to create mechanisms of accountability, I fully embrace the assertion by Robins that “we need a standard that encourages critical thinking instead of herd behavior.”

We need a legal regimen which forces directors at systemically important firms to familiarize themselves with what management is doing, and ask the tough questions of management before policies are implemented, to see if the downside risk of those policies is understood (or has been considered at all) and to change course when even an originally well conceived strategy is no longer suitable. Ultimately, we need to force directors to consider on an ongo- ing basis whether their firms’ managements should be in their positions at all, in order to screen out dishonest, reckless or incompetent persons.

As mentioned at the beginning of this post, Robins sets out proposed legal changes, at the state level, which include a set of “triggering events” to limit applicability to companies that are too big to fail.  He outlines conditions where compliance with Smith v. Van Gorkom would not suffice in any civil action alleging bread of any duty of care, including undismissed criminal and civil proceedings, bankruptcy, large write downs, etc.

I disagree with some of the details of Robins’ arguments and recommendations. Implementation of too big to fail reforms, especially by increasing director liability, seems doomed to failure if we must rely on adoption on a state by state basis. Perhaps I’m a cynic, but I think we have much more of a race to the bottom, rather than a race to the top. Management and self-sustaining boards control the state of incorporation, not shareowners.  Robins’ arguments, if not his recommendation, provide additional support for a federal corporation law. Maybe the recent carnage and public desire for change will prompt state courts and legislatures, especially in Delaware, to take a fresh look in attempt to preempt federal action. Both courses should be pursued. Public comments to the Delaware Court of Chancery, Charles M. Elson at the John L. Weinberg Center for Corporate Governance at the University of Delaware and the SEC Chair, and the SEC Investor Advisory Committee might help move such reforms along.

Additionally, while I like the idea of forcing directors to meet a high deductible for D&O insurance in circumstances outlined by Robins, what’s to stop any additional costs from being built into their compensation structure? I also disagree that “failures that arise from faithful management must come from the markets” for all but too big to fail companies. By the time markets recognize board decisions that are stupid, egregious or irrational, shareowner value has generally plunged and correction by markets, involving full blown proxy contests, are very expensive compared to other remedies, such as proxy access.

Robins is too modest in his proposal, many elements of which should be extended well beyond the scope of companies that are too big to fail, especially the ideas of flipping the business judgment rule presumption and requiring affirmative proof of reasonable care, going beyond process, if specified events have occurred. Nevertheless, applicability of these reforms at companies that are too big to fail would represent a good start, with the hope of later expansion. Dawn Following Darkness: An Outcome-Oriented Model for Corporate Governance warrants wide circulation and consideration. I urge readers to include Marty Robins, and his outcome-oriented model, in their discussions around corporate governance reforms that could reduce the likelihood of the next financial crisis.

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Parallel Universes Undercuts its Own Arguments

In his article The Parallel Universes of Institutional Investing and Institutional Voting, Charles M. Nathan appears to pine for the days when institutional investors took the “Wall Street Walk” if they disagreed with management on governance issues. T. Boone Pickens Jr’s response to that perspective:

That’s like the gardener telling the estate owner, “If you don’t like the way I take care of your property, sell it and move out.” That’s not the way the real world works.

Nathan’s major point is that institutional voting, for the most part, is no longer done by money managers, and is, instead, often handled by a separate internal voting function or is essentially outsourced to third-party proxy advisory firms. Because of the economies of scale, most resort to largely one-size-fits-all voting policies based on perceived corporate governance best practices, without reference to the particulars of each company’s situation. Therefore, firms should develop parallel systems to communicate with the two very different constituencies.

On the other hand, he also advises corporate governance specialists on the investor side to move to a more nuanced approach, recognizing the legitimate need for variation in corporate governance specifics in the context of more than 10,000 public companies in the US that exist in different sectors and different stages of development. That’s constructive advice. Unfortunately, Nathan also includes some very bad advice, such as the following:

The corporate governance community should recognize that it does not need and should not want to talk to the operating and financial management of a company because the voting decision makers are, by design, not involved with measuring the company’s operating and financial performance.

That advice is absurd. Many in the “parallel universe” of corporate governance are actually housed within the investment framework of their organizations. This is certainly true of CalSTRS and CalPERS. The CalPERS Corporate Governance team executes an annual process that identifies approximately 15 to 20 companies in the domestic internal equity portfolio that exhibit poor economic performance and corporate governance.

Nathan grasps the drive by shareowners to move the board from a “trustee model of a effectively self-perpetuating board” to “an assembly of annually elected representatives who are directly accountable to their electorate.” Yet, he believes “proxy access doesn’t involve investment decision makers but rather is the province of voting decision makers.”

While it may be helpful to recognize these functions governance and investment functions are often somewhat specialized, there certainly is frequent communication between the two functions on the investment side. Proxy access isn’t just “good governance.” For many, like myself, proxy access is one more mechanism to correct the “self-perpetuating board” that Nathan mentions. Many object to the ever increasing share of profits doled out to executives, up from 5% to 10% of the total.  Directors that are directly accountable to shareowners may work harder for investors than the CEO. That would be a plus.

Nathan cries that any attempt at accommodation to the demands of the corporate governance community becomes “merely a prelude to another round of demands.” Yet, he must recognize how far we are from that goal of “directly accountable” directors. Even if the SEC’s proxy access rule is finalized, it only facilitates direct accountability for 25% of the directors at companies; the other 75% can remain “self-perpetuating.”

He also loses credibility with retail investors when, in a footnote, he describes the “groundswell” to develop “client directed voting” as one that would allow a default voting pattern of “for or against management’s recommendations or to vote in proportion to all other shareowners.” Any client directed voting that doesn’t include allowing investors to build their own systems of default, based on the votes of institutional investors announced on sites like ProxyDemocracy.org or by advocates on sites like MoxyVote.com, should be flatly rejected.

Although the thrust of the article is to encourage companies to constructively engage in dialogue with what Nathan sees as separate corporate governance constituency, he frequently undermines his own arguments. That’s too bad because flexibility and dialogue are certainly needed on both sides.

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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.

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Lists for Governance & Board Candidates

My friend Bob Tricker, a leading governance academic and expert, has written a wonderful online booklet, Twenty Practical Steps to Better Corporate Governance for Corporate Secretaries International Association. He sought input from experts worldwide and came up with the following list:

  1. Recognize that good corporate governance is about the effectiveness of the governing body — not about compliance with codes
  2. Confirm the leadership role of the board chairman
  3. Check that non-executive directors have the necessary skills, experience, and courage
  4. Consider the calibre of the non-executive directors
  5. Review the role and contribution of non-executive directors
  6. Ensure that all directors have a sound understanding of the company
  7. Confirm that the board’s relationship with executive management is sound
  8. Check that directors can access all the information they need
  9. Consider whether the board is responsible for formulating strategy
  10. Recognize that the governance of risk is a board responsibility
  11. Monitor board performance and pursue opportunities for improvement
  12. Review relations with shareholders — particularly institutional investors
  13. Emphasise that the company does not belong to the directors
  14. Ensure that directors’ remuneration packages are justifiable and justified
  15. Review relations between external auditors and the company
  16. Consider relations with the corporate regulators
  17. Develop written board-level policies covering relations between the company and the societies it affects
  18. Review the company’s attitudes to ethical behaviour
  19. Ensure that company secretary’s function is providing value
  20. Consider how corporate secretary’s function might be developed

While the short list is of some value, the real value is in the sound advice offered around each topic. For example, Professor Mallin called for boards to give more attention to the “voice” of shareholders. Boards should critically assess their performance, and openly explain themselves to shareholders. The board’s relationships should recognize a “stewardship” role for institutional investors. Companies belong to their shareholders for whom the directors act as stewards.

Jeffrey M. Cunningham, writing for Directorship provides a list of six qualities to look for in today’s board candidates in Wanted: New Directors (3/25/2010)

  1. Battle hardened not battle weary
  2. Bureaucracy cutter
  3. Healthy not oversized ego
  4. Trusted comrade
  5. Ready for action
  6. Numbers and sense

I’d like to see “committed shareowner advocate” added to the list.

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Joo Calls for Explicit Examination of Normative Foundations in Corporate Governance Theory

In his recent paper, Theories and Models of Corporate Governance, Thomas Wuil Joo (incorporated into forthcoming Corporate Governance: A Synthesis of Theory, Research, and Practice (Robert W. Kolb Series), briefly surveys a history of American models of the corporation. On the currently dominant model, contractarianism, he notes that whereas early contractarians insisted that corporate governance consisted of legally enforceable contracts, more recent legal theorists of this vein commonly use “contract” in the nonlegal sense of a voluntary interaction. The contract, so central to theory is no longer.

After decades of model-building based on efficient-market and contractarian theories, the current state of corporate governance theory might be characterized as a ‘model-destroying’ phase,” with pundits from Eugene Fama to Alan Greenspan expressing doubts about market rationality.  Joo argues,

By assuming that unregulated markets are efficient, contractarianism conflates the two values of liberty and efficiency, obscuring their independent normative importance and the tension between them. As economic thinking came to pervade political and moral reasoning in recent decades, efficiency (in the sense of greater aggregate social wealth) became increasingly important relative to other values such as promise, consent and equity.

He reminds us that legal concepts draw strength not only from logic but from norms. Since “models often masquerade as proofs of normative positions,” we should build in acknowledgement and examination of such commitments as models are constructed. Joo cites Stephen M. Bainbridge as one theorist whose work is “unusually candid in this regard.”

Theorists should not use abstract models to disguise these unspoken normative visions but to flush them out and clearly define them. Theorists and lawmakers can then apply themselves to debating the wisdom of the law’s choice of normative goals and its success at realizing those goals.

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Collective Intelligence: Governance Systems for the Modern World

Governance in a Disenchanted World: The End of Moral Society by Helmut Willke reasserts the spirit of liberalism invoked during the American and French Revolution when moral attitudes based on religion were trumped by secularization and the invention of modern politics and law. According to Willke, we are now facing second revolution, which will replace the dominant normative focus of the state with a global network of knowledge-based systems of governance.

In those first revolutions, we moved from a fundamentalist search for ultimate and final truths to a system that largely banished religious or moral definitions of ‘truth’ from public discourse. Whereas a continuing shared understanding under fundamentalism required the oppressive use of state power, the liberal state flourished based on developing democratic decision-making structures which allowed individuals to pursue individual freedom within the agreed upon rules.

Over the years, we developed mechanisms to lessen the likelihood of a tyranny of the majority, such as separation of powers, a hierarchy of laws and horizontal subsidiarity, allowing health, economic, university, family and countless other systems to be largely self-governing. As we transition to a knowledge-based economy, secular trends seep further into these self-governing systems. What were formerly moral questions are now discussed in the public square using scientific evidence, instead of moral exhortation, since religious morals can be less readily agreed upon than the rules for decision-making. While this frees public deliberation somewhat from moral passions, it also largely converts the power of those passions into the rational calculation of interests. Many find that wholly dissatisfying and continue to search for common touchstones and eternal truths.

Added to that, “social systems do not follow the motives and desires of people but instead follow their innate operation logics,” leading to ‘estrangement’ from our own social inventions… such as the modern corporation. A procedural approach provides guidelines for activities without assuming or mandating specific outcomes. While this liberates creativity and freedom it can also lead to a backlash by fundamentalists who witness the havoc of temporal complexities, absent any universal idea of social justice.

In the spirit of liberalism, Willke argues that rather than delimiting democracy to the level of nation-states and leaving global contexts to a laissez-faire regime, we would be better to support emerging global governance regimes like the ISO, WHO, Basel II framework and the WTO that strengthen self-organization and self-governance, even if as we lower our aspirations for more formal democracy at that level through world systems like the United Nations.

He sees globalizing knowledge societies as moving “from unitary order to complex order, from homogeneity to heterotopia, from linear order to a combination of order and disorder, and from hierarchy to heterarchy.” In fact, the new job of the political system is provide the preconditions for developing an array of distributed and decentralized collective intelligence, as well as coordinate and moderate the interplay of largely autonomous units.

As Charles Handy has pointed out, the transformation of wealth generation from tangible objects, to one largely based on knowledge, has huge implications for politics. “It is for instance, impossible to give people intelligence by decree or to redistribute it.” That leads Willke to the conclusion that “public policy and democratic decision-making are therefore inappropriate for dealing with questions of the creation and distribution of intelligence and expertise.”

Politics, it seems, retreats to the concern of deciding on the premises of decision-making. It is bound to leave the actual and factual decision-making to more knowledgeable and more competent actors, organizations and institutions, particularly in the fields of economic and financial policies.

Politics loses traditional command and control responsibilities of “telling people what to do,” while becoming more important in the role of capacity building and infrastructure. Institutions and professions become largely self-governing but political actors are still involved in requiring transparency, monitoring externalities, demanding accountability and arbitrating disputes. The idea of democracy itself must be transformed from one based on “moral demands for solidarity,” to one based on agreement upon methods for determining “moral hazard, misguided incentives, and counter-productive side effects of social security provisions or other well-intended legislation.”

In order to increase the collective intelligence of social systems it seems necessary to retire the time-honored ideal of ‘security’ as stability in favor of a more daring idea of security as resilience… ‘having the capacity to change before the case for change becomes desperately obvious.'”

The retreat to moral authority undermines the unconditional rule of democratically created law.  Dissenting opinion is branded as fundamentally wrong or even treasonous in everything from global finance, terrorism, global warming, etc. Willke argues these and many other complex problems “exceed the coping mechanisms and capacities for understanding of simply too many people. In constellations of excessive uncertainty recourse to morals turns out to be an efficient way to reduce complexity.” Unfortunately, that leads to insoluble fragmentation and dissipation.

While I may disagree with Willke concerning the “capacities for understanding” of the masses, I certainly do agree that systems head in the wrong direction when they emphasize skill sets needed for twentieth century industry, rather than analytic reasoning and critical thinking, which are increasingly required in a world of growing complexity and uncertainty.

I like Willke’s exposition of the danger of social systems becoming “iron cages.” Like the sorcerer’s apprentice, we seem to have waved our magic wand only to have generated systems that have evolved beyond our control. Our desperate search for a grounding often leads to a regression to moral arguments that places guardians above the law and independent of empirical facts. Yet, in a pluralistic world guardians are soon challenged by others also claiming legitimate authority based on moral grounds. Willke’s alternative visions is a world of largely cognitive-based rule systems, deriving their legitimacy from a continuous process of criticism and revision as to what passes for empirical fact and congruence.

I can’t envision a better grounded system myself but it would only seem to work if a majority of citizens are immersed in “scientific communities” and “communities of practice.” Even in the United States, McKinsey estimates that only about 40% of jobs are mostly based on knowledge work involving abstraction, system thinking, experimentation and collaboration… and how many of them work in an environment where empirical evidence usually prevails over systemic rules-based iron cages? We sure have a long way to go in any transition from individual morals to collective interests. Willke is dealing with the most crucial issues of our time. After reading it, I certainly have a better understanding of the challenges… unfortunately, most of the answers, like the challenges, aren’t simple.

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How to Govern Corporations So They Serve the Public Good: Wrong Title, Right Book

William Sun’s excellent book is less on how to govern corporations to serve the public good than it is an analysis of corporate governance from the perspective of ontology, epistemology, and sociology of knowledge. Sun does an absolutely fascinating job of tracing the development of two pre-Socratic cosmologies that continue to shape modern thought. Heraclitus emphasized the primacy of a fluxing, changeable and emergent or processual world. Parmenides insisted on the permanent and unchangeable nature of reality… a homeostatic and entitative conception of reality.

Sun favors a processual perspective, since it allows us to understand corporate governance as is is socially constructed. By stripping away the semiotic mask, he reveals how much of what is known in shareowner and stakeholder models of corporate governance is based on political power.

Reading his book was a personal joy to me, since my mind was transported back to graduate school days as a student of Peter Berger during his all too brief tenure at Boston College. I found Berger and Luchmann’s The Social Construction of Reality a liberating work, since it implied that reality could be reconstructed to diminish coercion and domination.

However, Berger and Luchmann excluded from their treatise on the sociology of knowledge epistemological problems which they felt “belong” to the discipline of philosophy. “The sociology of knowledge must first of all concern itself with what people ‘know’ as ‘reality’ in their everyday, non- or pre-theoretical lives…” In other words, they didn’t seek to explore the possibility of obtaining a better approximation of the “truth,” but rather a better explanation as to how commonsense knowledge is externalized, internalized and institutionalized.

The failure of Berger and Luchmann to weigh historical factors and their abandonment of ultimate concerns left no grounding or basis for analyzing coercion, long-term trends or future possibilities. Instead, through his body of work we are largely provided a description of how social reality constructed in the past is maintained in the present. The resulting static relativism limited Berger’s emancipatory potential, since a critical theory must evaluate whether the naive realism of everyday life is a necessity due to biosocial needs or a mere justification of false consciousness, necessary to maintain the status quo.

Berger lays blame for society’s ills largely on the state, which he sees as “devoid of personal meaning.”

One of his most liberating works, To Empower People, stresses the need for increasing the individual’s political efficacy through the mediating structures of neighborhood, family, church and voluntary associations. The only institutions not viewed by Berger as political are businesses. Failure to include that sphere may serve Berger from the “trap of politicizing all of life” but it largely dooms his efforts to empower people to failure.

William Sun’s offering suffers no such limitations. While the book speaks only indirectly to how corporations can be governed to better “serve the public good,” implicit is that such positive changes will follow once people realize how the corporate governance we know as “real” was socially constructed and once we employ a processual framework of time, space and context, leading to reflexive dialogue.

Sun is under no delusions. He writes, “living in a processual reality, we cannot ‘mirror’ corporate governance practices accurately, and cannot construct corporate governance ideally.” “To improve corporate governance we should not force-fit corporate reality into the established abstract templates… we need to turn away from the current dichotomized, entative and static way of theorising… We need to dive into the underlying living experiences and processes that comprise corporate practices to understand the internal impetuses and environmental dynamics that drive the processes and changes of corporate reality.”

After leading the reader through an exceptional deconstruction of Cartesian dualism, Locke’s empiricism, Kant’s objective idealism, the fallacy of representationalism, the realities of shareholder and stakeholder perspectives, the myth of market and economic efficiency, and much more, Sun focuses on the value of a processual view of knowledge, borrowing from a bevy of resources, including Richard Rorty.

Rorty aimed for a “philosophy without mirrors,” believing that what we need “is the ability to think about science in such a way that its being a ‘value-based enterprise’ occasions no surprise.

All that hinders us from doing so is the ingrained notion that ‘values’ are ‘inner’ whereas ‘facts’ are ‘outer.'” In his seminal work, Philosophy and the Mirror of Nature, Rorty wrote that “Hermeneutics is not ‘another way of knowing’ – ‘understanding’ as opposed to (predictive) ‘explanation.’ It is better seen as another way of coping.”

If we see knowing not as having an essence, to be described by scientists or philosophers, but rather as a right, by current standards, to believe, then we are well on the way to seeing conversation and the ultimate context within which knowledge is to be understood. Out focus shifts from the relation between human beings and the objects of their inquiry to the relation between alternative standards of justification, and from there to the actual changes in those standards which make up intellectual history. (p. 389)

Likewise, Sun has a similar aim for what he terms the processual approach, which is “not a denial of substance; rather, it views substance as merely stabilized clusters or patterns of variable processes.” “Processism tends to be ontologically realistic; yet, it is not a ‘being’ realism, but a ‘becoming’ realism.” Those who rail against a “one-size fits all” approach to corporate governance will find a strong advocate for structures that contextually emerge, rather than are pre-designed.

The shareowner model may be waning, because as Sun notes, physical assets and financial resources used to be more important than human resources and social capital. In the stakeholder perspective public corporations must be aware of their social obligations, such as fairness, social justice and the protection of employees. Human-capital intensive firms are more likely to move in the direction of the stakeholder model. Under a processual approach, political institutions, indeed all institutions, cannot take human nature as a given but must accept some responsibility for their involvement in its creation.

“Unlike the current theoretical models that rest their solutions on scientific measures and universal recipes, we suggest the explicit change of corporate governance to be initiated and triggered in the sense of collective construction and discourse formation.” “The key factor in context-making is to find or create a more powerful ‘attractor’ to compete with the dominant ‘attractor’ and to shift the old one to the new one to create a new context.” “Corporate governance and control must be realised through our collective representations – representations of our will, desire and sense-making, representation of a specific mode of thought and social convention, and the representation of social negotiation, selection endorsement and rationalism… in an ideal construction process, corporate governance is not seen as universally good, but as partial, selective and interested.”

While Sun appears relatively certain that a processual approach will bring new insights and open dialogue, he is less certain about the criteria for judging governance, “all of which depend on the social construction of ‘faith.'” Ultimately, he aims for “balanced and pluralistic thinking.”

“Although the damage caused by corporate violations is far more serious than the individually perpetrated crime, it is regarded by the public as less of a crime.” To get people to understand that requires a change in conciousness. Corporate governance is best understood in the context of capitalism, where Sun finds three dilemmas:

  1. The conflict between self-interest and others’ interest, or private interest and public interest. Capitalism presupposes the sacredness and inviolability of private property rights as its first principle. Other interests must be considered within that context.
  2. The conflict between the economic interest and the social interest. All other possible principles and values such as justice, equity, humanity, and religion are subsumed to protecting capitalist interests. This rationality leads to its own contradiction and such notions as “the only responsibility of the corporation is to make profit.”
  3. The conflict between shareowner and manager interests. How capitalist interests are protected from management’s manipulation is a serious concern of politicians, academics and corporate owners. Agency theory, will it hold back the coming pitchforks?

Perhaps Sun will shake up the world of corporate governance like Werner Karl Heisenberg shook up physics. But, as Robert Chia notes in the book’s introduction, “despite the advent of quantum mechanics the assumption regarding the primacy of substance and entities over patterns and relationships remains pervasive and overwhelming.” Our conceptions of reality take a long time to change. Unfortunately, time for central issues like corporate governance may be running out, given the moral and environmental challenges we face.

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Does Corporate Governance Matter to Economic Development?

The editors of Corporate Governance and Development: Reform, Financial Systems and Legal Frameworks (The Crc Series on Competition, Regulation and Development), Thankom Gopinath Arun and John Turner answer with a resounding yes. As they indicate in their introduction,

If finance matters for economic development, then corporate governance must also affect economic development for at least two reasons. First, corporate governance affects how and at what cost firms finance their real investments… Secondly, the quality and nature of corporate governance can affect the structure of the financial system.

If shareowners are poorly protected, finance through bank loans will be more expensive.

This collection of essays provides a broad outline of recent scholarship around the world. Chisari and Ferro suggest that unintended consequences of reforms in Argentina could impinge on consumers. Based on experience in Botswana, Gustavson, Kimani and Ouma also argue reforms originating in Anglo-American models must tailored better when imported to other cultures. Goyer and Rocio also find that corporate governance is mediated by the larger institutional framework in their study of electricity sectors in Britain and Spain.

Other authors focus on corporate governance relative to the banking sector, finding a correlation between debt and poor performance, the need for prudent regulatory reforms for divestiture of government ownership and good governance practices, while two chapters on Bangladesh also argue for strong legal and regulatory institutions to protect minority shareholders, creditors and depositors.

Three additional chapters focus on legal frameworks in Ireland, UK and the EU, as well as more broadly. It is that broader focus of developing a “shareholder protection index,” which I found most interesting. Building on prior work by La Porta and others, Priya P. Lele and Mathias M. Siems construct a much more elaborate index of shareowner rights based on a “leximetric” (quantative measurement of law), rather than econometric approach.

They endeavored to include the variables which best reflect shareowner protections developed in the UK, US, German, France and India over the last 35 years. Aggregate scales for each of these countries trend upward. Shareowner protections have increase, especially in the last five years. On a number of scales, the US comes out at or near the bottom but that doesn’t mean the authors recommend redirecting capital from the US to France, for example. Other aspects, such as financial disclosure, the rule of law and socio-economic attitudes have not bee considered. Neither have factors such as blockholder control and other variables. They didn’t examine whether a better score leads to better governance or economic development but will be examining these questions in the future.

Overall, the volume offers a good cross-section of essays reflecting current scholarship in field of growing importance.

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Review: An Islamic Perspective on Governance

An Islamic Perspective on Governance (New Horizons in Money and Finance) by Zafar Iqbal and Mervyn K. Lewis reads like a carefully constructed dissertation setting forth a theory of justice, taxation, government finance and accountability, governance and corruption grounded in Islam. Indeed, it originated as an academic piece and is unlikely to find the wide audience it deserves in this format. Continue Reading →

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Moving Beyond Cycles of Regulation, Deregulation & Reregulation

The endless cycle of government regulation is explored in a new book, Regulation, Deregulation and Reregulation: Institutional Perspectives (Advances in New Institutional Analysis Series) by Michel Ghertman and Claude Menard. Contributors bring an international perspective, touching on a myriad of industries. While not directly focused on developing a post-subprime regulatory framework in the financial industry, the book does reflect the latest thinking by a respected group of scholars for understanding theory and practice in regulatory approaches.

For example, the research of Andres, Guasch and Azumendi develops indexes of regulatory governance from cross-country data and shows that regulatory involvement improves results in utility performance. Another study by Delmas, Russo, Montes-Sancho and Tokat finds that deregulation has a negative impact on efficiency and a positive impact on the provision of renewable energy. ne way to create willingness to pay for public goods is to bundle them with private goods. Consumers are willing to pay a premium for non-toxic cleaners because they see the likelihood of direct impacts on their own health.

More on target for those concerned with reform of the financial industry, Romano discusses how SOX’s use of a "one-size-fits-all" approach is oblivious to the microanalytic approach of firms matching governance structures and processes to specific organizational developments and requirements. Rulemaking expansions often occur after business crises galvanize public opinion and action by legislators around sometimes ill-conceived compromise solutions supported by powerful and vocal interest groups. In contrast, refinement of poorly conceived regulatory schemes generally takes many years and requires substantial research.

If nothing else, be sure to read the essay by Ghertman who outlines Stigler’s 1971 article, the "Economic Theory of Regulation," which recognized that many rules are advocated by incumbent firms as barriers to entry. Stigler generally favored market-oriented deregulation… the road we took for decades. Ghertman goes on to discuss refinements offered by subsequent scholars that discuss variables such as group cohesion, political balance, and unintended incentives and transaction costs.

Explanations of movements away from and back toward a dominating policy paradigm (regulation or deregulation) benefit from the dynamic properties of political science for third order changes (the paradigm), the dynamic properties of transaction cost theory for second order changes (regulatory instruments), and the behavioral theory of the firm and the contractual design view for first-order changes (regulatory mechanisms).

Transaction cost economies are better grounded than a simple Stigler-based assertion that "regulation (or government) IS the problem" would warrant. Finding appropriate proxies to measure transaction attributes is problematic, especially across industries and jurisdictions, but is essential. We need to focus more on ex ante choices and less on ex post empirical tests if we are to move beyond the cycle of regulation, deregulation and reregulation.


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Corporate Governance: Principles, Policies and Practices

Bob Tricker helped introduce many of us to corporate governance as a field. His 1984 long out of print, Corporate Governance: Practices, Procedures and Powers in British Companies and their Boards of Directors was first to include the phrase "corporate governance" in the title. His definition of the term, even then, was spot-on: "The governance role is not concerned with the running of the company, per se, but with giving overall direction to the enterprise, with overseeing and controlling the executive actions of management and with satisfying legitimate expectations of accountability and regulation by interests beyond the corporate boundaries." Twenty-five years later, Tricker updates his opus.

Tricker notes in his introduction that, "Some teachers, particularly those working with students without a lot of business experience, might prefer to build their courses from theory to practice. This is quite feasible, not least since to date the theories of corporate governance, other than a broad concept of agency, have not contributed significantly to its development. The underlying paradigms have been derived from company law and the codes of good practice have emerged as responses to corporate catastrophe and collapse." Thus, readers can see at the outset, Tricker is a realist.

Anyone familiar with his work knows he has certainly tried to build the discipline. Corporate Governance: An International Review was his effort to publish cutting-edge research in comparative corporate governance in hopes of building theory and practice on rigorous science. Tricker has often proclaimed the 19th century the entrepreneur’s, 20th century management’s, and 21st that of governance. We certainly see focus swinging to questions of legitimacy and effectiveness in wielding power worldwide. By the time the 22nd century dawns, corporate power may actually be exercised "in a way that ensures both the effective performance and appropriate social accountability and responsibility… rooted in rigorous and replicable research," as Tricker envisions. If it happens, it will be in no small part due to Tricker’s contribution. I was delighted to see my website, corpgov.net, listed as the first of many useful websites at the end of each chapter.

Tricker quickly outlines the history and issues of corporate governance. He covers all the usual topics in corporate governance but does so from a multitude of perspectives, as perhaps only he can. Included are a large number of graphics and case studies that simplify understanding of complex relationships and concepts. I even like the typesetting. If you want to know not only about corporate governance in the United States, but also internationally, especially current and former Commonwealth countries as well as China, Japan, Russia, etc., you will find the book an unequaled guide.

Tricker generally takes a very measured approach to his subject, providing the latest advice on principles, policies and practices, balancing all perspectives worth attention. However, when it comes to grounding praxis in the results of research, he is passionate. For example, in discussing the future of corporate governance reporting, he predicts, "The current box ticking approach to simple structural questions will be replaced by performance measures against corporate governance criteria. The reports will also provide independent and objective opinions on the caliber of directors and boards, and on the quality of corporate governance, in the same way that auditors now report on corporate finances." I hope he is right and I hope they are not as "independent and objective" as some recent reports on corporate finances but as good as they could be without current conflicts of interest.

Tricker calls for a "new paradigm," that reflects the interests of all principal stakeholders. "Instead of legal entities, corporate bodies could be seen as self-governance social institutions… defined by the ability of external parties to exercise power over the entity… governance arrangements may also have to be more participative, less secretive, and fare more transparent."

While Tricker sees globalization driving integration, a counter movement of nationalism and economic patriotism is also on the rise, especially with the latest economic crisis. "Ultimately, a class of directors of global companies may emerge who transcend national boundaries, economic interests, and political barriers."

He cautions that "greed seems to have replaced trust as capitalism’s driving force. Indeed, the dominant paradigm of corporate governance, agency theory, is rooted in the belief that people are utility maximizers who need to be controlled because they cannot be trusted." "Above all, governing bodies need people who can be trusted, people who understand their fiduciary responsibilities, people who put the rights and needs of others ahead of their own." He then reminds us, "the best interests of people need not be solely power, personal aggrandizement, or greed." Integrity, treating employees and other stakeholder fairly and being reliable stewards for the others’ interests must be elevated in importance.

Be sure to check out the blog Tricker writes with Chris Mallin, Founder and Director of the Centre for Corporate Governance Research, at the University of Birmingham, UK. Read more about both. As I write my review, Tricker is back in Hong Kong. He notes, the State-owned Assets Supervision and Administration Commission of the State Council (SASAC), the largest investment fund in the world, ensures that the State’s interests are represented in the activities of China’s listed companies, including removal of directors and top executives. Obama recently removed the head of General Motors and the British Government is currently involved in the appointment of directors to various British banks they have nationalized.

"Maybe convergence is a two-way street," he concludes. Undoubtedly. Although primarily aimed at graduate students, complete with projects, exercises and self-test questions, practitioners will also benefit. Corporate Governance: Principles, Policies and Practices reflects the author’s worldwide experience and multi-faceted perspective on the critical subject he has been instrumental in naming and advancing.

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