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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.
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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.
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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