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Photograph by Benjamin Child

January 9, 2017

Below is the Corporate Governance Alliance Digest, with compliments from Eleanor Bloxham, CEO of The Value Alliance and Corporate Governance Alliance and John M. Nash, Founder and President Emeritus, National Association of Corporate Directors.


If would like to receive your own complimentary email copy going forward you may sign up here.


We’d like to begin the year by helping you to meet your new year’s resolution to read more books -- so this edition features highlights from a few books you may want to read.


Wishing you all a wonderful start to 2017!


This edition includes the following topics in the news:
I.    Short-termism and manager pay
II.  The role of investment managers: their active responsibilities
III. Comings and goings


I. Short-termism and manager pay


In 2013, former Hewlett Packard chair Ralph Whitworth was named one of 10 activist investors you should know. Quartz


Whitworth, who died last year, sparred on TV frequently with John M. Nash on a variety of governance topics.


Here is a video of Whitworth and Bloxham discussing short-termism. He assigns responsibility to boards. “Who are the shortest of short-termers?,” he asks. “Management,” he says -- because of the way they are paid.


Short-termism in the Capital Markets and Companies


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******A lightly edited excerpt from the book What They Do With Your Money by Stephen Davis, Jon Lukomnik, and David Pitt-Wilson on how to reboot capitalism (available here) discusses pay and short-termism:

“Executive compensation is … what has enabled economic ADHD to jump from investors to directors. This is not healthy for our economy. Perhaps that realization is starting to dawn on forward-thinking board leaders. Speaking to a gathering of one thousand directors, former Merck chair and CEO Raymond Gilmartin noted that "short-termism" has moved from the stock market to the boardroom because "incentive systems really emphasize this system of maximizing near-term share price" rather than "intrinsic corporate value".


The reliance on equity-linked compensation has … perverse consequence[s].


The trend toward mechanistic formulae in the remuneration of CEOs allows directors, CEOs, shareowners, and others to pretend there is a level of precision in compensation that just doesn’t exist. Every time an anomaly arises, ever more complexity is added to the remuneration package. [And] directors are able to exercise ever less judgment.


Supporters of this false precision—and they include shareowners, compensation consultants, directors, and intermediaries who advise institutional investors how to vote on compensation issues—claim that formulaic compensation is necessary to reduce subjectivity. But it doesn’t. A study by Income Data Services compared executive remuneration to company performance over the first thirteen years of this century. They found almost no relationship between the two.


In any case, trying to eliminate subjective judgment cannot be sensible, since using judgment is what directors are supposed to do. Informed discretion is supposed to be how owners, through their board representatives, exercise stewardship and oversight.


Substituting formulas for judgment has allowed board members to avoid the hard compensation decisions that real owners would make, such as rewarding a CEO who invests in new products that will pay off years later but that will depress the stock price for a few quarters, or cutting a CEO’s pay for failing to foresee a competitive challenge.


Current pay packages require CEOs and other executives to respond to markets that value trading over stewardship. Pay formulas tied to stock prices that are increasingly swayed by high-frequency traders undermine directors, the very people elected by owners to provide oversight. In effect, corporate directors are complicit in their own disempowerment.”******

At the close of 2016, the Financial Times reported that pay packages that involve paying “management via share options and other share awards [do] not necessarily boost [shareholder] returns. Indeed, in the US, enterprises which pay their CEOs less than the median of their peer group seem to [outperform]. Cheapskate companies performed 39 per cent better than their peers over the past decade, say MSCI.” Financial Times Financial Times


But what could persuade board members to pay CEOs less?


****** A lightly edited excerpt from the book Rigged by Dean Baker on how to change conscious policies to create a stronger economy (available here) discusses how board members can construct a win/win for themselves and all other stakeholders related to CEO pay.

“It is possible to envision … pay packages for directors that give them a direct incentive to limit CEO pay. Suppose that directors were given the opportunity to share half of the savings from cutting the pay of the CEO and the next four highest-paid executives, provided that the subsequent stock returns matched or exceeded those of a peer group.
This would mean that if the directors of a steel company cut the pay of their CEO by $3 million a year for a three-year period and they achieved comparable savings from the compensation packages of the next four most highly paid executives taken together, then they would be able to split a total of $9 million (half of the $18 million in savings) if the returns on the steel company’s stock at least matched those of its competitors for these three years, and a subsequent five-year period. The latter is necessary to avoid incentivizing short-term behavior.
There are many ways to design contracts that would incentivize directors to restrict CEO pay. From the standpoint of shareholders, this is the way directors should be thinking. They should constantly be asking whether it is possible to get comparable performance from the CEO and other top executives while paying less, just as management tries to minimize costs by paying ordinary workers as little as possible given their levels of productivity.”
“The run-up in CEO pay [also] has the effect of raising salaries for top executives in educational institutions, hospitals, and private charities.”
“Donors [to tax-exempt organizations] can deduct their contributions from their taxable income… A person in the top 39.6 percent income bracket saves 39.6 cents in taxes for every dollar contributed to a tax-exempt organization, money that must be made up by other taxpayers. If the contribution takes the form of a bequest in a will, the public foregoes the 40 percent estate tax that otherwise would have been collected.
In short, taxpayers are major contributors to these organizations. [Related to the salaries of] top executives of foundations and universities, the amount of the taxpayer subsidy is impressive.” ******

And the impacts matter, Baker notes. A tax subsidy of just $1 million, for example, equates to 656 “food stamp years, based on the $127 per month average food stamp benefit.”
Board members must be vigilant.


******A lightly edited excerpt from the book The Activist Director by Ira Millstein on how to secure the future of corporations (available here) discusses the importance of active directors.

“To halt backsliding corporate governance, a regress enabled by a mutated capital markets structure, where too many push their own short term agendas and imperil the growth of corporations and individual portfolios…. [and promote] agendas [that] are not in the best interest of shareholders or the economy….[we need] a new type of director – a director who recognizes the imperative need for change.


Directors, and value-driven shareholders who invest in the long-term future of the corporation, accept responsibility for selecting, retaining, and motivating management through the right incentives, and they want to, and are able to, partner with management to do what is in the best interests of the future of the corporation. That focus is missing today. I will urge that directors be chosen with the same care and diligence as is the case with choosing the CEO….
[In] the history of corporate governance in America …. A relatively simple market structure evolved to one of extraordinary complexity. More often than not, I found that boards of directors didn’t change their thinking to stay in step with the changing capital market structure. Boards have the same mindset they did decades ago, when the American economy was flourishing and there was little foreign competition. Back then, boards could remain relatively passive and entrust their managers to grow the corporation.
Today the mantra most common in corporate America is still this: ‘Boards don’t manage, they just oversee.’ Far too many directors take that hands-off approach; they check the legal compliance boxes and otherwise limit their involvement. The future of the corporation – strategy – is left to management.
This mantra must change. Some argue that change is unnecessary – that developed capital market systems, including corporations, will adjust and eventually correct themselves. I disagree. Yes, markets may self-correct, but only in the long term. In the meantime, the livelihoods of shareholders, employees, customers and so many others are at risk.”

Investors are also an important part of the governance solution.


II. The role of investment managers: their active responsibilities


Here is another video of Whitworth and Bloxham discussing Sarbanes-Oxley. He assigns responsibility for that legislation to investors.


Why Sarbanes-Oxley


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Increasingly, investors are being urged to take their responsibilities seriously.
Pension funds: In line with advances in the UK, new U.S. interpretative guidance explains that to meet their fiduciary obligations, pension funds have a positive obligation to communicate with management and vote their proxies on matters involving environmental, social and governance issues. One of the reasons cited is the impact these issues have on economic value. (This interpretation echoes the valuation principles described in the book Economic Value Management: Applications and Techniques, namely that corporate behavior vis a vis stakeholders directly impacts economic value - something that may seem obvious but is too often overlooked.) Copy of the interpretative guidance
Mutual funds: Ceres has produced a graph of the votes by mutual funds on climate change matters. In their report, Ceres notes that “Vanguard and many other mutual fund firms and investment managers – including American Funds, BlackRock, Dimensional, Fidelity and Lord Abbett – that fail to support climate resolutions have publicly stated that environmental and social issues can be material financially. They are all members of the UN’s Principles for Responsible Investment and have publicly pledged to adhere to… Principle 3 [which reads]: ‘We will seek appropriate disclosure on environmental, social and governance (ESG) issues by the entities in which we invest.’ Many of the resolutions Vanguard and others vote against request this disclosure.” View the chart here Tim Smith, Director at Walden Asset Management, writes that “Two or three years ago companies like State Street and Northern Trust voted against all climate resolutions and now they support a healthy percent of them. Walden, its clients and 30 other investors, have together filed resolutions with BlackRock, JPMorgan Chase and Bank of New York Mellon on this issue. Zevin Asset Management has continued to lead resolutions to T. Rowe Price and Franklin.” In December, Walden filed resolutions requesting a review of climate change voting practices in the Vanguard 500 Index and Vanguard Total Stock Market Index funds.


Lagniappe (pun intended): Is your company considering a stock giveaway for customers ala Domino’s and T-Moblie? If so, issues to address include potential broker conflicts of interest and federal and state legal requirements. Bloomberg/BNA, Domino’s SEC filing, T-Mobile’s SEC filing


III. Comings and goings


Business could face stiff economic winds if Social Security or Medicare are cut or if provisions of the Affordable Care Act are repealed, but Congressional rules changes have been approved that would allow swift moves to repeal provisions in the Affordable Care Act without having to specify the deficit implications, and make it easier to cut Social Security and Medicare as well. Beyond specific industry impacts (health, insurance, financials, etc.), lower - or riskier - individual net incomes could impact all firms via lower aggregate customer demand for goods and services. Businesses could also suffer due to added strains on employees or their families. CNN
Securities and Exchange Commission chair Mary Jo White is leaving her post on January 20. She was on the opposite side of President-elect Donald Trump in a contentious deposition (in a case he brought that was eventually dismissed by a judge), which revealed personal and business details about Trump. Compliance Week, Washington Post To replace her, Trump has nominated Jay Clayton, an attorney who defended Goldman Sachs and other big banks in the aftermath of the financial crisis, and worked on IPOs like Alibaba (a company that is not an exemplar of good governance). CNNMoney, New York Times
Despite a recommendation from her staff to file a civil enforcement against OneWest bank, current incoming Senator and former California attorney general Kamala Harris did not follow through to enforce the law against the bank related to “widespread misconduct” and “over a thousand legal violations” involving “violating notice and waiting period statutes, illegally backdated key documents, and effectively gamed foreclosure auctions.” The alleged illegal behavior occurred at OneWest during Treasury Secretary nominee Stephen Mnuchin’s tenure there as CEO. The Intercept, CNBC, Copy of the staff recommendation
“Exxon Mobil [gave] Ex-CEO [Secretary of State nominee Rex Tillerson a] $180 million payoff.” Wall Street Journal
Here in one place are snapshot backgrounds of many of the new federal government nominees. Marketplace
Thanks for reading.

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