Corporate Governance – A New Religion?
I invited my uncle, a rabbi I deeply respect, to this event. When he saw the title of my speech –
"Corporate Governance – A New Religion?", he, in effect, said, "David, I'm impressed. I didn't know you were an
expert in religion."
I told him the truth. I had to provide a title for the invitation, and I picked it before I figured out what
I was going to say but I was told the title should appeal to a broad audience.
Which allows me to summarize my thesis today in 3 points:
One – Corporate Governance is not new.
Two – It should not be a religion; and
Three – It definitely shouldn't be dealt with in the way I picked the title for my speech.
Since Berle and Means' classic book, "The Modern Corporation and Private Property", the topic of
how corporations and their diffuse group of owners interact with directors and with managers, and other
constituencies – employees, customers, the environment - has been a focus of great attention.
Regretfully, in recent times the result has sometimes been characterized by simplistic thinking that
has not fully uncovered the complexities surrounding this topic. It is my hope that the Fischer Center will be able to
tackle these issues with the seriousness they deserve.
Let me start with a historical sketch of the way corporate governance has changed in the U.S. over
the past 75 years. This will allow us to place current concerns in a broader context and to better understand some of
the complexities involved – and I recognize that other countries, particularly in Europe and here in Israel, have other
corporate ownership settings that potentially lead to different conceptual frameworks, although they too are in flux.
Since Berle and Means published their book in the early 1930s after the breakup of some major
individual and family fortunes created during the "Robber Barons" period, and incidentally their research was funded
by the Rockefeller Foundation, the U.S. corporate world has gone through several stages. The first – the
conglomerate/managerial stage – was characterized by a disconnect of ownership from management, with
corporations led by a strong managerial class with great power and social standing. By the 1970s, we see the
aggregation of immense, diverse asset pools under corporations – hence the ITTs and Gulf + Westerns of the world,
with management feeling that the corporation was their fiefdom.
As is the case with most social phenomena, it was inevitable that the scales would be readjusted to
correct for this extreme disconnect, and the pendulum swung.
In the 80's – a combination of available liquidity through the junk bond innovation, significant
arbitrage opportunities between stock prices and the underlying value of the corporate assets – Boone Pickens
recently told me that in the early 80's a barrel of oil cost 70% less on Wall Street than in a fully producing Texas oil
field - and relatively relaxed anti-takeover regulation, led to a frenzied takeover period which resulted in the breakup
of many large industrial conglomerates. This obviously led to a great deal of consternation from management, who
were being exposed to a force with which they were unfamiliar and uncomfortable. Incidentally, it was the same for
other constituencies as well which were exposed to the fallout of highly leveraged/shareholder value-focused
takeovers, including massive layoffs and the decimation of entire communities.
It did not take long for the next pendulum swing, and by the end of the 80's some well-known
excesses gave hostile takeovers a negative reputation resulting in a crackdown by banking regulators on "easy"
money, anti-takeover legislation on the state level, federal legislation dealing with mass layoffs of employees
following a takeover, and the invention of the "poison pill" defense. The threat of the unwanted takeover – at least
from financially as opposed to strategic players – was somewhat removed as a major catalyzing force in the
relationship between stockholders and managers.
Thus, during the 90s, we see the rise of a comfortable managerial class, relatively immune from
hostile takeovers from financial players. The struggle to regulate the relationship between stockholders and
management is now focused on the rise of the institutional holder as a major player in corporate America, and we see
the rise of the highly-compensated CEO being paid and incentivized through significant option grants in a way
designed to "align" his interests with stockholders.
But I think if you were to press the "pause" button in 1999, you'd generally find a system that's
happy with itself: everybody was making money, stock prices were at an all-time high, and although GM, IBM and
American Express all replaced their CEOs, generally CEOs achieved rock star status.
The early years of this century brought a swift end to this. What happened:
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The Internet stock market bubble crashed and the telecom revolution stalled when investors realized
that page-views and unused fiber did not generate earnings.
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Enron, Worldcom, Tyco, Adelphia and, by the way outside of the U.S., Parmalat, Royal Dutch Shell and
Vivendi happened. But let's not forget that many corporate scandals occurred before the year 2000.
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Hedge funds, more activist and more concentrated investors than the general institutional investor class,
became a major marketplace force and figured out they owned more than 60% of corporate America
and had a responsibility to exercise the rights of ownership. Their size and the size of their holdings
also made it more difficult to accept the idea of simply selling if they were dissatisfied.
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Option grants and backdating as a source of management wealth emerged as a key issue, turning what
was meant to be a tool to cause convergence between the interests of executives and of stockholders
into an example of management taking advantage of its position at the expense of owners. Incidentally,
the stock option backdating problems would not have been uncovered but for academic research on
this topic of the type this center will be dedicated to.
The pendulum swung again – perhaps more sharply than before. This was a perfect storm –
phenomena that were at least somewhat unrelated to each other were lumped together and wide-ranging one-sizefits all solutions were imposed for problems that had not been thoroughly understood or studied; perhaps some didn't
even exist. I will describe this in a moment.
To appreciate the severity of this storm and put things in context – a Republican Congress and
President enacting a law like Sarbanes – Oxley would be almost akin to a Meretz controlled government introducing
Jewish law as a basis for commercial law in this country.
But first – let us not lose sight that corporate governance is really a subset of a broader issue –
what are the responsibilities of an organization or its managers when it has external constituencies? A corporation is
one of these organizations but there are many others – Universities, Hospitals, Foundations and others. In all of
these cases there are managers and constituencies, and as we all know these are critical organizations in our society.
What is the constituency of the university – its students, its teachers, its researchers, society as a whole? And if its
students are the key constituency – is it the undergraduate or its post-graduate students? These are the same type
of issues facing corporations – except that they're often easier in the case of corporations. One, there is a general
consensus that the key constituency directors and managers of corporations should focus on is its stockholders. Two,
there is a daily grading system – its stock price – which acts as a daily scorecard for managers. And, three, there is a
relatively easy way to leave the relationship – sell your stock.
None of these exist in the case of Universities, Hospitals or Foundations. Indeed a leader of a
major foundation – and foundations in the U.S. control well over half a trillion dollars in assets― said "Foundations
are one of the few institutions in society where there is no price to pay for failure".
But, the perfect storm did happen – and what is the outcome – SOX was hastily enacted, with little
or no consideration of the problems sought to be remedied, the appropriateness of the proposed fixes, and the
potential impact of using a shotgun where a sniper's rifle may have been more appropriate.
While there is no question that there were excesses in the 90's that needed to be addressed – the
"solutions" that have emerged are in many cases formulaic and rules-based – catechismic or Shulkan Aruch like and
in my view will and are leading to some unanticipated results. For example, assorted "checklists" to determine
whether a corporation has "good corporate governance" and metrics like ISS's "CGQ" ("corporate governance
quotient") which purport to scientifically score a corporation against its peers. Some of these include, and I'm reading
from ISS's 65-point scoring checklist:
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Director term limits
Limit on number of boards directors can serve on
Policy re advisor rotation
Requirement that directors offer to resign on job change
Whether former CEOs serve on the board
Mandatory retirement age
Interestingly, the sight of corporate governance rating businesses blessing a corporation's CGQ is
reminiscent of the church selling indulgences, not least because these same businesses often sell analysis to the
very same corporations they are rating.
Or directors. There is an exaggerated sense of what directors, in their multiple roles as providers
of business input and advice, monitors, reviewers of key management appointments and compensation, can achieve;
they have time constraints, lack of the same level of knowledge as management, and most importantly – as director
independence has recently become a matter of absolute faith – very little incentive to really get involved. It's
interesting that even highly motivated directors – such as those representing controlling stockholders in this country –
sometimes get it wrong as perhaps happened in the recent Bezeq situation.
Are the corporate assets and attention that have been diverted as hundreds of accountants have
been dispatched under SOX for months on end to review every piece of paper to ensure the adequacy of "internal
controls", really responsive in their scope to some of the issues that have come to light?
There also has been a massive outcry about executive compensation – there have been calls to
regulate it in absolute terms, and attempts to regulate it through the process for approval (empowered independent
compensation committees, annual disclosure running into the dozens of pages, and Congressional proposals for
shareholders to take annual advisory votes on the pay packages).
Many people – including many in the academic world - believe these are positive developments.
It's an interesting coalition – unions (spending more time focusing on executive pay than minimum wages),
academics who have made a career out of corporate governance reveling in their newfound spotlight, politicians who
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were caught in a tide of popular anger with Enron's collapse, and journalists who cannot resist a popular story about
$6,000 shower curtains or $2 million toga birthday parties on Mediterranean islands.
These are complex topics and the statistical studies that purport to show some correlation between
affirmative performance in scoring on corporate governance checklists and positive outcomes – be they higher stock
prices or lower incidences of accounting fraud – are tenuous and in many cases confuse correlation with causation.
Consider that Enron and Worldcom could have been rated as top performers under a CGQ index.
Consider, conversely, that Google and Warren Buffet's Berkshire Hathaway, probably two of the
most respected companies in the world are at the bottom of the CGQ rating.
A recent panel of research analysts clearly stated that corporate governance, or at least corporate
governance ratings and scores, aside from outlier cases, is a non-factor in their minds in deciding whether to
recommend to buy or sell a company's stock.
Moreover, the overall mantra of this governance movement – namely, returning power to the
stockholders at the expense of entrenched management – may ignore some of the fallacies of a simplistic
"stockholder constituency" model. To suggest that stockholders are a monolithic group with shared interests ignores
the practical impossibility of simultaneously serving the best interests of the diffuse group of stockholders that
populate the shareholder lists of today's corporation. Can you reconcile the interests of a widow who has held the
stock for 20 years, a hedge fund that bought a 15% interest yesterday, a stockholder who is a non taxable institution
vs. one who is taxable, a worker holding most of his retirement funds in company stock, a day trader who will likely
sell before the day is over, and a sophisticated investor who may have used derivatives to divorce the economics of
owning shares from the voting rights associated with such ownership? These are not theoretical issues.
One need look no further than recent takeover battles such as Mylan/King to see that the identity of
the stockholder constituency becomes fluid and the best interests of the stockholders is an amorphous and moving
target. In the Mylan/King transaction, Richard Perry, a hedge fund investor, engaged in complex derivative hedging
transactions in order to buy the votes associated with about 10% of Mylan's outstanding stock without exposing
himself to the economic consequences of ownership – his motive? To use his voting rights to win the Mylan vote in
favor of the acquisition of King because he held a large stake in King on which he stood to make a substantial profit if
the acquisition was completed.
What is the outcome of this type of rigid formulaic rule-setting? I believe the results could be the
same as those that result from over–oppression by a dogmatic system – emigration!
There are two types of emigration in this context.
– Going Private
– Leaving or not coming to the U.S.
The 50 largest PE firms control over $550 billion in equity capital; assuming a conservative
leverage opportunity of five times, buying power approaching $3 trillion is at their disposal. Over the last five years,
PE has been the most significant corporate phenomenon in America. And guess what – it puts an end to the
separation of ownership from management, and "agency" costs are almost gone. Companies, including Toys' R Us,
TXU, Freescale, Equity Office Properties and HCA have been acquired. Now, as we all know, people don't always
accurately portray their motivations, but it is quite telling that escaping the new tyranny of corporate governance is an
oft-cited justification for removing these companies from the public markets.
And given all the corporate governance outcry associated with excessive compensation, you'd think
that executive compensation would go down after a going-private transaction in which "agency costs" have basically
disappeared. I believe the opposite occurs, with executives of newly private companies being even more highly
compensated as ownership and management converge. Bearing in mind the risk of confusing correlation with
causation – I'd suggest to you that the inordinate, formulaic rule setting for corporate governance and executive
compensation is one of many drivers of the PE phenomenon.
It's also interesting, that these PE firms are now taking their management firms public, but doing so
in a way that does not expose the PE firms to any meaningful public stockholder control or input. Blackstone has
filed papers with the SEC to take its management company public – structured as a limited partnership, the public
stockholders' only right will be to a share of the revenue streams from Blackstone's management of its private equity
funds with virtually no governance rights to speak of.
The game has become circular. A publicly-traded corporation, owned by institutional investors,
gets acquired in a leveraged buyout by private equity firms whose passive investors, with no corporate governance
rights are often the very same institutional investors. Those same investors are at the forefront of shareholder
activism in public companies, but will be more than happy to double-down on their investments in the private equity
firms by investing in the IPOs of the management firms where they will have no meaningful monitoring or other voting
or governance right.
Another interesting outcome of this situation is the recreation of two earlier phenomena that had
seemed to disappear – the conglomerate and control of the economy being concentrated in a relatively limited group
of people. One wonders if we have returned to the "Robber Barons" period. The leading hedge fund / private equity
firms have become conglomerates and each one of them is led by one or two individuals who has amassed massive
fortunes in a short time frame. For example Cerberus – controlled basically by one or two people, controls
companies with more than $50 billion in sales with hundreds of thousands of employees, including Burger King
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restaurants, car rental companies, banks, software, forestry, construction, industrials, now Chrysler and maybe Bank
Leumi.
Another form of emigration has been the flight of foreign companies from the US capital markets
and the widely-cited decline of New York as the listing destination of choice for foreign companies seeking access to
the global capital markets. Koor and Matav have recently headed down this path.
There are those who believe that this is due to a desire to escape the costs and scrutiny of SOX
and corporate governance religionists. I'm not sure I agree its that simple.
But all of this demonstrates that there are many topics to be studied here and this Center can make
a great contribution. The data needs to be examined carefully without a dogmatic agenda; the complexity of these
situations needs to be acknowledged and the fact that the perfect is many times the enemy of the good needs to be
understood.
I happen to believe that, although rules and their effects can not be discarded, the role of norms,
principles and culture in differential outcomes, a topic that has recently been the focus of some academic attention, is
of crucial importance.
Which brings me to Bayta and Issachar Fischer. Issaschar, together with Avi and their partners,
have created one of the leading law firms of Israel, and Issachar and Batya have raised a family that represents the
best that norms, principles and culture have to offer.
Their family – Shai and his wife Sanam, Yossi and his wife Tamar and their children Oded, Ron
and Shiri. The three children of their eldest child Maya, Guy and Eyal and Vered – Avi's lovely wife are a testament
to the effect of norms, principles and culture have.
And finally – their eldest – Avi. He is obviously one of the leading business people in Israel with a
worldwide reputation. More importantly, one could not hope for a better friend; and the example he is setting by
establishing this wonderful center will hopefully serve as a model for many other Israelis who now are in a position to
give back to society from the wealth they have created.
Thank you.
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