External pressures to conform to generic pay standards and so-called “best practices” are undermining the ability of Compensation Committees to create differentiated compensation strategies that are grounded in their own company’s business needs and priorities. That’s bad for investors and employees alike. Continue Reading →
Tag Archives | compensation
A proposal by Qube Investment Management, which owns 10,208 shares of Microsoft ($MSFT), to cap pay has been challenged through the “no-action” process. See incoming correspondence to the SEC. The resolved clause of Qube’s proposal reads as follows:
Resolved: The the Board of Directors and/or the Compensation Committee limit the average individual total compensation of senior management, executives and all other employees the board is chanted with determining Continue Reading →
Wednesday October 17, 2012, 2pm EDT/11 am PDT, To register for this complimentary webinar, click here.
Shareholder value growth is the core challenge of every business and the ultimate Continue Reading →
An increasingly popular trend in recent years has been the adoption by Delaware public companies of an exclusive forum provision in their bylaws. An exclusive forum provision generally provides for the Delaware Court of Chancery to be the exclusive forum for certain disputes (including derivative actions, breach of fiduciary duty claims, claims arising pursuant
to the company’s charter or bylaws and other shareholder litigation) against the company — and prohibiting such suits in other jurisdictions. Expected benefits cited by companies of adopting exclusive forum bylaw provisions include decreased litigation costs, avoiding parallel litigation in multiple jurisdictions and the predictability of Delaware courts. Continue Reading →
A complimentary 90-minute webinar co-sponsored by Eagle Rock Proxy Advisors and Waller Lansden Dortch & Davis, LLP will be held at 2:00 p.m., EDT, on Thursday, November 1, 2012. Register now. Continue Reading →
Aligning CEO pay with shareowner value is key for many. A new tool (at least new to me), the Compensation and Wealth Calculator, from the Stanford Graduate School of Business, Corporate Governance Research Program, allows users to see how the compensation of CEOs and other NEOs, which they have already received over the years in the form of stock and stock options, aligns with share price. Continue Reading →
A roundup of just a few of many relevant news items worth reading. Continue Reading →
These are some relatively quick notes that I’m sharing from the Corporate Directors Forum 2012, held at the University of San Diego, January 22-24, 2012. This post may be a cryptic… incomplete sentences bt hopefully mor intelligible thN txt msgN or Tweets. Continue Reading →
Bill Moyers is back on television! Here is a recent episode of “Moyers and Company,” which asks: “how did our political and financial class shift the benefits of the economy to the very top, while saddling us with greater debt and tearing new Continue Reading →
Do I need to apologize? I’ve been using USPX guidelines to vote down pay packages at large companies over the $9 million 2010 median reported by Equilar earlier this year. Now, they’ve revised their pay figures. Final data show median pay for top executives at 200 big companies last year was $10.8 million, up 23% from 2009. (We Knew They Got Raises. But This?, New York Times, 7/2/2011)
The average US worker earned $725 a week in late 2010, up 0.5% (less than inflation) from the year before. I’ve been voting down almost all pay packages where a named executive officer (NEO) earned more than what I thought was the median last year of $9 million. Now it looks like I’ve been too harsh and should have only been voting against those over $10.8 million. I suppose I could say I’m sorry for my vote at those companies where an NEO got more than $9 million but less than $10.8 million. On the other hand, only 1.5% of the companies in the Equilar study had they pay proposals rejected… so, no harm, no foul.
Do we really need to pay them that much? I think our attempt to link pay to performance has resulted in refocusing the corporation. Instead of serving some reasonable public purpose and paying profits to shareowners, many corporations now are moving off shore to avoid paying taxes and are focused on maximizing profits for named executive officers.
Meanwhile, a study from Capgemini and Bank of America Merrill Lynch estimates that financial wealth control by the high net worth individuals jumped 9.7% over the last year to $42.7 trillion. It is hard to see the economy really recovering while the middle class is being hollowed out… although I suppose we could pin our hopes on exports to the growing middle classes of China, India and Brazil.
A new proxy vote analysis service, InGovern Corporate Governance Platform, allows institutional investors to analyze various companies, follow the agendas of shareholder meetings, exercise votes and collaborate with other investors. Research based on “objective criteria” – Governance Radar – is also embedded into the platform, according to a press release from Bangalore.
This is a part of InGovern’s pioneering efforts at promoting shareholder activism among institutional investors in India.
Global research has shown that there is high correlation between good corporate governance and long term returns on an investment. Shareholder activism is in its infancy in India. The Ministry of Corporate Affairs and SEBI have been prodding institutional investors to exercise their rights as minority shareholders in companies. Investors can hope to get superior investment returns by actively participating in enhancing the corporate governance culture in India.
I get hundreds of e-mails every day and often delete before even glancing if I am especially busy. Fortunately, Timothy Smith of Walden Asset Management also sent out an e-mail on a post by Theo Francis, of footnoted*, that had already hit my trash. We’ve all heard about Transocean’s bonuses for “the best year in safety performance in our Company’s history.”
The bonus incident speaks volumes about Transocean and the tone set at the top of the company. But so do two other details in the filings. First, the company’s board created a Health Safety and Environment Committee in August last year, some four months after the spill. Guess how often it met during the four months between then and the end of the year? Once.
Agenda Item 2 in the proxy is even more eye-opening. To hear the company tell it, the provision is an attempt to “discharge the members of the Board of Directors and our executive management from liability for their activities during fiscal year 2010,” explicitly including the rig explosion and oil spill. It would, Transocean says, not only prevent many shareholders from suing directors and officers entirely — whether by taking part in existing lawsuits or future ones — it would give other shareholders a narrow window of just six months to sue.
Those who vote for the measure give up their right to sue altogether, Transocean says. Those who vote against the measure, assuming they fail to stop it, will have just six months to sue, the company says:
“After the expiration of this six-month period, such shareholders will generally no longer have the right to bring, as a plaintiff, claims in shareholder derivative suits against our directors and executive management.”
And there’s more at Transocean’s quiet risk panel & push for immunity | footnoted.com, 4/6/2011. (apologies to Paul Harvey)
When GlobeScan began tracking views in 2002, four in five Americans (80%) saw the free market as the best economic system for the future–the highest level of support among tracking countries. Support started to fall away in the following years and recovered slightly after the financial crisis in 2007/8, but has plummeted since 2009, falling 15 points in a year so that fewer than three in five (59%) now see free market capitalism as the best system for the future.
GlobeScan Chairman Doug Miller commented: “America is the last place we would have expected to see such a sharp drop in trust in the free enterprise system. This is not good news for business.”
The results mean that a number of the world’s major emerging economies have now matched or overtaken the USA in their enthusiasm for the free market. The Chinese and Brazilians, 67 percent of whom regard the free market system as the best on offer, are now more positive about capitalism than Americans, while enthusiasm in India now equals that in the USA, with 59 percent rating the free market as the best system for the future.
Among the 20 countries polled in both 2009 and 2010, an average of 54 percent today rate the free market economy as the best economic system, unchanged from 2009.
Americans with incomes below $20,000 were particularly likely to have lost faith in the free market over the past year, with their support dropping from 76 percent to 44 percent between 2009 and 2010. American women have also become much less positive, with 52 percent backing the free market in 2010, down from 73 percent in 2009.
My guess is that these numbers could easily be reversed with higher taxes on the rich, a more equal distribution of the wealth and of productivity gains, as well as more democratic corporate governance. A free market that allows the vast majority of its population to fail or stagnate, while the wealth of the top 1% soars, is not going to win any popularity contests. What are we waiting for?
At a time most employees can barely remember their last substantial raise, median CEO pay jumped 27% in 2010 as the executives’ compensation started working its way back to prerecession levels, a USA TODAY analysis of data from GovernanceMetrics International found. Workers in private industry, meanwhile, saw their compensation grow just 2.1% in the 12 months ended December 2010, says the Bureau of Labor Statistics…
Median CEO pay in 2010 was $9.0 million, based on 158 Standard & Poor’s 500 index companies with the same CEO serving all of 2009 and 2010 that have reported CEO pay, according to the USA TODAY analysis of data from GovernanceMetrics based on proxies that have already been filed. (CEO pay soars while workers’ pay stalls – USATODAY.com, 4/1/2011)
As William Lazonick, professor at the University of Massachusetts points out in the article, while companies in the S&P 500 boosted profit 47% last year, much of that was due to cost-cutting and layoffs. Actual revenues for selling goods and services grew at only 7%. How much longer can businesses grow profits through layoffs and cost-cutting? If businesses are really becoming more efficient, shouldn’t workers expect raises and shouldn’t shareowners expect rising dividends.
I’ve been thinking about “say on pay” votes lately, trying to figure out how I should vote as an individual retail investor. I’m relatively lazy when it comes to researching clawbacks, holding periods, correlations between pay and performance and all the rational factors that go into voting by large institutional investors like CalPERS or voting advice from Glass Lewis or ISS. Usually, I’ll look up on ProxyDemocracy.org or MoxyVote.com to see how others who put time and research into their efforts are voting.
However, after talking with some large progressive institutional investors, I’m concerned that none appear to be using any decision models that address the “Lake Woebegone Effect,” where all the children are above average. Former DuPont CEO Edward S. Woolard, Jr. speaking at a Harvard Business School roundtable on CEO pay said,
The main reason (CEO) compensation increases every year is that most boards want their CEO to be in the top half of the CEO peer group, because they think it makes the company look strong. So when Tom, Dick, and Harry receive compensation increases, I get one too, even if I had a bad year…. (This leads to an) upward spiral.
Every year companies want to pay their CEOs more than average and every year when compensation consultants survey a company’s peers they find that average going up. Yes, it is a little simplistic but one way to stop that spiral would be if every shareowner voted against every CEO pay package that is above the median. For 2010, that would be every pay package above $9 million.
I’m not sure what CEO pay should be but I find it difficult to believe that any CEO would work 30% harder for $12 million than they would for $9 million. Personally, I almost always worked at full capacity no matter what my pay because I enjoyed my work and it was meaningful… I still do and it still is.
I started my career as a teacher. It was long before Alfie Kohn wrote the book Punished by Rewards: The Trouble with Gold Stars, Incentive Plans, A’s, Praise, and Other Bribes but even back in 1970 I felt that rewards and punishments were artificial ways of manipulating behavior that destroy the potential for real learning. Instead, I found it was better to design classroom experiences to provide an engaging atmosphere so that students could act on their natural impulses to explore and gain knowledge.
Most social psychology studies show the more you reward someone for doing something, the less interest that person will tend to have in whatever he or she was rewarded to do. Instead, their focus moves to the reward itself. Isn’t leading a Fortune 500 company intrinsically rewarding? Shouldn’t $9 million be enough for anyone for one of those jobs?
As long as shareowners approve outrageous pay packages for CEOs the averages will keep ratcheting up and the disparity between the top 1% and the rest of us will continue to grow. We need to ratchet down the Lake Wobegon effect and bring our CEOs down to earth.
Yes, I’m still going to check ProxyDemocracy.org and MoxyVote.com to see how others are voting. If Florida SBA or CalSTRS are voting against a pay package I’m likely to join them. However, a couple of weeks ago, I voted against Andrew Gould’s $15 million pay at Schlumberger just because it was too much. I might just do that for all pay packages over $9million. What do you think? Can $9 million ever be too little?
The Securities and Exchange Commission is proposing rules that will direct the New York and other national securities exchanges to adopt listing standards regarding the compensation committee of a company’s board of directors, as well as its compensation advisers.
The rules are required by the Dodd-Frank Wall Street Reform and Consumer Protection Act.
In establishing the independence of each compensation committee, the exchanges would be required to consider such factors as:
- The sources of compensation of a director, including any consulting, advisory or compensatory fee paid by the company to such member of the board of directors.
- Whether a member of the board of directors of a company is affiliated with the company, a subsidiary of the company, or an affiliate of a subsidiary of the company.
The SEC’s proposal also would require new disclosures from companies concerning use of compensation consultants and any conflicts of interest.
Public comments on the rule proposal should be received by April 29, 2011. The listing standards for compensation committees can be found in the SEC announcement. via Exchanges Will Be Required to Check Out Compensation Committees.
Interesting post from Dominic Jones, brilliant author of the IR Web Report, who wonders if directors fumbled, given that so many three year Say When on Pay proposals are being voted down. Or did directors intentionally channel investor anger “towards the less important of the two say-on-pay proposals.”
Such a diversionary tactic gives “a window-dressing opportunity to their institutional investors,” writes Jones. When funds disclose their votes, they can seem to take a hard line, while taking attention away from the fact that they are also voting in favor the more concrete executive pay proposals. “In fact, 87% of pay votes so far have received more than 80% support from investors.” (Say-on-pay frequency battles a clever diversion | IR Web Report, 2/25/2011)
Interesting theory, but I don’t really see directors taking that much interest in providing cover to funds so that fund managers can say they “stood up for the little guy.” The driver here is more likely to be proxy advisory firms that have drawn a line in the sand that is easily understood, publicized, and followed.
Investors can easily understand, “give me power every three years or give me power every year.” What we can’t understand, unless we devote a lot of resources to filling out scorecards on executive pay proposals using the typical metrics used by large and conscientious institutional investors, is whether or not we should vote in favor of a board’s pay proposal.
We often know in our gut that the bottom line pay that a proposal yields will be outrageous. But aren’t basketball players paid outrageous amounts too? Unless we’re willing to crunch all the numbers, we generally vote with the board’s recommendation.
While I’m all in favor of incentives to increase the holding period on option and/or stock grants, clawbacks for unearned bonus and incentive payments, cutting back on absurd perks, tying bonuses to performance that take into account market movements and peers, limits on severance or change-in-control payments, and the myriad of other details these good governance funds are concerned with, I also think we also need a few simple overarching guidelines.
- Will the CEO earn more than 100 times the average worker?
- Will they take more than 5% of the company’s net profit?
- How are funds voting that actually put themselves out there by announcing their votes in advance on ProxyDemocracy.org?
I’m sure there are more simple guidelines and these examples may not be the best. As I said in a recent post, which I’m delighted Jones cites (Addressing CEO Pay), members of the United States Proxy Exchange will soon begin working on a paper to address the issue of CEO pay. I’ll be advocating a few simple metrics to ratchet down the “Lake Wobegone effect” and to help wean America away from what has increasingly become a “winner take all” mentality.
As long as directors keep thinking their company’s CEO is above average, the average will keep going higher and higher every year as the baseline comparison rises. Between 1980 and 2004, real wages in manufacturing fell 1%, while real income of the richest one percent rose 135%. The top 1% average $3.2 million a year, while the bottom 90% average $31,000 based on 2008 data. The top 1% control 35% of America’s net worth, while the bottom 90% control 27% based on 2007 data. (It’s the Inequality, Stupid, Mother Jones, 3-4/2011) Looking at the world as a whole, the richest 1% control 43% of total assets according to The Economist (More Millionaires Than Australians, 1/22/2011), whereas the bottom 50% control 2% of assets.
I don’t think we should wait for these gaps to widen further before taking action. If average CEO pay for S&P 500 firms moved from the current $9.25 million per year to $4.6 million a year, would average CEO performance be cut in half? I doubt it. Conscientious institutional investors will go after the outliers, the most outrageous examples. Somebody needs to go after the herd. Let’s make use of the pay ratios that have to reported in the CD&A because of Dodd-Frank while we still can. That requirement could be gone before we know it the way things are headed in Congress.
Frank Rich, citing Winner-Take-All Politics: How Washington Made the Rich Richer–and Turned Its Back on the Middle Class, concludes the growing divide between the superrich and the rest of us is the direct “result of specific policies, including tax policies, championed by Washington Democrats and Republicans alike as they conducted a bidding war for high-rolling donors in election after election.”
The top 1 percent of American earners took in 23.5 percent of the nation’s pretax income in 2007 — up from less than 9 percent in 1976. During the boom years of 2002 to 2007, that top 1 percent’s pretax income increased an extraordinary 10 percent every year. But the boom proved an exclusive affair: in that same period, the median income for non-elderly American households went down and the poverty rate rose.
Rich counters charges that increasing taxes on the superrich would reduce the ability of small business owners to create jobs. The Tax Policy Center found that only 2% of all small-business owners are in the top bracket. The yearly tax increase for those earning between $200,000 and $500,000? $700, not enough to hire anyone.
Robert Frank, author of Richistan: A Journey Through the American Wealth Boom and the Lives of the New Rich, analyzed the 400 richest Americans and found a “hardening of the plutocracy” and scant mobility. Only 16 of the 400 were newcomers.
How does corporate governance come into play? Most of the superrich aren’t entertainers, sports stars or entrepreneurs. Instead, they are “corporate executives and managers — increasingly (and less surprisingly) financial company executives and managers, including those who escaped with outrageous fortunes as their companies imploded during the housing bubble.”
When Obama campaigned, he promised to increase taxes on the rich. As Frank Rich concludes, there are many ways to create a more equitable tax code, “but surely few, if any, are easier than eliminating a tax break that was destined to expire anyway and that most Americans want to see expire.”
Rich argues that even more critical than the debt issue – borrowing from our grandchildren to give the superrich a tax cut – is the vanishing American Dream of mobility. (Who Will Stand Up to the Superrich?, NYTimes.com, 11/13/2010)
The increasing concerns of institutional investors and their advisors around reimbursement of new executive hires for losses on home sales necessitated by relocations, summarized in an excellent article by Joann Lublin of the WSJ of October 25, 2010, entitled “Shareholders Hit the Roof Over Home-Loss Subsidies” is confusing, to say the least. It’s certainly desirable that large shareholders are becoming more vigilant in their oversight of boards and management. However, I don’t see what is accomplished through a focus on this item.
As an illustration of the current situation, Patrick McGurn of ISS states that “Home loss provisions are a hot-button issue with our institutional clients.”
This may be, but I think it is unproductive. I’m a lot more concerned with management and board performance, as it translates into company performance, than I am with pay per se. To the extent pay is relevant, this should be on account of either its overall incentive effects regarding performance or whether it has any connection to “market value” for the position in question. Simply protesting this (or any individual) item of someone’s pay package has nothing to do with company performance. It makes no sense to address any individual line item for someone, without addressing their aggregate pay and assessing its implications and level.
Money being fungible makes it pointless and counterproductive to protest reimbursement for a home sale loss, if the beneficiary’s overall package is well structured for incentive purposes and in line with the market. If a corresponding increase in salary or bonus would not prompt shareholder protest, why should a protest result from the name of the payment? Similarly, if there is good reason to protest total compensation, the rationale still exists, notwithstanding the formal designation of a portion of it. Good performance relative to total pay should not lose its luster because of a home sale provision … and vice versa! For new hires, there will be little opportunity to evaluate performance, so the incentive structure and “fit” in the market will need to be closely evaluated.
All of this being said, it seems curious that the topic even exists. Such provisions make it more costly to hire someone who recently purchased a home, and is now required to relocate than someone who is similarly qualified but purchased their home 10-15 years ago, and still has some profit, or who has been renting during the same period. A given position is worth what it is worth in the market, and should not have its value tied to the housing status of its occupant any more than to such person’s marital status.
With the crying need for improved governance in order to avoid future financial meltdowns and corporate scandals, I suggest that a fundamental step in this direction would be an increased focus on aggregate performance and compensation and a reduction in concern with specific items, irrespective of what the analyst thinks of any of them.
Watch, as BNY Mellon’s Chief Economist Richard Hoey presents a summary of his October update.
We continue to expect a broad sustained global economic expansion over the next several years with the fastest growth in those countries in the strongest financial position (largely in the developing world) and the slowest growth likely in those countries with a debt hangover (largely in the developed world).
Another part of his message, although people are having a tough time digging out of debt, corporations have dramatically improved their positions. Profits have improved substantially, they refinanced their debt at lower cost and have been “cautious” about expanding capacity.
Also, panel II of a hearing of the congressional oversight panel subject: executive compensation restrictions for companies that received troubled asset relief program funds chaired by: Senator Ted Kaufman (D-DE).
Witnesses: Professor Kevin Murphy, the University of South Carolina’s (sic/means University of Southern California) Marshall School of Business; Professor Frederick Tung from Boston University School of Law; Rose Marie Orens, a senior partner at Compensation Advisory Partners; and Ted White, strategic advisor for Knight Vinke Asset Management and the co-chair of the International Corporate Governance Network Executives Remuneration Committee. (538 Dirksen Senate Office Building, Washington, DC. 12:21 P.M. EDT, today, 10/21/2010. FNS subscription required.)
The AP’s Cathy Bussewitz has done a very good job on a topic that I warned needed more attention. (AP Investigation: Calif. pension bonuses examined, 10/21/2010)
CalPERS’ plunging value came as stock values tumbled around the world, the state’s economy suffered its worst decline in decades and basic state services faced severe budget cuts.
Virtually all of CalPERS’ investment managers were awarded bonuses of more than $10,000 each, with several earning bonuses of more than $100,000 during the 2008-09 fiscal year. The cash awards were distributed as the fund lost $59 billion.
This makes CalPERS seem very bad. However, as the article goes on to point out, CalPERS was following normal practices at public pension plans. They’ve improved since then but could probably still use some additional reform. Maybe the AP article will result in a further reexamination of bonuses as CalPERS, other pension funds, and corporations.
CalPERS’ bonus structure suffers, to some degree, from characteristics frequently criticized in the corporate sector. Like options grants to corporate executives, CalPERS bonuses are structured with no downside risk, only upside gain. Additionally, adjustments or “clawback” provisions are needed to recoup unearned bonuses…
Additionally, it is my understanding that CalPERS annual bonuses are weighted (1 year performance counts 10%, 3 year 40%, and 5 year 50%) and that adjustments to fund valuation aren’t applied retroactively. If there is no mark-to- market accounting, staff might be getting performance bonuses based on a bubble. While the 1, 3, and 5-year bases give greater weight to long-term performance, since negative points aren’t considered, there is really no penalty for artificially spiking performance.
CalPERS should award negative points for under-performance and should subtract these from positive basis points. Payments should also be delayed to ensure performance reflects market, rather than book, value. This is especially important for real estate, alternative investment and other managers where value isn’t measured minute by minute, as it is with most equities.
Think about paying on a one or two year delay. Spread payout even more or scale it back if CalPERS is in a down cycle or the employee quits. In fact, if they quit, perhaps they should forgo their final year of performance pay. These reforms would not only better align pay with performance, they would decrease staff turnover and guard against a possible public relations nightmare.
CalPERS Board has made some changes to the compensation program to increase accountability. The new features include: the Board can defer, cut or eliminate performance awards if the fund’s fiscal year absolute return is less than zero percent, or for any other reason.
- Awards only given to staff employed by CalPERS at the time the award is to be paid, except in the case of involuntary separation without cause.
- Eligible employees must be in compliance with all regulatory requirements and ethics and conflict-of-interest policies.
- CalPERS can also require repayment of a performance award, with interest, if within three years of the payment it is discovered the employee was not entitled to the award because of a policy violation.
While these are improvements, in my opinion they still should:
- Award negative points for under-performance and subtract those from positive basis points.
- Delay payments by two years.
- Claw back based on accounting adjustments, not just policy violations.
- Substantially reduce bonuses in the case of employees who are terminated or quit.
Update: Apparently the AP article was written without taking into account new changes to bonuses at CalPERS. You can see draft documents here. They may have changed somewhat before being adopted by the Board. I only took a few brief moments to scan but still believe my recommendations are appropriate.
Robin Ferracone hits the right buttons in her new volume (Fair Pay, Fair Play: Aligning Executive Performance and Pay) when she describes how to develop of an “alignment” report that can be used by boards and shareowners to ensure executive pay will be judged as “fair.” She also interviewed the right people to work in a reasonable degree of wisdom from the perspective of shareowners. However, she falls short in glossing over high executive pay as a potential problem, a “myth.”
That’s understandable, given that she is a pay consultant. Shouting out that most CEOs are overpaid isn’t likely to win clients, since most compensation committee members still look to CEOs and other incumbent directors, not shareowners, to hold them accountable… although that may be changing. The book is clearly aimed at compensation committees but shareowners will also find the book useful, once they get past some of the contradictions in Ferracone’s analysis as an amateur sociologist and into the tools she has developed to better align pay with performance.
Warren Buffett, who doesn’t use compensation committees or consultants at Berkshire Hathaway thinks the best way to effect irresponsible board members and overpaid CEOs is to embarrass them. Nell Minow advises that stories on overcompensated CEOs loudly name all members of the compensation committee.
In contrast, Ferracone hopes that “solid and consistent analysis, not embarrassment” using her “Alignment Model” will lead corporations to “self-monitor and adjust their executive pay practices, and that voluntary reform will obviate the need for additional government intervention and allow government to go back to helping solve other problems in our society, such as issues in education and the environment.” Yes, and if companies would just take the necessary steps voluntarily, governments won’t have to mandate measures to address global climate change. We can all imagine it; but will it happen?
As a result of the recent financial crisis, many investors have seen their 401(k) plans reduced to 200½(k) plans. Those who haven’t lost their jobs and still hold some equity in their homes count themselves lucky. Ferracone’s says, “The notion that America’s wealthy people have become wealthier by virtue of seizing the wealth from others instead of creating it is just simply misguided logic.”
The rich may not have “seized” our wealth at the point of a gun, but they did largely take control of our government through false advertising… dramatically reducing their own taxes, overturning laws and regulations designed to guard against fraud and externalizing corporate costs, filling regulatory agencies with executives who believe companies will “self-monitor.” Citizens United further entrenches CEO power, since they spend company funds to install candidates friendly to their own entrenched power.
The rich now bring home the largest proportion of income since the 1920s. One out of seven Americans lives below the poverty line, while the top 2% fight to retain Bush tax cuts amounting to $700 billion over 10 years. Upward mobility in the USA is now lower than in almost all other developed economies. The only industrialized democracy with a higher concentration of wealth in the top 10% than the United States is Switzerland. (Poverty Rises as Wall Street Billionaires Whine, Huffington Post, 9/18/10; Wealth, Income, and Power by G. William Domhoff, updated August 2010)
The American Dream was based on a growing middle class and the prospect that by working hard, you could rise from log cabin birth to business tycoon or President. While the dream is still alive, myths often take time to die.
Ferracone wants to dispel myths, but she focuses her pitch at helping boards find that zone of acceptability, where pay is aligned with value delivered. High pay can still be justified, even in a “say on pay” environment.
While Ferracone’s alignment model is a surer route to justifying pay at most companies than putting up the pirate flag of Larry Ellison or hiding behind all-virtual shareowner’s meetings, such as that held by Symantec, I can’t give Ferracone a free pass as myth buster, even though her actual discussions on how to pay for performance are on target.
According to Ferracone, the vast majority of CEOs are not overpaid. Their compensation, adjusted for company size, industry, performance and inflation, has been virtually flat over the last 15 years, only increasing 1.6 times. Productivity gains alone account for all but $400,000 of the increase.
Investors agree. “About 75% of the investors surveyed by the Center On Executive Compensation in 2008 said that they had no real concerns about the levels of executive compensation in the United States.” Who are the members of the Center? They are the chief human resource officers of 300 of the large companies. They work for the CEOs! (See their comments to the SEC requesting a narrow view on Dodd-Frank) Who were the investors surveyed? They were the top twenty-five institutional U.S. equity investors. Many, like Goldman Sachs, JP Morgan, and Morgan Stanley were the same “investors” who took the financial services sector from 20% of the economy to 40% before the crash, through bets on synthetic derivatives and other nonproductive “investments.”
Even after driving the world economy to the abyss and being bailed out, the CEOs of many of these large investment firms still got huge bonuses. Ask the beneficial owners if CEOs are overpaid; you’ll get a different response. They didn’t put “say on pay” or a requirement to report pay ratios into the Dodd-Frank bill because 75% of the biggest institutional investors surveyed had no concerns. They did so because beneficial owners and average Americans are outraged.
Unfortunately, the American Dream and the personal aspirations of too many CEOs are built around the trinity of wealth, power and fame. These superficial values have become too embedded in the American consciousness. As we strive to resolve the financial crisis, we would do well to examine the need for a constructive shift in values. (See, for example, Corruptions of the American Dream: Wealth, Power and Fame by Joseph Yumang, a graduate student at Saint Mary’s College Of California). CEOs should be looking more to their mission, rather than their pay, to measure their success. Having one’s mission of dying with the most toys and money should no longer be socially acceptable.
Ferracone contends people are angry because a small percentage of companies have distributed excessive pay packages, which she rather arbitrarily defines as companies paying at the 95th percentile or higher… coupled with low performance. Yes, it is hard to argue that outlier CEOs paid anywhere from 15 to over 250 times median performance-adjusted pay deserved what they got. Does that mean those who weren’t outliers earned their pay?
No, not even according to Ferracone. Many companies say that they align pay with performance, but most don’t know whether, in fact, they’ve achieved alignment. Only 8% of variation in Performance-Adjusted CompensationTM (i.e., compensation after performance happens) is explained by variations in performance, defined as Total Shareholder Return (TSR); on the other hand, 30% of variations in Performance-Adjusted CompensationTM (PACTM) is explained by differences in company size, 11% is explained by industry, and 51% is unexplained. With only 8% explained by performance, how can Ferracone argue the vast majority of CEOs are not overpaid?
In a study Ferracone herself conducted, she found the vast majority of board directors and executives feel as though greater government intervention will not only not solve the Alignment issue, but could make matters worse. Is this supposed to be a revelation? Of course they don’t want government intervention.
Ferracone does offer some degree of balance in her Epilogue. She notes, “executive compensation should mostly be a matter that is between shareholders and the executives they employ.” Government “needs to make sure shareholders have the rights they need to appropriately influence the companies in which they are invested.”
Unfortunately, the first right she goes on to mention is the ability to buy and sell shares in a level exchange process. While that’s important, the “Wall Street Walk” encourages poor pay alignment, since if the investors who are unsatisfied walk away the more passive investors who are left are unlikely to take action regarding pay abuses.
She adds that shareowners “need to be in a position to elect board directors and vote on key proposals that affect their equity.” Good, but I would have felt better if she had inserted the word “nominate” with regard to selecting directors. Those interviewed by Ferracone for the book overwhelmingly indicated that retention is an overblown argument for increasing executive pay. Most CEOs identify strongly with their companies and generally won’t leave companies because of pay. If true, why are so many of them paid so much? Of course, the problem isn’t just incentives for CEOs. After all, traders at AIG Financial Products practically brought the entire economy down, and none were senior executives.
Ferracone’s firm, Farient Advisors LLC, is one of a growing number of pay advisers that sprung up to meet the needs of compensation committees that don’t want to be seen as conflicted by hiring the same firm that simultaneously works for management. That’s certainly a positive step in the right direction, as is Ferracone’s discussion of how to align pay and performance. Ferracone moves beyond Corporate America’s Pay Pal (NYTimes, 10/15/10) by wanting to be the shareowner’s pay pal too. If both sides converge around her Performance-Adjusted CompensationTM that would be another good move.
Yonca Ertimur, Fabrizio Ferri and Volkan Muslu offer some further hope in their paper, Shareholder Activism and CEO Pay (download pdf). They studied a sample of 134 vote-no campaigns and 1,198 non-binding shareholder proposals related to executive pay between 1997 and 2007 and found that shareholders are sophisticated enough to identify firms with excess CEO pay, both when targeting firms and when casting their votes.
Proposals that try to micromanage level or structure of CEO pay receive little or no voting support. Instead, shareholders favor proposals related to the pay setting process (e.g., subject certain compensation items to shareholder approval). These proposals are also more likely to be implemented. In some cases, compensation-related activism has a moderating effect on CEO pay levels. Firms with excess CEO pay targeted by vote-no campaigns experience a $7.3 million reduction in total CEO pay. The reduction in CEO pay is $2.3 million in firms targeted by proposals sponsored by institutional proponents and calling for greater link between pay and performance. (Hat tip to Stephen Davis for tweeting about the study.)
Perhaps the increasing power and sophistication of shareowners, combined with somewhat more neutral firms, like Farient Advisors LLC, will make the difference. Probably even more important, is the need for a shift in cultural values so that CEOs are driven by more altruistic missions than simple greed.
See also, Executive Compensation and Corporate Governance in Financial Firms: The Case for Convertible Equity-Based Pay (pdf) by Jeffrey N. Gordon, July 2010 and What’s your CEO really worth? INSEAD’s Corporate Governance Initiative creates a model, 9/22/2010.
What are the new SEC disclosure rules for executive compensation, especially the “risk” to the corporation of their compensation plans? How are companies dealing with these new rules — what do the early returns from this proxy season indicate? Are these new SEC requirements more of an annual risk assessment of compensation than disclosure rules — is any company really going to make a disclosure that its compensation policies create a risk to the entity? Will the RMG/ISS guidelines have as much, or more, impact than the SEC rules? How will these rules relate to pay for performance? Exactly what compensation programs are “unduly risky”? What mitigation practices will companies adopt? What are the “best practices” that should be considered?
Those were some of the issues taken up by panelists bright and early at 7:30 am at a monthly meeting of the Silicon Valley chapter of the NACD:
- Lon Allan, Chairman of the Silicon Valley chapter of the NACD.
- Katie Martin, Senior Partner at Wilson Sonsini Goodrich & Rosati’s Palo Alto office, where she practices corporate and securities law.
- Tom LaWer, Senior Partner at Compensia, a management consulting firm providing executive compensation advisory services.
- John Aguirre, Senior Partner at the law firm of Wilson Sonsini Goodrich & Rosati, specializing in executive compensation and employee benefits, including tax, ERISA and federal and state securities laws.
I’m certainly no expert in this area but I’m sure it was paradise for actual practitioners in the trenches. What follows are a few items that struck me as an interested observer. Although I know I got the order of panelists right, who said what is less certain. The links are to sites I think readers might find useful. I didn’t run them by the speakers for endorsement.
Katie Martin started with some discussion on changes to required disclosures. For example, directors must disclose seats held at any time during last five years. Legal proceedings: 10 year look back, rather than 5. Disclosure is expanded to include judicial proceedings relating to mail or wire fraud, violations of state securities, disciplinary sanctions.
Disclose experience, qualifications, attribute and skill that led to selection. Most are placing disclosures right below the biography. She discussed the new RiskMetrics Group Risk Indicators GRId (their new gov scoring system). The old CGQ scores will be frozen on March 17, 2010 and retired completely at the end of June 2010. Here’s an SEC FAQ for issuers.
My own impression, reinforced at the meeting, is that the SEC rules are largely non-prescriptive, whereas the substance of disclosures will mean more when graded by RMG. Verify the facts. Look at ways to improve. Use new D&O questionnaires, which ask directors to self-identify their particular experience, qualifications, attributes and sills.
Diversity considerations. Whether, if so, and how. The SEC rules include no mandates and the definition of diversity is being interpreted broadly.
Board leadership structure. Whether and why CEO and Chair are same or separate. If same, description of Lead Independent Director is critical. Review governance policies with respect to the role of lead independent director to consider whether further clarity is needed. Discuss and document the rationale for your current leadership structure.
Risk management oversight. Disclose the board’s responsibility for risk-management oversight. For example, is it the responsibility of entire board or is the function assigned to one or more committees for different categories of risk? This is a good opportunity to discuss these issues with the board and/or appropriate committees. Discussion will normally bring some changes and more formality. There is a trend toward having a separate risk management committee, not so much in the tech sector, but in larger firms.
With the new rules regarding 8-K requirements, we’re talking close to real-time disclosure, within 4 business days after meeting. File preliminary results, if final results not known.
Non-GAAP Financial Measures: Recent SEC Interpretations. Historically, restrictive approach by SEC to non-GAAP financial measures. Recent changes have not led to full blown non-GAAP report but anything that flushes out trends would be positive. SEC filings should be consistent with other public communications. If doing an offering, get comfort from auditors. (Revised SEC Interpretations Regarding Non-GAAP Financial Measures, Cooley Godward Kronish LLP, 2/26/10)
Focus on process aspects, risk and possible litigation. Don’t let your board get blind-sided.
John Aguirre – New Compensation Disclosure Rules: Policies and Practices Relating to Risk Management — Requires narrative disclosure regarding compensation policies and practices for all employees to the extent that risks arising from such policies and practices are “reasonably likely to have a material adverse effect on the company.” Reasonably likely is the same disclosure threshold used in the Management Discussion & Analysis. Whether disclosure is required is a facts and circumstances test for each company and its compensations programs (e.g., the program features and goals). Dodd bill may require comp committee to have their own attorney. Focus on process.
Risk disclosure, grants, and consultant fee disclosure… Forward-looking statements that don’t create risk.
SEC examples of practices that may have risk requiring disclosure included business unit that:
- carries a significant portion of company’s risk profile.
- has compensation structured significantly different from other units within the company.
- is significantly more profitable than other units.
- has compensation expenses as a significant percentage of unit’s revenues or compensation that varies significantly from the overall risk and reward structure of the company, such as when bonuses are awarded upon accomplishment of a task, while income and risk to company from task extend over a significantly longer period of time.
If disclosure is required, the SEC noted possible areas for discussion:
- General design philosophy and manner of implementation of compensation policies and practices for employees whose behavior is most affected by incentives created, as related to risk-taking on behalf of company.
- Risk assessment or incentive considerations, if any, in structuring compensation policies and practices in awarding and paying compensation.
- How compensations policies and practices relate to realization of risks resulting from employee actions in both short and long term, such as policies requiring clawbacks or imposing holding periods.
- Policies regarding adjustments to compensation policies and practices to address changes in risk profile. Material adjustments that have been made to compensation policies and practices as a result of changes in risk profile. Extent of monitoring of compensation policies and practices.
List of SEC’s examples is not exhaustive. SEC expects principles-based approach in the disclosure, similar to CD&A requirements. Avoid generic or boilerplate discussion. SEC does not require an affirmative statement that a company’s risks arising from its compensation policies and practices are not reasonably likely to have a Material Adverse Effect. If a company does not disclose any material adverse risks, the SEC likely will, in the course of its review, issue a comment asking the company to explain the nature of the internal analysis that was conducted in making its determination that no disclosure was required.
What should you do? Update board or comp committee on new rules. Consider whether compensation policies need updated. In addition to the examples John provided, which I expect may be referenced on the SVNACD site, here are some examples from Holme Roberts & Owen LLP.
Must disclose aggregate “grant date fair value” of awards computed in accordance with FASB ASC Topic 718. Whole value of the award, even if they may never get it. This effects who is covered in your table.
Tom LaWer – The SEC has set a very high bar for disclosure. If disclosures are made, expect disclosure of past issues along with disclosure of how the issue has been fixed. The rules provide a fresh opportunity to focus in on the risk assessment of compensation policies and practices. The examination will likely influence compensation plan design… Revising compensation programs to improve design based on issues uncovered in the risk review. You might indicate, for example, that policies are reviewed annually.
No generally accepted compensation principles. Best practice guidance is sometimes conflicting. Most guidance is conventional wisdom. Standards may evolve over time based on empirical research. SEC examples tend to focus on the issues for financial companies.
Again, RMG risk guidelines might be a more important driver than the SEC. He went over several practices that will get further scrutiny and possible mitigating factors. It is a good time to review and assess for correct goals, mix, use, and design flow. For example, did the person who was demoted still got their bonus because there was no discretion built into the compensation plan? Are you doubling up, because long-term and annual incentive plans are based on the same metrics? Tell shareowners how your actions ensured these problems don’t arise again.
Here are some handouts from a similar panel meeting of the Twin Cities Chapter of the National Association of Stock Plan Professionals and brief overviews from O’Melveny & Myers, Grant Thornton LLP , Seyfarth Shaw LLP., Jenner & Block, Dorsey & Whitney LLP, Ulmer & Berne LLP, Thomson Reuters, and TheCorporateCounsel.net. I hope readers find these links helpful. The panel did a great job on a rather technical topic and brought home in many examples how requirements might be addresses, especially by the predominately high tech companies of Silicon Valley. Also be sure to see SVNACD’s page with handouts and interviews, as well as a podcast from KPMG/NACD, New SEC Proxy Disclosure Rules for 2010: What Boards Are Doing to Prepare.
First, a precautionary note about this post. These are strictly my impressions. There is no intention here to present juicy findings with regard to any corporation, fund, individual etc. My purpose is simply to help facilitate dialogue and understanding. Keep this in mind as you read my notes, as well as the following. One of the panelists from a government agency began with the standard disclaimers about how what he said was his opinion alone and did not necessarily reflect the views of his agency. Ted Mirvis, a partner with Wachtell, Lipton, Rosen & Katz interrupted, as I recall, saying something to the effect that he not only disavows the applicability of any of his statements to his firm, he also disavows their applicability to himself. That got a laugh, but says it all. The conference was the perfect venue for throwing out ideas and seeing what sticks… what resonates with those attending. We can learn a lot from that. Of course, there were also plenty of hard facts.
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Prior to the dinner, there was a networking reception held outside the Joan B. Kroc Institute for Peace & Justice… a wonderful facility in a beautiful setting overlooking the northern part of San Diego. My little point and shoot camera can’t do the place justice. I’m sure the Forum will have much better photos on their site, perhaps on the Conference Materials page where you will find a wealth of studies, books and other resources.
Keynote: The Honorable Leo E. Strine, Jr., vice chancellor, Delaware Court of Chancery.
At the dinner to kick off Directors Forum 2010, Strine’s main point seemed to be that we can’t expect corporations to act in the long-term interest of shareowners if most investors are rewarding short-term performance. He looks at corporations as republics, rather than direct democracies. Regarding proxy access, he appears to favor the opt-in option to encourage innovation without imposing a government mandate. Shareowners who propose changes should have long-term holdings, whereas most activists hold only a short time. They should have a substantial positive interest and disclosure should be required so we know they aren’t shorting.
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. Hedge funds are turning over their shares three times a year. Active mutual funds are holding only for a year on average. At the NYSE turnover was 130% in 2008 and 250% in 2009. Owning Intel 14 times in 10 years isn’t being a long-term owner by Strine’s measure. Institutional investors have been too little concerned with risk management and utilizing leverage. Too many are focused on getting rid of takeover defenses, stock buy-backs and replacing CEOs who don’t yield the highest short-term returns. We’ve been driven to the point that 280 out of the S&P 500 spent more on stock buy-backs than on investments.
Strine ended by quickly throwing out some reform ideas to consider. I didn’t get them all down but here are a few:
- Pricing and tax to discourage short-termism.
- Build fundamental risk analysis into corporate governance measures.
- Compensation of investment managers based on the horizons of beneficiaries and beneficial owners.
- 401(k) and college plans consistent with those time horizons.
- Indexes should act and vote consistent with long-term
- Limitations on leveraging and disclosure by hedge funds
- Fixing the definition of “sophisticated investors.” Many trustees are 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.
- We need to know more about hedge funds – your positions, your voting policies, etc.
- Investors should focus less on leverage and gimmicks, more on real cash flow and perfecting business strategies. Let’s get away from checklist proposals.
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.
Welcome & Introductions from Linda Sweeney, executive director, Corporate Directors Forum; Larry Stambaugh, conference program chairman, Corporate Directors Forum. I must say, Linda, Larry, Cyndi Richson and Jim Hale have built this conference into a premier event.
Plenary Session: Shareholder Hot Topics
Moderator Cynthia L. Richson, president, Richson Consulting Group; former member, PCAOB Standing Advisory Group, former head of corporate governance, OPERS & SWIB. Panelists – Patrick S. McGurn, special counsel, RiskMetrics Group , ISS Governance Services; Jennifer Salopek, chairman, Charlotte Russe Holding, Inc. principal, ARC Business Advisors LLC; Andrew E. Shapiro, president, Lawndale Capital Management, LLC; John Wilson, director, Corporate Governance, TIAA-CREF.
Again, there was some focus by panel members of long-term vs. short. Are compliance driven measures and the use of compensation consultants driving oversized compensation? Some seem concerned that directors are more focused on compliance and in developing a plan that can be explained than they are in coming up with the best package. Also of concern, last year’s rally may lead to out-sized awards implemented last March or April.
As several others at the conference also pointed out, options are a vestige of the tax system… better to see restricted stock granted as performance targets are met. The feeling expressed by many is that the tax system shouldn’t be driving the form of C-Suite pay. There is also a tendency by a shareowner elite to focus on exit that leads many companies to underinvest in strategy, R&D, and management systems.
Shapiro sees a wave of management led buyouts on the horizon as well as activism by creditors to address over leveraged balance sheets and liquidity problems. He is buying up debt that can be converted to equity… reamortizing balance sheets. He expects this to continue for several years because of limited economic growth. Management is likely to see the light at the end of the tunnel first and will use that advanced knowledge to look for private buyout opportunities. He sees too many no-shop clauses, rights of first refusal and other deal protectors that give a control premium to management. In these situations, independent directors should seek real competition through an auction.
John Wilson was asked about how proxy access would be impacting TIAA-CREF. He responded that ideally they will have access rights and never use them. Just having that power should lead to more dialogue between shareowners and companies. They will look at each situation individually and may side with as access filer or management.
Pat McGurn said these types of contests will be management’s to lose, not to win. RiskMetrics will need to be convinced of the need for change. It will be something of a last resort, like just vote no campaigns. Many are likely to settle out before proxies are finalized, either through trade-offs or board enlargement. He also noted that out of 12,000 board candidates up for election last year, fewer than 100 didn’t get elected. Many such contests are coming at companies that don’t have majority vote requirements.
Shapiro and others pointed out the real impact of proxy access may be overblown, since not much will be saved by having a universal proxy card. Challengers will still need to campaign and that costs money. Additionally, many hedge funds won’t use it because of the change-in-control exclusion.
Asked about liquidity, Wilson said at TIAA-CREF it is driven more by economic conditions than any growing net-flow of baby boomers out of the workplace. Companies should see long-term shareowners as their allies, not those who acquire rights just before the proxy vote. Again, emphasized the need for constant communication.
Salopek said one of the advantages she has found in having a split chair is increased dialogue with shareowners. Shareowners find it more difficult to talk about concerns, such as about CEO pay, when the CEO is also the chair.
Shapiro emphasized the need for communication, citing its lack as the biggest reason for escalation by funds like his. He also sees that interaction as part of director responsibilities around “duty of care.”
Another panelist cited a university of Santa Cruz study that showed even one woman director on a corporate board led to greater board independence and better financial reports. (sorry, I did a quick search but didn’t find the study) That led to discussion around diversity and the need to apply thinking more broadly. I know that CalPERS and CalSTRS are working to build a pool of potential candidates for proxy access nominations. Diversity will play a large part in developing the list.
Shapiro gave some advice concerning annual meetings, pointing to Warrn Buffett’s practice of calling on individual committee chairs to report their respective parts of the annual report. Also some discussion around virtual meetings with Intel pulling back on their virtual-only meeting, but that web broadcast would allow many more to participate and would make them a real event that could generate a lot of publicity and positive dialogue. (see my posts on this from 1/20/10 and earlier same day)
Wilson’s final advice included papering in a day or two of engagement for directors with shareowners before the meeting. Shapiro similarly recommended calling your top 10 shareowners to hear their concerns… actually check in with several types. Keyword for the panel — communication. Further reading: Activist Shareholder Dialogue, Andrew Shapiro.
Plenary Session: Shareholder Rights AND Responsibilities
Moderator The Honorable Leo E. Strine, Jr., vice chancellor, Delaware Court of Chancery. Panelists – Theodore N. Mirvis, partner, Wachtell, Lipton, Rosen & Katz; Brandon J. Rees, deputy director, office of investment, AFL-CIO; Lynn A. Stout, professor, Corporate and Securities Law, University of California, Los Angeles School of Law; Lynn Turner, managing director, LECG; former chief accountant, SEC; trustee, AARP, Colorado PERA.
We were reminded that individuals still own about a third of all shares, mutual funds and ETFs are the next largest holders with pensions coming in third with about 20%. Turnover by all seems to be going through the roof. While it was about 150% in the early 2000s, it accelerated to 200% and last year 300%.
Among the most pressing issues this season for labor are “say on pay” and proxy access. Compensation plans aligned with long-term interests and holding. Restricted stock awards should be held for five years and preferably beyond retirement. When chasing return and trying to beat the market, active managers are likely to be little concerned with corporate governance or proxy issues. Yet, ideally these should factor into investment decisions. Labor would like to see reforms in the tax code and a very small transaction tax to discourage turnover.
Turner was largely in agreement with Rees up until that transaction tax. He sees the need for taxreforms, greater transparency and much more dialogue, as well as a heightened fiduciary duty that would include better disclosure of conflicts of interest. All funds should have to disclose votes and policies. He also sees too many funds voting for poorly performing corporate directors. As I heard this last point, I couldn’t help thinking, “Yes, but how do we know which are the poorly performing directors?” Maybe the new disclosures required by the SEC will begin to give clues.
Ted Mervis noted a 2003 Conference Board report that investment fundsshouldn’t compensate on a quarterly basis. Yet, that isn’t likely, because funds with the highest returns this year attract the most capital next year… even if there is no correlation in the performance for both years. Perhaps sharowner democracy amounts to “faith-based” corporate governance, since there is so little evidence that shareoweners are really in it for the long-term.
There was some mention that corporations are more likely to talk to activist funds than indexed funds, even though they are less permanent shareowners. I presume this is because activist funds are more likely to spend time and money analyzing the issues, whereas indexed funds, wanting to minimize expenses, may do less.
Stout said there is decades of evidence that trading eats up about 1.5% of return each year. The greater the sharowner power, the higher the issuers turnover.
Rees said he supported indexing, long-term investing, defined benefit plans, disclosure of proxy voting and a reassessment of securities lending practices and rules.
Mervis thinks too many directors may be knowing each other “by name tags” because of increased turnover and less collegiality.
Strine seemed to put forth the idea that shareowner rights aren’t inherently good. In fact, maybe we should embrace shareowner ignorance. Increasing leverage to chase returns can lead to ruin. He agreed with Stout, we need higher fiduciary standards for investors.
Stout seemed disposed to a small transaction tax and thought ERISA standards are needed to limit what funds can invest in. It is also time that companies looked at adopting bylaws limiting those who can file bylaw proposals to those without certain conflicts and derivative positions… maybe shareowners should have to hold for two years. That got a lot of attention from directors in the audience who virtually swarmed Stout at the panel’s conclusion.
For further reading see The Mythical Benefits of Shareholder Control (Stout, 2007) Fiduciary Duties for Activist Shareholders (Iman Anabtawi & Lynn Stout, 10 April 2009) Find more reading from several of the panelists on the Conference Materials page. Personally, Lynn Stout is one of my favorites. I don’t always agree with her conclusions, but she is certainly a creative and stimulating thinker.
Plenary Session: The Fast Changing Regulatory Landscape: Judicial, Congressional and Executive Developments
Moderator Theodore N. Mirvis, partner, Wachtell, Lipton, Rosen & Katz. Panelists Rhonda L. Brauer, senior managing director, corporate governance, Georgeson; Byron S. Georgiou, of counsel, Coughlin Stoia Geller Rudman & Robbins LLP, Financial Crisis Inquiry Commission member; Robert Jackson, Jr., deputy special master for executive compensation, Department of the Treasury (aka deputy “pay czar”); Frank Partnoy, George E. Barrett Professor of Law and Finance; director, University of San Diego Center for Corporate and Securities Law.
Mervis went over the pending proxy access proposal and discussed legislative push for separating board chair and CEO, push against staggered boards, mandatory risk management committees and enhanced disclosures. Some boards are getting ahead of the ball by passing their own measures granting shareowners a say on pay but limiting it to every three years.
Brauer advised boards to be ready with their own proxy access proposals.What alternative does your board want if given and opt out option. Be ready for that possibility and check with your shareowners first.
Jackson advised to look at how your compensation policies might be incentivising risk. Have a discussion before the fact with your shareowners and disclose the process you use to think about risk. Too many financial intermediaries are making decisions that extend over years but are paying bonuses based on only yearly returns.
Partnoy thinks reviewing a “worst case” scenario might be a useful exercise for most companies in developing a risk profile. Partnoy expressed his desire to see financial institutions treated differently.
Georgiou noted the Financial Crisis Inquiry Commission got an enormous volume of google searches during its first hearing. Regulators can’t keep up with innovation and need market mechanisms to enforce behavior.
One key reform might be a requirement to have underwriters hold a portion of the securities they create. They should be required to eat their own cooking, maybe also institute clawback provisions for their earnings. Capitalized gains and socialized losses doesn’t work. The issuer paid model is faulty. Even CEOs recently asserted no one should be too big to fail. Discussion around a resolution authority to take down such companies without risk to the larger economy. Problems at seven or eight firms shouldn’t be allowed to infect the whole system.
Lunch Panel: Bad Loans, Gatekeepers and Regulators – Is change on the Horizon or just a Mirage?
Moderator Lynn Turner, managing director, LECG, former chief accountant, SEC; trustee, AARP, Colorado PERA. Panelists – Charles Bowsher, former Comptroller General of the United States & Head of the GAO, director, the Financial Industry Regulatory Authority (FINRA); Kristen Jaconi, former senior policy advisor, for Domestic Finance, US Department of Treasury, former senior counsel to Michael Oxley, US House of Representatives; Barbara Roper, director, investor protection, Consumer Federation of America, member, PCAOB Standing Advisory Group.
Bowsher sees at least part of the problem stemming from traders getting essential control of several banks, like at Enron. Safe and sound banking is important to reestablish. Favors a risk regulator with real stature but is worried that legislation that is 1700 pages long fails to focus.
Roper sees the idea of an individual systemic risk regulator as a reform in name only, since they wouldn’t have the tools to do the job. They need to have the staff, tools and the authority, otherwise reform will be a mirage. See her testimony to Congress here. What we need, if anything is to be accomplished, is a fundamental shift in how we see regulation.
Jaconi says we aren’t thinking big enough. The center of arbitrage is London, not New York. We need to be thinking on the scale of the IMF. Another point she emphasized was the importance of inspections and examinations. Training inspection staff will be critical but there is little notion of that in current proposals.
The consensus of the group seemed to lean in the direction of mostly mirage with some substantive reform. The public has embraced say on pay but watered down derivative regulations appear likely to mostly miss the mark.
Plenary Session: Risk Management: Monitoring for Known and Unknown Risks Moderator James Hale, former EVP, general counsel & corporate secretary, Target Corp.; director, The Tennant Company. Panelists Heidi M. Hoard Wilson, VP, general counsel & corporate secretary, The Tennant Company; Stephen A. Karnas, director, Mars, Incorporated; Lynn Turner, managing director, LECG; former chief accountant, SEC; trustee, AARP, Colorado PERA.
Wilson discussed their extensive process at Tennant, from weekly meetings, board involvement, measuring probability and potential costs, disaster recovery plans, their ranking process, supply chains, etc. She discussed the need to pay special attention to sole source suppliers. You need to know who to turn to if they go bankrupt.
Karnas described his experience at Mars and their use of a chief risk officer primarily functioning as facilitator. Their process is top down as well as bottom up, a little different than that of their recent acquisition, Wrigley, which views risk primarily from a centralized perspective. He discussed how each work and how they are likely to be integrated. Interestingly, the Mars board gets very involved, apparently traveling on a bus, during quarterly Board weeks, to their factories so they can view the production process and operations and become very familiar with risk at the core business level.
Turner discussed his approach as one of finding out keeps them up at night. Ask your external auditor what are the top five risk areas at your company and at the competition. Ask the executives the same and note differences. What are the key trends in marketing, spending rates… key dashboard issues. How do you get to know risks that don’t get communicated? He stressed the need for a bottom up process, as well as top down.
The consensus of the group was that risk is an issue that should be addressed by the full board, not shuffled off to an individual committee… although it may be important for the board to get input from multiple committees.
Plenary Session: A Compensation Committee in Action (A Socratic Dialogue)
Moderator Larry Stambaugh, chairman & CEO, Cryoport, Inc., principal, Apercu Consulting. Panelists – James Hale, former EVP, general counsel & corporate secretary, Target Corp., director, The Tennant Company; Garry Ridge, president & CEO, WD-40 Company; Anne Sheehan, Director of Corporate Governance at CalSTRS; Matthew T. Stinner, senior managing director, Pearl Meyer & Partners.
This was an interesting play-like exercise that was so much fun, I failed to take notes. However, I do recall the pretend CEO using that famous line, “It depends on what the meaning of the word ‘is’ is,” in response to a question from the compensation committee. It was a good discussion of the factors of what goes into pay for performance and the importance of what gets left out that isn’t recognized until after the fact.
Key points: Most companies don’t factor in consideration of performance relative to peers or even the market… and they probably should. Plans should be simple and easily understood but driving compensation based on a single metric, like net income, probably results in too narrow of a focus. Payouts should be held for 3-5 years to emphasize longer term thinking. Further reading: Compensation Committee topics on BoardMember.com and Compensation Season 2010 (Wachtell, Lipton, Rosen and Katz)(PDF).
Dinner and Keynote Speaker; John J. Castellani, president, Business Roundtable
Castellani asserted there is a cultural divide between public thinking reflected by Congress and that of business leaders that is not unlike the divide between C.P. Snow’s scientists and nonscientists. The public wants many thing from business: high quality, employment, good stewardship, earnings, shared sacrifice. They see little difference between finance and other sectors… lumping all large businesses together. Board attention is generally more concentrated on good earnings and stock performance.
Congress suffers from ignorance regarding how businesses work. They think boards are constituent based. They think boards operate like Congress does. The prevailing view is that directors are rubber stamps of CEOs. Yet, the truth is that CEOs are practically an endangered species (my term, not his)… going from a tenure of 8 1/2 years in 2006 to 4.1. He sees most of the reforms like “say on pay” and separating CEO and chair positions as a “relief valve” for American frustration with bigness and fears there will be unintended consequences.
We need to help politicians understand how businesses work. He noted that the costs and performance of the U.S. health care system have put America’s companies and workers at a significant competitive disadvantage in the global marketplace. (see Business Roundtable Health Care Value Comparability Study) People hate insurance companies and banks. They are looking for shared sacrifice. For further reading: John J. Castellani’s blog entries on the Huffington Post.
Plenary Session: Insider’s View of Surviving a Proxy Contest
Moderator Karin Eastham, director, Amylin Pharmaceuticals, Inc., Illumina, Inc., Genoptix, Inc., Geron Corporation. Panelists – Daniel M. Bradbury, president & CEO, Amylin Pharmaceuticals; Daniel H. Burch, chairman, CEO & co-founder, Mackenzie Partners, Inc.; Suzanne M. Hopgood, director of board advisory services, National Association of Corporate Directors director, Acadia Trust Realty, Point Blank Solutions Inc.; James P. Melican, senior advisor, Ridgeway Partners, former chairman, PROXY Governance, Inc.; Alison S. Ressler, partner, Sullivan & Cromwell LLP
One discussion during the session was the problem that during a proxy fight, particularly in a three card proxy fight, shareowners can split their vote between cards, picking the best directors from each advocate. However, that opinion was not universal. The opposing viewpoint was that slates are good because they are more likely to result in an integrated board and directors with complimentary vetted skills.
It was a very informative session focused mostly around Amylin Pharmaceuticals, in addition to several experiences of Ms. Hopgood. Aside from three proxy cards at Amylin, the company also had three previous CEOs on their board, one as chairman. Takeaway points for me were as follows:
- Things generally go worse when the company refuses to talk. Earlier is better.
- RiskMetrics doesn’t seek to review a strategic plan from dissident slates unless they are seeking a change of control.
- Most dissident groups are giving more thought to their director candidates these days… no longer mostly relatives.
- Hire a good proxy solicitor.
- Review corporate governance practices and consider eliminating those that are unpopular with media, like shareholder rights plans (poison pills). If you are going to make changes, do it before the contest.
- Identify possible conflicts of interest all around.
- Don’t retain CEOs on the board after they leave.
- Pay close attention to board skill sets and succession planning.
- Learn what shareowners are thinking.
- Dissidents shouldn’t assume they’ll get the votes if the stock price tumbles.
Plenary Session: What is the Director’s Job Today, and How Does He or She Prepare for It?
Moderator Kenneth Daly, president & CEO, National Association of Corporate Directors. Panelists – John T. Dillon, director, Caterpillar, Inc., Kellogg, Company, DuPont; Matthew M. Orsagh, director, Capital Markets Policy, CFA Institute Centre for Financial Market Integrity; Margaret M. Foran, VP, chief governance officer & secretary, Prudential; Richard H. Koppes, director, Valeant Pharmaceuticals International, former general counsel, CalPERS.
Ken Daly explained that NACD had worked with CII, ICGN, AFL-CIO, BRT and others to develop 10 principles, which they have posted on their website and on the Conference Materials page. He urged all directors to download the principles, review them and provide NACD with feedback. The idea is to empower boards to lead the way in restoring public and investor confidence. “If we don’t act, lawmakers will do so with prescriptive rules and regulation.”
One interesting finding from a recent survey was that board members are less happy with agendas than CEO/Chairmen. Strategy is top priority for boards in the coming year. Interestingly, the conference made use of their ability to rapidly survey those in attendance regarding various topics. We simply pressed numbers on a little remote control type gadget and in seconds they displayed the results. This worked smoothly until this panel where there was one glitch. Asked if information received from management engages the board’s expertise in planning and executing strategy, the graph makes board members seem a little more satisfied than they really are, since there isn’t much difference between 51% and 49%.
Aside from the fun with numbers, I noted the following takeaway points:
- Boards want to discuss strategy before it is fully baked; strategy is job #1.
- Directors shouldn’t play the role of gotcha. Trust and respect are essential to board functioning. Dissent should be accepted.
- IT expertise and succession planning deficient on many boards.
- Balancing long and short-term strategies is key… see Aspen Principles.
- Put something in your proxy regarding succession planning.
Further reading: The New and Emerging Fiduciary Duties of Corporate Directors by Elizabeth B. Burnett and Elizabeth Gomperz.
Keynote Speaker: William A. Ackman, founder and managing partner, Pershing Square Capital Management LP. Apparently, Ackman was on a recent edition of Charlie Rose, so Frank Partnoy couldn’t resist beginning the interview as if he were Charlie Rose.
With all the talk about the need for long-term holders, that was one of the first questions. Pershing Square typically holds for about 2.5 – 3 years. Ackman described his process, which mostly involves picking stocks that are undervalued (spread between price and value) and then he works on a strategy to get the market to recognize that value.
He described his efforts at Wendys, which owned Tim Hortons. The chains weren’t really a great fit because of differences in how they operate and management styles, so he worked to get Hortons spun off… yielding a hefty profit. Ackman believes competition for board seats will give us better candidates and will cause boards to do more self-examination. Choice will force board to adopt term limits to keep fresh.
He says boards should invite their largest holders and short-sellers to discuss any issues or concerns they may have. Try your best to understand your harshest critics. You’ll probably learn something. Asked how he’d do that, he suggested issuing a press release inviting the company’s biggest critics to call in and schedule a confidential meeting.
Another case he discussed extensively was Borders, which he believes had been consistently mismanaged and is now finally facing a possible turnaround, even though the CEO that helped them regrow the company had just resigned the night before for a better offer… with no warning.
One factor that appears to keep him invested for a longer term is reputation. If he bails out too quickly with a loss, his reputation suffers more than if he keeps a company for longer but ends up making something.
Where’s the next crisis? Akman thinks it is likely to be failed municipalities.
Pre-Conference Bonus Sessions – “Legal Issues in the Year Ahead: What Directors and General Counsel Need to Know”
Session 1: “What to Expect in Regulation,” presented by Frank Partnoy, director of USD’s Center for Corporate and Securities Law.
The sun was shining outside our beautiful auditorium at the University of San Diego but Professor Partnoy’s prognostications inside the hall were gloomy with his comparisons of the current financial crisis and the Great Depression. “This is 1931,” he said, noting that markets recovered from the 1929 crash but then turned down again. Because of the recovery (like the little bear market in 1930), he doesn’t see strong demand for reform. Like then, banks say they will reform themselves. Like their Pecora Commission, our Financial Crisis Inquiry Commission is mostly political theater. Pecora didn’t even arrive at the commission remembered for him until 1933. Our efforts could be similar. If history is a guide, it will take a couple of years.
Partnoy doesn’t see real reform on the horizon until more revelations of wrongdoing. He predicts the Volker rule will be watered down and sees an absence of commonsense in the process.
Proxy access is coming but there are still some vestiges of a federal versus state law battle. Delaware incorporated companies may already adopt bylaws and many may do so to preempt the proposed federal default rules. (Elsewhere at the conference the advice was more to be ready, once we know what the rules will be.) Partnoy described the basic outline of the proposed default, with its thresholds ranging from 1, 3 and 5%, depending on size – the 25% limit on board members so nominated and the one year holding period.
Broker nonvotes won’t count this year and that has hedge fund activists excited. They don’t care much about proxy access because the new rule can’t be used for a change in control, and that’s what hedge funds seek. Derivative and credit rating reforms may be the most important reforms on the horizon for 2010. However, strong action appears unlikely. Yes, they’ll probably pass something but there won’t be a central clearing platform for the derivatives that really matter. Banks don’t like the idea of open source disclosure of all contracts, even on a lag basis.
Partnoy thinks the Fed will have to raise rates at some point and when they do, we may see derivative contracts implode. Institutional investors who actually depend on rating agencies to grade risk are being naïve or irresponsible. He cited several commonly know examples where the rating agents gave companies high marks… even as companies tumbled into bankruptcy. Perhaps on of the more important provisions will be to expose credit rating agencies to legal liability. See additional discussion at Proposed Credit Rating Reforms May Empower an Embattled Moody’s (HuffingtonPost, 1/4/2010) and Why Rating Requirements Don’t Make Sense (WSJ, 1/18/2010)
Session 2: What to Expect in Litigation, facilitated by Fran Partnoy. Panelists included Leo E. Strine, Jr., Vice Chancellor of the Delaware Court of Chancery; Darren J. Robbins, Coughlin Stoia Geller Rudman & Robins LLP; and Koji Fukumura, Cooley Godward Kronish LLP.
Initial discussion focused around the issue of individual director liability and the fact that many funds are pushing for that. They want individual directors to feel the pain, not just be covered by D&O insurance. So far, it appears that most of the money that has come out of director pockets has come from CEOs who also chair their boards. Cases were down in 2009 because the market is up. Companies have spent up to $80 million to defend two directors. Strine offered up a bit of speculative advice. Separate director’s insurance from officer’s insurance. Officers get most of the focus, often depleting the coverage available. Options backdating and earnings smoothing created a culture of corruption that led to the move by public funds to go after individual directors. See discussion at Insurance for A-Side D&O Exposures after Enron—A Riskier Proposition?, IRMI.com and Recent Developments in D&O Insurance, HLS CG&FR Bog.
There was also discussion around the fact that many disclosure only cases filed in state courts are abusive. They are filed as soon as any action happens, like an agreement to sell. Several cases discussed. Strine also cautioned to watch shortcuts regarding tax avoidance and don’t sign consents of action after the fact… like documents where management fills in the blanks later. Gimmicks are gimmicks and should be avoided. Also some discussion around a case where the company tried to sue its own internal auditors for malpractice but couldn’t.
TheCorporateCouncil.net posted a transcript of a recent Webcast on the SEC’s new Proxy Disclosure requirement. Like always, they do an excellent job of sorting out issues for those getting into the weeds.
RMG reports “The wave of new federal securities lawsuits related to the global credit crisis has finally subsided, down 7-24% depending on whose data you use. The largest category of 2009 cases were those that arose from the credit crisis. (Investors File Fewer Lawsuits in 2009, 1/6/10)
theRacetotheBottom.org has covered a raft of issues lately that are worth a read. These include: Executive Compensation at Goldman Sachs, Executive Compensation, Delaware’s Top Five Worst Shareholder Decisions of 2009 and the need for reinstating Glass-Steagall.
Bowing to pressure from shareholders of On2 Technologies, 11.5% of whom voted they share through MoxyVote.com, Google raised its offer to $132 million, up from $106.5 million. (Shazam! Google raises its offer price for On2, 2/7/10)
Study finds Private Investments in Public Equity (PIPEs) announcement returns decrease almost linearly across the first six PIPE transactions, going from positive to negative. Firms that issue multiple PIPEs have high cash levels, and a majority make acquisitions. Successive PIPE transactions delay accessing of public markets while keeping institutional ownership low. Hence, they are greeted skeptically by the market as maintaining managerial entrenchment. (Are Private Placement Announcement Returns Really Positive? On the Information Content of Repeated PIPE Offerings, Ioannis V. Floros and Travis Sapp, SSRN, 1/7/2010)
Small ESOPs, those controlling less than 5% of outstanding shares, benefit both workers and shareholders, implying positive productivity gains. However, the effects of large ESOPs on worker compensation and shareholder value are more or less neutral, suggesting little productivity gains. These differential effects appear to be due to two non-value-creating motives specific to large ESOPS: (1) Management-worker alliances to thwart hostile takeover threats and (2) To substitute wages with ESOP shares by cash constrained firms. Worker compensation increases when firms under takeover threats adopt large ESOPs, but only if the firm operates in a non-competitive industry. (“Employee Capitalism or Corporate Socialism? Broad-Based Employee Stock Ownership”, Kim and Ouimet, SSRN, 12/1/09)
The conference opened with a great dinner and a fascinating keynote speech by Jim Chanos, founder and managing partner of Kynikos Associates, the world’s biggest short-seller. In introducing him, conference co-host Larry Stambaugh proudly held up a copy of the Financial Times from two days earlier that had Chanos’ picture not only above the fold but above the headlines. (View from the Top, 1/26/09) In the FT interview Chanos said of the banks, "there is still a lot of damage on these balance sheets that has not come out." Asked if America’s financial shift is moving from New York to Washington, he said, "power is beginning to shift… anyone who doesn’t see that is kidding themselves." He thinks the next target for regulation is likely to be private equity funds.
Short positions represent only a small portion of hedge fund activity, according to Chanos. Take out 3-6% being arbitraged and that leaves only about 0.5-1% of pure shorts. Although short-sellers are often viewed as "skunks at the garden party," "we’re not your enemy." In fact, short sellers are needed for efficient markets. He told of the case of three Irish banks that lost 40% of their value and had to be nationalized when short-sellers were required to disclosure their positions.
Short sellers are "real-time financial accountants," whereas the SEC reviews are more like "archeology." He advised that when short-sellers attack, directors should ask their CEO or CFO why. If they don’t know, they’d better find out, because they are usually doing so based on real evidence of problems. He questioned why the SEC has so few staff with real world experience, suggesting that at least one commissioner should be someone with trading desk experience. He thought it was a good time to short the rating agencies and questioned how senior executives of Wall Street banks could be so clueless. Perhaps they weren’t, because many were shorting their peers.
Chanos sees that any company still distributing analog products is likely to be in trouble, given the marginal costs of distribution over the Internet. Expect a shakeout of firms as the giants go digital. On a more global scale, he seems to be shorting Mexico, seeing a crisis coming. He covered an enormous amount of ground and took lots of questions. No, he’s never been called by a director to find out why he is shorting a company. Ask your CEO or CFO. He’s usually found some accounting issues that show bad judgment.
Everyone I talked to learned a lot from Chanos. He wasn’t a "skunk at the party" at all, at least not at Directors Forum 2009. Those of you who were unable to attend might glean the much of essential message from Short Sellers Keep the Market Honest. (WSJ, 9/22/09) Of course, you’ll have missed a great deal of wit and charm. See also, IIROC releases two studies on marketplace trends related to short sales.
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Cynthia Richson moderated the first panel of the Forum’s program on the topic "Shareholder Hot Topics." Richson co-founded the Directors Forum and has been a dynamic figure in corporate governance well before creating the Directors’s Summit for the State of Wisconsin Investment Board, which the Forum used as something of a model. Panelists were among the most distinguished in the field: Richard Ferlauto, Peggy Foran, Mike McCauley and Pat McGurn. The auditorium was modern and comfortable. (right) Here, I’m not going to report individual comments either here or as I discuss other panels, since that could stifle frank debate at future Forums.
Needless to say, there was a lot of speculation concerning the role the Federal government will take at financial companies coming under the TARP. Shareowners will be taking a laser light to executive compensation, especially repricing. There are expectations that holding periods will extend beyond tenure. Investors expect stronger succession planning. Compensation should be built around developing and meeting strategic plans and leadership expectations.
Shareowners will be more proactive. Corporations should talk to their major investors before taking controversial actions. Companies expect investors to talk with them before submitting resolutions. Panelists expressed concern over both short-term shareowners and CEOs. They briefly discussed recommendations of the Group of Thirty, the Aspen Institute’s Principles, the shift to independent chairs, and many other issues. One colorful bit of advice that I think all would agree with came from Pat McGurn. "Engagement is critical. Don’t get in a defensive fetal position."
John Wilcox, Chairman of Sodali, previously with TIAA-CREF and Georgenson, moderated the panel, "Do You Know Who Your Shareholders Are? The Changing Face of Activism." Distinguished panelists included William Ackman, Brian Breheny, John Olson and Frank Partnoy. Short-selling was again discussed, including the issues of disclosure, share lending, voting by short-sellers, etc. Readers might want to review ICGN’s best practices from 2007.
Another topic discussed was the fact that so many investors are short-term holders, rather than long-term owners. Panelists appeared to agree that companies shouldn’t take action to placate shareowners by generating short-term gains that would impair long-term value. However, they couldn’t agree on requiring something like a one year holding period before being eligible to vote.
Again, it was another far-ranging discussion about disclosures, the need to create forward looking risk models, the problem of real property prohibitions against foreign ownership above 5%, the desire of shareowners to be able to talk with their elected representatives (directors), the use of Reg FD as an improper excuse not to engage (see interpretive release), and much more.
The final Monday morning session was on "The Future of Corporate Governance: the Next Five Years?" Henry duPont Ridgely, Steven A. Rosenblum, Richard Ferlauto, and Sara Teslik were moderated by James Hale. (picture on right) Again, lots of disagreement among this group. However, they all appeared to agree that technology is leveling the playing field. Just as it helped Obama win office, it is changing the way corporate governance is pursued.
Another development that could have lasting impact is the Delaware Supreme Court’s agreement to accept questions certified to it by the SEC. The first questions involved AFSCME’s proposal to CA, Inc. The Court knocked that decision out in twenty days. There was general agreement that dialogue is needed but disagreement as to how big of a stick shareowners need to get into the conversation. Majority vote provisions for director elections have been tremendously effective. Future actions may focus more on directors, rather than symptomatic issues that are often addressed in shareowner resolutions. When shareowners can speak with one voice, that facilitates agreements.
Directors need to focus on process with regard to risk. Bad outcomes don’t equal bad faith but bad documentation can certainly lead to trouble. There was a good discussion around split chair/CEO movement, including mention of Millstein’s recent attention to the topic. Yet, when the chair wants to actually be the CEO, the split might not work as well.
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Almost on cue, the keynote speaker for lunch, Rex D. Adams, discussed their transition to separating out the role of chairman. At that time Invesco was a UK company and the idea was pushed by investor groups, such as the Association of British Insurers. Invesco kept the structure when the moved to a New York Stock Exchange listing but is now reexamining their position. He acknowledged good arguments that a single position strengthens the focus of accountability on one person and ensures against distraction. However, he thinks the split provides greater transparency with respect to roles and puts the board in a better position to evaluate the CEO and management team. As chairman, he sets the board agenda and governs allocation of the board’s time but does so in close collaboration with the CEO. There were several questions from the audience and Adams did a good job of detailing his experience with split roles.
The afternoon broke into concurrent sessions. I missed "IFRS: Sound Principles — Or More Room for Manipulation?" Here’s a recent update from Business Finance – Regulatory Strategy 2009: What to Watch Right Now. Instead, I opted for the more popular, "Compensation: Pay Practices Under Fire, with panelists Karin Eastham, Charles Elson (left), JoAnn Lublin, Robert McCormick, and Anne Sheehan, moderated by David Swinford. Much of the discussion centered around repricing options, most of which are currently underwater. Movement now is to rethink the base vs bonus with more emphasis on restricted shares.
Directors were warned to tread carefully. Investors have a sense of betrayal and compensation packages may be the best place to regain trust… or lose it altogether. A good explanation goes a long way. I heard it in the panel and elsewhere that more investors are focusing on pay equity within the enterprise. Does the comp committee even look at it? Too often, CEO pay is driven totally by comparisons with other companies with no look within the organization. Employees won’t be motivated if CEO pay gets too far out of alignment. Few boards appear to be cutting back on board pay… maybe because directors are putting in so much more time and effort.
Of course, CEO pay remains the hot button issue and Forum panelists are in the news commenting. "This is different. The arguments against curbs don’t make sense any longer. My friends will bring up the issue even before I do. Opinion has been galvanized," said Robert McCormick. (CEO pay cuts: Not just for banks, CNNMoney.com, 2/4/09)
I then missed "Risk Assessment: Questions Directors SHOULD be Asking." Here are materials on that subject from Deloitte. Instead, I attended a session on "Corporate Governance "Lite" for Smaller Companies." The panel consisted of Janet Dolan, Gregory P. Hanson, William McGinis and Deborah Rieman, moderated by Scott Stanton. Panelist discussed some issues common to small companies, like too often trying to rely on board members as adjunct staff experts. Again, there was discussion of split chair/CEO positions and at what stage that transition might take place. They discussed SOX, the fact that small companies have thin or no coverage from analysts and their stock price is more vulnerable to attack on shareholder bulletin boards. The most fascinating discussion for me was of founders who don’t want to let go of the reins. What made it even more so, was discussion from audience members in that position.
That evening at dinner, we heard from New York Times columnist Joe Nocera. His speech was short and highly entertaining. He took a lot of questions from the audience on wide-ranging topics from the "great unwinding" that would have happened if Bush had been successful in privatizing Social Security, to the likelihood of credit card debt forming the next crater. One thing he was definitely sure of, each generation discovers its own cycle of "fear and greed." The cycles seem to be accelerating.
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Former SEC Chairman Christopher Cox (right) made a plea for an "exit strategy" from government ownership and involvement. The speech was very similar to one he delivered to a joint meeting of the Exchequer Club and Women in Housing and Finance last December. He spent some time on how we got into the mess, explained the economy goes through cycles and although he did not discount the need for intervention, his main message was that we shouldn’t conflate the role of market regulator with market actor. He said Congress does two things well, "nothing and overreacting."
Interestingly, he made no mention of reinstating the leverage limits the SEC removed on 2004 under William Donaldson. For years, financial institutions could lend 12 for every 1 dollar they held in reserve. "Using computerized models, the SEC, under its new Consolidated Supervised Entities program, allowed the broker dealers to increase their debt-to-net-capital ratios, sometimes, as in the case of Merrill Lynch, to as high as 40-to-1." (Ex-SEC Official Blames Agency for Blow-Up of Broker-Dealers, New York Sun, 9/18/08)
The 2004 decision gave the SEC authority to review the banks’ increasingly risky investments in mortgage-related securities but the program was a low priority for Cox. Seven staff, without a director, were assigned to examine the companies, with assets more than $4 trillion. As of September 2008, "the office had not completed a single inspection since it was reshuffled by Cox more than a year and a half ago." "The commission’s decision to effectively outsource its oversight to the companies themselves fit squarely in the broader Washington culture of the past eight years under President George W. Bush" according to U.S. regulator’s 2004 rule let banks pile up new debt, International Herald Tribune, 10/3/08.
Bill George was next up. He’s the type of inspirational leader conferences often put at the beginning to fire up those in attendance, but it works just as well to end on a high note. The themes of his advice to directors have broad appeal:
- Board independence is critical. Executive sessions were the most important thing to come out of SOX.
- Board composition should reflect their customer base — a diversity of life experiences and thought. Strongly favors self-evaluations and a mechanism to ensure directors rotate off.
- The form of board leadership isn’t so important — it doesn’t guarantee results.
- Time and commitment are important. He also favors totaling the location of board meetings for context/access.
- Board chemistry is important and is often improved by offsites or other informal occasions that result in honest conversations and straight talk about values and strategy.
- Increase interactions with management, not just the CEO. The company’s future may depend on it.
- On executive compensation, look internally as well for equity issues. How is pay for performance viewed from the inside?
- Ensure the corporation’s reputation through transparency. Employees should hear it from the company first, not the newspaper.
- Maximizing short-term shareholder value will destroy the company — focus on the next 10 years. Don’t forecast earnings — let the analysts do that.
- Remember that government charters companies to do something of value. Ensure you a fulfilling society’s mission and instill values in those coming up. People are not just motivated by money. Search for meaning and significance, being part of something special.
Continuing the theme of ending with a bang, the last panel of the Forum was "Selecting & Training Directors — the Role of the Governance/Nominating Committee." The moderator was Richard Koppes. Panelists were Bonnie Hill, James Melican and Kristina Veaco. Whereas some might argue that Christopher Cox spoke too long and left too little time for questions, that certainly wasn’t the case here. The audience had every opportunity to ask for advice on issues that concerned them. Hill spoke on lawsuits, risk issues and culture… much around how Home Depot had learned its lessons the hard way with shareowners. Melican talked about working with clients, such as CalPERS, about the needs of a particular board. With proxy access coming, proxy advisors may be placed in such a role on a more routine basis. Veaco got right into the grit of reference binders, policies, contracts, charters, etc., emphasizing the need for new director orientation and the benefits of being assigned a mentor. Plan ahead and get items on an annual calendar… two to three years ahead. Now that’s planning!
They talked about the importance of resources, like The Corporate Library, the Society of Corporate Secretaries and Governance Professionals, and Stanford Directors College. Hill (pictured at right) spoke of the importance of getting to know the directors before you join a board and the need for boards to think ahead, keeping a reserve of potential directors in the pipeline. She stressed the importance of peer evaluations… and the need to shred the written component. Melican suggested evaluations should be conducted by a third party rather than in-house staff. Veaco preferred evaluations have a written component as well as an oral interview and that the most sensitive questions/answers would occur orally, but that in any event the questionnaires would not be kept and only summaries of the results would be provided.
Hill advised shareowners they don’t have to submit a proposal before getting a hearing. Have the conversation prior to submitting proposals. Veaco seconded that, saying discussions should go on all year, not just during proxy season. Corporate secretaries should be reaching out to top shareowners.
Hill spoke of the increased time commitment directors are making and the use of conference calls and tools like BoardVantage. Again, split chair and CEO came up as a topic as it did so often at this year’s Forum. Hill described their use of a lead director at Home Depot. Pay was also touched on again. Home Depot has moved away from a per meeting charge, using a flat retainer. Veaco said in her experience directors are paid meeting fees, even when they are called on to attend a large number of meetings, and the amount is the same for telephonic as for in-person meetings, but companies can handle this differently. Melican stressed the need to look beyond compensation to what shareowners might view as perks. This is not the time for junkets in Paris or to line up the limousines. Look at your charitable contribution match. Think of eliminating meeting fees and address the issues before they hit the press. (see also Nominating/Governance Committee Roundtable)
Of course, much of the essence of the Forum were the encounters that happened outside the formal conference. The beautiful setting, wonderful food, small number of participants to speakers, the high quality of both, and the importance and timeliness of the topics all contributed to a very successful program. I’m sure Linda Sweeney has already begun planning Directors Forum 2010.
This year’s steering committee did a great job. Three cheers to each of the following:
|Larry G. Stambaugh||Cynthia L. Richson||James Hale|
|Linda Sweeney||Annalisa Barrett||David Bergheim|
|Bruce Doyle, III, Ph.D.||Karin Eastham||C. Hugh Friedman|
|Deborah Jondall||Garry Ridge||David Salisbury|
|John C. Stiska||Bill Trumpfheller|
Comments From Attendees
Putting Jim Chanos on the agenda on the first evening was absolutely brilliant. The theme of the meeting was the focus on shareholders. Many of us, including me, had never heard a talk by a short seller! Bill George was very inspirational and a wonderful way to top off the meeting. — Julia Brown, Targacept, Inc.
It’s always useful to understand what the latest issues are from a shareholder’s (or shareholder activists’) point of view. That helps us as management to be mindful of those as we make decisions and communicate with the shareholders. And, the exchange of ideas with other attendees was invaluable in helping improve our own companies’ performance on an ongoing basis. — Bruce Crair, Local.com
The planning and organization of the event left nothing to chance making it an outstanding experience. The Forum brought together people with diverse thinking and backgrounds but all dedicated to improving corporate governance throughout the United States. I was proud to attend and be part of the conference. — Richard A. Collato, YMCA of San Diego County; Director Sempra Energy, WD40, Pepperball Technologies and Project Design Consultants
The highlight for me was Bill George’s presentation – concise, insightful and practical. — John F Coyne, Western Digital Corporation
It was the best one yet – I really enjoyed listening to all the speakers — Lynn Turner, former SEC chief accountant
The conversational format, close to the audience, was much better than the usual sitting up high on a stage all lined up on a panel — Kristina Veaco, Veaco Group
My second Director’s Forum – again this year, very worthwhile. — Lou Peoples, Northwestern Corp.
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Pre-Conference Bonus Session
Even before Directors Forum 2009 began, there was a very worthwhile "Pre-Conference Bonus Session," entitled The Latest Research in Corporate Governance, presented by the Corporate Governance Institute at San Diego State University. There were two concurrent sessions. I attended Management and Law reviews. Therefore, I missed Finance and Accounting. All bibliographies and presentations are available on the CGI’s Post Conference Materials page.
Lori Ryan did a great job of touching on some of the highlights of studies published in 2008 on "management" topics. Following are a few of the many findings that struck me.
- The strength of a director’s identification with being a CEO will have a positive relationship with resource provision, but a negative relationship with monitoring. The strength of a director’s identification with shareholders will have a positive relationship with resource provision and monitoring. (Directors’ Multiple Identities, Identification, and Board Monitoring and Resource Provision by Amy J. Hillman, Gavin Nicholson, Christine Shropshire)
- After a large spike in likelihood of taking a board seat in year 1, it drops significantly (deterioration). Former officials better take one of those offers quick, before their currency expires. (Former Government Officials as Outside Directors by Lester, Hillman, Zardkoohi, and Cannella)
- Firms linked to fraudulent firms lost an average 1% of market value within 2 days of fraud allegation announcement, $49B overall. Penalties diminished when the linked firm exhibited certain "effective" corporate governance structures (e.g., heavily independent board, inside director ownership) (Director Interlocks and Spillover Effects of Reputational Penalties from Financial Reporting Fraud by Eugene Kang)
- Fewer women sit on boards in countries with long traditions of female elected political officials. (Female Presence on Corporate Boards)
- While the mere presence of women on boards does not increase firm value, greater gender diversity does (Gender Diversity in the Boardroom and Firm Financial Performance).
- CEOs’ ingratiation and persuasion tactics toward institutional fund managers reduce the effect of institutional ownership on specific changes in board structure and composition, CEO compensation, and corporate strategy that are believed to compromise management’s interests. (The Pacification of Institutional Investors)
- Executives ward off stock downgrades by currying favor with analysts that cover their companies. The greater the earnings shortfall, the more favors. Analysts who downgrade a stock receive significantly fewer favors thereafter. Even analysts who see a fellow analyst receive reduced favors from a firm are less likely to downgrade that firm. (Sociopolitical Dynamics in Relations Between Top Managers and Security Analysts)
- Advice seeking by CEOs increases with CEOs’ stock ownership and performance-contingent compensation, and with board monitoring. (Getting Them to Think Outside the Circle)
- CEOs are more likely to manipulate firm earnings when they have more out-of-the-money options or lower stock ownership, and when firm performance is low. (CEOs on the Edge: Earnings Manipulation and Stock-Based Incentive Misalignment)
- Firm-specific downside risk is strongly correlated with CEOs’ stock divestitures and their magnitude. (Too Risky to Hold? The Effect of Downside Risk, Accumulated Equity Wealth, and Firm Performance on CEO Equity Reduction)
- Only a firm’s largest institutional holder is perceived as having an information advantage, based on an increased buy/ask spread. The greater the percentage of shares held by the largest institutional investor, the greater the perceived information advantage. (Information Advantages of Large Institutional Owners)
- Increases in the size of portfolio holdings, number of portfolio blockholdings, portfolio turnover, and the importance of a particular holding reduce monitoring effectiveness. (Institutional Ownership and Monitoring Effectiveness: It’s Not Just How Much but What Else You Own)
- Firms with outsider-dominated (80%+) boards are more likely to enact shareowner resolutions that pass, as are smaller outsider-dominated boards and larger non-outsider-dominated boards. High levels of CEO ownership reduce the likelihood of enactment. (The Ethical Implications of Ignoring Shareholder Directives to Remove Antitakeover Provisions)
- Commercial ratings are not linked to firm performance. Commercial ratings are not linked to shareholder voting (or ISS voting recommendations), according to a forthcoming study by Professor Ryan.
Professor Paul Graf‘s bibliography highlighted some important recent court decisions and articles but his presentation honed in more on common threads and direction, which I find difficult to summarize. Much of his talk centered around the concept of "good faith," which can’t be indemnified. The duty to act in good faith is "intertwined" with the duty of care, but it is different. It is "shrouded in the fog of hazy jurisprudence, grounded in the duty of loyalty, but it does not involve self dealing." "It is more culpable than a breach of the duty of care—gross negligence."
Sounds a bit like a Zen koan. In Disney, failure to act in good faith is 1) where the fiduciary intentionally acts with a purpose other than that of advancing the best interests of the corporation, 2) where the fiduciary acts with the intent to violate applicable positive law, or 3) where the fiduciary intentionally fails to act in the face of a known duty to act, demonstrating a conscious disregard for his duties. The last was emphasized by Graf, who went on to quote several other attempts to surround the concept of good faith, including Nowicki’s notion that courts are focusing on bad faith, instead of defining good faith. I liked his distillation of Hill and McDonnell. "On the continuum of liability from duty of care to duty of loyalty, good faith occupies the vast middle ground." Apparently, ill defined ground.
From what I gathered, the duty of care is morphing into the duty of good faith in recent cases such as Stone v. Ritter and Ryan v. Lyondell. Plaintiff alleged the directors knew that they had a known duty to act to ensure an offer was the highest available but they chose not to act. Therefore, good faith was implicated for purposes of the motion to dismiss. What was crystal clear was the need to document "actions" taken, even if they would otherwise be viewed as non actions, since if the board "acts," its actions are reviewed under the more favorable business judgment rule.
In sessions I did not attend, David DeBoskey provided a review of 2008 in Accountancy and Nikhil Varaiya reviewed Finance. You can find their bibliographies and presentations on CGI’s Post Conference Materials page.