Waterboard the Boards
Posted November 2008
Anyone wanting to investigate torture and misbehavior needs not travel to Guantanamo or those mysterious non-existent prisons maintained worldwide by the CIA. They only need look to the recesses of corporate boardrooms around America and watch how corporate boards do and mostly don’t protect the shareholders who are their bosses.
Corporate governance is led by the Board of Directors – the people selected by the shareholders to oversee management of companies we own. We should not be deluded by the (legal and moral) fact that these Directors work for us, the shareholders and actually expect them to behave accordingly. Since the beginning of corporations in mercantile England, Boards have always been beholden to management and have, almost as often, toadied to management interests at the expense of shareholders. No less than the 1938 edition of Security Analysis by Graham and Dodd has a rant (by the modest standards of gentlemen) about Directors failing their duty.
We’re past time for change.
What Boards Do
It was the Board of Directors that let notable felons Bernie Ebbers, Ken Lay, and the entire dot.com world create monstrous meltdowns of shareholder wealth. It is the Board of Directors that allows General Motors Rick Waggoner to continue his unusual brand of leadership while watching GM’s share price fall from the high $60 range to a couple of bucks (a running joke around Detroit these days involves the critical personal choice of buying a share of Ford instead of a cup of coffee because coffee is too expensive). It was the Board of Directors that signed compensation packages for Wachovia execs who pocketed $580 million from “change of control” clauses despite the change of control being a result of those executives destroying the company.
Boards create compensation plans for executives. Congress, in their usual misguided approach to socializing American business, wants to take on that duty with completely predicable results. Instead, Congress needs to focus on duties and responsibilities of Boards of Directors to force those guardians of shareholder wealth to do their duty properly by exercising fiduciary responsibilities the law gives them.
Fortunately, we see increasing attention being paid to this shadowy world. No less a Director than Carl Ichan has launched “United Shareholders of America”, an advocacy group for responsible Directorships (leaving the reader to form conclusions on whatever credibility Mr. Ichan may or may not have on that issue). Additionally, Jonathan Macey, a Yale law professor, has recently published Corporate Governance: Promises Made, Promises Broken (Princeton University Press), a very useful exploration of abuses and failures of Boards to meet even their basic legal requirements.
Perhaps a growing crescendo will catch the attention of our lawmakers and corporate leaders and generate a new (old) concept of governance. We doubt it but we’ll help anyway.
Legal Framework
Among the reforms of the Enron era, multiple duties were proscribed and excised from Directors, none of which were particularly necessary or effective. Congress, rather than wasting time on who flies where on what, must seriously attend to the roles of Directors, both on compensation committees and on overall governance with scalpels and sledgehammers.
The sledgehammers should come first. Limiting the types and amounts of perks, compensation and benefits given Directors needs addressing; breaking up the old boys (and now, finally, old girls) network that rewards pals of management with free air flights, golf outings, exotic vacations and other nonsense is essential to strip management of their tools to buy off Directors. One delightful review of how completely abusive managers can be in this are is Burrough and Helyar’s Barbarians at the Gate.
One effective way would be to treat 100% of these perks as taxable income to the Directors themselves (with appropriate felony charges for failure to declare and prohibitions against any corporate payment of these taxes or legal fees for defending against them, paired with a requirement that all such expenses be removed from pre-tax ordinary expenses on the P&L and add them back in after net profit – allowing shareholders to see exactly the dollar amount paid out by management to bribe Directors.
Scalpel work is more interesting but not so ritzy and surely will interest our sound-bite Congress much less. An example of scalpel work would be to term limit Directors, require the compensation committee chair to be an independent Director and further require that specific committee chair be rotated at least every couple of years with and dictate chair be held by a Director newest to the Board – how interesting that would be – or be held by a Director nominated by shareholders not representing an institutional investor.
Additional focus on how Directors are nominated is worthy as well, striving to limit the influence of management in choosing new Directors and perhaps raising the threshold for election of management nominated Directors from one-half to two-thirds or otherwise rebalancing voting systems to enhance electability of shareholder nominated Directors.
Shareholder Responsibility
Shareholders are not wallowing in this swamp blamelessly, either. A fundamental duty of shareholders is to vote their shares directly or by proxy – mind numbing and largely incomprehensible if management wishes to disenfranchise shareholders – and, as most Director nominated are complete unknowns to most shareholders, we encourage all shareholders to follow the Unicorn by voting against any and every Director nominated by management. Imperfect as it is, we believe there is value in reminding management that a few dissidents exist who assume management is serving themselves and not shareholders unless and until management proves otherwise.
For retail investors, this proxy voting is symbolic. Power of proxy is held, as always, by the institutional investors holding thousands and millions of shares. Sadly, these people rarely challenge management nominations, more rarely offer their own candidates and generally ascribe to simple minded notions that share ownership does not imply or require action on their part. While there is no legislative solution to this absentee landlord mentality, each of us can contact our respective mutual funds, 401k managers and their ilk to, at least, make some noise on the issue.
Similarly, making noise directly to the Boards is intriguing. Remember – the Board of Directors are our employees. Unicorn has never failed to receive a response (usually a form letter over a stamped signature) after writing to a Director and we do believe – strongly- that a concerted effort by retail investors to communicate directly with Directors can be a ripple growing to a wave resulting in a tsunami changing forever the practices and attitudes of Boards nationwide.
But then, as you know, we believe in Unicorns, too.
(Disclosure Notice: Unicorn Equity Analysts and/or the author(s) of this article have substantial positions in General Motors and Ford Motors)
