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We always like to think that conformity and pressure to conform is externally driven. Of course, it isn’t. The pressure is internal — a desire to fit in, to be accepted and a fear of taking on this adventure called life. Maybe it was shaped in childhood but the choice to conform is one each adult must make.

Pressure for conformity does indeed lead to lack of innovation.

Jim McRitchie at Corpgov.net has an interesting story on his website about the reluctance of boards to participate in innovative programs despite the fact that there is a feeling that something more and different would be beneficial. http://corpgov.net/wordpress/?p=2397

Paul Hodgson had an entry in May on The Corporate Library Blog on the lack of conformity in governance thinking http://blog.thecorporatelibrary.com/blog/2010/05/corporate-governance-is-like-religion.html.

Despite this, much of what companies actually do is quite uniform. See http://money.cnn.com/2010/05/25/news/companies/say_on_pay_law.fortune/ and http://money.cnn.com/2010/06/17/news/companies/banker_compensation_finreg_risky.fortune/  on pay.

The uniformity of pracitce is so pervasie that it makes new ideas all the more appealing. It’s why I applaud Bebchuk and others for thinking about new approaches even though in any particular example I may think they aren’t the right solution. http://money.cnn.com/2010/07/02/news/companies/aig_executives_compensation_debt.fortune/index.htm

I had a refreshing conversation with a director a few weeks ago who put it this way: benchmarking is anti-American — it’s the antithesis of innovation.

I agree with this sentiment and even said so when I spoke for the Best Practices Institute a couple of years ago. (So called best practices are often used by firms to “benchmark” their own actions.) I told the BPI audience much of what I described on that subject in this Digest http://www.thevaluealliance.com/PDF/CGADigest122908.pdf i.e. it is important  to innovate beyond benchmarks and so called best practice.

Benchmarking in compensation has been taken to an extreme. Last week Fortune published this article I wrote on an IRRC and Proxy Governance study. http://money.cnn.com/2010/07/15/news/companies/compensation_committees.fortune/

The study showed that quite a few compensaiton committees in their benchmarking pick outsized peers — and quite a few pay markedlly more to their own CEO than the CEOs receive in the peer group selected.

Is this the veneer of conformity? Do the boards recognize that it’s veneer?

Of course, we also often have the reverse issue — the veneer of innovation, the veneer of considering new ideas.

In this article Fortune published on Friday, I talk about the situation of Tim Leech trying to take on that veneer and the conformity he has faced. http://money.cnn.com/2010/07/16/news/economy/COSO_SEC_flaws_Sarbox.fortune/  It is an important story because it goes to the heart of what is plaguing us, mired in conventional wisdom and failing to access the talent which could provide us solutions. It is also important because it gets at some of what caused the “Great Recession”. If you are wondering “why SOX didn’t work”  – and what could make a big difference — the specifics as well as the processes that need to be fixed are told in this tale.

Still the question remains: Will the Great Recession be motivation enough?

The Value Alliance and Corporate Governance Alliance www.thevaluealliance.com

Eleanor Bloxham www.eleanorbloxham.com

Copyright 2010 The Value Alliance Company. All rights reserved. 

 

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On November 16, 2009, I sent in comments to the SEC in response to their request for comments on their strategic plan. http://www.thevaluealliance.com/PDF/sec_comments_nov2009.pdf

One section of my comments was entitled: “Issue: Conflicts in the Mission” and stated “In articulating its strategy, SEC articulation of how it intends to reconcile the competing elements in its mission statement is key. ‘The mission of the SEC is to protect investors; maintain fair, orderly, and efficient markets; and facilitate capital formation.’  How does the SEC reconcile and evaluate its responsibilities (actions or inactions) when the different elements of the mission come into conflict. For example, when facilitating capital formation conflicts with investor protection – what trumps? How does the SEC reconcile this? A pinch of this and a pinch of that?  What in other words are the governing principles?

When the SEC asks for issuer comments on the difficulty in complying with a new investor protection, the conflict between issuer requirement and investor protection comes into focus. What is not clear is how the SEC in each instance thinks strategically about how it is reconciling the different parts of its mission to the actual decision and activities it undertakes.  A similar conflict occurs when the SEC makes determinations about what may or may not be included on the proxy. How in these instances is the SEC choosing ‘protect investors’ vs. ‘maintain fair, orderly, and efficient markets’ vs. ‘facilitate capital formation’ or something else.

Clear articulation of this decision-making process would be very helpful in evaluating the SEC’s proposals and strategic objectives and in strengthening and building a bridge of trust between the SEC and the public related to its own transparency and integrity.”

In her speech to the Society of Corporate Secretaries and Governance Professionals July 9, 2010, Mary Schapiro addressed some of these issues in her remarks. “The SEC has a three-pronged mission: protecting investors; maintaining fair, orderly and efficient markets; and facilitating capital formation. Obviously, each of these mandates is intertwined with the others—investors are better protected when markets are fair and orderly; markets are more orderly and efficient when investors have access to honest brokers and accurate information; and capital formation is more efficient when markets are functioning smoothly and investors are confident.But if there were to be a conflict between, for example, investor protection and efficient markets, the debate would be settled by asking the question I have posted on the door to my office: ‘How does it help investors?’ And so, investors are the focus of our agenda.”

This statement is a step in the right direction in terms of articulation of purpose — and it  will help to flesh this out further.

What helps investors more? The definitons of “helping” and “investors” become the issue. That’s why in my November 16, 2009 comment letter, I also suggested that SEC define what the SEC means by investor and what is encompassed in protection.

“Issue: Who is Being Protected?  – In articulating its strategy, the SEC’s definition of investor is key.

One issue in the current dialogue on proxy access and other matters relates to the mission of the SEC in protecting ‘investors’. While the document, ‘The Investor’s Advocate: How the SEC Protects Investors, Maintains Market Integrity, and Facilitates Capital Formation’ provides valuable information about the mission and objectives of the SEC, it does not address the issue of whom the SEC is protecting.  This definition is critical. Are flippers and traders the subject of protection? Are retirees? Are institutional investors?  What about small versus large holders?  What is meant by protection for each kind of investor? And if the protection of the different categories of investors creates a conflict, how will the Commission resolve that conflict between the different categories?

I believe that the SEC should strive to address this vital issue in writing with clarity before providing guidance on significant issues.

For example, in the area of proxy access, by clearly articulating the meaning of the mission statement with respect to this matter and addressing the SEC’s responsibilities and protections of the different investor classes, a roadmap would be in place which would make it simpler to understand the outcome of proxy access related to: who and why them?

In this strategic plan, the issue is raised also in Outcome 2.1, the first performance metric where ‘the SEC plans to conduct a survey of financial analysts and institutional investors to elicit feedback on the quality of disclosures and the Commission’s disclosures requirements’.  This raises the clear questions of:  why them and not individual investors? Why would the input of short term financial analysts and institutional investors trump that of long term individual holders?

The Values of the SEC state that ‘the SEC treats investors … fairly’. Clarity and clear articulation of the implicit assumptions around who is ‘the investor’ i.e. the assumptions which represent the SEC’s operating model of decision-making would be very helpful in evaluating the SEC’s proposals and strategic objectives and in strengthening and building a bridge of trust between the SEC and the public related to its own transparency and integrity.

Issue: Protection  — In articulating its strategy, the SEC’s definition of ‘protection’ is key.

The Values of the SEC state that ‘the SEC treats investors … fairly’. Whom and what are investors being protected from? (This list could include bad disclosure, unfair solicitation practices, poor governance; it could also name the possible actors who might be involved.) Is it the same for every class of ‘investor’? Being explicit, here as well, will help to resolve seemingly intractable issues like proxy access more deliberately and thoughtfully. It will also help validate (or not) specific objectives in the strategic plan and the recommendations related to future disclosure requirements.”

In her speech, Mary Schapiro referred to the pending review of proxy access this way: “we will be looking at ways to improve the voting process; we will be looking at communications and shareholder participation; and we will be looking at the role of proxy advisors, among other subjects.”

To do this carefully and critically, I believe the SEC needs to carefully consider the issues of “who is to be protected” and “what protection means”.

The Value Alliance and Corporate Governance Alliance www.thevaluealliance.com

Eleanor Bloxham www.eleanorbloxham.com

Copyright 2010 The Value Alliance Company. All rights reserved. 
 

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Yesterday Fortune published this article which I had written on incentive compensation design. http://money.cnn.com/2010/07/02/news/companies/aig_executives_compensation_debt.fortune/index.htm

Later in the day I submitted comments due into the FDIC (12 CFR Part 327  RIN 3064–AD57) on their new proposed assessment scheme and I realized the two had been related. 

In the FDIC’s proposal, they stated: “The FDIC has found that debt issuer ratings, particularly for the largest institutions, do not respond quickly to an institution’s changing risk profile.”  In saying that, they had made one of the points I had made in the article, and actually it would have been quite useful to have realized they had said it and quoted them.

I believe the purpose of incentive compensation is to shape and mold behavior. If you simply wanted to retain someone and felt more money was necessary, just up the salary.

Incentives really are about creating an incentive to behave in a certain way. What is key is the impact that the incentive has on the behavior of the recipient. And that is why performance metrics are key (a point the Federal Reserve makes in their guidelines to banks).

For this reason in the article for Fortune I set out two tests that should be applied to any incentive scheme  – (1) can managers control the outcome of the measure? and (2) if they can control it, is it an outcome we really want managers focused on? If they can’t control the outcome, the purpose of having an incentive is missing. So that’s either a waste of a good incentive or a distraction — neither good. If managers can control the outcome but it isn’t a proper area of focus, why dilute their actions? Again, a waste of a good incentive and a distraction – or worse, it may cause them to take actions that are not in the best interests of the company, all shareholders and stakeholders.

The failure of incentives was clear in this last crisis. As I wrote to someone who had sent me a message about the article yesterday, my interest in the incentives is from the perspective of the behaviors of  executives and shaping that behaior in advance of the markets’ understanding/catching on to the full picture. My interest is in ensuring executives are motivated from the beginning to manage risk before markets catch on. I am interested in changing behavior as much as pay.

And as I note in the article, internal views of risk will always be more robust than what any market player without inside information can glean. In this BP article for Fortune http://money.cnn.com/2010/06/22/news/companies/bp_horizon_macondo_whistleblower.fortune/index.htm  I quoted Michael Griffin’s thoughts on reflecting on the Challenger accident – which is applicable to the financial crisis too:”When we investigate, we always find that there were people who did see the flaw, who had concerns which, had they been heard and heeded, could have averted tragedy. But in each case the necessary communication — hearing and heeding — failed to take place.” There were people who understood. They either did not speak or were not listened to.

Financial institutions manage risk and know much more about those risks than the markets ever will. If executives were paid based on properly designed risk based metrics, incentives could act in advance of the catch up markets do in understanding.  

While I have always felt strongly about these issues, I feel even more strongly post-crisis. Before the crisis and the markets had recognized what was happening, on December 6, 2006 on CNBC, I was asked about executive pay at investment banks and I questioned the huge bonuses from the standpoint that it did not seem to me that the performance results for the banks were long term sustainable. The stock price was the argument used against what I said. (Therefore I have  issues with equity based pay as my article outlines.) At the time, the CDS spreads, had someone used that argument, would have gone against me too. (They spread later according to this paper by Bolton, Mehran and Shapiro. http://www.newyorkfed.org/research/staff_reports/sr456.pdf)

I believe we need to fix incentives properly. I’d like to stop the (gravy) train before it ever leaves the station and support the aims to get bankers focused as they should be — and the behaviors aligned.

It’s a tough task. And I think regulators have a very important role in encouraging this tough work to prevent what happened from happening again. Every day I see what not doing the tough work has cost so many people and I do not like what I feel inside as I think about it.

We can do this. Happy July 4th.

The Value Alliance and Corporate Governance Alliance www.thevaluealliance.com

Eleanor Bloxham www.eleanorbloxham.com

Copyright 2010 The Value Alliance Company. All rights reserved.