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Equal access? The SEC's rulemaking, S7-19-03 (comments, Editor's: 1, 2 & 3) would have been a weak first step. Compare the petition Les Greenberg and I filed to allow shareholder proposals to elect directors: Petition File No. 4-461, which the Council of Institutional Investors said "re-energized" the "debate over shareholder access to management proxy cards to nominate directors." See Equal Access - What Is It?, Inside Track interview, ad. Evolution at Solicitation of Public Views Regarding Possible Changes to the Proxy Rules and Shareholder Access to the Proxy. Hold that thought until 2008. Current News. News Archives. Disclaimers, Copyright and Conflicts of Interest. Your purchases and ad clicks help us pay the bills. BookBites. Directors Compensation Up Compensation for directors of large US companies was up18% in 2004, according to Mercer Human Resource Consulting. The study, which analyzed 2005 proxy statements, found median total direct compensation (pay for board service, committee service, and equity grants) for board members at 350 large, publicly traded firms has increased by almost 50%, from $105,000 to $155,000 over the last four years. The study also found that the use of stock options as a part of director compensation has declined greatly while restricted stock has increased in popularity. Equity represents 55% of total direct compensation in 2004, up from 51% in 2003. Board retainers increased 25% from $40,000 in 2003 to $50,000 in 2004. Use of lead directors and non-employee chairmen has increased dramatically in recent years. 47% of the Mercer 350 companies reported ownership guidelines in 2004. This is the third consecutive year of double digit increases, up from 37% of companies disclosing guidelines in 2003 and 25% in 2002. Most companies express their guidelines as a multiple of their annual retainer – five times the annual retainer being the most common. Although still relatively small, the number of Mercer 350 companies disclosing holding requirements was up from approximately 5% in 2003 to 8% in 2004. Among this group, the holding period is split evenly among (a) a one-year minimum, (b) until retirement from the board, and (c) until ownership guidelines are met. Based on these trends, Mercer expects to see the following changes in director compensation:
To override an initial ISS negative vote recommendation, a company must demonstrate (and disclose in its proxy statement) that its director compensation program contains all of the following:
CalPERS OKs Limited Investment in Black-Listed Countries The Board approved a policy allowing investments in international pooled real estate funds that have up to 25% of their assets invested in countries excluded from thir permissible country list, including China and Eastern European countries. Up to $650 million may be invested in such pools despite poor labor standards, according to a report in the 8/22/2005 issue of Pensions & Investments. (CalPERS OKs Some Real Estate Investments Off Country List) Maxim Forgives Loans The board of directors of Maxim Pharmaceuticals voted to forgive a $2.8 million company loan to its chief executive and potentially pay certain taxes or tax penalties on the money. Let's hope this provides an example to other firms that strongly discourages them from making loans to senior officers. Charles Elson, director of the Weinberg Center for Corporate Governance at the University of Delaware, said the Maxim board's action underscores the "toxic" nature of corporate loans to executives. "It's like mixing oil and vinegar," said Elson. "The board is put in the position of being a banker, and it becomes a mess." "It is unfortunate that they (Maxim's board) find themselves in this situation," Elson added. "But the ones who really have the problem are the shareholders. It's the shareholders' money." (Maxim's board forgives loan it made to boss, San Diego Union-Tribune, 8/27/2005) Audit Problems Persist A survey by the Center for Strategy, Execution and Valuation at DePaul University's Kellstadt Graduate School of Business commissioned by Grant Thornton LLP of chief financial officers, controllers and treasurers from public and private companies across the US found:
See "SOX Makes Director Recruiting Tougher Than Ever," PlanSponsor.com, 8/26/2005. I wish they had asked if these senior financial officers favored having auditors selected by the exchanges, as recommended by David Skeel in his book Icarus in the Boardroom, or having them selected by shareholders, as recommended by Mark Latham of the Proxy Monitoring Project. As long as they are chosen by corporate officials, we expect problems to persist. India's Passage to Prosperity Good corporate governance alone is not enough. Arvind Panagariya's “A Passage to Prosperity” in the 7-8/2005 edition of the Far Eastern Economic Review recommends four badly needed reforms.
Back to the top Majority Voting Gains Support On 8/10/2005 TheCorporateCounsel.net Blog reported that two more companies have entered the fold:
Islands of Democracy Schlumberger Ltd., an oil-field-services company with 52,000 employees spread over 80 countries, has created what a recent Wall Street Journal article called 23 "communities of practice," ranging from chemistry to well engineering, with about 140 special-interest subgroups, and counts more than 11,750 employees as members. Schlumberger allows these island of peer review democracy to elect their own leaders. In the example provided in the article, a geological engineer elected to leadership of the company's rock-characterization community "spends 15% to 20% of his time organizing an annual conference and occasional workshops, overseeing the group's Web site, coordinating subgroups and the like." Members post CVs to an internal intranet to identify themselves to each other. "Each nominee had to be backed by at least one other community member and by his or her manager, who was consenting to let the subordinate devote a chunk of time to the endeavor. Turnout in early elections was an impressive 60%, but it since has fallen to 30%. Leaders are elected to a one-year term and can be re-elected only once. In all, more than 275 employees serve as elected leaders of communities or subgroups." (Motivating Workers By Giving Them a Vote, 8/25/2005) As we have noted on this website for ten years, there are benefits to democratic corporate governance both at the board level and the "shop floor." Schlumberger may have a model worth replicating. Ohio PERF May Create Target List As reported by Pensions & Investments (August 23, 2005), Ohio Public Employees’ Retirement System, is considering developing a focus list of companies to target for corporate governance action, said Lori F. Hacking, executive director of the $64.5 billion system. “We’ve never done that before,” she said, adding that staff is still developing the idea to possibly bring to the board for its consideration. “We are trying to upgrade our corporate governance program and presence.” CEO Pay Abuses The 5 most outrageously overpaid CEOs, according to MSN Money, 8/24/2005. • Top honors go to Patrick Nettles at Ciena (CIEN, news, msgs). His shareholders have been virtually wiped out -- losing 93% in the past four years. His compensation over that period: $41.2 million. All Majorities Not the Same Broc Romanek's blog at TheCorporateCounsel.net notes that "Disney's standard parallels the 'Pfizer' guidelines (ie. based on a majority of votes cast); whereas Office Depot's standard requires a withhold or against from 'a majority of the Company's shares.' That sounds like it means a majority of outstanding shares would need to withhold, which is a higher standard - and arguably not even a 'majority vote' standard because a majority of those voting could withhold and yet not trigger the guideline. If Office Depot sticks with that type of standard, I wonder if they are going to add an 'against' box to their proxy card? His further writings provide some insight on these and other issues. Icarus in the Boardroom America loves risk-taking CEOs, but when such behavior crosses over to boardrooms it could have massive consequences because of the growing scale of businesses and society's greater dependence on equity markets. Icarus in the Boardroom: The Fundamental Flaws in Corporate America and Where They Came From, by David Skeel draws on Greek mythology to present a candid warning aimed at corporate directors and anyone concerned with our economic future. Trapped in a labyrinth of his on construction, Dedalus made wings for himself and his son Icarus. He warned Icarus not to fly to close to the sun but Icarus got carried away, failed to heed the warning, and plunged to his death after the sun melted the wax that held his wings together. Similarly, the corporation is a powerful human innovation, but is dangerous if not used properly.
The bulk of the book is devoted to a short history of the corporation followed by an excellent treatment of these three thematic factors and corporate failures though US history. He explains how government has responded to Icarus effects and how corporations have worked to first adapt, then often to circumvent or unravel government's attempt to save us from corporate excesses.
“Ordinary Americans no longer see corporations as 'other,'” because more than half now own stock (directly or indirectly). As defined benefit plans dwindle and 401(k) participation increases, Americans have come to see their own stakes, however small, as tied to those of corporations. Skeel cites an important study by Dallas Federal Reserve Economists John Duca and Jason Saving that found “a direct correlation between stock ownership and the Republican vote in recent Congressional elections. As stock ownership goes up, so does the Republicans' share of the Congressional vote.” It's no wonder President Bush keeps pushing privatization of Social Security. “The increasing identification between ordinary Americans and corporate America is perfectly understandable, but beneath it lurks a terrible irony: at the same time as our passion for real reform has declined, the risks have radically increased,” writes Skeel. In the past, investing in stocks was an activity largely limited to the rich who could afford to speculate. Now stocks have become the investment of choice for “life” savings and retirement.
Back to the top Chamber Opposes Majority Vote As we reported in June, the American Bar Association (ABA) Committee of Corporate Laws issued a discussion paper on majority elections for corporate directors and invited public comment by 8/15/2005 to: E. Norman Veasey. Support among shareholder proposals for a majority election standard continues to grow, winning a 43% average level of support at over 50 companies this season. A recent (8/18/2005) ISS Friday Report (Business Groups Defend Plurality Elections), carried excerpts from a letter submitted by the US Chamber of Commerce, which spent more than $53 million on lobbying in 2004:
As we reported last month, the Council of Institutional Investors, representing $3 trillion in assets, posted its June 15th letter to Veasey on their website indicating their clear support for an initiative that would "presumptively provide for the election of directors by a majority of votes cast for and against, unless otherwise provided in the certificate of incorporation or the bylaws." "The benefits of this change are many: it democratizes the corporate electoral process; it puts real voting power in hands of investors; and it results in minimal disruption to corporate affairs—it simply makes boards representative of shareowners."
Pfizer Inc., Office Depot Inc., Automated Data Processing Inc., and Walt Disney Co. have also recently adopted similar policies. The Chamber must have known a majority requirement has widespread among owners when they issued their statement, yet they claim to be unaware "of substantial concern among fund managers and other investors who inject most of the money into the system." Are they putting their head in the sand or is there a nuance here? Maybe they value the opinion of those who place the stock orders over the opinions of owners and fiduciaries? I've asked the Chamber to clarify the basis for this comment, but so far have only received an automated receipt of the question. ISS submitted comments which included the following statement: "Majority voting will provide for the missing element of board accountability to shareholders. In doing so, the standard will confer upon owners a new level of responsibility to determine the members of the board. We are confident that shareholders will exercise that responsibility wisely, for the benefit of themselves and the corporate issuers they own." Better Governance = Better Credit Governance practices impact on credit ratings, according a review of 27 major U.S. financial institutions by Moody's Investors Service. For example, Moody's noted that governance practices contributed to Wells Fargo Bank's upgrade to Aaa in 2003, as well as Sovereign Bancorp's change in outlook to positive from stable in 2005. (For Banks, Better-run Means Better-rated, CFO.com, 8/17/2005) France/US Rock/Hardplace US companies that do business in France are in a tough bind: If they set up anonymous whistleblowing hotlines to comply with Sarbanes-Oxley, they risk fines from data protection authority Commission Nationale de l'Informatique et des Libertes, or CNIL, which sees such anonymous tip lines as unnecessary America-style impositions on its current fraud reporting methods. If they don't set up the hotlines, they risk U.S. civil or criminal penalties for violating Sarbanes-Oxley. (US firms find fraud hotlines too risque in France, MarketWatch.com, 8/17/2005) CalPERS Effect Shrinking 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. They hypothesized that CalPERS was less aggressive with its governance campaign in the late '90s, and the bear market drove investors to more blue chip-type stocks, making it tougher and longer for ailing companies to regain stock market value. (Study sees less reward for CalPERS' activism, Sacramento Bee, 8/16/2005) I think a more likely explanation is that low hanging fruit is harder to find. How to Get on a Corporate Board Since beginning CorpGov.net 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. Even John C. Whitehead's article "The Virture of Quiet Leadership" and the interview with him, while not directly on topic, offer insight. Being a leader is one of the prerequisites of getting on a board and the former co-chair of Goldman, Sachs & Co. offers sound advice. The core article on the subject, however, is by Norman R. Augustine, former CEO of Lockheed Martin. A few of his tidbits are as follows:
Ann McLaughlin Korologos, former Secretary of Labor, offers advice of common misconceptions about board service. Roger W. Raber, CEO of the National Association of Corporate Directors offers:
That's the tip of the iceberg. For much more, see the Third Quarter edition of Directors & Boards magazine. Excellent Proposal Needs Major Endorser 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. The Board would take all necessary steps to hold the vote at the year-2006 shareowner meeting, with the following features:
We believe this type of proposal should make up a key part of any long-term strategy by shareholders seeking governance reforms at specific firms. Proposals submitted in the year following passage of such a resolution would be likely to receive more favorable reception if endorsed by the impartial corporate monitor. All it would take for these proposals to take hold would be adoption by an influential pension or mutual fund. Chamber Protects Mutal Fund Insiders The U.S. Court of Appeals for the District of Columbia delayed implementation of SEC mutual fund governance rules while the court considers the latest challenge by the U.S. Chamber of Commerce. The rules require that board chairs and 75% of fund directors be "independent." Adopted in June 2004, the court sent the rule back to the SEC in June this year for reconsideration of costs that would be incurred by fund companies and also ordered the SEC to consider alternatives to rule. A study by the SEC released about a week later before Donaldson left concluded the financial burden would be minimal. The Chamber of Commerce then filed a second suit against the rule that was due to take effect in January 2006. Disney Decision In a 174-page ruling, Chancellor William B. Chandler III ruled that yes, the $140 million severance package was ‘breathtaking.’ But no, it did not constitute an outright breach of duty by Disney's board of directors. Attorneys for shareholders who sued the board said they would appeal the ruling. The plaintiffs had sought damages of more than $260 million from directors, which would have gone into the company's treasury. "This creates an aura of ambiguity at a time when boards and corporate leaders need to have a bright line of proper conduct drawn for them," Jeffrey Sonnenfeld, a senior associate dean of the Yale School of Management told the Wall Street Journal. He called the Ovitz ruling a "stunning reversal" of a 1985 case in Delaware, Smith v. Van Gorkom, which shook the corporate world by challenging the standards for informed decision-making by boards. Chandler did rebuke the directors, saying their conduct "fell significantly short of the best practices of ideal corporate governance." He also criticized Eisner who "enthroned himself as the omnipotent and infallible monarch of his personal Magic Kingdom" and who "stacked his...board of directors with friends and other acquaintances who, though not necessarily beholden to him, were certainly more willing to accede to his wishes." "The redress for failures that arise from faithful management must come from the markets....and not from the court," Chandler wrote. He also made a distinction between governance and Delaware law, saying, "The standards used to measure the conduct of fiduciaries under Delaware law are not the same standards used in determining good corporate governance." In his ruling, Judge Chandler also noted that ideas of the role of directors changed significantly after scandals at Enron, WorldCom and elsewhere. It would be unfair to apply today's standards to past conduct. "This court strongly encourages directors and officer to employ best practices," he wrote, "as those practices are understood at the time a corporate decision is taken." He continued that "Delaware law does not - indeed the common law cannot - hold fiduciaries liable for a failure to comply with the aspirational ideal of best practices." (Big Pay Packages May Fade After Ruling on Ex-President of Disney, NYTimes, 8/10/2005) (Judge Backs Disney Directors In Suit on Ovitz's Hiring, Firing, WSJ, 8/10/2005) “Shareholders can sell their stock,” but as disappointed shareholder activist Les Greenberg notes, "not a mention that shareholders should have a viable means to replace directors through the proxy process. Now that shareholders have been informed that the BOD 'underperformed,' how can they be held accountable for their 'bad management?'" Ironically, another Chancery court judge, in denying Roy E. Disney’s request to publicly disclose documents that he obtained pursuant to a Shareholder’s inspection rights, stated, “There are other avenues for bringing directors to account for their mismanagement, most notably by contesting elections and by instituting derivative litigation.” (Roy E. Disney v. The Walter Disney Company, Delaware Chancery Court, Case No. 380 2004, Opinion on Remand 6/20/05, Page 13) "In the real world, those 'avenues' are currently insurmountably barricaded," according to Greenberg. Back to the top The Monitor The Monitor was developed by corporate governance firm Glass Lewis & Co., headed by Greg Taxin. It's a web-based product that utilizes corporate disclosures to alert customers to early warning signs that could spell trouble like slowdowns in cash conversion, changes in accounting policies, CFOs or auditors and irregular insider-trading patterns. Cost starts at $25,000 and is dependent on the number of users. Barron's Online reports, "Of the 10% worst-performing companies in any quarter between June 1, 2003, and March 31, 2005, about 49% were the subject of a Monitor alert during the preceding six months, according to the company. On average, those stocks lost about 27% of their value during that quarter." If they can keep up that rate of predictability, we expect a lot of subscribers. (An Early-Warning System For Investment Dangers, 8/8/2005) Forums to Unite Investors 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. Share Power will focus on two specific shareowner resolutions, one at Chevron (CVX) and the other at Dow (DOW). The Chevron resolution asks the company to report on new management initiatives to address health and environmental concerns regarding oil-related contamination by its subsidiary Texaco in Ecuador. The Dow resolution asks the company to report on its accountability for the 1984 gas leak in Bhopal, India at a subsidiary Union Carbide plant. The Share Power program is not limited to these resolutions and hosts an online forum where participants can track the progress of shareowner advocacy campaigns across the US. For example, participants can post the proxy voting records of institutions to provide others information as fodder for their own campaigning. (Power to the People: Amnesty Launches Grassroots Shareowner Advocacy, SocialFunds.com) We hope the idea takes off. We also endorse the effort by Andrew Eggers through MyProxyAdvisor to alert investors about how respected institutional investors with a variety of voting philosophies have chosen to vote their shares. You tell MyProxyAdvisor which funds you most agree with and which stocks you own. When they know how a fund you have chosen will vote on a stock you own they'll send you a free alert. You'll have a week or two to look at their decisions and cast your own ballot. You could also use this time and information at the Share Power online forum to coordinate efforts to get other institutional investors to vote similarly. Sovereign Bancorp Bows to Relational Investors Back in May 2004, Ralph Whitworth of Relational Investors threatened a proxy fight over the issue of extraordinary pay for outside directors at Sovereign Bancorp (SOV) who averaged $313,000. More than a year later, after a review by an outside compensation consultant, the bank relented. Effective 10/1/05 they will instead pay directors $50,000 and award them $50,000 in company stock annually. Sovereign also will pay the "lead" director and the chairman of the audit committee an additional $25,000. Other committee chairs will receive $15,000. Directors also will be required to own $200,000 worth of company stock. (Sovereign bows to critics of bonus plan, MarketWatch, 8/5/05) Comments Sought on SOX SEC Release 33-8599; 34-52189; File No. 265-23 includes a 29-page questionnaire for submission of comments to the Advisory Committee on Smaller Public Companies ("Advisory Committee"). No bright-line definition of what a "smaller" company is for the purpose of this questionnaire is provided, although respondents are asked to indicate the size of their company. Many of the 20 questions address Sarbanes-Oxley Section 404 and the related SEC and Public Company Accounting Oversight Board (PCAOB) rules regarding management's report and the auditor's report on internal control over financial reporting. Other questions address broader corporate governance and listing standards; the relationship of the smaller public company with its independent auditor; and other regulatory provisions of the SEC affecting smaller public companies and accounting issues affecting smaller public companies. Comment deadline on the questionnaire is 8/31/2005. Responses are being posted. The next meeting of the SEC Advisory Committee on Smaller Public Companies is scheduled for 8/9/2005 in Chicago. Information on accessing the webcast and agenda is included in the Notice of Meeting. (SEC Questionnaire Seeks Small Public Company Input By Aug. 31, FEI) SRI Effectiveness WSJ carried an article on 8/3/2005 "Helping Your Portfolio, Not the World," in which Jonathan Clements writes that although the amount invested in socially responsible mutual funds has grown 137% since year-end 2000, easily outpacing the 24% asset growth for all stock and bond mutual funds, "the results suggest socially responsible investing isn't changing corporate America." "If your aim is to reward good companies and punish bad ones, forget playing the stock market. Instead, focus on how you spend your paycheck." Shelley Alpern, Director of Social Research & Advocacy
In most instances mutual funds don't change companies by boycotting them, although that can be an effective tool. Most effective change comes by fulfilling basic fiduciary duties, such as conscientiously voting in the interests of your investors, and through dialogue. In those areas SRI funds have a substantially better record than most other funds. New Links We have added a link to the German Corporate Governance Network on our Links page in the International Corporate Governance section. Thank you Dr. Gregory Jackson of Corporate Governance Japan for bringing this site to our attention. We added two other links to our NewsLinks page. One is to Michelle Leder's Footnoted.org, which has been up for years but I missed it. She provides tips on how to read 10-Q's for signs of aggressive accounting and significant changes, as well as an award winning blog on her own detective work. The second new link on that page is to a Corporate Library blog worth checking in with periodically. Have ideas for new links? Please pass them along to the publisher. ACGA Update The Asian Corporate Governance Association (ACGA), a non-profit membership organization dedicated to implementing effective corporate governance practices throughout Asia, has largely completed a newly revised Annotated Links section of their site. Very nice! Their site also contains news and information about their 5th Annual Conference upcoming in Singapore, October 14, 2005, as well as other events in Asia. Tocqueville at 200 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. Tocqueville recognized “the right to direct the official presumes the right to discharge him.” Mass owners (250 million worldwide and growing) and stakeholder are demanding representation on boards through pension funds like CalPERS, a growing number of mutual funds and NGOs willing to engage in public debate. (Insights into Tocqueville's thought in this article are largely derived from 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.) Let Exchanges Assign Auditors David Skeel of the University of Pennsylvania Law School advocates having the NYSE and NASDAQ assign auditors to the firms they list. "If the auditing firms viewed stock-market regulators as their client, rather than the company being audited, they would have a far greater incentive to take a careful look at the company's accounting." While not as elegant as Mark Latham's proposal for auditor independence based on shareholder vote, Skeel's proposal would nonetheless address the fundamental problem of allowing companies to select their own auditors, even if selection is done by so called "independent" board members. Skeel cites an experiment that found auditors 30% more likely to find accounting treatment was kosher if they had been hired by the firm they were auditing, rather than by a company doing business with the firm. (Self-Serving Bias, Across the Board, 7-8/2005) Fix the NASD Arbitration System An article in the San Diego Union-Tribune relates a story relevant to longtime securities attorney and NASD arbitrator Les Greenberg's campaign to improve the NASD arbitration process. “A retired nurse turned over her $1.3 million nest egg to a broker who lost more than $900,000 of it. The arbitrators concluded that the retiree deserved restitution, but only awarded her $5,000. As the same time, the arbitrators dinged her $5,600 for the proceeding.” Apparently, this was one of the 55% of arbitration cases the NASD considers a "victory for investors. (Stockbroker losses bring no trials, lots of tribulations, 7/31/2005) The article later asks, what did the NASD do after the state of California insisted that neutral securities arbitrators disclose all conflicts of interest to participants? “Rather than comply, the NASD sued.” Les Greenberg, who worked with me to try to improved corporate governance by co-sponsoring a proposal that led to SEC's failed rulemaking, S7-19-03, is once again at it. His rulemaking petition (4-502) would among other reforms:
I hope Les has better luck with this reform then we did with the last one. He's certainly making an historic effort. NASD has now filed a proposed rule change, 34-52009, with the SEC to provide written explanations in arbitration awards upon the request of customers, or of associated persons in industry controversies. See Les Greenberg's letter. We urge readers to join with Greenberg in calling for reform. Back to the top July 2005 Wyser-Pratte to Launch Fund The hard charging ex-marine with the German-sounding French name, Guy Wyser-Pratte, is plunging his investment activism full throttle into the limited arena of corporate governance-dedicated investment funds. Wyser-Pratte plans to launch the publicly listed Wyser-Pratte Euro Value Fund this September. Everyone wants to see investors get rewarded for backing companies striving to improve corporate governance. Now here's your chance, if you have the $2 million minimum investment. Learn of this and other opportunities by signing up now for the TurnaroundTactician now to get subscribe at their charter rate. The False Promise of Pay for Performance Many, including this reviewer, called Bebchuk and Fried's Pay without Performance: The Unfulfilled Promise of Executive Compensation the best corporate governance book of 2004. James McConvill's The False Promise of Pay for Performance: Embracing a Postive Model of the Company Executive , largely a critique of Pay Without Performance, deserves similar attention.Bebchuk and Fried clearly demonstrated that many features of executive pay are better explained as a result of shear managerial power, rather than arm's-length bargaining by boards of directors. Their recommendations on improving executive compensation are aimed at eliminating or reducing some of the most egregious problems and are written to shareholders, since such reforms are not likely to be raised by "independent” directors, as independence is currently defined. One of their major points is that board members should not only be independent of CEOs, they should also be dependent on shareholders. McConvill does not dispute that managerial power has led to the decoupling of pay from performance but he takes issue with Bebchuk and Fried's failure to clearly reject agency theory, which “derives from a narrow - and ultimately false - understanding of human motivation and behavior.” McConvill contends “the managerial power thesis assumes that only economic factors (based on agency theory) influence executives in their attitude towards remuneration…” He further writes that Bebchuk and Fried “suggest that managerial power provides a complete explanation” for the decoupling of pay and performance. (my emphasis) Despite what I believe is exaggerated rhetoric, since I did not read such assertions of certainty into the work of Bebchuk and Fried, McConvill's book is critically important as one of too few works that begin to explore alternatives to homo economicus in corporate governance. The book should find immediate appeal among the mostly liberal proponents of socially responsible investing, who also embrace the notion that we are not driven by money alone, and among conservative pro-management organizations like the Business Roundtable because of McConvill's assertion that “positive corporate governance” will do away with the need for external regulations. However, the book should also be read by anyone open to at least to thinking about alternative avenues of motivation. McConvill's main point is that it is not money that motivates CEOs but company performance, trustworthiness, job satisfaction, ego, and status. Unfortunately, too many tend to take pay as a proxy measure of these motivating factors. I like the starting point though. Acknowledging that statistics show a very weak link, if any, between pay for performance, Bebchuk and Fried ask how we can improve that link, while McConvill is more focused on increasing executive productivity through other means. Both areas warrant attention. There is something to the argument that economists have convinced many in business and law that their discipline is more rigorously scientific than psychology, sociology, and management studies. Equating rationality with being driven by self-interest may actually contribute to a self-fulfilling prophecy whereby managers do, indeed, turn out to be cheats and devious idlers. Most people conform to trends. As McConvill notes, “informational cascades” prompt us to base our beliefs not on what we know but on what people do or say. Even though we know a decision may be wrong, we tend to go along with the majority to stay in their good graces, resulting in a “reputational cascade.” How we are socialized and the words we use have real world impacts. Do we really want to reinforce the notion that CEOs should be primarily driven by the acquisition of personal wealth? McConvill goes on to describe differences between the predominant “law and economics” movement and the “behaviorial law and economics” movement, which seeks to better understand how human beings truly behave - frequently in unselfish ways. He cites lessons from game theory to support the notion that cooperation and trust are vital to personal well-being and the well-being of society. Placing too much emphasis on external rewards, such as pay, may have the effect of diminishing internal incentives to do our best. McConvill's research finds a stronger correlation between democracy and happiness than wealth and happiness. He might have cited studies by the National Center for Employee Ownership that more democratic companies are also more productive. He does note that relative wealth is more important than absolute wealth. So as long as CEOs measure their own self-worth by how much they earn in comparison with others, boards will face inflationary pressure. “Pay for performance is flawed in the sense that it accentuates, and to a large extent depends upon, the continuation of the social comparison treadmill - with executives always keeping their eyes and ears alert to who is earning more than them.” McConvill calls for what he terms “positive corporate governance,” borrowing from positive psychology which sees beyond what have become traditional concerns with treating the sick to also using social science to build what is right - strength, virtue and the highest qualities of civil and personal life. With most material wealth needs met, more people are focusing on meeting their need for meaning in life. Happy people don't follow the money; they follow their passions. We need CEOs who are passionate about making the best products, having the most creative or satisfied employees, and creating sustainable companies. He admits that his critics “will consider much of the argument underlying positive corporate governance as being not only counterintuitive but pure fantasy.” Such criticism would not be without reason. McConvill should give us pause when he writes, “If we can be confident that executives are naturally inclined to pursue what is best for the company, and doing so is an incentive in itself, external regulation can be dispensed with.” (my emphasis) Even if we could do that by checking their DNA, I'm not sure having a CEO who is inclined to do what is best for the company would warrant dropping all external controls. While such statements and his attacks on Bebchuk and Fried are liable to win support among BRT members, his notions could also be used to promote a path toward sustainability. In the end, he appears to want to ground management in positive professional norms. “Education is the key to positive corporate governance working, in terms of promoting the virtues of adhering to a professional ideal, and the rewards which flow on from this, as opposed to emphasizing the need for external incentives and sanctions to influence certain outcomes.” He has a point but I wouldn't throw out agency theory altogether. We need to align pay with performance but we also need to promote sustainable norms into our business model, not just by requiring business ethics courses for all MBA candidates. The key for the success of “positive corporate governance,” as envisioned by McConvill might be for organizations such as the Business Roundtable to hold up as an ideal for executive pay CEOs like Costco's Jim Sinegal. Last year he earned a salary is just $350,000, plus a $200,000 bonus. Costco's average pay for employees is $17 an hour; 42% higher than its rival Sam's Club. By many measures, including its health plan, Costco's model is more sustainable, in terms of treating its employees, host communities and even its shareholders better in the long run than Wal-Mart. [(How Costco Became the Anti-Wal-Mart, NYTimes, 7/17/2005) (Disclosure: The reviewer is a Costco shareholder)] McConvill says he does not attempt to construct a new pay-setting approach, although he suggests “best practice” might tie executive compensation to “15-20 times average weekly earnings” of employees. He also cites a study in New South Wales that found excessively high pay levels for CEOs coincide with lower corporate earnings. Christopher Mann of Moody's recently authored a report that found businesses that offer their CEOs unusually large bonuses or option plans have higher bond-default rates and more frequent and deeper rating downgrades than their peers, (Report Links Defaults, Excessive CEO Pay, CFO.com) The False Promise of Pay for Performance will get you thinking. If widely read, it could help move us from a narcissistic model of corporate governance, that “greed is good,” to one that encourages all employees, including the CEO, to be more fully human at work. CalPERS Earnings The California Public Employees' Retirement System earned a 12.7% return on the nation's largest public pension plan portfolio for the one-year period ended June 30, 2005, raising its portfolio’s market value to a record $189.8 billion. Investments in real estate, private equity, and international stocks were the main performance drivers, with the real estate gaining nearly 38%, and the fund’s Alternative Investment Management Program, which specializes in private equity and venture capital holdings, generating the second highest rate of return at 22.8%. Investments in corporate governance funds that target ailing public companies posted a 20.8% return, while its international stock portfolio rose 17.3%. Global fixed-income investments returned 10.8%, and domestic stocks earned 7.5%. (PlanSponsor, 7/25/2005) PERA Shortfall Widens The Colorado Public Employees’ Retirement Association plans to report a widening shortfall to the state’s Legislative Audit Committee. The funding gap in the pension plan grew by about $3 billion last year in spite of the fund posting a 14% return, beating its target 8.5%. The plan has a deficit of $12.8 billion and only has about 70% of assets needed to meet its obligations. Market losses and increased benefits, along with pension accounting rules were cited as the reasons for the shortfall. Colorado PERA has considered increasing the amount of contributions employers make to the plan and have made efforts to reduce benefits, but those reductions were limited to future hires. Colorado PERA manages about $32 billion and has more than 361,000 members. Call for Investigation of SEC Nominee Cox President Bush's nominee to head the SEC, Congressman Chris Cox, has among the worst anti-consumer records in Congress. As a private attorney, Cox helped a swindler, William Cooper, peddle his Ponzi scheme to the public, costing small investors as much as $130 million. The US Senate Banking Committee is holding a 7/26/05 confirmation hearings on Cox. Listen to or read Foundation for Taxpayer and Consumer Rights President Jamie Court's commentary against the Cox nomination on public radio's Marketplace. Stop Cox by faxing your Senator TODAY! Cooper went to jail; Cox went to Congress. Ask your Senator to subpoena Cooper and Cox's billing records to find out what Cox really did or didn't do for Cooper. Also up for confirmation are President Bush's nominees Roel C. Campos and Annette Nazareth to fill the two Democratic seats. Mr. Campos, a Texas businessman and a former federal prosecutor, has been serving as a member of the commission since 2002. Ms. Nazareth, the head of the commission's division of market regulation, would succeed Harvey J. Goldschmid, who is leaving the agency soon to return to teaching at Columbia University School of Law. Published reports point out that the nominations could help clear the path for the confirmation of Rep. Christopher Cox, the conservative Republican from California who has nominated for SEC chairman Air Alaska Reject Binding Proposal that Passed According to a 7/19/05 letter to shareholder activist Jim Roberts, Alaska Air Group will not be adopting a binding bylaws proposal to elect each board director annually since that "could violate Delaware corporateion law." "In order to elminate the Company's classified board, it would be necessary to the certificate of incorporation." They don't have to dit and they won't. DOL to Enforce 1959 Law The Department of Labor is reportedly about to start enforcing a 1959 law which requires disclosure of gifts, ratuities and entertainment used by employers, service providers, labor union officials, and plan trustees to influence each other. "Just because you parked your car beside a fire hydrant for 35 years (and didn't get a ticket) doesn't mean you won't get a ticket tomorrow," Don Todd, deputy secretary, said at a July 7th meeting where a reporting extension was announced. In the interest of achieving greater compliance with the reporting requirements of the Labor-Management Reporting and Disclosure Act of 1959, the Office of Labor-Management Standards (OLMS) announced new compliance assistance efforts and enforcement guidelines for filers of Form LM-30 (Union Officer and Employee Reports). Under a cooperative agreement concluded with the AFL-CIO, OLMS is not requiring new filers who submit their Form LM-30 reports by August 15, 2005, to submit reports covering the same financial interests for any prior years, absent extraordinary circumstances. ULLICO, a money manager for Taft-Hartly penison dunds had been planning to increase marketing expenses for entertaining clients but with DOL's announceint of a $25 limit for exclusions, virtually all entertainment is not excluded so they will shift resources to less effective areas, such as direct mail. The same issue of P&I carries an editorial warning the 2/3 of institutional investors which aren't claiming their share of settlements in securities class action suits are likely breaching their fiduciary duty. It also includes a guest editorial by Jeffrey DuFour calling on the government to require education and oversight requirements for all retirement plan trustees. [(Union Fund Officials Lose Some Perks, Pensions & Invemsntments, 7/11/05) (Form LM-10 (Employer Reports) Advisory, 7/15/05) ] TIAA-CREF Told to Practice What it Preaches Shareholders press TIAA-CREF officers to explain several governance scandals and its investments in socially irresponsible companies. At is annual meeting, the nation's largest pension fund once again will come under fire from the Make TIAA-CREF Ethical coalition. On July 19, advocacy groups are joining shareholders to demand greater accountability from TIAA-CREF, the $350 billion pension fund for educators and researchers. After SEC complaints, two trustees had to be removed because of financial conflicts of interest. Additionally, their CFO, now on a leave of absence, is under investigation by the SEC and DOJ for practices in her previous job. Finally, after doing an insufficient background check, they reportedly hired a criminal, resulting in a breech in security and a subsequent lack of candor about events surrounding her removal. Back to the top CII on Majority Vote As we reported last month, the American Bar Association (ABA) Committee of Corporate Laws has issued a discussion paper on majority elections for corporate directors and invites public comment by Aug. 15 to: E. Norman Veasey. Resolutions have been voted at more than 50 companies so far this year. The Council of Institutional Investors posted its June 15th letter to Veasey on their website. CII supports changes that would that would "presumptively provide for the election of directors by a majority of votes cast for and against, unless otherwise provided in the certificate of incorporation or the bylaws." "The benefits of this change are many: it democratizes the corporate electoral process; it puts real voting power in hands of investors; and it results in minimal disruption to corporate affairs—it simply makes boards representative of shareowners."
In May, CII sent letters to about 1,500 heads of major US corporations requesting they adopt CII's policy: "When permissible under state law, companies’ charters and by-laws should provide that directors are to be elected by a majority of the votes cast. If state law requires plurality voting (or prohibits majority voting) for directors, boards should adopt policies asking that directors tender their resignations if the number of votes withheld from the candidate exceeds the votes for the candidate, and providing that such directors will not be re-nominated after expiration of their current term in the event they fail to tender such resignation." Subscribers to TheCorporateCounsel.net can listen to an interesting interview by Broc Romanek of Ann Yerger on CII’s Majority Vote Policy. During the interview she says that most of the companies that have responded appear to be at least studying the issue. CII posts responses on the members only portion of their site. SEC Guidance on Independent Chair & Environmental Proposals The SEC has given activist shareholders guidance in the form of a staff legal bulletin on writing shareholder resolutions requesting that companies name an independent director as the board chair. The heart of the advice is as follows:
"The guidance also follows a battle earlier this proxy season over the director independence issue between pioneering shareholder activist Bob Monks and ExxonMobil Corp. (XOM). Monks' proposal suffered the fatal flaw because there was no explicit out for the company if a chairman lost his or her status as an independent director, for whatever reason." (SEC Enters New Territory With Holder Proposal Guidance, Dow Jones Newswires, 7/13/2005) The bulletin also lays out how environmental and public health proposals need to be crafted to avoid a no action letter.
ISS Buys ICCR Institutional Shareholder Services, the nation's largest proxy advisory firm, has reportedly agreed to pay more than $10 million to acquire the Investor Responsibility Research Center, which was founded in 1972, has been struggling to compete since becoming a for-profit entity four years ago. Though most IRRC staff will be offered jobs at ISS in Rockville, MD, all the proceeds of the sale will go to create the a new IRRC Institute for Corporate Responsibility, a new independent nonprofit think-tank. The institute will be started with existing IRRC board members, who will search for an executive director. ISS asked for one board seat, but no decision has been made on the size of the board. (Institutional Shareholder Services buys IRRC, Pensions & Investments, 7/13/2005) The combined company, with almost 500 employees across 11 global offices, will be able to offer a broader range of products and services, an improved set of solutions and an expanded research universe of 33,000 companies across 115 markets. (PRNewswire, 7/13/2005) Generally, I hate to see reduced competition in any industry. In the last few years, even with the rise of several other proxy advisory services, it has become apparent that ISS is dominant in the US and is quickly becoming so worldwide. Their opinion can make or break proposed mergers and other corporate governance decisions involving the votes of institutional investors.
Arbitration Award Explainations Proposed NASD has filed a proposed rule change, 34-52009, with the SEC to provide written explanations in arbitration awards upon the request of customers, or of associated persons in industry controversies. For an example of thoughtful comments, see Les Greenberg's letter. The Public Investors Arbitration Bar Association supports getting rid of the industry arbitrator. So does Les Greenberg. His Request for rulemaking under the Securities Exchange Act of 1934 concerning arbitration sponsored by NASD Dispute Resolution submitted to the SEC in May would:
TIAA-CREF Meeting to Draw Controversy The "Make TIAA-CREF Ethical" coalition will be there. Join them and influence how $350 billion is invested. Raise your voice inside the annual meeting in New York City on July 19th. For participants and sympathetic others: Demonstrate outside the corporate office in New York
The coalition asks you to "make your plans now." The meeting begins 9:00 a.m., Tuesday, July 19 (participants must call 1-877-535-3910, ext. 2440 for a pass to attend). Demonstration runs 8-10:00 a.m., 730 Third Ave. (between 45th and 46th Streets). Anyone can raise a voice from their hometown during the week before the meeting (July 11-19). Call CEO Herbert Allison at 800-842-2733 or 212-490-9000. Ask for Mr. Allison and speak to his assistant. Calls are best, but you can also email HAllison@tiaa-cref.org For background, see makeTIAA-CREFethical.org (and sign-up at web site for campaign updates). For further details, contact NJWollman@manchester.edu The coalition summarizes their requests regarding particular companies as the following:
Back to the top Corporate Governance and Firm Valuation by Lawrence D. Brown and Marcus L. Caylor of Georgia State University create Gov-Score, a summary measure of corporate governance based on 51 Institutional Shareholder Services factors, representing both external and internal governance. After showing that Gov-Score is positively related to firm valuationGov-7, they create a parsimonious index based on seven of the 51 factors underlying Gov-Score, and show that Gov-7 fully drives the relation between corporate governance and firm valuation. The seven factors are as follows:
Quack Corporate Governance In The Sarbanes-Oxley Act and the Making of Quack Corporate Governance, Roberta Romano evaluates the substantive corporate governance mandates of the Sarbanes-Oxley Act (SOX) and of the political dynamics that produced the mandates. The Article concludes that SOX's corporate governance provisions should be stripped of their mandatory force and rendered optional. To mitigate future policy blunders on the scale of SOX, it also suggests that emergency or crisis-mode legislation provide for reevaluation at a later date when more deliberative reflection is possible. Tax-Abuse Settlements Dozens of US corporate executives and 33 companies have admitted using abusive tax shelters to under-report hundreds of millions of dollars in compensation as part of a settlement with the Internal Revenue Service. Executives had until May 23 to report their involvement in the shelter and participate in the settlement program, which requires them to pay a 10% penalty -- half the 20% penalty that could have been applied. In the typical tax shelter, a corporation grants an executive stock options. The executive transfers the options to a family partnership established solely for receiving the options, usually owned by the executive, spouse and children. The executive takes a 15- to 30-year promissory note as payment for the options. The partnership sells the options and takes the position that taxes aren't due for 15 to 30 years. Shooting Blanks Steven M.H. Wallman, founder of FOLIOfn and a prior SEC commissioner, writes that the definition of "good" corporate governance has been decided by a small number of proxy advisory firms based on proscriptive, one-size-fits-all formulas. (A New Approach to building Shareholder Value, The Corporate Board, 7-8/2005) Wallman cites a study (How Important is Corporate Governance?) by David F. Larcker of the University of Pennsylvania, which evaluated 39 corporate governance indicators (e.g., board characteristics, stock ownership, institutional ownership, activist stock ownership, existence of debt-holders, mix of executive compensation, and anti-takeover variables) refined into 14 governance constructs using principal components analysis. We find that these 14 constructs are related to operating performance, have a somewhat mixed association with abnormal accruals, Tobin’s Q, and excess stock returns, and little relation to class action lawsuits and accounting restatements. Wallman points to the overall conclusion that the typical structural indicators have "limited ability to explain managerial decisions and firm valuation." One limitation he doesn't acknowledge, unless I missed it, is that the study only analyzes a single year of data, not exactly a long-term approach. Wallman says that his firm, PROXY Governance, doesn't believe in the one-size-fits-all approach, nor do they believe corporate governance is a zero-sum game between managers and shareholders. The goal must be on creating long-term shareholder value, not on gaining power for shareholders or management. Company-specific evaluation should be relative to peer companies in its industry over some reasonable period. Is the company improving or deteriorating? CEO and director pay should promote long-term wealth, rather than schemes that temporarily boost stock price. He argues that a staggered board can foster more open and frank boardroom discussion. On majority voting, Wallman indicates shooting "real bullets," instead of "blanks," doesn't allow shareholders to send a message without actually putting them out of office. On socially responsible investing, Wallman argues the "legitimate goal of shareholders is to see the value of their investments increase," a goal "not enhanced by arbitrary, flavor-of-the-month approaches to proxy voting recommendations." Shareholders serve they interests best "when they zealously oversee boards with the goal of eliminating self-dealing and excessive pay, and replace boards and managements that are unable to increase value for shareholders over the long term." No one can reasonably argue against the need to be vigilant in eliminating self-dealing or to build trust between the shareholder-management-team. I also agree that corporate governance must be tailored to the specific firm and its point in development. However, in attempting to decrease "the shrillness of discourse" and increase trust, we should not ignore the fact that shareholders must be able to hold directors accountable. We can only "replace boards and managements" if we have "real bullets." Big Box Standards Investors representing $33 billion backed issued a set of nine guidelines for major retailers to use in making decisions about store site locations, land procurement and leasing. The guidelines developed by Christian Brothers Investment Services, Inc. and Domini Social Investments urge major retailers to embrace environmental stewardship; public disclosure of siting policies; advance consultation with affected communities; respect for Indigenous cultures; protection of cultural heritage; and adherence to “smart growth” practices. While companies are encouraged to adapt the guidelines to suit their unique business models, the report strongly recommends that all retailers should have a clearly formulated, well-monitored and effective policy for assessing and mitigating social and environmental risks associated with store siting. See Guidelines To Curb Controversies Over “Big Box” Store Locations Issued By Christian Brothers Investment Services, Domini Social Investments for the guidelines and endorsing funds. Adoption of the policies would go a long way toward reducing conflicts with communities and would reduce the risk of lawsuits, political action, and boycotts.
Unocal Deal Reveals Weakness The fact that directors of the China National Offshore Oil Corp. (CNOOC) were not brought into the deal until late in the game may reveal a troublesome weakness in Chinese corporate governance practices. According to a report in Time magazine, the subject of buying Unocal had never before been discussed at a board meeting until 3/29. "The ship was about to leave the port, and the [directors] hadn't even known there was a ship," said one adviser to CNOOC. According to SEC documents, as far back as December, CNOOC's CEO Fu Chengyu had directly discussed the possibility of acquiring Unocal with the California firm's CEO, Charles Williamson. "He was treating his own board as an afterthought," says one source close to outside board members. "It was very much the China of 20 years ago in the way the directors were treated initially—where the boss decides and the board just rubber-stamps everything. Why were they treated that way? I don't have a clue." Three key outside directors—former Shell Chemicals CEO Evert Henkes, former Swiss ambassador Schurtenberger, and Courtis of Goldman Sachs—all raised pointed questions at the 3/29 meeting, according to the report in Time. They questioned whether the company was prepared for a hostile U.S. political reaction wondered about the debt load that CNOOC would have to take on to finance the transaction. Had the board been consulted in advance, CNOOC would have been more likely to have initially offered to shed some of Unocal's American assets to address concerns about the loss of domestic U.S. reserves. They might have also brought in a US partner to absorb some of the risk and political flak, as Haier did in its bid for Maytag last month. (Uncharted Waters, Time, 7/11/2005) In contrast with last year, only two Chinese firms that have gone public so far this year have listed their shares in the United States, in part because of concerns over more stringent corporate governance requirements. "Companies are coming to the United States to raise capital, they are just doing it through 144A offerings in the institutional market as opposed to SEC-registered public offerings," according to one quoted source. (Chinese IPOs sticking close to home, China Daily, 7/11/2005) Maybe Chinese companies are so attractive that investors are willing to forego good corporate governance practices. That seems more like gambling than investing to me. China doesn't need to ape US corporate governance practices, they're not that good. But if they're going to imitate anything, it shouldn't be the royal CEO and rubber stamp board. I hope lessons are learned from the Unocal mess. More democracy in corporate governance could make a great contribution to continued economic growth on a more sound footing -- advice that applies to those on both sides of the Pacific.. Oxley at ICN US congressman Michael Oxley, co-author of the US Sarbanes-Oxley corporate governance legislation, attended the International Corporate Governance Network conference. Oxley told delegates that he had “mixed views” on Europe, referring to issues like “hostility to cross-border mergers in the banking sector.” He said investors “have enormous influence and I think they are finding their voices that here to fore have not been so strong. Oxley also said auditors should not have “cosy relationships” with company management. “If there is an area where that needs separation and this independence, it is this particular area.” (US’s Oxley on corporate governance, ipe.com, 7/8/05) Strine at European Policy Forum Judge Leo Strine, a vice-chancellor of the Delaware Court of Chancery, warned federal legislato | ||||